New Math at the IRS:
2+2=3
Gina L. Husby was a senior vice president with the Bank of America in San Francisco; her husband, Paul, was a retired San Francisco police official. On March 11, 1986, the computer at the IRS’s Service Center in Ogden, Utah, sent the Husbys a notice claiming they owed the government some additional taxes.
Although the California couple did not know it, they were about to be unlawfully defamed by one of the IRS’s many poorly designed and badly managed computer systems.
The fiscal and psychic costs imposed on the Husbys by the IRS proved to be considerable. The costs imposed on all the other millions of taxpayers who over the years have been wrongfully damaged by the IRS are incalculable.
It is of course a given that Congress has assigned the IRS an extraordinarily difficult job. It also must be asserted that a large number of dedicated, intelligent, and honest IRS managers and employees are desperately trying to make their bureaucracy work. Finally, it is freely conceded that in some ways the IRS works: Collected revenues are now running about $1 trillion a year.
But these acknowledgments do not eliminate other truths. First, the agency’s managers are responsible for the design and operation of a series of tax collection systems, many of them computerized, that often causes serious harm to honorable and well-intentioned taxpayers. Second, on many occasions these same managers have allowed their imperfect systems to go on harming innocent taxpayers long after their inadequacies were fully known to them.
Shortly after the California couple received the initial IRS demand for additional taxes, they met with their lawyer and decided the government’s claim against them was not valid. On June 9, 1986, they formally asked the U.S. Tax Court for a hearing to resolve their disagreement with the agency. Under federal law and IRS regulations, when a taxpayer files such a petition, the agency is required to halt all of its collection activities until the dispute has been resolved.1
A few weeks after the Husbys had requested the hearing and had given the IRS written notice of this action, however, something unusual happened: The Ogden office sent a second computerized note demanding prompt payment of their alleged debt.
The Husbys’ lawyer immediately filed a written complaint with the agency pointing out that because the couple had petitioned the Tax Court, the second demand for back taxes was illegal and improper. He also noted that should the IRS continue the collection process to the point where the agency moved to seize the assets of the Husbys, it would then be violating a section of the tax law prohibiting the government from the “knowing or negligent” disclosure of tax return information except in certain prescribed situations.
A third demand came from the IRS on November 10. The Husbys’ lawyer fired off another written protest. Shortly thereafter, Debra K. Estrem, a San Francisco–based attorney for the IRS, acknowledged the mistake and promised that the collection action would be halted.
But somehow Estrem and her IRS colleagues in San Francisco were not able to transmit the news of their promise to the agency’s Ogden computer. On December 15, 1986, and January 19, 1987—despite further protests from the Husbys—it dispatched two more personal dunning notices.
So far all the IRS notices had been sent directly to the Husbys. But that was about to change. On March 23, just one year after the collection process had begun, the IRS sent a notice of levy to the credit union of the San Francisco Police Department, seizing $3,789.53 held in an account by Paul Husby. On April 3, a second levy notice was served on the couple’s stockbroker.
In total frustration, the Husbys and their lawyer turned to Federal District Court Judge Stanley A. Weigel, who immediately enjoined the IRS from issuing any more liens and levies on the couple’s holdings. On April 13, 1987, however, despite the provisions of tax law, the agency’s regulations, Estrem’s official promises to stop the collection action, and the judge’s injunction, the IRS computer dispatched a notice of lien to Marin County, where it was placed in the county’s public files.
As always happens in such situations, the lien on the Husbys’ house was soon spotted by credit company clerks who monitor county real-estate records. Shortly thereafter, the news of the lien was broadcast to the entire world by an item that was added to the record of their credit rating maintained by several companies. It also was picked up by a newsletter sent to area real-estate agents.
Judge Weigel, the Husbys, and the couple’s lawyer were outraged and a hearing was scheduled. Speaking for the IRS at this session was Jay R. Weill, an assistant U.S. attorney in San Francisco.
Weill’s attempt to defend what the system had done to the Husbys makes no sense. Weill informed Judge Weigel that the computerized system designed and operated by the IRS was “very effective and efficient in finding sources of assets from which to collect tax liability.” He added, however, that once the process got started, it “sometimes was very hard to stop.”
Despite the admission that the computerized dunning process had a systemwide problem and that incorrect claims against the Husbys had been generated by a faulty computer, Weill contended that the government was not liable for the mistakes. “There is no IRS agent here who has purposely and with bad faith improperly disclosed return information about the plaintiffs,” Weill told the judge.
In a later interview with me, Weill did not mention the general problem of the hard-to-stop computer that he had cited in court. “We’re talking here about a computer glitch, not a purposeful error,” the federal prosecutor said. “This is a system that is spitting out tens of thousands of notices each day and I don’t think Congress intended that the agency be penalized every time there is a little error.”
Weill’s maddening argument is familiar to anyone who has ever been victimized by any of the nation’s large public or private organizations that regulate consumer credit, sell health insurance, license cars, provide Social Security, or take on dozens of other chores. “We didn’t do it; the computer did it,” the managers argue, magically excusing themselves from the responsibility of designing, purchasing, and operating the faulty computer systems that they have chosen to blame.
Although Weill may not have known it when he appeared before the court, IRS officials in Washington had long understood that the discrete bureaucratic atrocity that the agency committed on the Husbys was, in fact, not a little computer glitch, but a general problem that, to this day, continues to affect an unknown number of other taxpayers.
One bit of evidence indicating that IRS Commissioner Lawrence B. Gibbs and other senior agency officials knew about their flawed system emerged during a special briefing they received on March 16, 1988. The occasion was one of the regularly scheduled meetings of the commissioner’s advisory group, a collection of tax lawyers, accountants, and state tax administrators who in theory serve as a policy sounding board for the agency.
A few minutes after eight on that March morning, Hank Philcox, the assistant IRS commissioner, Information Systems Development, began the first presentation of the advisory group’s spring meeting. His subject was a massive new computer system the agency had begun planning in 1985. In his effort to justify the IRS’s proposed expenditure of billions of dollars, however, the official felt compelled to describe the flaws in the fifteen-year-old system that the agency still employs. The current system, Philcox said, requires constant maintenance, is expensive to operate, and takes far too long to retrieve information needed by the agents.
Then Philcox turned to the issue of direct concern to individual taxpayers such as the Husbys. “Our inability to turn off the third or fourth notice is something we are concerned about,” he told the commissioner’s advisory group.
What happened to the Husbys was not an accident. What happened to them was the product of flawed choices made by officials of a flawed agency. In this particular case, the IRS many years before had selected a poorly designed system that caused this couple and thousands of other taxpayers to be treated in an abusive, arbitrary, and even coercive manner.
