ADMINISTTUTION'S HSCAL YEAR 1994 BUDGET
PROPOSALS FOR THE BUREAU OF ALCOHOL,
TOBACCO, AND HREARMS; U.S. TAX COURT;
AND INTERNAL REVENUE SERVICE
Y 4. W 36: 103-34
AdniiistratioR's Fiscal Year 1994 B...
HEARINGS
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
OF THE
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRD CONGRESS
FIRST SESSION
APRIL 22 AND 28, 1993
Serial 103-34
Printed for the use of the Committee on Waya and Means
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U.S. GOVERNMENT PRINTING OFFICE
70-792 CC
WASHINGTON : 1993
For sale by the U.S. Govemmenl Printing OITicc
Supeniilciiil
cm of Documents. Congressional Sales OtTice. Washington. DC
ISBN 0-16-041803-8
20402
/ ADMINISTRATION'S HSCAL YEAR 1994 BUDGET
PROPOSALS FOR THE BUREAU OF ALCOHOL,
TOBACCO, AND HREARMS; U.S. TAX COURT;
AND INTERNAL REVENUE SERVICE
( 4. W 36: 103-34
idniBistratioR's Fiscal Year 1991 B. . .
HEARINGS
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
OF THE
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRD CONGRESS
FIRST SESSION
APRIL 22 AND 28, 1993
Serial 103-34
FVinted for the use of the Committee on Ways and Means
Mh 1
U.S. GOVERNMENT PRINTING OFFICE
70-792 00 WASHINGTON : 1993
lor sale h\ the I'.S. Govcmmenl Priming OITkl
Superinicndcni of Docuinenis. Congressional Sales OITice, Washington, DC 20402
ISBN 0-16-041803-8
COMMITTEE ON WAYS AND MEANS
DAN ROSTENKOWSKI, Illinois, Chairman
SAM M. GIBBONS, Florida
J.J. PICKLE, Texas
CHARLES B. RANGEL, New York
FORTNEY PETE STARK, California
ANDY JACOBS, Jr., Indiana
HAROLD E. FORD, Tennessee
ROBERT T. MATSUI, California
BARBARA B. KENNELLY, Connecticut
WILLIAM J. COYNE, Pennsylvania
MICHAEL A. ANDREWS, Texas
SANDER M. LEVIN, Michigan
BENJAMIN L. CARDIN, Maryland
JIM MCDERMOTT, Washington
GERALD D. KLECZKA, Wisconsin
JOHN LEWIS, Georgia
L.F. PAYNE, Vii^nia
RICHARD E. NEAL, Massachusetts
PETER HOAGLAND, Nebraska
MICHAEL R. MCNULTY, New York
MIKE KOPETSKI, Or^on
WILLIAM J. JEFFERSON, Louisiana
BILL K. BREWSTER, Oklahoma
MEL REYNOLDS, Illinois
BILL ARCHER, Texas
PHILIP M. CRANE, Illinois
BILL THOMAS, California
E. CLAY SHAW, Jr., Florida
DON SUNDQUIST, Tennessee
NANCY L. JOHNSON, Connecticut
JIM BUNNING, Kentucky
FRED GRANDY, Iowa
AMO HOUGHTON, New York
WALLY HERGER, California
JIM McCRERY, Louisiana
MEL HANCOCK, Missouri
RICK SANTORUM, Pennsylvania
DAVE CAMP, Michigan
Janice Mays, Chief Counsel and Staff Director
Charles M. Brain, Assistant Staff Director
PHILUP D. MoseLEY, Minority Chief of Staff
SUBCOMMnTEE ON OVERSIGHT
J.J. PICKLE, Texas, Chairman
HAROLD E. FORD, Tennessee
CHARLES B. RANGEL, New York
WILLIAM J. JEFFERSON, Louisiana
BILL K. BREWSTER, Oklahoma
GERALD D. KLECZKA, Wisconsin
JOHN LEWIS, Geoigia
AMO HOUGHTON, New York
WALLY HERGER, California
MEL HANCOCK, Missouri
RICK SANTORUM, Pennsylvania
(II)
CONTENTS
Press release of Friday, April 16, 1993, announcing the hearings
WITNESSES
Page
2
U.S. Tax Court, Hon. Lapsley W. Hamblen, Jr., Chief Judge, and Charles
S. Casazza, Clerk of the Court 6
U.S. Department of the Treasury:
Bureau of Alcohol, Tobacco and Firearms, Stephen E. Higgins, Director,
Daniel Black, Deputy Director and Associate Director, Office of Compli-
ance Operations; and David C. Troy, Chief of Intelligence Division,
Office of Law Enforcement 28
Internal Revenue Service, Michael P. Dolan, Acting Commissioner; David
G. Blattner, Chief Operations Officer; Philip G. Brand, Chief Financial
Officer; Henry H. Philcox, Chief Information Officer; and Lee R. Monks,
Acting Taxpayer Ombudsman 115
SUBMISSION FOR THE RECORD
U.S. General Accounting Office, Jennie S. Stathis, Director, Tax Policy and
Administration Issues, General Government Division, statement and at-
tachments 256
(in)
ADMINISTRATION'S FISCAL YEAR 1994 BUDG-
ET PROPOSALS FOR THE U.S. TAX COURT
AND THE BUREAU OF ALCOHOL, TOBACCO
AND FIREARMS
THURSDAY, APRIL 22, 1993
House of Representatives,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, D.C.
The subcommittee met, pursuant to notice, at 9:34 a.m., in room
B-318, Raybum House Office Building, Hon. J.J. Pickle (chairman
of the subcommittee) presiding.
[The press release announcing the hearings follows:]
(1)
FOR IMMEDIATE RELEASE
FRIDAY, APRIL 16, 1993
PRESS RELEASE #8
SUBCOMMITTEE ON OVERSIGHT
COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES
113 5 LONGWORTH HOUSE OFFICE BLDG.
WASHINGTON, D.C. 20515
TELEPHONE: (202) 225-5522
THE HONORABLE J. J. PICKLE (D. , TEXAS), CHAIRMAN,
SUBCOMMITTEE ON OVERSIGHT, COMMITTEE ON WAYS AND MEANS,
U.S. HOUSE OF REPRESENTATIVES,
ANNOUNCES A HEARING TO REVIEW
THE ADMINISTRATION'S FISCAL YEAR 1994 BUDGET PROPOSALS
FOR THE BUREAU OF ALCOHOL, TOBACCO AND FIREARMS,
U.S. TAX COURT, AND INTERNAL REVENUE SERVICE
The Honorable J. J. Pickle (D. , Texas), Chairman of the
Subconunittee on Oversight, Committee on Ways and Means, U.S. House
of Representatives, announced today that the Subcommittee will hold
two hearings to review the adequacy of the Administration's fiscal
year 1994 budget proposals relating to the allocation of resources
and the staffing levels for the U.S. Tax Court, Bureau of Alcohol,
Tobacco and Firearms (ATF) , and Internal Revenue Service (IRS) . The
Subcommittee will also examine various budget-related issues
affecting programs under the jurisdiction of these agencies.
The Administration is requesting $35.3 million and 352 positions
for the U.S. Tax Court in fiscal year 1994, an increase of
$2.9 million and no additional positions from 1993 levels. The
budget proposal requests $359 million, user fee receipts of an
additional $5 million, and 4,201 positions for ATF, a total
appropriation decrease of $7.1 million and 60 positions. The
Administration is requesting $7,396 billion and 116,060 positions
for IRS, an increase of $280 million and 792 positions ^rom fiscal
year 1993 levels.
The hearing to review the budget requests for the U.S. Tax Court
and ATF is scheduled for Thursday, April 22, 1993, beginning at
9:30 a.m., in room B-318 Rayburn House Office Building. Witnesses
invited to testify include the Honorable Lapsley W. Hamblen, Jr.,
Chief Judge of the U.S. Tax Court, and Mr. Stephen E. Higgins,
Director of ATF.
The hearing to review IRS's budget request is scheduled for
Wednesday, April 28, 1993, beginning at 9:00 a.m., in the main
Committee hearing room, 1100 Longworth House Office Building.
Witnesses invited to testify at the hearing include
Mr. Michael Dolan, Acting Commissioner of IRS, and representatives
from the U.S. General Accounting Office.
In announcing the hearing. Chairman Pickle stated: "Ten years
ago, IRS employed 82,857 people, had a budget of $2.6 billion, and
collected $632 billion in taxes from the American people. Back
then, the cost of collecting $100 was approximately 42 cents. In
1991, IRS employed 115,628 people and spent $6.1 billion to collect
slightly more than $1 trillion. The cost of collecting $100 jumped
Lo 56 cents. This year, IRS's budgat request totals $7,396 billion,
an increase of about 4 percent. The cost of collecting $100 in 1994
is expected to exceed 60 cents.
"With the implementation of tax systems modernization and
improvements in the area of worker productivity, the cost of
collecting taxes should be decreasing, not increasing. I am
concerned that within the agency, there may be areas of waste and
inefficiency that is prohibiting IRS from operating more
effectively. I intend to ask IRS how it plans to improve its
performance.
"Included within IRS's budget are a series of compliance
initiatives designed to improve voluntary compliance and strengthen
(MORE)
IRS's examination and collection efforts. One initiative will focus
on foreign firms operating in the U.S. that are avoiding taxes
through transfer pricing. I want to know what progress IRS has made
in the past year to ensure that all corporations comply with our tax
laws and pay their fair share of taxes. I also want to know to what
extent transfer pricing cases are clogging-up the Tax Court's
docket.
While the Administration is proposing modest budget increases
for IRS and the Tax Court, ATF is looking at a funding decrease.
I want to know how a cut in funding for ATF will affect its
operations, particularly in light of its responsibility for over
$14 billion in the collection of alcohol and tobacco excise taxes."
DETAILS FOR SOBMISSIOM OF WRITTEN COMHENTS;
Persons submitting written comments for the printed record of
the hearing should submit six (6) copies by the close of business,
Tuesday, May 18, 1993, to Janice Mays, Chief Counsel and Staff
Director, Committee on Ways and Means, U.S. House of Representatives,
1102 Longworth House Office Building, Washington, D.C. 20515.
FORMATTING REQUIREMENTS;
Each statement presented for printin( to the Committee by a witness, any written statement or exhibit
submitted for the printed record or any written comments in response to a request for written comments must
conform to the (uidelines listed below Any statement or exhibit not in compliance with these |uidelines will not
be printed, but will be maintained in the Committee files for review and use by the Committee
1 All statements and any accompanyinj eihibils for printing must b« typed in sin|le space on le{al-size
paper and may not exceed a total of 10 pates
2. Copies of whole documents submitted as exhibit material will not be accepted for printing Instead,
exhibit material should be referenced and quoted or paraphrased All exhibit material not irwetinf tlwse
ipecifications will be maintained in the Committee files for review and use by tht Committee
3 Statements must contain the name and capacity in whKh the witness will appear or, for written
comments, the narT>e and capacity of the person submitting the statement, as well as any clients or
persons, or any orfanization for whom the witr>ess appears or for whom the staterT>ent is submitted.
4 A supplenwntal sheet must accompany each sutemenl lislin| the narrw, full address, a telephone
number where the witness or the desi|n<ted representative may be reached and a topical outline or
summary of the comments and recomrT>cndations in the full statement This supplemental sheet will
not be included in the printed record
The above restrictions and limitations apply only to material being submitted for printing Statements and
exhibits or supplementary material submitted solely for distribution to the Members, the press and the public
during tt>e course of a public hearing may t>e submitted in other forms
Chairman PiCKLE. The committee will come to order.
Judge Hamblen, you may take your seat at the witness table.
Judge Hamblen. Thank you, Mr. Chairman.
Chairman PiCKLE. Today the subcommittee will discuss the fiscal
year 1994 budget proposals and related program operations of the
U.S. Tax Court and the Bureau of Alcohol, Tobacco and Firearms,
the so-called ATF.
Today's hearing is part of the subcommittee's annual oversight
review of agencies under the committee's jurisdiction. The sub-
committee will hold its hearing on IRS' fiscal year 1994 budget
next Wednesday.
I want to say at the beginning that we have got two groups to
hear from this morning, the U.S. Tax Court and the Bureau of Al-
cohol, Tobacco and Firearms. By agreement, we will hear and visit
with the U.S. Tax Court and Judge Hamblen first. After that, then
we will hear from the Director of ATF, Mr. Higgins.
I want to say to the members that they will be limited to 5 min-
utes in their aiscussions, and if time permits, we will go back for
a second round. But we may be on limited time.
First let me talk about the U.S. Tax Court. I am pleased that
Chief Justice Hamblen will be appearing and is appearing before
our subcommittee today. This will be his first appearance before
this committee since his appointment as the Chief Judge of that
court, and his appointment was in June of 1992.
The U.S. Tax Court provides taxpayers with a forum for the judi-
cial resolution of tax disputes with the Internal Revenue Service.
The court is not only a forum for high-powered lawyers to argue
on behalf of wealthy clients; it has also functioned in many in-
stances as a sort of people's court where taxpayers can represent
themselves without the strictures of formal rules of evidence or
procedure and where taxpayers can go to court without first paying
the taxes in dispute.
Over the past year, the court has continued to reduce its inven-
tory of cases from 84,000 cases at the end of fiscal year 1986 to
45,000 cases at the end of fiscal year 1992. It is important that we
again review the activities of the court and take notice of its suc-
cesses, as well as any problems that arise.
With respect to the Bureau of Alcohol, Tobacco and Firearms, I
want to welcome Director Higgins, who will be here shortly, be-
cause we agreed that he would be a few minutes late.
As chairman, I and, I think, members of this committee will re-
serve any final judgment about the tragic events at Waco, Tex.,
until more information is made available, and we may conduct ad-
ditional hearings later if the facts so develop.
For the pubfic's information, I am inserting in the subcommit-
tee's hearing record and making available to the press and the pub-
lic, copies of the affidavits filed by the ATF in support of the arrest
and search warrants in Waco. Copies of these affidavits are made
available on the press table and at the members' table in the event
that you want a copy of that affidavit as so filed.
I want to also clarify that today's hearing was planned a month
ago, well in advance of this past week's events.
Of course, I want to express my sorrow to Director Higgins and
to the ATF for the loss of life that occurred when that tragic raid
took place. To the families of the ATF agents who were killed as
well as the family members of the Branch Davidian followers and
the children who perished in that compound, I do express my deep-
est sympathy. This was a tragic and a sickening event that should
cause all of us to reexamine our Nation's purpose and meaning,
and our futures as citizens of this great country.
For many of the new members of this subcommittee, today's
hearing will be the first opportunity to discuss ATF operations with
the Director. Under the administration's proposal, ATFs budget in
1994 would be $364 million, slightly less than current levels. In
1994, ATF will collect over $14 bilHon in taxes. I beUeve that ATF
must maintain a strong presence in the various industries it regu-
lates to ensure that this tax revenue is not put at risk. ATF has
substantial duties to undertake with its 4,200 employees and $364
million budget. I hope that they are not spread too thin.
ATF has jurisdiction over enforcement of alcohol, tobacco and
firearms taxes and the National Firearms Act, which are matters
under the jurisdiction of this committee. ATF has responsibility for
crime control laws, alcohol product safety, arson investigation, ex-
plosives storage, and more which are handled by other committees.
Because of recent events and the horrible tragedy that occurred,
serious questions must be answered by the ATF, by the FBI, and
by local and State authorities. I hope we could explore today's ATF
jurisdiction, what is their authority, at what point do they get in-
volved, and who makes the final decision on when to make a raid,
execute orders, or enter into negotiations.
In my opinion, the biggest error in Waco was that it went on too
long. For nearly 1 year, we have known that the group was violat-
ing firearm and tax laws. And yet, from the affidavits filed, it is
clear and unmistakable that the ATF allowed this group that had
come together to continue to violate our laws.
The leader of that compound was a nut, and his followers agreed
to live with a nut. I guess that is permissible. But when people
come together in a manner such as they did, they must obey the
law. And, if enforcement efforts are delayed too long, it is inevi-
table that death and destruction will occur. That is what happened.
It is obvious to me from the affidavit that the ATF had a plant
within the compound. At the same time, it appears that there was
a plant in the law enforcement ranks. While you can argue about
whether this is true, they knew what you were doing, and you
knew what they were doing. And, on February 28, they were fully
armed and dressed in battle fatigues when the raid occurred.
Why did you insist on going forward with the raid, knowing that
you were outgunned and probably would be possibly mowed down
and have to withdraw?
Well, I want to ask the witnesses this morning to provide this
committee with their honest evaluations of their agencies and the
answers to some of these questions. We will proceed forward in an
orderly procedure.
But I first want to recognize Mr. Houghton for any opening re-
marks he might want to make on this subject.
Mr. Houghton.
Mr. Houghton. Thank you, Mr. Chairman.
Well, I am delighted to be with you here. This is the first time
I have had an opportunity to review the operations of your court,
Judge Hamblen, I am delighted to be here with you.
Judge Hamblen. Thank vou.
Mr. Houghton. I consider this man one of the great chairmen,
so this is an honor, being associated with him.
The U.S. Tax Court and the BATF are probablv the best kept se-
crets around here. You do your work in private, behind the scenes.
You try to stay out of the public eye. But obviously with the tragic
events, human events, that took place in Waco, Texas, that is no
longer possible.
I am not going to make any comments, Mr. Chairman, about the
BATF at the moment. I think I will just wait for Mr. Higgins to
appear.
I would like to mention something about the U.S. Tax Court,
though. It seems to me that one of the things that we will be look-
ing at and inquiring about is your mission. What is your mission?
Is it the same as it was last year? Are you geared to do the things
which you think are important in the future?
As I see it, you have a staffing level which is basically un-
changed. You have a falling workload, and yet you asked for in-
creased funds. So the question is: What are you trying to do, and
what are the things you see coming around the corner that will af-
fect your operation?
So, Mr. Chairman, thank you very much. I would like to ask
some questions later on, but I would like to turn it back to you.
Chairman Pickle. Judge Hamblen, I think the best way to pro-
ceed now is for you to make your statement, and we may ask you
questions thereafter. If you will proceed, sir, we welcome you to the
hearing.
STATEMENT OF HON. LAPSLEY W. HAMBLEN, JR., CHIEF
JUDGE, U.S. TAX COURT, ACCOMPANIED BY CHARLES S.
CASAZZA, CLERK OF THE COURT
Judge Hamblen. Thank you, Mr. Chairman, and members of the
subcommittee.
My name is Lapsley W. Hamblen, Jr., and I am the Chief Judge
of the U.S. Tax Court. With me today is Mr. Charles S. Casazza,
the Clerk of the Court.
I am pleased to accept your invitation to testify here today con-
cerning the Tax Court's caseload, the Tax Court's appropriation re-
quest for the fiscal year 1994, the increase in the dollar amount in
dispute at the court, and the Section 482 cases.
I would like to make a few remarks, if that is your pleasure this
morning, and then try to answer any questions which you might
have. Also I would ask that my written statement be made part of
the record of the hearing.
Chairman Pickle. That will be granted. Judge.
Judge Hamblen. Thank you, sir.
Let me begin with a brief report of the Tax Court's caseload. In
this regard, I am happy to report, as you have noted, Mr. Chair-
man, that for the sixth straight year, the court has experienced a
yearend decrease in its caseload. I am also happy to report that
this trend is continuing in the current fiscal year.
As you know, the Tax Court's inventory reached a historical
monthend high in October of 1986, when there were 84,007 cases
pending at the court. As of the end of last month, the figure was
down to 41,123, and this represents a reduction of nearly 43,000
cases, or over 50 percent during this time.
To the extent that the short-term future can be predicted, we an-
ticipate that the Tax Court's inventory will continue to decline, but
we do not expect that any future decrease will be as large either
in terms of numbers or percentages as that of the past 6 years.
I would like to turn now to the Tax Court's budget request for
the fiscal year 1994. The court has submitted an appropriation re-
quest of $35,350,000 and 350 permanent positions. This request
represents a $2,915,000 increase over the appropriation for the last
fiscal year, but no increase in the number of permanent positions
has been requested.
We are satisfied that if the Congress endorses the full amount
of our appropriation request, the Tax Court will have the resources
necessary to fulfill its mission. While we remain fully committed to
further reductions in our caseload, our paramount goal must nec-
essarily be the disposition of cases in a fair, just, and expeditious
manner.
At this point, I would like to say a few words about a very inter-
esting phenomenon which the Tax Court has witnessed over the
course of the last 3 or 4 years, and this phenomenon involves an
inverse relationship between the inventory of our cases and the ag-
gregate dollar amount of deficiencies in dispute. In other words, as
the court's inventory has steadily fallen, the dollar amount in con-
troversy has dramatically increased.
I think a few pertinent statistics will aptly illustrate this devel-
opment. At the end of the 1986 fiscal year, as the Tax Court's case
inventory was about to crest at the 84,000 mark, the dollar defi-
ciencies in dispute amounted to about $16.3 billion. Today, how-
ever, while the court's inventory hovers at around 41,000 cases, de-
ficiencies in dispute have increased to about $34.3 billion. Now this
difference, some $18 billion, represents a 110 percent increase, and
the vast majority of this increase, some $16 billion, has come since
the end of the 1989 fiscal year.
The increase in the aggregate dollar amount in dispute is attrib-
utable to an increase in the number of large cases ana in particular
to an increase in the number of what we call jumbo cases, and
these are cases in which the deficiencies in dispute exceed $10 mil-
lion.
Currently the Tax Court's inventory includes 301 jumbo cases.
This number amounts to less than 1 percent of the court's caseload,
yet these 301 iumbo cases account for over 85 percent of the aggre-
gate dollar deficiencies in dispute at the court.
The number one challenge faced by the Tax Court during the
1980s was managing the sheer size of its docket. The number one
challenge of the 1990s very well may prove to be managing the ag-
gregate dollar amount in dispute.
The court recognizes that it must carefully balance its resources
between the large cases and the smaller ones. Although the large
cases are relatively few in number, they demand attention because
of the very substantial deficiencies in dispute.
8
In contrast, the dollar magnitude of the smaller cases is rel-
atively modest. But these cases demand attention not only because
of their very number, but more importantly in order to maintain
the confidence of the taxpajdng public in our system of taxation
and our judicial system.
Finally I would like to say a few words about the Section 482
cases. More often than not, the jumbo cases which are commenced
in the Tax Court involve Section 482 and present various foreign
income and transfer pricing issues. Like the jumbo cases in gen-
eral, Section 482 absorb significant judicial resources.
The Tax Court believes that the solution to the problems pre-
sented by the Section 482 cases, as well as by the jumbo cases in
general, lies in innovative management initiatives, and the court
has already instituted significant case management strategies to
effectively control the scope of these cases and the judicial time in-
volved in deciding them.
For example, the court has instituted a procedure permitting the
assignment of a judge almost immediately after a large case is at
issue. Another initiative involves alternative dispute resolution,
and the court has amended its rules of practice and procedure to
authorize expressly the use of voluntary binding arbitration, and
we are actively promoting and encouraging arbitration as a dispute
resolution technique.
In addition, the court has amended its rules to permit the
nonconsensual deposition of expert witnesses. In this regard, the
court believes that the knowledge and understanding of the opinion
of an adversary's expert not only enhances trial preparation, but
facilitates the settlement of cases as well.
Mr. Chairman and members of the subcommittee, this concludes
my remarks. I appreciate the opportunity and privilege to appear
before you today, and I will be pleased to endeavor to answer any
questions which you might have at this time.
[The prepared statement and attachment follow:]
STATEMENT OF LAPSLEY W. HAMBLEN. JR., CHIEF JUDGE.
UNITED STATES TAX COURT
Mr. Chairman and members of the Subcommittee, I appreciate
the opportunity to appear before you today to discuss the Tax
Court's caseload, as well as the Tax Court's budget request for
fiscal year 1994. As requested by Chairman Pickle, I will also
discuss what I see as one of the greatest challenges presently
facing the Tax Court, as well as the Court's experience with
section 482 cases.
DURING FY 1992, THE TAX COURT'S INVENTORY
DECREASED BY 3,998 CASES AND A COMPARABLE
REDUCTION IS EXPECTED IN FY 1993
As of March 31, 1993, the Tax Court's inventory consisted of
41,123 pending cases. This number included 32,685 regular cases,
8,374 small tax cases, and 64 declaratory judgment cases.
Insofar as the age of the cases is concerned, the Tax
Court's inventory is reasonably current. At present, nearly 53
percent of the Court's pending inventory of regular (or non-"S")
cases have been conunenced since January 1, 1991. Insofar as the
small tax cases are concerned, more than 94 percent have been
commenced since January 1, 1991.
The closing of the Tax Court's older cases is generally
dependent on action by some other court, such as action by a
local probate court in an estate tax case, action by a Court of
Appeals in a related tax shelter case, or action by a Bankruptcy
Court. Regarding bankruptcy, it should be noted that the
Bankruptcy Code specifically provides that the filing of a
petition in bankruptcy operates as a stay of "the commencement or
continuation of a proceeding before the United States Tax Court
concerning the debtor." 11 U.S.C. sec. 362(a)(8).
The Tax Court's inventory reached an historical high in
October 1986 when it crested at 84,007 cases. Since that time
the Court's inventory has consistently decreased. However, the
decrease has been less dramatic, but still statistically
significant, during the last two fiscal years, falling from
51,708 cases as of September 30, 1990, to 48,374 cases as of
September 30, 1991 (a 6.4 percent decrease), to 44,376 cases as
of September 30, 1992 (an 8.3 percent decrease). As stated
above, the Court's inventory as of March 31, 1993, consisted of
41,123 cases (a 7.3 percent mid-year decrease).
The Tax Court's inventory presently includes approximately
12,000 tax shelter cases. Most of these dockets will be closed
as soon as test cases, which have been tried and decided by the
Tax Court and subsequently appealed, are disposed of by the
various United States Courts of Appeals. Relatively few new tax
shelter cases are currently being filed.
THE TAX COURT'S BUDGET REQUEST FOR FY 1994 IS
SUFFICIENT FOR THE COURT TO FULFILL ITS MISSION
Earlier this year, the Court submitted to the House and
Senate Committees on Appropriations a fiscal year 1994 budget
request for $35,350,000 and 350 permanent positions. The number
of permanent positions does not represent any increase over the
number for the last two years. The budget request of $35,350,000
represents an increase of $2,915,000 over the fiscal year 1993
appropriation of $32,435,000.
Approximately $1,500,000 of the $2,915,000 requested
Increase is attributable to personnel salary and related
benefits. Another $1,200,000 of such increase is intended for
the replacement of personal computers used primarily by the
judges and their staff, as part of an overall plan to install a
networking system within each chamber.
10
The fiscal year 1994 budget request reflects our best
judgment as to the funds and personnel resources needed to manage
the Tax Court ' s caseload and to continue the progress the Court
has made in reducing its inventory.
The Court has provided the House and Senate Appropriations
Subcommittees having jurisdiction over the Tax Court's budget
with information on the Court's operations and our proposed
expenditures for the 1994 fiscal year. Last month I had the
opportunity of testifying before Congressman Steny Hoyer's
Subcommittee (Treasury, Postal Service, and General Government).
We hope that the Congress will endorse the full amount of our
appropriation request. In our judgment, the Court's fiscal year
1994 budget request of $35,350,000 Is sufficient to operate the
Court efficiently and effectively.
ONE OF THE PRINCIPAL CHALLENGES PRESENTLY FACING
THE TAX COURT IS TO EFFECTIVELY MANAGE THE AGGREGATE
DOLLAR AMOUNT IN CONTROVERSY, WHICH HAS INCREASED
DRAMATICALLY IN RECENT YEARS
As indicated above, the Tax Court's inventory of cases has
steadily decreased in recent years. However, as the number of
dockets has fallen, the dollar amount in controversy has
dramatically increased, particularly over the course of the last
three and one-half years. This inverse relationship between
inventory and deficiencies in dispute presents one of the
greatest Challenges to the Court. The Court is responding to
this challenge with a variety of management initiatives.
By way of statistical background, it should be noted that,
total deficiencies In dispute as of March 31, 1993, amounted to
about $34.3 billion. By comparison, total deficiencies in
dispute at the end of the 1986 fiscal year (shortly before the
Tax Court's inventory reached its historical high) amounted to
about $16.3 billion. The difference, some $18 billion,
represents a 110 percent increase .
Most of the $18 billion increase in the aggregate eunount in
dispute has come during the last three emd one-half years. Thus,
at the end of the Tax Court's 1989 fiscal year (September 30,
1989), total deficiencies in dispute amounted to about $18.3
billion. The increase since that time, $16 billion, represents
an 87 percent rise.
The dramatic increase in the aggregate dollar amount in
dispute is attributable to an increase in the number of large
cases. There are presently 1,365 million-dollar cases pending
before the Tax Court. Of this number, 256 involve deficiencies
in dispute in excess of $10 million, 24 involve deficiencies in
dispute in excess of $100 million, 14 involve deficiencies in
dispute in excess of $250 million, and 4 involve deficiencies in
dispute in excess of $500 million. There are also 3 billion-
dollar cases presently pending before the Tax Court. The single
biggest case involves over $6.5 billion.
The advent of the jumbo cases, and in particular the super-
jumbo cases, is a recent phenomenon. Most of these cases have
only been pending for a relatively short period of time. Thus,
for example, the three billion dollar cases have all been
commenced since 1989; the four half -billion dollar cases have all
been commenced since 1990, and all but one of the 14 quarter-
billion dollar cases have all been commenced since 1989.
The flow of large cases into the Tax Court is likely to
continue, if not increase, for at least two reasons. First, many
tax professionals believe that international tax compllemce will
be the tax Issue of the 1990 's. This belief is supported by the
11
fact that already, more often than not, the jumbo cases in the
Tax Court involve section 482 and present a variety of foreign
source income and transfer-pricing issues. During the recent
presidential election. President Clinton suggested that tougher
tax enforcement would yield an additional $40 to $50 billion over
the next four years from foreign corporations doing business in
the United States. It can be expected, therefore, that the
Internal Revenue Service will maintain, if not increase, its
audit activity in the international arena. In any event, the Tax
Court understands that there are billions of dollars in potential
tax adjustments currently pending in the IRS audit and
administrative appeals pipeline. Although most tax controversies
are settled without litigation, many will inevitably find their
way into the Tax Court.
The second reason that the flow of large cases into the Tax
Court is likely to continue, if not increase, has to do with the
coordinated examination program ("CEP") of the Internal Revenue
Service. Cases having their origins in this prograun involve
deficiencies ranging upwards to $100,000,000 or more and involve
domestic, as well as foreign, issues. In recent years the
Internal Revenue Service has been emphasizing coordinated
examinations and devoting increased resources to CEP cases.
Large cases generally present a multitude of both procedural
and substantive issues. More often than not, these issues are
factually and legally complex. Trials frequently consume four or
more weeks, transcripts run for 1,000's of pages, and exhibits
number in the 100' s. The resolution of arcane factual issues
typically requires the involvement of experts in fields such as
economics, finance, banking, and valuation. Opinions resolving
the issues in large cases can run several hundred pages and take
months to prepare.
Large cases obviously require a major investment of judicial
resources, both at trial and during the post-trial period when
briefs are read, the record is analyzed, and opinions are
written. However, large cases also require a major investment of
judicial resources during the pre-trial period. This is because
large cases become unwieldy without effective case management.
The key to effective case management is the active
involvement by a judge in the case. The Tax Court's experience
demonstrates that the earlier a judge becomes involved in a case,
the greater the benefits become. Of course, early and active
involvement by a judge means that more time and greater resources
must be devoted to a case during its pre-trial stage.
In October 1991, the Tax Court announced a procedure which
permitted the assignment of a judge almost immediately after a
large case is at issue. This procedure differs considerably
from the traditional and routine practice of the Court, by which
judicial officers become involved in cases only after the cases
are calendared for trial. The involvement of a judge at the
outset of a large case makes it possible to streamline the
eventual trial by narrowing the issues, limiting discovery, and
stipulating facts by informal agreement between the parties.
Notwithstanding the time-intensive nature of the large
cases, the Tax Court must also be attentive to the balance of its
docket. After all, the sub-million dollar cases account for
nearly 97 percent of the Tax Court's docket, and the Court's
mandate has always been to provide for the just, speedy, and
inexpensive determination of every case that comes before it.
In particular, the Tax Court wamts to remain "user friendly"
to the small taxpayer who represents himself or herself and whose
claim or contention is as important to such person as that of the
largest corporation with a multi-million dollar deficiency. In
12
this regard it should be noted that taxpayers represent
themselves in over 90 percent of the small tax cases. Insofar as
the regular (or non-"S") cases are concerned, taxpayers represent
themselves in almost 40 percent of such cases. If all cases are
considered in the aggregate, taxpayers represent themselves in
nearly 50 percent of such cases.
In order to keep its docket current and minimize
inconvenience to taxpayers, the Tax Court conducts regularly-
scheduled trial sessions in 78 cities throughout the United
States. Every effort is made to calendar cases for trial within
a year after the petition is filed. In small tax cases the norm
is about six months. In cities such as New York, Los Angeles,
and San Francisco, where the Tax Court's inventory is the
greatest, six 2-week trial sessions are generally scheduled each
year. In addition, special trial sessions are scheduled not only
during the fall, winter, and spring terms of court, but also
during the summer months .
As the foregoing indicates, one of the greatest challenges
facing the Tax Court today is the balancing of its resources
between the large cases and the smaller cases. Although the
large cases are relatively few in number, they demand attention
because of the substantial deficiencies at issue. In contrast,
the dollar magnitude of the smaller cases is relatively modest.
Nevertheless, these cases demand attention because of their very
number. More importantly, the smaller cases demand attention in
order to maintain the confidence of the taxpaying public in the
judicial system in general and in the tax administration system
in particular.
For the Subcommittee's information, an appendix is attached
to this report analyzing the Tax Court's current inventory by
dollar amount in dispute.
CASES INVOLVING TRANSFER-PRICING AND OTHER
SECTION 482 ISSUES, WHILE RELATIVELY FEW IN NUMBER,
CONTINUE TO ABSORB A SUBSTANTIAL AMOUNT OF JUDICIAL
RESOURCES, BUT HAVE NOT PROVEN TO BE PROBLEMATIC
FOR THE TAX COURT IN TERMS OF THE NUMBER OF FILINGS
More often than not, the jumbo cases which are commenced in
the Tax Court involve section 482 and present a variety of
foreign source income and transfer-pricing issues. Fortunately,
this trend has not proven to be a problem in terms of the number
of cases filed, as contrasted with the previous situation in the
tax shelter area.
The Tax Court has adopted a variety of case management
strategies to deal effectively with the scope of section 482 and
other large cases and the judicial time involved in deciding
them. I have already discussed some of those strategies, such as
the Court's procedure for the assignment of judicial officers
almost immediately after large cases are at issue.
Another recent Court initiative involves alternative dispute
resolution. In 1990, the Court amended its Rules of Practice and
Procedure to adopt a new rule, Rule 124, which expressly
authorizes the use of voluntary binding arbitration as a dispute-
resolution technique. In October 1991, former President Bush
issued Executive Order 12778 regarding government civil
litigation. The executive order generally directed government
litigation counsel not to seek, nor agree to use, binding
arbitration, except as to "practice under Tax Court Rule 124".
Accordingly, we have continued to actively promote and encourage
the use of voluntary binding arbitration.
13
Section 482 cases typically present fact-intensi\e issues.
Voluntary binding arbitration under Tax Court Rule 124 lends
Itself to the resolution of such issues. In March 1992, the
first agreement to enter into binding arbitration to resolve a
section 482 case pending in the Tax Court was accomplished when
Apple Computer, Inc. and the Commissioner announced that they
would submit Apple's $340 million case to baseball-type
arbitration under Rule 124. The parties filed a comprehensive
agreement setting out the ground rules for the arbitration.
Under the parties' agreement, arbitration will be conducted
before a three-member panel consisting of a retired Federal
judge, an economist, and an industry expert. Using the baseball
approach, each party will submit a dollar figure and data to
support that figure to the panel. The panel will ultimately pick
one of the two figures presented to it and is not permitted to
substitute a different or compromise figure. If the arbitration
proves successful, we expect that litigants in other large
section 482 cases will submit their cases to arbitration under
Rule 124.
Yet another recent Court initiative involves the deposition
of expert witnesses. In 1990, the Court eunended its Rules of
Practice and Procedure to authorize the nonconsensual deposition
of expert witnesses. Previously, in Estate of Van Loben Sels v.
Commissioner. 82 T.C. 64 (1984), the Court had ruled that such
depositions were not within the scope of the Court's limited
discovery rules as then written. New Rule 76 now overcomes the
former prohibition.
The adoption of Rule 76 is attributable in large part to the
advent of the jumbo case. The Court began to be frustrated by
the inability of litigants to settle disputes where experts
played a major role. Rule 76 is bottomed on the premise that
knowledge and understanding of the opinion of an adversary's
expert enhances trial preparation, minimizes surprise, clarifies
expert testimony, and uncovers the improper use of expert
testimony.
One final initiative which deserves mention involves the
Increased attention which the Court is directing to the use of
experts. Thus, in 1990 the Court amended its Rules of Practice
and Procedure to require, generally, that the parties exchange
expert reports 30 days before trial. In large, complex cases,
however, 30 days does not provide much opportunity to study and
analyze an expert report. Accordingly, the Court may require the
parties to exchange expert reports more than 30 days before
trial. Particularly in section 482 cases, some of the judges
have required that the expert reports be exchanged much earlier.
Judges have also directed that the experts prepare rebuttal
reports and that the rebuttal reports also be exchanged more than
30 days before trial.
CONCLUSION
Mr. Chairman and members of the Subcommittee, I appreciate
the opportunity you have given me to discuss the Court's
inventory and the outlook for our fiscal year 1994 budget, as
well as other matters of mutual interest. We believe that if the
Congress approves the Court's fiscal year 1994 budget request,
the Tax Court will have sufficient resources with which to
satisfactorily fulfill its single mission: the judicial
resolution of Federal tax cases.
On behalf of the Tax Court, I would like to thank the
Subcommittee for its interest in the work of the Court.
14
APPENDIX
United States Tax Cotirt
Inventory by Dollar Amount In Dispute
(as of March 31, 1993)
Aggregate
Dollar Amount Number of Percent of Dollar Total Percent of
— in Issue Dockets Total Dockets (in Billlonst ■ Dollar Total
$1 -
1,000,000 39,758 96.68 $2.1 6.1
$1,000,000 -
10,000,000 1,064 2.59 $3.1 9.0
$10,000,000 -
100,000,000 256 0.62 $7.2 21.0
$100,000,000 -
250,000,000 24 0.059 $3.9 11.4
$250,000,000 -
500,000,000 14 0.034 $4.8 14.0
$ 500,000,000 -
1,000,000.000 4 0.010 $3.1 9.0
$1,000,000,000 - 3 0.007 310 1 29 5
^1.123 100.000 $3473 lOOTo
15
Chairman PiCKLE. We thank you, Judge, very much for your
statement. We do want to proceed now with the questions, and we
will proceed to follow that procedure.
Now, Judge, in fiscal year 1992, for the first time perhaps in sev-
eral years, there had been an increase in the number of cases filed
with the court, and you have just estimated that there would be
an increase in cases filed in fiscal year 1993.
Do you have any idea again of what is causing the increase in
the cases?
Judge Hamblen, Well, perhaps hard economic times, Mr. Chair-
man. That could be one thing.
The other thing could be the fact that the laws are more complex
and get more complex, it seems, every year.
There is no way we can really put our finger on that.
Chairman PiCKLE. Well, are the cases so technical that you can
just expect more to be filed and take longer for a decision? If so,
then your backlog is going to grow bigger and bigger.
Judge Hamblen. Well
Chairman PiCKLE. Are the cases involved ones that pertain to
amortizations of intangibles? Is that a serious problem?
Judge Hamblen. Well, sir, I think it may well be, since the Su-
preme Court yesterday handed down its decision in the Newark
Morning Ledger case.
Now as we understand it, your committee, Mr. Chairman, is pro-
posing a new law which would allow amortization of intangibles,
which could provide a very good relief measure there.
Chairman PiCKLE. Well, are there any particular issues that are
being litigated more frequently than others?
Judge Hambi-EN. Well, we are beginning to see in the estate tax
area something that is really a carryover I think, of many years,
and that is the valuation of closely held businesses, some of the
technical provisions involved in the election to get relief under the
valuation of real estate and closely held businesses.
Chairman PiCKLE. Then you are saying that the valuation ques-
tion is a serious one for the court?
Judge Hamblen. Well, I think it always has been, and hopefully
our remedial provisions for arbitration, if they are employed, if the
taxpayers and the Government will employ i,hem
Chairman Pickij^:. Now I want to ask you some questions about
482. You commented on it, but let me go after it a little bit further.
Last year Judge Nims testified before us that there are approxi-
mately 101 cases docketed in the Tax Court involving Section 482,
the transfer pricing issue.
Now this committee, as you know, has been very interested in
these transfer pricing questions.
Judge Hamblen. Yes.
Chairman PiCKi^. Can you describe for us the experience you
have had with 482 cases for both inbound and outbound taxpayers?
How many of these cases are before the court now? Can you tell
me?
Judge Hamblen. I would have to — I think Mr. Armen — do you
have
Chairman PiCKLE. Can you give me a general estimate?
Judge Hamblen. Excuse me just a minute.
16
Mr. Casazza. There are a total of about 90 section 482 cases, Mr.
Chairman.
Judge Hamblen. Ninety of them.
Chairman Pickle. Ninety. Well, do they threaten to drain your
resources of the court, much like tax shelter cases did?
Judge Hamblen. Yes, sir. Let me give you a good example.
I was the judge in the Sundstrand case, for which we have just
received the decision document, and that case is now through and
perhaps this will help the deficit a little bit with the taxes that are
going to be collected there.
But in any event, it took over a year to get that case ready for
trial, and this was just for 2 years, 1979 and 1980, if I recall cor-
rectly.
Chairman PiCKLE. Well
Judge Hamblen. It took 3 weeks to try it and over a year to get
to an opinion. These are very factual, technical, and legally com-
plex cases, Mr. Chairman, and they do absorb a great amount of
judicial resources.
Chairman PiCKLE. Well, my blunt question would be to you: Is
the IRS outgunned and outmatched in these complex cases?
Judge Hamblen. Let me say this. I think in the Sundstrand
case, the Grovernment really was not ready to try that case. That
is just my personal impression as a judge of the case.
What I saw in cases like the Procter & Gamble case, I thought
the Government was very well prepared, did a very good job. I
think the Government did a good iob as much as it could in the
Sundstrand case, but they did not nave that good a case. But
Chairman PiCKLE. But what?
Judge Hamblen. As a general rule, I think the Government law-
yers do a pretty good job, and some of them do an excellent job.
It is like anything else, Mr. Chairman. You have some that are bet-
ter than others.
Chairman Pickle. The various agencies involved, the IRS £ind
perhaps some from the court, have indicated to us and testified
that they have been outgimned in both witness and the volume of
expert testimony given before the court, and it is involved in for-
eign languages quite often, and it just goes on and on.
And I am trying to ascertain, is this draining the resources of
your court? Is this slowing down your procedure? Do you need more
expert witnesses and more personnel?
Judge Hamblen. No, we do not need any more personnel. There
are — it would be nice sometimes if we could hire our own expert,
perhaps to counter what the parties bring forth.
Chairman PiCKLE. Let me ask you one last question. Last year
Judge Nims testified that your court had before it four cases in-
volving about $8 billion in taxes with the transfer pricing issue re-
lated to the Saudi Arabian oil. In three of these cases, he stated
that trials have been held and the court was awaiting briefs. Has
the court made any decision in these three cases?
Judge Hamblen. Those cases are before Judge Whitaker. It is
my understanding that he is working on them and that the opinion
is in the process of being drafted. That is the Aramco issue, I be-
lieve, that you are referring to, which involves Texaco and Exxon
as petitioners.
17
Chairman PiCKLE. Well, this case has been going on for some pe-
riod of time. How long?
Judge Hamblen. Oh, I would say 3 years at least.
Chairman PiCKLE. And no decision on it yet?
Judge Hamblen. No, sir. And what you must understand, and I
would like for you to understand, Mr. Chairman, is that in a trans-
fer pricing case, you have expert reports. Sometimes you will
have— each side will have three or four experts.
In the Sundstrand case, we had over 2,500 exhibits and around
2,500 pages of testimony after a 3-week trial. And the briefing pe-
riod takes longer because the factual and legal issues are so much
more complex. And I think that is one reason it takes so long to
get to an opinion. You hear the case, and then you must go back
and go through that record after the briefing is done and try to
make findings-of-fact and come up with conclusions-of-law and an
opinion. It is a very laborious, intensive procedure.
Chairman Pickle. Judge, I want you to give us a figure. How
many new 482 cases were filed this past year and the disposition
of the various cases that have been made this past year and how
many are pending? Will you give that to the committee, too?
Judge Hamblen. May I have Mr. Casazza — for the record, could
I have Mr. Casazza answer that, my Clerk?
Mr. Casazza. We can supply it for the record, Mr. Chairman.
Chairman PiCKLE. Yes, I would appreciate that.
Judge Hamblen. We will get that up to you, Mr. Chairman.
[The following was subsequently received:]
The Tax Court docs not maintain statistics with respect to the types of issues
raised by the parties. Nevertheless, I understand from commercial publication
sources that 26 section 482 transfer-pricing cases were commenced in the Tax Court
last year and that 10 such cases have been filed so far this year. I further under-
stand that 89 section 482 transfer-pricing cases were pending as of the end of March
of this year, 74 of which were commenced since 1990. Finally, the Court issued 6
opinions last year in section 482 transfer-pricing cases. Four of those opinions re-
solved dispositive issues, and involved the Sundstrand Corp. and Westreco, Inc., a
subsidiary of Nestle, S.A. The remaining two opinions resolved various procedural
and evidentiary issues, and involved Exxon and Texaco and the Yamaha Motor
Corp.
Chairman PiCKLE. All right. The Chair wants to recognize Mr.
Houghton now for any questions.
Mr. Houghton.
Judge Hamblen. Thank you, sir.
Mr. Houghton. Thank you, Mr. Chairman.
Judge, as you know, this is primarily a budget overview hearing,
and in no way do I want to obstruct justice. But here you have on
one hand the Bureau of Alcohol, Tobacco and Firearms with all
their problems in Waco, suggesting a $9 million cut in their budget,
and your organization, irrespective of the jumbo cases, which has
done a wonderful job in reducing the number of cases on the dock-
ets, asked for even more money.
So what I am asking you is: What are the implications of the
things you are doing?
For example, what about these 482 cases? Do you see now a
greater emphasis on this issue of transfer pricing? It is going to be
very important.
18
Another thing, will some of the President's deficit reduction pack-
age affect your activity? Where, in effect, is the money going to be
spent?
Judge Hamblen. Well, let me say this, Mr. Houghton. About one-
third of the request for the increase would be applied to new com-
puters for judges' chambers for networking in the chambers among
the judges and their law clerks, hopefully to enhance production of
opinions. The opinion process is still a laborious one.
For each case, we are required by statute to give a written re-
port, which means findings-of-fact and an opinion based upon those
facts.
Now we do have bench opinion authority, which we can utilize
for certain small cases and which we do utilize as often as we can
in a simple case.
But the fact of it is, some of our most important issues come from
very small cases. For example, the taxation of welfare benefits in
California; is that taxable income or is it not? That takes a Special
Trial Judge to try that small case and a Presidentially appointed
judge to review it and adopt it because of the importance of the
issue.
Mr. Houghton. Judge, could I just interrupt a minute. I thought
you said that 85 percent of the expenditures were on the big jumbo
cases.
Judge Hamblen. Well, 85 percent of the dollar amount in dispute
is in the jumbo cases, if I recall correctly. In other words, these big,
gigantic cases like the one Chairman Pickle referred to, the Aramco
cases, Exxon and Texaco, aggregate about $8.5 or $8.6 billion. And
that is one reason it is taking so long, because you have a battery
of lawyers in there representing those taxpayers and some of the
best lawyers that the Government could produce up there and add
a full staff of them, and they went at that thing tooth and nail, and
it took a long time to try it, and it is going to take a long time to
decide it because of the complexity of the issues.
We have got, I suppose, 80 to 100 of those cases, Mr. Casazza?
[Affirmative nod.l
Judge Hamblen. And then we have cases like — I think the Fire-
stone estate; that is not a 482 case; that is not a transfer pricing
case. But the deficiency amoimt there is about $850 million. And
that is an estate tax case. And you have to be very careful when
you are dealing with those kinds of figures.
On the other hand, we feel we must be just as careful with the
smallest case that we have, because that small taxpayer, who may
be representing himself, his case is just as important to him as
that Aramco case is to Exxon and Texaco. And we want to give just
as much attention and consideration as we can to those people in
the context of our facilities and our resources. It just does not take
as long with his case.
Mr. Houghton. Thank you, Mr. Chairman.
Chairman Pickle. Thank you, Mr. Houghton.
Mr. Jefferson, do you have any questions?
Mr. Jefferson. Thank you, Mr. Chairman. I only have 1 or 2
questions.
19
If I could take you back a minute to Mr. Houghton's question,
you talked about the need for additional money this year in order
to upgrade the computer system in the judges' chambers?
Judge Hamblen. Yes, sir.
Mr. Jefferson. With the idea that you can get decisions cut
faster.
Judge Hamblen. Hopefully.
Mr. Jefferson. Well, that is what I want to ask you about.
There has been some discussion about the delay in rendering deci-
sions even after the cases have been concluded, just getting a deci-
sion out to the litigants involved.
What is the average time, if you can say, that elapses between
the trial of a case and the issuance of a decision?
Judge Hamblen. All right, sir. We try to get a case calendared
for trial within a year after the petition is filed. When a petition
is filed in the court, the Government has 45 days to respond to that
with an answer. Then in some instances the taxpayer must file a
reply before the case comes to be what we call "at issue".
And then, Mr. Jefferson, depending on the case itself, you have
got discovery, and you have got trial preparation which goes on
during that
Mr. Jefferson. I am really talking about the time after you
have done all of that and the case is decided.
Judge Hamblen. All right. Now when the case is tried, Mr. Jef-
ferson, the parties generally are given 75 days for their opening
briefs, and that is sort of a rule of the court, a rule of thumb, and
they are given 45 days aft^r that for their reply briefs, which is
about 120 days.
And there are other variations. For example, if motions for sum-
mary judgment are filed in the case that might have to be disposed
of, which could extend the time that has to be applied to an indi-
vidual case, but generally the general rule would be 120 days after
trial, the briefs are in and the judge is ready to go to work on the
opinion.
We are trying to have those cases decided within 1 year after
that last brief is filed. Sometimes that cannot be done for a number
of reasons. For example, cases could be involved in bankruptcy.
Automatically any consideration that we can give is stayed by oper-
ation of law. An automatic stay comes in, and there is nothing we
can do until the Bankruptcy Court
Mr. Jefferson. Could I interrupt you for a minute?
Judge Hamblen. Sir?
Mr. Jefferson. Could I interrupt you for a minute?
Judge Hamblen. Yes, sir.
Mr. Jefferson. Certainly where there are intervening cir-
cumstances, that is something extraordinary that you do not have
control over.
I am talking about the cases that do not involve any outside
intervention like that, and I am just trying to get an idea of an av-
erage length of time.
Would you say it is a year from the time that all the briefing has
been concluded? Is that the case?
Judge Hamblen. That is what we shoot for, Mr. Jefferson.
20
Mr. Jefferson. Do you think that is a reasonable goal for the
court to have, a year?
Judge Hamblen. Yes, sir, because it takes — ^you have got a num-
ber of cases, and you sort of take them seriatim, in the order that
thev are put into your inventory after they are tried and briefed,
and you just take them in that order. And some cases take longer
to decide than others because of the complexity.
Mr. Jefferson. If your budget is expanded as you want, what
sort of improvement from a year's disposition time can the commit-
tee expect, can the people expect? Can you quantify it?
Judge Hamblen. Mr. Jefferson, I do not believe we are going to
be able — and that is a goal, the year's time. I think it would be
very difficult to improve on that time because of the nature of the
cases we have to hear and decide. We are the fact-finder; we are
the opinion writer, and it is a laborious, time-consuming process.
Mr. Jefferson. Well, with all respect, if we do not improve on
the time, and the additional money is calculated to improve the
time of decisionmaking, then what do we get for the additional
money?
Judge Hamblen. Well, the only thing we could do is try to im-
prove on that time, Mr. Jefferson. But I just cannot get up here
and assure you that that is going to happen. That would not be a
correct representation for me to make to you.
Mr. Jefferson. I do not have any other questions.
Chairman Pickle. Well, I am going to follow through on that just
briefly and not just with respect to 482.
Mr. Jefferson asked a question about how you handle these dis-
covery cases and dispositions.
Now normallv a deposition is a routine matter, and most courts
can handle and get it quickly out of the way. But under your Tax
Court rules, your rules seem to be so restricted that you cannot get
a deposition unless the taxpayer agrees that employee can give a
deposition, and even if you get that, your rules are — the IIiS has
got to prove that you have got to have extraordinary circumstances.
Now under that environment, it is hard to get a deposition and
hard to make the discovery process move forward.
Why are your rules much more restrictive than a regular court?
Judge Hamblen. Well, let me give you an example, Mr. Chair-
man. I was a law clerk on this court with Judge Atkins back in the
middle 1950s when I just — I came up here from Atlanta, the Re-
gional Counsel's Office of the Internal Revenue Service to be Judge
Atkins' clerk. And as I recall it at that time, we did not have any
discovery rules. Life was much simpler back then, so to speak.
I came into the court in 1982, and all of a sudden I see that they
have got interrogatories, requests for admission, other discovery
tools have come along, and then the deposition area, we sort of
hark back on our old system that says in the Tax Court, Mr. Chair-
man, stipulation and informal discovery is a way of life that has
been going on since its very beginning, and that is generally the
best way to do it.
Now the Federal Courts are requiring mandatory disclosure. We
have always required that.
Chairman PiCKLE. Judge, my question was particularly with ref-
erence to 482. Your laws on the deposition and discovery are so re-
21
strictive that, in my judgment, it puts IRS at a disadvantage, par-
ticularly in 482 cases.
Now your rules are entirely different than a lot of the other
courts, and I want to know why. I do not want to belabor this
point, but it just seems to me that puts IRS at a very definite dis-
advantage.
Judge Hamblen. Well, we have come along, for example in our
rule 76, I believe it is, and you can now — you do not have to have
the consent of anyone to depose the other party's expert. It is called
nonconsensual deposition of an expert witness. And that is on the
books.
And I have said before many tax audiences that as a trial judge
I would have no hesitancy in ordering a deposition of an expert.
We think if they go after these experts in depositions, they can
enhance trial preparation much better, and that is on the books.
It is available to them.
Chairman Pickle. Judge, I do not want to belabor it, but I am
of the definite opinion you have put the Internal Revenue Service
at a great disadvantage because of your rules, and we want to look
into this further with you about why your rules are different than
other courts, particularly on these 482 cases. So we will come back
to that later,
Jud^e Hamblen. Thank you.
Chairman PiCKLE. The Cfhair wants to recognize Mr. Hancock.
Mr. Hancock. Just a couple of questions, a little history on the
Tax Court.
How many judges do we have serving on the U.S. Tax Court?
Judge Hambijcn. Mr. Hancock, by statute, we have 19 judges.
Mr. Hancock. Nineteen, OK
Judge HAMBlJi:N. We have senior judges who retire at age 70
under the various retirement rules, some of whom are recalled,
some of whom are not because of health and other reasons.
Mr. Hancock. Now these numbers of 350 staff positions, that is
the clerks and
Judge Hambij<:n. The clerks. And we have 14 special trial judges,
who are like magistrates, who handle a lot of our small cases and
some of our larger cases that we can assign to them under a Su-
preme Court case called Freytag, and they can handle cases like
tax shelter cases, the mopup of those big tax shelter cases.
Mr. Hancock. OK Now, is the change in the 1986 tax law, is
that the main reason that the number of cases on your docket
started declining? I mean, is that what — the tax shelters — is that
what caused it to decline from, what, 84,000 down to 41,000?
Judge Hamblen. Yes, sir, I think that had a very important part
to play in that.
Mr. Hancock. OK Well, my question is, we have consistently in-
creased the amount of money that we are spending for the funding
of your court, and yet the caseload has declined from 84,000 to
41,000. It looks to me like we ought to be able to cut that expense
about in half
Judge Hamblen. Well, if you wanted to do that, sir, that is
your — I do not think it would help. I think it would just keep us
from getting those cases out. We might cut down to about 50 per-
cent production.
22
These are difficult cases that we try, even the small ones, and
it takes time and resources to do them right. And we are appointed
and confirmed by the Congress to do these things right, and that
is what we are trying to do, sir.
Mr. Hancock. Well, I understand that. But it just would appear
to me that when the workload goes down, that the cost of the oper-
ation ought to go down a little bit, too. Maybe not to that extent,
because I realize, like a business, you know, you have got a break-
even point. But we are asking for additional funding here of what?
Judge Hamblen. Well, we have a lot of things that go on like
continuing salaries, in-grade increases, £ind other nondiscrim-
inatory spending for which we have to budget and which in turn
increases the budget.
The only really discretionary item that we have asked for new,
if I am not mistaken, would be the computer equipment, and that
is about $1.2 million, is it not, Mr. Casazza?
Mr. Casazza. Yes.
Mr. Hancock. Well, let me ask a question. I know that the Presi-
dent's new tax law proposal is somewhat, well, kind of up in the
vapors right now. We do not know exactly what is going to come
out.
Chairman PiCKLE. Me, too.
Mr. Hancock. But if — well, we are going to have a little discus-
sion about whether it comes out the way you think it is going to,
Mr. Chairman [laughing].
Have you had the opportunity — and I am sure you have read the
newspapers and all, have you — in your judgment, would some of
the proposals that the President's budget and his envisioned pro-
gram, would that increase your load, or have you had a chance to
even consider that?
Judge Hamblen. Sir, that is ahead of us, Mr. Hancock. And what
we are trying to do is take what we have got now and move it for-
ward. And we really do not pay too much attention to what the
Congress does with substantive law until it is enacted.
Mr. Hancock. I understand. I am just asking for
Judge Hamblen. I have not given that any
Mr. Hancock. I understand. And I can understand not only why
you would be hesitant to answer a question like that. But is it not
true that the simpler that we could make our tax law, the less
problem you would have?
~ Judge Hamblen. I think that is true. But a lot of tax practition-
ers say: God save us from simplification, because it tends to— it
seems like it tends to become more difficult.
Mr. Hancock. Well, I realize that. If there is anything that
scares me to death, it is when they start talking about tax reform
up here, you know. But let us face it. Something has got to give
before too long.
I do not even know how many tax laws we have got now on the
books in this country. But it has reached the point that I do not
understand how you can make decisions on a lot of these cases in
a year's time, because by the time you get through with it, they
have changed the law. So I guess as long as they are not too retro-
active, we are in pretty good shape.
23
Anyway, I do think that some of us could use some suggestions
from the court on how we could maybe solve some of those prob-
lems in legislation. Here again, I understand the separation of pow-
ers. But we could sure use some suggestions.
Thank you.
Chairman Pickle. Thank you. Mr. Brewster, do you wish to be
recognized?
Mr. Brewster. Thank you, Mr. Chairman.
Judge Hamblen, I missed part of your testimony, so I may be
repetitious in my question here.
Judge Hamblen. All right, sir.
Mr. Brewster. Last year. Judge Nims testified that the court
had amended its rules to authorize voluntary binding arbitration.
Judge Hamblen. Yes, sir.
Mr. Brewster. And that Apple Computer was one of the compa-
nies that was possibly being done that way.
I was curious, how is that working, the voluntary binding arbi-
tration, and what has happened with the Apple case?
Judge Hamblen. It seems to be moving along. What they have,
they have agreed to three arbitrators: a retired Federal judge, I be-
lieve; an economist who is learned in the area of computer tech-
nology; and then a computer technology expert. I believe that is
what their system is.
As I understand it, the arbitrators are being appointed. I have
not talked to Judge Jacobs, who is in charge of that case, but it
is my understanding that that is where it is headed.
And then it should move along fairly fast after that. They are
using what is known as baseball arbitration, in which each side
gives this panel of arbitrators a number, and the petitioners say:
This is how much we owe. And the Government gives them a num-
ber and says: This is how much they owe. And if they are too far
askance either way, I think that panel of experts is going to be able
to pick it up pretty quickly, and it looks like it is going to be a pret-
ty expeditious way to get this settled.
Mr. Brewster. But really in the last year, then, all that has
happened is they have been attempting to appoint
Judge Hamblen. Yes, sir.
Mr. Brewster [continuing]. The arbitrators? OK
Looking at how it works in baseball, it kind of makes you wonder
sometimes.
Judge Hambijcn. Yes, sir.
Mr. Brewster. At the same time, it is my understanding that
Chairman Rostenkowski wrote about a case last year that was
tried in the Tax Court clear back in 1985, and the iudge did not
render a decision for 3 years and 10 months after the trial. Con-
sequently, the penalties and interest exceeded the amount of the
tax. That particular one did not look too complex, in that there was
$31,000 underlying tax, and they ended up with $43,000 penalties
and interest.
Does the court monitor the length of time it takes judges to issue
their decisions?
Judge Hamblen. Yes, sir. What we try to do is have the judges
keep us informed of their inventory, and the chief judge — and then
24
we monitor that and go to that judge and put as much pressure
as we can on him or her to get those cases resolved.
Mr. Brewster. I understood in your statement a moment ago
that on average about a year elapses between the time of the trial
of case and issuance of a decision.
Judge Hamblen. No. From the dates that the briefs are filed,
which is usually 120 days after the trial, the date of decision, a
year after that.
Mr. Brewster. So about a year and 3 months.
Judge Hamblen. A year, 15 months, something like that.
Mr. Brewster. Yes, something like that.
Judge Hamblen. A year to 15 months.
Mr. Brewster. Would it be fair to stop penalties and interest at
the time the judge starts deliberating?
Judge Hamblen. I will leave that to the wisdom of Congress.
Mr. Brewster. I am just asking for an opinion.
Judge Hamblen. It is my imderstanding that the Service does
have the authority now to ameliorate the interest factor, and I as-
sume that they could do that on a case that has been decided. I
would think they could. That is my understanding.
Mr. Brewster. Well, any case that takes 3 to 4 years to decide,
the penalties and interest become very tough —
Judge Hamblen. Yes, sir.
Mr. Brewster [continuing]. On the taxpayer.
Judge Hamblen. Yes, sir.
Mr. Brewster. And that particular point is something that
would kind of stick with me.
Thank you.
Judge Hamblen. Thank you, sir.
Chairman Pickle. Well, Judge, I will make the observation, if
you have got a case in this instance that Mr. Brewster mentioned,
which was worth $31,000, and now after 3 years that the judge has
been considering, and the interest and penalty is more than the tax
at issue, now there has got to be some kind of explanation of why
it takes 3 years to settle a $31,000 case when the interest and pen-
alty is more than the case was originally.
Why would it take 3 years?
Judge Hamblen. Sometimes some judges get an inventory of
cases much larger than the other judges on the court, and we are
trying to work that out now, so that we can transfer cases back and
forth.
Chairman Pickle. Well, that judge
Judge Hamblen. That is about all I can tell you.
Chairman PiCKLE. Well, that is an unsatisfactory answer.
Judge Hamblen. I understand.
Chairman PiCKLE. It just — on the face of it, there is no way to
accept satisfactorily and put yourself at ease, you have got a case
worth that much money and fool around with it for 3 years — now
if you take 3 years and some judge is overloaded, you ought to shift
your cases around. But there is no good explanation for that. At
least, I do not accept that, and it bothers me.
Now let me ask you another question along with
Judge Hamblen. It bothers me, too.
25
Chairman Pickle [continuing]. On the line about the arbitration.
Judge Nims a year ago testified that you all agreed to set up these
arbitration rules. Tha^t should speed things up, and I am encour-
aged, and we were encouraged then. And yet it has taken you a
vear to appoint the arbitrators. That is not much speed, and you
nave not made any kind of decision yet.
Now I think it has a great prospect, but it seems to me like if
it takes you a full year just to make arbitration, I do not know how
much we are going to really gain by using that procedure.
Is that an unfair observation?
Judge Hamblen. Well, sir, let me put it this way, Mr. Chairman.
The parties are the ones who tie up the arbitration and how it is
going to be done. Perhaps we should get more into how it is going
to be done.
Chairman Pickle. I see.
Judge Hamblen. And see if we cannot push these parties to a
better system than the one they have done.
Chairman PiCKLE. Well, I agree with that. I agree with that.
Should we, the Congress, give you a directive on that type of
thing or on any of these issues we are talking about? Would it help
you if you had more authority from us?
Judge Hamblen. Well, I think what we need to do is go back and
look at what we have and see what we are doing wrong or right
now with regard to the Apple Computer case and how long that
case has taken and then come back to you, if we can, Mr, Chair-
man.
Chairman PiCKLE. Well, I would like for you to do that.
Judge Hamblen. We shall.
Chairman PiCKLE. Now let me g^ve you an example of why I am
interested in this type of thing.
The University of Texas School of Law in Austin has just estab-
lished a Center for Public Policy Dispute Resolutions and to pro-
mote alternative ways to achieve a settlement in these kinds of
cases.
The center works with State and local agencies of the courts to
promote these alternative dispute resolution techniques, such as
mediation. This is being practiced through private funding by foun-
dations in other places of the country. Our school has just entered
into it.
I attended a dedication of that center recently. I think it holds
great promise for speeding up and for settlement of cases — our
courts are getting clogged with all kinds of cases, because one side
or the other do not like it and say: I am going to sue you. And the
courts are getting bogged down, and it ends up on your doorstep,
many of them.
