Committee on Ways and Means, Full Committee, 9-16 Testimony

Statement of James W. Wetzler
Deloitte & Touche LLP
on
Management and Governance Provisions of IRS Restructuring Legislation
House Committee on Ways and Means

September 16, 1997

Thank you for the opportunity to testify on the management and governance provisions of proposed IRS restructuring legislation. Let me note for the record that I am speaking strictly for myself, as a member of the National Commission on Restructuring the IRS who dissented from the majority report, and that my testimony does not necessarily represent the views of Deloitte & Touche LLP or its clients.

Areas of agreement

It is important to emphasize that there was substantial agreement within the Restructuring Commission on many important points.

We agreed that the United States needs a world-class tax administration agency, one that formulates and executes strategic plans to accomplish its mission, achieves a high degree of compliance with the tax law, operates in such a way as to minimize the burdens that tax compliance imposes on taxpayers, treats taxpayers courteously and fairly, and successfully deploys modern data processing technology to these ends.

We agreed that there has been a governance problem at the IRS. Part of that problem is that political leaders have not been willing to support a consistent set of priorities for the Service. One day the emphasis is on raising revenue, the next it is on reducing burdens imposed on taxpayers, the next it is on increasing productivity within the Service. Specific shortcomings in the Service's performance take center stage for brief periods of time, and corrective action is demanded, without consideration necessarily being given to the significance of these shortcomings to the overall tax administration program. A second aspect of the governance problem is that the Commissioner of Internal Revenue has not always been properly supervised by his or her boss, the Secretary or Deputy Secretary of the Treasury, which has created an environment where certain serious shortcomings have not been attacked with a proper sense of urgency.

We agreed that a new governance structure for the Service should include substantial input from people outside the government who have expertise in information technology, marketing, organizational change and high-volume customer service, as well as the tax expertise that has traditionally dominated informed public discussion of tax administration. However, because tax administration is such a sensitive government function, we also agreed--after considerable discussion--that ultimate decision-making authority over tax administration should rest with people who are appointed by, and serve at the pleasure of, the President. The IRS is not the Federal Reserve Board, where a conscious decision has been made to insulate monetary policy from political accountability. If our tax administration is functioning poorly, the voters should be able to hold elected officials responsible.

We agreed that taxpayers have a right to be served by IRS employees who are properly equipped to provide good service; that is, who are properly trained and given access to the research tools, office equipment and facilities they need to serve the public. The Service needs to be sufficiently adequately staffed that it does not initiate contacts with taxpayers unless it is prepared to deal promptly and effectively with the taxpayers' responses to those contacts.

We agreed that the Service needs to proceed ahead with modernization of its systems, without which there will not be quantum improvements in the level of service to taxpayers no matter what changes in governance are adopted.

We agreed that steps need to be taken to increase the tenure of office of the Commissioner of Internal Revenue to achieve more continuity of management.

These areas of agreement create the basis for a successful effort to restructure the Internal Revenue Service if a good faith effort is made to resolve the remaining areas of disagreement, to which I now turn.

Areas of disagreement

I dissented from the Restructuring Commission report for two reasons. First, I disagreed with the recommendation that the Commissioner of Internal Revenue report to a part-time IRS Oversight Board dominated by private-sector members. Second, I believed the Restructuring Commission report failed to address several important issues that need to be considered in a comprehensive program of IRS reform.

Those involved in the IRS reform effort should start with a balanced view of the Service's strengths and weaknesses. We should not take for granted the fact that, despite its very real problems, the Service is an organization that accomplishes its mission. The U.S. has a tolerably high, although by no means optimal, level of voluntary compliance with the tax laws. Taxpayers get their tax forms and tax refunds every year, and their accounts are maintained with reasonable accuracy. The Service produces a massive amount of guidance on how to interpret and comply with our extremely complex tax law. Measured by the ratio of its budget to the revenue it collects, the Service is much more efficient than tax administration agencies in other countries or in states. The Service protects the confidentiality of taxpayer information. Since the 1950's, tax administration in the U.S. has been insulated from political interference. Under these circumstances, it is possible to make the Service a lot worse, and the downside from poorer tax administration, which potentially threatens the fiscal stability of the country, is substantial. Countries like Russia and Italy envy our successful tax administration.