The poor management endemic to the IRS, however, imposes other kinds of major penalties on the taxpayers of America. A second such penalty relates directly to the amount of taxes paid by ordinary wage earners. As a result of a range of faulty management decisions, the IRS routinely fails to collect billions of dollars in taxes that are lawfully owed by individual and corporate taxpayers. This failure to properly target IRS enforcement and collection procedures on those who owe taxes necessarily means that the tax bills of more diligent taxpayers are unfairly inflated. A third kind of unnecessary cost imposed on the taxpaying public by incompetent managers manifests itself in the agency’s purchase of hundreds of millions of dollars’ worth of overpriced equipment, some of which is unneeded, some of which does not work.
Given the fundamental importance of taxes to the government, both Congress and the courts have always been cautious about acting on the complaints of taxpayers against the agency. But in the Husby case, Judge Weigel rejected the IRS’s “computer glitch” defense and held the agency liable for its mistreatment of the couple. As the judge put it in his decision, he simply would not accept the argument that “this unfortunate incident was really nobody’s fault, that a computer is to blame.” The evidence was strong, his decision clear, and the IRS decided against an appeal. After weeks of negotiations, the government agreed to pay the Husbys $22,000 in damages and court fees.
(In 1988, Senator David Pryor persuaded Congress to pass the Taxpayer’s Bill of Rights. According to Jeff Trinca, the senator’s staff expert on tax matters, this new law is not expected to have an immediate impact on the massive system that damaged the Husbys. Under its provisions, however, Trinca believes that future Husbys may find it somewhat easier to hold the agency accountable. One section of the new law, for example, expands the authority of the IRS’s Taxpayer Ombudsmen to issue a “taxpayer assistance order” to protect couples like Gina and Paul Husby who are suffering or are about to suffer a “significant hardship” at the hands of the agency.)
Judge Weigel’s decision was an important development. A great victory for abused taxpayers everywhere. A strong restatement of the ground principle of government accountability. Maybe.
Maybe not. It is true, of course, that the judge awarded damages to Paul and Gina Husby. But the Husbys are just two of an unknown number of taxpayers who each year are mistreated by the same IRS process. What did Judge Weigel’s decision do for all of these other uncounted victims? Remember that the judge did not order the IRS to fix its dunning system, to make it less susceptible to the systematic errors that were admitted by the assistant U.S. attorney in San Francisco and Hank Philcox in Washington. Remember also that the judge made no effort to identify the official who originally had authorized the flawed system to be installed. Remember, finally, that the computer system that wronged the Husbys in 1986 and 1987 is still churning out the same kinds of notices, levies, and liens.
To this day, no one knows how many other taxpayers have their assets frozen and their credit records damaged because of wrongful notices spewed out by the IRS computers in Ogden and other locations around the country. While stories about similar mix-ups appear in the press from time to time, the evidence is anecdotal and, it should surprise no one, the IRS does not collect statistics on the problem.
But Weill’s statement to the court that the computerized process “sometimes was hard to stop” and Philcox’s admission that turning off the “third or fourth notice” was a worry prove the existence of a systemic problem. I assume that Weill, Philcox, and Judge Weigel knew what they were talking about and that the Husbys were damaged by a recurring flaw built into the IRS’s collection machinery. The next question is obvious: How many taxpayers were and are being kicked around?
Obvious questions, however, sometimes can produce misleading answers. This is because the scale of IRS operations is so vast that even when a tiny percentage is incorrectly handled the absolute number of abused taxpayers can be surprisingly large.
Here is the arithmetic. During the year the IRS made what it admits was an improper move against the Husbys, the agency sent out 2.7 million other notices informing taxpayers that they owed back taxes. As an outgrowth of these assessments, the IRS dispatched a total of 1.6 million levies to the banks, employers, and credit unions of the Husbys and all the other taxpayers whom the IRS felt had not paid their taxes. (Levies assert the government’s control over the assets in the levied accounts.) During the same year, the agency filed 767,000 tax liens on the property of targeted taxpayers. (Liens give the IRS first claim on any assets realized by the sale of the liened property. Even in those situations where a taxpayer has no intention of selling his or her house, the lien can have a major impact on the taxpayer’s financial situation. As we already know, this is because commercial credit companies such as TRW carefully monitor county property records specifically to pick up the names of individuals who are having trouble paying their taxes to the government.)
For the sake of this discussion, consider the possibility that for one reason or another the systematic computer problem referred to by Weill and the others meant that a tiny fraction—let’s say only one half of 1 percent—of all the liens and levies filed by the IRS was improper. One half of 1 percent of 1.6 million is 8,000. One half of 1 percent of 767,000 is 3,835. From the perspective of the commissioner and his lieutenants, a system that works 99.5 percent of the time must look pretty good, maybe even a cause for celebration. But from the perspective of the 11,835 taxpayers who in our hypothetical case were wrongfully and illegally defamed, the unnecessary expense and pain loom very large.
It is not only individual taxpayers like the Husbys who are victimized by the bad management of the IRS. Sometimes, the agency’s hapless harassment falls on the shoulders of businesses. As explained previously, the system by which the nation’s millions of employers withhold the taxes owed by individual taxpayers is the single most important channel of revenue flowing into the coffers of the federal government. The role of employers in the tax collection process is truly gigantic. In one recent year, for example, over 5 million businesses and other employers made 66 million withholding tax payments to thirty-four thousand federal depositories (usually banks), which accounted for 80 percent of all IRS collections.
It is an amazing money machine that the IRS keeps trying to improve. Despite these efforts, however, the bureaucratic machinery set up to receive the withholding payments and credit them to the correct employer and the correct employee sometimes breaks down. In June 1986, one Kerry R. Kilpatrick, an official in the agency’s own Internal Audit Division, completed a confidential report on some of these administrative shortcomings.2
Kilpatrick said that by the time the twelve months of 1986 were over the IRS system somehow would misplace about 1.1 percent of the withholding deposits. Although 98.9 percent of them would reach the right cubbyhole at the right time, he said, the 1.1 percent that somehow would take the wrong turn would lead the IRS to send employers 721,000 erroneous bills, penalties, refunds, and inquiries about withholding payments they had actually sent to the government. He estimated that in that year alone the withholding taxes covered by these improperly recorded deposits would total $6.5 billion.
“These problems will continue because of the inability of Internal Revenue Service control systems to timely identify and resolve employee and taxpayer errors,” the auditor calmly observed. He then suggested a series of small fixes that might somewhat reduce the problem.
The Kilpatrick report dramatically illustrates how, in an agency as large and complicated as the IRS, a series of tiny administrative mistakes can cause serious mischief to thousands upon thousands of individuals and corporations. This was serious business. Erroneous bills, penalties, and refunds—nearly three quarters of a million of them—concerning $6.5 billion that the IRS could not immediately account for.