Now the question is: Can we get more settlements through alter-
native dispute resolution procedures to help settle some of these
things?
I am hoping that ours in Texas will work well. I believe it will.
I think it is going to take the use of local people to serve as medi-
ators, and we will make some progress.
So my question is: Is there any potential for these alternative
dispute resolution approaches in the Tax Court?
Judge Hamblen. Yes, sir.
26
Chairman Pickle. Expand. Tell me how you intend to work it.
Judge Hamblen. I think if we can — the parties have to agree to
do it, Mr. Chairman, unless you give us authority to compel them
to do it. Now I do not know whether you would want to do that
or not. But there are certain issues which, it seems to me, might
be perfectly — ^be better settled through arbitration than through a
judicial process.
One of them would be a lot of these valuation cases, where you
have closely held stock in a corporation, and the disparity between
the Government's figures and the taxpayer's figures is just enor-
mous. And it seems to me that any case, for example, a reasonable
compensation case, for that matter, any intensely factual case, is
tailor-made for arbitration.
So I think — I think what they are doin^ now at the University
of Texas is very worthwhile. At our judicial conference last year,
we had professors and other people come in and talk to us about
this in the hope that we can encourage litigants before us to do it.
But right now, you cannot force them to do it. You can just en-
courage them very strongly to do it.
Chairman Pickle. Well, I think this committee wants to make
any statement that would be helpful to you.
Judge Hamblen. Yes, sir.
Chairman Pickle. I do not think we want to set a time limit so
that you have got to settle a case within so many months. I do not
think we want to meddle with the due process procedure. I think
we can give language to you to indicate what our feelings are and
how you should proceed.
Perhaps we can work with you to find some ways to help speed
up this process.
I am encouraged that your cases are going down in numbers, al-
though it looks like you may get ambushed on a series of 482 cases.
Section 482 cases have got to be settled more quickly. They are
complex cases. But we have got to find some way to speed them
up, or else we are going to get engulfed in delays.
Judge Hamblen. Yes, sir.
Chairman Pickle. So I want to be working with you, and this
committee will try to find some way to speed up those cases and
try to make some decision and stop the interminable delays.
Of course, we do not want to direct you to make a decision before
you are ready to make it. But we neither want you to proceed like
slow as molasses in Maine.
Judge Hamblen. Yes, sir.
Chairman Pickle. In the wintertime. But somewhere in between
that, we can do a better a job, and I hope that we can.
Let me ask Mr. Santorum, do you have any questions to ask
him?
Mr. Santorum. No.
Chairman Pickle. Did not. Do any other members have any
questions to ask the judge at this point?
[No response.]
Chairman PiCKLE. Well, Judge Hamblen, we thank you. We have
had a great relationship with your court, and you are doing a good
job. We hope it continues. But we are also going to hope that we
can speed up a little on these cases.
27
Judge Hamblen. Mr. Pickle, we look forward to working with
you, sir.
Chairman Pickle. Thank you, sir. Thank you very much.
Judge Hamblen. Thank you, Mr. Houghton.
Chairman Pickle. Thank you. Judge.
Chairman Pickle. Now the Chair will ask the Director of the
ATF, Mr. Higgins, if he will come forward. I understand Mr. Hig-
gins is here.
Mr. Stephen Higgins is Director of the Bureau of Alcohol, To-
bacco and Firearms. You have some people with you. Would you
identify the individuals who will be accompanying you, Mr. Hig-
gins?
Mr. Higgins. I sure will. I have Mr. Dave Troy, who is Chief of
our Intelligence Division in Law Enforcement and Mr. Dan Black,
who is Deputy Director and Head of our Office of Compliance Oper-
ations.
Chairman Pickle. All right. Mr. Black and Mr. Troy, you are
welcome to this committee, too.
Now, Mr. Higgins, at the beginning of this session — earlier when
you were not here, we made opening statements. I will not go
through that statement again.
Mr. Houghton may have some additional statement, because he
withheld any comments until you arrived.
I simply want to say to you that we are not trying to make a
final judgment on who is right and who is wrong on the operation
of your concern. My questioning to you will be budgetary questions,
and also there will be questions with respect to the Waco incident.
But I will touch on those later, since I have already made the
statement.
I do want to recognize Mr. Houghton for any questions he might
want to make or a statement before you commence. Do you want
to make any statement now, Mr. Houghton?
Mr. Houghton. I do not think I need to. Obviously this is a very
sensitive subject. You are on the hot seat; you know it. We want
to be helpful. We do not want to cast blame. We do not want to
point fingers. But we do want to have the information which is im-
portant for us as a committee.
But thank you very much, Mr. Chairman.
Chairman Pickle. Mr. Higgins, and with that, then if you will
proceed, then we will proceed with our questions.
Mr. Higgins. All right.
Chairman Pickle. I personally want to thank you for coming, be-
cause I know that this is a very difficult time for you. But this is
a hearing we had set previously before the events of last week. We
need to talk to you about budgetary figures, and we need to ask
questions pertaining to the great difficulty and ordeal that you
have undergone. So we appreciate the fact that you would come
here under difficult times.
Mr. Higgins. Well, I think that is why they pay me such a high
salary to do this. [Laughter.]
28
STATEMENT OF STEPHEN E. HIGGINS, DIRECTOR, BUREAU OF
ALCOHOL, TOBACCO AND FIREARMS, U.S. DEPARTMENT OF
THE TREASURY, ACCOMPANIED BY DANIEL BLACK, DEPUTY
DIRECTOR AND ASSOCIATE DIRECTOR, OFFICE OF COMPLI-
ANCE OPERATIONS; AND DAVID C. TROY, CHIEF, INTEL-
LIGENCE DIVISION, OFFICE OF LAW ENFORCEMENT
Mr. HlGGlNS. Mr. Chairman and members of the subcommittee,
it is a privilege to appear before you to discuss our 1992 accom-
plishments, our 1993 operations, and our 1994 budget request. And
I also sincerely appreciate your statements of sympathy and sup-
port following the tragic incident in Waco and also your willingness
to wait for final judgment. Many people do not want to wait until
all the information is in, but I think that is the fair way for every-
one involved, and I appreciate your understanding of that.
The resource requirements for ATF in fiscal year 1994 are esti-
mated to be 4,201 full-time equivalent positions and $364,245,000.
That includes a slight program increase of five FTEs and
$1,685,000 to support the Bureau's system modernization program,
an increase of slightly over $8 million to maintain the current level
of operations, offset by reductions of $13,739,00 and 65 positions
associated with nonrecurring costs and other savings for fiscal year
1994.
The user fee proposal included in the President's budget seeks
authorization to establish a user fee program for processing appli-
cations for certificates of alcohol label approvals and conducting
laboratory tests and analyses. The anticipated user fee collections
of $5 million would offset the cost of processing the applications
and conducting the tests, and that would result, tnen, in a final fis-
cal year 1994 appropriation of $359,245,000.
The estimated collections from that user fee are based on current
processing levels, and we assume no dramatic decline in filings due
to the imposition of that fee.
In fiscal year 1993, we have taken a reduction of 43 FTEs, and
in 1994 we are estimating reductions of 60 FTE positions. That will
be spread both through Law Enforcement and Compliance. In Law
Enforcement, it is a reduction of three FTEs in the Alcohol Pro-
gram and 38 FTEs in the Explosives Program. In the Compliance
area, it would be a 19 FTE reduction in Compliance-Alcohol.
The reductions in Law Enforcement-Alcohol and Explosives are
being taken in order to minimize the impact of administrative re-
ductions on the Firearms Program, which is the prime focus of our
law enforcement efforts. The Law Enforcement Firearms Program
will maintain current levels of resources and workload during fiscal
year 1994 in all but one area. Firearms tracings are estimated to
increase 15.5 percent in 1994 without any additional resources. In
the Explosives Program, a 4.8 percent workload reduction in cases
initiated and suspects recommended for prosecution is anticipated.
The reduction of 19 FTEs in the Compliance-Alcohol Program
will lead to a 2.8 percent drop in inspections, specifically in product
and market integrity areas.
At your request, we are providing a summary of Bureau work-
loads from 1990 through 1994. We are also providing a history of
our 1994 request from our original submission to Treasury through
29
the final levels approved by 0MB and incorporated in the Presi-
dent's budget.
ATF conducts operations through four programs: Alcohol, To-
bacco, Firearms, and Explosives. And they are divided between two
programs. Compliance Operations and Law Enforcement.
We understand the committee intends to focus on revenue mat-
ters and related compliance operations programs, as well as on
major recent investigative cases with their resource implications.
ATF has undertaken several major investigations in fiscal year
1993. The most significant are, of course, the World Trade Center
bombing and the operation in Waco.
The World Trade Center bombing caused massive damage at the
site, an estimated loss of $500 million, resulted in six confirmed
deaths, and several thousand people who were treated for various
injuries.
On March 3, 1993, an ATF explosives enforcement officer, work-
ing as part of a multiagency team, uncovered a vehicle identifica-
tion number from rubble at the bomb scene that eventually led to
the apprehension of Mohammed Salameh. A total of six individuals
have now been indicted in connection with the bombing.
We estimate this investigation's costs could exceed $600,000, not
including the salaries of those involved.
The operation in Waco, which began on February 28, involved
the execution of a Federal search warrant at the Branch Davidian
compound, which was alleged to have scores of illegal firearms and
explosives inside. More than 100 special agents, including three
special response teams, were deployed to the scene.
Four ATF agents were killed and 16 others were injured in the
raid, which resulted in a 51-day standoff situation. The situation
concluded on April 19 with the destruction of the Branch Davidian
compound by fire. Nine cult members survived that fire.
We have had other notable firearms and arson investigations this
fiscal year. For example, ATF is conducting an ongoing investiga-
tion 01 a certain violent extremist group. Because of the sensitivity
of that investigation, specific details cannot be released. However,
I can say the group is responsible for supplying illegally obtained
firearms through their associates in several major U.S. cities.
These activities are being financed by criminal activities.
At the end of the investigation, we expect multiple indictments
for violations of Federal firearms laws. That investigation is esti-
mated to cost $457,000.
The Bureau has had several significant arson investigations
which have totaled approximately $43,000 in costs. These have in-
volved arson incidents in Carbondale and Alton, 111., and in Seattle,
Wash.
ATF has responded to these major investigations by shifting re-
sources from normal operating expenses such as training, travel,
and purchase of equipment and vehicles. Examples of activities
that the Bureau has had to postpone or cancel are as follows:
First, we were unable to send — ^fortunately, they were not need-
ed— additional special response teams to Los Angeles to help pre-
pare for the potential civil unrest after the verdicts.
Supplying additional special response teams to Boise, Idaho,
where the Randy Weaver and Kevin Harris trial is taking place.
70-792 0-93
30
The purchase of new radio equipment to support field operations.
The purchase of new vehicles.
There are others. Those are the more expensive ones.
Turning now to compliance operations, enforcement of the excise
tax laws relating to alcohol, tobacco, firearms and ammunition and
support to law enforcement efforts in the firearms and explosives
areas are the heart of ATFs compliance mission. Total tax collec-
tions in fiscal year 1993 will approach $14 billion.
Firearms and ammunition excise tax responsibilities were trans-
ferred to ATF during fiscal year 1991. Revenues of $150 million are
anticipated in fiscal year 1994. Since the tax computation is more
complex and the industry is not subject to the same degree of over-
sight as the alcohol and tobacco industries, the underpayment of
taxes and other compliance problems are more fi-equent with the
firearms and ammunition excise taxpayers.
In the first 6 months of the current fiscal year, we identified $2.3
million in additional firearms and ammunition excise tax liabilities.
Most of the resources allocated for Compliance Operations-Fire-
arms go to support law enforcement efforts by enforcing compliance
with the Gun Control Act and the National Firearms Act. There
are currently over 286,000 Federal firearms licenses, with acceler-
ated growth this year. We have developed a national program to
increase the frequency of dealer contacts within existing resources.
About 25,000 field inspections are planned for fiscal year 1993.
The explosives licensing and compliance program, on the other
hand, is one that is relatively stable. Due to the public safety im-
pact, we have continued to devote sufficient resources to this effort
to assure regular inspections of all licensees and permitees that
store high explosives.
Moving to tobacco, the tobacco program is exclusively concerned
with revenue-related activities. The 31 FTEs requested for fiscal
year 1994 will enable us to protect the $6.2 billion in project reve-
nue. Due to the tax increase effective January 1, 1993, we are
again in the process of collecting floor stocks taxes on cigarettes.
With payment not due until June 30, verification of taxes due will
continue well into fiscal year 1994.
Underpayments and errors are more common with floor stocks
than with normal excise tax collections. Common problems are
misstatements of inventories and failure to file until and unless in-
spected, which goes with floor stock taxes being one-time taxes that
require filings by thousands of businesses that do not ordinarily file
excise tax returns.
In addition, we are finding many instances of permitees and dis-
tributors moving aggressively to avoid the tax, often by shifting a
large burden downstream to unwitting retailers who are much less
likely to pay. In the first 6 months of the current fiscal year, we
identified over $400,000 in additional floor stocks taxes due.
In alcohol, the fiscal year 1994 alcohol revenue is expected to top
$8 billion. The compliance program, if funded at the level re-
quested, would authorize 791 FTEs and $48.5 million. This rep-
resents a decrease of 19 FTEs and $5.3 million compared to the
1993 authorized level.
31
The estimated user fee collections have been deducted from the
gross appropriation for this program and contribute to the $5.3 mil-
lion decrease in funding.
Revenue protection is enhanced by the permit system and by en-
forcement of alcoholic beverage labeling requirements under the
FAA Act, since products mislabeled may also be misclassified for
tax purposes. This is especially so in the case of imports, where in
addition to reviewing labels we require analysis of samples prior to
importation for certain tvpes of products.
Our investigations of label frauds involve imported products.
They have disclosed many cases where there were tax violations oc-
curring with or even at the root of the fraudulent violation of the
labeling rules.
Mr. Chairman, reaching the end of my opening remarks, I will
now move on to the issue of the user fee proposal in our 1994 budg-
et request.
The proposal, if enacted through the appropriations process, will
authorize collection of fees on various services which members of
the alcohol industry now obtain from ATF at no charge in order to
comply with regulatory requirements. An estimated $5 million will
be realized ana treated as offsetting collections to be used to fund
ATF operations in lieu of appropriate funds. Accordingly, our net
request is for $5 million less than would otherwise be required to
fund the same level of operations.
The proposal sets minimum fee levels as follows: $50 for each ap-
plication for label approval and $250 for each formula or laboratory
test.
User fees would be collected for processing applications for cer-
tificates of label approval — we call those COLAs — and for review of
formulas and laboratory tests and analyses performed under the
FAA and the Internal Revenue Code. Formulas and statements of
process are required to be submitted for alcoholic beverages that
are produced by methods other than fermentation or distillation —
for example, the manufacture of cordials and liqueurs.
Laboratory tests or analyses are required for imported alcoholic
beverages that would be subject to the same formula requirement
if they nad been domestically produced.
The $5 million estimate was arrived at by multiplying estimated
numbers of items processed by the proposed minimum fees. This
estimate assumes that the number of items processed will not de-
cline dramatically due to the imposition of those fees.
In conclusion, Mr. Chairman, we appreciate and we value the
subcommittee's interest in ensuring the integrity and quality of our
administration of the tax laws, and I and my associates will be
happy to answer any questions you may have.
Thank you.
[The prepared statement and attachments follow:]
32
TESTIMONY OF STEPHEN E. HIGGINS, DIRECTOR,
BUREAU OF ALCOHOL, TOBACCO AND HREARMS
Mr. Chairman and Members of the Subcommittee, it is a privilege to appear berore you to discuss our
1992 accomplishments, 1993 operations and 1994 budget request
Accompanying me today are Mr. Daniel Black, Deputy Director and Associate Director, Office of
Compliance Operations; Mr. Daniel Hartnett, Deputy Director and Associate Director, OfTice of Law
Enforcement; and Mr. Arthur Ubertucci, Assistant Director, Office of Administration and Chief
Financial Officer.
Resource requirements for the Bureau of Alcohol, Tobacco and Firearms in FY 1994 are estimated to
be 4,201 FTE positions and $364,245,000. This includes a program increase of 5 FTE positions and
$1,685,000 to support the Bureau Systems Modernization Program, an increase of $8,201,000 to
maintain the current level of operations, offset by reductions of $13,739,000 and 65 full-time equivalent
positions associated with nonrecurring costs and savings for I^ 1994.
The user fee proposal included in the President's Budget seeks aulhorli'.ation to establish a user fee
program for processing applications for certificates of alcohol label approvals (or exemptions
therefrom) and conducting laboratory tests and analyses. Anticipated user fee collections of $5,000,000
would offset the cost of processing applications and conducting laboratory tests so as to result in a final
FY 1994 appropriation of $359,245,000. The estimated collections are based on current processing
levels of chargeable items multiplied by the proposed fees, and assume no dramatic decline in filings
due to imposition of the fees.
No 1993 programs or funding levels have been reduced below FY 1992 actual levels. There is a
reduction of 43 FTE positions authorized. Our FY 1994 request is 60 FTE positions and $3,853,000
below our Fiscal Year 1993 budget authority level.
The FY 1994 reductions of 60 FTE positions (and associated funding) will be taken as 3 FTE's in
alcohol and 38 FTE's in explosives for Law Enforcement, and as a 19 FTE reduction in alcohol for
Compliance Operations.
The reductions in LE alcohol and explosives are planned to minimize the impact of administrative
reductions on the firearms program, which is the prime focus of our law enforcement efforts. The LE
Firearms program will maintain current levels of resources and workload during FY 1994 in all but one
area. Firearms tracings are estimated to increase 15.5 percent in FY 1994 without any additional
resources. In the explosives program, a 4.8 percent workload reduction in cases initialed and suspects
recommended for prosecution is anticipated.
The reduction of 19 FTE's in the CO alcohol program will lead to a 2.8 percent drop in inspections,
specifically in the product and market integrity areas.
At your request, we are providing a summary of Bureau workloads for 1990 through 1994. We are also
providing a history of our fiscal 1994 request from submission by ATF to Treasury through the final
levels approved by OMB and incorporated in the President's Budget.
ATF conducts operations through four programs: alcohol, tobacco, firearms and explosives which are
applicable to both Compliance Operations and Law Enforcement Activities.
We understand that the Subcommittee intends to focus on revenue matters and related Compliance
Operations programs, as well as on recent major investigative cases with their resource implications.
MAJOR INVESTIGATIVE CASES
ATF has undertaken several major investigations in FY 1993. Costs associated with these efforts are based on
actual and projected costs, consistent with the number of manhours expended. Specific staffing during each
investigation has varied; therefore, we cannot determine the exact levels of personnel. These investigations are
described as follows:
World Trade Center Bombing
On February 26, ATF activated its Northeast National Response Team to New York City to assist local
authorities and the FBI in the investigation of an explosion at the World Trade Center. The explosion caused
massive damage two levels above and below the suspected blast seat at a cost of $500 million. It resulted in 6
confirmed deaths and several thousand people who were treated for injuries, smoke inhalation, and shock.
33
On March 3, 1993, an ATF explosives enforcement officer uncovered a vehicle identification number from rubble
at the bomb scene. The number was traced, and it was determined that the vehicle, a Ryder Rental Company
van, had been rented but reported stolen the day prior to the explosion. Subsequent investigation revealed that it
was rented by Mohammed Salameh.
On March 5, 1993, ATF and FBI special agents, assisted by an ATF forensic chemist, executed a Federal search
warrant at a storage facility in New Jersey. Special agents recovered explosive materials from the site, including
urea, nitric acid, nilro-glycerin, cardboard tubes, and hobby fuse. Special agents served a search warrant on
Mohammed Salameh, based on information that the van he was driving was seen at the storage unit prior to the
bombing. A total of six individuals have now been indicted in connection with the bombing.
We estimated that this investigation could exceed approximately $600,000, not including the salaries of those
involved.
Waco Operation (Investigation of Branch Davidian Cult)
On February 28, ATF initiated the execution of a Federal search warrant at a compyound of the Branch Davidian
Movement in Waco, Texas, headed by Vernon Howell, aka David Koresh. The compound was alleged to have
scores of illegal firearms and explosives within its borders. More than 100 special agents, including 3 special
response teams, were deployed to the scene.
Four ATF agents were killed and 16 others were injured in the raid. The standoff concluded on April 19 with the
destruction of the Branch Davidian compound by fire. It has been reported that nine members of the cult
survived the fire.
We have an estimate of ATF costs for the Waco operation. But we are concerned about the significant number
of factors which go into making it as accurate as we'd like il. Therefore, we'd prefer to make this analysis of cost
for the Waco operation part of our review, which is about to begin. Ultimately, there will be a full and complete
accounting of funds expended in connection with Waco.
Firearms Investigation
ATF is conducting an ongoing investigation of a violent extremist group. Because of the sensitivity of this
investigation, specific details cannot be released. The group is responsible for supplying illegally obtained
firearms to their as.sociates in several major U.S. cities. These activities are being financed by criminal aas.
At the conclusion of the investigation, ATF expects multiple indictments for violations of the Federal firearms
laws.
Estimated cost of investigation to dale: 1457,000
Other Significant Arson and Explosives Invcslifalions
On December 6, 1992, the Midwest National Response Team was activated to Carbondalc, Illinois, to a.ssisl Stale
and local authorities in the investigation of an arson fire that (Kcurrcd in an off-campus apartment building. The
apartment building was occupied by students attending Southern Illinois University. Five students were killed
and nine were injured. Structural damage has been estimated in cxces.s of S.VXl.tXX). The assistance of the
National Respon.se Team was requested by Ihc Illinois Stale Fire Marshal, the Ll.S. allorncy's office, and the
Carbondale Fire and Police Deparlmcnis. ATF, along with the Illinois Stale Fire Marshal's Office, has
determined the cause of the fire to be arson. The investigation is continuing.
Estimated cost of investigation to dale: S5I,(X)I)
On October 23, 1992, an arson fire destroyed a Iwo- family dwelling in Alton, Illinois. Two firemen died while
fighting the fire when the structure collapsed on Ihcm. On October 28, 1992,
Iwo suspects were arrested by task force members for the fire and dealh of the firemen. ATF is a member of the
task force. The investigation is continuing.
Estimated cost of investigation to dale: 132,000
Between Augu.sl 6, 1992, and February 6, 1993, more than 1 10 similar incendiary fires occurred in the greater
Seattle, Washington, area. A serial arsonist was suspected as being responsible for the fires. A task force headed
by ATF was created. On February 6, 1993, a suspect was arrested by the lask force. The suspect confessed to 76
of the fires and is suspected of .selling many of the others. On March 5, 199.3, the suspect entered a plea of guilty
to 32 counts of arson. The investigation is continuing.
Estimated cost of investigation to date: $360,000
34
Result of Expenditure of Resources
ATF has responded to these major investigations by shifting resources from normal operating expenses, such as
training, travel, and purchase of equipment and vehicles.
Examples of activities that the Bureau has had to postpone or cancel are as follows:
o Sending additional special response teams to Los Angeles to prepare for possible civil unrest.
o Supplying additional special response teams to Boise, Idaho, where the Randy Weaver and Kevin
Harris trial is taking place.
o The purchase of new radio equipment to support field operations.
o The purchjise of new vehicles ($1.2 million).
o The purchase of more than $10,000 in investigative supplies.
o Most second-half training courses.
o Several national conferences and meetings.
COMPLIANCE OPERATIONS (CO) ACTIVITV
Our Compliance Operations Activity regulates several industries which market products that are
sensitive in nature and subject to continued public interest. Our policy has been to regulate only to the
extent necessary to achieve the intent of law. A balance is sought between effective administration of
statutory requirements, the protection of the public, and the legitimate needs of industries under ATFs
jurisdiction.
The Bureau is extremely selective in establishing goals to assure effective resources use. Compliance
Operations (CO) field offices continually assess and report on the levels of compliance in their
geographical jurisdictions. Field inspections are concentrated in those areas which present the greatest
risk to the revenue or which pose the greatest threat to public safely. In the firearms program, CO
field supervisors and their Law Enforcement counterparts work side by side to develop and evaluate
methods to identify those dealers involved in the illegal transfer of firearms, or those dealers whose
improper or fraudulent recordkeeping impede the ability of ATF to successfully trace firearms
recovered from crime scenes.
CO FIREARMS PROGRAM
This program is based upon the Gun Control Act of 1968 (as amended). Public Law 99-308 of 1986,
and other statutes. Licenses are required to manufacture, import, and sell firearms. The intent of the
statutes, and our qualification efforts, is to prevent statutorily prohibited persons (e.^., convicted felons)
from obtaining licenses.
Targeting criminals in possession of firearms is a very important aspect of our program. The
Compliance Operations Activity analyzes trace information on firearms recovered at crime scenes and
develops profiles which target various criminal elements (i.e., gang members, "straw man" purchasers,
illegal traffickers, possible terrorists, and international traffickers, etc.). Inspectors uncover purchasing
patterns of those weapons commonly used as crime guns. Field supervisors work closely with the Law
Enforcement Activity counterparts to evaluate areas where inspection field efforts will produce the
most valuable information and investigative leads. Inspectors accompany special agents on the
execution of search warrants to assist in the seizure and examination of firearms records, and to
investigate licensees who criminally misuse their licenses {e.g., by diverting firearms to illegal channels).
Inspectors support Achilles task forces and other special enforcement efforts, such as the High
Intensity Drug Trafficking Area (HIDTA) program. During FY 1992, 272 Achilles firearms inspections
were conducted and resulted in over 570 referrals to Law Enforcement. There were 12,000 criminal
background checks conducted and 14 percent of these resulted in "hits" (firearms purchasers that had
criminal records). Compliance Operations conducted 2,604 HIDTA inspections in southern California,
Arizona, and other specified areas in our Southwest Region. The results included 49 referrals to Law
Enforcement, 335 violations cited and 234 firearms licenses surrendered.
35
Inspectors verify records and inventories to maintain trace capability and examine transaction records
to identify likely violators (sji-, convicted felons, 'straw man" purchasers, gang member^, illegal
traffickers, etc.)-
During FY 1992, 20,023 inspections were conducted. As a result, licensees were cited for 8,938 serious
violations and 4,753 referrals were made to law enforcement agencies. Some examples of these field
activities include the following.
Dallas. Texas. During a compliance inspection an Inspector documented that an unlicensed individual
had purchased 30 small caliber automatic pistols, and the following day would be taking delivery on an
additional 90 handguns. The Inspector was informed that the individual had asked about purchasing an
additional 5,000 handguns. This information was referred to special agents who put the individual
under surveillance and obtained a search warrant for the suspect's home and car. The suspect admitted
the firearms were being smuggled to Mexico and the case is now pending before action by the Assistant
U.S. attorney's office.
Chicago. Illinois. In the course of.conducting an application inspection for a firearms manufacturing
license, an Inspector discovered that the female applicant was very unfamiliar with manufacturing
firearms and her husband would actually be managing the business. Further interviews and research by
the Inspector revealed that the husband had a felony conviction for possessing two unregistered
machine guns and selling an unregistered silencer to an undercover ATF agent. After his conviction,
the husband served time in Federal prison. Because of the disclosure of this information, the wife
withdrew her application.
Denver. Colorado. Referrals from a compliance inspection at a Denver firearms dealer have resulted
in one arrest and three criminal investigations. The individuals, illegal aliens active in Denver area drug
trafficking, are also under investigation by Immigration and Naturalization Service.
San Francisco. California. An Inspector responding to an anonymous lip from a concerned citizen
discovered some grave discrepancies in the records of a licensed firearms dealer. Because of the
dealer's potential for violence, the inspector was accompanied by special agents. The examination of
the records discovered that the dealer was using the names of decca.sed individuals to complete the
required records. Revocation proceedings will be initiated if the dealer Is not prosecuted criminally.
Southwest Border. In the Southwest, Operation El Tambicn focu.scd on delecting illegal exports of
firearms through .sales made by dealers. Inspectors and special agents visited about 215 licensees and
examined their records. Fifty-three individuals were identified as "straw purchasing' firearms for
transfer to Mexico. Over 450 firearms had been smuggled into Mexico during an eight-month period.
Firearms and Explosives Licensing Center
The Firearms and Explosives Licensing Center is responsible for processing firearms license
applications and maintaining the Bureau's licensee files. At the end of FY 1992, there were
284,117 firearms licensees. Compliance Operations offices pr(Kc.s.scd 95,958 applications, of which
37,085 were first-time applicants and 58,873 were renewals.
National Firearms Act (NFA)
ATF is also responsible for enforcing the registration and revenue provisions of NFA, a statute
regulating machine guns and certain other weapons. The register is maintained to make it difficult for
criminals to obtain access to these types of weapons. The NFA Branch handled over
170,000 applications and notices relating to these regulated firearms and devices during FY 1992. To
provide support and assistance to ATF Compliance Operations personnel and special agents, NFA
branch personnel conducted 1,255 certifications for criminal cases and 9,054 searches of the NFA
register. The NFA rcgi.slration files were automated to handle information on hundreds of thousands
of NFA firearms and to respond promptly to requests for information from law enforcement.
Firearms and Ammunition Excise Tax
firearms and ammunition exci.sc lax responsibilillcs were transferred to ATF during fiscal year 1991.
Revenues of $150 million arc anticipated in fiscal 1994. Since the lax compulation is more complex and
Ihc indu,stry is not subject to the same degree of oversight as alcohol and tobacco, underpayment of
taxes and other compliance problems arc more frequent wilh these taxpayers. In fiscal 1992 we
inspected 17 percent of firearms and ammunition excise taxpayers accounting for $16 million in taxes
paid. In the first six months of Ihc current fiscal year, ATF identified $2.3 million in additional firearms
and ammunition excise lax liabilities and conducted field examinations of returns totaling $31 million.
As in other programs, the Bureau u.ses seminars and similar initiatives as a means of improving
understanding of and compliance with Federal laws. ATF expanded the outreach program beyond the
licensee community by participating at gun and trade shows. The Bureau periodically publishes a
36
Federal Firearms Licensee (FFL) Newsletter and in FY 1992, provided 113 nrearms seminars to
firearms licensees. State officials are actively involved with ATF in conducting seminars. These
seminars seek to inform licensees on a broad range of topics including recordkeeping, prohibited sales,
and the licensee's role in tracing crime weapons.
CO ALCOHOL PROGRAM
This program ensures the collection of $8 billion in excise taxes on alcoholic beverages; provides
prompt deposit and accurate accounting for excise tax receipts; prevents entry into the industry by
criminals and persons who pose a risk to the tax through its qualification procedures; protects public
safety by investigating deceptive or misrepresented alcoholic beverage products; and, suppresses
commercial bribery and other unlawful practices in the marketplace.
Qualification
ATF is responsible for protecting the alcoholic beverage industry from criminals and those persons who
are likely to commit tax fraud, commercial bribery, or launder money from drug trafficking or other
illicit activities. This is accomplished in two ways:
1. Through financial and criminal background investigations, ATF ensures that permits are not issued
to convicted felons or persons whose business experience or associations indicate a propensity toward
fraud or illegal activities.
2. ATF ensures that entities already qualified and possessing permits remain in compliance by
conducting selective investigations to determine that no hidden ownership, unreported changes in
control or ownership, or illegal funding is present.
Tax Compliance
Historically, ATF has encouraged the alcohol industry to pay the proper amount of excise taxes through
a strong revenue examination program. Recent legislation increased the level of effort needed to
ensure tax compliance. Tax compliance is achieved by focusing on production facilities that pose the
greatest risk to revenue based on the volume of operations, past history of violations, poor internal
controls, or questionable financial condition. Compliance Operations conducts office audits of the tax
returns and conducts field inspections at production facilities to ensure that these taxes are paid timely,
and in full. During FY 1992, ATF collected $8.0 billion in alcohol excise tax. Field inspections covered
57 percent of revenue producing plants with tax payments of more than $25,000 per year. The dollar
value of returns audited during these inspections was $3.7 billion. During this same period, tax liability
on inventories held by permittees exceeded $27 billion.
ATF continues to upgrade the skills of its tax specialists and other employees by providing them with
modern equipment and advanced training. Phase 1 of the Integrated Collection System (ICS) was
successfully implemented. This data base will track all excise and special taxpayer accounts.
Employees will be trained in recently revised procedures and processing techniques. An improved
taxpayer assistance program is being developed.
ATF collected over $117.4 million in special occupational tax, (SOT), from over 400,000 manufacturers,
wholesalers and retail dealers during FY 1992. Cross checks between the floor slocks tax and special
tax databases were conducted to test the level of compliance by wholesalers and identify delinquencies.
Collection actions were then initialed on approximately 20,000 liquor dealers who were identified from
Hoor stocks tax returns as not having paid special tax. Significant floor stocks tax and special
occupational tax delinquencies include the following:
$350.000 Tax Increase From Major Breweries. The disclosure of infialcd tax credits at one brewery
disclosed infiated credits for returned beer at breweries across the country. Brewers were taking credit
for beer returned to their premises after January 1, 1991 at the new excise rate, even though the beer
had been tax paid at the lower rate, resulting in the brewers receiving twice the credit they were entitled
to.
Fort Wayne. Indiana. Inspectors discovered that a retail liquor dealer was making unlawful sales of
wine at wine tastings. Special (occupational) tax was incurred at each tasting where the wine was sold
or offered for sale. The company submitted a $30,000 offer to compromise the lax, penalties and
interest.
During FY 1992, the Bureau accepted 30 offers-in-compromisc, amounting to $439,859 for
revenue-related violations. Inspections disclosed over 1,100 violations, numerous referrals to other
agencies, and in excess of $2.4 million in increasing lax adjustments. Inspection examples include:
37
Kansas Citv. Missouri. During a recent lax compliance inspection, ATF inspectors discovered that a
permittee had failed to timely deposit excise taxes. ATF collected $40,000 for penalties and interest
incurred from the late payment.
Fresno. California. During a tax compliance inspection at a California winery, an inspector discovered
a recording error vk'hich resulted in an underpayment of excise tax of over $1 million. Forty thousand
dollars in interest was collected. Also discovered was a transposition error resulting in an
underpayment of $30,000.
Frankfort. Kentucky. ATF inspectors recently discovered violations regarding proof determination and
high solids content products at a distilled spirits plant. This case was settled when the permittee
submitted $35,000 to compromise the violations found.
In support of examinations conducted at the premises of revenue producing plants, specialists in
regional offices review lax returns and other documents submitted by revenue producers. These office
reviews are an important part of ensuring that excise taxes are collected and that proper payments of
claims are made.
Training, such as Advanced Examination Techniques, is being given to field employees so that they are
better able to detect tax payment deficiencies. To support field operations, profes-sional ATF auditors
are called on to assist with the most complex and sophisticated records of taxpayers, and also serve as a
technical resource for other segments of the Bureau.
Alcohol Product Integrity
Over the years, the Bureau has uncovered and taken corrective action on a number of imported
products contaminated with hazardous ingredients. In 1985, Foreign wines were found to contain the
ha7.ardous substance diethylcnc glycol (DEG). Imported brandies were found to be contaminated with
methanol. Contamination with fungicides and pesticides is a current ongoing concern.
ATF began testing various alcoholic beverages for lead when lead adulteration in wine was identified as
a potential problem. Over 600 products were analyzed and the results were shared wilh the Food and
Drug Administration (FDA). After further testing by both ATF and FDA, as well as a request by ATF
for a health ha7.ard evaluation, FDA set a temporary level for lead in wine at 300 parts per billion
(ppb). In July 1991, ATF released a 2-year study which had been conducted as part of our market
basket sampling program. Among samples testing in excess of the FDA's .300 ppb level, the study
revealed that decanted wine samples tested higher in lead. Significant lead contamination can result
from contact with corrosion products of the lead capsule. Such corrosion is easily dissolved in wine or
pouring from bottle lo serving container. In a related issue, use of lead crystal decanters was found lo
contribute to high lead content. This resulted in manufacturers changing ihcir methods to reduce the
risk of lead contamination. ATF continues lo test representative samples of domestic and imported
table wines for analysis lo determine lead content. During FY 1992, a random statistical sampling of
approved label certificates resulted in the selection of 183 imported products and 612 domestic
products to be sampled for lead content In addition, ATF commenced a random sampling for lead
content of table wines produced by the lop 10 pnxluccrs in the U.S. As of October 1992, 735 samples
had been analyzed. The following are some examples of our lead adulteration sampling project:
An imported wine was confirmed lo have over 300 ppb of lead. The importer and the wholesaler were
notified and they agreed lo voluntarily detain the product until confirmation analyses were completed.
The wholesaler ultimately destroyed the product.
A domestically produced wine consistently tested over .3(K) ppb of lead. Field investigation revealed the
source of the lead was the concrete storage tank in which the wine was produced. The proprietor
initialed a voluntary recall of the product from the retail market and has provided ATF with their recall
strategy.
Of the 735 .samples, an initial analysis disclosed nine imported pr(xJucts and nine domestic products
tested over .3(X) ppb. As these results are analyzed and confirmed, appropriate action, such as removal
from the marketplace, will be initiated.
The Bureau also tests for fungicides and pesticide contaminants. During FY 1992, ATF learned that
some Italian wines had been adulterated wilh the pesticide methyl isolhiocyanate, (MITC), a soil
fumiganl. ATF immediately began testing of the suspect brands while simultaneously requesting a
voluntary detention of these products by the importers. Upon Ihc receipt of a Health Hazard
Evaluation for the Food and Drug Administration, ATF formally detained the inventory at the
importer's prcmi.scs and obtained additional samples. The analysis of these samples resulted in the
recall of the affected products, and these adulterated products were either destroyed or re-exported.
38
Certificates of Label Approval (COLA) are required before alcoholic beverages may be bottled or, in
the case of foreign products, imported. In FY 1992, the Bureau processed 63,438 applications for label
approval. Each application is reviewed for compliance with regulatory provisions designed to prevent
consumer deception and protect public safety. For example, the sulfite warning. Government health
warning, varietal and vintage labeling on wine, and proper disclosure of alcohol content are reviewed.
There are currently 1.3 million approved labels on file.
Label approval is also an important aspect in our program to ensure that hazardous and/or deceptive
products do not enter the market and that taxes are paid at the proper rate. With a shrinking market,
incentives for label fraud and tax evasion schemes are increasing.
In the last few years, there have been widespread attempts at label and tjut fraud. In some instances,
importers have been found to use fraudulent labels to bring products into the U.S. and to understate
the tax class of beverage alcohol products. Some fraudulent labels are totally fabricated, including
forgery of the Director's signature on the certificate of label approval. These activities result in evasion
of excise taxes, deception of the public, and have the potential to eliminate or bankrupt competitors.
Sacramento. California. In a wine fraud scheme investigated over the past two years by ATF, grape
growers misrepresented cheaper grapes as more expensive varietal grapes which were in high demand.
Many wineries involved in the scheme were unaware of the grape growers' illegal actions; but we found
some wineries who knowingly used the cheaper, non-varietal grape in producing expensive varietal
products. The public was deceived by these actions when it purchased expensive wine labeled as being
produced from an expensive varietal, when in fact the winery fraudulently used cheaper grapes. In this
California case, five persons were convicted with sentences ranging from 3 years probation to
51 months in prison. Four winery officials entered into a plea agreement with the U. S. Attorney in
which they pled guilty. In addition, under the terms of the agreement, the winery will pay a $1 million
fine.
Through field inspections and product sampling, ATF also established a successful warning label
enforcement program. The Bureau has forced corrective action in numerous cases where the
mandatory health warning statement was neither prominent nor legible, defeating the intent of the
requirement.
Due to changing viticultural practices, industry materials costs and market conditions, potential
contaminants and fraud opportunities can change over time. Accordingly, the Bureau continually
adjusts targeting of trouble spots, selection criteria, and analytical techniques.
During FY 1992, there were a total of 65 labeling cases initiated and a total of 21 label fraud cases were
closed. A total of 92 days in suspensions were served by permittees, and a total of $165,000 in
offers-in-compromise was collected as settlement of violations.
We continue to find significant instances of label problems by which the public is deceived about the
contents of alcoholic beverages. The following are some results of our label fraud program.
$60.000 QIC accepted: An importer falsified 12 label certificates to effect the importation of
2,600 cases of wine, and two terminated label certificates were used to import wine.
$30.000 QIC accepted and 15 day suspension served: An importer imported 264 cases of distilled
spirits without an approved label certificate, 489 cases of mislabeled distilled spirits to evade taxes, and
smuggled into the U.S. 16 cases of distilled spirits.
$25.000 QIC accepted: An importer altered previously approved label certificates to effect the
importation of 18,000 cases of distilled spirits and wine. The majority of these products were seized by
U.S. Customs Service
Hartford. Connecticut. A Connecticut winery faces a maximum fine of $500,000 for presenting a total
of 83 false label approval forms to Customs during a two-year period.
21 dav suspension served: An importer imported 1,632 cases of distilled spirits after the approved label
certificate had expired, submitted a false invoice identifying the goods as wine rather than distilled
spirits, removed 816 cases of product that had no label certificate, and failed to pay Special
Occupational Tax.
Open Investigation. A possible French champagne fraud is under investigation. French authorities
have confirmed that the product in question is not produced in the Champagne region of France and
that the certificate of origin that was provided to an ATF inspector is fraudulent. We have detained the
suspect product pending further investigation.
39
Market Integrilv
To enforce commercial bribery provisions of the Federal Alcohol Administration (FAA) Act, ATF
aggressively investigates allegations of significant violations. Bureau efforts concentrate on those
industry members engaged in commercial bribery and intimidation tactics or inducements designed to
restrain free trade. The less complex, intrastate violations are left for State agencies to resolve.
Inspectors continue to conduct informational seminars addressing areas of current concern to industry
members. The goal has been to increase cooperation between ATF and State agencies and the level of
industry compliance. The seminars held last year were very well received by both industry and State
agencies.
Enforcement of the advertising provisions of the FAA Act moved to the forefront in FT 1992. In
response to public complaints (there is no mandatory pre-clearance process), advertising matter on a
number of competing products were reworked or withdrawn. One example of this was St. Ides
Mall Liquor. It was promoted nationwide in a radio and television campaign featuring 'rap' celebrities
touting the strength of the product. The Bureau stopped this campaign and accepted an
offer-in-compromise of $15,000 along with a stipulated three-day suspension of the permit to settle the
advertising violations.
During FY 1992, we accepted a total of 14 offers-in-compromise (13 for trade practice violations, 1 for
advertising violations), totaling $176,500. We also imposed two suspensions for three days each (one
for trade practice violations, one for advertising violations).
Compliance Operations International Activities
Because of ATPs expertise in the Held of domestic and foreign law as it applies to beverage alcohol
products, ATF is increasingly being requested to support U.S. Government efforts to minimize or
eliminate international barriers impeding U.S. export trade in wine, distilled spirits and malt beverages.
For example, ATF is continuing to play a major role arising from the September 1988 United States
European Economic Community technical consultations on beverage alcohol products. ATFs
participation also aids in the handling of contaminated imported products. ATF representatives
attended international wine meetings held in France and Spain to further the acceptance of U.S. wine
products in foreign markets. In FY 1993, the U.S. will host the General A.sscmbly of the International
Office of Vine and Wine (OIV). ATF is part of the organizing committee for this international
meeting of wine industry members.
ATF continues to provide substantial technical data to the U.S. Trade Representative Office with
respect to the Wine Equity and Export Expan.sion Act of 1984. To date, this data has made a
significant contribution toward facilitating wine export trade to Japan, Canada, Taiwan, South Korea,
and the Caribbean area.
Working with Treasury, the Stale Department and the US Trade Rcprcscnialivc, ATF has accelerated
a positive response to the changes in the political map of Eastern Europe. Import companies had
advised that at one point there was over $250 million in vodka shipments held up by the dissolution of
the Soviet Union and the lack of established priKcdures to cover importations from the newly
established countries. ATF facilitated the shipment of this product by granting an exemption from the
requirement for a certificate of origin and allowing the product to be bottled in the U.S. and labeled as
Russian vodka until December, 1992.
CO TOBACCO PROGRAM
In FY 1992 tobacco excise tax collections exceeded $5.1 billion. FY 1993 excise tax collections arc
projected to increase to over $5.8 billion due to a tax increase effective January 1, 1993, and the
accompanying floor stocks taxes. In FY 1992 inspections were conducted of S) percent of tobacco
products factories with over $25,000 in lax payments. Value of the returns included in the scope of
these inspections was $3.3 billion.
The Hoor stocks tax, due June 30, 1993, should generate $150 million in revenue. The tobacco program
is similar to the qualification and lax compliance aspects of our alcohol program. Applicants for
permits are .screened and qualification inspections arc conducted to keep out those likely to commit tax
fraud or to launder money obtained from illicit sources such as drug trafficking. Recent market and
legislative changes are altering the once stable environment surrounding the industry. With declining
consumption and incrca.sed tax rates, field inspections and office review of tax returns and other
documents arc essential to ensure that taxes are timely and accurate.
40
The Bureau is developing new inspection procedures and techniques to address the increased risk of
diversion of export cigarettes to the domestic market. Enhanced guidelines for inspecting export
warehouses were developed as a result of a recent smuggling investigation conducted jointly with Texas
authorities.
CO EXPLOSIVES PROGRAM
ATFs explosives program ensures that licenses and permits are issued only to eligible persons, that
records are maintained in order to permit traces of explosives used illegally, and that explosive
materials are stored safely and securely.
Licensing Center personnel review all applications for accuracy and initiate criminal records checks to
prevent convicted felons and other prohibited persons from receiving a license or permit. During
FY 1992, 4,443 applications were received and processed. Inspectors examine explosives storage
facilities before license or permit issuance to ensure that the facilities meet Federal standards for
magazine construction and separation distance (from occupied buildings, highways, etc.). Enforcement
of these requirements protects public safety.
After a person is issued an explosives license or permit, ATF inspectors conduct periodic compliance
inspections. During FY 1992, a total of 4,356 inspections were conducted which disclosed
1,793 violations and resulted in 96 referrals to law enforcement agencies. These inspections ensure that
the storage facilities continue to meet ATF safety and anti-theft requirements, and that sufficient
records are maintained to enable law enforcement officers to trace the movement of explosives.
Wichita. Kansas. An explosives compliance inspection at an importer, dealer and user of special
fireworks disclosed dangerous storage related violations. The licensee was storing over 21,000 pounds
of explosives only 120 feet from an inhabited building. This exceeded the maximum number of pounds
by 19,000 feet. Other violations disclosed explosives being stored too close to public highways. This
dealer has a very poor compliance history and revocation is contemplated.
Oklahoma City. Oklahoma. Inspectors joined special agents in conducting a search warrant on a
special fireworks dealer. The dealer had long been suspected of selling various illegal fireworks, and
had been identified as the source of a five-inch firecracker which blew off the right hand, and several
fingers of the left hand of an Oklahoma City man. The dealer is cooperating with ATF and has
identified other sources of illegal fireworks.
Compliance Operations auditors assist Law Enforcement agents in arson investigations. The financial
auditing expertise of this highly trained cadre is a valuable asset, with the financial evidence often a key
to obtaining a conviction. Auditors assisted in 245 arson-for-profit investigations during FY 1992.
Examples of explosives inspections and arson investigation assistance include:
Mvrtle Beach. South Carolina. An auditor performed a financial analysis of a $1.7 million arson fire at
the residence and business location of an individual. This individual and four other defendants,
including Hell's Angels paid to set the fire, were each found guilty on twelve counts of arson, mail fraud
and conspiracy.
Kansas Citv. Missouri. A financial analysis performed by an auditor established the money laundering
aspects of a drug trafficking case. The defendant pled guilty to the drug trafficking charges and faces
10 to IS years in prison without the possibility of parole.
St. Paul. Minnesota. A cache of explosives; six pipe bombs, one destructive device, and one can of
black powder, were found while questioning an individual who had pawned an illegal fully automatic
Mac-11. The individual stated he had made the pipe bombs to blow up his girlfriend. An inspector
found the illegal firearm during a compliance inspection and a referral to law enforcement led to the
discovery of the explosives.
LEGISLATIVE CHANGES
Public Law 102-393, effective October 6, 1992, prohibits ATFs expenditure of FY 1993 funds to
investigate applicants who are seeking restoration of Federal firearms privileges. Pending application
investigations have been discontinued, and the affected individuals have been notified and advised of
the provisions of this law.
The Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508) increased excise taxes on distilled
spirits, beer, wine, and tobacco on January 1, 1991 and again on tobacco on January 1, 1993. Floor
stocks taxes were mandated on all commodities on January 1, 1991, and again on tobacco on
January 3, 1993. With no additional resources, ATF administered a very successful fioor stocks tax
collection program for the taxes due on June 30, 1991. ATF will mount a similar effort to collect the
41
floor stock taxes on tobacco which will be due June 30, 1993. ATF projects collection of this tobacco
floor stocks tax to be $150 million. This estimate is based on collections for the first phase of the floor
stocks tax. Total tobacco excise lax is expected to be $5.8 billion in FY 1993.
Underpayments and errors are more common with floor stocks than with normal excise tax collections.
Common problems are misstatement of inventories and failure to file until and unless inspected, which
go with floor slocks being one-time taxes that require filings by thousands of businesses that do not
normsdly file excise tax returns. In addition, we are finding many instEuices of permittees and
distributors moving aggressively to avoid the tax, often by shifting a large burden downstream to
unwritting retailers who are much less likely to pay. In the first six months of the current fiscal year we
identified over $400,000 in additional floor stocks taxes due.
New Financial Administrative Accounting
and Revenue Collection System
The Bureau is in the process of installing a new financial system to integrate all aspects of tax
collection. The financial system is expected to be completed in FY 1993, and will bring revenue
collections and accounting systems into line with the Joint Financial Management Improvement Project
(JFMIP) "core requirements". The second phase of the tax collection system is expected to be
completed in FY 1996 and will provide a greatly enhanced ability to monitor the performance of
taxpayers and target those accounts where additional revenues might be owed.
The Bureau's Integrated Collections System and Fmancial Management Information System are
modernizing our revenue collection and financial management activities. During FY 1993, ATF will
take the initial steps required to develop a software application that will lead to an integrated revenue
collection system. In addition, beginning in F^ 1994, the Bureau's administrative accounting functions
will operate using the new financial system. These improvements in revenue collection and financial
management will assist the Bureau in complying with the guidelines outlined in the Chief Financial
Officer Act.
CONCLUSION
Mr. Chairman, that concludes my formal remarks to the Subcommittee. We appreciate and value the
Subcommittee's interest in assuring the integrity and quality of our administration of the tax laws. I will
be happy, as will my associates, to answer at this time any questions you may have.
-10-
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Chairman Pickle. Well, we thank you very much, Mr. Higgins,
for your statement, and your entire statement will be included in
the record.
I want to remind the committee that we are going to limit the
members to the 5-minute rule, and then we will come back for a
second run if we have the time to be allotted.
I am not going to go into the full jurisdiction of this committee,
but before you start the clock, we are charged with overviewing the
ATF programs, and by virtue of the Revenue Code of the United
States we have an ongoing authorization of jurisdiction over your
agency. We are trying to find out what are your needs and how can
we help, and we naturally will have some questions now.
Just as preliminary background, as I understand it, you said that
the World Trade debacle cost you around $600,000.
Mr. Higgins. Yes.
Chairman Pickle. What was the cost of Waco at this point?
Mr. Higgins. We have some figures on that. I have not entirely
totaled them because they keep changing. We are finding that we
have bills that we did not anticipate, tort claims and other obliga-
tions to settle. We will be reviewing the entire cost of that oper-
ation when we do the overall review. And so we will furnish it to
you at that time, if we could.
Chairman Pickle. And your current budget is some $350 million.
If those two incidents have cost your agency $5, $10 million or
more, whatever it is, that will have a direct bearing on your 1994
budget, since you would have to decrease other activities this year,
too.
We want to know what those costs are as we weigh what our rec-
ommendation will be with respect to your budget for 1994.
Mr. Higgins. I will furnish them as quickly as I can.
Chairman PiCKLE. All right, sir. Now let me go to two or three
questions now.
I said earlier, Mr. Higgins, that the most disturbing aspect to me
is that it has taken so long for us to get action on this particular
gproup in the Branch Davidian operation in Waco. I pointed out that
when this builds up and goes on and on, and we know they are vio-
lating the firearms laws and are evading the tax laws, inevitably
that is going to result in death and destruction.
Now my first question to you would be: How and when did the
ATF become aware of the activities that were taking place in that
complex?
Mr. Higgins. We became aware of those activities for the first
time in June of 1992.
Chairman Pickle. All right. In June of 1992. Now why did it
take you so long, then, fi-om June until, in fact, April, 9 months or
more, before you moved in?
Mr. Higgins. You perceive that as being a long time. Actually,
the information in June of 1992 was simply raw information with
respect to potential violations.
We undertook at that point to open an investigation and, if war-
ranted, develop documentation which would establish probable
cause. When we felt we could do that and try to serve the warrant
peacefully and successfully, it was the end of February. So there
48
was a period of time. But in the intervening period, as even the af-
fidavit you have will indicate, we were actively investigating that.
Chairman Pickle. All right. Mr. Higgins, the affidavit you filed
with the court is now open for anybody to examine and read. It
clearly to me shows that you knew exactly what was going on in
that compound. You' knew it for months and months. And they
knew what you were doing, and you knew what they were doing.
Yet there was some hesitancy about moving in.
[The affidavit referred to follows:]
49
40 Mi Mm. IMS WtrnM M> MMI
llnttfiii ^tatEB district (dourt
^
WESTERN
UNITED STATES OF AMERICA
V.
. DISTRICT OF .
RITA FAYE RIDDLE
To: The UnltM Statai Marshal
ana any Autnortzaa Unitao Siatea Olflcar
YOU ARE HEREBY COMMANDED to arrest
WARRANT FOR ARREST
CASE NUMBER: 1095'^?/^
RITA FAYE RIDDLE
and bring him or h«r forthwith to the near»$t magistrate to answer 8(n)
□ loaiclment Z. ln(orm»tk>nx)Q Complaint C Order o» court C Violation Notice D Prooeilon Violation Petition
charping him or her with «» mwwo^ » xi^tMi
conspiracy to mtirder fadaral agents
in violation of Tllla .
-lA.
DENNIS G. GREEN
ingOillcer
'tf,-rf^.i?
lOnalufiol Itluing O'llCer
Ball fixad at S
. Uniiao Stales CoOe. Seciion(s)___lill.
United States Magistrate-Judga
Tttl* ol luuing OMIcer
April 18, 1993 Waco, Texas
Dele eno Local ion
-^JS^ r^ .^(^^^ ^y^.^^^
sane oi Judicial Ollic«r
This warrant was recaivao ana executeO with tha arraat ol tha above^amed ctetendant
.. .^M ^^/^""
o*Tt necirvto [name *no rrae or AR«t»TiNO cfict^.
SMNATuu 0^ ARntrnMO offkcr
*0 »< Wty. »/»Bt CfUWmlCiiiriMiiiii *
50
o
MLED
APR 1 9 1993
CLEKK. U. L,. DIST. COL
. DISTRICT OP : ay ■XZ^ / ^r.
MmtBh ^tat£2 Btstrtct (Souit
WESTERN ^ TEXAS
UNITED STATES OF AMERICA 56?fZ,£I^
RZTA FAYS RZDDLS CRIMINAL COMPLAINT
CASENUMBEfi: iJ^^-^lP^
I. the unaersignad complainant being duly sworn stat* th« following Is tru* and correct to tha bast of my
FabruKry 1993 MeLanaaa
knowieage ana belief. On or about ^^_^_^ In county, In the
Western Texas
District of dafandant(s) dld,iT>K>iiti.i>..i».ovw«>ioii..w.
SEE ATTXCHKEKT.
In violation of Title United States Code. Sectlonia) .
SPECIAL AGENT, AT7
I further state that I am am) and that thia complaint la based on the following
omnaniit
facts:
SEE ATTACHED ATTIOAVIT
Continued on the attached sheet and made a pan hereof: {^ Yee D No
A.?.f^/]'^^A,
^MftC'tt^soKnar; special ageht, att
Sworn to before me and subscribed In my presenoa,
APRII. IS, 1993 WACO, TEXAS
0(tt city »na Slaw
U.S. Magistrate
city wia Slaw ^^ ^__^-^
51
XTTXcsMxrr
Froa on or about February, 1993, and continuing th«re&£tcr up to and
Including the data oC th« filing of tbla complaint, In tha Western District
of Texas, Defendant KZT& FAYS azODLX, did knowingly, willfully, and
unlawfully coablne, consplro, confederate, and agree together and with each
other to kill, with premeditation and malice aforethought, Special Agents
Steve Willis, Rob WilliaBS, Conway c. LeBlau, and Todd McKeehan, all officers
and employees of the United States as specified in Title 18, United States
Code, Section 1114, in violation of Title 18, United States Code, Section
1117.
OVZRT ACTB
in furtherance of such agreement and conspiracy and to effect the
objects thereof, the Defendant and her conspirators, known and unknown,
committed the following overt acts, among others:
1. On February 28, 1993, in the Western District of Texas, Special
Agent Steven O. Willie of the Bureau of Alcohol, Tobacco, and Firearms was
shot and killed by tha conspirators while he was attempting to execute search
and arrest warrants.
3. On February 28, 1993, in tha western District of Texas, Special
Agent Robert Williams of the Bureau of Alcohol, Tobacco, and Firearms was
shot and killed by the conspirators while he was attempting to execute search
and arrest warrants.
3. On February 28, 1993, in the Western District of Texas, Special
Agent Conway C. LeBleu of tha Bureau of Alcohol, Tobacco, and Firearms was
shot and killed by the conspirators while he was attempting to execute search
and arrest warrants.
4. On February 28, 1993, in the western District of Texas, Special
Agent Todd W. McKeehan of the Bureau of Alcohol, Tobacco, and Firearms was
shot and killed by the conspirators while he was attempting to execute search
and arrest warrants.
All in violation of Title 18, United States Code, Section 1117.
52
(P
ATTIDAViy
Affiant alleoeB the following grounfia for the aai^iiT-n >^nd »fT-f|g^
fill
Hy nana Is Earl Ounagan. I hav« bean a Special Agent with the
Bureau of Alcohol, Tobacco and Fireams, Department of the
Treasury, [hereinafter ATF] , for 23 years and in that capacity have
handled many investigatione into the illegal possession and
manufacture of weapons, as well as other offenses encompassed by
Titles 18 and 26, United States code. In addition, before serving
as a federal agent, I was an officer in the police departments of
the cities of Garland and Bryan, Texas, for approximately seven and
a half years.
For many months, I and other agents have been investigating
allegations that VZRUOH BOWSLL, also known as David Koresh, and his
associates have, and are. violating the federal firearms and
explosive laws at a compound located on approximately 70-80 acres
near Waoo, Texas, and known as the Mt. Carmal Compound. That
investigation has shown that members of the group have been
receiving substantial quantities of firearms and components to
illegally modify firearms and create destructive devices. The
results of that investigation were incorporated in an affidavit
that supported the issuance of a federal search and arrest warrants
on Februeury 25, 1993, and continuous updated warrants to and
including that issued April 13, 1993. Attached hereto and
incorporated herein is the latest affidavit of oavy Aguilera
53
S-
supporting that federal search warrant on these premises.
Affiant has spoken with and read the statements of many of the
ATF Agents who, on February 28, 1993, attempted to execute the
search warrant at the Mt. Carmel Compound and have reviewed the
results of the investigation conducted by your affiant and other
law enforcement officers into the murder of four KIT Agents at the
Mt. carmel compound and attempted murder of remaining agents at the
scene, resulting in 15 injured agents. Based upon this review, I
believe that there is probable cause to believe that the above
named person committed the offense of conspiring to murder a
federal officer engaged in or on account of the performance of his
or her official duties in violation of Title 18, United states
code. Sections 1111, 1114, and lll7.
Current and former associates of yZRUOlI HOVBLL, also
known aa David Koreah, have informed investigators that HOWXZX is
a leader of a group of individuals who reside at the Mt. carmel
Compound, Route 7, Box 4 71-B, Waco, Texas. As such, EOWXLL imposes
severe discipline upon his associates and demands total obedience
to his commando.^ Agents have also learned that Strvx BCEVSZDER
is HOWSLXt'B deputy and second in command at the compound. DOOOZJLS
^ Many of these individuals have expressed a fear of VemoB
Bovell and his current associates. Because Howell assumed control
of this group of individuals after a gun battle in 1987 and because
of the ferocity of the ambush of ATF agents on February 28, 1993,
I believe that this fear is well founded and thus, have not
identified certain sources of information for their protection.
Much, if not all, of the information obtained from these sources
has been corroborated through independent investigation, and I
believe that the information which I have included in this
affidavit is true and correct.
54
WAYVS MARTXH, a llcanavd attorney, is also a BOWBLZ. confidant and
holds a leadership position, being recognized by other residents as
the third in conmand at the compound.
Approximately 100 other men, women, and children live at
the Mt. carmel Compound. Certain of the male residents, including
JAZJUB CASTILLO, AOEBOWALE DAVZEB, CLXTZ DOYLZ, FLOYD LEOS EODTXAV,
DAVID MICHAEL J0HB8, JETF LITTLE, DODGLAa WAYKB MARTIU, ''PBILLIP",
whom I believe to ba PHILLIP HENRY, "BTBVE", whom I believe to be
STEVE HEHRY, JAMES L. RIDDLE, STEVE SCHXnSIDER, CLIFF BELL0H8,
GREOORY A. SOMMERS, KEIL VAEGA, MARX WEKOEL, Livingstone Fagan,
Oliver Gyarfas, "Stone" whom I believe to be Livingstone Malcolm,
David Thibodeau, and Kevin A. Whitecliff have been designated by
HOVELL as "Mighty Men". The "Mighty Men" designation appears to be
rooted in the Old Testament which describes a group of that name as
select warriors who fought for King David. Former residents of the
compound report that all the Mighty Men named above were on the
premises at the time of the ambush of the ATF Agents on February
28, 1993.
Former residents of the compound also report that all
adult residents of the compound, except for the elderly or infirm,
and some of the children undergo training, which could be described
as "paramilitary training" and are schooled in the use of multiple
weapons, including assault-type weapons such as the AK-47 and AR-15
or M-16 rifles.^ When taken into custody, one former resident of
' One 12 year old girl who refused to touch a rifle during one of
the training sessions was later allowed to leave the compound.
55
tn« conpound, Catharine Matteson, who was present at th« coatpound
during the ambush of the ATF Agents and has since left Mt. camel,
had in her possession detailed, handwritten instructions on
shooting, including notes on hov to shoot a person wearing a bullet
proof vest. Former residents of the coapound have inforaed
investigating agents wor)cing on this case that with the exception
of the elderly and the children, weapons — described as AR->15 or
AK-47 rifles — have been issued to all the adult residents of the
coapound and are Kept routinely in each's assigned bedroom.
I know based upon my training and experience that an AR-15 is
a semi-automatic rifle practically identical to the M-16 nachinegun
carried by United States Armed Forces. The AR-15 rifle fires .223
caliber ammunition and, just like the M-16 maohinegun, can carry
magazines containing between 30 to 60 rounds of ammunition. I have
been involved in many cases where defendants, following a
relatively simple process, illegally convert AR-15 semi-automatic
rifles to fully automatic rifles of the nature of the M-16. This
illegal conversion process can often be accomplished by purchasing
and installing certain parts which will quickly convert the rifle
to fire fully automatic.
Investigative agents working on this case have learned from
former residents of the Mt. Carmel Compound that such conversions
had in fact taken place at the compound prior to February 28, 1993.
From about January or February of 1992, neighbors whose property
surrounds the Mt. Carmel Compound reported hearing the sound of
automatic weapon fire, including machinegun fire, coming from the
56
(^
compound during the night hours. One of these neighbors, who has
prior military service, believes that some of the gunfire he heard
emanated from .50 caliber machineguns and possibly, m-16
machineguns .
It is known from former residents of the Mt. Carmei
Compound and associates of HOWHLL that HOWBLL maintains a large
cache of weapons and ammunition in his arsenal, including at least
123 AR-15/M-16 type rifles, 44 AK-47 type rifles, 26 M-1 type
rifles, 11 other long guns, 60 hand guns, 2 assault shotguns
(Street Sweepers), and 2 Barrett .50 caliber rifles. As to
ammunition, one former resident of the Mt. Carmei Compound
described seeing wood crates full of ammunition that were staOced
two deep and as high as the ceiling along a ten-foot wall within
the compound.
Through tracing firearms transactions forms and shipping
records ATF Agents have established that between October of 1991
and February 28, 1993, at least $199,715 has been spent on the
acquisition of weapons, related equipment, and ammunition by HOWZLL
and his associates. In addition to these purchases made by this
group from licensed firearm dealers, regular purchases of weapons
and ammunition have been made at flea markets and gun shows
according to former residents and associates of the group.
Identified as the purchasers of this weaponry are VEBKOH HOWSLL,
JXXMZ CASTILLO, Paul Fatta, DAVID MICHXEL JONZB, DOUOLAS WAYHX
MASTIK, Catherine Matteson, Michael Dean Schroeder, SCOTT KOJIBO
SONOBB, QREOORY A. SUKXERS, and JEF7 LITTLE.
57
Ponaer resid«nl:s also hav* raporxsd obBorvlng and
participating in tho illagal raactivating and rearming of hand
grenadtts. One BOWSLL aasoclata has advised agants that he knows,
based on parsonal obsarvations, that HOWKLL has manufactured live
hand grenades (a prohibited daatructive device) froa inert
grenades, black powder and fuses. This individual has seen hand
grenades and their component parts in the Mt. Carmel Compound as
late as January of 1993. ATF Agents present at the attempt to
serve the search warrant at the Mt. carmel Compound on February 28,
1993 recognized the sound of grenades exploding in their midst.
