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Tax Administration: Assessment of IRS' Report on Its Fiscal Year 1995 Compliance Initiatives

Published by the Government Accountability Office on 1997-08-27.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                 United States General Accounting Office

GAO              Report to the Ranking Minority Member,
                 Committee on Governmental Affairs,
                 U.S. Senate


August 1997
                 TAX
                 ADMINISTRATION
                 Assessment of IRS’
                 Report on Its Fiscal
                 Year 1995 Compliance
                 Initiatives




GAO/GGD-97-158
      United States
GAO   General Accounting Office
      Washington, D.C. 20548

      General Government Division

      B-272840

      August 27, 1997

      The Honorable John Glenn
      Ranking Minority Member
      Committee on Governmental Affairs
      United States Senate

      Dear Senator Glenn:

      As part of its fiscal year 1995 appropriation, the Internal Revenue Service
      (IRS) received $405 million to fund various compliance initiatives. That
      appropriation was intended to be the first installment of a 5-year,
      $2.025 billion project, and IRS agreed to report quarterly to Congress on the
      progress of the initiatives. However, the initiatives were terminated after
      the first year.1 Thus, the report covering fiscal year 1995 (hereafter called
      the “Compliance Initiatives Report”) became the final report.2

      IRS originally estimated that the compliance initiatives would generate $9.2
      billion in additional enforcement revenue over 5 years, with $331 million
      projected for fiscal year 1995.3 The initiatives were funded on the basis of
      this estimate, which is referred to in the Compliance Initiatives Report as
      IRS’ “commitment.” Before the start of fiscal year 1995, IRS revised that
      estimate after altering its initiatives’ staffing plans. The revised estimate
      showed a projected return on investment of $9.6 billion in 5 years, with
      $728.3 million coming in fiscal year 1995.4




      1
       The administration’s budget request for fiscal year 1996 included about $4.5 billion for tax law
      enforcement, which was to fund, among other things, the second year of the compliance initiatives.
      When Congress reduced that request to about $4.1 billion, IRS terminated the initiatives.
      2
       IRS FY 1995 Compliance Initiative Final Report (Document 9389, Jan. 1996).
      3
       IRS expected the first year’s revenue to be relatively small because of the amount of time and cost
      involved in hiring and training new staff.

      As used in the Compliance Initiatives Report and in this report, “enforcement revenue” includes the
      direct revenue resulting from enforcement actions, such as audits, delinquent return investigations, or
      efforts to collect delinquent tax debts. According to an IRS official, “enforcement revenue” does not
      include any revenue that might result indirectly from those enforcement actions, such as might occur
      if voluntary compliance increased as a result of an increase in IRS’ enforcement presence.
      4
       Although IRS reestimated the revenues to be generated by the compliance initiatives, it did not show
      the revised estimate in the Compliance Initiatives Report. Instead, the report compares the results of
      the initiatives with IRS’ commitment of $331 million.



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                   In response to concerns we had raised in reports on compliance initiatives
                   funded in years before fiscal year 1995,5 IRS developed a new methodology
                   to estimate the results of the fiscal year 1995 compliance initiatives, as
                   reported in the Compliance Initiatives Report. Under the new
                   methodology, which is discussed in more detail later in this report, IRS
                   starts with total enforcement revenue taken from the Enforcement
                   Revenue Information System (ERIS). That system, which was designed to
                   track actual enforcement results in terms of revenue collected, showed
                   total enforcement revenues of $31,431.3 million in fiscal year 1995. IRS then
                   used a formula to allocate the total revenue from ERIS between already
                   existing (or “base”) enforcement programs and new compliance initiatives.
                   Using the formula, IRS estimated that its base enforcement programs had
                   generated $30,628.0 million in fiscal year 1995 and that the fiscal year 1995
                   initiatives had generated another $803.3 million in additional enforcement
                   revenue that year.

                   This report responds to your request that we review the Compliance
                   Initiatives Report. Specifically, we (1) assessed the methodology IRS used
                   to allocate staff years and revenues between the base enforcement
                   programs and the compliance initiatives and (2) identified certain caveats
                   to consider in interpreting IRS’ reported results. As agreed with your office,
                   this report does not discuss the reliability of ERIS, which was the source of
                   revenue data in the Compliance Initiatives Report.6 The reliability of ERIS is
                   the subject of another assignment currently under way.


