To an IRS Mired in the ‘60s, ‘90s Answers Prove Elusive

Along a dreary row of metal tables, Internal Revenue Service clerks perform what for ages has been the quintessential government job--stamping forms.

The clerks use stampers, like the ones at grocery stores in the 1950s, to imprint a serial number on every tax return. During the spring rush, a few dozen clerks work around the clock here and at each of nine other regional tax centers--nearly 700 clerks pounding away day and night.

This bizarre scene in suburban Cincinnati that might have been pulled out of a Dickens novel of a century ago is instead today’s reality at an agency badly in need of modernization.

Virtually every federal government agency is struggling with outdated technology, but nowhere are the stakes higher or the problems more apparent than at the IRS. The agency is a clear example of just how far the government has fallen behind and how serious the ramifications are for the American public.

This jam did not develop overnight. It has taken more than two decades of poor planning, convoluted federal regulations, inadequate in-house computer expertise, mismanagement and lax oversight by Congress.

As early as the mid-1970s, the IRS began efforts to update its technology, and the agency has since gone through four modernization campaigns. But it has yet to implement an integrated and modern tax-collecting system.

Its latest effort began in 1988 with a projected cost of $8 billion and a completion date of 2000. By last summer, critics say, the cost had ballooned to $20 billion, with no completion date in sight. Many members of Congress have labeled the program a fiasco.

“The IRS has spent $4 billion with nothing to show for it,” said Rep. Jim Ross Lightfoot (R-Iowa), chairman of the House Appropriations subcommittee that controls the IRS budget.

$170 Billion Goes Uncollected in 1995

The size and complexity of the income tax system has always made the IRS’ job tough. With 106,000 full-time employees, it processes more than 165 million tax returns and collects in excess of $1 trillion a year.

Although the IRS takes exception to the blanket charge that its modernization is a train wreck, it acknowledges that its efforts have gone badly off track.

“The notion that we have nothing to show drives us crazy because it isn’t true,” said Michael P. Dolan, who as deputy IRS commissioner is its top career officer. “But nobody is prepared to say that we did it right the first time.”

Indeed, eight years after launching its modernization program, the IRS has yet to produce a detailed blueprint for its updated tax-collection system. And it has canceled several major parts of the program after sinking hundreds of millions of dollars into them.

A June report by Congress’ General Accounting Office concluded that the IRS’ modernization program “was jeopardized by persistent and pervasive management and technical weaknesses” and that the IRS showed no sign of overcoming them.

The consequences of failure fall heavily on the pocketbooks of taxpayers. With better computers and information technology, the IRS would be narrowing the so-called tax compliance gap, which is the difference between what taxpayers owe and what they actually pay.

Instead, the compliance gap has been growing as the economy grows. By the IRS’ own estimates, it missed collecting about $170 billion in taxes last year--about 14% of what was owed and easily enough to balance the federal budget and give every taxpayer a big tax cut.

Although it isn’t likely that the IRS could collect every cent of that $170 billion annually, the agency itself set a goal under its modernization program to narrow the gap to $110 billion by 2000. So far, it has not made any progress.

IRS Commissioner Margaret Milner Richardson said the agency had created a five-year initiative to improve tax compliance. The IRS was in the process of hiring an additional 5,000 employees when Congress cut its budget and forced it to lay off 8,000 workers.

With better information technology, the IRS probably would alienate fewer Americans. In the 1995 tax year, an estimated 91% of taxpayers’ calls for agency help in filing a return never got through, according to a GAO examination.

Taxpayers gave the IRS the lowest satisfaction rating among 200 private-sector companies and government agencies in a recent survey conducted by the University of Michigan Business School and ASQC, a Milwaukee-based firm. The IRS rating in 1996 plunged even lower than in two prior surveys in which the agency was also at the bottom.

IRS officials insist that the picture is improving. At a new toll-free telephone center, for example, IRS representatives have a data-retrieval system that allows them to access returns online to help resolve problems. For the average taxpayer, however, there is one problem: The telephone number is unlisted, and the IRS gives it only to select taxpayers with special needs.

Congress Loses Patience with Program

All this comes too late for Congress, which has lost its patience after years of relatively benign oversight of the IRS. In past years, the Democrats who controlled Congress seldom penalized the IRS for the slow pace of technology modernization and instead consistently granted the agency annual budget increases.

Earlier this year, however, Republicans who gained control of Congress in the 1994 elections slashed funding for the modernization program from the requested $850 million to $274 million for the budget year that began Oct. 1. Overall, Congress eliminated $1 billion from the agency’s budget request of $8.2 billion.

The cutbacks were only the first step in what probably will be major reforms at the agency, largely stemming from its technology failures. A national commission on restructuring the IRS is preparing recommendations.

Under legislation written by Lightfoot and enacted last fall, the IRS must cut all but 150 of its 2,016 jobs on the modernization program and turn over the work to private contractors, “putting it in the hands of folks who know how to get the job done. It’s clear after eight years and almost $4 billion spent that IRS cannot handle the job,” Lightfoot said.