Within that same time frame— early in 1993, this individual
obaarved two or three illegal firearm silencers being manufactured
within the compound. It is believed by this individual that the
silencers were designed for AR-15 rifles. This individual also
observed approximately 100 fully automatic AR-15/M-16 raachineguns
within the compound, as well as tactical veats, that is, clothing
designed to carry firearms ammunition and magazines; radio
equipment; police scanners; and other paramilitary paraphernalia.
A former resident of the compound has informed the investigative
agents working on this case that gas masks were distributed to the
Mt. Carmel residents after the February 28th ambush of ATF Agents.
Further, I know that ATF Agents attempting to execute the
search warrant on February 28, 1993, have stated that they observed
what appeared to be tactical vests on many of the Mt. Carmel
residents who were firing upon the agents. A fcrmar resident of
the Mt. carmel Compound has identified ZIBX FAHaiS, F«tICI»
58
(^
BOMOBE, MAROARETA VAEOA, Susan Banta, Beverly Elliot, Sherri Lynn
Jewel, Juliete santoyo Martines, and Ruth Oatoan Riddle aa among
those responsible for sewing the tactical vests.
From former associates of HOVBLL and former residents of
the Mt. Camel Compound, investigating agents have learned that as
part of their regular duties, adult Mt. Carmel residents received
indoctrination directed against law enforcement officials. An ATF
Special Agent working in an undercover capacity was even shown a
video recording that was specifically derogatory of ATF.
Specifically, HOWELL continually predicted a confrontation with law
enforcement officials and repeatedly instructed his followers that
should this occur, they were to "resist with arms" and "be ready to
fight and resist." According to a former HOWELL associate,
HOWELL, in discussing the firearms cache at the compound, always
said that they were maintained there for use against "the police"
and instructed both men and women that they were "to fight." As
part of their regular training, the adult residents of the Mt.
Carmel Compound maintained armed guard duty at the compound, with
instructions to shoot and kill any intruders.
Early in the morning of Sunday, February 28, 1993, the
undorcovar agent entered the Mt. Carmel Compound and met with
VZRMON HOWELL, STEVE 6CSMEIDER, and other residents of the
compound. VERIIOM HOWELL was then summoned from the room by a
fellow resident of the compound, Perry Jones, leaving the agent in
the foyer area. At about the same time, DAVID MXCHAEL JOKES, an
59
(9
associate of Vermoh sowell, had arrived at the compound after
learning that the compound might be raided that day. a short time
later, HOWELL returned to the room where the agent waited and
exclaimed that the ATP and the Kational Guard were coning to get
him. HOWELL continued, eaying, "Neither ATF or [sic) the National
Guard will ever get me. They got me once, and they will never get
ne again. They are coming; the time has come." Shortly
thereafter, the undercover agent left the compound.^
ABBOclatea who were present in the compound on that day
have informed investigating agante that, after the departure of the
undercover agent, the word spread throughout the compound that law
enforcement officials were coming. One resident of the compound
heard NEIL VXEOX say that the "Assyrians are coming" and became
frightened, realizing that law enforcement officers were heading
towards the compound.
Before the ambush, one resident observed VZRMOK HOWELL in the
foyer area of the compound building. rowcll was dressed In black
clothing and carrying an AR-15 rifle. KARK WENDEL wao observed in
the same area, also wearing blacX clothing. HOWELL directed the
elderly residents present on the lower floor to return to their
rooms. As this was occurring, one of these residente observed
several of the men carrying weapons, including ALRZCX QEORQE
BENNETT, JOHN MAUX STANLEY MC BEAK, JAMES L. RIDDLE, Petsr Gent,
Peter Hlpaman, and PABLO COHEN. This resident also observed two
■* Catherine Matteson who was present at the compound on February
28, 1993, has stated that VERNON HOWELL knew that this person was
an undercover law enforcement officer.
8
60
&
boxes containing hand grenadea on a table in the dining room.
DOOOtAS VAYKB MARTIN was observed with a string of hand grenadea
around his necK. ,
At approximately 10:00 a.m. on February 28, 1993, ATF Agents
arrived at the premises in an attempt to execute the search and
arrest warrant. When the ATF Agents arrived at the Mt. Camel
Compound, thoy were wearing uniforms bearing the words "ATf",
"SPECIAL AGENT", and "POLICE" in big letters and bold gold print;
some carried equipment upon which were displayed the words "ATF
AGENT" and "POLICE". As some of the agents approached the front
door of the premises, making loud verbal announcements as to their
identity and purpose of executing the warrant, at least one agent
observed VKRNON HOWELL standing in the partially opened front door.
VERNON HOWELL was observed to smile and then close the front door
to the agents. Gunfire then erupted from the inside of the
compound outward, piercing through the front door and adjoining
walls.
Lying againsc the outside front wall of the foyer after
being hit in the opening rounds of fire, ATF Special Agents heard
men's voices emanating from inside the compound building. While
listening, one Special Agent heard the names, "David" , whom I
believe to be David Koreah, VERNON HOWELL, and "Wayne," whom I
believe to be a reference to DODGLAS WAYNE MARTIN, and from the
context of the exchangee concluded that "David" and "Wayne" were
functioning in leadership roles. One compound resident who was
there during the encounter was informed by Brad Branch that VERNOM
61
C^
HOWELL was in th« foyer area whan ha was initially wounded despite
wearing a bullet proof vast.
Throughout the encounter, the agents reoaived a heavy
barrage of gunfire froa persona inside the compound. These
experienced and trained agents recognized the sounds of fire fron
automatic and seai-autoaatic weapons and fire froa large caliber
weapons, as well as the sounds of grenades exploding. Those AT?
Agents in the front of the coapound building observed gunfire
emanating from virtually every window of the compound building and
coming through the walls and doors. ATF Agents on the sides and
back of the compound building also observed firing froa the windows
of the building and froa the water tower located behind it. Agents
assigned to the task of climbing onto the roof to gain entry into
the area of VXRMON HOwnX's bedroom and arsenal room were fired
upon through the windows, roof, and walls of the compound while on
the roof and within the building; In addition they were fired upon
directly by those residents of the compound they encountered while
inside the building.
Residents present at the compound observed the following women
armed with rifles on the second floor of the compound building
during the shooting: TZSB8A NOBRZrOA, RITA VAYS RXDDLB, 7ELXCZTA
SONOBB, MAROARETA VAZOA, and Jaydean Wendel. During the shooting,
Brad Branch was obcarved with a gun, as was AARON AVDRI CALAZl,
AOEBOWALZ DAVIB8, PHItLIP HENRY, STBVE HENRY, FLOYD L. HOOTMAM,
JANE8 L. RIDDLE, CLIFF BELLORS, and LORRAINE SYLVIA. Also observed
with a rifle that day wasj ALRZCE OEOROE BEKKITT, JAIMI CAflTILLO,
10
70-792 0-93-3
62
PABLO COKBV, CLZVS DOYLE, LISX FMUII8, DOUQUIS WAYKK MARTIN, JOHN
MARX STANLEY MC BEAM, TERESA MOBRZEOA, RITA FAYE RIDDLE, STEVE
SCHNEIDER, SCOTT KOJIRO 80N0BE, HEAL VAEGA, Shari E. Doyle, Yvette
Fagan, Raymond Frlesan, Diana Henry, Sherri Lynn Jewel, sheila
Judith Martin, Roseoary Morrison and Kevin Whitecliff. JUDY
SCHNEIDER and Katherine Andrade were wearing gun belts.
As the result of this gunfire froa the residents of the Mt.
Camel compound, four ATF Agents were killed and 15 ATF Agents were
wounded. Physicians, as well as the agents who attempted to
assist the injured and dead, have stated that these agents received
gunshot wounds and that bullets or bullet fragments or grenade
shrapnel were located in these agents' bodies. Residents of the
compound who were present during the fire fight have identified the
following as being wounded during it: VERNON BOWELL, DAVID MXCSABL
JONES, jrmr scsnbider, soott XOJIRO sonobe, and Brad Branch.
Photographs and surveillance at the compound since the time of
the ATF Agents withdrawal establishes that the residents of the
compound have fortified their building and cut additional gun ports
in the walls. Residents of the compound have been observed
standing guard, including, according to former residents, ALORICX
aXOROB BENNETT, JAIME CASTILLO, PABLO COKEN, CLIVE DOYLB, LISA
FARRIB, DODOLAS WAYNE MARTIN, JOHN MARX STANLEY MC BEAN, STEVE
SCHNEIDER, SCOTT XOJIRO SONOBE, NSAL VAEOA, Shari E. Doyle, Yvette
Fagan, Raymond Friesen, Diana Henry, Sherri Lynn Jewel, Shiela
Judith Martin, and Rosemary Morrison.
Investigation and intelligence indicates that the following
11
63
adults were present at the coopound on February 28, 1993, at the
time of thtt aabush of the ATF Agents: Katherlne Andrade, ReBOs
Avrraa, Susan Benta, Marsha Bland, Graeme Leonard Craddock, Shari
E. Doyle, Beverly Elliot, Doris Adina Fa^an, Yvette Pagan, Raymond
Friesen, Sandra Elaine Hardial, Diana Henry, Pauline Henry, Vanessa
Henry, Zilla Henry, Novellette Sinclair Hipsman, Maxwell Mortimer
Howard, Shorri Lynn Jewel, George Kean, Derek Lloyd -Lovelock,
Livingstone "Stone" Malcolm, Anita Marie Martin, Diane (Daisy)
Martin, Wayne Joseph Martin, Juliete Santoyo Martinez, Allison
Bernadette Monbelley, Rosemary Morrison, Sonia Carolina Murray,
Majorie Powell, Ruth Ottoan Riddle, Wayne Ritsen, and Rebecca
Saipaia, and David Thibodeau. At this time, to your affiant's
knowledge the only ties these witnesses have to the central Texas
area arc with members of the group in the Mt. Carmel Compound.
Ar.^P^.r
^^^<^-^K
Earl Dunagan, Sp^dialAgent
Bureau of ATF -^
Subscribed and sworn to before me this I T — day of AC/^ f C-
1993.
Dennis G. Green,
United States Magistrate Judge
Western District of Texas - Waco
12
64
3^
This warrant, affidavit and all accompanying papers ar« hereby
sealed by order of this court.
Signed by ne this iS'^J* day of Afi£ f<^ , 1993.
'2^-^e^^ ^"^ •^'gy^gg*
Dennis G. Green,
United States Magistrate Judge
Western District of Texas - Waco
13
65
A0 9i iWt» gfBil 5«ntnW»rT»»w m
'^xiiizh ^tntzs Bistrirt Qlnurt
HfiSTFBH DISTRICT OF XEXJLS
in th0 Mattftr of thi Searcn of
rasxdanc* of V*rnon Hayna Hawaii. 4nd echars. Rt
7 BOS 471-B. AXAi Mounc Carnal Cantar, WaeoCASE NUMBER
McLannan Coua«y, TX, Ita appurraaanea*. vonielaa.
unaarground acrucxuraa loeacad on anciz* praaa-a**
of cha 77 acra coopound. Saa accacrvad phocoa a
proparcy daaeripcion Attachmanta A, B and C
SEARCH WARRANT
lv'?3-3o/^
TO: Special Anent Daw Aouilerii anO any AuttiorireO Off Icar of tr\a Unltad States
Allioavu(s) having Dean macaa Detore me Oy S/A Davy Aqpilftrw who has reas
Del lave mat i2 on the paraon of or (Son tna premisaa known aa mtm*. ottcnonen •mvo' lecinem
th» r««id«nc« of Vtmon Wayna How«il and oth«ra, Rt 7 Box 471-B, AXA: !
Canasl Cantar, Waco, HcLennaji Counry, Taxas, it« appurtsnancas, vault
undarground atruccurei locacad on ancira premiaas of tha 77 acra conpc
saa AttacAad photographs and proparcy daacripciona.
m tna u^y^■a^^^ DIatnct of Tenaa — • "'•'• '■
concaaieo a certain peraon or property, na/neiy ni«c»M i'<« Mrten c »r«Mnn
SEE ATTACHED SHEET FOR CONCEALED PROPERTY (ATTACHMENT D)
I am satisfied that the affldavit(s) ana any recoroeo testimony eatabllan probable cauaa to believe that the c
or property so fleacnbad Is now concaaiad on the peraon or premiaea aoove-deacnbeo ana astabllah groun
tna Issuance of this warrant.
YOU ARE HEREBY COMMANDED to search on or before A,0^f^ P^ ''^t^
(not 10 exceea 10 aaye) the person or place named above tor the person or properry specified, servtng thle w
and making tna search (la it>e ia'><m»a 6iOO AM lu tOW P M.I (at any time m the day or night as
reasonable cause has been estapilshgai and if the person or properry be found there to seize same, leaving c
of this warrant and receipt tor the person or prooeny taken, ano prepare a wntten inventory of the person or
any seized and promotiy return this warrant to Dennia G- ^f^^" _ — ^^
as reauirea by law.
DWanonfncuMjao wiy ano ai«. ^^^
""^'Ifi — '^"^ — "'^
66
(P
ATTXCmngHT X
The residsnca of Vernon Wayna Howail. and ochers. dascribad as a
Large tvo story tan structure witii a ligftt gray coDpoaition roof
several breads m the roof line and -white shuttera on the windows
with a three or four story square addition to the structure nea:
the center of the complex which appears to be an obaarvation tovar
There is a rusty cylindrical water tanJc at the north and of thi
structure which is approxioaceiy 60 feet in height. There are alsi
numerous vehicles of various maXes and Dodels around the structure
as wall as several outbuildings located on the preaisas which it
approximately 70 to 80 acres in size. At the entrance driveway ti
the premises is a small frame shack.
To locate the property begin at Exit number 33 0, Loop 340 and Texai
Highway number 6, at its intersection with Interstate Highway 3 5
^ust south of Waco, HcLennan County, Texas, go east on Loop 3 40
which curves into a northerly direction for approximately 8,1 mile:
to Its intersection with Texas Farm Road number 2491. Turn right
or east on Farm Road 2491, and proceed for approximately 5.6 milei
to its intersection with Double EE Ranch Road/County Road nuaba:
222. Turn left, or north and proceed approximately . 4 of a mile ti
the entrance driveway which is on the right or east side of Doubli
EE Ranch Road. At the entrance to the property is one smal.
mailbox and one large mailbox accompanied by a Waco Tribune Herali
delivery box which is yellow in color with blacJc printing upon it
Affiant and other authorized agents sealc to aaarch the entire 70-8<
acre compound, including all buildings, vehicles and structures o]
the premises located both above and below the ground.
PHOTOGRAPHS OF PROPERTY ARE ATTACHED AND MADE A PART HERETO.
67
ATTXegyrprf p
The fallowing property la concealed;
A quantity of £irearas, including but not limited to: an
assortmant of AA-15 rifles and \X-47 rifles, and parts thsraof,
MAC-lO and HAC-11 firaams, along with a quantity of assorcad
machinagun conversion parts, which, when aasambled, would be
classified as machineguns, machinery and implaments used or
suitable for use in converting seal-automatic weapons to fully
automatic and for constructing destructive devicee such as pipe
bombs and homaaade grenades, this machinery would include, but not
be limited to metal lathes and milling machinea and imaging
equipment, receipts and bills from hardware stores and other
raercnants reflecting the purchase of equipment used to construct or
convert explosive devices or firearms, .50 caliber anti-tan)c rifle,
3tan guns, grenade launchers, practice rifle grenadee, practice
hand grenades, various chemicals, including but not limited to
blaclc powder, ignitor cord, aluminum metal powder and potassium
nitrats, magnaaium metal powder, metals in various forms, inert
"pineapple" type hand grenades, pipe bombs and parts thereof, radio
controlled airplanes which could be utilized to carry explosives,
and other suitabls casings of un)ufiown description which, when
assembled, would be classified as destructive devices as thoae
terns are defined in Section 5845 (b) , and Section 5B45 (f),
Chapter S3, Title 26, United States Code, which are not registered
with the Netional riraarms Registration and Transfer Rsoord,
Washington. D.C., as required by law, ailenoers and parts thereof,
body armor, equipment vests and other such clothing, counter-
surveillance equipment (i.e. binoculars, spotting scopes, night
vision equipment) , scanners, two-way radios, cellular telephones,
KAK radios, video tape equipment (Vdt) , audio tape equipment
including video and audio tapes, documentary and computerized
evidence of receipt or ownership, video and other instructional
matter including book.let8 and magarines which contain instructions
for converting semi-automatic firearms into machineguns, and the
construction of improvised explosive weapons, or which may be
instructional in firearms training, including computer hardware,
peripheral equipment and software containing files and directories
and ths information thereon. This is to include any disks,
manuals, printouts and other assorted computer ac[uipmBnt.
68
iO 1M (Bev ( »7l Aiiiflivii lor Saircn W»ffini •
^ — . ■ FILED
Mniitb states Bistrtct fllauirt -^pri 3199
WESIESM DISTRICT OF
In tna Matt«r of tne Searcn of
residence oi Vernon Wayn« Howail, and othari APPLICATION AND AFFIDAVI
Rt 7 BOX 471-B, also known aa the Mt. Carmel FOR SEARCH WARRANT
Center, Waco, McLennan County, Texas, its appurtenances, vehicles ^
and underground structures located on the CASE NUH/»8ER: l/\/ ^/3 'S2i'^
encire premises of the 77 acre compound. See attached photos and proparf
descriptions, Attachnients A, B and C
' Davy Aguilsra being duly sworn depose an
I am a(«0 .tjocrial Aopnr. u^th the Bur>»Hii of hTF and hiv* raaaon to t
that \^ on the person ol or ^ on the property or premises Known as iahm (Muwiitn .»»«, »«•<*«
SEE ATTACHED "DESCRIPTION OF PROPERTY" WHICH IS INCORPORATED BY REFERENCE
THOUGH FULLY SET FORTH,
in the WESTERN District of TEXAS
there IS now concealed a certain oerson or property, namely MMcnMrnn'Mnw ••wot* km •»!«•
SEE ATTACHED "DESCRIPTION OF PROPERTY" WHICH IS INCORPORATED BY REFERENCE
AS THOUGH FULLY SET FORTH. SEE ATTACHMENT D,
which IS tliti**^** moraMM* (v itvct v«a M.iwf« Mt •OAtw^vv fcflt*"**' I'V'Mani ^^••V'C'tm'^ ^TMaMt*
contraband, evidence of the coimnisBion of a criminal offense, and things
criminally possessed
concerning a violation of Title IS & 26 United States code. RAffttnnut 922 fol. ';B45(fl. SB
The tacts to suooon a linoing of Probaote Cause are as follows:
SEE ATTACHED "AFFIDAVIT" OF SPECIAL AGENT DAVY AOUILEBA, BUREAU OP ALCOHC
TOBACCO AND FIREARMS, WHICH IS ATTACHED HERETO AND INCORPORATED BY REFER!
THOUGH FULLY SET FORTH.
Continued on me attached sheet ana maae a part hereof. (2 Yes Q No
signwiA* of A((i«p»/t)avy Aguriera , Spec;
/ ATF /
Sworn to Dclore me. arxl suDscrlbeo In my pretence
Z^^^,/^': /<?y5 at "'^°°r TX ^^
r^^nnis G. Green, U.S. Magistrate Judge >^^<^^««*<-» ^-<^ ..-^<^«9*«^ '
i^meeno Title 01 Juaici«iO(irc.r Slonwure ol JuOlclat Of fleer
69
^^
XTTXCmgHT X
Th« residence of Vernon Wayne Howell, and others, described as a
large two story tan structure with a light grey coaposition roof,
several breads in the roof line and white shutters on the windows;
with a three or four story square addition to the structure near
the center of the conplex which appears to be an observation tover.
There is a rusty cylindrical water tanJc at the north and of the
structure which is approximately 60 feet in height. There are also
numerous vehicles of various saXes and models around the structure,
as well as several outbuildings located on the premises which is
approximately 70 to 80 acres in size. At the entrance driveway to
the premises is a small frame shac)c.
To locate the property begin at Exit number 330, Loop 340 and Texas
Highway number 6, at its intersection with Interstate Highway 35,
just south ot Waco, McLennan County, Texas, go east on Loop 340,
which curves into a norrheriy direction for approximately 8.1 miles
CO Its intersecrion with Texas Farm Road number 2491. Turn right,
or east on Farm Road 2 491, and proceed for approximately S.6 milee
to its intersection with Double FE Ranch Road/ County Road number
222. Turn left, or north and proceed approximately .4 of a mile to
the entrance driveway which is on the right or eest side of Double
EE Ranch Road. At the entrance to the property is one sbbII
mailbox and one large mailbox accompanied by a Waco Tribune Herald
delivery box which is yellow in color with blacK printing upon it.
Affiant and other authorizad agenrs seeX to seerch the entire 70-BO
acre compound, including all buildings, vehicles and structures on
the premises located botm abov* and below the ground.
PHOTOGRAPHS OF PROPERTY ARE ATTACHED AND MADE A PART HERETO.
70
ATTACHMEMT P
(^
The following property ia coneealadi
A quantity of firearms, including but not limited to: an
assortment of AR-lS rifles and AX-47 rifles, and parts thereof,
MAC-lO and MAC-11 firearms, along with a quantity of asaortsd
machinegiin conversion parts, which, when assembled, would be
classified as machineguns, machinery and implements used or
suitable for use in converting semi-autonatic weapons to fully
automatic and for constructing destructive devices such as pips
bombs and homemade grenades, this machinery would include, but not
be limited to metal lathes and milling machines and imaging
equipment, receipts and bills from hardware stores and other
merchants reflecting the purchase of equipment used to construct or
convert explosive devices or firearms, .50 caliber anti-tank rifle,
sten guns, grenade launchers, practice rifle grenades, practice
hand grenades, various chemicals, including but not limited to
black powder, ignitor cord, aluminum metal powder and potassium
nitrate, magnesium metal powder, metals in various forms, inert
"pineapple" type hand grenades, pipe bombs and parts thereof, radio
controlled airplanes which could be utilized to carry explosives,
and other suitable casings of unXnown description which, when
assembled, would be classified as destructive devices as those
terms are defined in Section 5B45 (b) , and Section 5845 (f) ,
Chapter 53, Title 26, United States Code, which are not registered
with the National Firearms Registration and Transfer Record,
Washington, D.C. , as required by lav, silencers and parts thereof,
body armor, equipment vests and other such clothing, covinter-
surveillance equipment (i.e. binoculars, spotting scopes, night
vision equipment), scanners, two-way radios, cellular telephones,
HAM radios, video tape equipment (VCR), audio tape equipment
including video and audio tapes, documentary and computerized
evidence of receipt or ownership, video and other instructional
matter Including booklets and magasines which contain instructions
for converting semi-automatic firearms into machineguns, and the
construction of improvised explosive weapons, or which may be
instructional in firearms training, including computer hardware,
peripheral eq^iipnent and software containing files and directories
and the information thereon. This is to include any disks,
manuals, printouts and other assorted computer equipment.
71
ArriPAviT
(^
Affiant alleaea t{ie following grounds fox search and saizurw}
I, oavy Aguilara, being duly sworn, depose and state that:
T an a Special Agent with the U. S. Treasury Department, Bureau of
Alcohol, Tobacco and Flreams, Austin, Texas, and I have been so
employed for approximately 5 years. This affidavit is based on ny
own investigation as well as information furnished to me by other
law enforcement officers and concerned citizens.
As a result of ny training and experience as a Special Agent for
the Bureau of Alcohol, Tobacco and Firearms, I am familiar with
the Federal firearm and explosive laws and know that it is unlawful
for a person to manufacture, possess, transfer, or to transport or
ship in interstate coounercs machineguns, machinegun conversion
parts, or explosives which are classified, by Federal law, as
machineguns, and/or destructive devices, including any combination
of parts either designed or intended for use in converting any
firearm into a machinegun, or into a de-cructiva device as defined
by Federal law, and from which a destructive device may be readily
assembled, without them being lawfully registered in the National
Firearms Registration and Transfer Record, U.S. Treasury
Department, Washington, D.C.
During my 5 years experience with the Bureau of Alcohol, Tobacco
and Firearms, I have investigated persons who have unlawfully
poBseased, tranefarred or ahipped in interstate or foreign commerce
firearme and/or axploetve devices which ware not registered to them
with the National Firearms Registration and Transfer Record, and
have successfully participated in the prosecution of several of
these individuals.
on June 4, 1992, I met with Lieutenant Gone Barber, McLennan County
Sheriff's Department, Waco, Texas, who has received extensive
training in explosives classification, identification and the
rendering aafe of explosive devices and has bean recognized in
Federal Court as «n expert witness in this field. Lt. Barber
etated that he had received Information in May 1992, from an
employee of United Parcel Service, Waco, Texas, that from April
through June of 1992, several deliveries had been made to a place
Icnown as the "Mag-Bag", Route 7, Box 555-B, Waco, Texas, 7670S,
located on Farm Road number 2 4 91, in the names of Mike Schroeder
and David Koraah, which the UPS employee believed to be firearms
components and explosives. Through my investigation, I know that
the place known as the "Mag-Bag" is a small tract of land locatsd
at the above addresa which has two metal buildings located on it.
The name "Mag-Bag" comes from thi shipping label which is
72
acconpanied many items shipped to the above address. I and ochar
agents have personaily observed vehicles consistently over the past
six Donths at the "Mag-Bag" location which are registered to Vernon
Wayne Howell, aka: David Koresh. Lieutenant Barber further stated
that the UPS employee, Larry Gllbreath, becaae suspicious and
concerned about the deliveries, most of which were shipped cash On
Delivery, (C.O.D.) because of their frequency and because of the
method used by the recipient to receive the shipments and to pay
for thea.
Lieutenant Barber explained that David Koresh was an alias name
used by Vernon Wayne Howell who operated a religious cult commune
near Waco, Texas, at a place commonly known as the Mount carael
Center, which is one of the premises to be searched and more
specifically described above. i have learned from ny
investigation, particularly from my discussions with former cult
members that Vernon Howell adopted the name David Koresh more than
a year ago. The name "David Koresh" was chosen by Howell because
Howell believed that the name helped designate him as the messiah
or the anointed one of God. Lieutenant Barber further related that
he was told by Gllbreath that: he has been making deliveries to the
"Mag Bag" and the Mount Camel center on Double EE Ranch Road,
Waco, Texas, for several years, but he had never been suspicious of
any of the deliveries until 1992. Gllbreath became concerned
because he made several C.O.D. deliveries addressed to the "Hag-
Bag", but when he would stop at that location he was instructed to
wait while a telephone call was made to the Mount Camel Center by
the person at the "Mag-Bag", usually Woodrow Kendrick or Hike
Schroeder, notifying the person who answered the phone at the Mount
Camel Center that UPS was coming there with a C.O.D. delivery,
after which Gllbreath would be instructed to drive to the Ho\int
Carmel Center to deliver the package and collect for it. That on
those occasions when he was at the Mount Camel Center to deliver
and collect for the C.O.D. packages. He saw several manned
observation posts, and believed that the observers were armed.
Lieutenant Barber stated that he was told by Larry Gllbreath (UPS)
that in Hay of 1992 two cases of inert hand grenades and a quantity
of black gun powder were delivered by him to the "Hag-Bag." The
source of these shipments was unknown to Gllbreath.
On June 9, 1992, I was contacted by Lieutenant Barber who told me
that he had learned from Larry Gllbreath that in June of 1992, the
United Parcel Service delivered ninety (90) pounds of powdered
aluminum metal and 30 to 40 cardboard tubes, 24 inches in length
and 1 1/4 to 1 1/2 inches in diameter, which were shipped from the
Fox Fire Company, Poeateila, Idaho, to "Hag-Bag." From another
shipper whose identity is unicnown, two parcels containing a total
of sixty (60), M-16/AR-15 ammunition magazines were delivered by
UPS to the "Mag-Bag" on June 8, 1992. I know based upon my
training and experience that an AR-15 is a semi-automatic rifle
practically identical to the M-16 rifle carried by United States
73
Armed Forcaa. The AR-15 rifle fires .223 caliber amaunition and
just like the M-16, can carry magazines of ammunition ranging froi
30 to 60 rounds of ammunition. I have bean involved in many case,
where defendants, followxng a relatively simple process, convert
AR-15 semi-automatic rxfles to fully automatic rifles of the nature
of the M-16. This conversion process can often be accomplished by
an individual purchasing certain parts which will qulOcly transform
the rifle to fire fully automatic. Often times templates, milling
machines, lathes and instruction guides are utilized by the
converter.
Lieutenant Barber related to me the following background
information about the Mount Camel canter commune, which is located
at Rt. 1 , Box 471-B, Waco, Texas, and consists of some seventy (70)
acres of land, occupied by Varnon W. Howell, a/k/a David Koresh and
others.
The property was once owned and occupied by George Buchanan Roden,
who once was an unannounced candidate for the office of President
of the United States. Roden inherited the property sometime in the
1950 '8, and beginning about January 1986 established and led a
religious cult group with about twenty (20) followers. He claimed
to be the Prophet of the group. The property at that time was
known as the "Elk Proparty/Mt. Cannel Canter." About this sane
time, Roden was in jeopardy of losing the property by foreclosure
due to delinquent taxes which had not bean paid since 1968.
About this same time, Vernon Wayne Howell, had established a
similar group in Palestine, Texas, known as the Branch Oavidian
seventh-Day Adventists. Sometime in 1987, Howell, laid claim to
ownership of tha Mr. Carmel Center property and wanted to acquire
it by any means possible. On Novamher 3, 1987, Howell led an armed
group of eight nan into Roden 'a camp and a 45-minute gun battle
ensued. Roden was shot in the finger and was the only person
injured.
Eight people, including Varnon W. Howell and Paul Gordon Fatta were
arrested by the McLennan County Sheriff's Department, Waco, Texas,
and were indicted for attamptad murder by a McLennan County Grand
Jury. All eight 3Ub;)acts were tried in state court at Waco, Texas,
and ware acquitted of tha charges of attempted murder by a jury.
After the armed assault by Howell and his followers, George Roden
vacated the property. In 1987, the property was taken over by
Howell and his cult group. The taxes owed on the Mt. Carmel Center
have been paid by Howell's group. His cult has grovm to about
seventy (70) to eighty (80) people which includes men, woman and
children who now live on the Mount Carmel center property.
Lieutenant Barber furnished ma with recently taken aerial
photographa of the Mount Canael Center which had been taken by
captain Dan Weyenberg of the McLennan County Sheriff's Department,
74
(2i)
Waco, Texas. Among the things noted in the photographs was a
buried bus near the main structvxre and an observation tower,
approximately three or four stories tall with windows on all four
sides enabling a view from tha structure of 360 degrees.
I was also advised by Lieutenant Barber that Robert cervenka, a
known long time McLennan County citizen, who lives near the Mount
carmel center, compound, had, on several occasions, from January
through February of 1992, heard machinegun fire coming from the
compound property. Mr. CervenXa offered law enforcement
authorities his residence to be used as a surveillance post.
On July 21, 1992, I met with Robert L. cervenka, Route 7, Box 103,
Riesel, Texas. Mr. cervenXa farms the property surrounding ths
east side of the Mount carmel property. Mr. Cervenka stated that
he has farmed that area since 1948. From about January and
February of 1992 he has heard machinegun fire on the Vernon Howell
property during the night hours. He ia familiar with and knows the
sound of machinegun fire because he did a tour overseas with the
U.S. Army. He believes that some of the gunfire he heard was being
done with 50 caliber machineguns and possibly M-16 machineguns.
On November 13, 1992, I spoke with Lieutenant Gene Barber who told
me that Mr. Cervenka, whose ranch is adjacent to the Mount Carmel
Property, had reported hearing bursts of gunfire from the Mount
Carmel compound on November 8, 1992, at approximately 2:45 p.m.
On June 8, 1992, based on information gained from Gilbreeth by
Lieutenant Barber, I interviewed Dave Haupert, Olympic Arms Inc.,
Olympia, Washington, a company which had shipped several parcels to
David Koresh ac the "Hag-Bag", Route 7, Box 555-B, Waco. Texas.
Mr. Haupert told me that the records of Olympic Arms Inc. ,
indicated that approximately forty-five (45) AR-15/M16 rifle upper
receiver units, with barrels of various calibers, had been shipped
from March through April of 1992 to the Mag-Bag Corporation for a
total cost of $11,107.31, cash on delivery.
On January 13, 1993, I interviewed Leurry Gilbreath in Waco, Texas,
and confirmed the information which had previously been related to
me by Lieutenant Barber. Mr. Gilbrsath told me that although he
had been making deliveries at tha "Mag Bag" and the Mount carnal
Center for quite some time, his suspicion about the packages being
delivered to those places never was aroused until about February
1992. At that tiae the invcicss accompunying a number of packages
reflected that they contained firearm parts and accessories as well
as various chemicals. He stated that in May 1992, a package which
was addressed to tha "Mag Bag" accidently broke open while it wee
being loaded on his delivery truck. He saw that it contained three
other boxes the contents of which ware "pineapple" type hand
grenades which he believed to be inert. He stated that there were
about fifty of the grenades and that he later delivered them to the
Mount carmel Center. The Mount Carmel Center is that tract of land
75
depicted in the photograph labeled "Attachment B", with the main
residential structure being depicted in "Attachment c."
Mr. Gilbreath stated that these auspicioua pac)cageB were usually
addressed to the "Mag Bag" or to David Koresh. When ha would stop
to deliver them to the "Mag Bag", he was met most of the time by
Woodrow Kendrick, and on other occasions by Steve Schneider. They
would have him wait while they telephoned the Mount Carmel center
to tell them that UPS was coning with a C.O.D. package. He would
be instructed to take the package (s) to the Mount Carmel Center.
Upon arriving at the Mount Carmel Center, he was usually met by
Perry Jones or, on occasion, by Steve Schneider, who would pay the
C.O.D. charges in cash and would accept delivery of the shipments.
On this same date, June 8, 1992, I interviewed Glen Deruiter,
Manager, Sarco Inc., Stirling, New Jersey, and learned from him
that in Hay of 1992, their company shipped one M-16 parts set kit
with a sling and magazine to the "Mag-Bag" in the name of David
Koresh. The total value of these items was $264.95.
Also on June 8, 1992, I Interviewed Cynthia Aleo, owner /Manager,
Nesard Gun Parts Company, Harrington, Illinois, and learned from
her that in May of 1992, her conpany shipped to the "Mag-Bag", two
(2) M-16 machinegun car kits and two (2) M-16 machinegun E2 kits.
These kits contain all the parts of an M-16 machinegun, except for
the lover receiver unit which is the "firearm" by lawful
definition. Ms. Aleo stated that the total amount of sales to the
Mag-Bag was $1227.00. Within the past month, I have spoken with
Curtis Bartlett, Firearms Technician with BATF and have learned
that Nesard Company has been under investigation in the past by ATT
for engaging in a scheme to supply parts which would enable
individuals to construct illegal weapons from various component
parts.
On June 9, 1992. I requested that a search of the records of the
National Firearms Registration and Transfer Record, Washington,
D.C., to determine if Vernon w. Howell and/or Paul G. Fatta, one of
Howell's closest followers, had any roachinegxins or other NFA
weapons registered to them. The result of the search was negative.
On this same date, June 9, 1992, I requested a search of the
records of the Firearms Licensing Section of the Bureau of Alcohol,
Tobacco and Firearms, Atlanta, Georgia, to determine if Howell,
Fatta or the "Mag-Bag" Corporation were licensed as Firearms
dealers or manufacturers. The result of this search was negative.
On June 10, 1992, I requested a search of the records of the
Firearms Licensing Section of the Bureau of Alcohol, Tobacco and
Firearms, Atlanta, Georgia, to determine if David Koresh, Howell's
alias name, or David M. Jones, a known associate of Howell, were
licensed as Firearms dealers or manufacturers. The result of this
search was negative.
76
On June 23, 1992, I spoKe with ATF compliance Inspector Robert
Souza, Seattle, Waehington, who inquired about the Mag Baq
Corporation, Route 7, Box 555, Waco, Texas. He had reeaived some
invoices reflecting a large quantity of upper receivers and AR-is
parts being shipped to "Mag Bag", Waco, Texas, from Olyapic Anas
Inc., 624 Old Pacific Hwy., s.E. Olynpia, Washington. Inspector
Souza faxed me copies of invoices, reflecting purchaaaa of twenty
(20) AR-15 upper receiver units with barrels by the "Mag Bag" on
March 26th and 30th, 1992. These items are in addition to the
items referred to above.
As a result of ny investigation of shipments to Hovell/Koresh and
Mike Schroeder at the "Mag-Bag" Corporation, Waco, Texas, through
the United Parcel Service, and the inspection of the firearms
records of Henry McMahon, dba, Hewitt Hand Guns, Hewitt, Texas, I
have learned that they acquired during 1992. the following firearms
and related explosive paraphernalia:
One hundred four (104), AR-15/M-16, upper receiver groups with
barrels.
Eight thousand, one hundred (8,100) rounds of 9nffl and .223
caliber ammunition for AR-15/M-16.
Twenty (20), one hundred round capacity drum magazines for AX-
47 rifles.
Two hundred sixty (260), M-16/AR-15, magazines.
Thirty (30) M-14, magazines.
TWO (2) M-16 EZ )cits.
Two (2) M-16 Car Kits.
One M<-76 grenade launcher.
Two hundred (200) M-31. practice rifle grenades.
Four (4) M-16 parts set Kits "A".
TWO (2) flare launchers.
TWO cases, (approximately 50) inert practice hand grenades.
40-50 pounds of black gim powder.
Thirty (3 0) pounds of Potassium Nitrate.
Five (5) pounds of Magnesium metal powder.
One pound of Igniter cord. (A class c explosive)
Ninety-one (91) AR/15 lower receiver units.
Twenty-six (26) various calibers and brands of hand guns and
long qruns.
90 pounds of aluminum metal powder.
30-40 cardboard tubes.
The amount of expenditures for the above listed firearm
paraphernalia, excluding the (91) AR-15 lower receiver units and
the (26) complete firearms, was in excess of $44,300.
From my investigation, I have learned that a number of shipments to
the "Mag-Bag" have been from vendors with questionable trade
practices. One is presently under investigation by the Bureau of
Alcohol, Tobacco and Firearms, for violations of the National
77
Fireann« Act, which prohibits unlawful possession of machineouns
silencers, destructive devices, and raachinegun conversion kits. '
Because of the sensitivity of this investigation, these vendors
have not bean contacted by me for copies of invoices indicating the
exact iteos shipped to the Mag-Bag.
On November 13, 1992, I interviewed Lieutenant Coy Jones, McLennan
county Sheriff's Department, Waco, Texas, and learned froo hia that
he had spoken with an employee of the United Parcel Service, Waco,
Texas, Who wished to remain anonymous. This person told Jones that
Marshal Keith Butler, a relative of the person who wishes to remain
anonymous, is a nachinist by trade, and is associated with Vernon
Howell.
The records of the Texas Department of Public Safety reflect that
Butler has been arrested on seven (7) occasions since 1984 for
unlawful possession of drugs. Two of the arrests resulted in
convictions for possession of a controlled substance. Butler's
latest arrest and conviction was in January 1992. Butler received
a sentence of three (3) years in the Texas Department of
Corrections. In April 1992 Butler was paroled to McLennan county,
Texas.
On November 13, 1992, I Interviewed Terry Fuller, a deputy sheriff
for the McLennan county Sheriff's Department, Waco, Texas, and
learned from him that on November 6, 1992, at approximately 1:2S
p.m. , while on routine patrol in the area of the Mount carmel
Center, the property controlled by Vernon Howell, he heard a loud
explosion in the area of the north part of the Mount Carmel
property. As he drove toward the area where he thought the
explosion had occurred, he observed a large cloud of grey smoke
dissipating from ground level on the north end of the Mount carmel
property.
On December 7, 1992, I spoke with Special Agent Carlos Torres,
Bureau of Alcohol, Tobacco and Firearms, Houston, Texas, who had
been assisting me in a portion of this investigation. He related
to me the results of his interview on DeceoJaer 4, 1992, with Joyce
Sparks, Texas Department of Human Services, Waco, Texas. Special
Agent Torres told ne that Ms. Sparks received a complaint from
outside the State of Texas, that David Koresh was operating a
commune type compound, and that he was sexually abusing yoting
girls. Ms. Sparks stated that on February 27, 1992, she along with
two other employaas of the Texas Department of Human services and
two McLennan County Sheriff's Deputies responded to the complaint.
They went to the Mount Carmel Center compound located east of Waco
in McLennan County. When they arrived at the compound, they were
raet by a lady who identified herself as Rachel Koresh, the wife of
David Koresh.
78
^^
Mrs. Koresh was reluctant to tal)c with Ms. Sparks because David
Koresh was not there. She had strict orders from him not to talk
with anyone unless he was present. Ms. Sparks finally was ablo to
convince Mrs. Koresh to allow her to talk with some of the
children who were present, she talked to a youn? boy about 7 or 8
years old. The child said that ha could not wait to grow up and be
a man. when Ms. Sparks asked hin why he was in such a hurry to
grow up, he replied that when he grew up he would get a "long gun*
just like all the other aen there, when Ms. Sparks pursued the
subject, the boy told her that all the adults had guns and that
they were always practicing with then.
Ms. Sparks also told Special Agent Torres that she was escorted
thorough part of the building where she noted a lot of construction
being performed. She also said that she could not detenaina how
many people ware in the group, but estimated about sixty (60) to
seventy (70) people there including men, women and children. She
stated that she saw about IS to 20 adult males there.
MS. Sparks also said that on April 6, 1992, she visited the
compound again. On this occasion she talked with David Koresh.
She asked Koresh about the firearms which she had been told by the
small child. Koresh admitted that there were a few firearms there,
but said that most of the adults did not know of them, and that
there were too few to be of any significance. Ms. Sparks said that
when she pressed Koresh about the firearms and their looatlon at
the compound, he offered to show her around. He requested that she
wait about 3 0 minutes until he could get the other residents out of
the building so they would not see where he had the firearas
stored. After a period of time, Ms. Sparks was escorted through
part of the building by Koresh. She noted that there was more
construction activity and that the inside of the structure looked
quite different from her previous visit. Each time Ms. Sparks
asked Koresh about the location of the firearms, he would tell her
that they ware in a safe place where the children could not get to
them. He then would change the subject.
MS. spiurks said that she noticed a trap door in the floor at one
and of the building. When she inquired about it, Koresh allowed
her to look into the trap door. She could see a ladder leading
down into a buried school bus from which all the seats had been
removed. At one and of the bus she could see a very large
refrigerator with numerous bullet holes. She also saw three long
guns lying on the floor of the bus, however, she did not know the
make or caliber of them, she stated that there was no electricity
in the bus. Everything she saw was with the aid of a pen light.
When questioned by Ms. sparks, Koresh said that the bus was where
he practiced his target shooting in order not to disturb his
neighbors.
Ms. sparks felt the entire walk through the compound was staged for
her by Koresh. When she asked to speak with some of the children
79
and other residents, Koresh refused, stating thev war* nni-
available. She said that during her conversation with Koresh ha
told her that he was the "Messenger" from God, that the world 'wal
coning to an end, and that when he "reveals" himself the riots In
Los Angeles would pale in comparison to what was going to happen in
Waco, Texas. Koresh stated that it would be a "military tvoe
operation" and that all the "non-believers" would have to suffer.
On December 11, 1992, I interviewed Robyn Bunds in LaVeme,
California. Robyn Bunds is a former member and resident of Vamon
Howell's commune in Waco, Texas. She told me that in 1988, at the
age of 19, she gave birth to a son who was fathered by Vernon
Howell. Her departure from the commune in 1990 was a result of
Howell becoming progressively more violent and abusive.
While Bhe was there, she and the other residents were subjected to
watching extremely violont movies of the Vietnam war which Howell
would refer to as training films. Howell forced members to stand
guard of the commune 2 4 hours a day with loaded weapons. Howell
always was in possession of firearms and kept one under his bad
while sleeping. Robyn stated that her present residence in
California belonged to her parents. For a period of several years
Howell had exclusive control of the residence and used it for other
members of his cult when they ware in California. It was later
relinquished by Howell to Robyn 's mother. In June 1992, while she
was cleaning one of the bedrooms of the residence she found a
plastic bag containing gun parts. She showed them to her brother,
David Bunds, who has some knowledge of firearms. Ha told her that
it was a machinegun conversion kit. She stored ths gun parts in
her garage because she felt certain that Howall would sand soma of
his followers to pick them up. Subsequent to her discovery of the
conversion kit, Paul Fatta, Jimmy Riddle, and Naal Vaaga, all
reambars of Howell's cult and residents of the commune in Waco, came
from Waco, Texaa, to California and picked up the conversion kit.
On December 12, 1992, I interviewed Jeannine Bunds, the mother of
Robyn and David Bunds. She told me that she was a former masiber of
Howell's group in Waco, Texas, having left there in September 1991.
She is a registered nurse and was working in that capacity at the
Good Samaritan Hospital, Los Angeles, California. While at
Howell's commune in Waco, she participated in live fire shooting
exercises conducted by Howell. she saw several long guns there,
soma of which she described aa AX-4 7 rifles. Mrs. Bunds described
the weapon to ne and was able Identify an AK-47 from among a number
of photographs of firearms shown to her by me. I believe that she
is well able to identify an AX-47. In July of 1991, she saw Hovail
shooting a machinegun on the back portion of the commune property.
She Knew it was a machinegun bacauae it functioned with a very
rapid fire and would tear up the ground when Howell shot it. Mrs.
Bunds also told me that Howall had fathered at leaat fifteen (15)
children from various women and young girls at the compound. Some
of the girls who had babies fathered by Howell ware as young as 12
80
years old. Sh« had personally delivered seven (7) ©t thes
children.
According to Ms. Bunds, Howell annuls all marriages of couples wh
join his cult. He then has exclusive sexual access to the woaer
He also, according to Mrs. Bunds, has regular sexual relations wit
young girls there. The girls' ages are from eleven (11) years ol
to adulthood.
On January 6, 1993, I interviewed Jeannine Bunds again in Lc
Angeles, California. I shoved her several photographs of firears
and explosives devices. She identified an AR-IS rifle and
pineapple type hand grenade as being items which she had seen e
the Mount Carmel Center while she was there. She stated that sh
saw several of the AR-iS rifles and at least one of the har
grenades.
On January 7, 1993, i interviewed Deborah Sue Bunds in Los Angelas
California. She was the wife of David Bunds, and she had been
member of the "Branch Davidian" since birth. She stated she fir:
met Vernon Wayne Howell in July 1980. When Howell assuBc
leadership of the "Branch" in Waco, Texas, in 1987, he began t
change the context of their Doctrine. While she was at the Houi
Camel compound in Waco, Texas, she was assigned, under Howell'
direction, to guard duty with a loaded weapon. About Februu
1989, she observed Howell shooting a machinegun behind the
main structure of the compound. She is sure the firearm was
machinegun because of the rapid rate of fire and the rate of fii
was much different from that which was usually conducted durii
practice exercises on the compound. After describing the firing c
this weapon to me, I believe that Ms. Bunds was describing t)
firing of an automatic weapon.
Mrs. Deborah Bunds also told me that during an evening meal a sho]
time after having seen Howell shoot the machinegun, she overheai
Howell and his closest associates discussing machineguns. Howe,
was very excited about having a machinegun. He voiced a desire 1
acquire additional machineguns, specifically AX-47 tyj
machineguns.
Dviring this investigation I made inquiries of a number of 1<
enforcement data bases for information about those commui
residents who I have been able to identify. Through TECS I learm
that some forty (40) foreign nationals from Jamaica, Uniti
Kingdom, Israel, Australia and New Zealand have entered the Unit<
States at various times in the past and have used the address <
the Mount Carmel center, Waco, Texas, as their point of conta<
while here. According to INS records most of these forei'
nationals have over stayed their entry permits or visas and a
therefore illegally in the united states. I )cnow that it is
violation of Title 18, United States Code, Section 922 for
illegal alien to receive a firearm.
10
81
on January 1, and January 3, 1993, Mrs. Poia Vaega of Mangora
Auckland, Naw Zealand, was interviewed telephonicaily by Reaiden
Agent in Charge Bill Buford, Bureau of Alcohol, Tobacco an<
Fircanna, Little RocK, Arkanaaa, who also is assisting ne in thi
investigation. The results of Special Agent Buford '8 interview o
January i, 1993, was reduced to writing and furnished to ma
Special Agent Buford 'a interview on January 3, 1993, was tap
recorded with the permission of Poia Vaega and has since bee
transcribed and typewritten. Both the tape recording and tb
transcription was furnished to me by Special Agent Buford. Bot
interviewa with Poia Vaega revealed a false imprisonment for a tar
of three and one half (3 1/2) months which began in June of 199
and physical and sexual abuse of one of Hrs. Vaega 'B sisteri
Doreen Saipaia. This was while she was a member of the "Branc
Davidian" ac the Mount Carael Center, Waco, Texas. The physica
and sexual abuse was done by Vernon Wayne Howell and Stanla
Sylvia, a close follower of Howell, on several occasions.
It was learned from Mrs. Vaega that she and her husband, Leslie
were also members of Howell *s group in Waco for a short period c
time in March 1990. Upon their arrival at Mount cannel Center, s^
and her husband were separated and not allowed to sleep together c
have any sexual contact.
According to Mrs. Vaega, all the girls and women at the coapour
were exclusively reserved for Howell. She stated that Howell wouJ
preach hia philosophy, which did not always coincide with tl
Bible, for hours at a tiae. She and her husband left the compour
after ten (10) days because her husband did not agree with Howell'
doctrine, but that her two eisters stayed behind.
Mrs. Vaega also related that she was present at one of the stuc
periods held by Howell when Howell passed his personal AK--
machinegxin around for the group to handle and look over.
on January 6, 1993, I received the results of an examinatii
conducted by Jerry A. Taylor, Explosives Enforcement Office;
Bureau of Alcohol, Tobacco and FirearBS, walnut CreeJc, Calif oml.
in response to a request from me to render an opinion on devi'
deeign, construction, functioning, effects, and classification ■
explosives materials which have been accumulated by Howell and h
followers. Mr. Taylor has received axteneive training
Explosives Classification, Identification and rendering safe
explosive devices and has been recognizad on numerous occasions
an expert witness in Federal Court. Mr. Taylor stated that t
chemicals Potaeaiua Nitrate, Aluminum, and Magnesium, when mixed
the proper proportions, do constitute an explosive as defined
Federal law. He further stated that Igniter cord is an explosiv
Also Mr. Taylor stated that the inert pracrice rifle grenades a
hand grenades would, if modified as weapons with the par
available to Howell, become explosivee devices as defined
Federal law. Finally he stated that black powder, is routine
11
82
6^
used as th« main charts when manufacturing improvised exploBiv*
weapons such as grenades and pipe bombs. I know that Title 26
United States Code, Section 5845 makes it unlawful for a person tc
possess any combination of parts designed or intended for use i:
converting any device into a destructive device. The definition oi
"firearm" includes any combination of parts, either designed oi
intended for use in converting any device into a destructive devicf
such as a grenade, and from which a destructive device may b(
readily assembled. See Dntf d states v. Price. 877 F.2d 334 (5U
Cir. 1989) . SO long as an individual possesses all of thi
component parts, item constitutes a destructive device even though
it is not assembled, so long as it can be readily assembled.
Onited Btafs v. T^npay\^, 468 F.Supp. 322 (D.C. Tex. 1979).
on January 8, 1993, r interviewed Marc Breault in Los Angeles,
California. He is an American citizen who lives in Australia with
his wife Elizabeth. He was once a member of the "Branch Davidlan*
in Waco, Texas. He lived at the Mount Carmel Center from aarl>
1988 until September 1989. While there he participated in physicaJ
training and firearm shooting exercises conducted by Howell. He
stood guard armed with a loaded weapon. Guard duty was maintainec
twenty-four (24) hours a day seven (7) days a week. Those who stooc
guard duty were instructed by Howell to "shoot to kill" anyone whc
attempted to come through the entrance gate of the Mount CarseJ
property. On one occasion, Hovsll told him that he wanted tc
obtain and/ or manufacture macbineguns , grenades and explosive
devices. Howell stated he thought that the gun control lavs were
ludicrous, because an individual could easily acquire a fireara and
the necessary paurts to convert it to a maohinegun, but if a persor
had the g\m and the parts together they would be in violation ot
the law. On another occasion, Howell told him that ha wet
interested in acquiring the "Anarchist's Cook Book", which I )cnoii
is a publication outlining clandestine operations to include
instructions and formulas for manufacturing improvised explosive
devices.
On January 12, 1993, I spoke with Special Agent Earl Dunagan,
Bureau of Alcohol, Tobacco and Firearms, Austin, Texas, who it
assisting me in this investigation. He related the results of hie
inquiry to the ATF Fireatve Technology Branch, Washington, D.C,
for an opinion concerning the firearms parts which have beer
accumulated by Howell and his group. Special Agent Dunagan stated
that he had spoken with Curtis Bartlett, Firearms Enforceaent
Officer, Washington, D.C, and was told by Officer Bartlett that
the firearms parts which Howell has received and the method by
which he has received them, is consistent with activities in othez
ATF investigations in various parts of the United States, whicl*.
have resulted in the discovery and seizure of machineguns. Mr.
Bartlett stated that the firearms parts received by Howell could be
used to assemble both semi-automatic firearms and machineguns. He
has examined many firearms which had been assembled as machinegune
which included these type parts.
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(9
Mr. Bartlett also told Special Agent Dunagan that one of the
vendors of supplies to Howell has been the subject of several ATF
investigations in the past. ATF executed a search warrant at this
company and had seized a number of illegal machinagune and
silencers.
Special Agent Dunagan told ne that on January 12, 1993, he spoXe
with Special Agent MarJc Mutz, ATF^ Waehington, D.C., who was the
case agent on the above ongoing inveatigatlon dealing with the
illicit supplier who has provided qxxn parts to Howell. Special
Agent Mutz stated that during the execution of the Federal search
warrant at the company's office in South Carolina, he saw lar^e
quantities of M-16 raachinegun and AK-47 machinegun parts. The
company naintained their inventory of these parts as "replacement
parts* so they fell easily within a loophole in the Federal lav
which prohibited ATF from seiting the parts. Special Agent Mutz
stated that the company had all the nacesaary parts to
convert AR-15 rifles and semi-automatic AK-47 rifles into
machineguns if their customers had the upper and lower receivers
for those firearms. Based on my investigation, as stated above in
the daocription of gun parrs shipped to Howell, I know that Howell
possesBea the upper and lower receivers for the firearms which he
is apparently trying to convert to fully automatic.
Mr. Bartlett told me that another one of the vendors of supplies to
Howell, Neeard Gun Parts Co., 27 W. 990 Industrial Rd. , Barrington,
111., has also been the subject of an ATF investigation. Officer
of that company, Gerald Craysen Cynthia Aleo and Anthony Aleo all
pled guilty to ATF charges. The Naeard Co., which owned Sendra
Corporation, was shipping AR-15 receivers through the Sendra Corp.,
along with part kits from the Neeard Co. When these parts are
assembled it resulted in the manufacture of a short barrelled
rifle. Even though the above subjects are convicted felons they
continue to conduct business because the Neeard Gun Parts Co. ,
distributes gun parts and not firearms.
On January 25, 1993, I interviewed David Block in Los Angeles,
California. He stated that he was a meniber of Howell's cult at the
Mount carael Center, Waco, Texaa, from March 1992, until June 13,
1992. During the time he was there, he attended two Cun Shows with
Vernon Howell, Mike Schroeder, Paul Fatta. and Henry HcMahon who is
a Federally licensed firearms dealer. The gun shove were in
Houeton and San Antonio, Texas.
While at the Mount Carmel Center he saw a metal lathe and a metal
Billing machine which were normally operated by Donald Bunds and
Jeff Little. Donald Bunds, a mechanical engineer, has the
capability to fabricate firearm parts, according to Block. On one
occasion at the Mount Carmel Center, he observed Bunds designing,
what Bunds described as a "grease gun/stan gun" on an Auto Cad
Computer located at the residence building at the compound. The
computer has the capability of displaying a three dimensional
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84
rendering of objects on a computer monitor screen. The object
appeared to be a cylindrical tube with a slot cut into the side of
it for a bolt cocking lever. Bunds told him that Howell wanted
Bunds to design a "grease gun" which they could manufacture.
Mr. Block told me that on another occasion at the Mount Cannel
Center he saw Donald Bunds designing a template which Bunds
explained was to fit around the "grease gun" tubes indicating where
the bolt lever slots were to be milled out. This was another step
In manufacturing "grease guna" which had been requested by Howell.
I know that a "greaae gun" is a nachinegun following after the
design of a World War II era military weapon.
During hie time at the Mount Carmel Center Mr. Block was present
several occasions when Howell would ask if anyone had any knowledge
about making hand grenades or converting semi-automatic rifles to
machineguns. At one point he also heard discussion about a
Bhipment of inert hand grenades and Howell's intent to reactivate
them. Mr. Block stated that he observed at the compound published
magazines such as, the "Shotgun Newe" and other related clandestine
magazines. He heard extensive talk of the existence of the
"Anarchist Cook Book".
Mr. Block told me that he observed a .50 caliber rifle mounted on
a bi-pod along with .50 caliber asmunition. However, what Mr.
Block described to ATF Agents, was a British Boys, .52 caliber,
anti-tank rifle (a destructive device). Mr. Block further stated
that he also heard talk of the existence of two additional .50
caliber riflee on the compound. There wee also extensive talk
about converting the .50 caliber rifles and other rifles to
machineguns .
Mr. Block also told roe that he met James Paul Jones from Redding,
California, who was visiting the Mount Carmel Center in April or
May of 1992. According to Howell, Jones was a firearms and
explosives expert.
On February 22, 1993, Axr Special Agent Robert Rodriguez told me
that on February 21, 1993, while acting in an undercover capacity,
he was contacted by David Koresh and was invited to the Mount
Carmel compound. Special Agent Rodriguez accepted the invitation
and met with David Koresh inside the compound. Vernon Howell, also
known as David Koresh played music on a guitar for 30 minutes and
then began to read the Bible to Special Agent Rodriguez. During
this session. Special Agent Rodriguez was asked numerous questions
about his life. After answering all the questions Special Agent
Rodriguez was asked to attend a two week Bible session with David
Koresh. This was for Special Agent Rodriguez to learn the 7 Seals
and become a member of the group. Special Agent Rodriguez was told
that by becoming a member he (Rodriguez) was going to be watched
and disliked. David Koresh stated that Special Agent Rodriguez
would be disliked because the Government did not consider the group
religious and that he (Koresh) did not pay taxes or local taxes
14
85
because he felt he did not have to. David Koreah toid SDeeial
Agent Rodriguet that ha believed in the right to bear arms but that
the U.S. Government was going to take away that right. David
Koreeh aaked Special Agent Rodriguez if he )cnew that if he
(Rodriguer) purchaeed a drop-in-Sear for an AR-15 rifle it would
not be illegal, but if he (Rodriguez) had an AR-15 rifle with the
Sear that it would be against the law. David Koresh stated- that
the Sear could be purchaeed legally. David Koresh stated that the
Bible gave hia the right to bear anna. David Koreah then advisee
Special Agent Rodriguet tixat he had aoaething he wanted Special
Agent Rodriguet to see. At that point he showed Special Agent
Rodriguez a video tape on ATP which was made by the Gun Owneri
Association (G.O.A.). This fila portrayed ATF as an agency whe
violated the rights of Gun Owners by threats and liee.
I believe that Vernon Howell, also known as David Koresh and/or hij
followers who reside at the compound known locally as the Mount
Carmel Center are unlawfully manufacturing and possessinc
machineguns and explosive devices.
It has been oy experience over the five years that I have been i
Special Agent for the Bureau of Alcohol, Tobacco and Fireams, and
that of other Special Agents of the Bureau of Alcohol, Tobaoco am
Firearms, some of whom have the experience of twenty (20) yeara oi
mora, who have assisted in this investigation that it is a coaaoi
practice for persons engaged in the unlawful manufacture am
poaseasion of machinegvina and exploaive devicea to eBplo>
surreptitiouB methods and neane to acquire the products necessar;
to produce such items, and the production, use and storage of thosi
items are usually in a protected or secret environment. It is als(
my experience that persons who acquire firearms, firearm parts, am
explosive materials maintain records of receipt and ownership o
such items and instruction manuals or other documents explainin<
the methods of construction of such unlawful weaponry.
At approximately 10:00 a.m. on February 28, 1993, ATF agent
attempted to execute the previously ordered search warrant on th
Howell compound. As agents entered the premises, they were fire
upon with machineguns and other large caliber weapons. I wa
personelly present at the scene and heard the machinegun fire
Four ATF agents were killed and approximately seventeen wer
injured by gun fire coming from the compound. I personally spok
with Special Agent Bill Buford who is the Resident Agent in charg
of the Little Rock, Arkansas ATF Office. Buford, who was one o
the agents on the assault team who were attempting to execute th
werrant, advised ma that he wee able to enter a portion of th
Howell compound, and upon entering he observed what he described a
"an arsenal". He further told me that, "Everything that w
suspected to be in there was in there". I am making this affidavi
on April 13, 1J»S, and state to the court that although I ar
others have attempted to execute the warrant on the main coapour
location (deecribed above) , we have been unable to search th
IS
86
premisea and retrieve evidence because of heavy armed resistance
from members of the cult group living at the compound. On March S,
1993, special Agent Charles Meyer of the atp Austin, Texas, office
spoke with a cooperating individual who I do "O^^f^*^. ^° "*?•■;
this time because of serious concerns for the safety and well being
of the said cooperating individual. Meyer and I believe that this
individual is being truthful in the information given because both
Meyer and I have been able to - independently corroborate the
information received from thi» individual and have found the
information provided by this individual to be extremely accurate
and consisteSt with other evidence known to investigators such as
receipts for firearms and destructive device components. This
individual stated that she/he has lived at the Howell compound for
a long period of time. This individual has been personally present
on numerous occasions over the past year, a"d<i8 "cent as late
February, 1993 when Howell and others discussed the conversion of
flrearml from semi-automatic to "achineguns. This individual
stated that she/he has personally observed "^^-10 and MAC-11
firearms located within the Howell compound within the P"« *5
days. Further, this individual is aware ^'^^J^^"'". ?•"?"!;
observations that Howell has been using inert grenadee, blacX
Dowder and fuses to manufacture live hand grenades (a destructive
dAviSi This individual has seen these hand grenades and theii
comionint parts in the Howell compound described above within the
oaSrJs days It appeared to this individual that over the countei
gaJSvare anJ equipment was being utilized ^,'? 'nai.jif act^e thej^
«^-n.dM Witiiin that same time frame, this individual hai
Ssi^e^fireaiSL silencer, being manufactured within the compound.
??"« bef ie""by this individual that the silencers ««• Jj-ign*;
for AR-15 rifles. This individual also observed approximately 10
fSIl^aitoaatlc AR.15/M-16 -•c^in^'^,' ,«\«^i" ?^* fnJ''S«?gnSl
th« n«iit 4 5 davs. Tactical vests, that is, clothing designea ti
SJr? firear^'^^unrtion and magazines, radio «<f iP»«"t *nd oth.
pSn^hei^ialia w.re observed by this individual as "ere polic
scanners in the past 45 days. ^^^^her, I jaiow that Y/„7Sv
attempting to execute the search warrant on February 28. ^»" ' "';
itated that they observed what appeared to be tactical vest, an
bodv armor on many of the cult members who were ^^""^ "^T"- ^
aSents This individual observed that Howell was attempting t
Individual within the compound in ^he past 45 days. Thi
tS" the weapon, th.t "•" "'■•"'i*'' J"Vi.t jrw. oM.rv.d iS^
r^-^^,»,-v 2B 1993. During these observations, tney "■^* "■"" ^4,
16
87
®
telephone with Howell and othara since the 28 of February, when the
siege of the compound began. Howell and others have stated that
they (the cult) have night vieion equipment (believed by agents to
be star scopes) . I )cnow that cellular phones have been uaed by the
group located at the compound to communicate both before and during
the execution of the warrant. Phone toll records indicate this.
On March 2, 1993, Katherine Matteson, DOB: 2/3/16, a "Branch
Oavidian" member, who has been residing in the compound in Waco,
Texas, was released from the compound. Matteson brought out with
her some personal belongings, to include a notebook, which contains
explicit handwritten notes, of which I have reviewed. These
handwritten notes depicts various different caliber weapons and
ammunition. These notes also contain instructions on how to become
a proficient firearms shooter by utilizing the proper techniques.
These notes are so explicit, that it deecribes how co utilize
windage when shooting a weapon and how one should mentally prepare
oneself to survive.
On March 9, 1993, through ATF Command Post, Intelligence Branch,
Waco, Texas, I received information from the ATF Field Division,
Charlotte, North Carolina, concerning the activities of an FFL
d.b.a: Rhino/ Shooters Equipment/Armitage International, et al.,
Seneca, S.C. Greenville, SC. Special Agents determined that said
business had made eight shipments via UPS to Oavid Koresh, et al. ,
Route 7, Box 555, Waco, Texas. This information was reflected in
UPS activity between 3-92 through 7-92. A subpoena was
subsequently served on UPS in Greenville, SC, for copies of
invoices of the snipments being delivered to Vernon W. Howell. The
invoices reflect such items as eight (8) FN-FAL full auto Sears;
five (5) M-16 bolt carriers; one (1) M-16 selector; thirty-one (31)
M-16 full auto Soars and pins, all items of which are used to
convert an AR-15 eftmi-automatic rifle into a M-16 machinegun rifle.
On March 9, 1993, in conjunction with this on-going investigation,
I was advised by the ATF Los Angeles, California Field Division,
that ATF Agents from the Long Beach, California Field Office,
executed a search warrant at a residence located at 2707 White
Ave., La Verne, California. This rssidence is owned by Vernon H.