                   IRScould not compile actual revenue results from the fiscal year 1995
Results in Brief   compliance initiatives because ERIS only provides information on the total
                   amount of revenue collected as a result of enforcement activities and
                   because other systems, such as those that track IRS staffing, also do not
                   account separately for base enforcement activities and initiative activities.
                   Therefore, IRS developed a new methodology to allocate fiscal year 1995
                   enforcement revenues between base programs and the initiatives. That


                   5
                    See Tax Administration: IRS’ Implementation of the 1987 Revenue Initiative (GAO/GGD-88-16, Dec. 2,
                   1987); Tax Administration: Difficulties in Accurately Estimating Tax Examination Yield
                   (GAO/GGD-88-119, Aug. 8, 1988); Tax Administration: IRS Needs More Reliable Information on
                   Enforcement Revenues (GAO/GGD-90-85, June 20, 1990); Tax Administration: IRS’ Improved Estimates
                   of Tax Examination Yield Need to Be Refined (GAO/GGD-90-119, Sept. 5, 1990); Tax Administration:
                   IRS’ Implementation of Certain Compliance Initiatives (GAO/GGD-92-45FS, Jan. 30, 1992); Tax
                   Administration: Congress Needs More Information on Compliance Initiative Results
                   (GAO/GGD-92-118, July 31, 1992).
                   6
                    ERIS is an automated database that tracks enforcement cases across functional lines from initial
                   enforcement action (such as an audit) to resolution (such as collection or abatement).



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              methodology represented a significant improvement over past
              methodologies.

              IRS’new methodology (1) accounted for the opportunity costs associated
              with moving experienced staff off-line to train new staff; (2) provided that
              no staff or revenue would be allocated to the initiatives until planned
              staffing for base programs had been achieved; and (3) improved the
              Compliance Initiatives Report’s usefulness to Congress by including total
              staffing and total revenue for the various enforcement programs, allocated
              between base and initiatives, along with explanations for variances
              between the results anticipated when the initiatives were approved and
              the estimated final results.

              Although the methodology used for the fiscal year 1995 initiatives is an
              improvement over previous methodologies, the results of that
              methodology are estimates that are sensitive to assumptions embedded in
              the methodology about the productivity of new staff and more
              experienced staff.7 Those assumptions were based on the judgments of IRS
              managers rather than empirical data. We do not know what the correct
              assumptions are, but our sensitivity analyses showed that a change in
              productivity rates could have a significant effect on the reported results.

              In considering IRS’ estimates of the fiscal year 1995 compliance initiatives,
              there are two other caveats that are relevant. First, the fact that the
              initiatives generated a certain amount of revenue in fiscal year 1995 does
              not necessarily mean that IRS collected more enforcement revenue in fiscal
              year 1995 than it did in fiscal year 1994 but only that IRS collected more
              enforcement revenue in fiscal year 1995 than it had estimated it would
              collect without the initiatives. In fact, the amount of enforcement revenue
              IRS reported collecting in fiscal year 1995 was less than that reported for
              fiscal year 1994. Second, because the estimates of revenue attributable to
              the compliance initiatives depended on various assumptions, including
              how IRS decided to allocate staff, the results in fiscal year 1995 are not
              necessarily indicative of what other compliance initiatives would generate
              in their first year.


              To assess IRS’ methodology, we
Scope and
Methodology

              7
               Productivity is defined as the amount of dollars collected per staff year.



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                       •   discussed the methodology with officials in the Financial Analysis Division
                           of the Office of the Chief Financial Officer, which was the division
                           responsible for preparing the Compliance Initiatives Report;
                       •   determined the extent to which IRS’ methodology addressed the concerns
                           we had raised in reports on prior years’ compliance initiatives;
                       •   discussed specific assumptions in IRS’ methodology with cognizant staff in
                           IRS’ enforcement functions;
                       •   assessed the sensitivity of IRS’ results to changes in certain key
                           assumptions; and
                       •   verified the accuracy of IRS’ computations.