While the Kilpatrick report was bad enough, it failed to explore a broad range of questions that, if properly answered, would make clear that the underlying impact of the IRS accounting failures was indeed far-reaching. Kilpatrick, for example, did not determine the extent to which the mislaid withholding funds affected the tax accounts of individual taxpayers. Neither did he attempt to calculate the interest the federal government did not receive during the time the $6.5 billion was missing in action. He also failed to estimate how much it cost the government to send out the incorrect notices. Nor did he consider how much money the falsely accused employers spent trying to straighten out the record.
The Kilpatrick report, however, did include a disclosure about another very big problem caused by poor management. During 1985, Kilpatrick recalled in a historical footnote, the IRS had adopted a new system to collect withholding taxes that required employers to include a special numbered coupon with each payment they made. But somehow, an IRS bureaucrat somewhere in the middle reaches of the agency had failed to order the printing of a sufficient number of coupons.
The resulting coupon shortage made it difficult for the legitimate businesses that wanted to deposit their withholding payments in a proper fashion to get the funds credited to correct accounts. More significantly, the coupon shortage made it almost impossible for IRS sleuths to sort out the legitimate businesses that were trying to meet their obligations from the unscrupulous cash-short companies that knowingly were trying to rip off their employees and their government by not sending in the required withholding payments.
To the average citizen, the missing coupons might not sound very important. In fact, however, they prompted a significant collapse in one of the IRS’s major enforcement areas. “One direct result of the inventory problem,” Kilpatrick related, “was the [IRS] management decision to reduce the number of federal tax deposit penalties assessed, at an estimated dollar loss of over $100 million, and an unmeasurable long-range loss of compliance.”
One tiny management failure by one IRS bureaucrat, and the federal government is out $100 million. But remember, in the end, the penalties that were not properly assessed against all those lawbreaking employers meant millions of dollars less in general tax revenues and increased demands on the ordinary taxpayer.
Sometimes the unnecessary expenses generated by poor management are more obvious than those described by Kilpatrick. A month after his investigation of the agency’s withholding problems was completed, Gail A. Burns, another Internal Audit Division official, published her study of how the IRS had gone about the business of procuring some additional terminals for its central national information network. Burns said the IRS division in charge of this particular procurement had purchased two thousand more terminals than an agency study had found were needed and then proceeded to request funds for five thousand additional terminals. She reported that the cost of the unnecessary terminals was $25 million.
To document her allegation that at least some of the thousands of new terminals were not needed, Burns conducted a survey in a sample of IRS locations: three regional centers and ten district offices. The new terminals installed in the three regional centers, she acknowledged, were fully utilized. But in the ten district offices, Burns discovered so many unneeded terminals that, on the average, each one was humming less than 3.5 hours per a day, even though the network they were hooked into was in service for more than sixteen hours a day. “In one office,” the official found, “22 Integrated Data Retrieval System terminals were delivered, although only five persons performed Integrated Data Retrieval System research.”
The IRS often creates task forces to study its nagging problems. In 1986, for example, such a group was formed because the IRS found its filing system was collapsing. The specific problem was that agency employees frequently were unable to locate an individual tax return when they needed it for an audit or other agency action. Sometimes the returns were lost forever. Sometimes they turned up so long after they had been requested that they were useless. After a two-year study, the task force confirmed there was indeed a problem.
During the year ending in October 1987, IRS employees made 41 million requests for tax returns and other documents that had previously been provided the agency under the requirements of law. Because of faulty filing procedures and poorly trained personnel, however, the agency was unable to locate 2 million of the requested documents. Even where the documents were located, the searches often required an inordinate time to complete. In more than one third of the cases, IRS employees had not received the documents forty-five days after making their initial request.
Because missing or delayed documents seriously damage the ability of the agency to collect taxes and to treat taxpayers in an efficient and fair manner, one might expect the IRS to make every effort to maintain an effective retrieval system. The task force’s 1988 report, however, concluded that this was not the case. “Unfortunately, over the years, the diligence directed [by the agency] towards the proper handling of tax documents has diminished.” To support this judgment, the group pointed to the facts that the locations of stored documents had been moved to less desirable sites, the budgets and staff for document storage had been cut, and the grade level of managers and clerks assigned to the area had been downgraded.
The Husbys’ credit rating was impeached because IRS managers were unable to stop the Ogden computer from generating false information. Hundreds of thousands of incorrect payment demands were sent to businesses because the computerized system for recording withholding payments did not function properly. Tens of millions of dollars in fines were not collected because a manager forgot to order enough necessary coupons. Millions of dollars were wasted on overpriced and unneeded computer equipment. The ability of the IRS to retrieve documents has been eroded.
Each of these complex situations is an example of bad management. IRS bureaucrats, of course, challenge this interpretation. They earnestly argue that the IRS’s failures should be regarded as normal administrative problems that almost all large institutions encountered as they moved into the computer age. They contend that the IRS’s past record—primarily its steady collection of billions of dollars a year in taxes—proves that the agency remains a good manager. They assert that the IRS effectively accomplishes its central mission: the collection of taxes in an efficient and equitable fashion.
There are times, it must be admitted, when you are sitting across the desk from a confident IRS official in a comfortable Washington office, when these arguments appear to be partly valid. But then you recall yet another administrative horror story and the IRS’s smooth talk seems a good deal less persuasive.
In 1982, for example, senior officials of the IRS decided to close down a small staff organization explicitly created to oversee the design and installation of a new computer system in the agency’s ten regional service centers. Unfortunately for taxpayers all over the United States, the managers ordered that this oversight group be abolished several years before the new computers were scheduled to go on-line. The lack of a central monitor meant that the same IRS managers were not informed during 1983 and 1984 that the installation of the new computers was falling farther and farther behind schedule. This, in turn, meant that the managers made no effort to head off what in 1985 would develop into the most disastrous year in the recent history of the IRS.
The vast scale of IRS operations makes it very hard to describe and comprehend the administrative chaos that almost swamped the agency during the 1985 tax year because of the incompetence of the agency’s bosses. At one point, for example, the IRS lost fifty-eight computer tapes containing detailed information about millions of interest and dividend payments made by the banks and insurance companies located in one area of the country. The total value of these payments was over $3 billion. Later investigations suggested that the tapes were misplaced because of weaknesses in the agency’s receipt and control procedures.
The loss of these tapes, and a variety of other problems directly related to the failure of the IRS to comprehend that its new computer system was way behind schedule, meant that the agency that year sent out millions of erroneous dunning notices. Millions of incorrect notices, millions of confused and angry taxpayers, almost certainly hundreds of millions of dollars of taxes paid by people who did not owe them. But no public executions.
