Taxed by Technology

he Internal Revenue Service will greet the new century with a new executive team, a new mission statement, a newly reorganized bureaucracy, a new performance measurement scheme--and computer systems that date back to the 1970s.

For nearly a decade, the service has been hobbled by repeated failures to modernize its systems. The issue isn't merely old technology, but IRS' very ability to get its job done. For IRS, more than most other agencies, the computer systems are at the heart of its business.

Only computers and communications systems enable the service to process the 227 million returns it will receive this year and to collect the $1.7 trillion or more that Americans owe. Only these systems can track an individual's refund or a small business' installment payments for back taxes.

The agency's performance measures, human resources systems and financial management systems are tied into the tax processing systems, and they all need modernization. Although the General Accounting Office gave IRS an unqualified endorsement of its financial statement for fiscal 1997, the auditors pointed out that serious weaknesses remain in the agency's financial systems. For example, there are inadequate safeguards against embezzlement, and the agency can't readily distinguish taxes owed from the smaller sums that it is likely to collect. Only the latter should be called receivables, GAO says.

Because the financial systems are antiquated and non-standard, IRS couldn't generate acceptable statements automatically, GAO reported. Instead, the employees made manual ledger adjustments totaling over $1.6 billion in IRS' 1997 reports. This situation is unlikely to improve much until new computer systems are in place, observers generally agree.

The latest IRS Tax Systems Modernization scheme was scrapped in 1997, after the service had spent $3.4 billion on it. Since then, the IRS has been revising and updating its systems strategy and selecting a systems integrator to carry out the plans. In December, Computer Sciences Corp. beat out Lockheed Martin Corp. for the 15-year contract, which could be worth $2 billion or more. But even as Lockheed and CSC battled each other for the contract, IRS once again was revamping its modernization plans.

Arthur A. Gross, the service's chief information officer from 1996 to 1998, drew up the initial modernization blueprint. Gross, who was running New York state's tax systems when the IRS recruited him, impressed many on Capitol Hill and in the information technology industry as a savvy, no-nonsense manager with the clear vision needed to straighten out the IRS mess. But when Charles O. Rossotti became the first IRS commissioner with a technology background in late 1997, he and Gross clashed on issues of both substance and style. Gross returned to New York last spring, and Rossotti replaced him with Paul J. Cosgrave, a respected systems consultant.

Undeniable Faults

Meanwhile, a firefight was taking place along Pennsylvania Avenue. The IRS was sustaining heavy hits from congressional critics, and the Clinton administration was hard-pressed to mount much of a defense. Although the IRS critics painted an exaggerated picture of the agency's faults, those faults were undeniable. Some in the service had ignored taxpayer safeguards in the interest of collecting revenue, and some had refused to listen to the legitimate arguments of honest citizens. The frustration felt by thousands of citizens who over the years had received incomprehensible tax notices made itself felt in the drive for IRS reform.

At the core of the anti-IRS movement was the small-business lobby, which often gets the ear of Congress. Agency officials say small businesses are the segment of America's taxpayers least likely to comply fully with the tax laws and pay their fair share. The tax rules for businesses are more complex than those for individuals, but many small businesses can't afford to pay large sums for tax advice and assistance. Nonetheless, the IRS expects them to keep records professionally and comply with the 4,000-plus pages of tax laws, just as if they were General Electric or Ford Motor Co. Small businesses also can be created as tax dodges or money-laundering operations more easily than large public companies. In short, small businesses can be a big problem for IRS, and the agency sometimes treats them accordingly.

The IRS reform campaign ended with the passage of legislation tilting the balance of power more toward the taxpayer and incorporating the new commissioner's reform plans. However, Rossotti was forced to asked Congress at the last minute to delay the effective date of some provisions because of the need to focus all management attention on an even more immediate IT issue: the year 2000 problem.

The IRS is spending more than $1 billion renovating its computer systems to ensure that they will recognize dates correctly after Dec. 31. "We're talking twice what General Motors is going to spend," Rossotti told a group of accountants last fall. Even so, the service expects some glitches during the current tax-processing season. Last year it began to experience some of those failures. "There were a few people who got notices saying they owe the IRS $300 million," the commissioner admits.

The risk facing the IRS is not simply faulty computer-generated notices. In the worst imaginable case, the agency would fail to collect and record large segments of taxes. It's responsible for 95 percent of the federal government's receipts. Even a major lapse in sending out refund checks would be disastrous.

The expense and difficulty of minimizing these risks is further evidence that it's time for an overhaul of IRS computer systems, which comprise some 62 million lines of software code. And in fact, the service has taken advantage of the year 2000 problem to consolidate 67 mainframes at 10 service centers into 12 mainframes at two data processing centers, and to replace 11 different electronic mail systems with one.

But the IRS still is saddled with archaic systems that take days, instead of seconds, to process updates. Because the agency keeps information in 59 separate databases, none of its systems can produce a summary of a taxpayer's interaction with the IRS, and synchronizing the data from one system to the next is a major headache. The systems also have significant security and privacy weaknesses.

The problem facing Rossotti is that the IRS' systems were created over the years to support the agency's regional organization. But now the commissioner is reorganizing the service into four divisions, segmented by customer type: individual wage earners and investors, small businesses, large businesses and nonprofit organizations. Because each group has different expectations and needs, Rossotti is establishing units that specialize.

Thus, during the next 18 months or so, the commissioner needs to revamp the entire organization, get a solid start on systems modernization and deal with the year 2000 problem. Each of these tasks is daunting, and all are interrelated. Most important, all affect customer service, which Rossotti has made the service's top priority--although revenue collection is by no means forgotten. "We are not just tinkering at the margins here," the commissioner vowed at a White House event last March.