                           IRS computed the results of the fiscal year 1995 initiatives using data on
                           planned and actual full-time-equivalent (FTE) staff years and planned and
                           actual revenues for various enforcement programs. To verify the accuracy
                           of IRS’ computations, we (1) traced actual FTEs back to reports generated
                           by IRS’ Automated Financial System, (2) traced actual revenues back to
                           reports generated by ERIS, (3) interviewed staff from IRS’ enforcement
                           functions about the methods used to develop planned FTEs and revenues,
                           (4) recomputed calculations, and (5) resolved any inconsistencies with
                           cognizant IRS staff. We did not assess the reliability of the reports
                           generated by ERIS or the Automated Financial System.

                           We did our work from June 1996 to May 1997 in accordance with generally
                           accepted government auditing standards. We requested comments on a
                           draft of this report from the Acting Commissioner of Internal Revenue or
                           his designated representative. The Acting Commissioner provided
                           comments in a letter dated July 24, 1997. Those comments are reprinted in
                           appendix II and are summarized and evaluated at the end of this letter.


                           In reviews of past compliance initiatives, we identified several weaknesses
IRS Used an Improved       in IRS’ methodology for computing and tracking initiative results. Our past
Methodology to             reviews disclosed, for example, that IRS
Allocate Enforcement
                       •   had overstated initiative results by failing to recognize the opportunity
Revenues Between           costs associated with moving experienced staff off-line to train new staff
Base Programs and          and by failing to adequately account for underrealizations of planned base
                           staffing,
Initiatives, but       •   was unable to track actual enforcement results, and
Estimates Vary         •   was not providing Congress with enough meaningful information on
Depending on               initiative results because it was reporting positive results from initiatives
                           without recognizing negative results from reductions in base activities.
Assumptions

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                              Over the years, IRS revised its methodology to address those, and other,
                              concerns. In preparing its fiscal year 1995 Compliance Initiatives Report,
                              for example, IRS recognized the impact of opportunity costs, obtained
                              revenue data from an automated system (ERIS) that was designed to track
                              actual enforcement results, and improved the report’s usefulness to
                              Congress by including not only the estimated results of the initiatives but
                              also the estimated results of the base enforcement programs and
                              explanations for variances between the results anticipated when the
                              initiatives were approved and the estimated final results. Also, in
                              computing the results of the fiscal year 1995 compliance initiatives, IRS
                              adopted a rule that no FTEs, and thus no revenue, would be allocated to the
                              initiatives until planned base staffing had been achieved.

                              Although the methodology used for the fiscal year 1995 initiatives is an
                              improvement over previous methodologies, the results of that
                              methodology are estimates that are sensitive to various productivity
                              assumptions. Those productivity assumptions were not based on empirical
                              data and could, if they were erroneous, cause IRS’ reported results to be
                              overstated or understated. Also, in verifying IRS’ calculations, we found
                              four errors that had a relatively minor effect on IRS’ reported results.



What IRS Reported as the      IRS developed and uses ERIS to track the results of enforcement activities.
Initiatives’ Actual Results   Assuming ERIS does what it is designed to do, it should provide the total
Are Estimates                 amount of dollars actually collected as a result of enforcement activities in
                              fiscal year 1995 (i.e., $31.4 billion). However, as IRS acknowledged in the
                              Compliance Initiatives Report, ERIS does not distinguish between the
                              dollars collected from base enforcement activities and the dollars
                              collected as a result of the initiatives. Similarly, the Automated Financial
                              System, from which IRS extracted the total number of FTEs spent on
                              enforcement activities in fiscal year 1995, does not distinguish between
                              staffing for base activities and for the initiatives.

                              Because its systems do not distinguish between base and initiative
                              activities, IRS, as part of its methodology, developed the formula we
                              describe in appendix I to allocate the $31.4 billion in enforcement revenue
                              between base and initiative activities. Before implementing its new
                              methodology, IRS briefed us on the allocation formula. We said then that
                              because IRS had no initiative-specific data, its formula was a reasonable
                              approach for identifying initiative results. We continue to believe that.
                              However, because planned (i.e., estimated) revenue and staffing levels are



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                          an integral part of that formula, the end results are estimates. Thus the
                          “actual” initiative results cited in the Compliance Initiatives Report are not
                          actual results but are estimates of results. IRS did not clearly disclose that
                          fact in the Compliance Initiatives Report. In tables throughout the report,
                          for example, IRS refers to “actual,” without clearly explaining the term.