There were other telling signs of the agency’s 1985 problems. That year, for example, the number of taxpayers who did not receive their refunds within the forty-five-day period required by law increased by 50 percent, 2.2 million in 1985 compared with 1.4 million in 1984. The failure of the IRS to meet this deadline obligated it to pay out $15.5 million more in interest than it had during the previous year.
The lost records, the incorrect dunning notices, the improper levies and liens obviously forced individual and corporate taxpayers to take whatever steps they could to defend themselves against a bureaucracy that suddenly had gone berserk. In January 1985, for example, the IRS ordered the Rohm & Haas Company of Philadelphia to pay a $46,806.37 penalty. The basic charge was that Rohm & Haas had failed to pay a $4,488,112.88 payroll tax deposit. After weeks of negotiations, the IRS finally admitted that it had mislaid the company’s $4.5 million check: An angry Thomas C. Friel, Rohm & Haas’s manager of corporate taxes, said that straightening out the IRS error had required a good deal of extra work by five corporate accountants, the writing of seven separate letters, and an official visit to an IRS office by several corporate executives.3
The 1985 IRS disaster was massive and costly. Because it affected so many millions of taxpayers in such a relatively brief period of time, Congress actually became mildly disturbed. The congressional response was entirely predictable: vote the expenditure of millions of additional tax dollars to fix the breakdown that would never have occurred in the first place if the managers had been doing their job.
This particular IRS failure became a public embarrassment that absolutely had to be fixed because it produced so many casualties so quickly. Because most IRS failures are considerably less dramatic, the agency usually is content to let them fester.
More than twenty years ago, for example, a few concerned officials within the IRS began to understand that a good deal of the tax information the agency was providing citizens was just plain wrong. Despite the growing belief within the inner circle of managers that this incorrect information was hindering its ability to collect taxes, nothing was done. In fact, for a three-year period during the Reagan administration the IRS actually began to drastically reduce the small number of employees assigned to answering the questions of puzzled taxpayers.
The most dramatic evidence of the agency’s years of callous indifference came in the summer of 1988, when the General Accounting Office completed a detailed analysis of the 6 million notices and letters that the correspondence offices in the regional service centers had sent to taxpayers in 1987.4
The key finding of the study: 48 percent of a sample of these IRS notices and letters were “incorrect, unresponsive, unclear or incomplete.”
Of the variously flawed responses, the GAO said that a significant number had “resulted in the assessment of incorrect tax and penalties.” Inaccurate assessments, however, were just one harmful product of the IRS’s error-prone correspondence. The GAO said a second, even more pervasive, problem was the waste of vast amounts of time and money on the part of the IRS and the taxpayers as both sides attempted to resolve the issues generated by the agency’s initial letter.
The 1988 Taxpayers’ Bill of Rights established the legal principle that any penalty or addition to tax attributable to incorrect written advice from the IRS will be abated. There are, however, a number of conditions. The wrongful written advice must have been given in response to a specific written request from the taxpayer. The wrongful advice must have been relied on by the taxpayer. The wrongful advice must not have been given by the IRS because the taxpayer failed to provide adequate or accurate information.
As bad as the IRS’s accuracy record was, however, the GAO found other serious flaws in the basic product of the service center correspondence officers. Here are a few examples:
• IRS regulations require examiners to acknowledge a taxpayer’s letter within seven days of its receipt, even in a situation where a complete response is not possible. In half of the cases where it was called for, however, no such acknowledgment was sent.
• IRS regulations require examiners to apologize when the taxpayer’s correspondence involves a situation where an error was committed by the IRS. In 70 percent of the cases where an apology was called for, however, no such letter was sent.
• IRS regulations require examiners always to include a reference to the date of the taxpayer’s inquiry. In half the cases where the date of the inquiry was known, the IRS responses did not include any date or referred to an incorrect date.
(The GAO findings were based on a random sample of letters drawn from all of the correspondence prepared by three of the IRS’s ten regional service centers from May 4 to July 31, 1987. The centers selected for the study were located in Fresno, Philadelphia, and Kansas City.)
The IRS record here is very bad. What makes it truly awful is evidence uncovered by the GAO indicating that IRS managers seemed to go out of their way to avoid getting the detailed knowledge that would have allowed them to improve the accuracy and completeness of the agency’s correspondence.
It is accepted practice for any large organization to establish a quality assurance unit to sample the product and identify problems so that management can solve them. And indeed, for many years the IRS has had special quality assurance units checking the output of the adjustment and correspondence branches at each of the service centers.
The GAO discovered, however, that clerks assigned to quality assurance had exactly the same salary and training as the clerks whose work they were checking. And in fact, at one of the service centers, a rotation policy had been established whereby clerks in the adjustments and correspondence branch would serve specific terms in quality assurance and then return to their original assignment.
Given these circumstances, it is hardly surprising that the error rate found by quality assurance people who had the same training and experience as those preparing the letters was substantially below that found by the GAO.
But the degree of blindness suffered by the agency is breathtaking. By sheer chance, seventeen of the letters that became part of the GAO’s sample survey and were found to contain critical errors or other shortcomings had already been examined by the IRS’s quality assurance team. The IRS had given passing grades to every single one of the letters that the GAO found wanting.
In July 1988, Lawrence B. Gibbs, then the commissioner of internal revenue, acknowledged what the agency could no longer continue to deny: There were serious deficiencies in the IRS’s correspondence. Testifying before a House subcommittee, the commissioner blamed the agency’s failure on three factors. First, he said, severe budget cutbacks had been imposed by Congress at a time when the agency was facing increasing workload demands. Second, all the new tax laws that Congress approved were causing confusion. Finally, “a variety of internal systemic problems” prevented the IRS from delivering “the kind of quality service to our ‘customers’ that we are committed to providing.”
There was a surface plausibility to the commissioner’s excuses. Yes, the operating budgets of the IRS were cut in the mid-1980s. Yes, Congress has passed a lot of new tax legislation. Yes, there were “internal systemic problems.”
Gibbs’s excuses, however, were also misleading. Each year, the commissioner and his lieutenants prepare a budget detailing how they propose to allocate funds to different parts of the agency. Although this budget may be somewhat modified by the White House or Congress, the basic outline of the commissioner’s spending plan seldom undergoes major changes.
An examination of its annual budgets proves that, at least until the last year or so, providing the public with accurate and complete tax information always has been a secondary concern of the IRS. The record further proves that IRS managers for many years have chosen to shortchange taxpayer service even though repeated study groups within the agency showed this was a serious problem.
A full five years before the GAO’s 1988 study, for example, a senior group of IRS officials completed a never-released report on the quality of the agency’s correspondence.
