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Prepared Remarks of Douglas H. Shulman, Commissioner of Internal Revenue, to the CERCA Fall Meeting 2011

PREPARED REMARKS OF
DOUGLAS H. SHULMAN
COMMISSIONER OF INTERNAL REVENUE
CERCA FALL MEETING
ARLINGTON, VA
OCTOBER 12, 2011

 

Good afternoon. It’s a great pleasure to be addressing CERCA’s members who have been our partners for 15 years… and I trust for many more years to come.

As we celebrated the one billionth e-filed 1040 return this year, it’s hard to imagine what it was like 25 years ago when IRS first piloted what was called the Electronic Filing System, or EFS.

The processing system consisted of a Mitron and Zilog, the oddly named early technology that would foreshadow a revolution in the use of technology in the tax system that continues to this day.

Here’s how EFS worked. The five tax preparers….yes, there were only five in the entire nation who participated in the 1986 pilot …would call a designated number at the IRS Cincinnati Service Center. An IRS employee would then plug the phone into the Mitron, which was a modem with a tape drive.

When the transmission was finished, the IRS employee would transfer the tape to the Zilog, the super mini-computer of the day, which would then manipulate the data into files that our Unisys System could process.   

To send the acknowledgement, the IRS employee would have to telephone the tax preparer who would then plug the phone into his or her modem and reverse the transmission. It was a far cry from today’s fast, easy and seamless e-file experience.

The reason for this look-back to the first days of e-file, when VCR’s, cassette tapes and floppy discs dotted the technological landscape, is not to wax nostalgic but rather to illustrate how technology is always changing and evolving.

Although it may consist of things like microscopic transistors, and solid state memory devices, technology is almost organic in its nature. Just like the natural world, a new technology may emerge and dominate, eventually leading to the extinction of another form.

There are many factors that come into play in technological evolution, such as cost… potential uses and ease of use …the ability to survive, grow and adapt to different needs, situations and environments… and of course, customer needs and preferences.

Indeed, the 1986 e-file pilot was intended not only to measure the costs and benefits of the nascent program but to gauge acceptance by taxpayers and return preparers. Marketing to tax return preparers and getting them to buy modems became a major focus of the program.

Technological innovation teaches us some valuable lessons.

It teaches us that we must not be afraid to say something no longer works or may not meet future needs.

It teaches us that we must think beyond today’s boundaries and ask the big questions and think big.

It teaches us that what’s not in our grasp today may be reachable tomorrow.
 
For example, Moore’s Law, named after Intel’s co-founder Gordon Moore, predicts transistor density, which drives computing performance, will double approximately every 2 years. And it has proved uncannily true.  

But before we get too far ahead, let’s first take a look at some of the more recent branches on IRS’ technological tree and how they developed. 

In the 1990s, Congress recognized the need for IRS to become a technologically intensive financial services institution. Both the Restructuring Commission Report and RRA 98
elevated the importance of modern technology and electronic interactions with the IRS to a new level. Many believe that the 80 percent mandate in the Restructuring Act helped fuel the upward trajectory in e-filing that’s still climbing today. In fact, for individual taxpayers, the e-file rate for the 2010 tax year stands at an impressive 78.4 percent.

However, creating and procuring modern technology is not an end in and of itself, but rather a tool that enables us to better serve taxpayers and improve efficiency and compliance. We must never lose sight of that guiding principle.

After a number of false starts, and years of underfunding, the IRS has clearly turned the corner on its technology. A big part of our success is having in place the right infrastructure, security, disaster recovery and such. 

The IRS has also embarked on a multi-year effort to streamline and standardize processes that will allow for substantial efficiency gains. For example, the IRS adopted the Information Technology Infrastructure Library – which is a collection of best practices used to aid in the implementation of a lifecycle framework for IT Service Management. And, in September 2010, an independent third party found that the IRS recently reached Capability Maturity Model Level 2 – a key measure of the maturity of our internal software development organizations.

Achieving this level allows standardized project management practices across projects. This will improve our agility and quality in delivering software, as well as reduce the cost of developing and maintaining products, and improve the cost of engineering services. These achievements may not grab all the headlines but are vital to our program’s health and accomplishments.

There are also a number of other important pieces that have helped support and drive our advances in technology. President Kennedy once said that “man is still the most extraordinary computer of all.” And I stressed in our Strategic Plan that to achieve our service and enforcement goals, we must invest in two strategic foundations – our people and our technology.

To guide and run our IT program, we recruited and assembled an excellent team of talented and highly motivated individuals. I was extremely fortunate to have been able to bring on board Terry Milholland as our CTO, who I think is one of the best CTO’s operating in the private or public sector today. 

Speaking of best, one of the first things I focused on when I became Commissioner was to make the IRS the best place to work in the federal government. And we’ve seen a big jump in survey scores across the board.  We had the biggest increase in the best place to work rankings of large agencies from 2008 to 2010. Our employee engagement index – which measures the degree of employees’ motivation, commitment and involvement in the mission of the organization – and the job satisfaction index have both increased in the last several years.