IRS’ Productivity         One important set of assumptions embedded in IRS’ methodology relates to
Assumptions Are Not       the comparative productivity of new staff versus experienced employees.
                          IRS used these assumptions in computing planned revenue, which was an
Based on Empirical Data
                          integral part of the methodology. The two primary IRS enforcement
                          functions, Collection and Examination, approached the issue of relative
                          productivity differently.8 Collection assumed that new staff were less
                          productive than experienced staff, even after they were trained, while
                          Examination believed that new staff, once trained, were as productive as
                          experienced employees. Neither of these assumptions was based on
                          empirical data.

Collection                According to IRS officials, to estimate the relative productivity of new
                          Collection staff, Collection Division officials met in a brainstorming
                          session and decided, based primarily on their institutional knowledge, that
                          new staff were generally 50 percent as productive as experienced
                          employees during their first year on the job.9 Part of that reduced
                          productivity assumed by Collection is attributable to the amount of time
                          new staff spend in training and part to the belief that it takes time for a
                          new employee to become as productive as an experienced one. (Collection
                          assumed that new employees do not reach full productivity until their
                          second or third year, depending on their position).

                          We have no basis to determine whether Collection’s productivity
                          assumptions are correct. We do know, however, that changes to the
                          assumptions could significantly alter the reported results of the
                          compliance initiatives. To demonstrate the sensitivity of the reported
                          results to changes in Collection’s productivity assumptions, we arbitrarily
                          adjusted Collection’s 50-percent assumption by 5 percentage points in
                          either direction and recalculated the initiatives’ results. Our recalculation
                          showed that a 5 percentage point change would either increase or

                          8
                           According to the Compliance Initiatives Report, these two functions accounted for 97 percent of the
                          $803.3 million that IRS estimated was generated by the initiatives. Of the $803.3 million, $545.2 million
                          (68 percent) was attributed to Collection. The other $237.1 million was attributed to Examination.
                          9
                           The 50-percent adjustment was used for most Collection FTEs. The only exception was for those
                          FTEs allocated to work on cases involving delinquent returns. For those FTEs, Collection assumed
                          that new staff were 64 percent as productive as experienced employees in doing that work.



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                  decrease IRS’ reported initiative results of $545.2 million by $42 million
                  (about 8 percent), depending on the direction of the change.

Examination       Unlike Collection, the Examination function assumes that new staff are as
                  productive as experienced staff after they have completed classroom
                  training. That assumption applies to all of Examination’s enforcement
                  staff—tax examiners, who audit simple issues by corresponding with
                  taxpayers; tax auditors, who do more complex audits generally by meeting
                  with taxpayers at an IRS office; and revenue agents, who do the most
                  complex audits generally by meeting taxpayers or their representatives at
                  the taxpayer’s home or place of business.

                  Examination officials told us that they did not have any empirical data to
                  support their assumption that new tax examiners are as productive as
                  experienced tax examiners because Examination’s information systems do
                  not track individual tax examiner’s accomplishments. Thus, historical data
                  cannot be separated between experienced and inexperienced tax
                  examiners. Instead, Examination officials justified their assumption by
                  noting that tax examiners work on relatively noncomplex issues and
                  returns and are able to get up to speed fairly quickly. However, according
                  to an IRS official, after 2 weeks of formal classroom training, tax examiners
                  are assigned to an on-the-job instructor for 10 weeks. The need for
                  on-the-job instructors suggests that IRS does not expect new employees to
                  be able to handle issues and returns as effectively or efficiently, and thus
                  be as productive, as experienced employees.

                  Examination officials also said that they did not believe that it was
                  necessary to assume different productivity levels for experienced revenue
                  agents and tax auditors and new agents and auditors. The officials
                  provided two reasons for their position.