Howell and or the Branch Davidians, and occupied by Branch Davidian
members. As a result of this search, the following items were
taken into ATF custody:
1) Correspondence to and from the compound in Waco, Texas.
2) Fifteen (15) audio cassette tapes, which contain predisposition
toward violence.
3) Five (3) audio cassette tapes, which also contain
predisposition toward violence.
17
88
On the following day. March 10. 1993. i was alec advised that a
conoent to search the garage of the residence located at 2707 Whlt.
Ave., La Verne, California was obtained by KIT Agents. As a result
of this search, the following coaponents for improvised explosives
were recovered and taken into ATF custody:
1) Sulfuric acid.
2) Nitric acid.
3) Baking soda.
4) Saw dus^, mixed with aluainuB powder.
5) Six (6) plastic baggies containing, what appear to be dirt.
on March 23. 1993, ATF Special Agent's Mike Taylor, Dale Littleton
and I, interviewed Henry Stanley McMahon Jr.. a Federal Firearms
License Dealer, who at one time did business at 909 Rosedale.
Hewitt, Texas. During this interview, McMahon stated that Vernon
W. Howell had told him that in the Spring or early Guaaer of 1992,
he had observed the "ATF S.W.A.T. Team" training at a vacant house
approximately 500 yards toward the compound next to the "Nag Bag".
McMahon further stated that Howell had told him that this was
training conducted by ATF to assault the compound/Mount carmel
property. Howell had stated to McMahon that ATF is so arrogant
that there conducting their training right in front of us because
ATF wants to send us a message of what there going to do to the
cult members. This training exercise, described by Howell that
took place in the Spring of 1992, was confirmed by ATF with Police
Officer Monroe Kelinske, Waco Police Department, as taJclng place
from March 5 through March 9, 1992. This vacant house was being
utilized by the Waco Police Department and other Police Departments
as a training facility to execute warrants.
On April 2. 1993, Joyce sparks, Investigation Supervisor.
Department of Human Services, Waco. Texas, provided me with a
narrative, concerning an interview she had with a former cult
member, who will be referred to as the source. The source stated
that she became a part of the cult when she was about three or four
years old. She also stated that when she was ten years old, she
was taken out of the compound to a motel room in the Waco, Texas
area by her mother, where Vernon W. Howell, A/K/Ai David Koresh was
waiting in bed for her with no pants on. She stated that, while in
the motel room, Howell sexually molested her. When asked how she
was feeling when this happened, she responded "scared", but
"privileged". She was asked if she knew what was going to happen
to her when she was left in the motel room by her mother. She said
that she knew it would happen "one of those times". She explained
that they didn't talk about this because they didn't have too. It
was understood in the group that this is what happens. They did
not need to talk about it. That was just the way it was and
everyone knew it. It was asked if she knew about any other girls
who had experienced this and she said yea. She reported that she
knew about Michelle Jones. When asked how she knew this, she
explained that Howell had talked about having sex with Michelle
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89
(§)
When 6ha wa« fourteen. He toid in a Bible Study once what it u««
like when he had sex with Michelle.
I now seek re-ieeuance for the warrant for the main compound and
surrounding land (entire description «et forth above). Further
because an extreaely dangerous situation exists at this tine and
will likely continue to exist, agents may need to take advantage of
the cover of darkness to enter the premises. Therefore, Z seek
permission for a nighttime (after iO:00 p.m.) warrant. I further
request that this affidavit and all accompanying papers be sealed
by the court to avoid further danger to agents and to avoid
detection of the nature and scope of the investigation.
TJavy Ag>n.icr«r-Special Agent
Bureau' of ATF
Subscribepl and sworn to before me this / 3'^ day of
^9^y . 1993.
Dennis G. Green,
United States Magistrate Judge
Western District of Texas - Waoo
This warrant, affidavit and all accompanying papers are hereby
s«al«d by order of this court.
Signed by ne this Z:?*^^ day of /:^Zt^li^ , 1993.
_ ,<^^ ^<:^>^^—
Dennis G. Green,
Unitad States Magistrate Judga
Western Distriot of Texas - Waco
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90
Chairman Pickle. Why would it take so long for you to act. You
did not have any question about what really was going on. You
knew what was taking place, and you knew tnat the tax Taws were
being violated.
Mr. HiGGiNS. We had a feeling that something illegal was occur-
ring. The Davidians, as you can see from the affidavit, legally were
ordering various parts and components and bringing them onto the
premises. What we were trying to establish was: Were they violat-
ing the laws after they got them onto the premises? We had to get
enough
Chairman Pickle. But, Mr. Higgins, you knew that. That was
not the question. You knew that they were doing that. You knew
they were violating the law.
What is even more disturbing to me is the statement you just
made that, in addition to the firearms that they legally ordered
through American businesses and shipped in by U.S. Parcel, vou
are now saying that you think that money was being supplied to
the group withm the compound by some criminal organization?
Mr. Higgins. No.
Chairman Pickle. Did you say that?
Mr. Higgins. No. I hope I did not give that impression. No.
Chairman Pickle. Well, you said you are now investigating the
possibility that equipment and/or funds were being supplied to this
group by illegal operations.
Mr. Higgins. No. There is some confusion, Mr. Chairman. That
was in response to another investigation that is going on that
Chairman Pickle. That has nothmg to do with Waco?
Mr. Higgins. That has nothing to do with the Davidian
compound, no.
Chairman Pickle. All right. Let me ask one other question be-
fore my time expires.
Is it true that at the start of this operation, the ATF agents re-
quested to carry more powerful weapons and were turned down; is
that correct?
Mr. Higgins. Categorically untrue.
Chairman Pickle. All right.
Mr. Higgins. They had all the weapons that they had requested
and, in fact, sufficient ones.
Chairman Pickle. All right. Then how do you answer the ques-
tion that comes to my mind?
You had plants within the compound that were posting you gen-
erally what was taking place, and they had plants within your op-
erations, because they knew what you were doing. On the morning
of February the 28th, they knew exactly that you were coming. You
knew that they knew you were coming. They were dressed in cattle
fatigues. They had their guns. They were at the front door waiting
for you to knock.
Nov/ you knew that was taking place. Was it your judgment or
the FBI's judgment, did you all agree that you would go ahead and
raid the group at that time?
Mr. Higgins. I have to refrain from going into details about what
we knew. That will come out during the subsequent review of
this — and I think in fairness to everyone who was part of that deci-
sionmaking process — ^that is the time for that to oe done. But let
91
me just continue to say that there is no one in ATF who I know
of who would purposely lead agents into a situation where they
knew they were going to be ambushed. There would be no decision
in advance that would order that; there would be no plan at the
time to do that.
These are not only just people who work for ATF. These are also
our friends.
Chairman Pickle. Well, I do not want to argue that point with
you, but from the affidavit I have read in a report you have already
filed, you knew exactly what was going on, and you knew that they
were posted. You knew that they were waiting for you to knock,
and you knew that you were going to meet an ambush. Now you
knew that. And yet you decided to go ahead.
I do not want to pass judgment that that was right or wrong. I
think overall perhaps the right decision was made in the oper-
ations. I think you were deahng with a bunch of nuts, at least the
leader of them, and inevitably something destructive would occur.
So I am not trying to pass judgment on anybody.
But you did know, at that time, that they were waiting for you
to come and that they had their machine guns ready. Yet you did
make the decision to proceed.
Now was that your decision, ATF?
Mr. HiGGiNS. The decision to go ahead with the raid, the decision
to conduct the raid, was ATFs decision.
Chairman PiCKLE. All right.
Mr. HlGGEMS. That does not mean I agree with everything else
that has been described. But we have been asked not to discuss
what happened that day, and I think there is a fair time to do it.
You may think we made the wrong decision. I am not saying that
somebody will not. I am just saying that if everybody listens to
what I say and tries to get
Chairman Pickle. I am not trying to pass judgment, but I am
asking why.
Mr. HiGGlNS. Yes.
Chairman PiCKLE. Now l6t me yield to Mr. Houghton for any
other questions. Mr. Houghton.
Mr. Houghton. Thank you, Mr. Chairman.
First of all, thank you very much for being here. I know it is a
difficult time, and I know that it is hard to answer a lot of these
questions. But clearly we are interested, as you would imagine any
public group, particularly a congressional committee.
There may be issues as far as the alcohol revenue and as far as
tobacco revenue, but it is so overwhelmed by the Waco incident, I
hope you do not mind me homing in on this, following up on the
Chairman,
You know, there are two universal questions which are always
asked when anything happens. One: Who is guilty? And secondly:
What is to be done?
And I would prefer not to talk about who is guilty, but the ques-
tion really is: What is to be done?
You have had an extraordinary record in terms of the forensic
work which you have done. You did a terrific job as far as the
World Trade Center, I know, and in covering some of these massive
92
organized crime groups like the Jamaican posses. You have done
an extraordinary job here.
But I think our question is: How is this avoided in the future?
Are we organized properly? What is your mission? How do you co-
ordinate with the FBI and with other agencies, including the State
agencies like the Texas Rangers or whatever State might be in-
volved? What do we do to be assured that you are doing those
things which are important to protect lives in the future?
Now from a fiscal standpoint, I applaud what you are doing in
terms of really trying to take care and trying to reduce some of
these special nonrecurring costs. But the bigger question is: Are
you set up, are you stationed appropriately, to do the work which
would avoid a situation in Waco, and also are you getting the prop-
er signals from here, from the Justice Department, from any other
groups like the FBI that could help you in your task? Those are
the key questions.
Mr. HlGGDsrs. Whenever our special response teams are utilized,
we review those responses to access what we did right, what we did
wrong, and, more importantly, what we can do better in the future.
This operation will be reviewed even more extensively than any
other in history, and I honestly think it should be reviewed from
the standpoint of how do we better deal with these situations in
the future. Nobody would want a tragedy like this to be repeated.
And I am convinced that will happen. It will happen every step
of the way from the questions that the Chairman had as to why
we went in when we did, whether that was too long or too short,
what kind of training our people had, what the decisionmaking
process was, what we do about these kinds of groups with these
kinds of weapons.
So we will learn from that. There is going to be a time for that,
and that will be done, and that will be reported to this committee
and to the American public at the same time.
I cannot give you a specific answer.
Mr. Houghton. That is helpful. But I would like to probe this
thing a little further.
Mr. HlGGDSfS. Certainly.
Mr. Houghton. Your mission years ago — I am not sure when the
Department was founded, but it was rum runners and gun smug-
glers and people like that. It is different; it has varied over the
years.
But now we have two cases very forcefully put on edge with the
World Trade Center or also with Waco. What is your mission now?
What can we do to help you? What can we do and what can others
do to better coordinate your activities with clearly other govern-
mental agencies which are involved here, because the FBI really
took over responsibility here from you?
Mr. HiGGlNS. Well, I think one thing you can do is not rush to
judgment based on one incident. We have used these special re-
sponse teams hundreds of times in the last 4 or 5 years. This is
the first time we had anyone hurt, other than one agent who was
slightly injured. We did this in order to protect our people, not to
get them killed.
We are in the business of enforcing the firearms and explosives
laws, unfortunately against some very violent people. And these
93
are not the only ones in this country. So that is the business we
are about in our law enforcement area. That is separate from the
taxing part of our agency.
We work very, very closely with State and local organizations.
You do not have to take my word for that; you can ask them. We
do coordinate our activities, including the day on which this raid
occurred. We coordinated those activities; when we saw we had a
hostage situation— we asked the FBI to come in because they are
outstanding in hostage negotiations. The FBI and other agencies
have asked us to come in when they have had similar operations
and had similar needs for our special response teams, whether it
be in Los Angeles after the riots or the incident in Idaho in the
Randy Weaver shooting.
So law enforcement, I think, works closely together. We think we
have a definable mission. We think, though, «iat what happened
here should not be seen as a complete failure of the organization,
and it should be weighed in the entirety.
Mr. Houghton. I am not being accusatory.
Mr. HiGGiNS. I was not trying to suggest that.
Mr. Houghton. I am trying to be supportive. But I would sug-
gest, Mr. Chairman, since we are so close to this particular inci-
dent, and maybe a lot of the details in terms of reformulating what
you are about, where you need help, that maybe we try to get a
report sometime within the next month or 2 to give us some of the
answers to the specific questions.
Chairman Pickle. Mr. Houghton, I said in my opening statement
that we may have additional hearings based on facts that will be
developed as we go along. So we should withhold judgment, and
you are exactly right.
And we are not being accusatory, Mr. Higgins.
Mr. Higgins. I am sorry if I am reacting like I think you are;
I am not.
Chairman Pickle. Well, I can see why you would be very sen-
sitive about it. Overall you have done an excellent job. Your work
at the World Trade Center was outstanding. But we are fearful
about whether that kind of thing could happen again. What a hor-
rible thought your mind can conjure up about what could happen.
We are not trying to pin the fault on you on this instance.
But I am concerned, you said ATF made the decision. But you
told Mr. Houghton that the local authorities were also told what
you were going to do, and I assume the FBI. Did all three know
that you were going to move in on February the 28th?
Mr. Higgins. The FBI, to my knowledge, would not have known.
They were not part of that operation. They came in because of the
hostage situation. The locals would have known, yes.
Chairman Pickle. All right. Thank you.
The Chair recognizes Mr. Jefferson for any questions. Mr. Jeffer-
son.
Mr. Jefferson. Mr. Higgins, in your statement, if I followed it
correctly, you have indicated that the underpayment of firearms
and ammunition excise taxes are more frequent now. Tobacco ex-
cise taxes, taxpayers are acting more aggressively to avoid paying
the taxes, and that alcohol investigations have found a number of
70-792 0-93-4
94
cases where there were tax violations occurring on a more frequent
basis.
The question is: Will these tax evasion problems, in your opinion,
worsen or improve if the budget that is proposed now, which ap-
pears to reduce the funding in these areas, is adopted?
Mr. HiGGiNS. In the directly revenue-related areas, the tax collec-
tion, we are going to try to maintain a constant level. The cuts we
have taken have been primarily in nonre venue areas.
Part of what is happening in the tobacco area is a function of the
floor stocks tax itself, and we find those taxpayers not to be in as
high compliance as the manufacturers who pay the overwhelming
majority of that $6 billion. That revenue comes from just a very
few taxpayers, and their compliance levels are outstanding. So part
of this is transitory, in that once the floor stocks, which is due on
June 1, comes in, that part of the problem will not be there.
With respect to the other side of it, the non tobacco taxpayers,
while we are concerned that that might be a trend, we still have
a very high level of presence with the major taxpayers, and I think
we can prevent that from being a serious problem. But we are con-
cerned about it, obviously.
Mr. Jefferson. Well, one of the reasons there, then — you can
cite it as a trend — what have you identified as the reasons why this
underpayment is getting more frequent?
Mr. HiGGlNS. Dan is in charge of our compliance area. I will ask
him to respond, since he has been more directly involved with that
than I have.
Mr. Black. I think when we are talking about the underpay-
ments, the biggest problem we are having right now is with the
floor stocks taxpayers. The last two excise tax increases demanded
a floor stocks tax which essentially puts the alcohol taxpayer on an
honor system. Several thousand businesses are responsible for pay-
ing floor stocks tax, and we just plain and simply do not have the
resources to go to every single one. The result is less than full com-
pliance in the floor stocks tax area.
Mr. Jefferson. Well, what is to be done about that?
Mr. Black. I am not sure I have the answer. The Congress sees
fit each time there is an excise tax increase to establish a floor
stocks tax, and that is probably fair. But since it is generally a one-
time-only tax, we do not get additional resources, and must take
resources out of the existing tax program in order to handle floor
stocks.
Mr. Jefferson. What is the problem with underpayment, mov-
ing from alcohol to firearms, in that area?
Mr. Black. ATF assumed the responsibility of collecting the fire-
arms and ammunition excise tax from the IRS about 3 years ago.
We did this because we also inspect firearms manufacturers. It
made good sense.
What we are finding is that it is a fairly complex tax. It is very
much like a value-added tax. And we are looking at it very aggres-
sively, because certainly we believe that if there is a tax due, we
have to do everything possible to collect that tax.
Since our approach is more aggressive than what they had expe-
rienced under IRS, we are finding more excise tax problems in fire-
arms and ammunition.
95
Mr. Jefferson. Well, is there a plan there to deal with that
underpayment problem in this area?
Mr. Black. It is partly an education problem. We are doing the
best we can to notify those firearms manufacturers that owe taxes
of the complexities of that tax, with a hope that that will increase
compliance. Once they get used to what we are looking for when
we conduct those inspections, I think we will get a better compH-
ance rate.
Mr. Jefferson. Is there any way you can estimate how much
money you are losing? Let us just say in the underpayment in
taxes on firearms and ammunition, how much do you estimate the
Government is losing there because it is unable to collect all the
taxes that are due?
Mr. Black. I do not think at this point we could estimate with
any degree of accuracy. I am going to say, however, that right now,
it is not an extensive amount. We anticipate collecting about $160
million this year. Last year, we collected about $130 to $140 mil-
lion.
What we are really losing in there is probably an unknown fig-
ure, but I am going to say that it is not extensive.
Mr. Jefferson. And would that be true in the case of tobacco
and alcohol underpayments as well?
Mr. Black. If we are talking about the $14 billion we collect for
alcohol and tobacco, I am going to say no. We see good compliance
rates there. But alcohol and tobacco floor stocks tax is an unknown
quantity.
Mr. Jefferson. There has been some talk about raising the ex-
cise tax on firearms and ammunition. You may have heard about
it. A member of the Ways and Means Committee, Mel Reynolds
from Chicago, has proposed it.
Or whether you have heard about that particular one or not, I
want to ask you if you would foresee any collection problems, any
exacerbation of any collection problems, if that bill were passed? It
essentially doubles the excise tax on tobacco and firearms.
Mr. HiGGiNS. Yes. I could answer it, or Dan could. We really
have not looked at that. I think the same problems would exist as
they exist now, only at double the level. But in terms of whether
it would be a different problem to us, no, it will be simply a ques-
tion of educating the people as to what they owe, coupled with
some reasonable expectation that we are going to come and audit
them.
Mr. Jefferson. Well, the bottom line, is it realistic to rec-
ommend reductions in the areas where you are having problems al-
ready in collecting taxes, as this budget does?
Mr. HiGGiNS. I think what we tried to do in this budget is to
avoid the cuts in areas where we have the most problems. This was
not one of those — I guess it is one of those where you cut the worst
of a lot of good ones, and that is hard to do sometimes, but we have
tried not to do it in those areas.
Mr. Jefferson. Yes, you are trying to cut. But I am just asking
whether you picked the right places to cut, given that these are
places where we may be losing revenue that we could collect?
Mr. HiGGlNS. It is a tough tradeoff, because we are balancing the
revenue collection with the enforcement of some of the firearms
96
laws, and we have tried to do it in the fairest way. This is always
subject to second-guessing.
dnairman PiCKLE. Thank you, Mr. Jefferson. Now the Chair rec-
ognizes Mr. Hancock.
Mr. Hancock. Thank you, Mr. Chairman.
You mentioned earlier when Mr. Houghton was questioning you
that your organization had used the special response teams hun-
dreds of times.
Mr. HiGGlNS. Literally.
Mr. Hancock. You know, I have read a few times, but give me
a figure. How many times a month do you organize a special re-
sponse team?
Mr. HiGGlNS. I will tell you exactly how many. In the last 18
months alone, it has probably been close to 350.
Mr. Hancock. Well, now is this primarily as a result of viola-
tions of gun ownership? Is it merely because some guy that has
been convicted of a felony happens to own a shotgun, or is it auto-
matic weapons and bazookas?
Mr. HiGGESfS. The decision, number one, to even have the SRTs
and to develop them and train them was based on the increasingly
violent levels of people we were arresting. But the use of the teams
is limited to those cases where we are arresting someone who is ei-
ther known to be violent and/or armed. And in enforcing the gun
laws, most of the people you go after are armed to start with. But
we use them in high-risk situations.
And so while they may not be as large as the Waco operation,
we are using them in the inner cities and in other places.
Mr. Hancock. Now the Waco operation, was that known violent
offenders down there? I mean, had there been any previous history
of violence when you went out there?
Mr. HiGGlNS. There was violence associated with their move into
the compound in the first place. But I think the Chairman's ques-
tion as ne read through the affidavit was, if we knew that these
people were potentially dangerous, why did we not do something
about it?
Mr. Hancock. Well, I can understand that. I just wonder if that
has been made public to the extent of the numbers of times that
these situations exist, because I doubt if the public is looking at
Waco
Mr. HiGGlNS. I know that.
Mr. Hancock [continuing]. Hearing about, what 5 or 6 years ago,
I think that you went in — and I am trying to remember the name
of the organization; they called it the TSA down in south Missouri.
Mr. HiGGiNS. CSA, Covenant, Sword and the Arm of the Lord.
Mr. Hancock. CSA, that is it.
Mr. HiGGiNS. Right.
Mr. Hancock. That is right. And you went in down there with
a special response team as the result of a highway patrolman
being
Mr. HiGGiNS. Killed, yes, in Missouri.
Mr. Hancock [continuing]. Executed with an automatic weapon.
At what level is the decision made to use an SRT — I mean, is
that delegated to your authority? Does it come up to you as the
final decisionmaker, or does it go above you?
97
Mr. HiGGlNS. If the decision is to use a single special response
team, we have certain delegations of authority. That decision could
be made by the special agent in charge of one of our field divisions.
If the decision is to use multiple SRTs, as was the case in Waco,
that decision would have to come to headquarters, to the Associate
Director for Law Enforcement to approve and in such large oper-
ations, he would, in fact, advise me.
Mr. Hancock. What comprises the makeup of an SRT?
Mr. HiGGlNS. Dave Troy has been in charge of setting those up
and involved in the training, so he can provide much more detail
than I.
Mr. Troy. Each field division has a special response team. We
have 23 field divisions in ATF. Each team is comprised of approxi-
mately 15 members, which varies depending on the size of the divi-
sion. They all go through an intensive 2-week training course
where we teach high-risk entry techniques, being able to get into
buildings, fortified locations, particularly in urban areas where we
have a lot of problems with armed drug dealers.
They go through this 2-week training course, and then they go
through recurring training when they are back at their field offices,
to keep those practices and techniques honed to a very fine edge.
As Mr. Higgins said, they are used on high-risk search and arrest
warrants where we know the people we are attempting to take into
custody have a history of violent activity, who use firearms in vio-
lent crimes, and have had a record of that activity.
We activate those special response teams when we know that we
have more than just tne usual situation.
Mr. Hancock. Well, I understand in the situation down in Waco,
after it is all coming out, that either the FBI or you all had listen-
ing devices of some type inside the compound; is that correct?
Mr. Higgins. I think it has appeared in the paper, but I do not
know if that has been confirmed.
Mr. Hancock. Well, when were they put into the compound?
Prior to the time that you went out there? And if so, were they put
in as a result of a court-ordered permission, you know? I mean, I
do not understand how you can get listening devices inside a
compound after you went out there to knock on these people's door,
and they started shooting at you.
Mr. HlGGC^S. That is a question that should be directed to the
FBI, which was in charge of the operation. And I doubt that they
will comment on how or why they would do that, since that is an
investigative technique. But you could certainly ask them.
We got our information by the use of undercover agents.
Mr. Hancock. Well, maybe they might not want to answer it in
a public forum, but I think that mayoe we might be able to ask
that question, because I am curious, frankly, about whether that
type of thing is done by the FBI as a result of a court order pre-
viously or what have you, because I think we are talking about
some other areas.
Mr. Higgins. There are extensive rules that cover when ■
Mr. Hancock. I understand; I understand. I would just like to
know how it is done.
I would just like to ask vou a real quick question. We have got
a situation now with the law enforcement in this country where
98
anyone, anyone that has been convicted of a felony, they cannot le-
gally own a weapon and even own a shotgun to go hunting.
It seems to me — and that is — if you are convicted of a felony that
has nothing to do, absolutely nothing to do with the use of a weap-
on, it seems to me like that is a little infringement on the second
amendment rights.
Would you even voice an opinion on that? I mean, for instance,
I have got a particular situation where a guy was convicted for fail-
ing to pay his child support, and yet he cannot own a shotgun. Is
that not carrying that a little bit too far?
Mr. HiGGlNS. Well, without commenting on whether it should or
should not be that way, you may not know that prior to this fiscal
year there was a process by which individuals who had been con-
victed of crimes like that could file for relief from disability. We
would conduct an investigation and, if the circumstances warrant,
restore that right.
There are also provisions where
Mr, Hancock, In the Treasury appropriation in the last session
of Congress, they took away your funding to do that.
Mr. HiGGlNS. Yes. So now we cannot grant relief. But there is
also a provision that if the State grants relief, they can have their
rights restored as well.
Mr. Hancock. Oh, is that right? OK, fine.
Mr. HiGGlNS. If by provision of State law, it works that way, then
they do not need relief.
Mr. Hancock. Thank you very much.
Chairman PiCKLE. We will explore that aspect of the code later
on.
Now the Chair recognizes Mr. Brewster.
Mr. Brewster. Thank you, Mr. Chairman.
Mr, Higgins, I know that hindsight is 20/20, and foresight is cer-
tainly not that good, and that there are a lot of Monday morning
quarterbacks sitting around that are criticizing, critiquing what
went on in Waco.
But was the original intent to search the premises for illegal
weapons?
Mr. Higgins. Illegal weapons and explosives.
Mr. Brewster. OK. Did you feel that you did not have probably
cause to arrest the individual, the leader, prior to that time?
Mr. Higgins. I do not want to give you the wrong impression. We
had both an arrest warrant for the leader and search warrants for
the premises.
Mr. Brewster. So you felt like you already had probable cause
for the arrest of at least the leader?
Mr. Higgins. Simultaneous. I want to show these as activities
which occurred — the warrants, I believe, came down on the same
day. We got the warrants on the same day.
Mr. Brewster. From the number of agents, 100 agents and 3
special response teams, I have to assume that vou expected to have
problems, expected to have violence or some kind of problem; am
I correct in that?
Mr. Higgins. The reason we used the special response teams is,
we had reason to believe there were a large number of weapons
and explosives. We developed a plan which required a certain num-
99
ber of people to go in, which we thought would enable us to effect
a peaceful conclusion.
When we served the warrants, our biggest concerns were the
safety of the people that were in there, and, in fact, I know that
some of our agents, as they went in, were more worried about get-
ting to the children and protecting them than anything else.
So we had that large a number of people in order to do it in that
way.
Mr. Brewster. Was any thought given to arresting the leader,
the individual, outside the compound when he went into Waco to
buy welders or whatever, as I understand that he did on a fairly
routine basis?
Mr. HiGGlNS. Well, I think how often he left the premises has
been greatly exaggerated. The best information we had — and cer-
tainly there will be second-guessing — was that he was not going to
leave the compound, was not likely to leave the compound, ana on
the unlikely occasion that he should, we still had the problem that
he may be surrounded — and as you can see by the events — ^by 15
to 20 people who were equally violent and equally committed. We
were concerned we still would have a search warrant, and we
would still have innocent people on the premises and still have the
problem of getting them out without somebody hurting them on the
premises, not outside the premises.
So we may have — in the unlikely event we caught him out
there — avoided him as the problem, but certainly would not have
avoided the entire problem.
Beyond that, with the series of articles which were starting in
the Waco paper — actually the Saturday before the warrants — with
respect to why law enforcement was not doing anything, we
thought that was going to make it increasingly more unlikely that
he would leave those premises.
Mr. Brewster. So you felt that even if vou arrested him off-
premises, there were others there that would pick up his leader-
ship and be just as violent, just as much of a problem as we was?
Mr. HiGGlNS. Absolutely.
Mr. Brewster. OK Now as far as weapons are concerned, were
there providers of illegal weapons to them, or were they buying
legal weapons and converting them, or both?
Mr. HiGGiNS. I cannot comment. But let me just say that a lot
of the purchases that he made, were purchases of legally available
parts for the conversion of weapons. What makes it a violation is
when you have all those parts together in one place and/or convert
the weapons to fire as automatic weapons. But the purchase of in-
dividual items is not a violation of Federal law.
Mr. Brewster. So you do not know of him purchasing illegal
weapons, even explosives or whatever?
Mr. HiGGlNS. Yes. I do not want to comment on all of the things
that were in there, and I am not sure that I am familiar with ev-
erything that was in there, but most of the illegal activities in this
case we felt took place once they were on the premises. I think that
is a fair statement.
Mr. Brewster. But it is a felony to convert a semiautomatic
weapon to an automatic weapon; am I correct?
Mr. HiGGiNS. Absolutely.
100
Mr. Brewster. OK Do you have much of a problem through the
agency, not just on Waco or otherwise, with providers of illegal
weapons today?
Mr. HiGGiNS. Yes. We have a number of investigations of people
who are converting automatic weapons, whether they be handguns
or long guns, and selling to people in narcotics activities or other
types of illegal activities. That is a continuing problem.
Mr. Brewster. Converting a handgun to fully automatic?
Mr. HiGGiNS. Yes.
Mr. Brewster. That would be interesting. There used to be a
Class C license. There is no longer a Class C license; am I correct?
Mr. HiGGiNS. I am not familiar with what that was, other than
that was a type of licensing for manufacturing.
Mr. Brewster. A Class C license allowed the sale of fully auto-
matic weapons some years ago. So today it is illegal for anyone to
own a fully automatic weapons, unless they had a previous license
under Class C some years ago.
Mr. HiGGESis. It is illegal for anyone now to have an unregistered
automatic weapon. The Taw was changed in 1986. It prohibited the
manufacture of automatic weapons
Mr. Brewster. After 1986.
Mr. HiGGms [continuing]. For sale to other than law enforce-
ment, military, and a few other restricted groups. Any weapons
that were in existence prior to the 1986 change could still be traf-
ficked among individuals, as long as they were registered with our
Department. So it is not illegal to have a registered automatic
weapon.
Mr. Brewster. You mentioned also that violent extremist groups
were out there. Do you see an increase in what you consider to be
violent extremist groups who have terrorist capacity in this coun-
try?
Mr. HiGGiNS. I am reluctant to say it is an increase, because
then people react to it as if we have a growing problem. But one
of the difficulties is, it is hard to find out about some of these
groups. So I do not know whether there has been an increase or
whether we have better intelligence. I do not want to make a value
judgment as to what is happening. Just suffice it to say that this
was not the only group like that.
Mr. Brewster. OK. Thank you very much.
Chairman PiCKLE. The Chair recognizes now Mr. Santorum. Mr.
Santorum.
Mr. Santorum. Thank you, Mr. Chairman.
I was interested in a couple of the comments that you made, Mr.
Higgins. First oflF, how long did you investigate the Branch
Davidians before any action was taken? How long was the inves-
tigation imderway?
Mr. Higgins. The first information we had that there may be il-
legal activities occurring there we got from, I believe, a Deputy
Sheriff in the locality in June of 1992.
Mr. Santorum. OK And you mentioned something that I
thought was interesting when you said about the stories tnat were
running in the local Waco papers, which was: Is anyone going to
do anyUiing about that?
101
Were you contacted by the reporters about the articles to be writ-
ten?
Mr. HlGGEV[s. Did we know? We were contacted, yes.
Mr. Santorum. You did? So you knew the stories were going to
run?
Mr. HlGGD^s. We did not know for sure until about 2 or 3 days
before, when they were going to run, but we know they started
running on Saturday. In fact, we sent someone in to see if it caused
any concern.
Mr. Santorum. You sent someone in? I am sorry. What? You
sent someone in to
Mr. HiGGiNS. We had an undercover agent go in on the first day
that the story ran to see if that caused any kind of increased
awareness or alert.
Mr. Santorum. Was there any attempt by your office to do any-
thing about holding those stories back? I mean, you gave me the
impression from your answer that this jeopardized and caused
problems. Since these stories ran, Koresh was less likely to leave
the compound, and this would create more problems for you. Was
there any attempt on your part to have those stories to be held or
asked the stories to be held until some action was taken?
Mr. HiGGlNS. Yes, there was.
Mr. Santorum. There was. OK
When did you communicate that to the papers?
Mr. Higgins. I can get you the exact date. But it was in advance,
obviously, of the articles being run.
Mr. Santorum. All right. You folks were obviously outgunned
when the assault was taking place. Is there a problem with your
funding as far as your capability of weapons?
Mr. Higgins. No. Let me comment on that. I think the
"outgunning" is an unfortunate choice. I know it is not your choice.
It is an unfortunate choice of words in that we did not go there to
engage in a gun battle, and that is not the way we conduct law en-
forcement in this country.
The people were equipped to go in and separate the men, women,
and children, the innocent ones, and to separate the violent ones
from the gun cache. So we went in there to do it in a way that we
could do it quickly, and there would be no firing.
We knew we did not have the capability ana do not have as law
enforcement the right to fire through walls and ceilings and roofs,
not being able to identify the targets. So we went in with weapons
that were appropriate to that kind of a mission.
Certainly we did not have, as they have been alleged to have,
.50-caliber machine guns that we could fire through the walls. We
could not have used them if we had had them. So the weapons we
had were appropriate to the situation.
Mr. Santorum. You could not go in because that is beyond what?
Why do you say you could not have you used them? Because that
is just not the kind of activity you would conduct?
Mr. Higgins. Right. We knew there were innocent men, women,
and children in that compound. When the element of surprise was
lost and they were ready for us, we did not know where those men,
women — one thing we assumed that they would not be where we
thought they were going to be if they were caught by surprise. So
102
we could not have used weapons that we could not have controlled
where the round would have ended up. Certain types of weapons,
when fired in a situation like that, are going to go through the
walls, as you saw on television when they were fired at our agents.
We could not use a weapon like that. That is not law enforcement.
Mr. Santorum. You mentioned the element of surprise, which
brings me back a little bit to the newspaper story. Was there any
attempt on vour part, knowing that these — ^how lon^ in advance of
the stories oeing run were you contacted about this potential re-
port?
Mr. HiGGlNS. I do not remember the exact number of days. I can
find that for you.
Mr. Santorum. Was it long enough for you to contemplate the
fact that this story may be running and to move up your
Mr. HiGGlNS. It certainly was. We had some flexibility, but not
entire flexibility. But, in fact, we moved it up one day in order to —
but to move it up any longer than that would have
Mr. Santorum. You could not have moved it up any — given the
notice you were given about when the report was going to be — ^you
could not move it up any further? You just did not have the re-
sources on hand, or what was — ^you did not have the agents there
or
Mr. HiGGlNS. We went when we thought we had the training and
the people there and the logistics and everything else. There was
not that big a window of opportunity, no.
I appreciate the opportunity to have this exchange with you, but
I think that is sometning that needs to be looked at when we look
at this entire — I mean, how much time was there, what could have
been done, what should have been done. I think those are legiti-
mate questions, and I understand why you have them.
I cannot answer them all today here, but I will do the best I can.
Mr. Santorum. And you mentioned training, and you mentioned
you have a 2-week training course on this kind oi activity. How
does that compare with the FBI or other folks as far as their train-
ing in this area?
Mr. HiGGiNS. I can ask Dave to expand on that. With respect to
the SRTs that other agencies have, whether they are State, local,
the Marshals' Service or others, I think that is comparable.
Mr. Troy. Our special response teams are very much like local
police and State police SWAT teams. It is the same type of tactic
and technique. I think our 2-week training course is very similar
to the specialized training that a SWAT team for a local police or
a State police agency would have, and they do the same type of
thing we do. When we pick people to be on an SRT and send them
through the 2-week training course
Mr. Santorum. Is this an ATF-run training course?
Mr. Troy. Yes, this is an ATF-run training course for our agents.
And when we get our agents through that course and we have an
active SRT, we do monthly training, much the same as a SWAT
team does with a police agency. It's recurring.
Mr. Santorum. The question is the level — I know my time is
up — ^but the level of training is similar to and the amount of train-
ing is similar to other SWAT teams, whether it be local or State
or Federal?
103
Mr. Troy. That is correct, the same type of thing, recurring
training after the initial training, practicing, and, of course, they
are used in live situations on a recurring basis all the time, when-
ever we have high-risk search or arrest warrants that we feel are
beyond just the normal group of agents in the field office to con-
duct.
Mr. Santorum. So you would state that the training that your
agents go through is as good or better than any other training that
any other SWAT team in this country goes through?
Mr. Troy. Well, I would not want to characterize it as better
than any, but I think it is as good as any SWAT team training that
any police agency utilizes.
Mr. Santorum. Thank you, Mr. Chairman.
Chairman PiCKLE. Thank you, Mr. Santorum.
The Chair wants to comment further to you, Mr. Troy, and to
you, Mr. Higgins. Earlier I had asked, knowing that the people in-
side that compound knew exactly when you were coming, why you
still risked your men. I do not want to infer that you knew there
would be gunfire and that you knew that you would lose your men,
they would lose their lives; none of us want to infer that.
But it does bother me that you knew from people you had inside
that they were prepared and were waiting for you. The element of
surprise was gone. Then why did you proceed?
Mr. HlGGENS. I am not quarreling with your interpretation. You
are assuming that we knew certain things, and I am saying that
there were a lot of people involved in the decisionmaking process
who have made statements to the Texas Rangers. They will also be
made to the review group that does this. And then — and I think
that is the appropriate time — ^you v\ill be able to review what they
knew and what they did not, and you can make a judgment as to
whether or not
Chairman P1CKI.E. And I do not want to be making a judgment
in advance, but I think the question must be raised and will be
raised over and over again.
Now the Chair wants to recognize Mr. Merger. Mr. Merger.
Mr. Merger. Thank you very much, Mr. Chairman.
And, Mr. Miggins, I just want to be one who makes sure that you
are aware that I am one who recognizes the very incredibly tough,
almost impossible job that you have, particularly in situations like
this. And again, it is very easy to Monday morning quarterback
how we would have done it differently, but yet certainly it is our
responsibility to examine what we did, determine whether or not
there might have been some way we might have done it differently,
if for no other reason than at least that we can be better prepared
should such a potential tragedy occur in the future.
You mentioned earlier that you were aware as early as June of
1992 that there was a problem taking place in the Branch
Davidian. That was when you were first aware.
What period of time were you monitoring them, monitoring the
compound, prior to
Mr. Miggins. I am not sure what month we
Mr. Merger. Approximately.
Mr. Miggins. David may know without even having to look it up.
104
Mr. Herger. Was it a matter of weeks, or are we talking about
months?
Mr. Troy. Well, as Mr. Higgins responded earlier, we got the ini-
tial information from a sheriffs department deputy in June of
1992.
Mr. Herger. Right.
Mr. Troy. The information was not definitive. The information
was not a case that you can take to the U.S. attorney today; that
was provable. The information was only that these people were ac-
quiring firearms, and there was reason to believe that they may be
acquiring firearms and converting them to full automatic, and
there was reason to believe they may be acquiring explosive compo-
nents which were legally bought and then manufacturing explosive
devices.
The information was not definitive, and it was certainly not
enough for any kind of warrant. But it was enough for us to react
to as an agency charged with enforcing those laws.
From that point forward, we had to basically build a case from
the ground up. I think it is important to note this was a group peo-
ple who were a closed society. You could not walk up to the front
door and strike up a conversation with these people. It took a long
time for us to get to the point that we could introduce undercover
agents into that compound successfully and get the intelligence in-
formation that we needed to get the probable cause to satisfy the
magistrate.
It took us 9 months approximately, from June of 1992 until Feb-
ruary of 1993, to have the probable cause necessary to get an ar-
rest warrant for Vernon Howell and a search warrant for the
compound.
In a case of this size, with the problems that are involved due
to the fact that it was a closed society and it was not a situation
that you could infiltrate very easily, 9 months was really not that
long a time, as most criminal investigations go on large groups of
people, particularly those that are so paranoid about Taw enforce-
ment.
This group of people was extremely paranoid, particularly Ver-
non Howell, about law enforcement, about ATF in particular. They
were very well aware of ATF. They knew who we were, and they
knew what our mission was.
And I suggest to you, there is one very good reason that that is
true. They were, in my opinion, in gross violation of the Federal
firearms laws and the explosives laws, and they knew that we were
the agency who enforces those laws, and quite frankly they knew
some day they were going to have to be called to account for that.
That is the reason that they were as paranoid as they were, and
that is the reason it took so long to get the information necessary
to secure a warrant.
But 9 months is not that long in a complicated case like that.
Mr. Herger. Did these individuals, Mr. Koresh and several of
the others that you have mentioned that seemed to be particularly
potentially dangerous, would they leave the compound from time to
time?
Mr. Troy. During the course of our investigation, Mr. Howell
was off the compoimd on many different occasions. However, at no
105
time did we observe him off the compound after we had an arrest
warrant for him.
We have been criticized for that in the press saying: Well, why
did you not arrest this guv when he was down at the 7-Eleven?
Well, we would have been happy to do so, if we had had an arrest
warrant for him, but our investigation had not developed the prob-
able cause necessary to get the warrant.
Once we had the probable cause, he was so heated up over what
he considered to be the Grovemment interfering in his business in
general, not necessarily ATF in particular, that he would not come
off the compound. He made it very clear, and our undercover
agents heard him say it. He was not leaving that compound; he
was never going off the compound. He had been called into account
on a couple of occasions by the Child Welfare Services because of
rumors and innuendo and conversation that there was child abuse
going on inside the compound. He had gone to a couple of meetings
off the compound, and he was very, very nervous about that, and
he made it clear that he was never leaving.
We never saw him off the compound afber we had an arrest war-
rant for him, or he would have been in jail. But we would still have
had to serve the search warrant on the compound. And I think the
FBI's 51-day attempt at negotiating those people out of there
proved that the people behind Vernon Howell were just as violent,
just as irrational, and just as willing to open fire on law enforce-
ment officers without any provocation whatsoever.
So serving the search warrant after Vernon Howell was in jail,
we could have had exactly the same problem that occurred on Feb-
ruary 28 when he was inside.
Mr. Herger. So what I in essence hear you saying is, some of
the concern that perhaps we did not wait for them to come out and
then arrest them at that time is really not really founded. They
really were not leaving the compound from the time you had your
arrest warrant; is that correct?
Mr. Troy. That is correct.
Mr. Herger. So therefore the only way you could serve it was
to do what you did.
Mr. Troy. Right. He was not leaving the compound.
Now there have been a couple of statements made in Waco by
persons in the news media that he was seen a week or 2 weeks be-
fore the raid. And we are not disputing that fact. We were not con-
ducting a 24-hour surveillance on Vernon Howell, because it was
impossible to do so without blowing our whole investigation. We
could not camp on that guy's doorstep and follow him everywhere
he went, or we would have blown the whole thing. We would have
been unable to even make a case, if, in fact, we would not have had
what happened on the 28th.
So we will not dispute the fact that at some point in time he
might have gotten off the compound and gone down to a local store
or whatever and then got back on. He could have done that. But
in order to arrest him, we would have had to camp on his doorstep
so closely we would have blown the whole case, i^d that just was
not a realistic way to approach it.
Mr. Herger. Very good. Thank you.
106
Chairman PiCKLE. Well, Mr. Troy, I asked the question: Why
would it take you 9 months to make a case when you had factual
evidence that these ammunition parts were being sent in, that they
were in violation of our Tax Code and the firearms laws? And I
think the question will remain with the American people, why it
would take you that long to make a case.
It bothers me that you said that you knew he, the man in charge,
was a violent person. He was a nut, and he was.
But you said the rest of them are just as violent, or many of
them were. Now you knew that, and you knew there was no ele-
ment of surprise that Sunday morning, and yet you moved in. And
the question is: Did you move in at the right time?
Mr. Troy. I understand.
Chairman Pickle. I do not think we should be passing judgment,
but I think that is a question that people have to ask each other,
and I think it is a legitimate question that will continue to be
asked.
Mr. Troy. I agree with you. I think that is a fair question.
Chairman Fickle. I do not think the question is whether your
people were trained. I think they were trained. It is not a question
of whether you do a good job. You do a good job. The question is
now: Was this the right thing to happen?
But whenever you let a compound of that kind get firearms and
build up to the degree of potential offensive action that thev had,
then you are going to expect death and destruction. I think that
probably did happen.
Now before I recognize you, Mr. Higgins, you said that 16 men
were injured. How are they doing?
Mr. Higgins. Physically very well, thank you.
Chairman PiCKLE. Good.
Mr. Higgins. Of the most seriously injured, two of the three ac-
tually, one is back at work and working strong, and the other has
been in part time. Most of the others are back at work.
Chairman PiCKLE. Well, that is good news.
Mr. Higgins. Very strong individuals.
Chairman Pickle. That is good news to have.
Now let me ask you another question. You, the ATF, you are the
arson and explosive experts in our Grovernment.
Mr. Higgins. Correct.
Chairman Pickle. You, of all aspects of our Government, are
charged with investigating explosives and arson. I think the Amer-
ican people in this instance want to know: What caused the explo-
sion and the fire in that compound?
Mr. Higgins. Because we are the experts, we realize that it
sometimes takes a long time when you have a crime scene like that
to find out exactly what happened.
Because of the fact that we were initially involved in this inci-
dent, that crime scene search will be made and coordinated by the
Rangers in this case with
Chairman PiCKLE. What do you think caused the fire?
Mr. Higgins. It would only be speculation on my part, and I do
not see how that would be helpful. I would not even want to specu-
late.
107
Chairman Pickle. I understand that some of the authorities said
they witnessed somebody from within the compound. Did you?
Mr. HiGGESfs. I did not personally. I have seen the same report.
I think that is a question that should be asked of the people who
could see the compound and were there. I have no reason to doubt
that what the FBI described as happening, happened. I simply did
not see it, and I do not have any independent information about
it.
Chairman Pickle. Well, as experts, you are the only one who can
really definitively tell us what caused the fire, who set it and how
it came about. It will be in your hands, and you do not have any
comment to make at this time?
Mr. HlGGENS. No. In this case, it will not be in our hands. It will
be done by the Texas Rangers.
Chairman Pickle. I do not know whether I ought to take comfort
in being from Texas that that is the case or not. [Laughter.]
Mr. HiGGiNS. I have a lot of confidence in them, and I think they
will have good assistance.
Chairman Pickle. I am glad you could give them help on that.
But, we are interested in knowing. The big question is: How did
the fire get started? Was it through any aspect of the tear gas?
Was it a combination? And a lot of other questions. I think that
is going to be the big question that needs to be answered.
Now let me yield now to Mr. Jefferson again. Mr. Jefferson.
Mr. Jefferson. Thank you, Mr. Chairman.
I just have a few questions more. I have deliberately avoided ask-
ing questions about the Waco incident, inasmuch as the Chairman
and the other committee members have done a fine job of covering
that subject.
And so the one I have now is not really an oblique reference of
any kind to that and is not asked in light of the Waco incident. But
it may be viewed as having something to do that, and so I wanted
to say that it really does not.
But ATF's operations, from your testimony and what I have
heard today from you and other witnesses, covered a varied range
of responsibilities, including tax collection, firearms enforcement,
alcoholic beverage testing and labeling, safe explosive storage, re-
ducing firearms possession of career criminals, eliminating drug
trafficking by violent gangs, preventing and investigating arson,
and the list goes on and on.
. Some of these responsibilities are also shared, from what you
have said in the testimony, by other Federal enforcement agencies.
The question is: Is ATF doing too much? Is it spread too thin?
Would certain ATF functions be better placed in different Federal
law enforcement departments? Can the responsibilities that you
are assigned to handle now be handled better if it is done dif-
ferently, or can you do the job you have now been assigned to do
by the Congress?
Mr. HiGGiNS. I think the name. Alcohol, Tobacco and Firearms—
and if you added explosives to that, you would have an even more
awkward name — gives the impression that we enforce a lot of stat-
utes. But when you look at, for example, what other Federal agen-
cies enforce, whether it be the FBI, the U.S. Customs Service, or
others, they are enforcing hundreds, if not thousands of statutes.
108
So I do not think we are spread as thinly as some other agencies.
So I am not think it is a question of having too much responsibihty.
Certainly we would always like to have more people, and I do not
know any bureaucrat who would not. But I think we have tried to
prioritize in such a way that we handle these in a responsible, ef-
fective way. If other people want to examine whether or not the
ATF should exist, they have a right to do that.
In my own personal view — and I am not unbiased — I do not
think change for the sake of change makes any sense.
Mr. Jefferson. Well, that is why I asked the question. No one
is interested in change for the sake of change. But the problems
you have talked about are huge ones. Waco is an isolated incident
in light of all of the responsibilities you have. But taking Waco out
of it and looking at all the rest of it, it is an area that is fraught
with all sorts of dangers and new activities and uncertainties.
And the question is: Can we get the job done through ATF? You
apparently think that we can, and that is why I asked the ques-
tion.
Now there are some things we will have to, I guess, explore as
we go along.
Related to that, the President has proposed some increases in ex-
cise taxes on — substantial increases on cigarettes and a few other
areas within the range of your responsibility.
Is ATF set up to deal with the problem of increases in tax eva-
sion that might result from additional excise tax collection respon-
sibility?
Mr. HiGGlNS. The difficulty in answering the question is, I am
not sure what resources we would get in order to do that. There
has not been a discussion of that.
The number of, for example, tobacco excise taxpayers, if the tax
continues to be collected at the manufacturer's level, which I as-
sume it would be, is relatively small, and we could effect almost
complete audit coverage. So I do not see the tobacco area as being
one that even necessarily requires a lot more resources. But it is
hard, without knowing how many
Mr. Jefferson. Well, would you expect there to be more of an
attempt to evade the excise tax when it is $1 or $2 a pack, rather
than 25 cents a pack?
Mr. HiGGiNS. There is always that possibility. I think we saw it
happen in Canada. We are working a number of cases where the
taxes have gone very, very high in Canada, and cigarettes are
being smuggled or sent into the United States and then smuggled
back to Canada. These are Canadian cigarettes. We know the
temptation increases as the taxes increase.
The reason that I cannot say whether or not we can eff*ectively
handle it is, I do not know how many resources we will get to react
to that. But whatever it is, we will do the best we can.
Mr. Jefferson. Well, does your budget assume any evasion lev-
els, any increased evasion levels?
Mr. HiGGlNS. Our budget is pretty much flat in those areas. It
assumes the same compliance levels. It is not based on any
additional
109
Mr. Jefferson. Realistically, do you think there may be some
tendency toward evasion, and is there no assumption built into the
budget numbers to take that into account?
Mr. HiGGlNS. Unfortunately, they will not let us budget on the
fact that there may be a tax increase. We have to deal with what
there is now. The only exception to that is in the user fee proposal,
and that is based on whether or not there would be a user fee pro-
posal. But then again, that will just be a reimbursable type ar-
rangement.
So they will not let us staff up in anticipation of a tax increase.
Mr. Jefferson. I do not have any further questions.
Chairman Pickle. Mr. Houghton, you are recognized again. Mr.
Houghton.
Mr. Houghton. Yes, Mr. Chairman, very briefly, again I want to
thank you gentlemen for being here, and thank you, Mr. Chairman,
for holding the hearing.
Clearly there are issues that have not been discussed here. There
are answers which are not forthcoming. You do not have the infor-
mation.
But I think we ought to get that information, and I expect that
you will provide that to us.
Also I would hate to have us sitting here a year from now and
having another tragic incident take place and saying: Well, we did
not have the coordination; we did not have the budget; we did not
think through what our new mission was.
We have just got to put that into better perspective, and I hope
you will do that for us.
Thank you.
Chairman PlCKlJ^.. Well, Mr. Higgins and Mr. Black and Mr.
Troy, I think you have been very forthcoming and very candid in
your statements today. We appreciate your statements, and we ap-
preciate your appearance.
I have a lot of questions about what has happened, and I think
a lot of Americans have the same thing. You are going to be
bombarded for an explanation of why did you do this. I have the
feeling that the outcome was inevitable, once you let a compound
get started, you let explosives get into their hands, and they are
locked up in the compound. You know what the results are going
to be. Maybe the results that happened were inevitable. So I do not
think we ought to judge. I think probably overall we have handled
the case maybe about as well as we could have. I am not passing
judgment on that, but that is a personal feeling.
I know that inside you had a nut running that compound, and
people were willing to follow him, and he kept saving he was wait-
ing for the word of God, and I do not think God had a thing to do
with it. I think we were just dealing with an egomaniac.
Now this has happened, and we have to answer a lot of ques-
tions. This committee first, with jurisdiction over the ongoing au-
thorization of your program, we must ask a lot of these questions.
Our primary concern at this point is: What is going to happen
to your program?
You testified about 1993 cuts in the inspection program and that
these additional costs that you have incurred may have a direct ef-
110
feet on your further compliance program. Is this going to be a seri-
ous problem for you?
Mr. HiGGiNS. We will take everjrthing out of the nonrevenue pro-
grams to make sure that any impact on the revenue collection is
minimized to the greatest extent possible. That is the best promise
I can make you.
Chairman Pickle. Well, you have gone from 4,400 alcohol com-
pliance inspections down to less than 3,700 without the World
Trade and the Waco incident. Will that not make your program
much more complicated and much more difficult to operate? Will
that lessen the degree of compliance that we can expect in this pro-
gram in the nextyear?
Mr. HiGGlNS, Trie reduction in the numbers, I think, is partially
due to the fact that we conducted a number of floor stocks tax in-
spections in the alcohol program that would not continue next year.
So some of that is deceiving when you look at the numbers.
With respect to the compliance levels of those returns we are au-
diting, we are going to keep the highest level we can, and, you
know, we are doing the best we can.
Chairman PiCKLE. I would hope that you would keep in touch.
We ask you to keep in touch with this subcommittee, because we
may want to have an update on your budget.
Mr. HlGGDSfS. Yes, sir.
Chairman Pickle. Regarding the budget figures, we need to
know further the costs of the World Trade and the Waco incidents,
and we may want to have additional hearings or at least have fur-
ther contact with you.
We know that ongoing questions are going to be asked, and some
of them need to be answered, some necessarily.
Did you give exclusive rights to a TV network to cover your raid?
Mr. HiGGlNS. If we did, I did not know about it. No.
Chairman Pickle. Well, how were they there?
Mr. HiGGlNS. You know, that is part of the investigation as to
how people were there. If the media wants to know that, the easi-
est thing it seems would be to ask the media present why they
were there. I mean, you do not need to ask ATF.
Chairman Pickle. But obviously there was no element of sur-
prise that morning, was there?
[No response.]
Chairman Pickle. Well, again, I want to thank you for coming.
We want you to keep up your work, because you are valuable.
I do think the question may be raised now with respect to juris-
diction. At one time, it was suggested that this agency might be
folded into the Justice Department. I do not know whether that is
advisable or not. But I do think you have important jurisdiction,
probably more so than any other law enforcement agency. You go
not only to alcohol, tobacco, and firearms laws; you also get into the
question of tax evasion. So you are a valuable agency. How you op-
erate is something, of course, that remains to be seen.
So, we are not trying to pass judgment on your overall operation,
except that we think you do a good job. Secondly, we are looking
forward to other questions, and we know you will be forthcoming.
Do you have any other questions, Mr. Houghton, at this time?
Mr. Houghton. No, sir.
Ill
Chairman PiCKLE. Well, we thank you for your appearance. We
appreciate your attendance. The committee is adjourned.
[Whereupon, at 11:49 a.m., the subcommittee adjourned, to re-
convene at 9 a.m., Wednesday, April 28, 1993.]
ADMmiSTRATION'S FISCAL YEAR 1994 BUDG-
ET PROPOSAL FOR THE INTERNAL REVE-
NUE SERVICE
WEDNESDAY, APRIL 28, 1993
House of REPRESEhfTATivEs,
Committee on Ways and Means,
Subcommittee on Oversight,
Washington, B.C.
The subcommittee met, pursuant to notice, at 8:34 a.m., in room
1100, Longworth House Office Building, Hon. J. J. Pickle (chair-
man of the subcommittee) presiding.
Chairman Pickle. We will ask the subcommittee to please come
to order.
We have a series of subcommittee hearings this morning, and
this subcommittee will proceed until at least 10:30, at which time
some of the members may go to a subcommittee markup or another
subcommittee, and then we may have a 5- or 10-minute recess at
that point. But we will make as much time as we can. In the mean-
time, I am going to make an opening statement and then yield to
Mr. Houghton. And then, Mr. Dolan, if you will proceed in what-
ever form you wish by way of summary, then we can get into some
of these questions. Is that satisfactory?
All right.
The Subcommittee on Oversight is meeting to review the admin-
istration's fiscal year 1994 budget proposal for the Internal Reve-
nue Service. The President recently nominated Ms. Margaret Rich-
ardson to be the new IRS Commissioner. She has not been con-
firmed yet, so Mr. Michael Dolan, Acting Commissioner, will testify
on behalf of IRS, and we are glad that he is with us today. I re-
serve the right to hold additional hearings with the new Commis-
sioner on issues not covered today.
I might point out that Mrs. Richardson is with us today, and
though she is not a witness, she is here, and we are delighted to
have you. We look forward to when you are confirmed.
When the new Commissioner takes over at the helm of IRS —
these are sobering thoughts, Ms. Richardson — she will inherit an
agency with a budget that exceeds $7 billion, employs 116,000 em-
ployees, and collects more than $1.2 trillion in taxes. She will be
confronted with directing a decentralized bureaucracy that is strug-
gling to modernize its antiquated computer systems, collect more
than $110 billion in delinquent taxes, and close an exploding tax
gap that currently exceeds $127 billion annually. She will lead an
examination force that has witnessed the audit rate plunge to
(113)
114
below 1 percent. She will be in charge of an agency with almost
5,000 law enforcement agents that sometimes spend more time
chasing drug dealers than catching criminal tax cheaters. She will
assume the awesome task of running this huge, mind-boggling pro-
duction machine at a time when taxpayers are becoming increas-
ingly dissatisfied with Government and its tax collector.
I personally believe our tax system is at a crossroads with many
critical decisions to be made in the months ahead. The problems
confronting the IRS are serious and will not be easily resolved.
There is evidence that voluntary compliance, which has held steady
for years, is beginning to slip. While most taxpayers met the April
15 deadline and filed their Federal income tax returns, we know
that 10 million people didn't bother to file and some will never be
caught.
According to IRS, more than $50 billion in tax revenues will be
lost in the next 5 years due to nonfiling. We also know that foreign
corporations taking advantage of our accessible and lucrative
consumer markets are avoiding billions in taxes as IRS's inter-
national enforcement efforts are plagued by program and manage-
ment weaknesses. We know that individuals who operate in the
cash economy and purchase luxury items, like cars and jewelry,
frequently underreport their income, while many don't bother to
file income tax returns at all. There is a growing public perception
that only "suckers" pay taxes. While this is far from true, it is im-
portant that we don't lose the confidence of the taxpaying public.
Over the past few years. Congress has pumped an enormous sum
of money into the operations of IRS. The Congress, and this sub-
committee in particular, I think, have tried to give IRS the re-
sources necessary to preserve our voluntary tax system. We have
supported tax systems modernization — a very expensive undertak-
ing to update IRS's computer systems — and we have constantly
sought adequate funding for compliance programs and taxpayer
services. We have sought to ensure that IRS collects the proper
amount of tax revenue, at the least cost to the taxpayer, while pro-
viding quality service. We have routinely developed "taxpayer bill
of rights" legislation because taxpayers have a right to expect fair
and equitable treatment by IRS employees. The public deserves no
less.
As this new administration takes over, I think it is appropriate
to reassess our vision for IRS. We should see IRS as an agency
where taxpayers are afforded more protections and safeguards;
where notices, letters, and bills sent to taxpayers are instructive
and make sense; where taxpayers are able to resolve their disputes
with IRS in a more timely and less costly manner; where the tax
collector is often more concerned with those deliberately cheating
the system than those striving to comply with tax laws; where the
agency provides accurate information and prompt answers to tax-
payer questions; where IRS personnel view taxpayers as customers
and not scoflflaws; and where new technologies can be timely em-
ployed to increase work productivity and reduce waste of precious
Government resources.
Today's hearing will go beyond a numerical discussion of staffing
and funding levels for tne various appropriations accounts. The fis-
cal year 1994 budget proposal for IRS represents the new adminis-
115
tration's tax policy and the administration's judgment as to how
many auditors, agents, attorneys, and others are necessary to effec-
tively administer our tax system. Our purpose today is to review
the administration's proposal, question its vision for IRS's future,
and establish a record in which to hold IRS accountable for the
promises it makes. We will report our findings and concerns about
IRS's programs and funding to the Committee on Appropriations in
time for their markup next month. With the cooperation of the wit-
nesses, I am confident that this hearing will prove fruitful today.
Now, the Chair will yield to Mr. Houghton for any opening state-
ment he may wish to make. Mr. Houghton.
Mr. Houghton. Thank you, Mr. Chairman. Mr. Dolan, Ms. Rich-
ardson, gentlemen, ladies, good to have you here.
This is an important session for a variety of different reasons,
not necessarily because of the budget at hand, but really for the
budget that might be.
I am, as an accountant, obviously interested in what you are
spending, the proportions, changing the trends, whether you are
over or under your budget, things like that. The question that real-
ly is foremost on my mind, and maybe others, is what happens
with the next tax changes.
I haven't been on the Ways and Means Committee very long, but
clearly in the next 2 to 3 weeks there is going to be a vast dif-
ference in what we have done than in the past, and it will affect
all of America. And as a result, you, when you take a look at the
President's new investment tax proposal, the Btu tax, and some of
the history which you have with the crude oil windfall profits tax
in 1980, whether there is any application of those types of experi-
ences here.
What are you going to need? What is going to happen? How can
you keep your budget at a reasonable level and at tne same time
take on all these new responsibilities? Those are the things in
which I am going to be particularly interested. We are delighted to
have you here.
Thank you, Mr. Chairman.
Chairman Pickle. Thank you.
Now we have a panel led by Acting Commissioner Mike Dolan.
Mike, why don't you introduce all the members of your panel with
you, and then we will proceed with your testimony.
STATEMENT OF MICHAEL P. DOLAN, ACTING COMMISSIONER,
INTERNAL REVENUE SERVICE; ACCOMPANIED BY DAVID G.
BLATTNER, CHIEF OPERATIONS OFFICER; PHILIP G. BRAND,
CHIEF FINANCIAL OFFICER; HENRY H. PHILCOX, CHIEF IN-
FORMATION OFFICER; AND LEE R. MONKS, ACTING TAX-
PAYER OMBUDSMAN
Mr. Dolan. I would be happy to, Mr. Chairman. Good morning
to you and Mr. Houghton both. It is nice to be back. It seems like
just yesterday we were up here to talk about tax systems mod-
ernization, but today we are going to talk about a broader range
of subjects, both as a result of the budget being before this sub-
committee, but also based on the expressed interest that you both
just articulated in your opening comments.
116
I think many of the folks with me this morning are not strangers
to this subcommittee. On my far left is Hank Philcox, who is our
chief information officer. Next to him is Dave Blattner, our chief
operations officer. On my right is Phil Brand, our chief financial of-
ficer. And someone who is new to this subcommittee is a gentleman
who has been acting as our ombudsman for the last 90 days. In his
normal life, he is the district director in Little Rock, but Lee Monks
is with us this morning and has been our acting ombudsman since
Damon Holmes retired.
I also have with me an assortment of other expertise, including
our acting chief counsel, Dave Jordan, as well as some other sub-
ject-matter experts to the extent that your questions or interest
take us in that direction.
What I am going to do, Mr. Chairman, with your permission, is
to, as I mentioned to you before, summarize from the statement
that you have in fi*ont of you, and what I will try to do is walk
through the pages so that you know where I am at any given time.
For starters, I would begin at the middle of page 1, and recap for
you the fact that our 1994 proposed budget is for a total amount
of almost $7.4 billion, and that, with reference to our 1993 budget,
represents an increase of $284 million and 792 positions. While
these net increases represent the smallest request in the last 4
years, there are below those numbers significant reallocations of
funds among programs.
Our budget attempts to balance four primary requirements, the
first of which is to achieve the President's objective to cut overhead
and staffing; the second, a very major one, to which you both re-
ferred, is the continuing modernization of our tax system. Third,
there are a series of initiatives in our budget designed to improve
compliance. In 11 discrete areas, we have proposed initiatives that
we think will improve compliance. And, fourth, there is a segment
of this budget request that attempts to make internal adjustments
to account for some of the issues I think, Mr. Houghton, that you
may be interested in.
Our major requests for increases include $186 million to continue
our tax systems modernization, another $207 million for mandatory
cost increases to maintain current programs, and then $150 million
for the compliance initiatives that I mentioned. These costs,
though, are partially offset by 300 million dollars' worth of reduc-
tions that we are taking ourselves as a result of the early yield
from tax systems modernization and application of the President's
injunction to cut overhead and reduce staffing.
In the area of reducing overhead, the bottom of page 1, the IRS
will clearly accept the President's challenge in this key area. As we
continue to improve our technology and our systems, we think we
are going to be able to produce even greater productivity.
For IRS, the President's goal for reducing Federal employment
translates to a 3-year reduction in staff of some 4,700 positions. As
a result of tax systems modernization efforts to date, we expect to
be able to achieve a large part of the fiscal year 1994 goal by reduc-
ing 1,200 positions through increased proauctivity. The balance of
our 1994 allotment we plan to achieve by streamlining our head-
quarters and field management staffs, a subject matter that I know
117
you have been interested in and have asked for GAO to do some
work within the organization.
Maintaining our frontline compHance activities, though, is a pri-
ority for us; and consequently, while staffing for these programs re-
flects some adjustments from the systems-related productivity sav-
ings, none of the additional reductions required to meet the Presi-
dent's goal have been taken from our front-line compliance activi-
ties.
The compliance initiatives, which are discussed beginning on
page 2 — and with your permission, Mr. Chairman, I will not detail
all the language that is there. But as you will see, we identify $150
million and 2,000 positions basically to fund 11 compliance initia-
tives. Specifically, these fiinds do two things: they enable us to
achieve additional accomplishments in some traditional enforce-
ment programs, including examination and criminal investigation,
but they also enable us to make special initiatives in areas like
international, in the underfunded pension plan arena, in taxpayer
assistance, and in the efforts to increase our effectiveness in collect-
ing the accounts receivable dollar.