Customers Before Collections

In a move that symbolizes the new way of doing business at IRS, Rossotti asked the public to comment, via the service's World Wide Web site, before he settled on a new mission statement that puts service before revenue production. The concern about customer service has been simmering for some time. During the past year, Vice President Al Gore's reinvention team worked with IRS employees to plan for changes in the interest of better service. The recommendations released at the White House in March addressed such nuts-and-bolts issues as employee performance assessments and the clarity of taxpayer notices.

The IRS was one of the first agencies to establish a full-blown performance measurement system. The system, which became a focus of the congressional hearings on IRS abuses, primarily measured revenue collection. Although the service was prohibited from using the revenue results in evaluating individual agents and line managers, the collection information colored employee appraisals and distracted the agency from helping taxpayers comply with the tax code.

Now the service is developing a new set of balanced measures to evaluate progress in fulfilling its mission and achieving three strategic goals: improving customer service, increasing compliance and improving its own productivity. When Rossotti asked for rank-and-file volunteers to help executives develop the metrics, several thousand employees responded. The effort is under way, and the new measures are scheduled for introduction this fiscal year. "[Fiscal] 1999 will be a transition year to introduce the balanced set of measures, educate and train managers and employees about the new performance measures, gather and analyze data, and refine the measurement system," the IRS said in a recent announcement.

Data Dearth

Observers both within and outside the service say selecting the right measures will be difficult. For example, the IRS aims to reduce the burden it places on taxpayers in collecting tax information, filling out forms, undergoing audits and so on. But GAO, in its review of the Treasury Department's fiscal 1999 annual performance plan, observed that "reliable data for measuring [the] burden do not exist because taxpayers normally do not track the time they spend complying with their tax and filing obligations." Often tax compliance activity takes place over the course of a year, and the overlap among federal, state and local tax systems makes it difficult to discern how much time was spent on federal taxes alone.

As another example, IRS officials often brag of the relatively high voluntary compliance rate among U.S. taxpayers, compared with those in other nations. The agency's compliance office says that for years IRS has collected about 87 percent of the amount it ideally should collect. But the fact is that for a decade, the service has had no good way of measuring how much taxable income is generated by Americans and therefore how much it would collect if the compliance rate were 100 percent. Rossotti himself raised this issue last spring, saying, "If you can imagine everything that's changed in the U.S. economy since 1988, an extrapolation based on 10-year-old data may or may not be accurate. . . . You can't continue to have a tax agency run efficiently without measuring what compliance is, and it hasn't been measured in 10 years."

Traditionally, the IRS measured compliance by intensive study of a sample of taxpayers, demanding documentation for every item on their tax returns and probing the source of almost every bank deposit. The program was politically unpalatable in the past, and it would be even more so now. But no one has yet figured out how else to measure compliance rates.

The service is paying close attention to measuring progress on its customer service goals and has hired a contractor to undertake customer satisfaction surveys. But observers such as James R. White, director of IRS oversight at GAO, question whether it's possible to separate taxpayers' dislike of the tax laws from their dislike of the tax collector.

Other observers have pointed out the difficulty of distinguishing between taxpayer assistance--such as explaining what an individual should report on his or her tax return--and collection and enforcement activities. In the new IRS, they will be part of a seamless whole.

Optimism Inside and Out

The old IRS was not a happy place to work. Employees now report that morale is up, and they are hopeful about the changes Rossotti is making. "I think the IRS is really headed in the right direction for the first time in the 30 years I've been working with them," says Robert M. Tobias, president of the National Treasury Employees Union, which represents 97,000 of the 102,000 IRS employees.

NTEU plays a larger role in IRS than unions do in most other federal agencies. For example, in October, when the agency created a new customer service representative position, it was announced jointly by Tobias and Rossotti--and only NTEU issued a press release. Middle managers and contractors are among those who have questioned whether the union's prominence hinders agency management. But after some debate, Congress ratified the status quo when it created a seat for an employee representative--expected to be Tobias--on the IRS board of managers established by last year's reform bill.

Middle managers, on the other hand, will not be represented on the board, and they complained during last year's IRS reform debate that their views were given short shrift.

Most IRS managers at every level are long-time agency employees. Their discontent has been magnified by the shifts in policy direction from Congress over the last decade, and by the limited promotion opportunities in the shrinking agency. It's widely believed that the agency needs new blood in its management ranks.

But on the whole, most IRS employees seem enthusiastic about the changes. Outsiders have similar comments. "The cultural shift is enormous," says Sharon Cranford, an officer of the National Association of Enrolled Agents, who represent taxpayers in their dealings with IRS. "From time to time, you still run into someone who's not quite on board yet," she says, but for the most part, IRS is "a case study in how to overhaul an agency and do it right."

Carol Thompson, an enrolled agent in Monterey, Calif., agrees that IRS has improved. But she says her clients still receive inconsistent treatment on occasion. The agency's information technology failures are more than an abstract problem "when you sit on hold for 20 or 30 minutes and then they tell you they can't send you the information you need because the computer is down," Thompson says.

In the end, it all comes down to information technology, the strategic tool that will enable IRS to carry out its makeover. Computer systems will enable the agency to pull together a taxpayer's recent account history so that a customer service representative can provide informed assistance, produce up-to-date reports on receipts, and accept more filings in electronic format. Although the volume of the IRS' data is unusually large, this is not rocket science. It's simply what the managers at any large American corporation would expect of their information systems.

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