              •   First, Examination adjusts its revenue estimates to consider the amount of
                  time that new staff must spend in classroom training. Examination
                  assumes, based on past experience, that the amount of time available to do
                  audit work is reduced between 19 and 25 percent (it varies between
                  revenue agents and tax auditors) because of classroom training
                  requirements. However, that adjustment only affects the amount of time
                  new staff have to do audits; it does not get at the issue of how productive
                  new staff are when they are doing audits.
              •   Second, Examination’s resource allocation model imputes a lower
                  marginal yield for each additional return audited by initiative revenue
                  agents and tax auditors. That means, in effect, that Examination assumes



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    that each additional return audited will generate less revenue than the
    return audited before it.10 However, although IRS assumes a lower yield
    with each additional audited return, it does not consider any differences in
    the efficiency with which experienced staff and new staff audit tax
    returns.

    In that regard, the officials said that, after completion of classroom
    training, new staff are expected to close the same number of cases in any
    year as experienced employees who work the same types of cases. But the
    productivity of Examination staff is determined not only by the number of
    cases they close in a year but also by the revenue generated from those
    cases. Thus, even if new staff were to close as many cases as experienced
    staff (Examination officials could provide no evidence to support that
    contention), they may or may not achieve comparable dollar results.
    According to an Examination official, revenue agents and tax auditors,
    during their first year on the job, have 10 weeks and 13 weeks,
    respectively, of on-the-job training after their classroom training. The need
    for on-the-job training suggests, in our opinion, that new staff may not be
    prepared to be as productive as experienced staff, after classroom
    training.

    Although we did not have data to test the appropriateness of
    Examination’s productivity assumption, we tested the sensitivity of IRS’
    reported initiative results to changes in that assumption by assuming the
    following:

•   New tax auditors would be 75 percent as productive as experienced tax
    auditors.
•   New revenue agents would be 69 percent as productive as experienced
    revenue agents.
•   New tax examiners would be 95 percent as productive as experienced tax
    examiners.

    We arrived at the 75-percent and 69-percent figures for tax auditors and
    revenue agents, respectively, by using Collection’s productivity
    assumption of 50 percent and adjusting it to recognize the fact that
    Examination’s assumption already includes a factor for lost productivity
    due to training. We assumed only a slight fall-off in productivity for tax
    examiners because the correspondence audits they do are straightforward,
    and thus, the skills needed to do them can be more quickly learned than

    10
     These estimates of marginal yield per return are based on data collected from the 1988 Taxpayer
    Compliance Measurement Program. We did not assess the sensitivity of IRS’ initiative revenue
    estimates to changes in the precision of the marginal yield estimates.



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                               the skills needed by tax auditors and revenue agents. Use of the different
                               productivity assumptions reduced the initiative results by $12.9 million—a
                               reduction of about 5 percent from the reported amount of $237.1 million
                               that IRS estimated was generated by Examination through the initiatives.

Only Minor Errors Were Found   We traced the data in the Compliance Initiatives Report back to supporting
in IRS’ Calculations           documentation and verified the various calculations involved in using IRS’
                               methodology. We found four relatively minor errors.

                               The first two errors involved the categorization of FTEs between revenue-
                               and nonrevenue-producing FTEs. A portion of the staffing increase
                               associated with compliance initiatives is for support staff, such as clerks
                               and secretaries. Those staff, unlike revenue officers, revenue agents, and
                               other frontline staff, do not directly generate revenue. Thus IRS, in its
                               calculations, segregated nonrevenue-producing FTEs from
                               revenue-producing FTEs. In verifying that part of IRS’ calculations, we found
                               two errors. IRS mistakenly (1) categorized about 140
                               nonrevenue-producing FTEs in the Collection function as
                               revenue-producing and (2) included 240 nonrevenue-producing
                               Examination FTEs in the formula it used to allocate enforcement revenue
                               between base activities and initiatives. The third error involved the use of
                               an incorrect average yield figure in computing initiative results for the
                               Compliance Research program. The fourth error involved a failure to
                               include about 180 tax examiners in computing the initiative results for the
                               Collection function.

                               By our calculations, these four errors—which IRS officials
                               acknowledged—caused IRS’ reported yield from the initiatives to be
                               understated by $2.6 million. Absent other changes, correction of the four
                               errors would increase IRS’ reported yield to $805.9 million.