What follows then, is a further alliteration of the international
tax compliance initiative value at $30.5 million and 177 positions;
and the underfunded pension plan initiative, a relatively small dol-
lar initiative but one that we think mav have a significant vield,
both to the IRS and its effectiveness ana the Grovemment at large.
Mr. Chairman, I know of your ongoing interest in this whole area
of underfunding. We think we can play a major part in shedding
more light on tnat through this initiative. The third initiative, the
nonfiler initiative, again, we have had extensive dialog with the
subcommittee. And, Mr. Chairman, I know of your personal inter-
est in our ability, as you said in your opening statement, to attract
the $10 billion annually that we think is now being lost as a result
of people not filing.
The fourth initiative on that page, the bankruptcy initiative,
again, is a relatively small dollar initiative, but one that ap-
proaches, we think systematically, a very crucial area of compli-
ance, one that spiked radically in the 1991 to 1992 environment
and to which we think we can add more rationality.
The accounts receivable initiative does a variety of things that I
am sure you will want to go into more particularly in the question
area. It is an attempt on our part to act responsibly both on our
internal learning as well as the advice and assistance we have got-
ten from folks such as GAO on fundamentally reinventing our col-
lection processes.
Lastly, there is a compliance initiative in the document matching
arena which, again, allows us to take resources and apply them to
an area that has been very cost-beneficial to the Grovemment £ind
to IRS.
The second area of the budget I would like to talk about begins
at the bottom of page 2, and that is the area of maintaining current
business operations. The only observation I would leave with you
on that point is that our budget, like any budget, private or public,
contains some certain element of cost over which management has
relatively little control. The 1994 budget attempts to cover a few
of these key areas, particularly in the area of increased costs in
118
health insurance, retirement funding, and then some within-grade
increases and career ladder promotions that do not get covered as
a result of the normal budgeting process that takes place in 0MB.
I would then move, Mr. Chairman, to the middle of the following
page, where we identify also a series of workload increase ele-
ments, much like the elements we routinely discuss with this sub-
committee. As a result of the growth in filings and a series of other
issues, I would say, Mr. Houghton, that we probably have not de-
tailed in this list nearly the sort of comprehensive set of reactions
that will be required from any new tax legislation, but with some
insight towards new tax legislation and with the knowledge that
our customer base will increase. You see described there on page
6 a variety of elements that will combine to create in our budget
request the need for 300 new positions to match pure growth in
workload in the 1994 environment.
The third area I would focus on is an area that we had the abil-
ity, I guess less than a month ago, to talk about it at some length
in an opening discussion. I think we all conceded that is a discus-
sion that needs to be built upon in order to earn the subcommit-
tee's support and understanding in the tax systems modernization
area. But that is our third key area of this 1994 budget.
In our 1994 budget, as I mentioned earlier, there is the informa-
tion systems budget itself that reflects a total increase of $188 mil-
lion, $186 million of which is to support tax systems modernization.
However, I would hasten to point out that the entire information
systems budget reflects a net increase of only $7.4 million from
1993 to 1994, the difference of that being the result of the reinvest-
ment that we were able to make of nonreccurring costs and in-
creased productivity that has already been achieved as a result of
the early stages of tax systems modernization.
What I do then in the following pages, Mr. Chairman, is identify
a series of key components in the 1994 tax systems modernization
increase category. And rather than take the subcommittee through
each and every one of those, I would like to invite your attention
to a few that I think are particularly key.
In packaging these for the subcommittee this morning, we have
thought of the tax systems modernization investments for 1994 in
terms of end user systems, infrastructure investments, and then,
lastly, something we call our integrated input processing strategy.
There on page 4 are a couple of initiatives that are particularly
key in the 1994 package. The first of them in something that is
called integrated case processing. This, Mr. Chairman, started out
as a series of isolated, independent business initiatives fostered by
exam, collection, criminal investigation, and our service centers, all
designed to do key things within their discrete businesses. But over
the last couple of years, consummating in the 1994 budget request,
we have brought those heretofore stand-alone departmental sys-
tems together in something called integrated case processing.
Our 1994 funding initiative for this integrated case processing
will allow us to purchase universal work stations and begin instal-
lation in service centers and field offices. This is a first step in
moving toward an integrated system supporting both taxpayer
service and compliance functions.
119
Importantly, the universal work stations are able to be procured
today through TMAC, the Treasury Multiuser Acquisitions Con-
tract, and will themselves not only support this first wave of case
processing applications, but will support all the TSM applications
through their useful life.
The second area is one that I know this subcommittee is inter-
ested in, and that is the compliance research and analysis system.
This is something that builds, Mr. Chairman, on an earlier con-
versation we had about finding ways to improve on our compliance
research. Under the concept of Compliance 2000, which is a core
strategy for the IRS, our objective is to identify and reduce
noncompliant taxpayer behavior.
The compliance research and analysis system, which we describe
on page 4, will support this effort by providing a capability to strat-
ify data on the population to identify many of the underlying
causes of noncompliance, which today we know far too little about.
The requested funds for 1994 will allow us to begin the develop-
ment of this system, which is critical to improving voluntary com-
pliance and building on the compliance measuring system that is
today based principally on the TCMP audit.
Another important area, Mr. Chairman and subcommittee mem-
bers, based on the interest of this subcommittee in the past, is
called the telephone routing interactive system. This is something
we were hopeful that we would get in the original supplemental re-
quest, which I know this subcommittee supported, where we would
have been able to buy some additional automated call distributors.
But this initiative is a way of eliminating the access problem — the
problem people have of reaching us during the filing season for re-
quests of either technical tax information or help on account
work — and substantially exploiting the technology of both auto-
mated call distributors and something called automated routing ca-
pacity to be able to, in fact, handle much more telephone traffic
than we can today.
The second subelement of tax systems modernization in this
budget is in the infrastructure investment area at the bottom of
page 4. I will only say in passing reference that both the corporate
svstems modernization/mirror image acquisition initiative and then
tne service center support system on the bottom of page 4 rep-
resent major, major components of the long-term tax systems mod-
ernization. Both of them are poised to allow contract award during
fiscal year 1994. Both of them are absolutely essential with respect
to straddling the workload that is today's business and laying the
groundwork for tomorrow's set of applications that will be part of
tax systems modernization.
The third leg of the 1994 request for modernization is under inte-
grated input processing. You will find that on the top of page 5.
There are a variety of initiatives there that are identified. Again,
I won't take you through each of them, but I would invite your par-
ticular attention to the first two: The funding for something called
service center recognition/image processing system. This is basi-
cally an imaging capability for which a contract was awarded with-
in the last 6 weeks to Grumman Corp. It allows us to take what
are very antiquated scanning devices in our service centers todav
through which we put about 156 million documents with the instal-
120
lation of this in three sites in 1994, to be able by 1995 to be putting
175 million documents through this scanning capacity.
The second item that is worth noting is what we call our cash
management system. We testified about this briefly in our earlier
tax systems modernization hearing. This is the front door to a day
when we will not have to handle by check and by cash the $1.2 to
$1.3 trillion worth of cash that flows through our system today.
This is the electronic doorway through which we will build on our
experimentation today in Atlanta for lousinesses that are beginning
to pay their Federal tax deposits this way. This money in the 1994
budget allows us to take this concept to a district office and allows
us to take the cash receipts in the district office and move the elec-
tronically into the Federal depository system as well.
What I would do in recapping, Mr. Chairman and subcommittee
members, is to suggest that 1994 is a very vital year in tax systems
modernization. I am now over on the bottom of page 5. With the
benefits of the modernization initiative also come costs. We have
talked about those costs, in at least preliminary detail with this
subcommittee. We recognize that a $7.8 billion additional invest-
ment, along with the $15 billion plus that would have been the cost
of continuing today's business represents a substantial investment
in the IRS, one to which we would like to rise quickly to your invi-
tation to be accountable before this subcommittee, one which we
know we've got to manage effectively.
A couple of areas have been identified as people have looked at
our accountability and looked at our ability to manage. One is
there on the top of page 6, and I know that this subcommittee has
had an interest in the funds classified as "no-year" funds. At the
point that we prepared this statement for the subcommittee, I am
not sure whether you have the $154 million total in the version you
are looking at there on the top of page 6. But as of February, there
was a total in that no-year funds accoimt of $154 million, essen-
tially made up of increments from 1990, 1991, and 1992. Today
that amount is $90 million.
Two significant contributors accounted for that money being in
no-year. As we indicate there, these funds were not expended in
the year they were appropriated, mostly due to contract slippage
and delay of site preparation while we reexamined our organiza-
tional structure. There was a third very important issue, and that
was that in 1992 Congress asked us specifically to not spend until
the last day of the fiscal year $97 million of our fiscal year 1992
appropriation. That, by definition, put us in a position where we
could not intelligently obligate that entire balance of 1992 funds.
Combined with that have been conscious decisions made to not
spend, particularly in the area of site preparation, the money that
would be required to prepare all 10 service centers for something
like the service center support system when today we know as a
result of additional business vision studies that we will not be re-
quired to build onto 10 service centers to be able to deliver tax sys-
tems modernization.
We are now today sure that we will be able to do in four centers
or five centers something that we thought in the past would have
taken 10 centers. We are now today sure that we will not have to
put the major computer power that today exists across 10 centers
121
and 2 computing centers in all 12 sites. And so that money has
been consciously identified as money to be kept available to do site
preparation in the right places.
What I will do, Mr. Chairman, mindful of your encouragement to
be brief in the opening, is finish on tax systems modernization by
saying this: Three areas of critique have come to us relatively rou-
tinely from folks who we have invited to evaluate us, and they are
identified on pages 6 through 7. They are identified as reinventing
IRS, as technical expertise, and as human resources. While my
statement is more complete, I will leave these sorts of thoughts
with you.
In each of these three areas, we have asked for and received le-
gitimate critique on how to do those three areas better.
In the reinventing area, we have talked with you earlier about
the year-long effort that has been under way to take the injunction
of this subcommittee and others seriously, to use the tax systems
modernization investment as a way to fundamentally reexamine
our business, to fundamentally reexamine how to impact on compli-
ance and service to the customers. We think in the next few
months, as Commissioner Richardson comes on board and as the
policy people at Treasuiy are in place and at 0MB, that we will
be able to describe that vision with much more clarity to this sub-
committee. We think we will, in fact, step up to every challenge we
have ever been g^ven with respect to usine tnis technology to lever-
age our business opportunities more fully than we might have
planned in the first.
The second category of technical expertise, you on this sub-
committee, as well as others, have questioned is our capacity inter-
nally to manage our technical future in tax systems modernization.
Two recent thmgs have occurred: one we described when we were
before you last. That is the creation of the office of a chief architect.
Within that office we have, as we mentioned to you last time, ac-
quired two very seasoned systems architects that will begin as soon
as their background investigations are complete, providing us a
level of expert help that we have not heretofore had.
A second achievement, which is more recent and which I don't
think we discussed last time we were together, is we have recently
awarded a contract to a federally funded research and development
center that is being headed by the Illinois Institute of Technology
and a consortium developed here locally with both the University
of Maryland and George Mason. The sole purpose of this consor-
tium— a not-for-profit entity — is designed exclusively to give us
independent technical expertise as we try to master the consider-
able technical challenges of tax systems modernization.
The last area is the area of human resources. We have conceded
that our focus earlier was on the business and technology issues.
We think we are fast closing the gap in the human resources area
by developing a human resource plan which will complement our
design master plan and be every bit the road map on the people
and human side that we hope the design master plan is for the
technical side.
Which brings me, maybe a little later than you had hoped, to a
summary on pa^e 8. In summarizing, Mr. Chairman and members
of the subcommittee, we have very much appreciated the support,
122
not only in budget areas but in the broad range of tax administra-
tion areas, that we have received from this subcommittee in the
past. We look forward to earning your continued support. We think
our 1994 budget reflects a very deliberate melding of our commit-
ment to achieve the efficiency and economy goals embodied in
President Clinton's program, as well as our urgent need to continue
to implement tax systems modernization.
We believe, and we think you share our belief, that we must keep
our tax system running, and running continuously better as we in-
vest in tax systems modernization. We must also provide adequate
support for our work force, and we must invest in the modest but
much needed increases in enforcement functions to address the
critical problems identified in our 11 initiatives as well as many of
the ones that I know this committee has interest in.
We seek your support for these absolutely critical areas. We look
forward to the continuing dialogue, and maybe we could begin that
by me stopping at this point and being willing to take the questions
or the observations of tne subcommittee members.
[The prepared statement and questions and answers subse-
quently received follow:]
123
STATEMENT OF
MICHAEL P. DOLAN
ACTING COMMISSIONER
INTERNAL REVENUE SERVICE
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
HOUSE COMMITTEE ON WAYS AND MEANS
APRIL 28, 1993
Mr. Chairman and Members of the Subcommittee:
I appreciate the opportunity to appear before the Subcommittee today to
discuss our FY 1994 budget request. Copies of our "Budget in Brief" have been
provided to the staff for your information and reference.
With me are Chief Financial Officer, Phil Brand; Chief Information Officer,
Hank Philcox; Chief Operations Officer, Dave Blattner; and Lee Monks, our acting
Taxpayer Ombudsman. The support of this Subcommittee for our budget over the
last several years has been essential to the progress we have made, and we
appreciate your continued support.
IRS ACTIONS AND THE PRESIDENT'S AGENDA
For FY 1994, the proposed budget of almost $7.4 billion represents a net
increase of $284 million and 792 positions over FY 1993. While the net increases
are the smallest requested in four years, there are significant reallocations of funds
among programs.
Our budget balances four requirements:
• achieving the President's objective to cut overhead and staffing;
• continuing the modernization of our tax system;
• shoring up programs to improve compliance with the tax laws; and
• adjusting Internal budgets to reflect the changing mix of work.
The only major requests for increases include the $186 million to continue
Tax Systems Modernization, another $207 million for mandatory cost increases
to maintain current programs, and $150 million for compliance initiatives. These
costs are partially offset by nearly $300 million In reductions as a result of
productivity savings, cuts in administrative costs and savings from information
systems changes. Taking into account these changes, we are requesting a net
increase of 792 positions and $284 million.
REDUCING OVERHEAD
The Internal Revenue Service's proposed FY 1994 budget implements one of
President Clinton's key goals - managing our operations at a lower cost. As we
continue to improve our technology and our systems, we will achieve greater
productivity and will spend less to accomplish a growing workload.
For IRS, the President's goal for reducing federal employment translates to a
three-year reduction in staff of some 4,700 positions. As a result of Tax Systems
Modernization efforts to date, we expect to achieve a large part of the FY 1994
goal by reducing 1,200 positions through increases in productivity. We plan to
achieve the balance by streamlining our headquarters and field management staffs.
Maintaining front line compliance activities is a priority. Consequently, while
staffing for these programs properly reflects adjustments from systems-related
124
productivity savings, none of the additional reductions required to meet the
President's goal have been applied against compliance programs.
COMPLIANCE INITIATIVES
Our FY 1994 request includes $150 million and 2,000 positions to fund 11
compliance initiatives. Specifically, these funds will provide 2,000 additional staff
for traditional enforcement programs, including examinations and criminal
investigations, and for special initiatives in international, underfunded pension
plans, taxpayer assistance, and collection. Each initiative is designed to address
areas of non-compliance most in need of attention or to focus on operations that
require additional staffing. Examples include:
• International Tax Compliance ($30.5 million and 177 positions).
Although reasonable people differ about the size of the tax gap that
we can assign to international taxpayers, there is no disagreement
about the need to be aggressive in efforts to close that gap. FY 1994
dollars are targeted to boost the investments in staff and thus boost
the number of international returns examined, expand the use of
outside experts and consultants, and heavily promote the use of
advance pricing agreements.
• Underfunded Pension Plans ($2.9 million and 43 positions). This is an
area of potential vulnerability for the United States government and its
citizens. Charged by the Congress to ensure compliance with
minimum funding requirements, the IRS would make inroads in
defining the extent and causes of underfunding and improving
examiner skills and the selection of returns for examination.
• Non-filer ($20.3 Million and 358 positions). This initiative further
supports our ongoing program to bring non-filers back into the tax
system. This initiative builds upon earlier decisions to redirect more
than 2,200 examination and information reporting positions toward
identifying and bringing into compliance the more than 10 million non-
filers. We estimate annual revenue loss at $10 billion from non-filing
of individual income tax for FY 1993 alone. The new focus would
place special emphasis on non-filers of trust fund taxes and would
provide assistance to taxpayers who voluntarily come forward and file
delinquent returns.
• Bankruptcy ($3.4 million and 60 positions). To address the growth of
bankruptcy workload and protect the government's interest.
Collection will increase special procedures staffing to address
increasing workload; Chief Counsel will protect the Service's priority
in bankruptcy and secure standing orders to compel filing of returns
prior to bankruptcy bar dates. Also Criminal Investigation will
prosecute cases of fraudulent bankruptcy filing.
• Accounts Receivable ($24.8 million and 529 positions). To reduce
the level of accounts receivable. Collection will extend hours of key
Automated Call Sites, expand the staffing for Service Center
Collection, and establish service center call sites for pre-notice contact
on large dollar cases. Taxpayer Services will extend the hours
devoted to working installment agreements and other account work.
• Document Matching ($4.3 million and 109 positions). We will identify
and contact additional underreporters through document matching.
MAINTAINING CURRENT BUSINESS OPERATIONS
In any budget, there are certain costs over which management has little
control. This budget covers the higher costs needed to pay for health insurance,
retirement funding, within grade increases and career ladder promotions. Overall,
mandatory increases in costs necessitate an additional $207 million in FY 1994.
125
Other significant factors are also affecting costs: increased seniority, declining
attrition, and the changing nature of our work.
• First, the decline in attrition results in a nnore experiences workforce,
but it also results in higher costs as employees receive within grades
or are promoted. There has been a marked decline in attrition over
the past three years -- from nearly 9 percent in FY 1990 to only 3.5
percent so far in FY 1993.
• Second, the nature of our work is changing. We have made a
conscious decision to concentrate on more complex work involving
higher income individual and corporate taxpayers. Again, this requires
better trained, more experienced employees to do the work.
In addition, as the tax filing population increases, staff must increase to
meet this growth in workload. Examples of FY 1993 workload expected to grow
in FY 1994 requires staff to:
revise and test more than 6,100 computer software program;
revise automated tax information scripts for telephone inquiries (over
32 million calls annually);
train 29,000 service center employees to process returns and
compute bills and refunds, and make adjustments;
train 8,000 taxpayers service employees who answer 40 million
taxpayer inquiries;
design or revise 250 forms and 110 publications;
print and distribute over 1.3 billion copies of forms and instructions at
a cost of $75 million. The competitive bidding process begins in early
spring in order to reserve three months of printing time in late fall by
the nation's largest commercial printing firms; and
• update taxpayer information and education materials.
We are requesting almost 300 new positions to meet the growth in FY 1994
workload.
INFORMATION SYSTEMS: TAX SYSTEMS MODERNIZATION
The FY 1994 Information Systems budget request reflects a total increase of
$188 million, which includes an $186 million increase for Tax Systems
Modernization (TSM). However, the entire Information Systems budget reflects a
net increase of only $7.4 million due to reinvestment of non-recurring investments
and increased productivity in our current information systems operations.
As we have previously testified, our plans for TSM involve incremental multi-
year investments that will enable IRS to fully implement a modernized tax
administration system by the year 2001. What we plan to achieve in IRS is
characterized by modernized systems that facilitate:
• electronic vs. paper receipt and storage of taxpayer data;
• one-stop customer service by telephone, rather than multiple contacts
through correspondence;
• on-line access to automated information by all IRS employees who
need the information to do their jobs, as opposed to one that takes
days or weeks to secure copies of returns and other necessary tax
information; and
• early information and resolution of compliance issues, as opposed to
one, two or three years after the fact.
70-792 0-93
126
We can achieve our goals of reducing taxpayer burden; Increasing revenue
thereby reducing the tax gap; and accomplishing more efficient and accurate case
work only through the technological components of TSM.
Major TSM increases for FY 1994 will fund end user systems; infrastructure
investments; and our integrated input processing strategy.
End User Systems
• Integrated Case Processing - This project will provide us the capability of
assembling all current taxpayer information in one electronic case folder accessible
by authorized users through a universal workstation. In other words, through one
workstation employees from all functions will have access to examination,
collection, or other compliance data, as well as current information on taxpayers'
accounts. This system will enable employees to increase their productivity, will
reduce errors, and decrease the time needed to complete cases or respond to
inquiries.
In FY 1994 funding for this initiative will allow us to purchase universal
workstations and begin installation in the service centers and field offices. This is
the first step in moving toward an integrated system supporting both taxpayer
service and compliance functions. The universal workstations will be procured
through the existing Treasury Multi-User Acquisition Contract (TMAC) contract and
will support TSM applications throughout their useful life.
• Compliance Research and Analysis System - Compliance 2000 is the core
strategy of IRS to identify and reduce noncompliant taxpayer behavior. The
Compliance Research and Analysis System will support this effort by providing the
capability to stratify data and to provide analyses that will allow us to identify
causes of noncompliance. Requested funds for FY 1994 will allow us to begin
development of this system which is critical to improving voluntary compliance and
reducing the tax gap.
• Telephone Routing Interactive System (TRIS) - This project supports one-
stop telephone service and will provide an automated routing system that permits
callers to direct their calls to the appropriate type of assistance. Also, TRIS will
enable some taxpayer inquiries to be resolved by an automated system without
assistance by an IRS employee. With the introduction of an automated routing
system, there will be less need to manually route incoming calls and employees
can spend more time providing substantive assistance.
FY 1994 funds will allow us to further develop and expand testing of this
sophisticated telephone management system. Our long-term vision is to provide
one-stop taxpayer assistance through the telephone.
Infrastructure Investments
Our request for infrastructure investments includes an increase for two major
acquisitions:
• Funding for the Corporate Systems Modernization/Mirror Image
Acquisition initiative will allow us to award a contract in FY 1994 that will both
sustain IRS' current tax administration systems and support redesigned tax
processing systems when implemented. Proposals for this effort are currently
being evaluated and the award will be made in early FY 1994.
• The Service Center Support System is the largest single procurement
initiative planned for TSM. Hardware and software procured under this contract
will replace existing mainframe computing capabilities at IRS computing centers
and will provide the platform for TSM applications. It will provide capacity relief
127
for the current system and support the implementation of new and redesigned
applications as TSM progresses toward full implementation. Hardware, software,
maintenance, and training services will be acquired through this procurement over
a twelve-year system life. Funding for this project will allow us to award this
contract in late Fiscal Year 1994.
Integrated Input Processing
Our request in support of the overall integrated input processing strategy for
TSM include funding for three projects:
• Funding for Service Center Recognition/Image Processing System will
allow us to replace obsolete imaging and character recognition equipment with
state-of-the-art systems at an additional three sites In FY 1994. We currently
process 156 million documents using optical character recognition equipment. In
FY 1995, with this new equipment we will process more than 175 million
documents.
• The requested increase for the Cash Management System will be utilized
to acquire support services to expand the TAXLINK prototype to include one
additional district office. Through this project, IRS is Increasing Its ability to
process and transfer funds electronically. The Electronic Management System will
serve as the point of electronic communications with the external business
community and, ultimately, the general public. This system will send, receive,
control and secure electronic data that Is transmitted to and from the IRS, such as
tax return, currency transaction, payer and employer information. In addition, IRS
employees will have information they need on-line and accessible through their
computer system instead of having to wait for tape delivery, data input or the
delivery of Information on paper. The increase for this project will be used to
purchase hardware, software and supplies necessary expand testing of the TeleFile
project, one step in moving toward increased electronic communications with our
customers.
• Additional resources for the Electronic Filing System will be used to
purchase equipment, maintenance, services and storage devices to support
increases in the volume of electronically filed returns. These funds will also allow
for the expansion of the Federal/State Joint Electronic Filing project.
Mr. Chairman, I believe that information processing Improvements enabled
by TSM, in conjunction with the Compliance 2000 program initiatives, have
enormous potential for reducing accounts receivable and closing the tax gap. For
example, TSM is expected to be fully implemented in 2001 and by that time our
workload will have increased by almost 20% over the current level. However, we
anticipate that TSM will allow IRS to conduct business in the year 2001 without
an increase in staff and at the same time produce additional revenue through
improved compliance systems, provide increased customer service, and realize
savings through electronic receipt and storage of taxpayer data.
With the benefits of the modernization Initiative also come significant costs.
However, not pursuing TSM would be even more costly in the long run. We
estimate that Implementing, operating and maintaining TSM through the year 2008
will require a capital investment of $7.8 billion above the projected $15.5 billion
cost to operate and maintain our current antiquated systems for the same period.
Through the end of Fiscal Year 1992, IRS has already spent approximately $800
million of this capital investment.
This overall investment will generate substantial taxpayer and IRS benefits.
Including reduced/avoided costs, interest savings and increased revenue estimated
at $12.6 billion. Consequently, we estimate that the total benefits, less the net
128
cost of $7.8 billion, results in a $4.8 billion net benefit to the governnnent. In
addition, we estimate taxpayer benefits over the life of TSM will include a billion
fewer hours dealing with the IRS and a $5.4 billion reduction in out-of-pocket
expenses paid in interest and tax preparer assistance fees.
NO-YEAR FUNDS
As of the end of February, we have approximately $154 million in no-year
funds remaining from FY 1991 and FY 1992. These funds were not expended in
the year they were appropriated primarily due to intentional decisions not to
prematurely obligate our resources as we assessed changes in our requirements,
the capabilities of new technology, and while we reexamined our organization
structure. We appreciate the flexibility the Congress provides us through no-year
authorization to meet these contingencies. Mr. Chairman, I assure you that havinc
this flexibility allows us maximize our resources while effectively managing our
procurements. A large portion of these funds will be expended when the Service
Center Support System and Corporate Systems Modernization/Mirror Image
Acquisition contracts are awarded.
TSM MANAGEMENT ISSUES
Throughout the life of TSM we have invited critiques of our efforts. GAO,
Internal Audit, National Research Council, and the Congress have made
recommendations regarding our Modernization program. Consistently these
reviews have focused on three areas: business change opportunities, technical
expertise, and human resources. We have taken their advice seriously and acted
on the recommendations. I would like to briefly discuss these three areas.
Reinventing IRS
Mr. Chairman, as we have previously testified, we have begun a review of
our current organizational structures in order to identify opportunities which fully
leverage the information technology TSM provides. In conducting the business
reviews we are pushing past our current organizational paradigm in defining a
better way to deliver service, influence compliance, and administer the tax system.
In short, we are moving beyond the incremental improvement horizon in
reinventing how we do business - to provide major breakthroughs in the ways IRS
encourages and enforces compliance with the revenue laws and improves service
to our customers. Many new concepts have emerged from the effort and provide
us an incredibly rich set of improvement opportunities.
We are engaged in discussions with the new Administration to secure their
views. We should be in a position to share our ideas and to obtain the help of your
Subcommittee in the near future. In general terms what we will describe to you is
a direction characterized by:
• A cross-functional organizational structure built around one-stop
taxpayer access by telephone, rather than a multi-stop,
correspondence-driven functional organization;
• A system that provides instant access to all relevant information,
allowing us to significantly reduce the time it takes to close routine
issues and errors on returns;
• A tax information and processing system that supports complete,
integrated and multi-year taxpayer files rather than the piecemeal,
free-standing systems now in place;
• Compliance programs designed to provide a comprehensive approach
to the needs of taxpayer market segments leading to a voluntary
compliance rate well in excess of 90 percent;
129
• A dramatic reduction in paper submissions of any kind through both
receipt of more than 80 million electronically filed returns and
electronic payments;
• Geographic flexibility in location of employees and operations through
electronic linkages;
• An interdisciplinary workforce ready to address a range of taxpayer
issues; and
• A highly skilled and empowered workforce with superior computer
skills, detailed knowledge of tax law, and outstanding interpersonal
skills.
To manage the difficult problems involved in making the transition from the
old way of doing business, we have appointed an executive level "transition
manager". The TSM Transition Manager reports directly to the Deputy
Commissioner and oversees the coordination of all TSM related technical,
operational, and human resources issues.
Technical Expertise
One of the recommendations made in the National Research Council report
on TSM was to establish a Systems Architects' Office to assist in managing the
technical components of TSM. IRS has established this office, reporting directly to
a senior level Information Systems executive. We obtained special positions from
the Office of Personnel Management to ensure we could recruit the best technical
talent. We have completed recruiting for the first of the computer scientists to fill
the most important positions in this office, and are now concluding necessary
paperwork to bring our selectees on board.
Further, on March 9, 1993, IRS awarded a contract for the FFRDC to
provide high level technology assessment and strategic planning and acquisition
support for TSM. The FFRDC will provide technical expertise and direction needed
for TSM, and will establish a TSM Institute devoted exclusively to TSM technical
issues. The contract awarded to a not-for-profit consortium has a value of up to
$78.5 million over a five-year period.
Human Resources
Recognizing that our vision of the future can never become a reality without
the commitment and support of our work force, we are paying close attention to
the people issues related to the Modernization. In an unprecedented effort to bring
our human resources organization into position to deal with the critical issues for
the future, we have brought some of our best talent together to develop
components of what will become our Human Resources (HR) Master Plan. The
goal is to produce a "human systems architecture" for the Service that parallels the
Design Master Plan for Tax Systems Modernization and supports the Business
Vision. A number of components of this master plan are already in place, while
others are now being brought together.
A first iteration of the Plan for Human Resources Issues has been published.
This plan offers a framework for dealing with issues such as retraining, recruitment
and job redesign. Actions and issues flowing from the review of our
organizational structure will provide another major component of the HR Master
Plan. Specifics including year by year, site by site requirements involving major
people elements such as the numbers and kinds of employees needed, training and
retraining requirements, work flow and work environment are being addressed. A
Resource and Support Study and a Customer Focus Plan will produce the long term
vision for the way in which HR services will be provided and a methodology for
assessing how well HR is meeting internal customers' needs.
130
SUMMARY
In conclusion, Mr. Chairman, our FY 1994 budget request reflects a very
deliberate melding of our commitment to achieve the efficiency and economy goals
embodied in President Clinton's program and our urgent need to continue to
improve tax administration. We must keep our tax system running while we invest
in Tax Systems Modernization; we must provide adequate support for our
workforce; and we must invest in modest but much needed increases in
enforcement functions to address critical problem areas.
Each of these increases is absolutely necessary to tax administration. Our
workload is increasing and becoming more complex; our mandatory stay-in-
business costs are increasing; and we must continue to forge ahead in modernizing
our systems and improving compliance. We seek your support for these absolutely
critical investments.
I would be pleased to answer any questions you or the Members may have.
131
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON. DC. 20224
September 3, 1993
COMMISSIONER
^^CBVED
The Honorable J. J. Pickle
Chairman, Subcommittee on Oversight
House Committee on Ways and Means
1135 Longworth Building
Washington, DC 20515
-^-^ 1993
^'ay? and A,iea,-c
^ubcommittee on Oversight
Dear Mr. Chairman:
I am enclosing responses to the questions posed in your
letter which followed up on your Subcommittee's hearing on our FY
1994 budget. To fully answer your inquiry it was necessary to
compile extensive information from numerous IRS functions.
We hope this information is helpful.
Sincerely,
^%J,y^u.i^'(L^-^^^^^'>^-^
Margarfity Milner Richardson
Enclosure
132
Answers to Follow-up Questions on April 28, 1993
on FY 1994 IRS Budget
IRS is reportedly experiencing a $200 million shortfall this
year -- fiscal year 1993.
a . Is IRS experiencing a budget shortfall?
b. Are any layoffs expected?
c. How will IRS make up the shortfall?
As happens every year, adjustments occur in the process of
matching the budget as appropriated with the actual rollout
of the programs. The adjustments account for labor cost
increases and actual program shifts.
During the financial plan development process for FY 1993,
we determined that there were not enough labor dollars
available to fully fund all FTEs in the budget. We resolved
the issue through a combination of reducing FTEs -- to be
accomplished through attrition rather than layoffs -- and
moving support dollars into labor. Additionally, we are
confident we can manage our way through the IRS share of the
President's FTE reductions with minimal program impact.
The upward trend in labor costs in recent years is largely
attributable to the conscious decision to concentrate on
different kinds of work -- specifically, more complex work
involving higher income individual and corporate taxpayers.
The payback is obvious but one conseguence will be fewer but
more highly-graded staff required to do the work.
Another contributing factor to higher labor costs is the
fact that automation and our large-scale systems
modernization effort are eliminating low-skill/low-pay
positions, leaving us with increasingly more positions at
the higher end of the grade scale.
An organization the size of the Internal Revenue Service --
with 70 percent of its budget labor-related -- is extremely
sensitive to escalating labor costs. For a number of months
we have been engaged in a serious review of a number of
options that will allow us to contain costs, for example,
through reducing span of control, redeploying staff
positions to the frontline, and eliminating marginal
programs.
IRS's fiscal year 1994 budget request includes $150 million
and 2.000 positions to fund 11 compliance initiatives.
There is concern that inadequate funding of IRS's base
operations could prevent IRS from delivering on these
initiatives.
133
a. How do you respond to these concerns?
There is a perennial concern that all labor costs are
covered within the budget. Next year, as in recent years,
certain realignments will occur to ensure that we can meet
increased labor costs. The IRS, with the backing of the
Department of Treasury and 0MB, is fully committed to
realizing these initiatives if funding is provided in our FY
94 appropriations.
Generally speaking, one outcome of the serious restructuring
effort now underway within the IRS is the commitment to
achieve a better ratio between frontline and staff
positions. We are beginning the process of redeploying a
number of regional and National Office staff to frontline
positions in the districts and of improving the span of
control by converting managerial positions into frontline
positions. As a result of our restructuring and systems
modernization efforts, we anticipate that we can meet
increasing workloads without increasing FTEs. The emphasis
will continue to be preserving frontline operations.
b. Does the 1994 budget afford IRS sufficient funding to
completely implement the 11 new initiatives?
Yes. We believe that the funding is adequate.
Included in the fiscal year 1994 budget proposal is a
reguest for $25.000 for official receptions. The same
amount was appropriated for fiscal year 1993.
a. How was, or will, the $25.000 appropriated for official
receptions be spent in 1993?
The Representation Fund is used by IRS to provide for
representation and reception expenses incurred in the course
of official business conducted with foreign dignitaries.
During fiscal year 1993, this fund is being used to cover
the Service's needs related to the following meetings:
executive council meetings of Inter-American Center for Tax
Administrators (CIAT) , sessions held by the Pacific Area Tax
Administrators (RATA) , the Group of Four meetings, and the
All Islands Tax Administrators Conference.
b. What would happen if no such funds were appropriated
for fiscal year 1994?
The IRS is authorized to spend $25,000 in representation
funds, but funds are specifically appropriated for that
purpose. The protocol conventions associated with IRS
participation in tax treaty meetings and international
conferences make it very important for us to reciprocate for
134
the courtesies extended by other nations and assume certain
costs associated with work-related social gatherings.
Twenty-five thousand dollars is a small cost in terms of the
good will that these funds engender in dealing with our
treaty partners.
The GAP has indicated to the Oversight Subcommittee that
IRS's examination plans for 1994 do not include any of the
detailed audits done under the Taxpayer Compliance
Measurement Program (TCMP) . For 30 years. TCMP has been
IRS's only tool to objectively measure taxpayers' compliance
and select tax returns on which an audit would be most
productive.
a. What are IRS's plans for TCMP audits?
We agreed with GAO that changes to Taxpayer Compliance
Measurement Program (TCMP) must meet the four criteria
stated in GAO's report "Tax Administration: IRS' Plans to
Measure Tax Compliance Can Be Improved" (GGD-93052, April 5,
1993). The criteria are: "... help to satisfy the
Compliance 2000 requirement . . . enable IRS to precisely and
consistently measure changes in nationwide compliance levels
. . . continue to provide objective methods of selecting
returns to be audited and allocating resources . . . continue
to meet the needs of the tax policy community and the other
external users." To carry out IRS' commitment to Compliance
2000, we are depending on future Taxpayer Compliance
Measurement Program (TCMP) surveys for data that will allow
us to measure and analyze taxpayer compliance on the basis
of market segments and to allocate resources to address
noncompliance.
b. Will IRS conduct an individual TCMP survey in calendar
year 1993?
No. The Taxpayer Compliance Measurement Program (TCMP)
survey of TY 1992 individual returns was deferred to allow
time for us to reevaluate our survey methodology. IRS is
also not planning to conduct a Taxpayer Compliance
Measurement Program TCMP survey of 1993 returns. This
decision was made due to insufficient time to determine the
compliance data needed to design and program specifications
for selecting an appropriate sample of returns.
In lieu of a 1993 survey, we will begin designing a survey
of 1994 returns. Audits of returns selected for the 1994
survey should begin in the fall of 1995.
c. If so. will it have a sample size similar to recent
'. individual TCMP surveys (i.e. approximately 55.000
returns)?
135
The design of the TY 1994 survey will approximate the size
of prior Taxpayer Compliance Measurement Program (TCMP)
surveys and allow us to compare results with those surveys.
Some other design features we are considering include
stratifying taxpayers by industry/market segment and
selecting a sample across all types (Forms 1040, 1120, etc.)
of filed returns. Also, survey returns selected from
specific market segments will be assigned to examiners who
have been specially trained to detect compliance issues
associated with those segments.
d. Will the TCMP audits examine every line on every
individual return that has an entry?
Examiners will consider every return line item. However, if
a line item is normal and reasonable, the examiner's
judgement will be used to determine the depth of the audit
work on those specific issues.
Included within IRS's budget request is an International Tax
Compliance initiative directed toward foreign firms doing
business in the U.S. The initiative calls for an
additional 177 positions and $30.6 million to increase
examinations of foreign firms, negotiate additional Advance
Pricing Agreements, and increase the use of expert witnesses
and outside consultants.
a. How many additional examinations does IRS expect to
audit under this initiative?
We anticipate that this initiative will result in
approximately 400 additional tax returns being examined
during the first fiscal year of the initiative. These
returns will include both Forms 1120 and 1120F.
b. The revenue estimate for the transfer-pricing
initiative is S50 million over five years. Why is the
revenue estimate so low?
We are confident that the yield from the initiatives will be
substantially higher than forecasted. Because of the
uncertainty of projecting revenue from compliance
initiatives, the Treasury's Office of Tax Analysis (OTA)
intentionally made a conservative estimate.
The Office of Tax Analysis (OTA) estimates that the average
yield over the life of the initiative will be $64,000 per
corporate return. The return on investment and the number
of returns examined should increase in later years (above
the 400) after the learning curve of agents as the training
costs decrease heightens associated with bringing revenue
agents up to speed on international issues heightens.
136
It is important not to define the success of this initiative
solely in terms of the direct revenue that it yields. This
initiative was broadly designed to impro"^^ compliance in the
international arena. While in most instances that will
result in additional tax dollars collected, some of the
investment, for example, in improved technology, will result
in a greatly improved program even though direct yield
attributable to the ADP upgrade will be difficult to
calculate.
There are areas where we are confident the investment will
result in additional dollars collected, but the exact
results are not quantifiable. An example is the amount of
revenue in the initiative associated with Chief Counsel
activities. The support provided by Counsel to our
International Examiners will assuredly increase revenue, but
it is difficult to quantify. Rather than specify any actual
dollar amount, we took a conservative approach and did not
attribute any revenue to this initiative.
c. Why does the compliance initiative lose $2 million in
the first vear?
The first-year revenue loss associated with the initiative
results from the opportunity costs of redirecting some of
the time of experienced international examiners from
examination activities to training duties.
d. How many new international examiners will IRS have on
board auditing returns during 1994? How manv
attorneys? Economists?
The FY 1994 initiative will provide an additional 50
international examiners and increase the authorized staffing
of international examiners to 682. The economist staffing
will remain at 68. The initiative will also provide 4
additional attorneys for the APA program, 3 attorneys for
FCC issues, and 37 additional attorneys to support large
case CEP examinations. With these additional positions,
Counsel anticipates being able to provide support
commensurate with any increased demand from Examination. We
intend to use the additional International Examiners to
increase the number of tax returns being examined.
e. Is it feasible for IRS to conduct a specific number of
current year audits so that it can assess the impact of
recent tax law changes and IRS enforcement efforts?
The IRS has launched initiatives to examine more current
years within the Coordinated Examination Program (CEP) .
Improvement is being made, but we are not yet auditing current
years. With respect to non-CEP taxpayers, the return years
137
currently under audit are almost all post-1986, the majority of
which are 1990 and 1991 returns.
Due to the newness of the Omnibus Budget Reconciliation Act
of 1990 (OBRA) , we cannot fully evaluate the effectiveness of
the new law's provisions. However, we can say that our examiners
are very aware of the new penalties, and have utilized funding
provided for outside experts. Our reporting system to date shows
the following for the two most prominent provisions.
FY 91 FY 92
IRC 6038A Failure to Provide Information
on Foreign Corporations
Penalties Proposed $464,000 $576,000
Tax Years Affected 363 268
Expert Witnesses (Used by International Examiners
on International Cases)
8 12
Please note that the penalties are proposed. Feedback from
field personnel indicates that OBRA's provisions strengthen
compliance and provide positive support for IRS'
international enforcement efforts. We see expert witnesses
being used extensively to provide needed expertise to
bolster IRS positions in complex tax issues.
f . Should the functions within IRS that deal with
transfer-pricing issues be centralized — under the
leadership of a national coordinator? Explain your
answer.
There is a close working relationship and coordination
between the Assistant Commissioner (International) and the
Associate Chief Counsel (International) in planning and
implementing initiatives, training international personnel, and
in drafting regulations or recommending legislation. The
relationship has been effective and has enhanced the Service's
efforts in dealing with transfer pricing issues, as well as other
international tax administration endeavors.
The Office of the Assistant Commissioner (International)
recently established the position of National Transfer Pricing
Coordinator. With the appointment of this Coordinator, we have
centralized our dealings on transfer pricing issues from an
administrative perspective. This incumbent will provide national
coordination on transfer pricing matters and enhance the support
given to international field personnel. The Coordinator will
work with Counsel and Appeals at the national, regional and
138
district levels to identify transfer pricing issues, develop
examination methodologies, explore information sources and
promote consistent applications in the development of issues.
The Coordinator will also work with the Transfer Pricing
Specialists of the International Field Assistance Specialization
Program (IFASP) and with the oversight, tax treaty and compliance
analysis functions of the Assistant Commissioner (International).
g . In the past three years, Congress has taken a number of
steps to provide IRS with access to transfer-pricing
information. IRS international examiners still have
difficulty getting information from third parties to
establish a comparable arm's length price. The problem
resolves around the third party's reluctance to share
cost data and pricing information with the Government,
since this data might be shared with their com.petitors .
i . Should third-party pricing data that is used to
validate transfer prices be protected?
The viability of the arm's length standard is dependent upon
the Service's ability to obtain and use potentially
sensitive third party information to establish comparables.
While protecting the privacy of third party information is
an important objective, the manner in which such protections
are afforded and the degree of protections afforded may
interfere with or effectively eliminate the Service's
ability to obtain and use such information to determine a
taxpayer's appropriate tax liability. Striking a balance
between the degree of protection to be afforded to third
party information and the critical need for access to such
information will be difficult.
ii . What does the Commissioner's Advisory Group (CAG)
think about this issue? When will the CAG issue
its report?
The International Subgroup of the Commissioner's Advisory
Group has been evaluating several issues relative to third
party comparables; however, there are not any conclusive
viewpoints at this time. The Commissioner's Advisory Group
(CAG's) Subgroup anticipates issuing its report in September
of 1993.
i i i . Is IRS able to protect this information under
existing law?
Section 6103 currently prohibits the disclosure by the
Service of comparable pricing information obtained from
third party return information, unless the information
otherwise meets the narrow "item" or "transaction" test
based upon a nexus with the taxpayer. Thus, if relevant
139
information were obtained from, for example, a U.S.
manufacturer during its audit, and that information would be
useful in the separate examination of an unrelated foreign
manufacturer, the information would be tax return
information of the U.S. manufacturer and could not be
disclosed to the foreign manufacturer.
However, if, in the context of an examination of a taxpayer
company, the IRS were to issue a summons to the unrelated
third party for the same comparable information referred to
above, the information obtained pursuant to the summons
would become the return information of the taxpayer under
examination and would, under current law, be available to
that taxpayer. Thus, if the U.S. manufacturer's information
were obtained by a third party summons during an examination
of the unrelated foreign manufacturer, the U.S.
manufacturer's information would not be considered the U.S.
manufacturer's tax return information, but rather
information related to the foreign manufacturer's tax
return, and in this situation, section 6103 would not
prevent the U.S. manufacturer's information from disclosure
to the foreign manufacturer.
iv. Does IRS need help from Congress to provide
confidentiality protections for third-party data?
The issue of third party comparable information highlights
the conflict that may arise between important policy
concerns as a result of our transfer pricing rules. The
answer to your question depends on the manner in which the
conflict between these competing policy concerns is
resolved.
As referred to above in the response to part (i) of this
question, third party comparable information (broadly
defined) is critical in the Service's ability to
successfully apply the arm's length standard to determine
the proper tax liability of an unrelated taxpayer. However,
there are legitimate competing concerns about protecting the
confidentiality of sensitive information obtained from
unrelated third parties and preventing the imposition of
undue burdens on such third parties (including U.S.
persons) .
To the extent that access to third-party comparables is
deemed necessary and desirable in some cases, current law
would almost certainly be insufficient to allow us to make
reasonable accommodation for privacy concerns in every case.
Until a balance is struck between the competing concerns,
however, it is difficult to predict what type of action will
be required.
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V. What is IRS's policy with regard to issuing third-
party "friendly" summonses to gain data on
unrelated transactions?
In the section 482 context, the adoption of the arm's length
standard makes it necessary to obtain third party comparable
data. Because the decision to enforce summonses for third party
comparable information raises policy issues of burden and
confidentiality, the Service has, of necessity, considered
whether it can issue "accommodation" third-party summonses when
requested by the third party in order to obtain such information.
The previous Administration decided that, in appropriate
circumstances, the issuance of "accommodation" third party
summonses would be permitted. The new Administration has not yet
determined whether it will be necessary to modify this policy.
vi . Are IRS examiners prohibited from issuing
"friendly" summonses to third parties?
The IRM contains no formal restrictions on the ability of
revenue agents to issue "accommodation" summons to third parties.
h . For years, there has been concern that IRS is
"outgunned" and "outmanned" ; that IRS auditors,
economists, and lawyers are not sufficiently trained or
experienced to handle these complex tax cases. IRS
takes experienced auditors and litigators off case work
to train new employees. This strategy reduces the
number of audits conducted and prolongs the examination
process.
i. Is there a better way to provide guality training
for IRS personnel?
Senior, expert and experienced IRS employees make a vital
contribution in training new employees across all the major
occupations -- revenue agents, revenue officers, attorneys,
appeals officers, etc. That investment of talent is one of
the key ingredients in IRS's technical training programs.
We have a number of initiatives now in process to maximize
the contribution which those senior employees make, while
minimizing the cost.
We are working toward a breakthrough improvement in our
ability to equip all IRS employees with the skills they
need. The result of this effort, an "IRS University", will
offer an integrated curriculum of first-rate courses in tax
law, accounting, economic and financial analysis,
information systems technologies, and other skills necessary
to deliver our new vision of tax administration.
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Included in the design concepts are some important systemic
changes from prior training approaches, such as:
• a dedicated technical training faculty with specialist
instructors who teach their areas of expertise;
• concentrated delivery of specialty technical training for
complex corporate and international tax issues and
instructor training, using the latest technology;
• ongoing relationships with universities and other
sources including Chief Counsel to supplement in-house
talent; and
• intensified training research and development efforts.
In addition to the long-term IRS University effort, we are
working with a number of universities to coordinate their
course curricula with IRS needs. We, in turn, are
streamlining and accelerating IRS training for graduates of
these programs.
Over the past three years, IRS has also made increasing
strides in using video-teleconferencing technology for
training applications. In Chief Counsel and Examination CPE
programs we have successfully leveraged the available
expertise and provided more efficient training to larger
audiences in the field.
In addition to these efforts, our present and future
automation tools, such as the Section 482 Expert System, the
Foreign Tax Credit Knowledge-Based System, and the
International Bulletin Board offer significant productivity
enhancements.
ii . Is it feasible and cost effective to have outside
experts instruct IRS personnel on transfer pricing
and other tax subjects?
We believe the use of outside experts for all types of
international training is feasible and therefore, is
currently being considered by IRS University. In the last
two fiscal years, we have successfully utilized outside
experts to conduct Cultural Awareness Training for our
international specialists.
i . The ability of IRS to sustain its examination results
throughout the administrative appeals process is
questionable.
i . Should large corporations have the benefit of an
appeals process?
Yes, for several reasons. First, the Service doesn't have
the resources to litigate every large corporate case and the
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courts don't have the resources to hear all of those cases.
Without an administrative appeals process to settle most of
the cases and issues raised in Exam, the resources of both
the courts and the IRS would quickly be depleted. In
addition, it is unfair to force large corporate taxpayers to
expend resources to litigate cases or issues that might be
settled outside of litigation in Appeals.
Large corporate taxpayers are entitled to an administrative
appeals hearing just like any other taxpayer. Low
sustention rates on large cases settled in Appeals reflect
many things — the complexity of the law. Exam's aggressive
pursuit of new and emerging issues, the taxpayers'
unwillingness or inability to provide the information
requested by Exam, the litigating hazards faced by the
government when these issues are tried. The sustention
rates in Appeals reflect the impact of all of these factors
on the adjustments that Exam proposes. Denying a large
corporate taxpayer the right to an administrative appeal
would result in punishing taxpayers who are trying to
cooperate, but have a genuine disagreement with the Service
over the interpretation of a particular Code section or
regulation.
ii . Should the role of Appeals be modified or
eliminated? Why or why not?
No, the role of Appeals in resolving cases without
litigation, in a manner that is fair to both sides is a
critical one. To be effective, tax administration needs a
form of alternative dispute resolution — a way of settling
the majority of the cases quickly and fairly without trial.
Appeals fills that role. Most cases are settled in a
reasonable amount of time and in a manner that reflects the
litigating hazards and the many other factors impacting on
the issue as discussed above.
The Service, in general, and Appeals, in particular, are
looking for ways to streamline the existing system to make
it better and to ensure high quality dispositions in a
timely manner. The traditional role of Appeals may change
slightly through that process. If implemented, the
traditional Appeals procedures could change, but the concept
of alternative dispute resolution -- with Appeals as the
focal point of the Service's efforts — should remain
essentially unchanged.
j . Alternative dispute resolution mechanisms, such as
Advanced Pricing Agreements and arbitration, have been
suggested as ways to avoid contentious audits and
protracted litigation.
143
i. What can be done to expand the use of Advance
Pricing Agreements?
The FY 1994 initiative would provide for additional
resources in the Office of the Assistant Commissioner
(International) and Chief Counsel to expand the operation of
the APA program. The resulting increased staffing at all
levels would be coupled with a program to better publicize
the benefits of the program.
ii • What can be done to expedite the arbitration
process?
We have one case with a transfer pricing issue that has
nearly completed the arbitration process. Because this was
the first case of this type to go to arbitration, much
effort was devoted, by both the Service and the taxpayer, to
negotiate and define the rules that would be followed. For
example, the first agreement for voluntary binding
arbitration had to be developed as well as procedures for
selecting the arbitrators. Subsequent, similar cases may be
completed within a shorter time frame because of our
experience with this first case.
Our Appeals office is considering other dispute resolution
techniques that may help us resolve cases more
expeditiously. For example, the early referral of an
unagreed issue to Appeals while the rest of the case remains
in Examination for development, may save the taxpayer and
the Service time. Also, mediation might prove to be a
beneficial process for resolving certain factual issues,
such as those involving valuation and transfer pricing.
With respect to Tax Court sanctioned arbitration, it must be
remembered that this is still an adversarial process, and
continues to require many of the same procedures involved in
traditional litigation. The purpose of attempting arbitration
was not solely to speed resolution of disputes. However, because
the arbitration panel is not constrained by a Tax Court judge's
docket, it is able to focus its attention and particular
expertise exclusively to the particular case. We believe that the
proceedings can move more quickly than traditional litigation,
and that a decision can be obtained more quickly.
k. In IRS's transfer-pricing report submitted in April
1992. IRS states that the Tax Court rules regarding
depositions limit IRS's ability to obtain relevant and
important information. In other Federal courts,
depositions are fairly routine.
i . Do the restrictive rules put IRS at a disadvantage
in litigating section 482 cases?
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Section 482 cases require extensive factual development, and
often the application of complex economic analysis to the
technical operations of a taxpayer. Thus, such cases may
turn less on the tax expertise possessed by a judge than on
the judge's evaluation of the credibility of a witness who
is expert in some non-tax discipline, and on the proof of
complicated facts that will support or disprove the
witness's economic analysis. The scope of the intensive
factual inquiry that is required and the frequent reluctance
of the taxpayer to provide all of the information requested
by the Service make difficult the Service's task of
developing the facts and ascertaining the taxpayer's theory
during an examination.
The difficulties faced by the Service during the examination
of these large, factually complex cases place a greater
burden on the Service in those cases that proceed to
litigation. Though the Tax Court has m.odified certain of
its rules in recent years, its rules of discovery (including
the use of depositions) remain more restrictive than the
rules in the other forums in which tax controversies may be
adjudicated (i.e. , the U.S. district courts and the U.S.
Court of Federal Claims) . The Tax Court rules were not
developed specifically with contentious, large case
litigation in mind, and thus do not generally contemplate
the level of discovery that may be commonly sought in such
complicated cases. These rules often will place the Service
at a disadvantage, because the Service is the party that is
not otherwise privy to the crucial facts of the case.
ii. What should be done to rectify this problem?
Both the Service and the Tax Court have been attempting to
adapt to the demands of large case litigation such as that
under section 482. The Service is focusing more resources
and attention on its examination function, and is working
more closely with its Office of Chief Counsel in the
development of cases that are under examination. This
involvement at the examination level is intended to improve
the factual development of legally relevant issues at an
earlier stage. This should prompt earlier resolution of
issues and better preparation of those issues that have to
be resolved in litigation in the Tax Court. While the
Service continues to explore alternative dispute resolution
methods, it is recognized that transfer pricing litigation
will continue to place a burden on the Service and the Tax
Court for the foreseeable future. The Tax Court, on a case-
by-case basis, has been attempting to strike the proper
balance between its discovery rules and the realities of
large case litigation.
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Notwithstanding these developments, the tension between the
limitations on discovery in the Tax Court and the
appropriate factual development of large, factually complex
cases in litigation would be lessened if the Tax Court's
discovery rules were made less restrictive (in general, by
more closely paralleling those of the U.S. district courts).
1. What specific progress have IRS and Customs made to
share information regarding transfer-pricing cases?
The IRS-Customs Policy Board was created in November 1992 to
address issues of common concern and where possible, to take
a one-department approach to their resolution. The Board
has discussed several areas for information sharing under
the current statutes governing disclosure of information.
The IRS has agreed to look into potential ways in which
Customs may participate in future Advance Pricing Agreements
recognizing a taxpayer disclosure waiver would be necessary.
The Board is also considering how to provide Customs with
information pertaining to transfer pricing methods used and
knowledge developed during the APA process while protecting
the identity of the specific taxpayers involved.
Additional information sharing between IRS and Customs has
included: the exchange of personnel for training in transfer
pricing and valuation methods, inter-agency meetings and
seminars dealing with technigues used in the examination of
large case examinations, joint discussions of Mexican
Maquiladora business operations, and Customs information
provided for IRS use in the development of transfer pricing
cases including identification of third-party comparable
transactions related to imported goods.
The fiscal year 1994 budget proposal includes $19.6 million
to help IRS implement tax law changes but does not provide
for any additional staff. will IRS have sufficient
resources to implement new tax legislation next year?
It is difficult at this time to comment on the adequacy of
our resource level for implementing new legislation. Our
early estimates indicate a need for increased resources to
implement the new diesel fuel compliance measures enacted in
P.L. 103-66. However, we do not yet know exactly what the
impact of this new legislation will be.
In the case of the FY 1994 provision, a substantial portion
of the $19.6 million will be spent to administer the Earned
Income Program and will include additional outreach and
assistance programs.
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Under the fiscal year 1994 budget proposal, the number of
employees for Taxpayer Service will have dropped by 400
positions from 1992 (from 8.476 in 1992 to 8,089 in 1994K
Have any of these cuts affected the operations of the
Problem Resolution Program? If so. how?
We are not aware of any negative impact on the Problem
Resolution Program resulting from changes in the resources
available to Taxpayer Service. Taxpayer Service has
answered more taxpayer calls during the 1993 filing season
than they did in the 1992 filing season and has provided the
necessary resources to work PRP cases.
While PRP receipts in service centers stayed stable between
1992 and 1993, they did decline in district offices.
Several improvements made by the Service may have
contributed to this decline. These improvements are the
one-stop Service concept, allowing more cases to be resolved
based upon taxpayer oral statements, changes in installment
agreement criteria, changes in of f er-in-compromise
procedures and additional tax systems modernization
improvements which allowed IRS employees to resolve taxpayer
problems sooner.
As a result of Tax Systems Modernization (TSM) and other
projects. IRS estimates that it will achieve productivity
savings of $55.3 million in fiscal year 1994. Last year,
the GAP testified that IRS failed to achieve real
"productivity savings" from its TSM efforts.
a. What will happen if the IRS does not achieve projected
productivity savings?
b. Will IRS have to cut positions or program activities to
make up the difference?
IRS is committed to achieving the FY 1994 productivity
savings. We intend to do our best to ensure that we deliver
the revenue projected in connection with the compliance
initiatives. In order to increase the certainty that this
will occur, the IRS is exploring other options — namely,
redirecting staff and overhead positions from National
Office and regional offices to front-line compliance,
customer service and processing-related activities.
c. How come fewer notices will be issued in 1994 (2.6
million) as part of the Underreporter Program than were
issued in 1992 (3.8 million)?
There are several reasons for the variations in notice
volumes in recent years. Improvements in the initial
computer process of matching tax returns to information
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documents have reduced the number of discrepancy cases and
cut down on the number of erroneous and marginal taxpayer
contacts initiated through the program. Also, several
budget adjustments reduced staffing for this program in FY
1993 and 1994.
• Each year 275 FTE were temporarily diverted from the
Underreporter (UR) Program to the Substitute for Return
(SFR) Program in order to eliminate backlogs of nonfiler
cases in this important area of noncompliance.
• Productivity reductions were taken for the Automated
Underreporter (AUR) System in anticipation of complete
implementation of that system. Full implementation is
now expected in mid-FY 1994.
d. If IRS doesn't achieve the expected productivity
savings in 1994, could the 11 compliance initiatives be
affected?
Initial estimates of FY 1994 productivity savings were
predicated on full funding in FY 1993. Following
Congressional cuts of $100 million, it was agreed that the
productivity savings would be reduced by $20.5 million.
However, since the FY 1993 economic stimulus supplemental
would have restored earlier Congressional cuts, the higher
level of productivity savings were retained. Absent passage
of that bill, IRS faces a productivity assessment of $20
million without the investment funding to implement those
projects.
In spite of this fact, IRS is committed to making every
reasonable effort to achieve the productivity savings agreed
to for FY 1994. The benefits will be achieved by taking
steps to change work processes and procedures to ensure that
operations managers take full advantage of the advances
offered by technology as soon as it is available. In
addition, over the next several years we will be redirecting
a number of staff and overhead positions from National
Office and regional offices to front-line compliance,
customer service and processing related activities.
9. Last year. GAP testified before the Subcommittee and
recommended that IRS reassesses the value, number, and make
up of its regional, district, service center, and telephone
call sites in order to take advantage of opportunities
afforded by TSM.
a. Has IRS undertaken a review of its organizational
structure?
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Yes, we chartered three studies focusing on different
components of our current structure. The first, the Service
Center Organization Study (SCOS) , concentrates on the work
currently performed by service centers, computing centers,
automated collection sites, and Taxpayer Services and
Central Inventory Distribution Sites telephone related work.
The second, the District Organization Study (DOS) , focuses
on traditional district-based front line functions such as
Collection, Criminal Investigation, Employee Plans and
Exempt Organizations, Examination, Information Systems,
International and Taxpayer Services. The third component,
the National/Regional Organization Study (NROS) focuses on
the support and overhead structures, including regional
office and national office roles and missions.
b. What conclusions has IRS reached with regard to
reorganization?
In general terms our future direction is characterized by:
• A cross-functional organizational structure built around
one-stop taxpayer access by telephone, rather than a
multi-stop, correspondence-driven functional
organization;
• A system that provides instant access to all relevant
information, allowing us to significantly reduce the time
it takes to close routine issues and errors on returns;
• A tax information and processing system that supports
complete, integrated and multi-year taxpayer files rather
than the piecemeal, free-standing systems now in place;
• Compliance programs designed to provide a comprehensive
approach to the needs of taxpayer market segments leading
to a voluntary compliance rate well in excess of 90
percent;
• A dramatic reduction in paper submissions of any kind
through receipt of more than 80 million electronically
filed returns and electronic payments;
• Geographic flexibility in location of employees and
operations through electronic linkages;
• An interdisciplinary workforce ready to address a range
of taxpayer issues; and
• A highly skilled and empowered workforce with superior
computer skills, detailed knowledge of tax law, and
outstanding interpersonal skills.
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c. When will IRS start implementing its structural
changes?
Our early strategy will focus on delivering prototype sites
representing new operating components in the 1996 timeframe,
leading to our ultimate goal for 2001.
d. Is it feasible for the National Office to oversee the
operations of IRS's 10 service centers and the three
form distribution centers?
The future role of the National Office is being addressed in
the National/Regional Organization study.
In September 1992. IRS implemented a nationwide, non-filer
program designed to bring approximately 10 million
individuals and businesses who have failed to file tax
returns back into the system.
a . It has been suggested that the non-filer program is
ambiguous and doesn't offer enough incentives for non-
filers.
i . Is the non-filer program being operated
consistently throughout the country?
The basic program has been implemented in all districts.
Some districts and regions have supplemented the program
with their own initiatives designed to address particular
populations .
ii. Why are some people taking advantage of the
program in some parts of the country and not
others?
We continue to monitor public response and are engaged in a
series of field visits to examine regional and district
inconsistencies. At a point later in the year, we will have
additional data from filed returns to analyze discrepancies
as well .
b. IRS employees are helping tax practitioner groups, like
the American Bar Association, assist taxpayers back
into the system. The problem is that if a taxpayer
voluntarily discloses his or her failure to file,
section 7214 requires the IRS employee to report this
violation to IRS.
i . Are IRS employees reporting individuals to IRS as
reguired under section 7214?
We maintain no data on these reports.
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ii. What is IRS's policy with regard to section 7214?
If a taxpayer seeks assistance in filing delinquent returns,
the IRS employee is not required to make a report if the
taxpayer indicates that the delinquency will be cured. If,
however, the taxpayer indicates continued noncompliance, a
report is required.
IRS first began planning for TSM back in 1986. So far, the
Congress has appropriated over $1 billion for TSM. Please
describe, in general terms, how the money appropriated by
the Congress has been spent.
Through the end of FY 1992, IRS had spent approximately $287
million to acquire mainframes, workstations, storage devices
and services. Approximately $40 million was expended on
telecommunications which lessened the need to fly tapes
around the country in order to process tax return
information. The new telecommunication system also serves
as the communications backbone for the future system which
will provide the necessary information to IRS employees and
increase their service to the taxpayers; and will connect
computer systems, thereby reducing processing time and
increasing productivity. The remaining $453 million was
spent for salaries and support including facilities,
training, travel, services and supplies. With the salary
dollars, we have acquired technical expertise to provide
assistance in laying the foundation for the Systems
Modernization which includes:
• Developing the Systems Architecture, the essential
blueprint of where IRS wants to go and how it will do
business in the future;
• Developing the Design Master Plan, our road map for
achieving TSM and a model for other government agencies;
• Completing activities to acquire the necessary equipment
and technical support for TSM; and
• Designing, developing, implementing and testing new
systems.
Projects which are being tested or have been implemented and
are already producing benefits to taxpayers and productivity
savings for IRS include:
• Electronic Filing
• TeleFile
• TAXLINK
• Federal/State Electronic Filing
• 1040PC
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• Corporate Files On-Line
• Automated Inventory Control System
• Totally Integrated Examination System
• Automated Criminal Investigation
• Taxpayer Routing Interactive System
• Integrated Collection System
12 . By how much have the total TSM cost estimates grown since
1990? What do you anticipate that the total price tag for
TSM will be?
In 1990, the estimated life cycle cost for TSM was $21
billion. The current estimated cost is $23.3 billion. A
large percentage of this increase is attributed to
converting from constant 1990 dollars to constant 1992
dollars.
13 . When he gave his address to the Congress, President Clinton
submitted a report entitled, "A Vision of Change for
America" describing the comprehensive economic plan he was
proposing for America. This report estimated the cost of
TSM, over the next four years, to be $1.8 billion.
a. Exactly what does that $1.8 billion figure represent
for fiscal years '94, '95. '96. and '97?
b. Is that the amount the IRS expects to request for TSM
over the next four years?
c. How much does the IRS expect to reguest through 2001?
Our request for FY 1994 TSM funds is $717 million. At this
time, we are formulating our FY 1995 and out-year
projections based on our new business vision.
14 . The supplemental appropriations (economic stimulus) bill
contained $148.4 million for IRS computer operations. Of
this amount. $107.4 million is for eguipment that is not
related to TSM.
a. As you move toward completion of TSM. will the IRS
continue to acquire equipment that is not related to
TSM?
b. How much of this equipment becomes obsolete when TSM is
completed?