The in-house study group found that the agency spent a good deal of time and money trying to respond to the House, Senate, and presidential aides, but paid little attention to the public. “Only Congressional, White House and Treasury correspondence have extensive visibility and emphasis,” it said. “General correspondence is not afforded the same luxury nor is it viewed as a major problem. This, compounded with competing priorities, has obscured any consideration for the resulting impact on taxpayers.”
To support the contention that the agency itself has consciously chosen to ignore the issue of taxpayer service, the 1983 in-house study group cited reports on correspondence problems that had been written by at least ten previous IRS groups. The recommendations of all these earlier reports, the 1983 report said, “have not been acted upon to date.”
A LEAKY VESSEL
A second area where the IRS has shown considerable nonchalance is in its protection of the confidential information it collects on the financial, medical, and other personal secrets of every taxpayer. The Tax Reform Act of 1976 sets a high legal standard for the IRS: Personal tax return information is not to be disclosed to any other organization or person except in certain precisely defined situations. The law made it a crime for any IRS employee to violate these rules.
In the age of the computer, one important component of protecting individual privacy obviously must be computer security. Shortly after the passage of the 1976 law, the Office of Management and Budget, an arm of the White House, issued a presidential directive requiring all federal agencies to develop elaborate procedures to protect the personal information about individuals stored in their computers. Then in 1982, Congress approved the Federal Managers’ Financial Integrity Act, which required the agencies to report to the president and Congress each year on exactly how well the data held in their computers were protected from loss or theft.
The 1977 report of the Privacy Protection Study Commission, which had been created by Congress in the wake of Watergate, explained this concern. “The fact that tax collection is essential to government justifies an extraordinary intrusion on personal privacy by the IRS,” the commission report observed. “But it is also the reason why extraordinary precautions must be taken against misuse of information the Service collects from and about taxpayers.”5
The unusual sensitivity of tax return information, the mandate of two laws, and several presidential directives all point in one direction: For many years the IRS has had an overwhelming legal and moral responsibility to make sure that the tax information it holds is protected from snoopers.
I know of only one case where an IRS employee, former employee, or outside computer hacker has broken into one of the agency’s hundreds of computer data bases. But given the near impossibility of proving such intrusions, and the IRS’s known penchant for hiding its failures from outside critics, I do not find the absence of a large number of cases particularly reassuring. My uneasiness is compounded by the agency’s casual attitude toward computer security.
Over the years, most of the publicity about IRS computers has focused on the giant machines that the agency maintains at its massive National Computer Center in Martinsburg, West Virginia. It is at this center, protected by armed guards and triple rows of ten-foot-high fences, that the IRS permanently stores most of the detailed information it collects about each taxpayer. Partly because the IRS’s West Virginia facility is somewhat obsolete, there is no direct access to the center’s prime computers via the telephone. Information about taxpayers is transferred to and from the national center by messengers carrying computer discs. This feature works to improve security because it is physically impossible for electronic intruders to invade the computers from a remote location.
But in eighty-one IRS offices around the country—the national office in Washington, the seven regional offices, the sixty-three district offices, and the ten service centers—the agency has kept up with the times and installed Zilog computers. The Zilog computers help the IRS perform at least eight jobs at these eighty-one offices, many of them highly sensitive. One task handled by the Zilogs, for example, is to keep track of every audit conducted in each of the districts. A second task is to handle the agency’s word processing and electronic mail services. In some offices, the Criminal Investigation Division uses a Zilog as an electronic filing cabinet to store the details of its investigations.
Unlike the computers at the national center, the Zilogs are vulnerable to raids by unauthorized persons because they were designed deliberately to allow employees to access them by telephone. The IRS contends it has overcome this access problem by adopting stringent security procedures. It says, for example, that only authorized IRS employees are given the passwords they need to get into the Zilog system. The agency also notes that the system periodically erases all the passwords that IRS employees have been given in the past. This feature is designed to assure that employees who retire or resign or are assigned to new duties cannot continue to inspect tax information they no longer require. The agency further boasts that to gain access to certain categories of unusually sensitive information, authorized employees are required to have two passwords.
It all sounds quite impressive. But a series of confidential investigations by the IRS’s own Internal Audit Division indicates that there are many lapses in the agency’s security efforts. Consider, for example, the report of Charles F. Combs on computer security in the IRS’s Central Region, an area covering Michigan, Indiana, Ohio, West Virginia, and Kentucky. In two of the region’s six district offices, he investigated the security provisions adopted to protect the tax information stored in their Zilogs.
Combs found that a total of 425 IRS personnel in the two districts were authorized to enter the Zilog system. Under agency regulations, district managers are responsible for deciding who will be permitted access to the information and for assuring that they have undergone extensive security training. The auditor found that 16 percent of those who had the necessary code words and thus could enter the local computer files of the two districts—sixty-six out of 425—were doing so without the required approval of top management. Almost as important, none of those sixty-six IRS employees had undergone the mandated security training.
One of the basic IRS security provisions requires that, when employees leave the agency or are assigned to new offices, the passwords they have been using to gain access to sensitive data will be eliminated.
Combs found, however, that the IRS did not follow its own procedures. In one test he measured the time it took IRS technicians to remove a departing employee’s password from the Zilog so he or she no longer could gain access to its information. In one of the sample districts, the average elapsed time between leaving the agency and erasing the password was eight months. In the other, it was a year and a half.
“As a result,” Combs said, “Central Region’s Zilog systems were exposed to risks over extended periods of time that separated employees could gain unauthorized remote access from any computer equipped with telecommunication devices.” It should be remembered that retired IRS agents frequently go to work for accounting firms or law firms or set up their own tax preparation businesses where inside information about an ongoing audit or criminal investigation can be of enormous value.
The computer security lapses are by no means limited to the IRS Central Region. Thomas Black, another inspector with the Internal Audit Division, looked at a small sample of offices in the Southeast, Southwest, and Midwest regions. Black said his investigation had identified forty-three former employees whose passwords had not been erased as required by agency regulation. He said this failure meant the forty-three former employees could have gained improper access to over twenty-seven thousand data files holding detailed information about current IRS employees, illegal tax protestors, and other matters.
Yet another inspector, Garth Streeper, investigated the security screen protecting a sample of thirty-two microcomputer hard disks. He discovered that 40 percent of the disks, thirteen out of thirty-two, were “without proper security to prevent access to this data.” Streeper’s report said “we [the investigative team] were able to enter the district office after hours on two occasions, access several microcomputers which contained taxpayer data and were not challenged or questioned by personnel in the general area.”
There is no question that a former employee or an outsider who has the correct password can gain access to the Zilog computer. This was proved during the early spring of 1985 when a thirty-two-year-old computer expert named William Van Nest tapped into the Zilog computer located at a suburban IRS office near Washington. Van Nest, working from his home computer, somehow had obtained the system’s “super user password”—in this case Zeus—which allowed him to tap into the IRS computer via the lines of the local telephone company.