                               In considering IRS’ estimates of the results of the fiscal year 1995
Caveats to Consider in         compliance initiatives, there are two other caveats that are relevant:
Interpreting IRS’              (1) the fact that IRS collected a certain amount in fiscal year 1995 as a
Reported Results               result of the initiatives does not necessarily mean that IRS collected more
                               enforcement revenue in fiscal year 1995 than in fiscal year 1994 but only
                               that IRS collected more in fiscal year 1995 than it estimated it would have
                               without the initiatives and (2) the first year’s results from the fiscal year
                               1995 initiatives are not necessarily indicative of what other compliance
                               initiatives would generate in their first year.




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Even With the Positive        Although IRS reported that the compliance initiatives resulted in additional
Results Reported From the     collections in fiscal year 1995 of $803.3 million, it does not mean that IRS
Initiatives, IRS Collected    brought in $803.3 million more than it did in fiscal year 1994. What it
                              means is that IRS estimated that it generated $803.3 million more in
Less in Fiscal Year 1995      enforcement revenue in fiscal year 1995 than it had estimated it would
Than in Fiscal Year 1994      generate without the compliance initiatives.

                              According to the Compliance Initiatives Report, IRS collected a total of
                              $31.4 billion in fiscal year 1995—$30.6 billion from its base programs and
                              $0.8 billion from the initiatives. Despite the estimated additional revenue
                              from the initiatives, however, the amount of enforcement revenue
                              collected in fiscal year 1995 was less than the amount collected in fiscal
                              year 1994. That is, IRS data indicated that IRS collected about $33.1 billion in
                              fiscal year 1994, or $1.7 billion more than in fiscal year 1995. According to
                              IRS officials, a number of factors could make enforcement revenue
                              decrease even with a staffing increase in the same year. Revenue collected
                              in one fiscal year is a function not only of that year’s staffing but also of
                              prior years’ staffing. Much of the revenue impact of a staffing increase or
                              decrease occurs in subsequent years because of the possibility of appeals,
                              litigation, and collection activity. In that regard, IRS officials said that
                              enforcement revenue in fiscal year 1996 increased to $38.0 billion, even
                              with a staffing decrease, partially as a result of the fiscal year 1995
                              compliance initiatives.


Results of Fiscal Year 1995   A second caveat to keep in mind is that IRS’ results in fiscal year 1995 are
Compliance Initiatives Are    not necessarily indicative of the results that would be achieved in the first
Not Necessarily Indicative    year of future compliance initiatives. The results achieved for any
                              compliance initiative depend on many factors that can, and most likely
of the Results That Future    will, vary from one initiative to another. Two of those factors, both of
Compliance Initiatives        which had a significant impact on the results achieved in fiscal year 1995,
Would Produce                 are (1) the extent to which new staff must be hired to fill the positions
                              authorized by the initiatives and (2) how IRS decides to allocate the
                              initiative positions among its various enforcement programs.

                              Most of the positions funded with the $405 million provided for the
                              compliance initiatives in fiscal year 1995 were filled not by new hires but
                              by staff who were already on board. This happened, at least in part,
                              because IRS’ fiscal year 1995 appropriation, except for the compliance
                              initiatives, actually resulted in reductions in IRS’ enforcement staffing.
                              Thus, many of the positions funded by the $405 million were used to offset
                              that reduction. According to data provided by IRS, of the 5,470 initiative



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              positions filled as of September 30, 1995, 1,145 were filled by new staff.
              The other 4,325 were filled by existing employees either through lateral
              reassignments or promotions (such as promoting tax auditors to fill
              revenue agent positions). If future initiatives require a greater proportion
              of new staff, the results could be different from those in fiscal year 1995
              because new staff (1) require more training, which, under IRS’ current
              procedures for training new staff, increases the opportunity cost
              associated with moving experienced staff off-line to do the training and
              (2) generally can be expected to generate less revenue, at first, than
              experienced staff.