The economic stimulus package contained equipment purchases
that are required to keep our current systems in operations
and position us for TSM. These purchases were not
considered as TSM funded initiatives. However, this
equipment would be fully utilized even with the
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implementation of TSM. The systems we are acquiring will
support TSM applications being developed.
15. How has the Corporate Files On-Line (CFOL) system changed
the way service centers do business?
a. How has CFOL benefitted taxpayers? Please provide
specific examples of typical taxpayer problems that are
being better handled because of CFOL.
Currently, taxpayers must write to one of ten IRS service
centers when they need an actual copy of their tax return.
Depending on whether the tax return is stored at the service
center to which they write, another service center, or a
Federal Record Center, it can take weeks to receive the
actual copy. Now CFOL provides an alternative. Using CFOL,
we are able to immediately print out information from the
taxpayer's prior year return that contains much of the same
information and can be used in lieu of an actual copy of the
return. Because we can offer these printouts so quickly,
public and private sector businesses are willing to accept
them in lieu of a copy of a tax return in order to provide
faster benefits to their customers. For example. Hurricane
Iniki and Andrew disaster victims received loans needed to
help get back on their feet one to two months faster because
the Small Business Administration agreed to accept these
printouts to process loans in lieu of a copy of the tax
return. In addition, colleges and mortgage companies have
begun accepting the printouts in order to expedite
processing.
b. What savings has the IRS realized as a result of CFOL?
In FY 1992, we were able to cut $15 million from our budget
for productivity savings as a result of partial
implementation of CFOL. In FY 1993, we were able to cut an
additional $14.5 million.
16. How has the Automated Underreporter Program benefitted
taxpayers?
The Automated Underreporter (AUR) project benefits taxpayers
by reducing burden and improving the quality of services and
products. AUR reduces computation errors and prevents the
tax examiner from overlooking items thereby improving the
quality of notices sent to taxpayers. Potential assessments
can be made faster thereby reducing the interest paid by
taxpayers. On-line review of information sent to taxpayers
will enable IRS employees to respond quickly to taxpayer
inquiries made by telephone. And finally, AUR makes the
most current address available thereby improving delivery of
notices to taxpayers.
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a. To what extent has automation of the Underreporter
Program improved productivity?
A productivity increase of at least one additional case per
hour in the screening and response phase is anticipated
after tax examiners learn to fully utilize the new system.
This assumption is based on processing a sample of FY 89
pilot cases at the Ogden Service Center. The accuracy rates
achieved during the pilot test reflect a 15% improvement in
underreporter pre-notice case processing and an 8%
improvement in response case processing.
b. Does implementation of the Underreporter Program mean
that IRS personnel in the Underreporter branch are
going to be out of a job? How many jobs will the
Underreporter Program eliminate?
Due to the productivity saving resulting from AUR, the
Service will be able to process the same volume of cases at
six sites instead of ten. Attrition and redeployment will
enable us to deal with the existing excess Underreporter
workforce as needed. To date we have re-deployed or
eliminated, by attrition, over half of the 1900 seasonal and
permanent staff at these four service centers. In
accordance with our Policy Statement P-1-112, we fully
expect to retrain and place all remaining employees whose
jobs are impacted by the introduction of technology.
c. The Subcommittee has heard from taxpayers who have
received underreporter notices simply because they
printed an amount on the line below the correct line on
the 1040. Will this no longer happen with the
automated program? To what extent will underreporter
cases be manually reviewed before a notice is sent?
Automated Underreporter will provide tax examiners with
improved capabilities that should provide more consistent
treatment for taxpayers involved in the underreporter
program. Tax examiners will continue to manually compare
the income and deductions reported on tax returns. Taxpayer
contact will continue to be made when taxpayers incorrectly
report income and it is not obvious to the tax examiner that
the income was reported on the wrong line of the return.
17 . In 1991. Commissioner Goldberg testified that the final goal
for completion of TSM was 1999.
a. Is this still the goal? If not, why not?
The current goal for full implementation of TSM is 2001.
When IRS first developed the year-by-year transition plan
for TSM, no constraints were placed on resources. We have
154
since capped our resources based on realistic budget
expectations .
b. What TSM projects have slipped behind schedule? How
far behind schedule have these projects fallen?
The Automated Underreporter (AUR) project was scheduled to
be fully implemented in this fiscal year. Due to a
procurement protest, two of the six sites will not receive
the AUR systems until FY 1994. When IRS developed the
implementation schedule for TSM projects, we assumed that we
would get optimum funding needed to rollout new systems.
The following five projects had modifications to their
schedules due to underfunding:
• Automated Criminal Investigation
• Counsel Automated System Environment
• Servicewide Electronic Research Project
• Totally Integrated Examination System
• Integrated Collection System
These projects are part of the Integrated Case Processing
project, described below.
c. Are any interim systems falling so far behind schedule
that IRS will reassess the need for these systems? If
so, which systems?
IRS has already completed the process of re-evaluating the
roles of the interim projects. Based on the evaluation, the
Integrated Case Processing (ICP) Project was established.
The mission of the this effort is to develop information
systems support for all of our case processing activities
regardless of the functional nature of the case work being
performed.
As part of this effort, officials responsible for the
Totally Integrated Examination System (TIES) , Integrated
Collection System (ICS) , Corporate Files On-Line (CFOL) ,
Automated Inventory Control System (AICS) , Case Processing
System (CPS) , Servicewide Electronic Research Project (SERP)
and Automated Underreporter (AUR) will report to the
executive responsible for integrating all case processing.
The Counsel Automated Systems Environment (CASE) also has
interface requirements with Integrated Case Processing. The
Automated Criminal Investigation (ACI) project will receive
program and funding oversight from this executive. This
will provide for more efficient use of resources and
standardization among all projects.
Development of interim systems will be frozen with a portion
of their ' resources redirected to developing ICP. These
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frozen initiatives will be rolled out to locations beyond
their planned prototype locations only if the business case
justifies it and sufficient resources exist. Any future
roll-outs will occur at the same locations to minimize the
cost of software development, telecommunications, facilities
and site support. Using the ICP approach, capabilities can
be delivered to the end user earlier than originally
projected at a lower total cost.
In 1991. testifying before this Subcommittee. Commissioner
Goldberg stated:
a. In fiscal year 1993 the CFOL (Corporate Files On-Line)
system would be fully operational. Is it?
CFOL will be fully operational at the end of this fiscal
year.
b. That in 1994 the CHEXS (Check Handling Enhancements and
Expert Systems) and SCRIPS (the Service Center
Recognition Image Processing) systems would be fully
operational? Are these systems still on schedule?
CHEXS was a procurement to provide equipment used to process
paper checks. IRS has made a business decision to move
paper check handling to third party payment processors and
therefore, the CHEXS procurement has been canceled. As a
result, IRS employees will perform fewer manual labor-
intensive activities associated with receiving, validating,
balancing and depositing payments from taxpayers. IRS has
adopted Electronic Funds Transfer (EFT) as the preferred
method for the receipt of tax payments. All payments not
converted to EFT will be considered exception processing and
will be processed by a third party payment processor.
The SCRIPS contract, awarded on February 8, 1993, will allow
IRS to acquire character recognition and image systems.
SCRIPS will be pilot tested in 1994 at the Cincinnati
Service Center. Pending completion of this system
certification in Cincinnati, SCRIPS will be fully
operational by June 1994.
c. That the Automated Underreporter system would be
implemented nationwide in fiscal year 1993. Is this on
schedule?
We will fully implement Automated Underreporter at Ogden and
three additional service centers during FY 1993. The
remaining two sites will receive the Automated Underreporter
system in Fi' \9'^iA .
156
d. That the AICS (Automated Inventory Control Systems) and
ICS (Integrated Collection Systems) would be
implemented nationwide in fiscal year 1994. Will they?
These projects are part of the Integrated Case Processing
(TCP) project. Development of these interim systems will be
frozen with a portion of their resources redirected to
developing Integrated Case Processing. These frozen
initiatives will be rolled out to locations beyond their
planned prototype locations only if the business case
justifies it and sufficient resources exist. Any future
rollouts will occur at the same locations to minimize the
cost of software development, telecommunications, facilities
and site support.
e. That in fiscal year 1995 the Examination Automation
System would be implemented. Will it?
The Totally Integrated Examination System (TIES) , a major
component of the Examination Automation project, is now part
of the Integrated Case Processing Integrated Case Processing
project. Development of this interim system will be frozen
with a portion of their resources redirected to developing
Integrated Case Processing. TIES will be rolled out to
locations beyond its planned prototype location only if the
business case justifies it and sufficient resources exist.
Any future rollout will occur at Integrated Case Processing
locations to minimize the cost of software development,
telecommunications, facilities and site support.
f . That by fiscal year 1995 the Service Center Support
System (to replace mainframe computers in the service
centers) would be completed. Will it?
Yes, we expect to award the Service Center Support System
contract in FY 1995.
19 . Will these organizational changes affect the design of TSM?
By what date should the Subcommittee expect IRS to have
finalized its plans for organizational change?
Results of the organization studies indicate that the new
business requirements can be satisfied within the existing
TSM framework. The studies were not constrained by previous
plans, but early results have shown that the Systems
Architecture and components of the Design Master Plan (DMP)
are valid. The Systems Architecture will be refined
somewhat and the relative size and priority of some projects
depicted in the DMP will be modified to accommodate the
business changes.
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In addition, TSM acquisition vehicles have been carefully
scrutinized by the study group and found to be flexible
enough to accommodate change brought about by the revised
business strategy. The flexibility is reflected in the
original range of requirements and will not entail extensive
post award modifications.
We are engaged in extensive discussions with the
Administration to solicit their ideas about our
organization. We should be in a position to share our
approaches and secure the advice and help of this
Subcommittee in the near future.
Next year at this time — when the IRS budget proposals are
submitted — how can the Congress assess how well IRS has
progressed in implementing TSM?
a. What are the 10 most important accomplishments you
expect to have made by this time next year?
By this time next year, we will have:
• Fully implemented Automated Underreporter in the
Ogden Service Center and five additional sites.
• Fully implemented Corporate Files On-Line, including
business master file information.
• Expanded nationwide, on a voluntary basis, the test
of TAXLINK, electronic filing of federal tax
deposits.
• Awarded the Service Center Support
System/Telecommunications Acquisition contract.
• Awarded the Document Processing System contract.
• Awarded the Corporate Systems Modernization/Mirror
Image Acquisition contract.
• Implemented Integrated Case Processing in the first
locations.
• Expanded TeleFile to seven states.
• Expanded joint Federal/State filing to 15 states.
• Provided your Subcommittee with more detail of the
concept resulting from our business studies.
b. What improvements in taxpayer service can we expect to
see by this time next year? By 1995?
70-792 0-93
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The attached charts depict an overview of the key
capabilities, projects which provide those capabilities and
the timeframe in which the capability will be available to
IRS and our customers. We would be happy to work with your
staff to develop additional materials which may assist your
Subcommittee in monitoring our Tax Systems Modernization
effort.
21. How will TSM affect the operations of the 10 IRS Service
centers?
a. Will the IRS still use the "pipeline" for processing
tax returns? If not, how will returns processing
operate?
Our labor-intensive "pipeline" will be modernized to process
returns more accurately and efficiently. The Document
Processing System (DPS) will convert incoming paper to
electronically-stored images, and permit us to store,
compile and update information electronically with instant
access by authorized employees. We currently input tax
return information manually and less than 40 percent of
return information is captured. Through DPS and additional
changes in the way we do business, we intend to capture and
make available through automated systems 100 percent of the
data provided by taxpayers. DPS offers a cost effective
solution to our current paper storage and retrieval problem.
Taxpayer benefits of DPS include faster refunds, more timely
responses to inquiries and fewer erroneous notices. Labor
savings, generated by eliminating paper handling throughout
the entire tax processing system, could be reapplied to
revenue producing jobs such as examination and collection or
be used to provide a higher level of customer service.
The Document Processing System will handle paper coming into
IRS, however our goal is to substantially reduce the volume
of paper by receiving information electronically. In
addition to expanding the electronic filing of tax returns,
the Electronic Management System (EMS) will serve as the
point of electronic communications from the external
business community. This system will ultimately be capable
of receiving information from the individual taxpayers and
the public in general.
Electronic Management System will send, receive, control and
secure electronic data that is transmitted to the IRS such
as tax return, currency transaction, payer and employer
information. In addition, IRS employees will have
information they need on-line and accessible through their
computer system instead of having to wait for tape delivery,
data input, or the delivery of information on paper.
Electronic Management System will also be capable of
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supplying certain types of account and reference data to
taxpayers and practitioners on-line in a "read only" basis.
This will enable individuals to ascertain the status of
their accounts without assistance from an IRS employee.
b. When TSM is fully implemented, will IRS still need 10
service centers; 63 district offices; and 7 regional
offices?
The organization studies have led us to rethink the
functions of our current operating components. Final
decisions concerning the number and location of new
organizational components will be made after further
consideration of the study recommendations and other
mitigating factors.
c. Currently, there are 115.000 IRS employees. How many
of these jobs will be eliminated by TSM?
TSM is expected to be fully implemented in 2001 and by that
time our workload will have increased by almost 20% over the
current level. We anticipate that TSM could allow IRS to
conduct business in the year 2000 with adjusted staffing
levels reflective of the benefits of TSM with no decrease in
customer service or audit coverage.
d. Will TSM enable the IRS to conduct more corporate
audits and audits of high-income taxpayers? If so,
how?
The Totally Integrated Examination System (TIES) includes
software capability for the examination of both corporations
and individuals, regardless of income level. TSM equipment
in conjunction with this software provides the technology to
conduct all examinations more efficiently. The Compliance
Research and Information System (CRIS) will provide market
segment analysis to classify tax returns by specific groups,
channelling examination activity to the areas of greatest
non-compliance. Benefits are projected assuming that the
same level of productivity will be maintained using fewer
staff years. These benefits are then translated into staff
year reductions. Reinvestment of these staff years would
increase examination coverage.
e. How will TSM affect IRS's ability to answer taxpayers'
^ questions and resolve taxpayer inquiries?
In the TSM environment information will be retrieved,
delivered and used electronically through an enhanced
nationwide telecommunications network, and on automated
workstations where authorized employees have on-line access
to current and complete taxpayer account information. This
160
capability will allow IRS to resolve taxpayer inquiries
during the first contact. In addition, TSM projects, such
as the Telephone Routing Interactive System (TRIS) and
Automated Inventory Control Systems (AICS) will assist us in
better serving our customers.
Telephone Routing Interactive System (TRIS) supports the
concept of one-stop customer service in the taxpayer
assistance area and other areas that use the phone to
communicate with taxpayers. TRIS will provide an automated
routing system that permits callers to direct themselves to
the appropriate source of assistance. The assistor will
have on-line access to taxpayer account data, allowing them
to resolve the customer's issue during the first contact.
Also, TRIS will enable some taxpayer inquiries to be
resolved by the system without an IRS employee intervening.
With the introduction of an automated routing system, there
will be less need to manually route incoming calls and
employees can spend more time providing more substantive
assistance. In addition, the IRS can provide more
assistance without increasing the number of assistors
proportionately .
Through the Automated Inventory Control System, now being
piloted at our Fresno Service Center, we are able to control
correspondence for the first time by assigning a unique
number to each piece of taxpayer correspondence so that the
status can be monitored and the issue resolved timely. This
eliminates the common burden of having taxpayers write
numerous letters to resolve an issue with their account.
Since all correspondence from a particular taxpayer can be
associated and timely routed to the appropriate IRS function
for action, we do not waste our resources or annoy taxpayers
by sending multiple letters on the same issue.
f . IRS's testimony stated that the result of TSM will be
improved voluntary compliance. How is TSM going to
improve voluntary compliance? Will TSM affect the tax
gap? How?
g. How will TSM affect the inventory of accounts
receivable?
We believe that information processing improvements enabled
by TSM, in conjunction with education and outreach -- two
components of our Compliance 2000 program -- have enormous
potential for reducing accounts receivable and closing the
tax gap.
Our experience indicates that taxpayers are more inclined
and able to comply with tax obligations voluntarily when
161
promptly contacted about an issue; TSM will provide the
technology needed to do that. Also, accurate account
information, available to employees sooner, will reduce the
number of erroneous accounts.
How many individuals filed paper returns in 1993 (tax year
1992)? How many individuals do you expect to file paper
returns in 1994 and 1995 that will be manually processed ?
Through April 30, 1993, approximately 94 million individuals
filed paper returns. We anticipate that approximately 108
million individuals will file paper returns in 1994 and
approximately 107 million in 1995.
a. How many returns were electronically filed in 1993 ftax
year 1992)? How many returns do you predict will be
filed electronically in 1994 and 1995?
Through April 30, 1993, approximately 13.7 million returns
were filed electronically. We anticipate that 16 million
returns will be filed electronically in 1994 and 20 million
returns will be filed electronically in 1995.
b. Did electronic filing levels for 1993 meet IRS ' s
original projections? If not, why?
IRS' projection of 14 million electronically filed returns
was not met in 1993. The change in withholding in tax year
1992 reduced the refund returns volumes significantly.
Although we encourage all individuals to file
electronically, most taxpayers who have elected to file
electronically have been due a refund. The system does
accept balance due returns and we encourage the use of
electronic filing for those taxpayers as well and refund
filers.
c. How much in savings have been realized due to
electronic filing? How have these savings been
realized?
The real savings in electronic filing for both IRS and the
taxpayer is in the improved quality, not just the lower
processing costs. ELF returns cost between 75 cents and
$1.75 to process compared with $3.28 for paper 1040A/EZ and
$4.28 for paper 1040 returns. However, the error rate —
mistakes by the taxpayer and IRS — run 17% on paper returns
and 2% on ELF returns. This differential translates into
thousands fewer notices to taxpayers which require their
time and attention to answer. Thus the fewer notices
required for ELF returns means substantial savings for IRS.
162
d. By this year 2001, what percentage of individual tax
returns will be paper? What percentage of individual
returns will be filed electronically? What percentage
will be filed by other methods? Will taxpayers be able
to prepare and file tax returns from home computers?
We estimate that in year 2001, approximately 51.1 percent of
individual returns will be paper returns; 42.3 percent will
be electronically filed and 6.6 percent will be filed using
Telef ile.
The biggest problem with allowing taxpayers to file from
their home computers is the speed of data transmission.
Most home computers use 1200 baud modems which are slow
compared to professional firms which can send returns to us
in volume at high rates of speed.
IRS is, however, looking at alternative ways of filing to
give taxpayers the benefit of speed without the costs.
Telefile will be one alternative now being tested for simple
returns. Also taxpayers can use home computers to complete
their returns using the 1040PC program which speeds
processing time. Many 1040PC computer programs include a
direct deposit option which gets the taxpayer's refund
sooner. And we are studying the feasibility of individual
electronic filing via home computer. This may be an
alternative for taxpayers in the near future.
e. How does IRS plan to increase the market for electronic
filing? Do you have any plans for the Government to
offer free electronic filing services to taxpayers?
IRS is devising detailed action plans to reach various
market segments including small volume preparers, older
Americans, employers, financial service providers, and on-
line communication services. In addition, the IRS has
expanded conferences and exhibitions to seven locations
throughout the country to draw more local attendance. The
seminar topics included in the conferences have been
broadened to attract practitioners who are not currently
electronic filers. Once at the conferences, all attendees
will get exposure to electronic filing.
The Service is also planning to expand Telefile to seven
states for the 1994 filing season. Telefile will permit
1040EZ filers in those seven states to file their return
using their touchtone telephones. We also hope to expand the
availability of electronic filing at district offices
through Taxpayer Service's Walk-in Assistance program.
163
f . How does IRS expect to encourage taxpayers to
electronically file documents other than returns (e.g..
Forms 1099 and W-2 ) ?
Forms W-2, Wage and Tax Statement, are processed by the
Social Security Administration. The Internal Revenue
Service has had a method for payers to file information
returns electronically for several years. The Martinsburg
Computing Center has the Information Reporting Bulletin
Board System (IRPBBS) available to payers who want to file
by electronic means. In the current processing year,
Martinsburg received seven million such returns.
The Executive Director of the Information Reporting Program
has established a goal of 70 million information returns to
be filed electronically in 1994. This goal was announced at
the Information Reporting Program Advisory Committee (IRPAC)
meeting held on May 19 and 20. IRS is actively working with
the payor community and internal stakeholders to attain this
goal .
IRS also participated with the Social Security
Administration's Government/Industry Forum on Electronic
Wage & Tax filing on June 8. Representatives from the
business community, states and other government agencies
discussed how to work together to achieve more growth in the
electronic filing of wage and tax information.
A major part of TSM is the Electronic Management System,
which will introduce Electronic Data Interchange (EDI) as a
method of electronically filing information returns in 1996.
How has electronic filing created new opportunities for
fraud? What resources has IRS allocated resources for this
problem? How many phony electronic returns have you seen in
1993?
False claims for refunds are filed electronically, just as
they have been filed on paper for years. The difference is
that the speed of our processing makes it important that we
move quickly to identify the schemes. Electronic filing
fraud is serious even though it represents a small part of
total ELF filing. At the end of February 1993, 9.2 million
ELF returns had been filed and we had detected 1,635
fraudulent returns. Another 1,311 fake paper returns had
been found also. The important point is that we caught them
early. These false returns claimed a total of $9 million in
refunds ($4.1 million on ELF returns) and we stopped $8.7
million ($3.7 million or 91% on ELF). The other $300,000 is
being investigated.
164
In the past three years (1990-1992) , the IRS has received
and processed more than 23 million electronically filed
returns. The total number of fraudulent ELF returns
identified in the past three years is 18,882.
There are several steps we have taken to stop ELF fraud.
The Questionable Refund Detection Team (QRDT) screening has
been tightened. Fraudulent returns are most likely to be
filed by first-time filers, claiming EIC and/or fuel tax
credit, showing only Schedule C income or with homemade W-2s
attached. The Department of Justice is aggressively
prosecuting these cases and major electronic filers have
been asked to participate.
There has been an increase in Criminal Investigation
staffing dedicated to the Questionable Refund Program. IRS
has increased staffing to address return fraud through our
QRDT for both paper and ELF returns. This year we are
devoting 10% of our CI staffing to Questionable Refund
Detection Team (QRDT) . This is up from about five percent
in 1992.
Over the past three years there have been 470 convictions
and 425 sentences of which 291 were imprisonments due to
electronic filing fraud.
2 4 . In testimony before the Subcommittee, IRS stated that it has
adopted Electronic Funds Transfer (EFT) as the preferred
method for the receipt of tax payments. IRS also stated
that of the $1.3 trillion in payments IRS receives and
deposits annually, only three billion dollars is through
electronic funds transfer. How do you plan to increase the
use of electronic funds transfer?
The Service plans to increase the use of electronic funds
transfer for payment of Federal tax by the development and
implementation of comprehensive network. This effort,
sponsored by Treasury and worked jointly by the Internal
Revenue and Financial Management Services, is well under
way.
A prototype system, TAXLINK, has been in operation in the
Atlanta Service Center since June 1992. TAXLINK, which is a
component of the IRS' overall modernization effort, is
currently accepting voluntary participants in the states of
South Carolina, Florida, and Georgia. To date,
approximately 10,000 transactions for a total of $250
million has been received through TAXLINK. These payments
have all been for Federal tax deposits, predominately
employment taxes.
165
An evaluation is being performed on the prototype. There
are two phases of the evaluation: an internal review will
examine how effective the Service was in applying credits to
the taxpayer accounts and the costs associated with
operating the system; the second phase is an analysis on
how well the system addressed the taxpayers' needs, the
effectiveness of the movement of money into Treasury's
account, and marketing issues.
The prototype will be modified as appropriate and a pilot
implemented in January 1994. This phase will continue with
Federal tax deposits, but will be offered to business
taxpayers throughout the country on an optional basis.
Based on the results of the prototype and pilot we will
develop a plan to encourage wider use of electronic funds
transfers.
2 5 . The National Research Council says that TSM must proceed in
order to prevent a major breakdown of the nation's tax
svstem. When do we have to worry about a major breakdown?
Last year, your Subcommittee supported funding for mainframe
computers which allowed us to replace the antiquated
mainframes in our service centers. These mainframes have
alleviated concerns over a major breakdown and will allow us
to more smoothly transition to a new way of doing business.
However, our current systems architecture is really out of
vintage and places constraints on fully realizing the
Service's goals of reducing taxpayer burden, increasing
compliance and quality-driven productivity and customer
satisfaction. We can achieve these goals only by fully
leveraging the technology TSM provides.
166
Chairman PiCKLE. Thank you, Mr. Dolan, for a very — I was
going to sav exhausting, but an extensive discussion of your aims
and your plans, and I think it is a recognition of some of the prob-
lems we have and the goals you hope to achieve.
Your statement is very complete. We will be submitting you
other questions as a follow-through to this hearing, specifically in
relation to the testimony that you have just given, some of wnich
may not be covered this morning. But we do appreciate it.
IKS was scheduled to receive about $150 million under the stim-
ulus package based on testimony you had given to our committee
and the Senate. Now, that program was killed. Have you made any
plans beyond this now, or d!o you have any other suggestions or rec-
ommendations to make? Because you don't have the equipment you
hoped you could have purchased?
Mr. DoLAN. Well, Mr. Chairman, I think, as you may recall,
about $40 million of the $148 million that we had built in the stim-
ulus was directly related to tax systems modernization. It was
going to allow us to advance the ball in some key areas.
We are now not going to be able to accelerate those paths, and
we will have to do them in the original timeframe scheduled.
There are a couple of key areas where we really do regret the ab-
sence of the stimulus package. One is in the area I mentioned
briefly. We were going to be able to purchase some automated call
distributors and automated routing units that cumulatively would
have allowed us to get to almost 1.2 million more callers trying to
get to our system by virtue of being able to apply that technology.
We could have done that in the next filing season, and that would
have had a material benefit for us.
Two other keys areas: Our budget is built on the premise that
we would achieve a $20 million productivity savings around two of
those initiatives. One was what we call the automated workload
management system, and another was by getting the last 6,000
laptops to our revenue agents. Inasmuch as both of those died in
the stimulus package, we find ourselves in a little precarious posi-
tion of having a budget now that assumes we can achieve 55 mil-
lion dollars' worth of new productivity in 1994, when, in fact, $20
million of that was predicated on getting those two component
pieces. So we have a little bit of dislocation there, and we are going
to figure out how to deal with that.
Chairman Pickle. All right. Now, I am going to ask you some
questions specifically in the area of transfer pricing. Other mem-
bers may also approach their questions on some particular item of
interest to them that you have just testified on. But let me ask you
a few questions about transfer pricing.
The administration has proposed to encourage corporations to
keep contemporaneous records of how they arrive at their transfer
prices. You made that as a recommendation under section 6662(e),
the imderstatement penalty.
Now, do you have that program in effect now?
Mr. Dolan. The proposed regulatory change?
Chairman PiCKLE. The proposed regulations under 6662 that
would require keeping contemporaneous records.
Mr. Dolan. That regulatory regime is currently in place, yes.
Chairman PiCKLE. Well, how is it working?
167
Mr. DOLAN. If vou don't mind, let me pass this one off to Mr.
Blattner and ask nim to make a few comments in this general area
of recordkeeping.
Chairman PiCKLE. Mr. Blattner.
Mr. Blattner. We are getting better records today to establish
an appropriate arm's-length price. In 1992, a significant part of the
$15 billion that we recommended in our large case program, our
CEP program, resulted from pricing adjustments.
We are working with the Commissioner's advisory group to get
assistance in how to secure better third-party data to determine
the appropriate price.
Chairman Pickle. Do you have that under way?
Mr. DoLAN. Mr. Chairman, I misspoke. They are still at the pro-
posed stage. They have not been finalized. I misspoke when I told
you they are in
Chairman Pickle. I am concerned that you have that as a goal.
I think it is a good approach. As I understand it now, foreign cor-
porations just do not keep any records of how they arrived at their
particular transfer price. If they are audited, they would go back
and say we will have a discussion and we will discuss with you and
IRS about how to settle it, but nobody keeps contemporaneous
records or very little, and so the information is never known until
after an audit has been ordered.
Now, is it your intent to see that major corporations do keep con-
temporaneous records? Is that going to be across the board, Mr.
Blattner?
Mr. Blattner. Mr. Chairman, if I might, that is the thrust of the
regulatory regime that has been proposed. It is an attempt to pro-
vide incentives through contemporaneous recordkeeping and then
to use the penalties as a way of further reinforcing it.
Chairman Pickle. Mr. Blattner, we understood you submitted to
us some documentation of how you would go about this, and we
looked it over and said, well, if you use this particular form, a
number of the corporations are going to be exempt, and so we have
suggested some changes. Have you made those changes? Do you
have the form in place now? Is it going to be effective?
Mr. Blattner. The hearing on 6662(e) is scheduled for May 14.
Chairman Pickle. May of this year?
Mr. Bij^ttner. Of this year.
Chairman Pickle. If it is going to be in May of this year, we
have got a legislative proposal tor across-the-board contempora-
neous records that is not in effect, is that correct.
Mr. DoiAN. Mr. Chairman, that is what I said. The regulations
are proposed regulations. The May 14 hearing is a hearing on the
proposed regulations; consequently, they are not in effect today.
They do not govern conduct of taxpayers today.
Chairman Pickle. But isn't it true that regulations on record-
keeping only applied to "other transfer" pricing methods? Isn't that
true?
Mr. DoLAN. It applies only to the larger taxpayers, yes.
Chairman Pickle. Well, it would seem to me in this area, not
being detailed or technical, that we have a lot of unanswered ques-
tions with respect to transfer pricing. The public does not really
know how much tax we are losing. We talk about it and we have
168
for 2 years. We have given you between 100 and 150 new examin-
ers in this field specifically. So my first question is, if we have
given you examiners, you don't really get to the heart of this thing
until you put into effect contemporaneous recordkeeping. Is that
basically correct?
Mr. DOLAN. I think that is going to be a very key piece of it. I
think what that does is
Chairman Pickle. Well, we will expect you to put that into effect
and put it into effect now and keep close coordination with our
committee, because we think we need to know.
The public is saying are we are really losing a lot of money out
here from the U.S. standpoint. Now, I notice that you are going to
spend $30 million in 1994, but you say, according to your testi-
mony, that you are going to raise only $50 million from the initia-
tive over 5 years. Now, why is the revenue estimate for this trans-
fer pricing initiative so low?
Mr. DoLAN. I think, Mr. Chairman, it is a combination of a cou-
ple of things. One is the Service making conservative estimates. I
think the other thing is that if you look at it over the life of those
resources, it is a $148 million return. I think more importantly, if
you look at it as a marginal investment, the point Mr. Blattner was
making before, the transfer pricing return in the large case area
is, on average, that $5 billion a year of those large case adjust-
ments are transfer pricing adjustments.
Chairman Pickle. Mr. Dolan, let me just review for you — I don't
want to dwell on this, but I am going to dwell on it for a while.
Mr. Dolan. OK.
Chairman Pickle. You have estimated in your testimony that if
we had this extra money, we are giving you $30 million more and
you are going to spend tnat, and you said in 5 years we will collect
$50 million more. Now, this committee has made an estimate over
2 years ago that we may be losing up to $20 billion annually. We
took whatever yardstick we could to try to arrive at what we
thought was as reasonable figure.
We never can get an answer from the IRS on exactly how much
you think is bemg lost. A previous Commissioner said it will
amount to several billion dollars. We did get a previous Commis-
sion, Mrs. Peterson, and she estimated it might be as much as $3
billion lost. Now, whether it is $3 billion or whether it is $20 billion
remains to be seen, but it could be sizable. Yet, you are going to
take $30 million and tell me in your testimony that you are going
to get $50 million more.
Now, what is the sum that is probably being lost? Can you give
me an estimate?
Mr. Dolan. Mr. Chairmati, I am afraid I am going to frustrate
you like others, in terms of not being able to give you a precise
number. I would come behind that, though, to tell you that as we
sit before you this year, we know much more about the
underpinnings of that number than we did when we sat before you
last year.
Chairman PiCKLE. I hope that is true. Now, I understand from
phone calls we made to the IRS that in 1989, you collected some-
thing like $6 billion-plus from foreign-controlled corporations. In
1990, IRS collected from the foreign corporations about $8 billion
169
in income taxes. Now, that would be an increase of about $1.5 bil-
lion or more. If those figures are correct, does that indicate that
you are putting more emphasis on this matter? Will that amount
increase?
Mr. DoLAN. We would certainly expect that it would, Mr. Chair-
man. I think it is a reflection of the additional staff that this sub-
committee has helped us secure. I think it is also a reflection of us
getting better at investigating a very fact-intensive, complicated
process in the transfer pricing area.
Mr. Blattner. Mr. Chairman, if I could just add to that. In July
of 1990, we had 1,100 cases under audit that were foreign-con-
trolled corporations. In 1991, that number grew to 1,500. In 1992,
it was 2,500. So over the last 2 years we have more than doubled
our commitment to the number of cases that we are working of for-
eign controlled corporations.
Chairman Pickle. Let me conclude. Those figures are interesting
and I am glad to have them and I am glad to know it. I think we
have got to put emphasis on this and try to find out what are the
facts. We have given you the personnel, as many as you have asked
for. In one instance, I think last year, you didn't ask for any more
examiners. We keep being told you are outgunned and you are
outmanned, and I think the public wants to know what we are los-
ing in terms of revenue.
Similarly, what are we doing with respect to American compa-
nies doing business overseas. But it has to work both ways. Now,
the problem may be more magnified, because there are more Amer-
ican corporations doing business overseas than there are foreign
corporations doing business here.
When you look at the figures of the adjustments proposed by the
IRS, it is rather shocking to know that U.S. corporations are doing
a lot of things that may be the same things that we are accusing
foreign companies of doing. But it isn't enough, Mr. Blattner, just
to acknowledge that. The question is what snould our companies
and what should foreign companies be paying to the Government.
I don't think anybody on this committee wants to play any kind of
a technical game. We want to know what are the figures.
I am going to yield right now to Mr. Houghton. I want you to
submit to the committee some information about how you are using
advance pricing agreements, what have you done, and how can you
do more to arrive at these advance pricing agreements.
[The following was subsequently received:]
170
USES OF APAs
The IRS developed the Advance Pricing Agreement (APA)
process with the issuance of Revenue Procedure 91-22 in March 1991. An APA
is a prospective agreement between the taxpayer and the Service that a particular
transfer pricing method when applied to the taxpayer's operations will determine
compliance with the arm's length standard of IRC section 482. If a treaty
country is involved, IRS will generally seek a mutual agreement. This process is
designed to arrive at an understanding with the IRS on three basic issues: 1.)
the factual nature of the intercompany transactions to which the APA applies, 2.)
an appropriate transfer pricing methodology to apply to those transactions, and
3.) the expected arm's length range of results from applying the transfer pricing
methodology to the transactions.
Currently, IRS has approximately 45 taxpayers in the APA program, at
various stages of development, involving operations in 16 foreign countries.
Fifteen of these requests are substantially complete. Further, 36 additional
taxpayers actively considering participation in the program, and have held very
preliminary discussions with the Service.
In terms of improving the program, the Service has undertaken several
initiatives for that purpose. Included among these are:
0 coordinating with outside stakeholders and professional groups to
improve the APA process;
0 providing recommendations to enhance the program's multifunctional
management between Counsel and other Service functions;
0 participating in a Commissioner's Advisory Group task force on
developing pricing information;
o developing revenue rulings using past experience gained from the
APA process; and
0 incorporating field guidance on the APA process into the internal
Revenue Manual.
171
Chairman Pickle. Let me now yield to Mr. Houghton, Mr.
Houghton,
Mr. Houghton. Thank you, Mr. Chairman.
Maybe you can help me out on the arithmetic. Let me tell you
specifically what I mean. The figures seem a little out of balance.
You are asking for $284 million more in fiscal 1994 than you are
in 1993. Yet, at the same time that you asked in the last testimony
for $148,4 million in the stimulus package. It just seems a little out
of sorts that the stimulus package off-budget, dire emergency
would not somehow be included. I can understand if you had put
$10 or $15 million or something, but to put 50 percent of your in-
crease into the stimulus package seems a little strange.
Also, while you are doing that — and you have been asked this
question before — you are taking money out of things like tax sys-
tem modernization, which is probably the highest increase of any
that you have in your whole budget, and you are transferring this
to the White House.
Here you get approximately $300 million, which is your increase,
but way off-budget here you get about $150 million. It just seems
out of sorts. Then while you are doing that, you are taking some
money and transferring it over to the White House, because, in ef-
fect, you don't need it. So maybe you can help me on those figures.
Mr. DOLAN. I will try to help you. Let me start with the first
point. The $148 million and the $284 million are different num-
bers. Most of the $148 million in the stimulus package did not
make its way into the increase that we have asked for in 1994.
They are things that need to be done, but are not before this sub-
committee by way of requests for increase in 1994. They are things
that carried with them individual paybacks.
Mr. Houghton. If I could interrupt, maybe I missed it, it was
in your testimony that you were saying that this budget was en-
tirely inadequate that you were looking at.
Mr. DoLAN. That the budget is entirely inadequate?
Mr. Houghton. Yes.
Mr. Doian. I was not saying that, nor am I saying that today.
Mr. Houghton. In effect, by the insertion of $150 million in the
stimulus package, clearly there was an inadequacy there which
was a different order of magnitude than anything I would have
normally thought of
Mr. DoivVN. Well, whether you call it an inadequacy, Mr. Hough-
ton, or whether you look at it in terms of its potential, we would
have replaced some very old minicomputers in our field office, got-
ten the benefit of a much higher computer power, saved $7 million
a year in maintenance costs on some stuff that is breaking down
around us. /. i •
Now, that was the criticality of it. We would, by virtue of buving
those automated call distributors I talked about, get to 1,2 million
of our customers who are trying to get to us and concerned they
cannot get to us. Those 6,000 laptops would have put more power
in the hands of the revenue agents, some of whom are doing these
large case and international examinations. They were all very ma-
terial opportunities for the IRS to do better had we achieved that
stimulus.
172
If I could go to your second point, unless you want to stay with
this point on the $7 million
Mr. Houghton. I will come back to it.
Mr. DoLAN. In terms of our understanding of it, apparently
somewhere in the last couple of weeks there was a characterization
of the money that came from the IRS that may have confused
some. The $7 million that is a part of the rescission proposal to
which you refer comes out of three IRS appropriations, but it comes
out of the rent accounts in those three appropriations. It was iden-
tified as potential rent surplus. It was and is rent surplus. It does
not come out of the acquiring of hardware, of software, of any of
the technical support in the
Mr. Houghton. If I could just interrupt, Mr. Dolan, I don't want
to make a big deal of this, because in terms of the magnitude of
your budget, $7.4 billion is not a big item, but to me that really
doesn't hold an awful lot of water, because if you can transfer IRS
tax law enforcement into Executive Office of the President and Spe-
cial Assistant to the President, tax system modernization to the
White House Office of Administration, it clearly doesn't make any
difference whether it is rent or pencils or salaries or something like
that.
Let me get back to the bigger issue. Are you saying, in effect,
that your budget increase really should be $450 million?
Mr. Dolan. I am saying, I think like any other agency that sits
before you, that there are a number of additional initiatives that
we could accomplish beyond the boundaries of any budget. Yet we
work in a system in which policy choices and application of funds
choices are made. So yes, we could use the $148 million associated
with the stimulus package.
Mr. Houghton. You see, what I am trying to get at, if I could
just take another minute, Mr. Chairman
Chairman Pickle. Yes.
Mr. Houghton. The point I am trying to get at is here we are
caught between the horns of a dilemma. Here you want to modern-
ize, you want to have good people, you want to absorb the new
things. Yet, at the same time you have the pressure on the costs.
What really are you looking atf Because this is not a 1-year propo-
sition. What are you looking at?
For example, if we ever go to something like a value-added tax
or some of these other proposals that the President has made, I be-
lieve that the burden on your system is going to be extraordinary.
What are you really talking about? Are you able to absorb some of
these new things within your cost structure by your modernization
programs? Are you going to be looking at very significant increases
over these next few years, if some of these tax proposals take ef-
fect?
Mr. Dolan. At the risk of overgeneralizing, Mr. Houghton, I
think what the tax systems modernization investments do for us is
create flexibility in our system that will allow us to absorb and
react to a variety of tax law and other policy changes. Absent that
investment, though, we would push the envelope in terms of trying
to make today's system be responsive to some of the proposals that
are out there on the landscape.
173
Mr. Houghton. Just one other question. In terms of your tax in-
formation category, the tax system modernization goes up dramati-
cally and the other three areas go down, processing, service compli-
ance and enforcement program support. I am assuming that is just
a recategorization.
Mr. DoLAN. In large part, it is. As I mentioned, a good part of
the nonrecurring costs come out of the information systems budget.
Mr. Houghton. Thank you, Mr. Chairman.
Chairman Pickle. Thank you, Mr. Houghton.
I am going to go ahead and recognize Mr. Jefferson now.
Mr. Jefferson. Thank you, Mr. Chairman.
I am trying to follow the request figures and the ones the Inter-
nal Revenue Service ended up with. It seems that you asked for a
20-percent increase or $1.4 billion, roughly, in funding for 1994,
and the budget that you have now is $1.3 billion and 7,400 posi-
tions less than you originally requested.
Are you going to have sufficient resources to do the job you have
been asked to do with this sort of difference in what you requested
and what you ended up now settling for?
Mr. DOLAN. We believe, Mr. Jefferson, we can do a very substan-
tial job, yes. The resources in this budget allow us to do the job cor-
rectly.
Mr. Jefferson. What would the 20 percent be used for and how
would it have added to your ability to ao the job, or was it unneces-
sary to begin with?
Mr. DoLAN. Again, as I mentioned earlier, there is always a
question of choice of where you make your investments. We nave
a variety of ways, particularly in the compliance initiative area,
that we would have been able to apply staffing, and we would have
applied greater complements of staffing in each of those 11 areas
to try to get the balance that we think we achieve in that initiative
package that is before you. That is principally where we would
nave made those investments.
There are some other places in our support categories where we
have been lean for years, and we would have tried to bolster our-
selves in those areas.
Mr. Jefferson. Well, how much additional revenue might you
have raised for the Government this year, if you had gotten the re-
quest that you asked for, that you aren't going to be able to do
now?
Mr. DoiAN. I am not sure I can give that to you now. Of course,
I would be happy to furnish that to you in terms of the attachment
to the original proposal.
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175
Mr. Jefferson. Is it true that the cost of collecting $100 now by
the Internal Revenue Service runs 62 cents? Is that right?
Mr. DOLAN. Well, I notice with interest in the chairman's invita-
tion to this hearing that he used that number, and I am assuming
that is using the gross budget against $1.2 trillion, and if you did
that, you would coipie out to 60 to 61 cents. Mr. Houghton might
see this differently as an accountant. I think I might take my $717
million of capital investment out of that equation, and if I did that,
that takes about 5 or 6 cents off of that equation. But we are in
that 55- to 60-cent category, yes.
Mr. Jefferson. Does this represent the cost going up or down
or stabilizing or what?
Mr. DOLAN. I think, depending upon your timeline, if you go
back, as I think the chairman did in his announcement, I don't re-
member the precise figure, but he showed a comparison which
would have had a cost increase from 40 to 60 cents. I don't have
that right in front of me, but it would represent a cost increase.
Mr. Jefferson. The fiscal year 1994 budget proposal includes
$19.6 million to help IRS implement tax law changes, but does not
provide any additional staff. Will the Internal Revenue Service
have sufficient resources to implement new tax legislation that is
now being proposed by the administration?
Mr. DoLAN. The short answer is yes, because we will make it a
priority by virtue of the reality of what a new tax act is. It becomes
a priority work item. We will clearly have to prioritize our already
applied staff in order to do the kind of job we will have to do on
a new law.
Mr. Jefferson. Will you have to forgo doing something else, if
you move this to the front burner?
Mr. DoiAN. In the early days, Mr. Jefferson, the principal activ-
ity of the IRS will be providing the kind of advice that we are nor-
mally asked for, both from Hill staff, committee members and with-
in the administration in trying to insure that the law is admin-
istrablc. We will then spend time trying to be sure that we are pre-
pared to handle the first returns, handle the first set of regulations
that might have to be promulgated under it. And then 3 and 4
years out, you will begin to see the new issues appear on tax re-
turns that get filed for presumably tax year 1993 and later.
Mr. Jefferson. Will you have to rewrite computer programs and
revise forms and publications and write new regulations?
Mr. DoLAN. Yes, we will.
Mr. Jefferson. This has got to be a lot of additional work on
the
Mr. DoLAN. It is, but I will tell vou that it is one of those senses
of deja vu, we have been here before. There was a point at which
we used to have a pithy little saying about how many times the
code had changed in the last 10 years, and it seems like every year
we are in some form of preparation to implement a new piece of
tax legislation.
Mr. Jefferson. Let me ask a question that deals with this new
tax legislation. Let's talk about the Btu tax for just a minute, if we
can. Do you foresee any problems with the enforceability of the Btu
tax?
176
Mr. DOLAN. I have to say you candidly at this point, Mr. Jeffer-
son, I am not enough informed on the ultimate character of that
tax to be able to give you a reliable answer.
Mr. Jefferson, That sort of nips my second question, which was
to get more specific about that and ask you whether, if we collect
the tax on oil at the terminal rack and gas at the burner tip, will
it make collectibility easier?
Mr. DoLAN. I will observe, Mr. Jefferson, that in the work we
have done in both diesel fuel and gasoline, we have consistently
found that the higher up the chain you are able to do the trans-
action, the easier it is for us to administer.
Now, that is a gross generalization and I would say to you that
we have had fewer problems at the terminal rack than we have if
you move down those sort of recordkeeping events lower in the
scheme. So as a general proposition, that would be the IRS's obser-
vation on administrability,
Mr Jefferson. So if we are trying to collect as much money as
we can from this Btu tax with as Rttle slippage as possible, the
best thing for the committee to do is to move the collection point
to the point of the consumer?
Mr, DoLAN, Well, my observations go beyond collecting an
amount of money. You really get into some recordkeeping burden,
you really get into the fact that some folks who have schemes in
the current system are there in ways that the more times you can
touch this thing, the more likelihood there is for scheming. So it
is a money issue, but it is also just a question of how you can easily
administer something.
Mr. Brand. Mr. Jefferson, if I might, back to the issue of imple-
mentation of any tax law change as far as 1994 is concerned, there
is a placeholder in the budget of about $21 million that the Presi-
dent and 0MB have submitted which is basically in the area of
service and supplies, the types of money that we would draw on for
a portion of the implementation process. Then, of course, depending
on how the law might change, we would then go through and cost
the implementation of that and determine whether that is
implementable within that placeholder, or whether we would need
to request through Treasury some supplemental appropriation or
something. But there is a placeholder that is there.
Mr. Jefferson. The last question I have, Mr, Chairman, is relat-
ed to the TSM project. What evidence does the Internal Revenue
Service have to support the apparent contention that productivity
savings will actually be realized if we make this huge investment
in tax system modernization?
Mr. Dolan. If you don't mind, Mr. Jefferson, I would like to ask
Hank Philcox to give you the answer on that.
Mr. Philcox. Mr. Jefferson, one of the things that we do with
each of the projects that we implement is go through a very exten-
sive business case analysis and a certification of the system before
it goes on line. We test each of the implementations in both a pro-
totype and a pilot environment small-scale before we implement it
nationwide. So by the time we are ready to implement a system,
we have a fairly good idea of what kind of productivity improve-
ment that system should get for us, and that is the basis on which
we have costed these productivity improvements.
177
Mr. Jefferson. I don't have any further questions, Mr. Chair-
man.
Chairman Pickle. Thank you, Mr. Jefferson.
The Chair now recognizes Mr. Brewster.
Mr. Brewster. Thank you, Mr. Chairman.
Mr. Dolan, I followed with interest my colleague's question here
concerning the 62 cents collection point now, and I looked back in
1972 and it was 52 cents, and then in 1982 it dropped all the way
down to 42 cents, and now we are at 62. What is causing the dras-
tic increase in cost for IRS?
Mr. Dolan. Well, I ^ess I might start with the observation that
that is still not a bad mvestment, even if you take the full 62 cents
on a $100 return. But I would also say that I think the 62 cents
is inflated by at least 5 to 6 cents, that that represents the extraor-
dinary capital investment associated with tax systems moderniza-
tion.
And then I come back behind that and say that I think the world
is a lot more complicated in 1993 than it was in 1982, and given
the combination of the multiplier effect of Tax Code changes that
have occurred and, quite frankly, the range of businesses that the
IRS has been invited into and expected to perform effectively, there
has been quite an expansion in that period of time.
Mr. Brewster. I notice the number of employees has just about
doubled in that length of time, while it is obvious the population
of the Nation has not doubled in 20 years. Is the range of business
greater than IRS should be in?
Mr. Doi^AN. From my perspective, I think we are in businesses
that are related to one another. I think we are in businesses that
we are capable of performing effectively, and I think we do our
darnedest to get the kind of return on those businesses that make
folks like this Oversight Subcommittee believe it is the right in-
vestment.
Mr. Brewster. I am having a difficult time believing that at the
moment. When you look at the reduction of 52 to 42, if you could
give me something in writing on that as to the reasons why it de-
clined. The cost of collection declined for 10 years, and 1 would
have to assume that was due to computerization and better meth-
ods of recordkeeping, and all of a sudden it increased dramatically
from 1982 to 1992.
On another question, what would be the six major TSM accom-
plishments we could expect to see at the end of fiscal year 1993
and fiscal year 1994? When you come back here next year, what
should we be able to see from TSM?
Mr. DoivVN. That is a fair question. Hank?
Mr. Philcox. Mr. Brewster, during 1993, I think we can look for-
ward to an expansion of electronic filing. We will receive oyer 12
million returns, and along with that have implemented additional
fraud detection capabilities.
We will also be expanding or will have expanded to 8 additional
States, so we will have a total of 15 States that we will be cooper-
ating with in a joint electronic filing environment. Our automated
underreporter program will be implemented in 3 additional service
centers. That is going to provide productivity benefits in that pro-
gram that you had asked about earlier.
178
We will be fully implementing our corporate files on-line project.
That will provide information to our caseworkers that they have
never had before, extensive amounts of information that will allow
them to work cases and deal with taxpayers at first point of con-
tact. They have never been able to do that before.
Those things, along with the fact that we will have by the end
of 1993 already have awarded two major contracts, one for a feder-
ally funded research and development center, and the other for our
SCfRIPS contract in 1993.
Did you ask for 1994, as well, sir?
Mr. Brewster. Yes, in fiscal year 1994.
Mr. Philcox. In 1994, we move into fully implementing that
SCRIPS contract. We will have the pilot in our Cincinnati Service
Center in November, and then begin implementing additional sites
in June of 1994. We will also be expanding our TAXLINK project
down in Atlanta. That is the electronic of "EDI" connection with
the payers of withholding, so they no longer have to file with paper,
they can file electronically through their oanking institutions. That
is going to be expanded nationwide on a voluntary basis.
We will be also awarding three other major contracts in 1994,
one for a document processing system which will be piloted in our
Austin Service Center. Mr. Chairman, you have been made aware
of that and briefed on it. Also, our corporate systems moderniza-
tion/mirror image acquisition contract and another contract for our
telecommunications environment will be awarded in 1994.
Finally, we will also be implementing the first of our integrated
case processing applications. I believe that there is about $82 mil-
lion in the 1994 budget that will allow us to do that. The money
in that 1994 budget will also allow us to further expand our telefile
filing initiative, which we have piloted in the State of Ohio. We will
spread that out to 7 States, based on the positive evaluation of
1992 and 1993. It will also allow us to further expand our Federal-
State electronic filing capability. So those are some of the things
we will accomplish by the end of 1994 with the budget that we are
looking at for that year.
Mr. Brewster. I note, too, with some interest that you are ask-
ing for a staffing increase of 6,681 positions. Is that correct?
Mr. DoLAN. I am not sure where that is coming from, Mr. Brew-
ster.
Mr. Brewster. What are you asking for in staffing increase?
Mr. DoLAN. It is 792 positions for fiscal year 1994.
Mr. Brewster. 791?
Mr. DoLAN. 792.
Mr. Brewster. 792. So you have gone from 68,000 employees in
1972 to 115,000 now, right?
Mr. DoLAN. Correct.
Mr. Brewster. At a time when computerization is increasing,
most industries are downsizing the number of employees and it
looks rather unusual to me, with the increase in personnel.
I also note that there is about $90 million left over unspent fi-om
the 1990 fiscal year. Is that correct?
Mr. DoLAN. I think what I may have done, Mr. Brewster, is
touched on that point before you came in. The answer is yes, there
is $90 million. I pointed out two driving reasons for that. One was
179
the request from the Congress that $97 million of our 1992 alloca-
tion not be spent until the last day of the fiscal year, which made
it difficult to do intelligently, and so some of that moved over.
The other is because of choices we are making today to be able
to achieve still further efficiency by not going to 10 service centers
to replicate today's computers. Because we will be able to do, as a
result of the tecnnology in 4 or 5 centers, what we used to have
to do in 10, we have neld back on doing site preparation that at
one point we expected we would have to do across all 10. So that
is captive in that $90 million that is still there, as well.
Mr. Brewster. I note, too, that you had $148 milHon in the stim-
ulus package, and yet I don't see where that is in the current budg-
et request. Is that correct?
Mr. DoLAN. You are correct, it is not in our current budget re-
quest.
Mr. Brewster. If that was so important in the other, why is it
not in the budget request?
Mr. DoLAN. Again, as I tried to explain earlier, in this process
there were a number of things that we thought we could achieve
in 1994, and in the process of making judgments about relative pri-
orities, those things did not find their way into our budget.
Mr. Brewster. I would like for you to give me some information,
though, as to the circumstances concerning the decrease in cost of
collection from 1972 to 1992 of 10 cents, from 52 to 42, and now
an increase of 20 cents from 1992 currently.
Mr. DoLAN. I would be happy to do that.
[The following was subsequently received:!
180
COST TO COLLECT $100
Clearly, if you consider all costs associated with doing
business, the bottom line numbers over the last several years
have shown more of an increase than in the earlier years.
Since 1990, however, the major factor causing this growth has
been the capital investment costs of modernizing the tax
system. When you discount for the cost of making these
capital investments, the IRS cost to collect $100 has been
essentially constant. In fact, if you remove the growth in
our Information Systems budget since 1990, the projected cost
for collecting $100 in FY 1994 is still $.48 — the same cost
to collect $100 as in FY 1991. When you add the growth costs,
however, the FY 1994 number jumps to $.56 per $100 collected.
We would sound one cautionary note in terms of putting too
much emphasis on this ratio of IRS costs to Treasury receipts.
Naturally, the ratio of IRS costs to Treasury receipts can
shift dramatically if there is a significant shift in receipts
(for example, a change in the marginal tax rate) . This shift
may occur independently of any improvement in IRS
effectiveness or efficiency. In that case, a jump in receipts
would change the mathematical formula and drop — artificially
— the IRS cost to collect $100 even though there has been no
actual reduction in the IRS cost of doing business.
181
Mr. Brewster. Thank you.
Chairman Pickle. Thank you, Mr. Brewster.
Before I recognize Mr. Herger, I want to follow through, Mr.
Dolan, on one or two of the questions I didn't get satisfactory an-
swers to with respect to transfer pricing. I want you to tell me ex-
actly how you would spend $30 million in the next 5 years and only
raise approximately 50 million dollars' worth of funds. Now, you
gave me an answer that you might collect, I think you use the fig-
ure of $148 million. How did you arrive at $148 milHon? Where
does that come in?
Mr. Dolan. Mr. Chairman, let me start at the beginning on the
investment versus the yield. I think, as you know, there is a pro-
jecting model that is used and so our $50 million is a result of the
way that revenue is scored, and the way that revenue is derived
from our application of those staff-years.
I personally believe that there is a yield capability well beyond
the $50 million. I hope it is
Chairman Pickle. The testimony says $50 million.
Mr. Dolan. Well, that is because of the projection regime we use,
Mr. Chairman, so as not to come before the Congress and overstate
the yield of an investment.
Chairman PiCKLE. The previous Commissioner said you might be
losing $3 to $10 or $15 bilHon. Now, vou ask for $30 milHon and
you said but we are not going to raise out $50 million. I don't want
to argue the point, but how do I explain that? How does the public
understand that?
Mr. Dolan. I guess from my lights there may be two different
issues. One is, I don't know that we are capable in one budget re-
quest of asking for enough of the right kind of things to make the
tax gap go away in FCC's.
I would say to you, Mr. Chairman, that a couple of the critical
things in this 1994 package have to do with laying some infrastruc-
ture in place that we have not had in the past. We will hire exper-
tise that we don't have in the Internal Revenue Service today. We
will avail ourselves of data bases that we don't have today.
Chairman Pickle. We have already given you 150 new examin-
ers. You sav you will hire, and I trust that you will. But you have
already had some extra help given to you just in this field.
Mr. Dolan. That is correct.
Chairman PiCKi^. I just don't understand the method you use in
arriving at the sum. Now, in these transfer pricing cases, what tax
years are you using now in your latest survey about income? How
much are we losing? What tax years are you taking?
Mr. Dolan. Is the question what tax years are under examina-
tion?
Chairman PiCKLE. Yes.
Mr. Blattner. The tax years that are under examination on
foreign- controlled corporations would generally be 1990 and 1991.
Chairman PiCKLE. Now, the information I have is that your last
figures that you have given to us, you used the audit years from
1986 and 1987.
Mr. Dolan. I think, Mr. Chairman, we are talking about two dif-
ferent things. I think you may be referring to the last TCMP sam-
ple, the tax years involved in the last international TCMP?
182
Chairman Pickle. I am assuming it was the tax years with re-
spect to 482 cases and that you have used the years 1986 and 1987,
that period, and I want to know why don't you use now the years
1990 and 1991, current years.
Mr. DOLAN. Mr. Chairman, that is part of the point I was trying
to make earher, that one
Chairman PiCKLE. If you are using the current year, are you tell-
ing me then it is only $50 million out of 3 years?
Mr. DoLAN. Let me see if I can avoid confusing you. I think what
Mr. Blattner says is that we are examining today in the active
audit stream tax years 1990 and 1991 of many foreign controlled
corporations.
Our research data, the last data upon which we would project
general trends, would be earlier than that, but part of what you
are buying in this $30 million investment is access to data that is
even more real-time, more current than the 1990 and 1991 tax
years.
Chairman PiCKLE. I want to ask that you specify more with our
committee, so we do have an understanding. I will tell you what
I think you probably ou^ht to do: It seems to me like you ought
to take 5 or 10 of the major corporations in the United States, take
the years 1990 and 1991 or 1992 and have a specific examination
ongoing for 1, 2, 3 years, and say that we want to have a report
made to us, not this broad, not questionable about the explanation
given to me now.
I think maybe it might be appropriate for our committee to give
the recommendation to the Appropriations Committee that tney
give you money for some of these operations contingent upon the
completion of these kinds of studies, because we don t seem to get
any information. We don't know what you are really telling us. And
I think we will make that recommendation to the Appropriations
Committee, so we can get something definite.
We know what the facts are, we think just as well as you do or
as a well as GAO, but we don't seem to get anything done about
it. You seem to be going backwards, instead of going forward. I
think the facts ought to oe known about those American corpora-
tions doing business overseas and foreign corporations doing busi-
ness here.
So my question to you now is who at IRS is in charge of transfer
pricing cases?
Mr. DoLAN. The Assistant Commissioner, International, Regina
Deanenann is
Chairman PiCKLE. Do you have a chairman or an individual who
is responsible for 482 cases?
Mr. DOLAN. We do, Mr. Chairman, and I think
Chairman PiCKLE. Who is that?
Mr. DoLAN. It is a gentleman by the name of Joseph Rosenthal,
who has recently been hired by the Assistant Commissioner, Inter-
national. He is a person who comes to his job having experience as
a lawyer and a CPA. He has worked in the appeals function, and
in the exam function. He is a very qualified individual.
Chairman PiCKLE. We will get better acquainted with that gen-
tleman.
The Chair now wants to recognize Mr. Herger.
183
Mr. Herger. Thank you very much, Mr. Chairman.
Mr. Dolan, could you describe what your plans are in the area
of motor fuels excise tax evasion? I notice in your statement where
some $2.5 million, I believe 25 employees are being added. Could
you go over that with me, the issue very quickly, which I am some-
what aware of, and just what your current plans are for how we
are going to utilize these people/
Mr. Dolan. It actually is in two pieces. One is the civil side and
the other is the criminal side. In the civil arena, we are building
on a pattern of having identified both in the gasoline and diesel
fuel area a series of returns in the last 5 or 6 years that have iden-
tified some trends, some of which we will continue to try to get at
in the examination process.
But in a more comprehensive way, what we are trying to do is
work with States, as well as make a relatively new process, an ex-
cise tax registration validation system, come into being in a way
that we will not have to essentially spend all of our time examining
at the exempt certificate level. So we are trying to ratchet up some
national systems that will allow the tracking of the motor fuel
uses, particularly in the area of the exempt purchasers to not be
as fact and examination specific, to be able to manage that on a
more comprehensive basis. That is the principal civil initiative,
along with some more audits.
On the criminal investigation side, we have found an alarming
involvement of organized crime, particularly in the diesel area. So
what we have done over the last 2 or 3 years is acquire increasing
sophistication in rooting out some of the more insidious organized
crime involvement in diesel evasion. So those are the two compo-
nent pieces of that initiative.
Dave, do you want to add any more to that?
Mr. Herger. And is most of this I believe in the area of diesel?
Is there much in the area of gasoline that is a problem, or is it pri-
marily in the area of diesel?
Mr. Blattner. Primarily in the area of diesel. We are also work-
ing with one State and the Federal Highway Administration, trying
to develop a system where we can trace diesel fuel in inventory
through the distribution process in that State. This is a cooperative
effort where we believe if we can work together and significantly
improve our ability to track the diesel fuel, we will be able to im-
prove compliance dramatically.
Mr. Herger. Tracking, does that have something to do with
coloring of the fuel? Is tnat what you are referring to, or are you
referring to something other than that?
Mr. Blattner. We are not coloring it. What we are doing is
keeping track of it at all import sites and then following the fuel
until actual consumption.
Mr. Dolan. If I could come back to your earher question, I was
just handed a note that identified that 60 percent of the cases we
are working in this that are currently in inventory
Mr. Herger. I am sorry?
Mr. Dolan. Sixty percent of our current fuel-related cases in our
criminal area do deal with diesel. Of the new cases that are being
created, about 80 percent of those deal with diesel. So diesel is the
predominant area of our criminal attention at this moment.
184
Mr. Herger. I represent a major agricultural area in northern
California, and this is certainly an issue. I know there has been
some suggestions in the past of putting a dye in the fuel which
would be very, very costly for our farmers. Yet, it is an area that
we need to address. I also have truckstops along the way that feel
there is a fairly major percentage of business that they are losing
that is going to this area. So it is something I am very supportive
of you addressing.
I notice that it averages about $1 million per scheme that you
have uncovered. While I am interested in you working this area,
we need to do it in a delicate way where we do not penalize the
vast majority, virtually all of them that are living within the laws,
and we not make life tougher for them and more expensive to do
business.
Mr. DOLAN. We are very conscious of that. I think that is part
of what underlies our interest in dealing with the more insidious
and invidious criminal schemes. The people who lose out are the
folks who are trying to play the game tne correct way.
Mr. Herger. Exactly. Thank you, Mr. Chairman.
Chairman PiCKLE. The Chair will recognize Mr. Houghton for ad-
ditional questions.
Mr. Houghton. I have two questions. One is about the employee
classification issue, you know, whether somebody is classified as an
individual contractor or somebody is classified as an employee and
the tax treatment of that. You are spending $30 million or approxi-
mately that in trying to track that down. What do you expect to
get out of this? How is the monev going to be used? Where are we
going to be next year when we ask this question?
Mr. Blattner. We are going to significantly increase the number
of examinations that we will be undertaking to determine em-
ployee/independent contractor status. What really has the most po-
tential benefit is we have been working with industry groups trying
to come to a definition of an employee and independent contractor
that the industry group can accept and IRS can accept. Then work-
ing together, we share that definition with members of that indus-
try group, so that we have a common definition of what is an em-
ployee and what is an independent contractor. That may have more
positive impact than just the enforcement, but we are coupling that
effort with an increased enforcement in dealing with examinations
and our revenue officers making contact to insure that the employ-
ee's designation is proper.
Mr. Houghton. So you, in effect, feel that with the expenditure
of this money, with the elapse of 10 or 12 months, that you will
have pretty much resolved this issue?
Mr. Blattner. No, I do not expect that.
Mr. Houghton. Did I put words in your mouth?
Mr. Blaitner. I hope that we can make meaningful progress in
dealing with the problem, and I think the real solution is working
with industry groups so that we can have a clear commonly accept-
ed definition. I don't believe we will solve this problem in the next
12 months. A lot of the problem involves cash businesses, and that
has many other ramifications. We are focusing heavily on trying to
deal with cash businesses, so that we can have proper definition of
an employee/independent contractor and proper reporting of the
185
cash income. I believe this will have a material impact and to im-
prove the situation.
Mr. Houghton. I think that is the most important issue.
The second question has to do with your area of expertise, Mr.
Dolan. I know that, sort of on an ex post facto basis, you take a
look at veterans benefits and food stamps and things like this. But
in every part of the Government, there is a very special process ex-
pertise which could be used in other parts of the Government.