Unbalanced or shrill criticism of any tax administration agency runs the risk of causing taxpayers to lose respect for the tax system, a sentiment that can affect their voluntary compliance with the tax law. Our comparatively high rate of voluntary compliance is a precious national asset that should not be jeopardized.

Objections to the Commission's Board proposal

My objection to the Restructuring Commission's recommendation that the Commissioner report to an IRS Oversight Board rather than to the Secretary or Deputy Secretary of the Treasury is that, having thought about this idea for the better part of a year, I still cannot identify sensible solutions to what I deem to be major problems with the Board proposal.

The proposal envisions a matrix management structure for the Service. The Board would hire and fire the Commissioner and approve the Service's budget and strategic plans. It would review operational plans as well as the pay and hiring of senior officials. However, the Board would be specifically precluded from involving itself in law enforcement matters, procurement decisions, and tax policy (which presumably includes both the content of guidance issued by the IRS and its input into tax policy decisions by both the Administration and Congress). I have trouble imagining how this would work in practice. Would the Secretary continue to supervise the Commissioner with respect to matters from which the Board is precluded? How would the Secretary exercise his authority over the Commissioner and senior staff over any aspect of their performance when he or she has no involvement (except as a Board member) in pay or personnel decisions? What would prevent the Board from intervening in the matters from which it is supposed to be precluded? In its hiring and firing decisions, how would the Board take proper account of the Commissioner's capability and performance in the areas from which it is precluded? Who would supervise the Commissioner with respect to the areas that are not specifically reserved for the Board but from which the Board is not specifically precluded? If Congress gets two different IRS budget requests, one from the Board and a separate one from OMB, will it simply pick and choose between the two proposals and adopt the lower level of funding for each line item? Absent answers to these kinds of questions, I am skeptical that matrix management is appropriate for the Internal Revenue Service.

Most private-sector candidates for appointment to the Board who have the expertise to oversee an organization as complex as the Internal Revenue Service will have conflicts of interest, actual or perceived. Personally, I am confident that well-selected board members could put aside their parochial interests and make decisions that are in the best interest of successful tax administration; however, the realities of present-day Washington are such that the conflict-of-interest issue will affect, and perhaps dominate, presidential appointments to the Board, the confirmation process, and public perceptions of the Board's impartiality.

Boards in general have a mixed record of directing organizations. Many Boards are actively engaged in their work and make sizable contributions to their organization's success. Others are inattentive and contribute little or nothing. Still others micromanage ineffectively and actually hurt their organizations. Under a Board-directed governance structure, accountability for the Service's success is diffused among several people, instead of being centered in the office of the Treasury Secretary. It is not clear to me why this should necessarily produce more effective supervision of the Commissioner.

An alternative governance structure

Virtually all of the advantages of the Restructuring Commission's Board proposal can be achieved, with few of the disadvantages, under an alternative governance proposal. The Commissioner would continue to report to the Secretary and Deputy Secretary of the Treasury. The Secretary would receive significant private sector input from an advisory board consisting of individuals who have the relevant skills, including both tax expertise and expertise in non-tax areas deemed essential to the IRS's success. The advisory board would review the IRS budget, strategic plans and major operational initiatives, just like the proposed IRS Oversight Board, and would make both private recommendations to the Secretary and public recommendations to Congress. As a practical matter, it will be very difficult for the Secretary to ignore public recommendations given by such an advisory board if they are reasonably well supported, but because the board is only advisory, the conflict-of-interest problem would be greatly reduced. If the advisory board is inattentive or gives little thoughtful advice, the Secretary and Congress remain free to ignore it. To increase the likelihood that the Secretary will make management of the IRS an important priority, the law should require that the Secretary appear at congressional hearings on IRS management twice a year.

I see no need to legislate the creation of an internal IRS management board consisting of government officials within the Executive Branch. As a practical matter, many Executive Branch agencies exercise some control over various aspects of the IRS--the Office of Personnel Management, the Office of Management and Budget, various bureaus within Treasury, the General Services Administration, and so forth. It seems reasonable to suggest that they should meet periodically with the IRS to make sure that they are all helping execute the same strategy, but I do not see any reason why these meetings need to be enshrined in legislation or an Executive Order.

Issues omitted from the Restructuring Commission report

Several significant issues of tax administration were omitted or addressed sketchily in the Restructuring Commission report, preventing it from being a comprehensive program of IRS reform. These may not all be suitable for inclusion in IRS reform legislation at the present time, but should be kept in mind for the future.