              Decisions on how to allocate staff among enforcement programs also
              affects initiative results. The change in IRS’ estimate of how much revenue
              would be generated by the fiscal year 1995 initiatives, which we noted at
              the beginning of this report, is an example of how staffing decisions can
              affect initiative results. IRS’ first estimate was $9.2 billion over 5 years and
              $331 million in fiscal year 1995. Then, in an effort to maximize revenues,
              IRS decided to allocate more of the $405 million to areas, such as
              Automated Collection System sites, that are staffed by lower graded
              personnel and to allocate fewer dollars to more costly areas, such as the
              Collection Field Function, which is staffed by higher graded revenue
              officers.11 This reallocation enabled IRS to fund many more FTEs than
              originally expected and resulted in revised estimates of $9.6 billion over 5
              years and $728 million in fiscal year 1995.


              IRS’methodology for computing the results of the fiscal year 1995
Conclusions   compliance initiatives is a significant improvement over past
              methodologies. However, there are productivity assumptions embedded in
              the methodology that are not based on empirical data and could cause the
              results of an initiative to be overstated or understated. We do not have a
              basis for determining what the correct assumptions should be, but our
              sensitivity analyses showed that a change in the assumptions used could
              have a significant effect on the reported initiative results of $803.3 million.
              For example, as discussed earlier, changing Collection’s productivity
              assumption by 5 percentage points would either increase or decrease the
              reported results by $42 million and changing Examination’s assumptions
              to be comparable to Collection’s would decrease the reported results by

              11
                This reallocation of resources was partly in response to a recommendation we had made in a 1993
              report entitled Tax Administration: New Delinquent Tax Collection Methods for IRS (GAO/GGD-93-67,
              May 11, 1993). In that report, we recommended that IRS restructure its collection organization to
              support earlier telephone contact with delinquent taxpayers and determine how to use collection staff
              in earlier, more productive phases of the collection cycle.



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                     B-272840




                     $12.9 million. After adjusting IRS’ reported results for the effect of these
                     different productivity assumptions and after increasing the results to
                     account for the $2.6 million in calculation errors, the estimated yield from
                     the fiscal year 1995 compliance initiatives would fall somewhere between
                     $751.0 million and $847.9 million.


                     We requested comments on a draft of this report from the Acting
Agency Comments      Commissioner of Internal Revenue. IRS provided comments in a letter
and Our Evaluation   dated July 24, 1997 (see app. II). Overall, IRS agreed with the findings in the
                     report, which it said confirmed that IRS accurately tracked and reported on
                     the results of the compliance initiatives. However, IRS expressed concerns
                     about two aspects of the observations in the report.

                     First, IRS took issue with our statement that it did not clearly disclose the
                     fact that the initiative results cited in the Compliance Initiatives Report
                     were not “actual” results but rather estimates. To show that it had clearly
                     disclosed that fact, IRS quoted two passages from the Compliance
                     Initiatives Report which refer to the allocation of the revenue to base and
                     initiative activities. In our opinion, the statements IRS quoted, while
                     informative to a careful reader, do not provide sufficient information to
                     make clear that the results are estimates, especially when every table in
                     the final report referred to the results as “actuals.”12

                     Second, IRS observed that, although we state that we did not assess the
                     reliability of the data in ERIS, (1) after reviewing the Compliance Initiatives
                     Report and supporting ERIS data, we have found no indication that ERIS
                     does not do what it purports to do—accurately accumulate and summarize
                     enforcement revenue; (2) work done to date on ERIS as part of our
                     financial audit of IRS had not disclosed any problems; and (3) an ERIS
                     sample we took as part of an audit of large corporations concluded that
                     ERIS does what it purports to do. IRS also observed that we have asked for
                     ERIS data in conjunction with two recently initiated audits.


                     We appreciate IRS’ viewpoint; however, (1) the scope of our review of the
                     Compliance Initiatives Report, as discussed earlier, did not include a
                     specific assessment of ERIS reliability; (2) we have not yet done sufficient
                     work on ERIS as part of the financial audit to reach any overall conclusion
                     about data reliability; and (3) the scope of our audit of large corporations

                     12
                       IRS also quoted similar language in its letter from several other documents to support this point.
                     However, we do not believe that language in other documents is directly relevant to understanding the
                     content of the final Compliance Initiatives Report because they would not be available to most
                     readers.