After gaining access to the Zilog, Van Nest ordered the computer to destroy several administrative files. It was this second action, court records show, that eventually enabled the IRS to track Van Nest to his home telephone. Although these records are skimpy, they indicate that if Van Nest had entered the Zilog merely to obtain information, rather than committing an act of destruction, the IRS would never have detected the penetration.
On April 23, 1986, Van Nest pleaded guilty in federal court in Washington to breaking into the IRS computer and was sentenced to three years on probation and a $7,500 fine.
The reports of the IRS inspectors and the indictment of Van Nest suggest that the masses of confidential tax information stored in the Zilog computers all over the country are not adequately protected. Almost as disturbing, however, is the evidence that senior IRS officials do not consider the security of tax information a primary concern and have sometimes even sabotaged efforts to identify systemwide security problems.
For at least twenty years, computer experts working in government and business and teaching at the universities have preached the importance of adequately protecting the billions of bits of personal information that insurance companies, banks, and agencies like the IRS routinely collect and store. In 1978, the Office of Management and Budget, the White House office that is supposed to help the president direct the operations of the federal government, issued a directive requiring all federal agencies to implement a continuous series of studies aimed at identifying the security weaknesses of their computer installations. The studies were to identify and correct problems before the systems were seriously compromised.
Between 1979 and 1981, the IRS complied with the presidential directive, performing risk analyses at six of its ten service centers. But such studies cost money. In 1981, according to a confidential report by John G. Hofmann, another IRS inspector, agency officials ordered the risk analyses halted “as part of a decentralized approach to security and to save resources.”
In 1983, the Office of Management and Budget imposed a new and tougher security audit requirement on all federal agencies, including the IRS. This new mandate specifically stated that the head of each federal organization was personally responsible for monitoring and improving the security of computerized data files.
But Hofmann, the IRS inspector, reported that the new pressure from the White House did not have the desired effect on the agency. The IRS’s Information Systems Risk Management Program, he concluded, “does not provide the information necessary to determine the level of vulnerability of its computer system or the adequacy of current or planned controls.”
The Internal Audit Division inspector said that IRS managers had created a serious gap in the risk-management program when they ruled that only the security problems of the computer systems in the major processing centers would be studied. Apparently excluded from consideration, for example, were the Zilog computers that other IRS inspectors had found to be vulnerable to penetration. Also excluded, he said, were “new systems, planned modifications and sensitive computer applications.”
Hofmann was disturbed by the agency’s decision to restrict its security studies to those systems operating in the agency’s service centers and not to examine all of its data bases. “With the proliferation of and increasing reliance on computer-based information systems throughout the Service, management has no means of determining to what extent sensitive data is being dispersed among numerous systems,” he said.
At the bottom of every page of every Internal Audit Division report are typed the words Official Use Only. The IRS’s explanation for the warnings is that federal law requires the agency to protect the privacy of taxpayers and the business secrets of companies that might be mentioned.
This explanation, of course, doesn’t make much sense because only a small number of all the hundreds of reports I’ve obtained contain information that conceivably might require protection. It seems to me much more likely that it is the IRS’s fervent desire to prevent the public, the press, congressional committees, and even the president’s managers at the White House from learning about all their goofy decisions. Senior IRS officials have an abiding interest in protecting their cozy world from the prying eyes of informed critics.
It is understandable that the managers of the IRS would prefer that the public not know about the instances when their flawed management prevented the agency from collecting hundreds of millions of dollars in lawfully owed taxes. Surely we can all identify with their protective instincts when it comes to those reports describing the occasions when they purchased millions of dollars’ worth of overpriced and unneeded equipment. Certainly their failure to protect the privacy of the American people is something they would prefer be kept a secret.
But what must cause senior IRS officials genuine, unmitigated, red-faced chagrin is their inability to balance the books of the IRS: This is truly the gang that can’t count straight. The IRS, the agency that each year imposes millions of dollars of fines on individuals and corporations who have failed to maintain their account books in an orderly fashion, itself is unable to keep track of its income and expenditures.
A few years ago, for example, the IRS discovered a massive and unexpected surge in the collection of revenue flowing into a special fund maintained for retiring federal employees. The abrupt $1.2 billion increase reported by the IRS led the Labor Department, the federal agency that administers this particular fund, to publish a special study. A few months later, however, Labor reconsidered the IRS data and decided something was fishy about the numbers: They didn’t make sense. Labor called IRS and asked for another count.
When the IRS went back to the books, it discovered that several of the agency’s own service centers had not classified the tax payments correctly and that these errors had led the IRS to exaggerate the revenue going to the fund.
Actually, the nonexistent $1.2 billion was just one example of a nagging problem that went back to 1984, when the IRS installed the Revenue Accounting Control System (RACS). RACS, as it is generally referred to within the agency, was supposed to assure that the IRS would be able to carry out one of its key responsibilities: accounting for and classifying the hundreds of billions of dollars of tax revenues it collects each year. RACS is also important for keeping track of agency refunds, disbursements, and other related financial transactions.
The IRS, however, had not followed through on its original intention to automate fully its revenue-accounting procedures, thus enabling a large number of inaccurate and incorrectly classified collection numbers to be introduced into the IRS’s books. When the General Accounting Office got around to looking at the problem in late 1988, it concluded that the IRS’s basic accounting system for all the tax revenues of the United States was “inefficient and susceptible to error.”6
In the last few years, the inability of RACS to function properly has been highlighted by another little glitch, this one in the inability of the IRS to count accurately the money that taxpayers owe in back taxes. According to the numbers coming out of RACS, the accounts receivable have jumped from $18.4 billion in 1981, to $537 billion in 1987. But because of problems in RACS, the IRS itself is not sure whether this increase was the result of population growth, new methods of detecting underreported taxes, or administrative errors by the service centers.
“Let me put it plain and simple,” said one senior GAO official. “The problem we found in RACS means the IRS cannot manage its assets. If the rapid growth in accounts receivable number is for real, why isn’t the IRS taking all sorts of administrative measures to collect the missing revenue? If the reported increase is phony, the product of a poorly designed adding machine, then why can’t the IRS count straight? Either way you look at it is bad for the IRS.”
The IRS demands that every individual and corporate taxpayer accurately estimate the income he or she expects to earn in the next tax year. Fines are imposed on those whose estimates are repeatedly wrong. But from 1978 to 1986, the IRS’s own annual estimates of the additional taxes the agency would claim that taxpayers owed the government in the upcoming year have been consistently less than the additional taxes that the agency ended up claiming. On the average, the annual underestimate of the IRS was 28 percent off the mark, ranging from $100 million in 1978 to $3.8 billion in 1986.7
There are lots of other examples of sloppy IRS bookkeeping. Some go back a long way. Just about thirty years ago, for example, the White House’s Office of Management and Budget completed a study of the casual financial-management practices of the IRS. One example of this easygoing attitude toward bookkeeping, the study said, was the agency’s habit of spending appropriated funds as it saw fit, with little regard for the intent of either Congress or the White House. The study mentioned one occasion when the agency spent $1.1 million for the special promotion of favored employees, “although no funds had been appropriated for that purpose.”