A House Appropriations Committee report issued earlier this year concluded, “Unfortunately, there is only modest evidence that concrete actions for improvement have been taken. . . . It appears while there is much movement at the IRS, there is no discernible forward progress.”

Private contractors say the IRS has consistently resisted the advice and ideas of outside experts.

“The IRS underestimated the complexity of the challenge,” said a senior executive at a major information technology firm working for the agency. “The IRS decided that a large IRS work force was the way to do this job. They hired more of the same kind of people they already had without investing in new skills.”

Competing fiefdoms within the agency have battled over the shape of the modernized tax system and, in some cases, fought against it, further jeopardizing the project, the executive added. And the IRS is so focused on the short-term pressures of annual tax collections that it has failed to devote attention to long-term goals.

Like many federal agencies, the IRS failed to step back and examine how technology could reshape its mission. Rather, it has sought to automate old and inefficient processes that have changed little since the 1960s.

Heavy Reliance on Paper Operations

Although much of the American economy already is underpinned by electronic financial systems, paper operations still dominate the IRS, which--with its $1.3 trillion in annual revenue--is in one sense the nation’s largest financial institution.

The agency acknowledges that if it has any hope of improving efficiency, cutting costs and reducing tax fraud, it must move toward electronic submission of tax returns. Such returns have far fewer errors, are easier to audit and require far less manual labor to handle.

The 700 clerks stamping serial numbers would be gone. So would thousands of low-tech jobs removing staples from returns, holding envelopes up to bright lights to make sure stray forms are not hidden inside and typing mountains of data into mainframe computers.

The IRS, with bright visions of a paper-free tax system, had set a goal of collecting 80 million tax returns electronically by 2001. But its own estimates now show that as few as 39 million returns will be collected electronically--just 17% of projected returns in that year and not much of an increase from the 12.6% filed via computer or telephone this year.

Among its signal failures, according to a lengthy GAO audit, is Cyberfile, a system the agency had hoped to start up this year to allow taxpayers to file electronic returns directly through the Internet. It had to abandon Cyberfile abruptly after the GAO found that the program jeopardized the confidentiality of taxpayer information. The agency had sunk $17.1 million into the troubled program before terminating it last summer.

The IRS also recently canceled its ambitious, $1.3-billion document-processing system, which was intended to be a cornerstone of automation by allowing documents to be scanned electronically into mainframe computers. The agency poured $300 million into the effort before abandoning it.

An earlier generation of scanner, known as Scripts, also got off to a rocky start two years ago, processing about half the returns the IRS had counted on. The system is operating more reliably now, but it takes a crew of up to 63 clerks at computer terminals to correct the errors Scripts makes in extracting data from the documents. Moreover, Scripts can scan only one-sided documents and thus cannot read two-sided 1040 tax returns.

These missteps are part of a problematic history of IRS efforts to improve its systems that began in the 1970s with a program known as the tax administration system, according to Shelley Davis, a former IRS historian who has written a soon-to-be-published book on the agency.

The IRS abandoned that effort by 1978 in favor of its equipment replacement and enhancement program. After a political outcry erupted over the agency’s plan to “enhance” its power, it changed course again and embarked on the equipment replacement program. By 1988, the IRS had started its current effort, tax system modernization.

“None of these improvement efforts came to fruition, except for some hardware replacements,” Davis said. “There has been no fundamental change in the manner that tax returns have been processed since the early 1960s.”

A standard 1040 return mailed to the IRS by a standard taxpayer goes through a dizzying process of paper handling. Envelopes must be opened, forms routed to different sections and inspections made to ensure that the returns are complete. At the end, data are key-punched into mainframe computers.

The IRS calls this its “pipeline.” But like the water mains and sewers in old East Coast cities, crud is building up on the inside of the pipes.

The mainframe system, known as the masterfile, can absorb only 44% of the data from the tax return. Those data are transmitted to a central computer facility in West Virginia, where they are subject to an automated examination for clues that might reveal cheating. The rigor of that examination is less than what the IRS could achieve with a more modern and robust system.

With only 44% of the data, the masterfile cannot cross-check much of the data reported on 1040s and submitted by other sources to make sure taxpayers are not hiding income. Asked, for example, if the computer automatically checked for capital gains when a taxpayer stopped reporting a dividend listed on a prior return, Dolan remarked, “I think I’d better stop talking.”

Dolan said newer technology should also speed up audits and examinations that typically do not begin until two years after a taxpayer files a return.

System Frequently Breaks Down

The shortcomings can’t be fixed with just a new mainframe.

“Our issues are not only in the age of the equipment but the applications that run on the equipment,” said Arthur Gross, the IRS’ new director for its computer modernization efforts. “In some cases, they are older than the equipment.”

Indeed, the IRS’ main software system for storing and analyzing taxpayer data, the masterfile, dates back 30 years. The software is written in machine assembly code, an obsolete computer language that apprentice programmers are no longer taught.

As Congress passes new tax laws each year, that massive body of software must be constantly revised, and programmers who can do the revisions are hard to find. Gross says the agency is retraining programmers who know Cobol, a relatively newer computer language, to do the revisions.