Many times, when some of us go back and go to the town meet-
ings, we are exposed to people who are really worried about excess
expenditures, extravagances, too much money being lost through
the system. I wonder whether you are helping other agencies, not
specifically to divulge obviously sacrosanct information, but some of
the things you do, because you probably are the greatest repository
of processed technology to catch people who are trying to defraud
the Grovernment of any organization around.
What are you doing to help some of these other agencies that
have this problem? Do you talk to them? Is it so confidential that
you are unable to? What is happening? Because there is a big area
here.
Mr. Dolan. That is a very interesting question and it is one that
we find ourselves, even as we speak, contemplating more broadly
than we have in the past. The short answer is we do a fair amount
of that today and probably have the capability of doing more. The
place that it is most concrete in today's world is we have a very
proactive relationship with almost all the State taxing organiza-
tions. We work on a predicate there, from the most fundamental
to the most sublime, of looking for places to not replicate each oth-
er's energy and to learn from each other.
For example, we this year are doing joint electronic filing with
15 States, which means essentially the customer of the tax process
only has to do it one time, and we can strip data off and move it
to the respective taxing authority.
Another very promising one is an initiative with the Labor De-
partment and with the Social Security Administration around the
vexing issue of the number of places employers have to send infor-
mation about the act of employing and paying their employees.
They have to send their Social Security reams of data to us, reams
of data to the Labor Department, local and State unemployment
authorities, local and State taxing authorities. We have something
that we are calling a simplified wage reporting initiative that is
gathering a fair amount of momentum, which we hope holds out
promise of being able to standardize a regime where the employer
could ideally file one place and have it stripped off and spread
around the Government.
Mr. Houghton. If I could just interrupt a minute, I am not to-
tally knowledgeable in this area, but my perception is that maybe
the biggest area of fraud is in Medicaid. I can't prove that, but peo-
ple drawing down their assets, disbursing them to their families,
being exposed then to a whole new government sourcing of medical
funds, and that was not the intent of the program.
Of course, as you know, the most rapidly rising part of that rap-
idly rising area is Medicaid. I don't know whether you are doing
186
anything in that area, but certainly attention needs to be put in
there.
Mr. DOLAN. I think it is a good suggestion. Outside of the context
of individual casemaking, of which we would do some in that area,
we do not at the moment have any comprehensive interaction
around the issue of financial fraud that might be present in that
industry. As recently as last month, at our senior level we have
had two encounters, one with the Los Alamos Laboratories about
some work they have done in the broader financial fraud areas,
and they, as well as the Kennedy School at Harvard, have both
suggested possibilities for some teaming to be done in this area of
financial fraud. It is an area that we have a lot of interest in trying
to contribute what we can, but also staying on our own active
learning curve in terms of applying those within the IRS.
Mr. Houghton. Just one more comment, Mr. Chairman.
I really think that in the area of fraud, the large sums are in this
area. I am going to continue to be interested in this thing, because
when you take a look at any health care plan which comes out of
the White House and the costs involved, there is so much that can
be done to contain those costs, when you are taking a look, for ex-
ample, at increasing the insurance for 35 million-plus people who
don't have any coverage at all. So those types of surveillance are
going to be extraordinarily important, and the arithmetic says they
have not been attended to.
Mr. DoioAN. I would say that we would welcome an ongoing dia-
log with you, and I think some part of the thought process you re-
flect is behind one of our 11 initiatives in the underfunding of pen-
sions plans. That is clearly an area where we think we have syn-
ergy between our mission and PBGC's in trying to identify up front
the things that may become PBGC's bad debt at the back end. We
are trying in that area to leverage some things we think we do well
in concert with parts of their mission that they do well.
Mr. Houghton. Thank you.
Chairman PiCKLE. I believe Mr. Jefferson has further questions.
But I'd say to you, Mr. Dolan, a few minutes ago you said to me
that with respect to auditing 482 cases that you use the 1990-91
tax years. I'm advised that's not correct. I want to ask you or the
staff, are those the years you said they've audited to ascertain the
impact on both the accessioility of information and the enforcement
provisions? What years were you talking about?
Mr. DOLAN. Let me try to replay what I think I said. Then I'm
going to ask Dave Blattner to correct me if I was wrong, I think
I was trying to differentiate between two things. The first question
that we answered, I believe was, what are the years that are under
audit in the current examination of FCCs? Ana I think the answer
to that was they would be 1990 and 1991 tax years.
As I further understood your question, I thought you might have
been referencing what would be the years from which the samples
would have been derived out of our TCMP for which to make pro-
jections.
Chairman PiCKLE. Mr. Blattner, what is the answer to this?
Mr. Blattner. Of the foreign-controlled corporations, 220 of
them are large cases, are big taxpayers. For that universe we are
auditing the 1988, 1989, 1990 years. That's a small part of the for-
187
eign controlled corporation universe. The big ones, we are in the
late 1980s. The smaller FCCs that we're working on a regular basis
we would be working years 1990 and 1991. So the answer to your
question is really both. But for the big, big foreign controlled cor-
porations our cycles would put us in the 1988, 1989 timeframe.
Chairman Pickle. All right. Now that is essentially the answer.
The information we were led to believe by Mr. Dolan that it was
the current years, 1990 and 1991. That is not correct. It's more cor-
rect what you said.
Now let me ask you to do this, Mr. Dolan. We're going to ask you
to give us a copy of the audit years of these firms you have ref-
erenced. If I'm going to make a recommendation to the Appropria-
tions Committee, then we've got to have some emphasis put on it
and make funds contingent upon that information. I've got to be
correct that I know what I am talking about, the years. So we're
iust going to ask you to give us that information and my staff will
oe in touch with you, so we can have that information.
[The following was subsequently received.]
Audit Years For FCC Returns
As of March 1993, our international examiners were involved in a total of 9,969
cases. Of these, 2,450 (25 percent) were foreign-controlled corporations cases. The
FCC tax years covered include 51 percent in years 1990 and after, 19 percent with
1989 years, 13 percent with 1988 years, 8 percent with 1987 years, and 9 percent
with years 1986 and prior.
Mr. Dolan. Mr. Chairman, let me hope that you don't believe
that I was misleading you on the 1990, 1991.
Chairman PiCKLE. I think you gave me kind of a broad state-
ment, and I think your staff sat there and accepted it, and I think
the record ought to be made clear.
Mr. Dolan. Can I go beyond that though? Mr. Chairman, I think
one of the things that I would very much like to leave today's hear-
ing with is that we understand your intense interest in the FCC
and the IRC 482. I think there's a considerable opportunity for us
to get a meeting of the minds on data, on what meets your needs
and what meets your staffs needs so that
Chairman Pickle. When we get the copy of the audits you have
referred to, we'll be able to understand now what we're talking
about factually. So we're going to do that and we'll know it for
sure.
In other words, I'm weary of not getting good information in this
field. The public, I think, grows weary of it. We're entitled to know
the facts. And we're entitled for you not to continue business as
usual and give us broad brush answers. I think we're going to try
to be more specific in this field.
Mr. Jefferson.
Mr. Jefferson. Mr. Chairman I want to ask two questions. The
first is, the GAO has reported that the Internal Revenue Service
examination plans don't include any of the detailed audits done
under the taxpayer compliance measurement program. For 30
years, of course, these TCMPs have been the Internal Revenue
Service's only tool to objectively measure taxpayer compliance and
select tax returns on which an audit could be the most productive
and most informative.
188
What are your plans for TCMP audits? And if you don't do them
or if it isn't covered in your budget, then won't the Congress be left
to rely on 1988 data in trjdng to make decisions about tax policy —
data that may be too outdated to be reliable?
Mr. DOLAN. Mr. Jefferson, we have had an ongoing dialog with
the General Accounting Office in this area. It is our objective to
have more current data available to us with which to measure com-
pliance, upon which to identify tax returns to audit, and make deci-
sions about how to improve compliance. In the past, we have relied
on TCMP for much of this data. At this point, TCMP has not been
replaced by any other measurement system.
When we conducted TCMP surveys of individual taxpayers, we
examined roughly 55,000 returns, the results of which we used to
decide where to apply our resources most effectively. These deci-
sions were based on data that described conditions 4 to 5 years ear-
lier.
One of the initiatives that I identified in my opening statement
is for something we call a compliance research and analysis sys-
tem.
We believe that we can make better use of data that's in our sys-
tem today by combining it with data from external sources to
achieve a greater understanding of the forces that affect compli-
ance and to be able to do so in a more timely manner.
We will not have gone through two or three economic cycles be-
tween the time that we took a TCMP sample and the time when
we implement corrective action.
So our long-term objective is to rely less on TCMP. Until we are
able to do this, we will continue to rely on TCMP.
Mr. Jefferson. So the report that it's not covered in your budget
request isn't correct then? It is in your budget request for this
Mr. DoLAN. I don't know that. Maybe Mr. Blattner can answer
what TCMP work is to be done or not to be done in 1994.
Mr. Blattner. I don't have that information.
Mr. DoLAN. Let me give you this answer. The fact that it doesn't
show up as a budget request in fiscal year 1994 doesn't necessarily
mean that we're abandoning TCMP. I'm not sure what part of
TCMP would or would not fall into 1994. It is not a budget year
specific program.
Mr. Jefferson. But your contention overall is that you are going
to continue with TCMP this year. You have a long term plan to do
something different.
Mr. DoLAN. Can I furnish you a more particularized response?
When we originally proposed to halve the sample size of TCMP,
GAO did not think that was a good idea. We described the smaller
TCMP as our way of fulfilling some needs while we started devel-
oping long-term solutions. In our reply to GAO, we essentially
agreed to do the full TCMP. But I think what we did was move it
back somewhere in the timeline. I'll give you a detailed description
of where we are today on that.
[The following was subsequently received:]
TCMP In FY 1994
The Service is not planning to conduct a TCMP survey of 1993 returns. Our deci-
sion to postpone the survey is based on insufficient time to determine the compli-
189
ance data that we need and to design and program specifications for selecting a
sample of returns that will provide the data.
In lieu of a 1993 survey, we will begin designing a survey of 1994 returns. Some
initial design features we are considering include stratifying taxpayers by industry/
market segment and selecting a sample across all types (Forms 1040, 1120, etc.) of
filed returns. Also, survey returns selected from specific market segments will be
assigned to examiners who have been specially trained to detect compliance issues
associated with those segments.
The design of the fiscal year 1994 survey will approximate the size of prior TCMP
surveys, require consideration of all return line-items, and allow us to compare re-
sults with those surveys.
Mr. Jefferson. Last thing. The inspector general's report of the
Buffalo district office, are you familiar with that where there were
some criticisms made of management and misconduct and so on?
Mr. DoLAN. I am.
Mr. Jefferson. I don't have to detail those things, you're already
familiar with it. The question is, is this an isolated instance or
have you uncovered this sort of misconduct at other Internal Reve-
nue Service operations? And if vou have, to what extent?
Mr. DoLAN. Mr. Jefferson, I d like to be able to say to you cat-
egorically that it's isolated. I believe it to be an aberration. But I
would also say to you that over the last 4 or 5 years we have had
a very aggressive ethics and integrity program ongoing in the orga-
nization to which we have encouraged people to come forward and
identify the things that bother them, that they thought were prob-
lematic. I will tell you, out of that process came a lot of identifica-
tion of things that we weren't happy about.
I think in Buffalo we had a convergence of those. It was the kind
of extreme circumstance on which we thought we had to take pret-
ty categorical action. We did take action. I suspect we have other
places where we need to improve in either the performance of a
senior manager or somebody in the management stream. But I
think we have both an environment and a consciousness about
identifying those areas and correcting them that I think is going
to be healthy for the organization.
Mr. Jefferson. Do you have any report anywhere about where
these problems are. and what ofTices, and what
Mr. Dolan. Probably the closest thing we would have is the
record that the Treasury Inspector General keeps in terms of the
compendium of allegations that are surfaced, investigated, and
then identified as either needing action or not needing action.
Mr. Jefferson. Thank you, Mr. Chairman.
Chairman PiCKLE. Thank you. Mr. Brewster, do you have addi-
tional questions?
Mr. Brewster. Yes, Mr. Chairman. I note with some interest
that in your budget request you're asking for 44 additional posi-
tions and $12.5 million to explore the possibility of contracting out
some tax collection jobs to private industry; is that correct?
Mr. Dolan. There is an initiative, yes.
Mr. Brewster. With that then, if you do pursue that avenue,
there are several questions that I would have. Number one, will
there be a reduction in employees at IRS?
Mr. Dolan. What I started to do was give you a longer answer
than I thought you wanted. Let me try not to give you a real long
one now. That initiative, Mr. Brewster, is designed to take work
that we're not getting to now. It's in either what we call our queue.
70-792 0-93-7
190
which is at a dollar threshold below what we're able to work, or
it's in something that we have called currently not collectible. It's
been worked once and based on a fact pattern at that point, we put
it in abeyance so that we could work the higher yield, more current
cases.
What this initiative is designed to do is some experimentation
around whether we could get some private vendors to help locate.
Some of the things that get written off as currently not collectible
are because we couldn't locate the taxpayer.
So it's designed to look at whether it would pay to look for some
of these lower dollar yield cases in ways that would still enable us
to train our major resource on the higher yield, the more active
cases. We want to see whether there's any advantage to using pur-
chased resources essentially to do some of the end of the stream
that we're not now getting to. Right now, we don't know what the
answer will be. It's designed to be more an experiment than it is
an operational decision about how to do collection work.
Mr. Brewster. What enforcement powers would these contrac-
tors have?
Mr. DOLAN. They will have none. The contractors will have a
very limited scope of responsibility. It will be in the area of identi-
fying, locating people, and in some instances, identifying to the tax-
payer, once located, what the alternatives are in terms of paying
the IRS — that is, the fact that installment agreements are avail-
able and our various forms of pajnnent. But they'll have none of the
enforcement responsibilities. They will have none of the tax compli-
ance responsibilities that reside in the IRS now.
Mr. Brewster. So how would you expect them really then to en-
force collection of money if they have no enforcement mechanism?
Mr. DOLAN. What we would gain
Mr. Brewster. They would contact you and say, I've found old
so-and-so and you'd collect it?
Mr. DoLAN. Again, this is experimental. We haven't spent day
one on actually doing this yet. But potentially what we would do
is put with a contractor one of our employees who does have en-
forcement responsibilities and authorities. And possibly, as a result
of identifying cases that ought to be worked with IRS authorities,
then we would trigger that employee to take the actions that are
unique to the IRS.
Mr. Brand. Mr. Brewster, about 17 States are currently using a
similar type activity, and it has been an interest of 0MB to test
this concept as to what in fact would result. So we're a long way
from where we would make even an operational decision on this.
It is simply a test.
Mr. Brewster. I have no quarrel with doing that if you can im-
prove efficiency and cut down cost. One thing that struck me very
quickly, how are you going to prevent some fraudulent group from
going out there and representing themselves as this type deal and
collecting the money?
Mr. Blattner. This collection operation would not receive any
money. The only thing they woiild tell the taxpayer to do is to pay
IRS.
Mr. Brewster. Your people you contract with. But how are you
going to prevent someone else from saying, we're the people that's
191
representing the IRS in this and give us the money, we'll give it
to IRS?
Mr. DoLAN. That's clearly one of the issues that we would have
to work our way through in the test, because even without being
in this business today we've got folks who fraudulently represent
themselves as the IRS and attempt to prey on people who don't
know better. So that would clearly be a problem we'd want to work
our way through. It may be a bigger problem than we could over-
come.
Mr. Brewster. I'll be interested in seeing how you develop this
situation. If it improves efficiency, that's certainly in the right di-
rection. And when you see the numbers from 68,000 to 115,000 em-
ployees, I've got to think there's some efficiency improvement avail-
able there, especially as the computer age has increased so much
the last 20 years.
Mr. Do LAN. Can I pick up on that? I think you have rightfully
taken that play at us a couple times today, and I want to come
back and respond in the way that you asked to the change in dol-
lars, and I'll do that by writing. But one of the things that I would
want to also do is, if I could for a minute, is thump my own tub
in the sense that we have, over the last 2 years, essentially pro-
duced 90 million dollars' worth of productivity savings as a result
of challenging the way we do business and using our technology in-
vestments.
As I mentioned earlier, this budget has us signing up for $55
million more; $20 million of that is a little suspect because of us
not being able to get the stimulus package. But we don't at all
shrink from your basic urging to look for more productive ways to
do business. We think we owe it not only to the subcommittee but
to the citizenry to look for those kinds of ways to become more effi-
cient.
Mr. Brewster. I have noted that the last 2 years you've actually
reduced employees from 115,628 in 1991 to 115,268 this year. But
the cost has gone up $1 billion, from $6.1 billion to $7.1.
Mr. Doi^N. Again, a good part of that is potentially improperly
cast in that there's a lot of capital investment in there on our way
to our systems modernization.
Mr. Brewster. I understand.
Mr. Brand. I was just going to say, Mr. Brewster, you are cor-
rect. In fact, the FTE levels in our organization have been rel-
atively flat now since 1990, and we are still on that kind of track.
I think as you cost the operations of IRS there's probably three ele-
ments to consider. The first is, in fact, the volume of work; the
number of returns and the actual volume of work assignments IRS
is doing.
We have also, because of the increased complexity of workload
that Mike alluded to in such areas as international, experienced
labor costs in fact going up. Lastly, there are always economic im-
pacts as to how much effort it takes to collect dollars, whether you
collect them earlier in the stream at less cost or later in the stream
at more cost. So there are a variety of factors at work that contrib-
ute to what it costs to collect $100.
Mr. Brewster. Thank you.
192
Chairman Pickle. Thank you. Mr. Herger, do you have addi-
tional questions?
Mr. Herger. I do; a couple quick ones, if I could. Mr. Dolan, just
a followup to my last question, if you have it. In the area of motor
fuel excise tax evasion we're adding about $2.5 million. Do you
have a ball park idea of approximately how much we're spending
in that area now? What that $2.5 million will be added to? What
our total expenditures would be approximately?
Mr. Blattner. Today in examination we are expending approxi-
mately 200 staff years directed toward diesel motor fuel. In crimi-
nal investigation, we had 108 prosecutions in 1992 on diesel fuel.
I don't have the staff years, but I could supply that for the record.
Mr. Herger. Thank you. Mr. Dolan, in another area, the Presi-
dent has indicated or has directed his Federal agencies to cut their
administrative overhead expenses by 14 percent over 4 years.
Could you tell me, go into a little bit what the IRS has done or is
currently doing to comply with this directive?
Mr. Dolan. Certainly. I think I may have done this perhaps be-
fore you entered the room. Part of that is to identify within our
1994 budget a 1,200-plus staff year reduction that we will take to-
ward that goal, that is in large part underwritten by some of what
we're able to do with technology. Beyond that though, we are in the
reasonably late stages of some organizational reinvention work
that has us with major proposals to take a good part of the balance
of that out of our headquarters and regional structure and over-
head.
So our objective, in relative terms, is to have at the end of the
day a higher percentage of our total resources on the front line
doing enforcement, service, and support kind of things. What we're
going to end up doing is take the balance out of headquarters, re-
gional offices, and overhead in our field offices. As I said, we've got
a plan that can achieve our 1994 equation; and for 1995 and 1996,
we think that what's on the drawing board in our reinvention .mode
will allow us to do that along with tne continued accrual of tax sys-
tems modernization productivity savings.
Mr. Brand. We've also recognized our percentage contribution in
those cuts in the budget formulation process.
Mr. Herger. Good. So that we are in the process of doing this;
is that correct?
Mr. Dolan. Yes.
Mr. Herger. Is that what I understand you're saying?
Mr. Dolan. Both as to staffing and a $30 million reduction we
took in the support categories as well, the President's objectives are
reflected in the budget that's before you for 1994.
Mr. Herger. What do you feel the effects of this will be?
Mr. Dolan. Ideally, we will be more efficient. I think it's incum-
bent on us as the senior leaders to do it intelligently and not do
it with any kind of an indiscriminate or meat-ax approach. I think
we have had the good fortune of having about a year's worth of ef-
fort underway to identify places we ourselves wanted to improve;
we ourselves had an objective of moving more resources to the front
line. So I think we have the capability of doing it correctly.
Mr. Herger. Will we be able to track this?
Mr. DoiAN. Yes, you will.
193
Mr. Herger. Very good. Thank you, Mr. Chairman.
Chairman Pickle. Mr. Dolan, I want to follow on quick ques-
tions. I understand that the administration is proposing to transfer
approximately $11 million in fiscal year 1993 appropriations from
six agency accounts, and that would include the IRS accounts, and
to transfer this money to the White House funding. Is IRS transfer-
ring some $7 million to the White House fund?
Mr. DoLAN. Yes, Mr. Chairman, we are.
Chairman PiCKLE. From where do you get that money?
Mr. Dolan. Mr. Chairman, the $7 million that's in question was
identified across three appropriations in the rent account in each
of those three appropriations. As you may well know, we have $538
million in rent in our budget, and in mid-year tracking there was
a $7 million surplus identified in that area. That's where the pro-
posal is coming from. Obviously you, the Congress, has to approve
any kind of a rescission like that.
Chairman PiCKLE. I understand that. Have you been requested
to transfer this money to the White House funds?
Mr. Dolan. I think what we've done, Mr. Chairman, is the
money has been identified and is part of the request from the ad-
ministration that is either before the Congress now or on its way
to the Congress.
Chairman Pickle. What would you have done with $7 million if
you didn't transfer it to the White House fiind? How would you use
that in the enforcement field?
Mr. Doi^AN. We would have most likely brought on some of the
revenue agents that will come in next year's initiative. We would
have brought some of that on earlier.
Chairman PiCKLE. Mr. Dolan, we've reached a point now in our
hearing where some members have gone or must go to another sub-
committee's markup of legislation. They want to be there to reg-
ister. Some may stay and some may come back here.
I'm going to suggest to the committee, as I said earlier, that we
have a recess now of approximately 10 minutes. I intend to come
on back — we'll send word to you immediately — because I want to
ask some additional questions on three or four areas. So I'm going
to ask you to just stand fast and we're going to declare an approxi-
mate 10-minute recess and then we'll resume the hearing in a few
minutes. I hope that's satisfactory. Is that satisfactory to all of you?
Mr. DOLAN. That's fine.
Chairman PiCKLE. We'll recess for 10 minutes then.
[Recess.]
Chairman PiCKLE. The subcommittee will come to order again.
I'm sorry that we had this inconvenience of having to call a recess,
but we had to accommodate some other committees too that had
previous meetings scheduled.
Let me ask a few additional Questions now. Mr. Monks, this will
be a question with respect to tne taxpayer's ombudsman. In 1977
we set up problem resolution officer positions in both the regional
and in the district offices and set up different procedures for their
responsibility. The program has worked well. I know in my own
district office we have a very effective problem resolution division
and it's extremely helpful to people who want a person-to-person
reply or response to their complaints.
194
Now we had a bill last year with respect to taxpayer's bill of
rights, and again this year at the beginning of the session I intro-
duced a Taxpayer's Bill of Rights 2. It is embodied in House Reso-
lution 22. It just simply contains a package of provisions designed
to provide taxpayers with additional protections and safeguards.
That is now pending.
My first question to you, Mr. Monks, is are you, as the new act-
ing ombudsman who succeeded Mr. Damon Holmes, do you support
the pending taxpayer's bill of rights?
Mr. Monks. Mr. Chairman, I think that there are a number of
provisions in the bill of rights that are excellent provisions and ob-
viously steps in the right direction. I think the Service supports the
majority of those provisions as safeguarding taxpayer rights. There
are some provisions relative to installment agreements, ofifers-in-
compromise, that I certainly see as a move in the right direction.
There are a couple of provisions, though, I'd like to comment on
that I do not favor. I'd like to focus on those. First of all, I want
to deal with the issue of whether or not the ombudsman should be
a political appointee or remain a Service executive. I feel that the
program has demonstrated its independence over the years and has
had strong support from the Commissioner's office, and the balance
of the organization vmderstands the unique position that the om-
budsman holds and the need for that position to be independent.
For that reason, I think it can work well with a Service executive
as the ombudsman.
I would also like to comment on the "line authority" that's pro-
posed in your bill — that is, having field problem resolution employ-
ees report directly to the Taxpayer Advocate. My own feeling is
that the organization works extremely well right now, and that's
been amplified by a number of other organizations such as AICPA
and the National Society of Public Accountants, TEI, and so on. To
change that organizational structure at this point in time would
tend to diminish the responsibility and accountability of the field
executives, including the directors at the service centers and dis-
trict offices for the program.
Right now they give excellent support to the problem resolution
officers in the field. They are the ones that are accountable for the
systems that are creating problems for taxpayers, and we want to
ensure that that accountability for beginning to improve those sys-
tems still lies with those individuals. It needs to be a team process,
with program direction provided from the Commissioner's office
and the ombudsman down to field executives and the problem reso-
lution officers.
I think moving to a line organization is not the right answer. I
think that leaving the problem resolution officers at the field level
under the direction of the directors is the best way for that pro-
gram to work.
Chairman PiCKLE. I understand you to say then that with re-
spect to the appointment of the ombudsman, you would think that
that person should be nominated by the IRS Commissioner and not
nominated by the President?
Mr, Monks. I believe it should remain a career executive within
the Service selected by the Commissioner, yes.
195
Chairman Pickle. Suppose the President were to nominate a ca-
reer person in the Service?
Mr. Monks. I'm sorry, I didn't
Chairman Pickle. Suppose the President says, all right, I'm
going to nominate one individual to be the taxpayer's advocate and
he comes from within the Service. Would that satisfy your
Mr. Monks. I think that would be fine.
Chairman Pickle. Would you feel deeply concerned whether the
person would be approved by the Senate?
Mr. Monks. That would not bother me at all.
Chairman Pickle. Either way?
Mr. Monks. That would not bother me.
Chairman Pickle. So if the President were to nominate some-
body from within the Service, that would satisfy your concerns?
Mr. Monks. I think that that would be fine.
Chairman Pickle. That's interesting. Now I know you don't nor-
mally want to see it, but I'm going to assume that if we have the
taxpayer's advocate, that person then is going to be reporting to the
Congress as well as to the Service. That does not bother your
Mr. Monks. That's right, and I support that provision. The om-
budsman has been making prior reports to Congress, along with
the Assistant Commissioner of Taxpayer Services, on various is-
sues. This requirement would, in effect, provide the Congress with
reports on recommendations made by the ombudsman and what
the Service has done about those recommendations.
Chairman PiCKiJ^.. The bill we have pending, the so-called Tax-
payer's Bill of Rights 2 that would require this new taxpayer's ad-
vocate to report to the Congress on the 20 most serious problems
encountered by taxpayers. What are the 20 most serious problems?
Mr. Monks. I don't have a list of 20, but I do have a short list.
If you want me to go over them, I could go over the list that I do
have, or we could provide them for the record.
Chairman Pickij<:. You could mention some of them and provide
me the whole list for the record. I want to know what they are just
in general and what importance you put to them. Where did you
get your list? Did you personally choose this list?
Mr. Monks. This is a list that was developed in conjunction with
the problem resolution staff in the national office. A number of
these issues are not new. They're issues that the Service has been
dealing with for quite some time, and there are actions underway
to deal with them. So I don't mean that they're not being dealt
with.
One is, of course, taxpayer's inability to access our telephone sys-
tems to the degree that they would like. Obviously, costs restrict
the certain number of telephone lines that we have, and taxpayers
have indicated they cannot readily access our systems.
Another is in the area of the tone and clarity of our notices. We
have done a lot of work in the notice clarity area, but we still have
a lot of work to do. We've recently initiated another task force, of
which I was designated as the chair, to begin to look at this and
try to simplify the process for improving clarity of notices and
streamlining the timeframe to get those notices into the system.
We have had meetings already and hopefully will have a number
196
of suggestions to make to the Service relative to improving that
process.
The accuracy of our information returns has been a continuing
problem and one that I think we've made some great strides on
over the past few years, but we still have problems in that area.
Taxpayers feel in some cases that we're not as responsive as we
can be in acknowledging their correspondence and getting back to
them timely. That's another issue that we're dealing with.
We've got some issues, I think, which the Bill of Rights 2 provi-
sions will assist us on, in the area of joint returns and some of the
issues that we deal with there — ^not being able to communicate to
one spouse an action taken by another.
That's just a short list. We have some others that we can deal
with and I would be more than happy to provide a fuller list for
the record.
[The following was subsequently received:]
197
PROBLEMS TAXPAYERS HAVE
DEALING WITH IRS AS IDENTIFIED
BY THE TAXPAYER OMBUDSMAN'S OFFICE
1. IRS does not fully know what concerns taxpayers have
with tax administration. The value tracking core
business system will be addressing this through
taxpayer focus groups and other data gathering efforts.
2. Clarity and tone of communications. IRS notices are
lacking in clarity and may contain IRS jargon. In many
cases, they do not provide adequate explanations of the
reason for the communication. In addition,
IRS communications to taxpayers take the same approach
whether the taxpayer has engaged in the same negative
behavior year after year or if the taxpayer has a
spotless history of compliance.
3. Issuance of erroneous notices by the Service. The
information reported to IRS by external sources on
wages, interest, etc., is not always accurate and
results in communications with taxpayers which are
sometijnes unnecessary, inaccurate or misunderstood.
4. Taxpayers are frustrated because when they submit
claims, payments, responses, etc., to IRS, they often
do not receive an acknowledgment and/or information on
the eventual disposition of the matter.
5. Inability to readily access IRS by phone. A recent GAG
report indicates that only 24% of taLxpayer calls reach
IRS when they call the toll-free number. This is
primarily due to current resource limitations.
6. Time delays on compliance related contacts. For
ejcample, IRS may not contact taxpayers on discrepancies
in income until two years after the income is received.
This burdens the taxpayer both due to the lack of
recall and potential additional charges for interest
and penalty.
7. Inability of taxpayers to get to one person who can
help them. The Service's one-stop service concept is
addressing this issue.
8. The complexity of tax laws and regulations.
9. IRS sometimes fails to update its files to reflect the
tajcpayer ' s most current address received by any
component of IRS. In addition, IRS frequently does not
take adequate steps to assure that its communications
reach both parties to a joint return when there has
been a divorce .
198
10. Cost to low income taxpayers of using electronic filing
to get quick refunds.
11. Implementation of the earned income credit. The ever-
expanding population of taxpayers involved with the
earned income credit frequently have less knowledge of
tax laws and need additional assistance due to the
complexities of this provision.
12 . Several million individuals each year who receive tax
refunds also make mathematical errors in computing
their tax. Currently the explanation of the error and
the refund checks are received from separate agencies
and in separate mailings resulting in confusion to
taxpayers .
13. The IRS mailout program for tax returns, estimated tax
payment vouchers, etc., is experiencing increasing
problems in these items reaching the intended
taxpayers .
14. Cash Management issues. The Service currently uses a
lockbox, i.e., a bank to receive and quickly deposit
checks, for individual estimated tax payments. IRS ' s
future plans envision a substantial expansion of the
use of lockboxes. There are issues involving potential
embezzlement and additional postage which need
resolution to assure that taxpayer burden and cost are
not increased by this cash management initiative.
15. Small business taxpayers are heavily burdened in
dealing with tax related issues including payroll tax
forms, FTDs, and differing filing and definitional
requirements for each type of tax, i.e., income, FICA,
FUTA.
16. The FTD process is extremely complex. Much attention -
must be paid to accounts of large taxpayers to assure
that the accounts are in proper balance.
17. Limited ability of taxpayers to do business with IRS at
convenient times and locations.
18. Administration of penalties. A large number of
penalties are imposed and then abated each year thus
causing an unnecessary burden on both taxpayers and
IRS.
19 . The inability of IRS to abate interest due to delays
caused by the IRS.
20. Taxpayers whose employers fail to provide timely Forms
W-2 do not always get the help they need from IRS in
obtaining these forms.
199
Chairman PiCKLE. Do you have any suggestions for taxpayer bill
of rights, number three?
Mr. Monks. Not at this point in time, but we're working on that
already.
Chairman Pickle. I would like to have any suggestions. I have
a feeling that the Congress is going to have a continuing concern
of saying to the public, we're going to give you more rights or we're
going to protect your rights in dealing with the IRS. I think this
is going to be an ongoing process. One or two of the things you just
mentioned are in the present bill of rights and they came from your
suggestions. So there are good things we can do as we study this
whole field. I'm glad to have these suggestions and any others, and
I would want you to give us a copy of these suggestions.
I notice you don't put anywhere in your listing the transfer pric-
ing question. Would that be one of your 20?
Mr. Monks. That's not on my short list, but I'm sure it could be
one of them.
Chairman Pickle. That will be on the Pickle list, and I may sub-
mit a list of 20 for you, too.
Mr. Monks. Thank you, Mr. Chairman.
Chairman Pickle. We'll compare lists then.
Last week at a committee hearing we made mention of a case.
I want to repeat to you the factual situation. In April, you re-
sponded to our subcommittee's inquiry on behalf of a taxpayer
whose case languished at the appeals level for 5 years while inter-
est accrued to more than $48,000. As I remember the case, the
original tax was no more than about $31,000, but penalties and in-
terest totaled $48,000. And it was pretty much admitted that the
delay was caused by the IRS's heavy inventory and lack of staff,
or at least the person assigned to it didn't take care of it. And for
5 years the interest and penalty built up.
Now as the taxpayer's ombudsman, Mr. Monks, do you believe
your response was an appropriate, fair answer. You were protecting
the handling of that case.
Mr. Monks. We did prepare a response to your office dated April
14 that outlined some of the circumstances. In general terms, I
think that 5 years for a case to linger in appeals is definitely too
long, and appeals would even acknowledge that. Obviously, this
case dealt with some extremely complex circumstances, and shel-
ter-related issues and so on. I don't know the full reason for why
the case lingered as long as it did but
Chairman PiCKLE. Then I submit that perhaps you ought to have
known this when the case was specifically submitted to you. Five
years is a long time for an individual to have to wait on a decision
of a case that didn't amount to $31,000 to begin with. And when
it languishes for 5 years just because nobody pays any attention to
it particularly, that's not acceptable. Should we amend the law to
take care of a situation like that?
Mr. Monks. I do agree that there should be some provision to
deal with issues, particularly on lower income taxpayers that this
would create a hardship for. And I do agree that 5 years is too long
for a case to languish in any one function in IRS.
Chairman PiCKLE. As you say in law, it's a res ipsa loquitur case;
the facts speak for themselves. That should not have happened.
200
And if cases like that linger on the books a long time the public
becomes disillusioned and angry and they have a right to be.
Mr. Monks. I agree.
Chairman Pickle. I know, Mr. Monks, I understand you're going
to be retiring. You have acted in a very short time, so you don't
have to be too accountable for what you re testifying here today. If
you've got anjrthing additional, you may be recognized for that pur-
pose, or if you have any suggestion for us in the general ombuds-
man field.
I think this committee is trying to say that we want a taxpayer's
advocate down there — and this is no comparison of Mr. Holmes'
work. He'd been an effective public servant down there. But we
want to know what you're doing, and we want to have a report
from you — the Congress — the same as the IRS has it, and under
the bill proposed we can do that. We just simply want to know how
you're responding and who you report to so we have that same in-
formation up here.
I don't want you to lose your independence or I don't want it to
become political. But after all, the Commissioner is a political ap-
pointee, and I don't see what if we have an advocate responsible
to Congress that that is any more political than the other. But I
think those things are generally understood and agreed to.
We wish you well as you go back to Arkansas. It seems to me
like nearly everybody from Arkansas is coming to Washington, and
here you're going back, for whatever reason. We wish you well and
we thank you for your service.
Mr. Monks. Thank you, Mr. Chairman.
Chairman Pickle. Now let me ask some additional questions
here. Mv next area would be in the underfunded pension plan area,
Mr. Dolan. You've got a budget proposal now for IRS that rec-
ommends a sum of about $2.9 million for fiscal year 1994 related
to underfunded pension plans. I assume the reason for that initia-
tive is because, you said the Federal Grovernment has a direct in-
terest in the prevention of underfunding because underfunded ter-
minated plans are unable to pay promised benefits to participants,
forcing the PBGC to assume responsibility for underfunded plans.
I couldn't agree with you more. Can you tell me, what would we
accomplish under the administration's revenue initiative? If you're
going to have $2.9 million for this, what is it for?
Mr. Dolan. Mr. Chairman, let me start by saying it's divided in
two general areas. One is what we identified as a comprehensive
study, and the other are a series of 2,000 enforcement examina-
tions. But John Burke, who is our Assistant Commissioner
Chairman PiCKLE. It's for a study and enforcement? All right.
Mr. Dolan. But John Burke, who is our Assistant Commissioner
for both exempt organizations and employee plans, I think may be
able to give you a more full explanation.
Chairman PiCKLE. Who's going to answer that?
Mr. Burke. I am. Congressman. Mv name is John Burke and I'm
the Assistant Commissioner for Employee Plans and Exempt Orga-
nizations.
Chairman PiCKLE. All right, Mr. Burke.
Mr. Burke. On your question with respect to the $2.9 million —
I don't think there's any doubt in our mind that there's a signifi-
201
cant problem in the underfunding of pension plans. We're not doing
a study to prove to anyone that there's a problem there. The fig-
ures speak for themselves in terms of where the PBGC is, the defi-
cit that they're facing, and some of the problems that they're deal-
ing with.
Our study and our enforcement actions are intended to do some-
thing a little bit different than just validate the fact that there's
a problem. At this juncture, I can't tell you what's causing the
problems. We've done a number of examinations over the past 6 or
7 years and they don't seem to have stemmed the tide of an in-
creasing deficit in the funding of these pension plans, particularly
the larger ones. And a number of people's benefits are at risk.
What we want to do, and what we're in the process of doing is
putting together a study to look at, first of all some of the 400 larg-
er plans that have a significant underfunding status, and then ana-
lyze what's causing it. And through the process of examining them
and going into them in some depth, be able to determine whether
or not it's a question of where they invest the funds, whether it's
actuarial assumptions, or whether it's some other problem that's
causing the underfunding. Then we will be able to take either en-
forcement action to improve the compliance
Chairman Pickle. That sounds good, because you normally look
at it that way and you would have done that for months and years
in the past. More specifically, of this $2.9 million you're going to
have, how much of that is for the study?
Mr. Burke. About half Out of some 43 staff years approximately
half would go to the study, and the other half would go to the ex-
amination of some 2,000 plans to determine how we can better
identify the trends that are causing the underfunding, and also
how we can identify better the cases that need to be examined.
Chairman PiCKlJC. Half of it would go for the study, and about
half, then I assume, for enforcement.
Mr. Burke. Yes.
Chairman Pickle. Now when will that study be completed?
Mr. Burke. We expect to have the examinations completed in
about a year; the study will be put together and developed by the
end of fiscal year 1994.
Chairman PiCKLE. 1991.
Mr. Burke. Fiscal year 1994, sir.
Chairman Pickle. You say in January — say that again?
Mr. Burke. The examinations should be completed in about a
year, and the study put together, developed, and ready for submis-
sion by the end of fiscal year 1994, which is September 30th, 1994.
Chairman PiCKLE. I misunderstood you. I was wondering how we
were going to go backwards here. But you said 1994.
Mr. Burke. Yes, sir.
Chairman PlCKiJC. Now the General Accounting Office has found
that the pension plans are not complying with the funding require-
ments enacted in the 1987 bill that we passed. Can you tell me
what specific findings has caused the administration to determine
that enhanced enforcement of the minimum funding requirement is
necessary?
Mr. Burke. Could you repeat the question again, sir?
70-792 O - 93 -
202
Chairman PiCKLE. I said, what specific findings have you made
that would cause the administration to determine that the en-
hanced enforcement of , the minimum funding requirements is nec-
essary? Why are you putting more money into the study and en-
forcement? What brought you to that conclusion?
Mr. Burke. First of all, on the GAO study, we have not received
a formal report from them. The first I got any inkling as to what
their thoughts would be was last week when they testified at an-
other hearing before this subcommittee and indicated that they had
done some studies with respect to the Pension Protection Act of
1987 and they had preliminarily reached some conclusions that
there were problems there.
I would probably stipulate at this point that there are problems
with respect to underfunding. The fact that we've examined some
4,000 to 5,000 of these plans during a 4-year period and found that
there are a significant number of them that had not paid the excise
taxes for the minimum funding rules and had not even filed the re-
turns indicates that we've got to do something different than just
examine each plan. The way we've approached it in the past is just
not adequate.
We've done the examinations. We've picked up additional tax.
We've picked up the additional excise tax returns, and still the
plans continue to be underfunded. We have to approach it dif-
ferently than we have in the past. The enforcement activity is not
just going out and trying to examine each plan and determine
whether or not it's paid its proper amount of excise tax. That's not
what this program is about.
Chairman Pickle. Last week, as I recall, we had two agencies,
both GAO and CBO made an analysis of the underfunded pension
problem, and found that, one, the underfiinded liability has gone
up tremendously to $51 billion — and, two, that we must take action
to try to correct that. In asking for suggestions, I think it was the
CBO that made some general recommendations. One of them was
that we didn't attempt to change necessarily figures in the mini-
mum funding but that we might have some kind of premium in-
crease, particularly increasing the variable rate.
Are you familiar with that approach? Could you comment on
that?
Mr. Burke. I have some familiarity with it, but I do not have
any awareness of what the CBO or GAO might have recommended
in that particular respect.
Chairman PiCKLE. Are you, representing the IRS, concerned that
we've got a pension program where funds, pension plans just don't
have to be funded if they don't want to, if they choose not to?
Should we change the law to require the pension plans to be fund-
ed timely and currently, and to enforce it by law?
Mr. Burke. It strikes me that something needs to be done.
Whether or not I can comment on a particular piece of legislation,
I'm not prepared to do that. But I'm certainly not one to fight
against the need to make some changes.
Chairman PiCKLE. We're going to proceed on this question in
much more detail in the immediate weeks ahead, so I appreciate
any suggestion that you people have on it — ^you or any other mem-
bers of the IRS.
203
Now Mr. Dolan, with respect to productivity savings, perhaps
you or any of the other gentlemen would want to comment. You
just said in your testimony that because of the new TSM system
that you are going to put into place that you would achieve produc-
tivity savings of $55 million in fiscal year 1994. I think Mr. Brew-
ster had asked, or Mr. Jefferson, some questions about that pre-
viously.
This brings up the question to me that if productivity savings are
real — and you say that they can be achieved — then why aren't we
seeing significant reductions in staffing, or at least an increase in
audits? Can any of you comment on that?
Mr. Dolan. Let me start and then invite anybody else in who
wants to comment. I think one of the points I tried to make, Mr.
Chairman, in the earlier statement was that notwithstanding the
fact that we have asked for a major increase in our tax systems
modernization this year, when you look at our entire information
systems budget, it's only a $7 million increase over what we have
spent in information systems. But for the ability to do things more
productively as a result of tax systems modernization that number
would be much larger.
I think you could look at a variety of other operational programs
and find, for example, in the taxpayer services, this year we have
answered on-line 5 million account calls as contrasted last year at
this time with about 2.2 million. We have done that within a re-
source base that is 200 people less than last year. At the same
time, we have achieved 106 percent of our planned telephone traf-
fic.
I know neither you nor I are satisfied that we're getting to all
the people we need to get to, but we achieved 106 percent of what
we tnought those resources would be able to achieve this year. So
I think productivity, while it's not translating itself maybe in gross
terms to a sharp decline, is allowing us to take on workload
growth, complexity growth, and more demand from our customer
base without adding additional bodies.
Chairman PiCKLE. Earlier you had testified, Mr. Dolan, that your
new taxpayer system is going to be a vastly and greatly improved
automated system where an individual's call can be routed imme-
diately to a particular function by saying, punch number one, two,
and three and you'll get the answers. Ana that you would, there-
fore, use less personnel. You'd save money by going to this new
equipment. That, I guess, is inevitable in this time and age. I don't
see why you ought not be a part of it too.
But if you do that, doesn't that mean you're going to be cutting
out these personal interviews with the individuals? If you go to all
automation
Mr. DoiAN. Not at all, Mr. Chairman. I think what we would
like to do is more of what we've been doing over the last 4 or 5
years. When you called toll-free 5 or 6 years ago, you might well
spend the time of a live assistor to ask for a form, to ask where's
the closest IRS office, to do a lot of things that really aren't that
much value added. Todav, we take 20 or 30 million of those calls
off-line, so that the macnine answers those. So that Mike Dolan,
who has a question about his account or has a question about "can
I take this on my taix return" finds more of those kind of questions
204
are getting answered. That's what we try to continue to do, answer
more of those questions.
Chairman PiCKLE. I would hope that as you go to automation
and to save personnel and money there, you'd channel more money
for personnel in the problem resolution program. I think probably
the best thing the IRS can do is increase your taxpayer services ap-
proach.
You made great strides in that area in the last 4 or 5 years and
I'm glad to hear you say that you've answered so many calls this
past year. I hope that number doubles. Because once the individual
can talk to some person and talk to them face-to-face, they get a
better understanding what the adjustment is, and how it's arrived
at, and then they know how to respond to it. If we lessen that, we'd
be doing a great disservice to the American taxpayer. So as you go
toward automation, I want you to keep in mind the taxpayers as
individuals. Person to person is still very important.
Mr. DOLAN. Mr. Chairman, we agree with that. I would also like
to link back to what Mr. Monks said. One of the things I think we'd
like to do is not answer the same question year after year. We'd
like to try to figure out what are the recurring questions and fix
them, so that we don't have to put the taxpayers through the same
problem year in and year out.
Chairman Pickle. I agree with that. Now, Mr. Dolan, when I
came on this committee and we worked in this area, we had an
audit rate of approximately 3 percent as I remember it. That may
be going back a few years. It went from 3 to 2. Last year it was
at 0.9, I think. This year you say it's going to be 0.91. It's going
down.
At any rate, it is less than 1 percent. Is that a satisfactory figure
for you?
Mr. DoLAN. No, Mr, Chairman, it's not.
Chairman PiCKLE. So what are you going to do about it?
Mr. Dolan. A couple of things. Clearly some part of our initiative
this year is based on enhancing our audit experience. But the
other, and I think we have had a conversation about part of this
before, is back when the audit rates were at 3 and 4, and even at
5 percent, that was before the matching program. That was before
some 3 or 4 million contacts which get made now in the matching
program essentially took the bottom end of what used to be done
in the examination program.
So, while the 0.91 or the 1 percent is not satisfactory and I'd like
it to be more, it also doesn't represent the precipitous erosion, I
think, that sometimes people think it is because of the introduction
of the very powerful matching capacity that we have in the pro-
gram now.
Chairman PiCKLE. If you took 1 percent, just for quick calcula-
tion, how many audits would that mean for taxpayers in one year?
Mr. Blattner. One percent is 1 million audits.
Chairman Pickle. One percent is roughly 1 million audits. Now
you're only recommending 0.9. Tell me again, how do you justify
that? Do you need more resources?
Mr. Dolan, I think, Mr, Chairman, it's again a question of where
priorities get established. We could use more. Within what we're
given, our objective is to use it the best possible way. So you've
205
seen a steady increase of our devotion of resources to the higher
income taxpayer. The initiative we have on the table with you
today is for additional examinations above the $100,000 income
level.
That's what we have tried to do. The downside of that is, when
you examine those larger, more complicated returns, you can't
stamp those out like you could if you were examining $20,000-
$30,000-a-year wage earner tax audits. So there's a tradeoff in
terms of how many you can get to.
Chairman PiCKLE. Now I want to shift to another subject. I
think, Mr. Houghton, I'll go ahead with that and then recognize
you.
Mr. Houghton. Absolutely.
Chairman PiCKLE. In the area of the nonfiler program, in Sep-
tember of 1992 the IftS implemented a nationwide nonfiler pro-
gram. It was designed to bring in about 10 million individuals and
businesses who have failed to pay taxes back into the system. Ac-
cording to your estimates, more than $10 billion in tax revenue is
lost annually due to nonfiling of Federal income tax returns.
You have assigned more than 2,000 IRS revenue agents and tax
auditors to identify nonfiler cases. I know that you put a great deal
of hope — at least the previous Commissioner — on the implementa-
tion of this program and we hope that it has gone well and will go
well. I want to ask you some specific questions regarding it.
How many taxpayers have come forward, and how much addi-
tional revenue has been collected? Can you give me an answer for
the past year?
Mr. DOLAN. Mr. Chairman, I will give you the data we have. I'll
say to you that soon I hope to have better data, because what we're
doing is a program that launched at the beginning of the fiscal
year. We think we know the data we want to capture, and because
of the newness of the program we don't have it all captured the
way we want.
We did this as a three-pronged approach. We did the outreach,
we did the examination staff years, and we did the criminal inves-
tigation.
In the outreach area was where we had done something fairly
unconventional. We had roughly 200,000 people call us or walk into
our walk-on sites in response to those public relations kind of out-
reaches. What we know — and we can't attribute to all of these to
this by any means — is that during the first 5 months of fiscal year
1993, we secured approximately 4.5 million delinquent returns.
Chairman PiCKLE. Say that figure again.
Mr. DoiAN. 4.5 million delinquent returns came in during the
first 5 months of this year. I do not attribute all of that, by any
means, to the nonfiler program, because some people on a regular
basis would have filed a late return whether we had any initiative
underway at all.
Below that though, one of the things that is impressive to me is
that over 100,000 of the people who did come in were people that
in our nomenclature we call the unknown nonfiler. That is, we had
no record of them. We had no record on our master file as having
filed. We didn't have information documents. So those are people
206
that I am hoping and assuming we have found a way to get to, that
in past matching and outreaches we haven't.
The examination area is another place where you had had some
interest as to how effective would we be. So far in this fiscal year,
we have completed 51,000 examinations. And on average what we
have brought in, in those 51,000, is $619 million associated with
those 51,000 closures. Now that, as you know, is part of a 2-
year-
Chairman Pickle. Of the 51,000 examined, what was the
amount of money?
Mr. DOLAN. $619 million.
Chairman Pickle. Billion or million.
Mr. DoLAN, Million. I wish it were billion.
Chairman Pickle. That's still impressive.
Mr. DoLAN. What I would suggest, Mr. Chairman, is the other
thing that's happened is we have had excellent cooperation across
a wide variety of interested parties. We've had the practitioner
community. We've had an awful lot of local media involvement and
interest. And then we've had, on the far end of the scale, an un-
precedented cooperation with the U.S. attorneys on the criminal
side.
Chairman PiCKLE. In calling in these people or offering them to
come in and discuss, does the IRS choose that list? Do you look
over your files and determine who hasn't filed and who probably
ought to be filing?
Mr. DoLAN. Yes.
Chairman Pickle. Did you prepare the list and invite the tax-
payer to come in?
Mr. DoLAN. Yes, we do. Of course, on a broad gauge basis, we
invite everybody who's out there that needs to get right to come in.
Chairman Pickle. Do you invite in those who you think might
want to come back into the system?
Mr. DoLAN. The examinations that we do, the invitations we
send out to come in and talk to us — as opposed to people who walk
through our door without invitation — those are done based on our
analysis of the highest probability of a return being due and tax
being owed.
Chairman PiCKLE. You choose kind of the people you think would
be good possibilities.
Mr. DoLAN. We send a particularized invitation, yes.
Chairman PiCKLE. Now doesn't the taxpayer who doesn't pay his
taxes, he gets the same treatment if you finally catch him. So you
give him essentially the same treatment, don't you?
Mr. DoLAN. We hope we give everybody the same treatment.
Anybody who will make a concentrated effort to file the returns
due and pay the money owed is going to get the same welcoming
treatment from us.
Chairman PiCKLE. Do you give that taxpayer any kind of assur-
ance that they will not be criminally prosecuted if they do come in
and reveal their
Mr. DoLAN. We have tried, Mr. Chairman, to be very explicit in
every way we know how about reinforcing what our longstanding
tradition has been. If someone comes forward, makes an accurate
207
return and makes an attempt to pay what's owed, we have not, nor
will we prosecute that person.
Chairman Pickle. Can you give me any kind of estimate of how
many people you think just do not file, and don't want to file, and
won't file a return on an annual basis?
Mr. DOLAN. At this point I've got to tell you, too many. I can't
tell you how many of that — I mean, right now with the identifica-
tion of the 10 million is still our outer parameter.
Chairman PiCKLE. There's an ongoing argument, I assume, about
whether the individual is better off staying out of the system, wait-
ing till he's caught, or sued, or prosecuted, than it is if he just
comes forward. Can you tell me, is the nonfiler system working
well enough that it ought to be expanded, or at least continued on
its present level?
Mr. DoLAN. We feel very much that it's working well. When we
first came into this and we first described it to you, we described
it as a 2-year investment of resources and examination, and rough-
ly that same sort of investment in outreach. The early results, the
5 or 6 months into the first year of it very much convince us that
it's an endeavor worth continuing.
Chairman Pickle. What's your policy with regard to waiving
civil penalties on those who come forward? Is this policy being uni-
formly applied?
Mr. DoLAN. We believe it is and hope that it is. We're basically
using the reasonable cause standard as the basis on which someone
can apply for relief against a failure to file or a failure to pay pen-
alty.
Chairman PiCKLE. I'm going to have some other questions per-
haps in this area, and/or we may be submitting additional ques-
tions to you. We're interested in knowing exactly how this nonfiler
program has worked. I know you have great anticipation of it work-
ing, and if we can get people back in the system that is to our cred-
it and helps protect our system.
If we don't do something, I'm afraid we're going to find that more
and more people, with regard to the percentage of compliance, that
we're just slipping away. IRS has got a tremendous challenge
ahead of it. The American people may be facing a decision within
the next few years of either going forward or making big changes.
So what we do down there in the IRS has a great deal to do with
what we, the Congress, or what the people decide, I think.
Mr. DoLAN. We agree, Mr. Chairman.
Chairman PlCKlJ-:. Mr. Houghton, would you like to ask other
questions?
Mr. Houghton. Yes, I'd like to ask the question, how many peo-
ple in this room are working for the IRS? Would you raise your
hands?
[Show of hands.]
Mr. Houghton. Thank you very much. Mr. Dolan, I'd like to ask
you a question. I've never understood the expense versus capital
Dudgeting portion of any Government agency down here. However,
you mentioned that through your TSM programs through the year
2008 — this is in your testimony — that you would be investing al-
most $8 billion above the projected 15 or 16 cost to operate. Yet I
208
see here, in terms of 1994 fiscal year, $121 million drop in equip-
ment purchases. Maybe you can help me on that.
Mr. DOLAN. If you wouldn't mind, I think maybe Mr. Philcox can
give you a more particularized answer.
Mr. Philcox. Mr. Houghton, that's largely because of the fact
that we bought a great deal of equipment in this year, in 1993, and
the money that we spent for that was all obligated and does not
recur. So that money was backed out of the budget as nonrecur
money.
We will be buying additional computer equipment in 1994, but
what we put in 1993 was an extensive replacement of all of the
equipment that we had in each of our service centers to sustain our
current applications throughout the modernization period. So it
was an extraordinary expenditure.
Mr. Houghton. It seems to bob around a lot; awfully lot for
somebodv like myself to track. You get $200 million one year, and
you get $440 million another year, and then you go down to a nega-
tive figure. I don't know, if you've got an $8 billion program, it
seems sort of a seismic way of going about it.
Mr. Philcox. Part of the reason is the fact that you no longer
can lease to purchase in Government. I think several years ago the
process was changed so that on any capital investment in computer
equipment you had to expend and obligate the funds in the year
in which you were making the initial purchase. Even though the
installation of that equipment might last over a period of years, the
money had to be obligated on the front end. I think that was the
result of the budget agreement that was drawn between the Bush
administration and the Congress.
For those reasons, you will see peaks and valleys in terms of
equipment purchase in the budgeting process. We do work those
very extensively with 0MB and would be happy to provide you
with that detail that would show you where the pluses and
minuses are.
Mr. DoLAN. I think, Mr. Houghton, you may be experiencing the
discomfort of your training. I think, as you point out as an account-
ant, the budget is prepared always with reference to the base, as
opposed to looking at the capital expenditures maybe more like
what you would have been accustomed to seeing.
I think both with respect to communicating about them and fol-
lowing the progress of a venture that's as long term as ours, it is
a more arcane experience to try to wind your way through, particu-
larly when it's in an appropriation that ebbs and flows, with ref-
erence both to the capital investment and the recurring, "keep the
747 flying" kind of expenses our organization as well. So I think
that may be one part of what the difficulty is.
Mr. Houghton. I understand that, you count differently. As a
matter of fact, one of the frustrations I had as being part of the
Grace Commission, we really had to reconstruct the figures of the
various agencies we were looking at because we couldn't under-
stand them.
But here you have an inflation adjustment figure of $153 million
in your budget. I would think that, plus at least keeping yourself
even with the equipment purchases would go a long way toward
209
digging into this $8 billion requirement you've got by the year
2000-and-whatever-it-is.
Let me ask you another question. It's a sort of a larger issue.
This is a very big service. There are lots of moneys involved. Why
isn't it reasonable for us — ^you had about a 9 percent increase in
1993 over 1992. You got about a 4 percent increase in 1994 over
1993. Why isn't it reasonable for us to just say, freeze this for 1
year; no increase?
Mr. DOLAN. Why is it not unreasonable? I guess a couple of
things that I would argue would go into your formula about wheth-
er irs reasonable or not. One is, probably three-quarters or more
of our total costs are people costs, and absent something interven-
ing with the normal cycle that accounts for pay raises, health pre-
mium increases, and for greater numbers of people taking advan-
tage of the matching option on the retirement system, those are
costs that have to be met. If zero was your line, your choice would
obviously be to offer substantially less service if you couldn't match
at least those costs.
Mr. Houghton. But if I understand it, Mr. Dolan — I'm not trying
to be nasty here.
Mr. Dolan. No, that's fine.
Mr. Houghton. I'm merely trying to probe. If I understand it,
that is because of this program you have for modernization, im-
proving quality and greater productivity, that you ought to be tak-
ing gulps out of the budget so that you just don't stay at a particu-
lar fixed number as far as people or whatever you're looking at.
Mr. Dolan. I would say that if we were talking about that purely
theoretically, I would agree with you. But when we're talking about
it in a context of 40 percent of the people who are trying to get to
us on the other end of a telephone call aren't getting to us, when
we're talking about it as $127 billion plus or minus as being on the
table in a tax gap and us examining 1 percent, I suspect from the
point of view of the viability of the business, of what you want us
to be about, you do have the choice of saying, take your efficiency
and let your head count come down. Or you say, take your effi-
ciency and apply it against parts of your mission that you're not
now able to get to. I mean, that's clearly the role of oversight and
clearly the role of policymakers.
I guess there are a couple of other things that people don't often
understand about our budget. In terms of printing and postage, we
are one of the big players in both of those markets in terms or mass
bulk postage and mass printing. Those prices also rise at a level
that, if somebody says to us zero growth, we are at the mercy of
market forces that are not foreign to anybody.
And in the telecommunications world, we have got such an
imbedded telecommunications need because of both voice and data
needs, when you identify four or five of those things, the costs con-
form to market forces. It's a very difficult proposition to take just
the fiat zero growth without having it erode performance in ways
that I think would be unsatisfactory to you.
Mr. Houghton. Now you sound just the way I did when I used
to defend my budget. It's all very logical, and I in no way want to
criticize the IRS because you do a superb job. However, there are
210
severe questions out in the real world that we go back to every
weekend.
And I would imagine that maybe a group or a single individual
amongst these thousands of people you have might be saying, sup-
pose the Ways and Means Committee under the chairman here
asked us to take $1 billion out of our budget in the next 3 years,
what would we do? I mean, would it be absolutely impossible?
Would we curtail some services? Would we have to reorient prior-
ities? Would we, in effect, because the knife is coming down from
another part, really have to do a simplification and updating at a
far faster speed than we wanted?
Mr. DOLAN. I think, Mr. Houghton, we ask ourselves those kind
of questions on some regular kind of basis. I think where we find
ourselves is in a process that is by definition incremental. We're
here annually to talk about annual budgets. We have 200 million
customers that we know are going to come at us annually in a
cycle. We aren't going to control much. We've got 75 million people
who are going to make contact with us on a cycle that we can't con-
trol.
So, it is clearly possible for us like everybody else, and should be
mandatory for us like everybody else, to draw back far enough to
ask the basic questions. One of the questions we ask about the 75
million people trying to get to us is: What can we do to make 25
million of those calls go away? Can we simplify forms? Can we sim-
plify publications? Can we make the transactions with the IRS dry
up? If not, can we get every last body on board to answer every
call? But can we take the kind of proactive stuff that makes deal-
ing with us more simple?
The 5 million calls that we solved on-line are calls that here-
tofore would have come in and we would have said, you've got to
write the service center. And once you write the service center,
we'll put you in inventory, and we'll correspond a couple of times.
Two million more this year than last got it resolved at the end of
a telephone call. And on the end of that telephone call they prob-
ably had an installment agreement against which they could make
payments immediately, and not wait for 6 months of transactions
back and forth.
So we know we've got to rise to those challenges, Mr. Houghton.
Mr. Houghton. Right. If I could just take a second longer, Mr.
Chairman, there's an interaction here that I think is important.
This really is keyed off of maybe the possibility of a value-added
tax. I mean, that is really going to be complicated. I don't know
how you're going to handle it.
But it would seem to me, I don't hear the types of things coming
from your organization — and maybe it's because I'm not listening
to the right people — that say, if you want this, this is what it's
going to cost. However, if you do this, this, and this, we could elimi-
nate vast amounts of expenses now which are really following
through on the laws which you're legislating. I don't see any of that
feedback. Frankly, if you're going to get this behemoth of a system,
our governmental system under control, that has to happen.
Mr. DoLAN. Mr. Houghton, I think that's a fair exhortation to us.
I think it's one that we will take seriously and I would expect you
211
to hear from us later in that context of how things might be done
significantly different.
Mr. Houghton. Thank you.
Chairman Pickle. Thank you very much, Mr. Houghton,
Now Mr. Dolan, the General Accounting Office has submitted to
us a study about your operations and their concerns. GAO is spe-
cifically concerned about the new compliance initiatives. They are
concerned that you don't have adequate staffing possibly in that
area. They've got serious questions about the accounts receivable
initiative. It's growing at a certain rate, and how much is actually
receivable and so forth.
I'm going to, for the record, include the GAO's study on the IRS
budget request for fiscal year 1994 so that it would be made a part
of the record. So I'm going to include that and then you'll be get-
ting a copy of it too directly from us and GAO.
Mr. Dolan. Thank vou.
[The information follows:]
212
GAO
United States General Accoiinting OfPce
Fact Sheet for the Chairman
Subcommittee on Oversight
Committee on Ways and Means
House of Representatives
April 1993
TAX ADMINISTRATION
Examples of Waste and Inefficiency
in IRS
dAO/GGD-93-lOOFS
Printed copies of this document will be available shortly.
GAO FwB 171 (1S/S7)
213
GAO
United States
General Accounting Office
Washington, D.C. 20548
General Government Division
B-252874
April 27, 1993
The Honorable J.J. Pickle
Chairman, Subcommittee on Oversight
Committee on Ways and Means
House of Representatives
Dear Mr. Chairman:
This fact sheet, prepared in response to your request,
provides specific examples of waste, inefficiency, and abuse
in the Internal Revenue Service (IRS). In our April 30,
1992, testimony on IRS' fiscal year 1993 budget request, we
noted that much unproductive work and rework, necessitated
in large part by obsolete processes and systems, occur in
IRS.'
Other information requested in your letter will be reported
separately.
OBJECTIVE, SCOPE. AND METHODOLOGY
Our objective was to document examples of waste,
inefficiency, and abuse in IRS. To do so, we primarily
reviewed our prior reports and reports prepared by IRS'
Internal Audit Division and the Department of the Treasury's
Office of Inspector General. We also reviewed congressional
hearings and various studies and other documents prepared by
and for IRS. These included documents relating to IRS' Tax
Systems Modernization (TSM) effort, including the public
version of the TSM Design Master Plan, the National Research
Council's 1992 report on its review of TSM, and various
business area analyses done by IRS.
To avoid outdated examples, we limited our review of reports
to those issued after August 1, 1990. Also, in compiling
the list, we excluded examples that we believed, based on
our ongoing work in the tax administration area, were no
'Tax Administration: IRS' Budget Request for Fiscal Year
1993 (GAO/T-GGD-92-34, Apr. 30, 1992).
214
B-252874
longer valid. Even so, some of the deficiencies noted in these
more recent reports may have been corrected since the reports
were issued. In preparing this fact sheet, we did not attempt to
determine the extent the deficiencies in the examples presented
in this report still exist.
Most of the effects listed in this fact sheet and appendixes were
taken from the cited documents. In some cases, however, we added
potential effects based on our knowledge of the issue. Those
instances are identified by an asterisk (*).
We did our work between August 1992 and March 1993 in accordance
with generally accepted government auditing standards.
RESULTS IN BRIEF
Our review of reports and other documents revealed many examples
of waste and inefficiency and several of abuse or employee
misconduct in IRS. These examples are listed in appendix I. We
believe that many of the examples derive from IRS' antiquated
computer systems, fragmented organizational structure, and
inefficient work processes.
Although the instances of waste and inefficiency described in
appendixes I through V involved increased costs and/or decreased
revenues, the amount of those costs and revenues was generally
not quantified in the source documents. In those examples where
the cost or lost revenue was quantified, the amounts totaled
about $87 million. In some cases, the dollar effect was
calculated on the basis of audit work at a few IRS locations. If
those results are representative of the same function throughout
IRS, the dollar implications could be much larger. In addition,
some of the examples for which there is no dollar effect cited,
such as those dealing with IRS' returns processing system and its
collection process, could have potentially large savings
associated with them. Also, many examples indicated that a
failure to eliminate the causes of the waste, inefficiency, and
abuse will erode taxpayer confidence in IRS and diminish
voluntary compliance with the tax system, further increasing
revenue loss .