Despite all the evidence to the contrary, IRS officials continue to boast about their sophisticated and totally rational management of the tax collection business. To support their claims, they often point to the Taxpayer Compliance Measurement Program, the massive national survey designed to tell the IRS what kinds of taxpayers are not paying the taxes they owe and how they are thwarting the tax laws. One obvious purpose of the TCMP is to provide IRS managers with the intelligence needed to direct enforcement efforts toward the most serious problems.
A few years ago, however, Susan B. Long, the persistent tax researcher mentioned previously, decided to test the thesis that IRS operations were based on intelligence obtained by the TCMP, that the agency methodically shifted its enforcement efforts from the geographic areas and income groups with the highest compliance to cover those with the least compliance.
Long loaded the IRS computer tapes with the results from the TCMP surveys completed in 1964, 1966, 1970, 1972, 1974, 1977, and 1980 into the computer at Syracuse University. On these tapes were recorded millions of bits of information documenting the shifting hot spots of the sixteen-year period covered by the surveys. Then she loaded tapes showing where the IRS had assigned its auditors by geographic region and kind of taxpayer.
Long’s astonishing conclusion: “In general, the introduction of TCMP compliance data did not bring about any dramatic restructuring in audit coverage—even when it disclosed regions or return classes receiving far less audit attention than compliant groups.” In other words, IRS managers have failed to redeploy their troops in response to the intelligence developed by their very expensive surveys.
THE CORPORATE BIAS OF THE IRS
Almost by definition, acts of omission are harder to identify and describe than are acts of commission. One of the agency’s most interesting acts of omission goes back more than ten years. In September 1976, a House subcommittee headed by the late Representative Benjamin S. Rosenthal of New York issued a report concluding that there was only one sensible way for the IRS to track down tax cheats in a country as large as the United States. The recommended approach: develop computers to compare the information contained on the millions of income documents sent to the IRS by employers, banks, publishers, real-estate agents, and many other institutions with the data individual and corporate taxpayers provide on their annual tax returns.
The subcommittee’s theory was quite simple. If taxpayers knew that the IRS knew about all the income they were receiving, the taxpayers would “voluntarily” pay more of their taxes. The trick was to devise a reasonable way to collect this information.
During the late 1960s and early 1970s, the computer provided the answer. Computerized personnel and payroll records were adopted by major employers. If a corporation decided to harness computers to process the routine payments it was making its employees, why not also use the machine to send out dividend checks to its stockholders? Banks, government agencies, insurance companies, publishing houses. The speed of the revolution was astonishing.
The 1976 report by the Rosenthal subcommittee recommended that the IRS establish a 1980 target date for the matching of all the income tax returns and the income reports. At first, the IRS resisted the proposed initiative. The agency, for example, did not enforce the existing legal requirement that all banks, corporations, and other organizations notify it about the dividends, interest, consulting fees, and other such payments. In 1979, three years after the first Rosenthal report, the General Accounting Office informed Congress that 60 percent of the nation’s small- and medium-size corporations were not filing 1099 information returns. A year later, surprisingly enough, the GAO found that five major government agencies, including the IRS itself, also were not fully complying with the payment-reporting requirements. One reason for the lapses, the investigators found, was that the “IRS has given little attention to enforcing this filing requirement.”
Slowly, however, the IRS’s interest in matching tax returns with information returns began to blossom, and by the mid-1980s the agency had become an enthusiastic supporter of what had developed into one of its most effective investigative techniques. That year, for example, the agency actually matched four out of five of the hundreds of millions of different information returns against every tax return filed by an individual.
It was about this time that the General Accounting Office and Congress discovered an amazing act of omission: Although the IRS in 1986 had the technology and the procedures to compare the information contained on about 107 million individual tax returns with the information on almost 800 million individual income reports, the agency had not developed parallel procedures to undertake the systematic computer matching of the various payments made to the nation’s 1.3 million businesses.
For more than a decade, the IRS had exempted more than 1 million of the nation’s richest taxpayers from a computerized investigative technique that has proved highly effective in identifying individual taxpayers who had failed either to report all of their income or to file any return at all.
The whistle was blown by Jennie S. Stathis, an official in the General Accounting Office. During the previous ten years, Stathis said, the IRS had come to regard its massive program comparing income reports with individual tax returns as “an extremely important enforcement tool.” In fact, she added, the latest available statistics showed that the program was generating $17 in assessments for every $1 it cost the government to operate. With the collection of $2.4 billion attributed to individual matching during the 1982 tax year, the ten-year drive to extend the computerized reach of the IRS was hardly a nickel-and-dime operation.
But, Stathis said, the IRS had not developed a parallel program to match the reports about interest and dividend payments going to business organizations with the income tax returns of these organizations. “Because the IRS’s Information Returns Program for individual taxpayers has become an important enforcement tool, and because IRS’s latest estimates show business non-compliance is increasing, some level of matching of business information returns should be considered,” she testified to the House Government Operations Subcommittee.
Representative Douglas Barnard, the new chairman of the House subcommittee that in 1976 had recommended systematic matching of all taxpayers, was surprised by the IRS’s omission. “Given the highly sophisticated matching program that already is in place for individuals, the minimal audit coverage of business taxpayers and the huge amount of interest, dividends and consulting fees paid to them each year, the burden of proof is on the IRS to justify its failure to extend the information return program to business taxpayers,” Barnard said at the hearing.
“That burden would appear to be a good deal heavier today in view of the year-long investigation by the General Accounting Office that found substantial numbers of business taxpayers are underreporting a significant percentage of their third-party income,” he added.
According to an analysis presented by the IRS itself, the initiation of business matching by the IRS would bring the government an additional $1.7 billion a year from business organizations that failed to report fully interest, dividends, rents, and capital gains. Several surveys by the GAO, however, indicate that the IRS’s estimate of corporate underreporting is far too low. Congressional auditors believe that the total tax loss from cheating business organizations may approach $8 billion a year.
Despite the soaring federal budget deficits of the late 1980s, the IRS has not launched a full-scale business matching program. Agency officials contend that such a program is not warranted for a variety of reasons. They say that the GAO has exaggerated the extra income that might be realized and has underestimated the technical difficulties.