This is especially heartening to me this year because we faced more than the usual number of challenges, from late tax law changes, to six short-term continuing resolutions during the filing season, to weeks of speculation of a possible government shutdown, and ultimately a decreased budget.         

After becoming Commissioner, I also took a hard look at the full range of projects in our IT portfolio and started narrowing them down to those that would deliver the greatest benefits to customer service and compliance and then pushed forward and accelerated these projects. Many of these will help drive efficiencies and drive down costs, much like e-file.

E-file is now recognized as one of the greatest success stories in all of government. It has truly changed the way Americans interact with the IRS. Increased e-filing also translates to big savings for the Federal Government as it costs only 17 cents to process an e-file return versus $3.66 for processing a paper return. This year we closed our 5th of the original 10 sites that processed paper returns.  This reduction in footprint along with the reduced labor costs in the remaining centers from processing fewer paper returns have resulted in over $200 million in taxpayer savings.
 
Allow me one final observation on e-file. Its success cannot be tied to one individual or even one organization but rather the partnership and the rich interaction that exists between the IRS, industry, and states and our collective investments in technology. And I salute CERCA for the contribution it has made to this team effort.

Let me spend a few minutes on Modernized e-file, or its shorthand name, MeF. As most of you know, MeF has a number of proven benefits. For example, it’s a transaction based system that processes returns as they are received. Transmitters receive acknowledgements within minutes during non-peak days and within 2 hours during peak days, instead of the 24-48 hours under the legacy system. There’s also better data validation. MeF can pinpoint the location of an error in a return and provide more information to correct the taxpayer’s return right up front. That means less hassle and rework for taxpayers and the IRS. 

We have delivered the infrastructure in stages over several years, but we now need your help to cross the goal line. To be candid, we have not seen the volume of returns submitted through MeF that we would have liked. But now that we will have completed the infrastructure for this coming filing season, my expectation is that everyone will treat MeF…not the legacy system…as the primary e-filing platform for the coming filing season. As the steward of the taxpayers’ dollars, I cannot run two concurrent systems indefinitely. Therefore, we plan to shut down the legacy system in the fall of 2012, as we have previously communicated to the software community.          

In order to ensure that this migration to MeF proceeds apace, we are considering putting in place parameters that will limit the volumes in the legacy system this filing season. I believe that this is a reasonable and measured step to take at this time to better ensure MeF’s ultimate success.

However, as with any system transition of this size, let me assure you that we will not allow anything to happen to jeopardize another successful filing season with electronic filing as the standard.    

As most of you know, since the late 1980’s, the IRS has been trying to move its core account database, which holds basic taxpayer information, such as your current account balance, whether you have outstanding amounts due, and whether you’ve made any recent payments, from a weekly or bi-weekly batch processing cycle to a daily cycle.

We are now on track to deliver this relational account database, called CADE 2, for the tax filing season commencing in January 2012. This is a major milestone for the tax system and the IRS as CADE is the modernized infrastructure we need for the future.

I think it’s very difficult to appraise the total value of the basket of benefits that CADE will deliver but let’s start with CADE provides the foundation for more effective tax administration.

The promise is quicker refunds for all taxpayers, up-to-date information at the fingertips of our customer account representatives, and a platform for more real-time analytics and compliance. It will also eliminate structural technology problems that could lead to timing problems with notices sent to taxpayers. Let me give you a few more specifics of CADE’s benefits.

It will enable faster resolution of taxpayer account issues and account adjustments which is a huge positive for both taxpayers and the IRS. And it will eliminate one of the biggest problems we have when a taxpayer calls about a payment he or she made, but our representative can’t tell whether it’s been posted or not.

You will also see quicker updates to web-based applications, and faster taxpayer notices.

And once fully operational, the CADE 2 database will allow IRS to consider offering a wider range of web-based, self-initiated service solutions that could fundamentally change the way taxpayers interact with the IRS. 

CADE 2 also supports sophisticated, next-generation compliance systems which will improve overall compliance through enhanced workload selection and by enabling advanced decision analytics.

The completion of the CADE 2 core taxpayer account database creates a foundation for our ongoing modernization efforts and the opportunity and innovation that lie beyond it. 
And that’s what I want to focus on next.

This spring, I gave a speech before the National Press Club…or more to the point started a conversation…about a potential new structure that would fundamentally change the way we do our business. And technology is one of the keys to unlocking its potential.

We’ve initially come to call this vision the real-time tax system because it would deal in real time and avoid audits that may take place three years after a return is filed. We’re moving away from the after-the-fact, or “look-back” model – where we chased after taxpayers who had to hunt for or recreate records and documentation – to one where we’re reducing burden.

The “look-back,” which is the model of most major tax systems in the world, has some flaws. The biggest deficiency is that it does not deal with taxpayer problems up-front.