Much like the IRS’ nine other service centers, the Cincinnati-area center has a lot of computer hardware that could be displayed in a museum. The center’s check-processing machinery, for example, was built by Burroughs Corp., a Detroit-based computer manufacturer that disappeared 10 years ago in a merger with Sperry Rand.

“It is an outdated system that breaks down frequently,” said John Ressler, director of the Cincinnati center. “When it breaks down, our processes stop.”

Only a few steps away, Ressler has equipment that shows what new technology could do. It’s the IRS’ “Telefile” system, which allows taxpayers with the simplest return--the 1040EZ--to file by telephone. The system rejects returns that are not complete, eliminating the need for the agency to hound taxpayers about error-ridden forms.

The Cincinnati center processes about 14 million individual tax returns every year--about 10 million paper and 4 million electronic. To handle the deluge of paper returns, the center hires 2,600 seasonal workers each spring. The electronic returns are handled with a crew of 30 to 40, Ressler said.

“We are finding it increasingly difficult to recruit workers, and technology was supposed to be the answer,” he said. “But if we don’t get the money for modernization, then it becomes problematic.”

In response to the budget cutbacks ordered by Congress, the IRS is reassessing the entire modernization program and cutting back its scope, an IRS spokeswoman said. Exactly which parts of the program will be axed remains undecided.

Political attacks on the IRS, coupled with the agency’s own technological problems, have undermined morale. One employee at the Cincinnati center said low wages, fast-paced work and constant equipment breakdowns have damaged worker motivation.

Davis, the former IRS historian, says the agency’s problems are far more serious than generally recognized. The agency, she warns, is risking a breakdown of taxpayer compliance.

“The rivets are popping off the ship,” she said.

But Dolan says the IRS sees no evidence of such a crisis. IRS officials assert that the United States enjoys the highest rate of voluntary tax compliance in the world. Nonetheless, he acknowledges that the agency is not unmindful of the potential consequences of its problems.

“Clearly, there is a risk if the public perceives the IRS is not efficient or effective. The game is a moving set of pieces.”

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A Taxing Process

The IRS service center in Cincinnati handles both paper and electronic tax returns. Each winter, the center hires about 2,500 temporary workers to handle about 10 million paper returns. For the 4 million electronic returns it handles, it has a staff of about 30 to 40.

PAPER RETURN

An abbreviated look at how the service center processes a 1040 paper return:

1. Four to five tractor-trailer trucks per day haul in tax returns to the loading dock at the Cincinnati service center.

2. Envelopes are opened and money is counted. About 20% of the returns include a check for annual taxes.

3. Returns are sorted by type at 136 Tingle Tables, named for the industrial engineer who designed them in the 1960s.

4. Serial numbers are applied to each return by clerks with manual stampers, much like the ones grocery stores used in the 1950s.

5. The returns are individually checked for completeness and edited at the “Document Perfection Branch.”

6. Data from the returns are key-punched by clerks. About 16% of returns contain errors--about half of them caused by taxpayers and about half by IRS key punchers.

7. Taxpayer data are downloaded to a nearby tape drive; periodically during the day, the tapes are transported to a secure computer room, where the data are again transferred to another local computer.

8. The entire day’s processing is transmitted over secure phone lines to the IRS computer center in Martinsburg, W.Va. The IRS then performs an examination of the returns, using a secret formula to ferret out cheats.

9. Tax refund data are sent by computer tape to the Treasury Department Disbursing Center. If tax is still owed, the service center mails a “balance due” notice to the taxpayer.

10. The paper returns are sent to the federal records center in Dayton, Ohio, where they are kept from six to 10 years before they are destroyed.

ELECTRONIC RETURN

An abbreviated look at how the IRS service center processes a 1040 electronic return:

1. Tax preparers electronically file returns via telephone lines to a special computer modem at the Cincinnati service center that is open only to about 20,000 authorized preparers. The computer automatically rejects returns that contain errors, then notifies a tax preparers if the return was rejected.

2. Data from the computer are downloaded to a tape drive, then reloaded to a second computer system, providing a physical break for security between the receiving computer and the center’s main processors.

3. A second examination for errors is done during batch processing at night. The returns are then transmitted over secure phone lines to Martinsburg, W.Va., where they are handled the same way as paper returns.

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About This Series

The Times is running a three-part series examining the long history of failure in the federal government’s information technology programs. Government operations generally depend on computers and software systems purchased in the 1960s that are badly antiquated and seriously undermine government efficiency.

SUNDAY: The $300-billion investment in information technology that has flopped, jeopardizing the nation’s welfare, eroding public safety and squandering untold billions of dollars. The problems extend to virtually every agency, court and the Congress.

TODAY: The Internal Revenue Service’s troubled attempts to modernize its computer systems, which have led to the expenditure of $4 billion with marginal results so far in the agency’s ability to track down tax cheats. Another organization, the Defense Mapping Agency, spent a decade developing a $2.6-billion computer system that was obsolete by the time it was completed.

TUESDAY: The intensive effort to reform the system, which includes four major pieces of legislation enacted to streamline cumbersome federal regulations and raise the priority of information technology in the government.