by Roger Russell

The Internal Revenue Service is winning the battle but losing the war, according to exiting Commissioner Charles O. Rossotti.

In a wide-ranging, end-of-term report to the IRS Oversight Board, Rossotti singled out tax professionals as among those attempting to take advantage of the IRS’s diminished capacity by engaging in questionable schemes.

In his report, Rossotti told board members that, despite significant improvements in the management of the IRS, the health of the federal tax administration system is on a serious long-term downtrend.

"Over the last 10 years, the size and complexity of the tax system increased enormously," he stated. "Beyond the simple increase in number of taxpayers and revenue dollars, the majority of tax revenues now come from sources that are more subject to manipulation by those who wish to pay less than the law requires and much more difficult and time consuming for our agents to uncover."

Rossotti’s five-year term as IRS commissioner officially ends in November.

The source of the problem, he said, is two conflicting long-term trends: increasing demands on the tax administration system due to rapid growth in the size and complexity of the economy, and a steady decline in IRS resources due to budget constraints.

The effect of these trends over a 10-year period has been to create a huge gap between the number of taxpayers who are not filing, not reporting or not paying what they owe, and the IRS’s capacity to require them to comply.

Tax professionals are often part of the problem, said Rossotti, who charged that some in the profession are too quick to take advantage of a damaged IRS.

"Recognizing the IRS’s diminished capacity, promoters and some tax professionals are selling a wide range of tax schemes and devices designed to improperly reduce taxes to taxpayers based on the simple premise that they can get away with it. When this perception becomes increasingly widespread," he said, "the essential pillar of our tax system is lost - namely, the belief of honest taxpayers that if someone does not pay what he or she owes - then the IRS will do something about it."

Rossotti said that the sheer size and complexity of the Tax Code is, itself, a source of disrespect for the law. The only reasonable course, he said, is to address the practical problem that the tax administration faces by gradually closing the gap in the capacity of the IRS to perform its essential tasks, while pursuing a parallel path attempting tax simplification.

He noted that favorable opinion of the IRS had declined steadily since the early 1980s, and that by the mid-1990s, Congress, as well as the public and other key stakeholders, had lost confidence. The worst year - 1998 - was at the beginning of Rossotti’s five-year term.

A number of factors contributed to the condition of the IRS, said Rossotti. "Budget and staff cuts, rapid economic growth and the shift in the tax base from middle-income wage earners and domestic corporations to upper-income entrepreneurs, pass-through entities and global corporations, all contributed to a diminished capacity to cope with service and compliance demands."

As a result of the increased pressure, he said, the IRS began emphasizing enforcement revenue and statistics as a way of justifying its budget. It measured the success of its compliance activities by direct enforcement revenues. "This is like a police department assessing its success by the number of traffic tickets written rather than by the safety and security of the community it serves," he said. "This grave mistake further alienated the public, yet failed to address the systematic, emerging compliance and budget problems."

According to Rossotti, the IRS was also slow to update its compliance practices in the area of models used to select returns for audits and the management of the exam and collection processes.

But, he said, the major problems and constraints faced by the IRS are now being addressed. "Some are resolved; clear plans are in place to correct the remaining ones over the next five years."

Public confidence in the IRS has improved, e-filing has tripled over five years, resources are being better focused and the IRS has successfully made the transition to a modern customer-based organization, Rossotti said. However, he called for steady progress to continue on a yearly basis.

"There should be no doubt that the IRS can be raised to a level of quality and efficiency comparable to the best managed financial services organizations."

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