An IRS audit often occurs years after the return was filed. For example, by law we have up to three years to audit an individual’s tax return; more time if there’s a 25 percent or more omission of income, or if fraud is involved. As I speak now, we may still be looking at returns filed in 2008. This after-the-fact compliance approach can create problems and frustrations for both taxpayers and the IRS.

It can be a real dilemma for taxpayers, who may no longer have the money that was refunded to them, but it turns out, they were not entitled to. There’s also possible sticker shock because interest and perhaps penalties may have been accruing on any tax due for up to three years. Taxpayers ask, “Why didn’t you notify me earlier?” This hurts the IRS’ image and contributes to a “gotcha” perception.

As we all know, it’s much easier and cheaper to resolve a problem up-front than let it fester. That’s why consumers often get a call from a credit card company within days after missing a payment due date. Although no one likes these calls, taxpayers rightly wonder why they can’t receive the same timely response from the IRS and not get stuck down the road with interest and penalties.

Under the vision of a real time tax system, the IRS could embed third-party information into its pre-screening filters, and could ask the taxpayer to fix the return before we accept it if it contains data that does not match our records. This is a real game-changer.

We would have more accurate returns and deal with many more problems up-front. We could shift resources to spend more money getting it right in the first place, and do less back-end auditing. I’ve said all along that that there are huge compliance and service benefits associated with such a system. We’ve already gotten feedback from a wide variety of stakeholders and we’re certainly open to a conversation on the vision.  

Now, I’ve been asked a lot whether this vision is one of the IRS pre-filling tax returns and sending them out. That’s not what this project is about. This is about making fundamental improvements to the current system where taxpayers or their tax return preparers are responsible for completing a return and submitting it to the IRS.   

Six months ago, I said I wanted to start a dialogue on the vision and engage the business community and other stakeholders, like CERCA.

It’s certainly not too soon to start scoping the technology work that we would need to undertake to help us make the next big leap in how our tax system fundamentally works.

As most of you know, technological innovations allow us to process large amounts of information exponentially faster than just a decade ago. We also now have information coming to us in a digital format, which is a prerequisite to quicker population of our databases and systems. In other words, the pieces are starting to come together. Both internal and external factors make the time ripe to think big, and broad and long-term.

I seriously believe that this vision for a more real-time tax system for the nation is real and doable. For the past six months, we’ve been taking those first steps down the path toward taking the vision to the next level.

Shortly after the Press Club speech, a small IRS team started gathering an information return fact base. This gives us a better focus on each information return, including volumes, sources, time and accuracy, to name a few, and helps us to see if the data confirms our theories.

We also wanted to document the manner in which these information returns are received, particularly if they are sent in electronically. We are also examining the mix of information returns for major taxpayer segments with an eye on the group where IRS follows up after-the-fact primarily because of data and information gaps relative to information returns.

And of course, we are also taking a hard look at potential benefits, such as helping taxpayers get it right from the start…resolving issues more quickly for taxpayers… reducing the time and effort and even money it takes to file your return…in other words improving the overall taxpayer experience while reducing burden.

Let me share with you some interesting data on information returns:

More than 96 percent of taxpayers receive at least one type of information return.

A small fraction of the population skews the average number of information returns per taxpayer to about 10 even though more than 50 percent of taxpayers receive less than four information returns 

The vast majority of information returns are filed electronically, except for 1099-MISC and 1099-S. That certainly is an important prerequisite for a real-time tax system.

We’ve heard from some that up-front validation could run into problems when information returns are amended by the “payor” – be it an employer, bank, or other third party. So far, we’ve looked closely at the number of information returns that we receive that are later amended, and that rate is relatively low – on average less than one percent. Assuming this holds, this gives us an initial indication that the initial information return submission is of sufficient quality to be used for real-time compliance matching.

We know that information returns are not distributed equally across the base of individual income taxpayers.  For example, based on 2009 data, about 76 percent of taxpayers receive a W-2. However, that only constitutes about 12 percent of the total volume of information returns. On the other hand, 11 percent of taxpayers receive 1099-Bs but that equates to 37 percent of total information return volume.

Payor concentration is also an eye-opener. Fifty-six payors constitute 50 percent of the overall volume of information returns.

Of course, these are just statistics. I share them with you to give you a sense that we are digging deeper to understand how we can move forward and where the leverage points lie. I can tell you that six months since I started the dialogue, a real time tax system appears much more achievable.

A real time tax system is also all about stakeholders and communities and involving them in the conversation. I’m talking about taxpayers… preparers…software companies…employers…financial institutions…and other parts of government.

It’s our job to recognize and understand these different communities and reach out to them. We will be doing much more outreach in the near future, and I look forward to having a further dialogue around this important initiative.

As you can see, we have a number of opportunities and challenges facing us today. But as Oliver Wendell Holmes observed, “The great thing in the world is not so much where we stand, as in what direction we are moving.” And I am convinced that we are moving in the right direction, and by working and moving together we can reach our goal of fundamentally changing how our tax system works so it works better for all of America’s taxpayers. Thank you.

    

Page Last Reviewed or Updated: 24-Mar-2014