                     Page 12                                   GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
B-272840




was also not broad enough to reach any overall conclusion about ERIS
reliability. Until such time as ERIS’ reliability can be determined, we
necessarily continue to rely on ERIS data for some of our work because
they are the best data available. However, the standards applicable to our
work require that we disclose that data reliability has not been confirmed.


We are sending copies of this report to the Committee Chairman; the
Chairmen and Ranking Minority Members of the Senate Committee on
Finance, the House Committee on Ways and Means, and the House
Committee on Government Reform and Oversight; various other
congressional committees; the Secretary of the Treasury; the
Commissioner of Internal Revenue; the Director of the Office of
Management and Budget; and other interested parties. We will also make
copies available to others upon request.

Major contributors to this report are listed in appendix III. If you have any
questions, please contact me on (202) 512-9110.

Sincerely yours,




Lynda D. Willis
Director, Tax Policy and
  Administration Issues




Page 13                         GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix I

IRS’ Methodology for Calculating Initiative
Results

               According to the Compliance Initiatives Report, IRS estimated the amount
               of revenue attributable to the fiscal year 1995 compliance initiatives by
               means of a general formula that consists of two components. The first
               component is the ratio of total actual yield per FTE (base and initiative
               combined) divided by the total planned yield per FTE (base and initiative
               combined). This component indicates by how much the average tax yield
               was over or under what IRS expected. If IRS accurately predicted the
               average yield, the ratio value of the first component would equal 1. If the
               actual yield was more or less than what was predicted, the ratio value
               would be greater or less than 1. The second component multiplies the
               number of “actual” FTEs allocated to the initiatives by the planned yield per
               initiative FTE.

               The result of the second component is then multiplied by the result of the
               first component. If the first component equaled 1, the yield attributable to
               the initiatives would be equal to the number of initiative FTEs times what
               yield they were predicted, on average, to realize. However, if the first
               component was less than 1, implying that the average yield of both base
               and initiative staff was less than expected by some percentage, the
               expected tax yield per initiative FTE would be reduced by the same
               percentage. Conversely, if the ratio value of the first component was
               greater than 1, the second component would be increased by the
               percentage by which the actual average yield exceeded what was
               expected.

               To illustrate, assume the following information:

               Total actual yield — $70 million
               Actual number of FTEs (base and initiative) — 1,800
               Actual yield per FTE ($70 million divided by 1,800 FTEs) — $38,889

               Planned total yield — $85 million
               Planned number of FTEs (base and initiative) — 1,500
               Planned yield per FTE ($85 million divided by 1,500 FTEs) — $56,667

               First component: $38,889 divided by $56,667 = 0.686 or
               68.6 percent.

               Planned initiative yield — $5 million
               Planned initiative FTEs — 400
               Planned yield per initiative FTE — $12,500
               “Actual” initiative FTEs — 700



               Page 14                         GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix I
IRS’ Methodology for Calculating Initiative
Results




Second component: 700 times $12,500 = $8,750,000.

“Actual” initiative yield: 0.686 times $8,750,000 = $6,002,500.

The above information is an illustration. The numbers and thus the results
would vary among initiatives and even within an initiative. For example,
Examination assigned its initiative staff to various audit classes
(“individual taxpayers who file a Form 1040C showing total gross receipts
of less than $25,000 dollars” is an example of an audit class). For each
audit class, IRS would apply the above formula; and for each audit class,
the numbers and the results would be different.




Page 15                               GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix II

Comments From the Internal Revenue
Service




              Page 16    GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix II
Comments From the Internal Revenue
Service




Page 17                              GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix II
Comments From the Internal Revenue
Service




Page 18                              GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix II
Comments From the Internal Revenue
Service




Page 19                              GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
Appendix III

Major Contributors to This Report


                        David J. Attianese, Assistant Director
General Government      James A. Wozny, Assistant Director
Division, Washington,   John Lesser, Evaluator-in-Charge
D.C.                    Charles C. Tuck, Economist




(268739)                Page 20                         GAO/GGD-97-158 IRS’ FY 1995 Compliance Initiatives
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