IRS is aware of these problems. In its TSM documentation, for
example, IRS identified many of the problems that contribute to
its inefficiency. Along with modernizing its systems under TSM,
IRS is reassessing the roles and responsibilities of its various
organizational components. When TSM and related organizational
changes are fully implemented, many of the inefficiencies
discussed in this fact sheet should be alleviated, thus improving
215
B-252874
IRS' overall effectiveness. We will continue to monitor the
progress of those efforts.
We are sending copies of this fact sheet to various congressional
committees, the Secretary of the Treasury, the Commissioner of
Internal Revenue, and other interested parties. Copies will be
made available to others upon request.
The major contributors to this fact sheet are listed in appendix
VI. Please contact me on (202) 512-5407 if you or your staff
have any questions.
Sincerely yours,
itj6M^v_v J. /xh^i^^^^
Jennie S. Stathis
Director, Tax Policy and
Administration Issues
216
CONTENTS
LETTER
APPENDIXES
I
EXAMPLES OF WASTE, INEFFICIENCY, AND
ABUSE IN IRS FROM IRS INTERNAL AUDIT
REPORTS AND DOCUMENTS
II
EXAMPLES OF WASTE, INEFFICIENCY, AND
ABUSE IN IRS FROM DEPARTMENT OF THE
TREASURY'S OFFICE OF INSPECTOR
GENERAL REPORTS
16
III
EXAMPLES OF WASTE, INEFFICIENCY, AND
ABUSE IN IRS FROM GAO REPORTS
19
EXAMPLES OF WASTE, INEFFICIENCY, AND
ABUSE IN IRS FROM IRS STUDIES
AND DOCUMENTS
28
VI
EXAMPLES OF WASTE, INEFFICIENCY, AND
ABUSE IN IRS FROM OTHER STUDIES
AND CONGRESSIONAL HEARINGS
MAJOR CONTRIBUTORS TO THIS FACT SHEET
36
40
ALERTS
ARTS
IRS
ISMIS
OIG
TSM
ABBREVIATIONS
Automated Labor and Employee Relations Tracking
System
Automated Regional Training System
Internal Revenue Service
Internal Security Management Information System
Office of Inspector General
Tax Systems Modernization
217
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o
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01 □:
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CM
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a 01
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Taxpayers' rights are violated
because information on taxpayer
accounts is maintained in an
unpublished system which could
subject IRS to possible
litigation.
Potential exists for lost revenue
of more than the $71,000 in the
sample reviewed.
Additional cost to resolve
taxpayer problems resulting from
IRS throwing out tax documents and
checks .
01
a
E
10
X
CU
IRS does not centralize
information for its criminal
Investigations. Information is
kept in the Case Management and
Time Reporting System and in
project files. Not all
information can be pulled from
the project files and often
files cannot be found.
At the two service centers
reviewed, the candling process
used to check envelope contents
did not adequately ensure that
all contents had been removed
from envelopes before they were
discarded. Internal Audit
found 45 documents in the
55,000 envelopes reviewed,
including 11 checks. This
sample represented about 1
hour's work from both centers
during the filing season.
0
z
^
fN
70-792 0-93-9
218
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01
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4J
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-- Potential exists for inequitable
treatment of taxpayers.
-- Additional cost incurred by other
IRS functions to correct errors.
-- Potential exists for lost revenue
if interest assessments are
undercharged.
-- IRS could save an estimated
$538,000 annually.
-- IRS could reduce lost tax revenues
from erroneously claimed pension-
related deductions. (Internal
Audit estimated that about $13
million in taxes was being
avoided. )
0)
a
E
<a
X
u
Interest on certain taxpayer
accounts must sometimes be
manually calculated.
Processing of these accounts
(known as restricted Interest
accounts) is fragmented among
several service center units,
branches, and divisions. In
addition, interest charges were
not being properly assessed.
Instructions for handling these
accounts and assessing Interest
are not contained in one
handbook and vary in quality.
Processing of employee benefit
plan returns could be further
improved if IRS took steps to
( 1 ) reduce and Improve
correspondence, (2) eliminate
unnecessary processing steps,
and (3) enhance computer
programs to identify erroneous
pension-related deductions on
Forms 1040.
0
z
n
'»•
219
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c
9>
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-- IRS' costs for automated data
processing contracting support may
be higher than necessary.
-- Contract cost proposals were
accepted for amounts higher than
required in the contract.
- IRS inconsistently handled
reimbursement of contractor travel
costs and may have overpaid these
costs.
Potential exists for lost revenue
from IRS pursuing unproductive
cases.
Staff resources were inefficiently
allocated.
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Contract administration
controls need improvement in
the Automated Data Processing
Support Services Contract to
ensure services are obtained at
the most advantageous cost to
the government and in
accordance with acquisition
regulations. Internal Audit
found that the software used to
evaluate contract cost
proposals was used Incorrectly
and that market surveys were
not required for certain
proposals .
Of the underreporter cases
pursued by two service centers
for tax year 1987, 51 percent
could have been excluded with
better procedures and computer
programs. By working these
cases, staff were not able to
work more productive cases.
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Sept. 14, 1992
(Abstract Ref.
#12090201)
Sept. 16, 1992
(Abstract Ref.
#82050603)
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-- Revenue loss of about $87,000 from
the sample reviewed for interest
not earned on funds not deposited
in a timely manner.
-- Potential exists for unnecessary
taxpayer correspondence and
additional IRS work in responding
to that correspondence.
-- Taxpayers could be treated
inconsistently. *
-- IRS could be held liable for
taking actions (i.e., not abating
tax assessments) in violation of
the bankruptcy code.
-- IRS may be required to do
additional work to make
abatements . *
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A review of one service
center's deposit function
identified inadequate controls
over the processing of
payments. Instead of
depositing remittances by the
next business day if $10,000 or
less or on the same day if over
$10,000, about 5 percent of the
remittances sampled took 3 or
more days to be deposited (an
average of 11 days).
IRS violated the Bankruptcy
Code in one district by failing
to identify and abate
assessments of taxes,
penalties, and interest that
had been posted to the master
file in 8 of 66 cases reviewed
where the taxpayers had
initiated bankruptcy
proceedings.
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Sept. 18, 1992
(Abstract Ref.
#12100402)
Sept. 25, 1992
(Abstract Ref.
#02321508)
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-- Some returns did not get properly
screened prior to the refund
deletion deadline, which could
result in erroneous refunds.
- Recovering fraudulent refunds
after they are issued results in
additional costs; some of the
refunds might never be recovered.
- Potential exists for inconsistent
treatment of taxpayers.
Resources are inefficiently used.
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Discrepancies were found in one
service center's controls for
tracking outstanding returns
ordered by the Questionable
Refund Detection Team.
Internal Audit's analysis
showed 7 percent of the returns
were outstanding while the
service center log showed 17
percent.
Collection's employment tax
adjustment program did not
establlBh a mlnlmura tolerance
level for screening out
proposed assessment cases which
are not cost-effective tc
pursue. Of the cases sampled,
43 percent would not have been
pursued had training manual
criteria for screening out
unproductive cases been
applied.
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Sept. 25, 1992
(Abstract Ref.
#02340502)
Sept. 30, 1992
(Abstract Ref.
#02330202)
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-- When money is not promptly
deposited, the U.S. government
cannot use the money to help pay
current obligations. Thus the
amount of interest paid by the
government increases.
-- Significant backlogs of mismatched
appeals cases have accumulated in
several Appeals offices.
-- Potential exists for revenue
increase of about $5 million from
implementing proper internal
controls.
-- Research is duplicated for repeat-
case discrepancies.
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Criminal investigation seizure
procedures require seized money
to be deposited into a Federal
Reserve Bank account promptly.
In five of seven seizures
reviewed in one district, funds
were stored in safe deposit
boxes from 7 to 57 workdays
before being deposited in an
account. In another district,
checks for more than $230,000
were stored in a safe deposit
box for about 4 months.
There are no comprehensive
guidelines for controlling the
inventory of appeals cases.
Existing guidelines do not
require physical inventories or
include comprehensive
procedures for resolving case
discrepancies identified
through a computerized
comparison of cases in two
databases. Inventory control
problems exist even when there
are no discrepancies between
the two databases .
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-- Lack of adequate Internal
controls could result in
increased risk of theft,
waste, and misplacement of
the equipment.
-- Because there was no
assurance that all
equipment was properly
accounted for, additional
waste could occur if
management decided to
purchase equipment on the
basis of inaccurate
Inventory data.
-- Potential for abuse and
inefficiency with the use
of ALERTS.
-- ALERTS was not meeting the
IRS goal of promoting
consistency of discipline
throughout the agency.
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In a review of IRS* Office of Chief
Inspector's investigative equipment,
the Office of Inspector General
(OIG) found that internal controls
needed to be strengthened. They
found that while physical
inventories of the equipment were
conducted at the end of the fiscal
year, the equipment on hand did not
always match the official inventory.
In a review of the implementation of
IRS* Ethics Action Plan, OIG found
that during a 3-month period in 1991
about 19 percent of the IRS regional
and district offices had not either
entered and/or updated cases in the
Automated Labor and Employee
Relations Tracking System (ALERTS).
They also found that ALERTS did not
provide supervisors with a periodic
report of case activity.
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Business Area
Analysis for
Input
Processing
(Aug. 1990)
00
in Hi
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-- Increased costs incurred to do
something manually that could be
done by computer.*
-- Inefficient use of resources.
-- Many instances of duplication of
effort, revalidating and rekeying
payment amounts .
-- Problems with the use of coupons
include errors from incorrect
entries on the coupons or coupons
sticking together, getting lost,
or becoming torn and unreadable.
0)
Q4
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u
Because not all information is
transcribed from returns during
processing. Statistics of Income
receives from the master file
only 14 percent of the data
needed for business returns and
about 50 percent of the data
needed for individual returns.
The remaining information must be
manually edited and transcribed.
In fiscal year 1991, 152.9 staff
years were budgeted for this
purpose.
IRS* financial management
processing operation is a
patchwork of manual, labor-
intensive procedures and stand-
alone computer systems, all of
which is supported by a massive
paper environment. Coupons
completed by taxpayers or banks
account for much of the paper.
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00
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243
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- Potential lost revenue as a
result of the delay in processing
the deposits.
Potential for IRS to incur
additional costs while responding
to taxpayer inquiries about their
payments .
Error rate increases
significantly with manual input.
Processing delays create problems
for taxpayers who must then
correspond with IRS to inquire
about their payments.
IRS incurs additional costs
responding to the taxpayer
inquiries . *
0)
a
E
10
X
u
A major problem with the Federal
Tax Deposit processing system is
the time delay from when the
taxpayer makes the deposit until
the deposit is credited to a
Treasury account and classified.
The deposit float is typically 1
day, allowing the depositaries
rather than Treasury to benefit
from 1 day's worth of interest
income. The classification
process adds another 3 days.
Some stand-alone computer systems
are effective in accomplishing
their (unctions timely, reducing
the volume of paper documents and
errors within these systems.
However, these systems are not
integrated and they require
manual intervention, such as for
screen input and tape loading.
Current system limitations
require that some transactions
must be processed manually, which
can take up to 6 weeks. The most
common transaction type that must
be manually handled is the
transfer of taxpayer accounts
from one service center to
another.
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245
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0)
Business Area
Analysis for
Training
(Oct. 1991)
IRS Systems
Architecture
Concepts of
Operation for
Tax
Publ ications
and Forms
Distribution
(Sept. 28,
1990)
u
o
0)
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<4-l
111
-- Redundant information is
maintained in each region's
database.
- If the host system goes down,
every site using ARTS loses it.
Operation that could be done
through automation is handled
manually. *
0)
a
E
<a
X
u
The Automated Regional Training
System (ARTS), the current
nationwide training system, does
not interface with any other IRS
system. It does not interface
with the automated personnel
systems to enable trainers to
plan training for new hires.
Each region has a database for
ARTS that was customized to suit
its needs. The regions are
dependent on the host system.
Access to ARTS is not available
to all organizations.
Requests for 'ax forms received
at district office toll free call
sites are handled through a
manual paper process. To process
such a request, the Taxpayer
Service telephone assistor
manually completes an Internal
IRS form showing the requester's
name and address and the tax
forms and publications requested.
The completed internal forms are
sent each night to the
appropriate distribution center,
where the information Is entered
Into the Centralized Inventory
and Distribution System.
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external sources, and the
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computers. It takes 15-18
months to identify reporting
discrepancies and to issue
taxpayer notices. This delay
is due to IRS' computers being
up to full capacity during the
filing season and the time
required to process, perfect,
and correlate all the paper and
electronic information and
match it with the taxpayer's
accounts .
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through electronic funds
transfer. The balance of these
receipts is collected through
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activities are paper-driven
(i.e., payment coupons and
checks). For example, IRS
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checks (worth about $100
billion) through the Treasury
Financial Management System.
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252
APPENDIX VI APPENDIX VI
MAJOR CONTRIBUTORS TO THIS FACT SHEET
GENERAL GOVERNMENT DIVISION, WASHINGTON, D.C.
David Attianese, Assistant Director, Tax Policy and
Administration Issues
Ellen Wineholt, Evaluator-in-Charge
Carrie Watkins, Evaluator
Monika Niemann, Evaluator
Barbara Brown, Secretary
Judy Lanham, Secretary
(268496)
40
I
253
Chairman PiCKLE. Now I want to ask you a broader question.
April 15 has just passed. How is the fihng season going now?
Mr. DoLAN. Mr. Chairman, we were holding our breath because,
I think as you know, the receipt pattern was very much later this
year than it ever has been in the past. We were concerned that the
effect of the change in withholding had basically had us, all filing
season long, somewhere in the 4 to 6 percent behind where we
should have been.
So we had two things that we thought could happen. One was
we could have a lot of these people decide that because they owed
money they wouldn't file. The other was they would all file in the
last week.
Thankfully, the second of those occurred. We do appear to have
essentially caught up in the last week of the filing season. We don't
yet know all the details; we haven't yet accounted for all the re-
ceipts. We anticipated in the last 3 or 4 days after April 15 that
as much as $68 billion would come in as part of amounts due on
balance due returns. We will know within the next couple of days
how close that projection was.
But our volume projections look like we essentially caught up
and got what we expected by way of filings in those last 3 or 4 days
of the filing season.
Chairman Pickle. You're telling me then that essentially the fil-
ing system is going on schedule and about the same as last year.
At least you're not dropping back as you feared you might do.
Mr. DoLAN. We put as much strain on the system as we ever
want to in that last week. That is not the ideal way for us to have
to receive the returns or account for the payments. But the good
news is that it does not appear that we had any major fall-off in
filing this year.
Chairman PlCKiJC. With all the addition of new equipment under
the TSM program, do you anticipate that you will be laying off peo-
ple in the IRS?
Mr. Doij\N. I think what we anticipate, Mr. Chairman, is a se-
ries of redeployments involving parts of the organization that now
have the introduction of some technology. Two things will probably
happen. Either that person will have to be retrained to be able to
work in concert with that technology, or it may well be that fewer
people will be needed for part of the business, and they will be re-
trained for another part of the business. That is our approach to
taking care of our human resource.
Chairman Pickij-:. The rumor keeps floating back to us that In-
ternal Revenue will need less district offices or regional offices and
that some of the IRS service centers throughout the country will
be closed down. Do you anticipate taking any such action?
Mr. DoiJVN. Mr. Chairman, I think it is at your invitation that
we're looking very hard at our regional structure and our national
structure. We have looked first at the areas that represent over-
head, that represent the potential to do either in a location with
less, or potentially without a regional location. So those things are
under active consideration, but are very preliminary, short of the
Commissioner being on board and her having a chance to look at
them.
254
At the centers and districts, Mr. Chairman, we do not see any
major change in the location of district offices in the short run. I
think centers will be the places most affected by the technology. So
there will be some centers that will do different tasks than others.
They will not all look alike. So there will be that form of change
in the centers.
Chairman Pickle. We want you to keep us posted about your
plans as they may develop during the year. I don't want to read
it in the newspaper after it's already done. You keep in close touch
with us because we know that is a rumor and people ought to be
assured
Mr. DOLAN. We owe you that, Mr. Chairman. We owe you that
and we will do that.
Chairman Pickle. All right. Now Mr. Houghton, do you have any
other questions?
Mr. Houghton. I do not, Mr. Chairman.
Chairman Pickle. Mr. Dolan, we have additional questions, but
we've been going on now for a considerable time. I appreciate, num-
ber one, that you would come in early this morning. We had two
committee hearings that we had to coordinate and it has worked
out very well. This has been a little longer than perhaps we had
anticipated. But we have a lot of good information and we're going
to submit additional questions for you that we would like to have
responses [see p. 131].
I want to say two things. One, I'm particularly concerned about
nailing down something specific on the 482 transfer pricing issue.
We ought to know what our problem is and what you're going to
do about it. And I want to know some clear facts on it.
Secondly, I am more concerned about what's going to happen to
our volunteer tax system. If we can't clear up a lot of problems we
have, our system is going to get worse. It's slipping now, and we've
got to bolster it up again. I want whatever steps taken to do that.
And I need any suggestions and recommendations you or the new
Commissioner will have on it because I think it's tremendously im-
portant.
So we will enlist your cooperation and your recommendations to
keep the system strong. It's the greatest system in the world, but
we've got to shore up every place whether there's loopholes or
whether there's abuse or neglect or else we will get in more dif-
ficult trouble. So we need to be working together.
Unless you have any other suggestions or questions
Mr. Dolan. I would only like to make one closing comment, Mr.
Chairman. We clearly appreciate the attention of the subcommittee
today and the ongoing support. We take very seriously both yours
and Mr. Houghton's invitation for ideas, invitation for ways to im-
prove on many of these important areas, and look forward to being
able to supply you an initiative that will be in your interest as well
as the IRS's ability to get better. So thank you for your time and
your support.
Chairman PiCKLE. It's to our mutual advantage that we do that.
We may try to set up a system here within the committee that we
ask each member to take a special interest in a specific subject and
be in touch with you because we need to be better coordinated on
what's happening. Our subcommittee will be doing it, too.
255
Mr. DoLAN. Can I do one more commercial? I would very much
like, if at all possible, to reschedule what we had to take off the
calendar for the Atlanta trip. I think the subcommittee could put
in context tax systems modernization if we could take the sub-
committee to a service center.
Chairman Pickle. We must do that, and we'll coordinate with
you. We'll do it as soon as we can.
Mr. DoLAN. Thank you.
Chairman Pickle. I don't have any other questions or testimony,
so the committee will stand adjourned. Thank you for your coopera-
tion.
[Whereupon, at 11:40 a.m., the hearing was adjoumed.l
[A submission for the record follows:]
256
STATEMENT OF JENNIE S. STATHIS, DIRECTOR, TAX POLICY AND
ADMINISTRATIVE ISSUES, GENERAL GOVERNMENT DIVISION
U.S. GENERAL ACCOUNTING OFFICE
Mr. Chairman and Members of the Subcommittee:
At your request, we have reviewed IRS' budget request for fiscal
year 1994. That request calls for $7.4 billion and 116,060 full
time equivalent (FTE) staff--an increase of almost $284 million
and 792 FTEs over IRS' authorization for fiscal year 1993. The
two most significant increases are (1) $145 million and 190 FTEs
for Tax Systems Modernization (TSM) and (2) $150 million and
2,000 FTEs for 11 compliance initiatives. These increases are
offset, in part, by decreases for such things as productivity
savings and nonrecurring costs.
Our statement the following six points:
--We question the appropriateness of more than half of the
requested increase for TSM because it is intended for
implementation of a project for which critical plans have
not been completed.
-- Although we generally support the direction IRS appears
to be taking with many of the compliance initiatives,
inadequate funding of IRS' base operations could prevent IRS
from delivering on those initiatives.
-- The goals of some compliance Initiatives could be
achieved more efficiently without a further increase in
staff.
-- The budget request provides for a slight increase in
audit coverage, but that increase depends on IRS realizing
certain productivity savings.
-- Tax law changes in 1993 could increase IRS' taxpayer
service workload and exacerbate problems IRS now has meeting
taxpayer demand for telephone assistance.
-- Operating efficiencies are available through TSM and
changes in the way IRS does business.
TAX SYSTEMS MODERNIZATION
We question the appropriateness and timing of $82.8 million, or
more than half of the requested $145 million increase in TSM
funding for fiscal year 1994. The $82.8 million is being
requested for the synchronized deployment of four interim
systems: (1) the Totally Integrated Examination System, (2) the
Integrated Collection System, (3) the Automated Criminal
Investigation System, and (4) the Automated Inventory Control
System.
While we do not question the concept of synchronized deployment,
we have some general concerns with funding this deployment before
completing critical plans. Deployment planning is in the early
stages, and much remains to be done before IRS will be able to
develop and approve a detailed deployment plan. For example, IRS
has not yet (1) confirmed through thorough technical and economic
analyses which interim systems should be deployed and when, (2)
identified the sites where the systems will be deployed, or (3)
performed a risk assessment of the plan and developed a risk-
reduction strategy.
We are concerned whether IRS will be able to complete these tasks
in time to allow synchronized deployment in fiscal year 1994.
First, determining which interim systems will be deployed
requires not only a thorough reassessment of their technical and
economic merit but also a balance of available system development
resources--the people who will actually develop these systems--
between the interim and long-term TSM systems. Although IRS has
shown that the Totally Integrated Examination System meets
cost/benefit criteria for deployment, this is not yet the case
I
257
for the other three systems. Second, identifying deployment
sites depends on completing ongoing business studies. These
studies could result in significant changes to IRS' field
structure, including changes in the number and functions of field
offices. Third, a risk assessment of the synchronized deployment
strategy is needed to ensure that IRS identifies and addresses
critical risks, such as increased complexity due to the large
number of concurrent tasks that will need to be planned,
coordinated, and verified.
To ensure that the requested funding is commensurate with IRS'
ability to plan and execute the synchronized deployment of
selected interim systems, the Subcommittee may wish to withhold
its support for this funding until IRS presents a detailed
deployment plan accompanied by an economic analysis and a risk
assessment of the selected deployment strategy.
COMPLIANCE INITIATIVES
Many of the 11 compliance initiatives in IRS' budget request are
targeted at critical issues (such as collecting delinquent taxes,
increasing international tax compliance efforts, increasing audit
coverage, and reducing electronic filing fraud) that we have
reported on in the past. We generally support the direction IRS
appears to be taking with many of those initiatives. We are
concerned, however, that inadequate funding of IRS' base
operations could prevent IRS from delivering on these
initiatives. We also believe that the goals of some of the
initiatives could be achieved more efficiently without a further
increase in staff.
Need to Adequately Fund Base Operations
As we have discussed in past budget hearings before this
Subcommittee and in other forums, IRS has had problems realizing
or sustaining the growth intended by compliance initiatives
authorized as part of previous years' appropriations. One of the
major reasons for those problems has been IRS' need to redirect
resources to offset budgetary shortfalls. Again in 1993,
according to IRS' budget documents, IRS has had to scale back
staffing and redirect resources from travel, training, and other
support activities to offset unfunded labor costs of over $200
million.
There are certain aspects of the fiscal year 1994 budget request
that could lead to a similar situation next year. For example,
various factors that IRS has identified as contributing to labor
cost shortfalls continue to exist. Those factors include ones,
such as reduced attrition, over which IRS has little control and
others that result from internal IRS management and program
decisions. We were told that IRS is working to resolve these
issues to the extent they are within IRS" power to resolve.
Productivity savings are another aspect of the fiscal year 1994
budget that could adversely affect IRS' base. The budget
includes decreases of $55 million and 1,219 FTEs attributed to
productivity savings associated with various systems being
implemented as part of TSM. Those decreases offset a large part
of the increase being requested for compliance initiatives. From
what we know and what we have observed about some of these
systems, such as the Totally Integrated Examination System and
Corporate Files on Line, we would agree that they enable IRS
employees to work more efficiently. We did not have sufficient
information available to us, however, to assure the Subcommittee
that the productivity savings estimated for fiscal year 1994 are
realistic. If the savings are overstated, IRS' base operations
would be eroded and at least some of the growth intended through
the compliance initiatives might go unrealized.
258
The potential impact of unrealized productivity savings might
best be demonstrated in the Information Reporting area. One of
the 11 compliance initiatives calls for an increase of about $4.2
million and 107 FTEs to allow IRS to work additional
underreporter cases. That increase is more than offset, however,
by a decrease of $7.5 million and 252 FTEs for savings expected
from implementation of the Automated Underreporter System.
Despite the net decrease, IRS estimates that it will be able to
issue about 2.6 million underreporter notices in 1994--up from
the approximate 2.4 million IRS expects to issue in 1993 but
still well below the approximate 3.8 million issued in 1992.
Problems have been delaying implementation of the Automated
Underreporter System. If those delays continue or if the
expected savings from that system fail to materialize, IRS'
enforcement presence in the Information Reporting area will most
likely continue to decline rather than increase.
Various tax law changes are anticipated this year that could also
contribute to a diversion of IRS resources in fiscal year 1994.
Although the budget request includes $19.6 million to help IRS
implement tax law changes, it is impossible to assess the
adequacy of that amount until specific tax law changes are
enacted. Also, although the budget request provides funds for
implementing tax law changes, it does not provide additional FTEs
even though staff will be required to do such things as rewrite
computer programs, revise forms and publications, and write
regulations. Depending on the nature of any tax law changes, the
impact on IRS' staffing could be significant and, with no
provision for that impact in the budget request, could require
IRS to divert authorized staffing from other areas.
Goals of Some Compliance Initiatives
Attainable Without Increased Staffing
As discussed below with respect to the collection of delinquent
accounts, electronic filing fraud, and motor fuel tax evasion, we
believe that the goals of at least some of the 11 compliance
initiatives in the budget request can be achieved without an
increase in staff.
Collecting delinquent accounts
Although IRS has been placing increased emphasis on reducing its
accounts receivable, collection results are not very encouraging.
As shown in figure 1, collections of delinquent taxes over the
past 5 years have not changed very much; they actually declined
in 1991 and again in 1992. Over the same 5 years, the gross
accounts receivable inventory, adjusted to eliminate the increase
caused by the change in the statutory collection period in fiscal
year 1991 from 6 to 10 years, has been growing at a steady pace.
259
Figure 1: Comparison of Total Accounts Receivable and Collection
of Delinquent Accounts, Fiscal Years 1988 Through 1992
I I ColecKXi 01 OrtnouWl •ooounu
^H| GroM accoxiu racaoDH imarnixy
Note 1: Accounts receivable values for fiscal years 1991 and
1992 have been adjusted from a 10-year to a 6-year statutory
collection period.
Note 2: In 1992, IRS redefined the gross accounts receivable
inventory by excluding certain amounts previously included. The
1992 inventory value was calculated on the basis of the old
definition and, therefore, is comparable to prior years.
Source: IRS data.
IRS" gross accounts receivable balance does not mean much in
terms of potential revenue, but does reflect the collection
workload. Because of overstatements in the inventory and because
of errors by IRS and taxpayers, much of the gross balance is
Invalid and does not reflect the amount of delinquent taxes
actually owed. In addition, many of the valid accounts in the
inventory are considered uncollectible because the delinquent
taxpayers cannot pay or IRS cannot find them. After considering
all of the above, IRS estimates that only $28.1 billion of the
September 30, 1992, accounts receivable balance of more than $100
billion is collectible.
The compliance initiatives in the fiscal year 1994 budget request
Include an additional 777 FTEs and $49.5 million for IRS'
Collection function. Most of these resources are to be directed
toward reducing the accounts receivable Inventory by:
--pilot testing the use of private collection agencies;
--extending hours at Collection call sites;
--expanding the role of the Service Center Collection
Branch;
--establishing call sites in service centers for pre-notice
contact on large dollar cases;
260
--extending Taxpayer Service hours for participation in
installment agreements and other accounts receivable related
work; and
--increasing the number of revenue officers in the field to
collect delinquent taxes and secure returns from nonfilers.
We agree with the primary focus of these initiatives on IRS'
collection activities at service centers and call sites. Indeed,
work we are doing for the Subcommittee on alternative collection
strategies suggests that IRS needs to place even more emphasis on
collection activities at the service centers and call sites and
less emphasis on field collection activities. Currently it can
take up to 6 months after a delinquency arises before IRS
attempts telephone contact with the taxpayer. In the private
sector, most delinquent accounts are closed within that time. If
telephone contact is not successful in resolving the
delinquencies, IRS sends the accounts to the field where more
experienced collection employees (revenue officers) attempt face-
to-face contact with the taxpayers. IRS has allocated almost
two-thirds of its Collection staff to this field collection
activity, while other government and private collection agencies
are relying more heavily on early telephone contact.
With that in mind, while we support the goals of the initiatives
we do not support the new positions being requested to implement
them. We especially do not support adding more revenue officers.
Even with existing processes, IRS projects average revenues of
$377,000 for each FTE requested for its call sites but only
$89,000 for each additional revenue officer FTE requested. We
believe, instead, that IRS should make fundamental changes in its
collection processes and redirect existing resources from the
field to the service centers and call sites.
Electronic filing fraud
As we recently reported, electronic filing fraud has been a
growing problem. "^ IRS statistics for 1992, for example, show
that IRS identified 12,725 electronically filed returns involving
fraudulent refunds totalling $33.6 million and that one-third of
those refunds were issued before IRS could stop them. IRS took
various steps in response to our report and its own internal
studies in an attempt to alleviate this problem in 1993.
Preliminary statistics for 1993 indicate that those steps have
had a positive effect. According to the statistics, IRS was able
to stop 88 percent of $11.3 million in fraudulent refunds claimed
as of March 31, 1993. At the same time last year, IRS had
stopped 80 percent of $10.1 million in identified fraudulent
refunds. We were also told by Criminal Investigation officials
that about 240,000 "bad" returns were kept out of the system by
up-front verification of taxpayer names and Social Security
numbers .
IRS' budget request includes 81 FTEs and about $5 million to help
expedite the identification and deletion of fraudulent claims for
refund associated with the electronic filing program. Criminal
Investigation officials told us that this request is to fund
staff who are already assigned to questionable refund detection
teams in IRS' service centers but who are currently being funded
by other functions. Although the additional staff have
apparently helped IRS combat electronic filing fraud, we believe
that the use of manual labor is the least efficient way to deal
with such fraud. It would be more efficient, for example, if
IRS, as we recommended in our report, improved the criteria its
computers use to screen electronic returns for potential fraud
after the returns have been filed.
^Tax Administration: IRS Can Improve Controls Over Electronic
Filing Fraud ( GAO/GGD- 93-27 , Dec. 30, 1992).
261
As demonstrated by IRS' experience with up-front verification of
names and Social Security numbers, an even more efficient way to
combat such fraud is to implement controls at the front of the
process to help keep fraudulent returns from being filed in the
first place. Because fraudulent refund schemes generally involve
the preparation of false Form W-2s and the fabrication of wage
and withholding information, the best up-front control would be
for IRS to electronically match wage information received from
employers with wage information on the electronic returns. Such
a capability should become available, although not in the
foreseeable future, as IRS implements its Tax Systems
Modernization Program. Currently, employer wage information
other than that provided by taxpayers is not available to IRS
until after it processes taxpayers' returns because of the time
it takes to verify the information and correct any errors.
Motor fuel excise tax evasion
Another of the compliance initiatives calls for providing IRS'
Criminal Investigation function with about $2.6 million and 25
FTEs to pursue cases of motor fuel excise tax evasion. The
required funding would come from the Federal Highway Trust Fund
under a reimbursable agreement with the Department of
Transportation. The additional staff would be used to expand
criminal investigations of motor fuel excise tax fraud.
Although a criminal deterrent is a necessary component of tax
enforcement, we question the need for the requested increase.
Compliance with motor fuel excise taxes can be enhanced by
reducing opportunities to evade the tax and by obtaining better
information to target enforcement efforts. To the extent these
can be achieved, the need for an increased criminal enforcement
presence, which would carry over into future fiscal years, is
decreased.
In a 1992 report, we said that reliable statistical information
did not exist on the extent of motor fuel excise tax evasion.^
Anecdotal information and the professional judgment of some
industry and government officials, however, suggested that
evasion was a significant problem. On the basis of recent
meetings with federal officials and selected industry
representatives interested in this issue, we understand that
reliable statistical evidence is not yet available but concern
about evasion continues, with a growing concern about diesel fuel
evasion.
In our earlier work, we found strong arguments suggesting that
refinery level taxation of gasoline, rather than taxation at the
terminal rack, could reduce the potential for evading taxes.
Because the level of evasion was not known and industry
representatives had concerns about the desirability of such a
move, we suggested that Congress explore the level of evasion.
If evasion was found to be sufficiently high, we said the tax
collection point for gasoline should be moved to the refinery
level .
Developments since our report have reinforced the desirability of
considering a revised collection point for excise taxes on
gasoline and diesel fuel. The President has proposed a BTU tax
that for gasoline and diesel would be collected at the refinery
tailgate (when products leave the refinery) . If the BTU tax is
collected at the refinery, efficiency arguments suggest that
motor fuel taxes also be collected at the refinery.
In addition, the Environmental Protection Agency has adopted
regulations under which high sulfur diesel equivalent products
^Tax Administration: Status of Efforts to Curb Motor Fuel Tax
Evasion (GAO/GGD-92-67, May 12, 1992).
262
must be dyed. These products cannot be used on highways. The
dyeing requirement provides an improved means to segregate diesel
for on-highway use, which is taxable under the motor fuel excise
tax, from diesel for off -highway use, which is not taxable.
The proposed BTU collection point is controversial, however.
Some industry representatives have been working on a proposal to
impose both the BTU and motor fuel excise taxes at the terminal
rack. While this would not represent a change for gasoline, it
would be a higher collection point for diesel fuels and,
especially coupled with the dyeing requirement, could reduce the
potential for evasion schemes involving this product.
Under the auspices of the Department of Transportation's Joint
Federal/State Motor Fuel Tax Compliance Project, IRS has been
working to make better use of data on taxpayers who are
registered to deal in tax-free motor fuels and on motor fuel
transactions among all types of motor fuel industry companies.
IRS recently established a database of taxpayers who are
registered to engage in tax-free exchanges of gasoline. This
database is intended to enable industry members to check that a
purchaser is validly registered to buy gasoline without paying
the excise tax. IRS plans soon to incorporate diesel fuel
companies into the database. Diesel vendors far outnumber
gasoline vendors.
IRS is also working with the state of Michigan and oil industry
members to test the feasibility of a system that would track
motor fuel transactions between vendors. This system would be
used to identify transactions that are subject to tax and assure
that taxes are collected.
We believe that these initiatives to reduce the up- front
potential to evade motor fuel taxes and better identify when
taxes are not paid are likely to increase overall compliance more
effectively than additional funding for criminal investigations.
If additional funds are to be allocated to IRS from the Federal
Highway Trust Fund, efforts to accelerate progress on the tax-
free vendor database and the system to track motor fuel
transactions should be considered.
Compliance Initiatives Expected to
Increase Audit Coverage Slightly
Three compliance initiatives are expected to increase the number
of tax returns examined over the next several years. These
initiatives are directed at (1) high income nonbusiness returns,
(2) employees misclassif led as independent contractors, and (3)
nonf ilers .
The biggest of these initiatives (about $31 million and 400 FTEs
IRS-wide) is directed at misclassif led employees. The initiative
would probably not be needed if Congress were to require either
withholding or enhanced information reporting on payments to
independent contractors. In addition to discussing these
proposals, we reported last year that the common law rules for
classifying workers are unclear and subject to conflicting
interpretations.^ As a result, small businesses, which are
often the subject of employee classification audits, have
difficulty classifying their workers and could end up having
large tax assessments levied against them. The rules need to be
clearer and the compliance incentives stronger to obviate the
need for a compliance initiative like this one.
The compliance initiatives suggest added staffing for the
Examination function. But, after considering projected
^Tax Administration; Approaches for Improving Independent
Contractor Compliance (GAO/GGD-92-108, July 23, 1992).
8
263
productivity savings, the budget request provides for only a
nominal increase in Examination FTEs over 1993 (+94) and less
FTEs than in 1992 (-678). Almost all of the productivity savings
are related to the Totally Integrated Examination System. This
is one of the systems, however, that could be affected by delays
in the synchronized deployment project discussed earlier.
Although IRS anticipates examining more returns in fiscal year
1994, those expectations could go unrealized if deployment of the
Totally Integrated Examination System is delayed. Even if the
additional audits are done, audit coverage is only expected to
increase from 0.91 percent in fiscal year 1993 to 0.95 percent in
1994.
Ideally--if the budget allowed--overall audit coverage should be
higher than 1 percent. An economics study reported in the
December 1990 issue of National Tax Journal* estimated that if
IRS had kept its audit coverage rates at the 1977 level (about 2
1/2 percent for individuals and about 9 1/2 percent for
corporations) through 1986, taxpayers would have reported about
$16 billion more in taxes for 1986. The authors concluded that a
greater likelihood of being audited induces taxpayers to report a
higher tax liability on their returns. While voluntary
compliance is partly based on taxpayer education and assistance,
the fear of an IRS audit may also affect compliance levels and
the size of the tax gap.
Thus, it seems prudent to maintain a certain level of audit
coverage for all taxpayer groups. Beyond that, IRS" enforcement
efforts should be targeted to more noncompliant populations.
Between 1980 and 1987, small corporate compliance, as measured by
IRS' Taxpayer Compliance Measurement Program (TCMP), dropped from
81 percent to 61 percent. Over the same time, IRS' audit
coverage of small corporations dropped from 6.1 percent to 1.1
percent. This rate increased to 2.5 percent in 1992. Until IRS
has evidence of improved compliance in the group, audit coverage
should be maintained at least at this level.
We have been told that IRS' examination plans for 1994 do not
include any detailed audits for a TCMP. For more than 30 years,
TCMP has been IRS' only tool to objectively measure taxpayers'
compliance and select tax returns for audit. In a recent report,
we raised concerns about changes that IRS planned to TCMP.^ IRS
intended to make TCMP cheaper and quicker for IRS and less
burdensome on taxpayers--goals that we support. However, we
found that problems with TCMP were small when compared to its
benefits. Further, IRS' planned changes would have severely
hampered TCMP's ability to provide statistical data for varied
'Jeffrey A. Dubln, Michael J. Graetz, and Louis L. Wilde; "The
Effect of Audit Rates on the Federal Individual Income Tax, 1977-
1986", National Tax Journal, December 1990, pp. 395-409.
^Tax Administration: IRS' Plans to Measure Tax Compliance Can Be
Improved (GAO/GGD-93-52, Apr. 5, 1993).
264
and crucial uses. As a result, we recommended that IRS not make
these changes.'
In comments on a draft of our report, IRS agreed to defer the
planned changes and use criteria we recommended in making
changes. At the same time, however, IRS reiterated its intent to
improve or replace TCMP. We are concerned that IRS will continue
to delay the next cycle of TCMP audits and thus the data
generated by those audits. The most recent cycle covered tax
year 1988 and the next cycle would have covered 1991 had IRS not
delayed it to make changes. As a result, our report also
recommended that IRS cover 1993 tax returns in the next TCMP
cycle. The longer IRS waits, the older and more unreliable the
data on which IRS, Congress, and the Administration will base
decisions on tax policy and administration.
International Tax Compliance Initiative
Focuses on Important Issues
One compliance initiative would provide about $31 million for
international tax compliance. Many of the elements of this
initiative address needs we have seen in our work on transfer
pricing.' Funds for 50 extra international examiners should
enable IRS to continue Increasing the number of international tax
returns examined although, as of March 1993, IRS had not yet
adopted a staffing model to help allocate international staffing
resources. IRS' plans to have the model in place by September
30, 1993. IRS will also be adding 82 FTEs to its international
counsel's office. This will enable it to set a goal for advance
pricing agreements at 75 per year and to increase its early
counsel involvement with international cases, thus focusing on
problems we have seen in sustaining examination findings.
In addition, IRS will use about half the funds for the
international initiative on (1) more expert witnesses and
consultants to also help sustain its findings and target cases
and on (2) various information and automation systems.
Even with this international initiative, the challenges of
dealing with transfer pricing will remain. This is because the
growing global economy will increase the potential for
underpayment of U.S. taxes through transfer pricing practices and
the arm's length standard governing transfer pricing will
continue to be difficult for IRS to enforce.
*For example, IRS had planned to cut TCMP's sample size in half.
Such a cut would lower statistical precision and limit the
usefulness of the results. Moreover, IRS was going to give TCMP
examiners discretion on which tax return lines to audit, instead
of requiring them to check all lines. Such discretion would
leave users of the aggregated TCMP results in the dark on whether
the taxpayers had indeed complied or whether many TCMP examiners
had simply chosen to skip certain lines.
To guide any improvements to TCMP, we offered four criteria. We
recommended that IRS ensure that any changes provide statistical
data that allow IRS to (1) consistently measure tax compliance,
(2) objectively select returns to be audited, (3) effectively
decide how to structure its enforcement programs, and (4) meet
the needs of tax policy and other users in the executive and
legislative branches.
'International Taxation: Problems Persist in Determining Tax
Effects of Intercompany Prices (GAO/GGD-92-89, June 15, 1992) and
International Taxation: Updated Information on Transfer Pricing
(GAO/T-GGD-93-16, Mar. 25, 1993).
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265
BUDGET REQUEST FOR TAXPAYER SERVICE
MAY NOT IMPROVE TELEPHONE ACCESSIBILITY
To measure how accurately IRS' toll-free telephone assistors
respond to taxpayers' tax law questions, IRS test callers place
anonymous calls to assistors and score their answers to various
questions. IRS statistics on the results of these test calls
show that assistors answered 89 percent of tax law questions
accurately from February 1 through March 27, 1993--a 1 percent
improvement over the same period last year.
Although taxpayers are generally receiving accurate answers to
tax law questions, they are having more difficulty reaching IRS
to ask questions. According to IRS data through March 27, 1993,
(1) IRS received about 55 million calls in 1993, about 15 million
more than for the comparable period in 1992, and (2) assistors
answered about 13 million calls, slightly less than for the
comparable period in 1992. By dividing the number of calls
answered by the number received, we computed an answer rate of 24
percent this year, down from 33 percent last year. We defined
calls received as the sum of calls answered, busy signals, and
calls abandoned by the taxpayer before an assistor got on the
line. Busy signals continue to be a problem for taxpayers. IRS'
data show that about 73 percent of callers this year got a busy
signal, up 8 percentage points from 1992.
Accessibility is lower this year primarily because the demand for
IRS' telephone assistance has increased sharply while the
resources available to provide it decreased. To illustrate, from
January through March 28, 1992, IRS had received over 40 million
calls and had applied 1,027 staff years to answer about 13
million of them. For the comparable period in 1993, IRS had
received over 55 million calls but only used 911 staff years--116
less than in 1992. Because of productivity gains, IRS was able
to answer almost the same number of calls--over 13 million--in
1993 as it did in 1992 but the higher demand meant that more
taxpayers received busy signals or were placed on hold and hung
up before IRS could help them.
The fiscal year 1994 budget request provides for about $17.3
million in additional funds for Taxpayer Service but 67 fewer
FTEs. Even with fewer staff, IRS expects to answer 880,000 more
telephone calls. With new automated call routing equipment at 9
of IRS' 32 toll-free telephone sites, productivity should improve
so that more calls are answered by each assistor at those 9
locations. IRS' Taxpayer Service staffing plan also envisions a
continued trend toward more permanent and fewer temporary
positions, which should also have a positive effect on
productivity.
Despite the above, it seems rather optimistic to believe that
overall productivity will jump 3 percent. If the tax laws are
changed this year, it is reasonable to expect an increase in IRS'
telephone assistance workload as taxpayers call with questions
about those changes. Consequently, we doubt that this budget
strategy will result in an improved answer rate in 1994.
EFFICIENCIES AVAILABLE THROUGH TSM AND
CHANGES IN THE WAY IRS DOES BUSINESS
At the request of the Subcommittee, we have prepared a fact sheet
that summarizes several examples of waste and inefficiency at IRS
as cited in past reports issued by GAO, IRS' Internal Audit, and
the Department of the Treasury's Office of Inspector General as
well as various studies done by and for IRS. As noted in that
document, a copy of which is being submitted for the hearing
record, IRS' antiquated computer systems are a major contributor
to waste and inefficiency. Modernization of those systems
through TSM is expected to make IRS more efficient. We have
already begun to see some of that promise in Corporate Files On
11
266
Line (CFOL) and in the various filing alternatives now being
offered taxpayers.
Corporate Files On Line
By providing on-line access to taxpayer account information, CFOL
has helped IRS streamline operations and use current technology
more efficiently. For example, the previously-discussed up-front
verification of names and Social Security numbers that kept about
240,000 "bad" returns out of the electronic filing system was
made possible through CFOL. Likewise, information we obtained
from the Memphis Service Center indicated that implementation of
one CFOL component that electronically verified name and address
information enabled the center to save between 10,000 and 15,000
staff hours in manual verification.
Filing Alternatives
As of April 16, 1993, about 12.2 million taxpayers had filed
their returns electronically. These taxpayers generally received
their refunds faster than they would have if they had filed paper
returns and had greater assurance that their computations were
correct. IRS, on the other hand, was able to process and store
electronic returns more efficiently and with less rework needed
to correct taxpayer and/or processing errors. Two other filing
alternatives were also available to some taxpayers in 1993.
One alternative being tested in Ohio, known as TeleFile, allows
certain taxpayers to file using a touchtone telephone. Because
TeleFile returns are processed through the Electronic Filing
System, they provide the same kinds of efficiencies for IRS as
electronic returns. As of April 16, about 147,000 Ohio taxpayers
had filed via TeleFile. The second alternative, known as 1040PC,
allows users of tax preparation computer software to file a
computer-generated answer sheet rather than the standard Form
1040. Because the answer sheets show only line numbers and
amounts, they can be keyed by data entry clerks faster and with
fewer errors than the standard Form 1040. As of April 16, about
3.6 million taxpayers had filed a 1040PC.
IRS Can Streamline
Regional Office Operations
Although systems modernization should produce significant
efficiencies, IRS needs to go beyond that. As we have been
urging for some time, IRS needs to take advantage of the
opportunities afforded by modernization to change the way it does
business. One result should be an ability to streamline its
organization and achieve even greater efficiencies. In 1992, IRS
began to reexamine its organizational structure. In that regard
and at the Subcommittee's request, we have been assessing one
component of IRS' organization--regional offices. Appendix I
includes general information about regional offices, including
some historical information and data on regional office staffing
and costs, along with details on the preliminary results of our
assessment, including some preliminary data from questionnaires
we sent district and service center managers.
As discussed in the appendix, our work, while identifying several
positive aspects of regional office operations, has also
identified opportunities for improved efficiency. For example:
-- One reason for establishing regional offices was to
reduce the National Office's span of control. Span of
control may be a valid consideration in managing 63 district
offices. It seems less valid, however, when considering
service centers and forms distribution sites, of which there
are 10 and 3 respectively. We see no need to have layers of
management between the National Office and those field
offices .
12
267
-- Span of control could also become irrelevant if IRS
consolidated the various telephone operations that take
place in 32 taxpayer assistance call sites, 21 collection
call sites, and the 3 forms distribution centers. Under
IRS' current organizational structure, those telephone-based
operations report through district and regional offices to
the National Office. A consolidated telephone operation
could report directly to the National Office.
-- Efficiencies could be achieved by consolidating
administrative services (such as processing travel vouchers
and recording accounting transactions), resource management
activities (such as training and personnel management), and
automated data processing activities.
IRS has several initiatives directed at achieving the kinds of
efficiencies discussed above. Several regional offices, for
example, have initiatives that focus on reducing duplication in
administrative services and resources management. The National
Office has initiatives that focus on reducing layers of
management IRS-wide and diverting staff to front-line activities.
In that regard, IRS has decided to reduce regional office
staffing levels by December 1994 and to reduce the number of
regional offices from 7 to 5 by December 1995. Whether further
reductions are possible will depend on the extent to which (1)
front-line operations can be streamlined and thereby provide
opportunities for direct reporting to the National Office; (2)
the National Office assumes a larger role in providing
centralized leadership and direction, thereby minimizing the need
for detailed regional office guidance; and (3) front-line
managers have discretion to make decisions that formerly would
have required consultation with the regional office.
The Subcommittee also asked for information on (1) IRS
correspondence; (2) IRS' forms, publications, and notices; and
(3) the exchange of data between IRS and Customs. That
information is in appendixes II, III, and IV.
13
268
APPENDIX I APPENDIX I
IRS' REGIONAL OFFICE OPERATIONS
The Subcommittee has had a continuing interest in waste and
inefficiency in IRS. When we testified on IRS' fiscal year 1993
budget we said that IRS' operation has much built-in waste. Two
examples we cited were (1) the redundancies and inefficiencies
that are fostered by IRS' field structure and (2) IRS' functional
organization which results in a fragmented view of the
taxpayer.' In 1992, IRS began to reexamine its organizational
structure in light of the opportunities presented by Tax Systems
Modernization. Before discussing some of IRS' planned changes,
we will provide some specific information you requested on IRS'
regional offices--a brief history, cost and staffing data, and
our preliminary observations on (1) the regional offices'
positive contributions, (2) areas where they contribute to
duplication and delay, and (3) opportunities to streamline
regional office operations.
A BRIEF HISTORY
In 1952, prompted by a corruption and embezzlement scandal that
involved politically appointed local tax collectors,' IRS
established a three-tier organization made up of a multi-
functional National Office, 17 regional offices, and 64 district
offices. Although the number of field offices has changed, that
structure has virtually remained intact. IRS has reduced the
number of regional offices three times since the reorganization.
In 1953 the number was reduced from 17 to 9. In both 1964 and
1965, IRS eliminated one regional office.
The seven regional offices, each under the direction of a
Regional Conunissioner , have traditionally operated as autonomous
entities. They report to IRS' Chief Operations Officer and
execute National Office policy and oversee the functions and
activities of the district offices and service centers within
their geographical boundaries. As shown in figure I.l, IRS'
regional office structure generally mirrors the National Office
functional structure (i.e., collection, examination, returns
processing, etc.)
°Tax Administration: IRS' Budget Request for Fiscal Year 1993
(GAO/T-GGD-92-34, Apr. 30, 1992).
'Today, only two IRS of f icials--the Commissioner and Chief
Counsel--are political appointees.
269
APPENDIX I
Figure I.l: Regional Office Organization
APPENDIX I
Emplovmeni
OpponuMiiy Oltic
> uanagemeni
Aulomaled
Syslems
Suppofi
Funclion
'Oislosun and sscunly programs a
wilhin the RssourcM Manag«menl fi
Regional Commissionef
Source: IRS' Planning Division.
IRS also has seven Regional Inspectors and seven Regional
Counsels that have separate management structures, although they
may be housed in the same space as the Regional Commissioners.
The rest of our discussion about regional offices focuses only on
activities under the direction of Regional Commissioners.
REGIONAL OFFICE STAFF ACCOUNT FOR A
SMALL PORTION OF TOTAL IRS STAFFING
Of the 136,865 IRS employees on board as of March 6, 1993,'°
about 2 percent (2,428) were in the regional offices. Table I.l
shows a breakout of those staff by position title. Of the 2,428
regional office staff, most (1,360) were involved in resources
management, which includes activities such as budget and
financial management, procurement, training, facilities
management, and personnel management. Besides doing these
activities for their region, regional office staff may also
support similar functions in district offices and service
centers. In a few instances, regional office staff will do these
activities directly for district offices and service centers
under a consolidated authority. For example, staff in the
Central Regional Office provide procurement services for the
regional office, one service center, and six district offices.
'"This number is higher than the average number of staff on board
during the year because it includes temporary staff who are hired
for the filing season.
15
270
APPENDIX I
APPENDIX I
Table I.l: Number of Regional Office Staff by Position Title as
of March 6, 1993
Regional office occupation
Number
Percent
Managers
192
7.9
Analysts
661"
27.2
Technicians /Specialists
676"
27.8
Administrative
455
18.7
Other
444
18.3
Total
2,428
100.0
"Regional analysts are tasked with helping field offices
understand program requirements, monitoring performance, solving
problems, and elevating field office concerns to the National
Office.
"The technician/specialist category includes staff working in
accounting and personnel functions in the resources management
area or as computer specialists.
Source: IRS' Automated Financial System.
Regional office staff are not on the "front line" in
administering the tax laws. Instead of directly serving
taxpayers, they provide support to front line staff in service
centers and district offices. Regional office staff are graded
more highly than IRS staff overall. About 56 percent are GS-12s
or higher compared to 24 percent IRS-wide.
REGIONAL OFFICE COSTS
IRS* total fiscal year 1992 costs were about $6.7 billion. Field
offices, including regional offices, accounted for about $4.7
billion of that cost. Regional offices alone accounted for only
about $209 million. However, these costs overstate the true cost
of operating a regional office because they include some costs
incurred by district offices. IRS' Automated Financial System,
the primary system IRS uses for reporting costs, does not readily
separate regional office costs from district office costs for
certain activities such as training, supplies and services, and
printing. To get a better idea of what it costs to operate a
regional office, we asked IRS to provide this information for two
regions. According to budget officials in the Mid-Atlantic and
Southwest Regions, fiscal year 1992 obligations for those two
regions were $22 million and $26 million, respectively.
CONTRIBUTIONS OF IRS' REGIONAL OFFICES
The National Office has traditionally relied on regional offices
to develop guidance needed to execute National Office policy and
otherwise help reduce the span of control over a field structure
that includes 10 service centers, 63 district offices, and about
600 posts-of-duty . It is not surprising, therefore, that
district office and service center managers we talked to said
that the regional offices act as their advocates with the
National Office and provide assistance and evaluation.
IRS field managers also told us that regional office staff, many
of whom had worked in district offices and service centers, are
in a better position to provide a field perspective on program
operation and policy development. Some managers told us that
National Office staff do not always have the field experience
necessary to develop realistic guidance when implementing new
16
271
APPENDIX I APPENDIX I
programs. District office managers also said that regional
offices act as advocates for the districts.
To assess the regions' role in implementing National Office
policy and to gain a broader perspective on district office and
service center managers' views of IRS regional offices, we (1)
have been reviewing how three regional offices implemented the
nonfiler initiative that began this fiscal year and (2) sent a
questionnaire to all service center directors, district office
directors, and service center division chiefs and to a sample of
district office division chiefs.
The nonfiler initiative, which is part of IRS' Compliance 2000
strategy, is aimed at bringing nonfilers into the tax system and
preventing others from becoming new nonfilers. The Regional
Commissioner of the Southwest Region, acting on behalf of the
National Office, is responsible for Implementing the program over
a 2-year period beginning October 1, 1992.
Preliminary information indicates that the regional offices have
generally had a positive effect on the nonfiler program. In one
region, regional office staff from different areas responsible
for implementing the program formed a nonfiler working group to
clarify National Office policy and guide district office and
service center implementation. Staff from three district offices
in the region commented favorably about the working group and
mentioned, as an example, the group's role in developing a
uniform nonfiler data sheet.
Staff Use this data sheet to help ensure that they have all the
information they need from taxpayers to help them file their
returns. These data sheets also provide information for IRS to
use in following up with taxpayers who had called IRS and had
their nonfiler information recorded by a Taxpayer Service
employee. The sheets are also important if IRS is to have
reliable data on such things as the results of its nonfiler
program and the reasons for not filing. In the absence of a data
sheet from the National Office, some districts had been
developing their own, and the information required by those
sheets was not consistent from district to district. A data
sheet that will be used universally by all regions was finalized
by the National Office in March 1993 — 5 months after the program
started.
REGIONAL OFFICES CONTRIBUTE TO
DUPLICATION AND DELAY
Although regional offices do several things that contribute to
IRS' mission, they also contribute to duplication and delay.
In our questionnaire to district and service center managers, we
asked them to identify the least useful services provided by
regional offices. In responding to the questionnaire, some
managers said that:
Regional office reviews are duplicative and do not
contribute to problem solving. (Some IRS managers we spoke
with also complained about duplication in the quality review
area. )
Regional offices sometimes act as a paper conduit between
the National Office and the districts/service centers
without adding any value to communications between the two
levels of the organization.
Our review of the regional offices' role in the nonfiler program
also identified examples of the regional office serving as a
conduit. For example, on September 1, 1992, a National Office
17
272
APPENDIX I
APPENDIX I
assistant commissioner sent a memo to an Assistant Regional
Commissioner for Criminal Investigation asking him to have his
district chiefs discuss IRS' nonfiler efforts with local U.S.
Attorneys in preparation for implementing the program in fiscal
year 1993. About 3 weeks later, the Assistant Regional
Commissioner sent a similar memorandum to the district office
directors. The attorneys may have been contacted earlier if the
National Office had sent the memo directly to the districts.
In a separate review of offers in compromise being done for the
Oversight Subcommittee, we encountered a delay in receiving data
from some district offices because communications between the
National Office and the districts were funneled through the
regional offices. The district offices in one region never
received the communication and several weeks went by before the
problem was identified and resolved.
In our questionnaire, we also asked district office and service
center managers about the extent to which regional offices
duplicate activities of other IRS offices without adding value.
Figure 1.2 shows their responses, by position title, based on our
analysis of about 50 percent of the returned questionnaires.
Figure 1.2: Field Managers' Perceptions on the Extent to Which
Regional Offices Duplicate Activities of Other Offices
I I Very gfeat/gceal extern
Moderaie exient
^^^H Some/lillle or no exieni
Source: Analysis of about 50 percent of the responses to a GAG
questionnaire.
OPPORTUNITIES TO STREAMLINE
REGIONAL OFFICE OPERATIONS
We believe that IRS could achieve efficiencies if certain
existing oversight responsibilities were removed from the
18
273
APPENDIX I APPENDIX I
regional offices. Reducing the National Office's span of control
was one of the primary reasons for establishing the regional
offices. Although the span of control issue may be valid
considering the current number of district offices, it seems less
a factor for oversight of service centers and forms distribution
centers. For example, since there are only 10 service centers,
span of control should not be a significant factor. Span of
control is even less an issue for National Office oversight of
the three forms distribution centers. Currently, the
distribution centers are located within the facilities management
branch of a district office. As a result, requests for resources
and other support must pass through a district office and
regional office to reach the National Office. Guidance to the
distribution centers filters down through the same chain.
In July 1991, we testified on several options for changing IRS'
field structure that could reduce redundancies and
inefficiencies.'' Some of these options would further reduce
the need for a regional presence. For example, we suggested that
IRS could consolidate the different telephone operations that
currently take place in 32 taxpayer assistance call sites, 21
collection call sites, and the 3 forms distribution centers.
Under IRS' current organizational structure, these telephone
based operations report through district and regional offices to
the National Office. A consolidated telephone operation could
report directly to the National Office, eliminating the roles of
the district and regional offices.
As we discuss below, within the last year, IRS began taking some
important first steps in considering some of the options we
raised in our July 1991 testimony.
IRS' Plans for Reorganizing Its Field Structure
IRS has several initiatives underway that involve reorganizing
its field structure. Local initiatives in regional offices focus
on reducing duplication in resources management and
administrative functions. National Office initiatives focus on
reducing the layers of management IRS-wide and diverting more
staff to front-line activities. Both of these efforts will
affect the future role of IRS' regional offices.
Local initiatives
Several regional offices have undertaken initiatives to reduce
duplication within or across their regional boundaries. One
target of opportunity is administrative services (such as
processing travel vouchers, processing personnel actions, and
recording accounting transactions). These functions are
performed to varying degrees by staff at district offices,
service centers, and regional offices. Some regions have
consolidated or plan to consolidate these types of administrative
functions at the regional level or at a particular district
office. The Central Region, for example, expects to reduce its
managerial positions by 33 percent by consolidating all of its
resources management activities. The North Atlantic Region plans
to consolidate its accounting functions in West Virginia and is
looking at the possibility of consolidating additional
administrative functions. It has also agreed with the Mid-
Atlantic and Southeast Regions to consolidate administrative
functions across regional boundaries.
Information services (automated data processing activities)
provide another opportunity for consolidation. For example, in
"Identifying Options for Organizational and Business Changes at
IRS (GAO/T-GGD-91-54, July 9, 1991).
274
APPENDIX I APPENDIX I
the past, the Central Region and its districts each maintained a
cadre of computer specialists who managed office computer
resources. The Central Region recently sought National Office
approval to consolidate its information services at the regional
level. It expects to improve its service to district and
regional office customers while reducing the number of managers
at each office and the inefficiencies associated with maintaining
expertise at each office. It also expects the streamlined
organization to react more quickly to technology changes and the
changes anticipated from TSM.
National Office initiatives
In March 1993, the Deputy Commissioner briefed IRS field offices
on decisions about structural realignments for the National and
regional offices. According to IRS officials, three guiding
principles were used in making these decisions: (1) reducing the
number of executives, (2) reducing the number of layers of
management in IRS, and (3) reducing regional and National Office
positions by 2,000 and redeploying them to the front line to
improve customer service. Using these principles, IRS has
decided to (1) downsize the regions by December 1994 by reducing
the number of regional analysts, (2) establish consolidated sites
(the number yet to be determined) to provide resources management
and information services, and (3) reduce the number of regions
from 7 to 5 by December 1995.
IRS is also considering changes that could affect the number and
roles of service centers and district offices. Such changes,
when decided, could further affect the roles of regional offices.
IRS plans to announce these changes sometime in 1993.
20
275
APPENDIX II APPENDIX II
IRS' CORRESPONDENCE
In an August 21, 1992, letter to IRS, the Subcommittee expressed
concern about a particular type of correspondence sent to
taxpayers. The Subcommittee's concern was that the
correspondence, which IRS calls "interim letters", was
inappropriate for the situation and likely to generate additional
taxpayer inquiries. Specifically, the taxpayers had sent
payments to IRS, but IRS' interim response did not acknowledge
that a payment had been made. Instead, the interim response
contained language thanking the taxpayer for their "inquiry". In
a September 15, 1992 reply, IRS agreed with the Subcommittee's
concern and said that it was taking immediate action to change
the interim letter. You asked us to determine if IRS had solved
the problem.
To respond to your request, we reviewed the examples of interim
letters you provided us and IRS' response to you describing the
corrective actions taken. Then, at IRS' Cincinnati Service
Center, we sampled interim letters sent after IRS made its
changes to see if the problem had been corrected. We reported
the results of our work to you in an April 27, 1993 letter.
The problem has not been solved, primarily because IRS directed
only one of several service center functions that correspond with
taxpayers to correct its procedures. In 25 of 26 cases we
reviewed from the other functions where taxpayers had written to
IRS and sent payments, IRS' response did not acknowledge receipt
of the payment. We also found several other instances of what we
believe to be unclear responses to taxpayers that did not involve
payments .
One reason IRS did not respond appropriately was that IRS staff
who prepare the letters did not choose appropriate language when
composing the letters on IRS' computerized letter writing system.
We do not know why this continues to occur, but we will study the
problem in more depth as part of a broader review of IRS
correspondence issues we are doing for the Subcommittee.
276
APPENDIX III APPENDIX III
IRS FORMS, PUBLICATIONS, AND NOTICES
At the Subconunittee' s request, we assessed the accuracy of
commonly used IRS forms, publications, and notices. We examined
forms and publications for conformity with current legal
requirements as stated in the Internal Revenue Code and Treasury
Regulations. To judge understandability, we compared notices
with purpose statements contained in IRS' Taxpayer Service
Handbook and the Catalog of Federal Tax Forms, Form Letters and
Notices . We expect to issue a report on the results of our work
by April 30.
While we did not identify any instances where the documents were
not in conformity with current legal requirements or IRS
guidance, we did identify 59 changes that could be made to
improve the understandability and usefulness of these documents
to taxpayers. Generally, we suggested changes directed toward
the use of more specific language and consistent terminology and
the inclusion of appropriate references to IRS forms and
publications. For example, we suggested that the 1991
instructions accompanying Form 2119, Sale of Your Home, should
more clearly define the term "sold" as it relates to the date of
sale. The 1991 instructions did not clearly define this term,
leaving it to be interpreted as either the date a seller accepted
a contract from a prospective buyer or the date title was
transferred from seller to buyer. We also suggested IRS consider
a new format to display taxpayer account Information which is an
important part of many IRS notices to taxpayers. Our suggested
format more clearly compares data reported on the taxpayers 's
return with IRS' proposed adjustment to the taxpayer's account.
IRS officials said that our suggestions would be incorporated as
the forms and publications involved are revised. With respect to
notices, they agreed to consider the issues we raised as each of
the notices are revised and to the extent IRS' present and
planned system of computers, printers, and related equipment
permit .
22
277
APPENDIX IV APPENDIX IV
EXCHANGE OF DATA BETWEEN IRS AND CUSTOMS
We recently submitted to the Subcommittee on Oversight
correspondence relating to the collection and exchange of data by
IRS and Customs.'^ In general, the sharing of desired
information is one way--from Customs to IRS--due to the
disclosure restrictions of Section 6103 of the Internal Revenue
Code. Specifically,
--Customs officials said that IRS has access to all
information on importers, manufacturers, third parties, and
fraud investigations and that IRS can use Customs data to
find undisclosed related parties.
--Section 6103 of the Internal Revenue Code prohibits the
disclosure of taxpayer information for unauthorized uses.
Customs' transfer pricing issues are not considered
authorized use.
--IRS said that it has given Customs access to requested tax
return information when it is relevant to a case going
before a Federal grand jury and that Customs has routine
access to the Currency and Banking Retrieval System and has
access to publicly available statistical information and
industry trend data.
We found that each agency is developing its own database on
comparable prices. In addition to the Section 6103 barrier, we
identified barriers to sharing of data between the two agencies.
For instance, we noted that:
--The timing of IRS' audits prevents it from providing
Customs with information that is useful and current.
--IRS does not have most of the information desired by
Customs (such as examination reports) on an automated
database and has no plans to automate it.
(268607)
"IRS-Customs Data Systems Exchange (GAO/GGD-93-33R, Apr. 6,
1993) .
23
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