IRS budget.--The report outlined a vision of world-class tax administration, but it did not ask, much less answer, the question of how much this vision would cost. Today, the Service spends about 50 cents for every $100 of revenue it collects. Tax administration agencies at the state level and in other countries typically spend a lot more. For example, Australia, which was often cited as a model for the IRS during the Commission's hearings, spends $1 on tax administration for every $100 collected. The Restructuring Commission recommended a flat IRS budget for three years without analyzing whether that would be adequate to achieve the Commission's vision. It also recommended several additional spending initiatives for the Service, including additional phone service, more funds for the Exempt Organizations function, subsidies for electronic filing, more training, and greater availability of payments of attorneys fees incurred by taxpayers, without identifying the source of funds to pay for these ideas in the context of a flat budget.

Budget scorekeeping.--The Restructuring Commission recommended some helpful changes in how budget scorekeeping rules apply to the IRS's budget by institutionalizing a procedure under which the IRS budget can be increased under certain conditions to improve taxpayer service or tax compliance. Under existing law, the Service is treated like any other agency for budget scorekeeping purposes; that is, less spending on tax administration frees up money for spending on other programs even if it can be demonstrated that the reduced spending on tax administration will lead to a revenue loss or increase burdens on taxpayers. More generally, the revenue impact of tax administration is simply not accounted for in the present budget process. Congress should revisit the budget scorekeeping rules for the IRS to ensure that they reflect the Service's unique role as administrator of the tax system that funds the rest of the government and interacts with virtually all of the American people. More realistic scorekeeping rules should apply not just to proposed IRS budget increases but to budget reductions as well.

Tax compliance gap.--The commission report describes the IRS as a high-volume, data-intensive financial services organization, which it is to some extent. However, it is also, and some would say primarily, a law enforcement organization. Consistent with its vision, the Restructuring Commission paid little attention to the tax compliance gap. A successful restructuring of U.S. tax administration should ask and answer the following questions: using cost-effective initiatives that are consistent with a reasonable definition of civil liberties, by how much is it possible to reduce the present tax compliance gap, and how would one go about doing so? I do not know the answer to this question, and I suspect that the analysis needed to derive a reliable answer does not presently exist. (Indeed, in some respects our knowledge of the tax compliance gap is shrinking as old TCMP data lose relevance and the Service fails to replace the TCMP with a less burdensome and more accurate way of measuring noncompliance.) Nevertheless, we should put in place a process that produces reliable and widely accepted answers that can become the basis for a serious policy discussion about improving tax compliance.

Congressional oversight

The Restructuring Commission report correctly points out that diffuse and inconsistent congressional oversight makes it difficult for the IRS to set and maintain priorities without appearing unresponsive to Congress. Without presuming to trespass on the sensitive question of congressional committee jurisdiction, let me just say that some self-restraint and centralization of congressional oversight would be helpful, and the report presents a sensible way to do this.

The Restructuring Commission also reviewed GAO's oversight of the Service, both regarding its operational audits and its financial statement audits. In both cases, many Commission members concluded that GAO could improve its performance, although these sentiments were somewhat toned down in the final draft of the Commission's report. I especially commend to your attention the discussion in the report on IRS financial accountability. Each year, the GAO issues a report announcing that it cannot certify the IRS financial statements, and this attracts headlines owing to the inference that the IRS is applying standards of financial accountability to taxpayers that it cannot itself meet. However, the Restructuring Commission report documents that the financial management deficiencies that prevent the Service from obtaining a clean opinion from GAO are largely out of the Service's immediate control, and that GAO appears to have been less than totally cooperative in assisting the Service is getting a clean opinion. The IRS should have a clean opinion on its financial statements, but this should be a joint responsibility of the IRS, GAO, and the other Executive Branch agencies, like GSA, who will need to change their behavior in order for the Service to get a clean opinion under the present GAO standards. The practical significance of the Service's failure to obtain a clean opinion appears to be greatly overstated in much public discussion of the IRS.

Conclusion

The Internal Revenue Service is the one federal agency that interacts with virtually all Americans. It should be a model of public sector management. Congress has a opportunity to build on the Restructuring Commission report to move us closer to this goal; however, it must also be mindful of the fact that the financial stability of our country depends upon a successful tax administration effort and that reform of the Internal Revenue Service should not be a pilot project for untested ideas.