Many IRS critics charge that the agency’s enforcement programs are biased against the individual and in favor of business. One explanation for this bias, assuming for the moment that it exists, looks to the well-paid corporate lawyers who make going after businesses a lot harder than going after individuals. Some IRS audit statistics appear to support the critics’ view of the agency.
The numbers are complicated. First the overview. During the last decade, the overall chance for any kind of audit has steadily declined, even while the total number of IRS employees has increased. The IRS maintains that this decline in the rate of all audits is due to the changes voted into the tax laws by Congress. Everything else being equal, the more complicated the law, the more time it takes a revenue officer to complete a tax audit.
Again considering the last decade, businesses always faced a better chance of being audited than individuals; however, when the decline of audits for businesses is compared with the decline for individuals, it appears that the IRS has allowed businesses to come out way ahead.
In 1976, two out of a thousand individual taxpayers were audited. A bit more than a decade later, in 1987, only about one in a thousand received a visit from the tax man. During the same period, corporate audits went from ten out of a thousand to two out of a thousand. In other words, between 1976 and 1987, audits for corporations have declined five times more than for individuals.
The IRS was asked for an explanation. “Over the past several years our corporate examination program has placed more emphasis on the examination of larger more complex corporations,” an agency spokesperson replied in a brief statement. “Since they take more time to examine, fewer can be examined. However, from a yield standpoint, this is a more efficient utilization of our resources.” The IRS offered no proof of its assertion.
But what do we know about what might well be the most important measure of the IRS’s effectiveness: the quality of the audits that the agency actually conducts? Almost nothing. Of course, individuals and businesses are free to draw conclusions about the knowledge and expertise of the revenue agent who audits them. But as far as I know, no outside organization in recent years has attempted a systematic assessment of the completeness, fairness, and accuracy of the audits completed by the IRS, for either businesses or individuals.
Every once in a while, however, a door will pop open that provides the observer with an insight into this most intimate interaction between the tax agency and the taxed. In this case, our doorman is Peter Stockton, one of the best investigators on Capitol Hill. Stockton is on the staff of the Oversight Subcommittee of the House Energy and Commerce Committee. In the last two decades he has been a lead player in some of the most bruising congressional investigations.
In 1984, the subcommittee obtained information that General Dynamics, at that time the largest defense contractor in the United States, was playing fast and loose with the taxpayers’ money. Representative John Dingell, chairman of the subcommittee, ordered Stockton and Arthur Brouk, an investigator on loan from the General Accounting Office, to investigate the allegations. Some months later, there were explosive public hearings.
During the course of their investigation, however, Stockton and Brouk began to wonder about whether the IRS had any serious interest in the taxes paid by General Dynamics.
“There was a whole lot of funny business going on at General Dynamics,” Stockton recalled. “Among many different matters, we came across a large number of fraudulent expense vouchers which General Dynamics had used to support the deductions the company was taking from the federal taxes,” he said in an interview. “Hundreds and hundreds of vouchers with no one’s name on them. There was one case where one of the executives had submitted vouchers for the expenses he allegedly had racked up while attending more than five hundred business conferences in one year. Of course, vouchers without names on them are not supposed to serve as the basis for a tax deduction and no one can attend five hundred widely scattered business conferences during the 365 days of a single tax year.”
After the subcommittee published its General Dynamics hearings, including some of the questionable vouchers, Stockton said he got a call from an IRS employee named Douglas Lindville, who indicated he was the revenue agent assigned to audit the company. “It is hard to believe,” Stockton said, “but here was the largest defense contractor in the world and there was one guy from the IRS.”
Stockton remembers that Lindville insisted he had never seen the vouchers that he and Brouk had obtained. “Mind you, if some ordinary guy like you or me had submitted those vouchers, the IRS would have been at our throat. But Lindville and his supervisor just kept saying that General Dynamics had shown an overall $3 billion tax loss that year so that denying the deductions claimed on the fraudulent vouchers wouldn’t have made any difference. Even if this were so, I never could figure out why the IRS didn’t bring criminal fraud cases against both the corporation, which seemed to be using the vouchers in a fraudulent way, and the corporation executives that had submitted them in the first place.”
In defense of Lindville, the tax returns and supporting documents of a corporation the size of General Dynamics can easily amount to hundreds of thousands of pages.
Stockton said a second unusual insight provided by the IRS agent concerned the tax year he was then auditing. “What made the whole business totally ridiculous was that Lindville told Art Brouk and me that the General Dynamics books he then was auditing were exactly ten years old,” he said. “It was 1984, and here was one tired old IRS bureaucrat looking at the 1974 books of the world’s largest defense contractor that we had shown was fiddling with at least some of its numbers. It was pretty sorry.”
Although various restrictions limit how far in the past the IRS may conduct its investigations, the agency may lawfully ask a taxpayer to waive these rights. Partly because of fear of precipitous IRS action if they don’t, taxpayers usually agree to the requests. Given the rapid turnover of corporate executives and the deterioration of records in most organizations after only two or three years, the question must be asked: What is the value of auditing ten-year-old books?
When I asked the IRS about Stockton’s scathing description of the agency’s casual approach to auditing General Dynamics, Wilson Fadley, an IRS spokesman, noted that the privacy law prohibited him from commenting on any taxpayer, individual or corporate. “But I can tell you in a general way that for many years the IRS has assigned groups of agents with specialized skills to undertake audits of that class of taxpayer under what we call our large case program,” he said.
“These teams, which include a case manager, specialists in major industries, and experts on various areas such as international trade or pensions, conduct the kind of carefully coordinated audit that a company like General Dynamics might expect.”
Fadley added that in the case of a large organization with offices in many locations it was possible that a single IRS employee might be working alone in one office. He also said that in the auditing of complex corporate tax transactions it was possible that the agency might be looking at transactions that were a decade old.
Alvin A. Spivak, Washington spokesman for General Dynamics, offered an explanation that partly explained the contrary visions of the IRS presented by Stockton and Fadley.
Spivak, in a 1989 interview, said that the so-called completed contract method of accounting that was in effect at the time of the dispute with Congress provided the company and several other large defense contractors with tax credits that enabled them to avoid paying federal taxes. “I am not saying that this particular method of accounting was good national policy, but under its rules we legitimately did not pay federal taxes for a period of several years, and it made no sense for the IRS to be examining our books. Now, the rules that used to give us these net operating losses have been abolished and we are again paying taxes. And I want to assure you that there currently is a quite extensive group of IRS experts—specialists in international finance, computer experts, and specialists in pensions—looking at our operations.”
After all the dust had settled, the federal government did not bring any criminal or tax charges against General Dynamics. In a March 1985 press release, however, the giant corporation advised Congress it would voluntarily reduce by $23 million the $170 million in expense statements it had submitted to the Defense Department for the years 1979 through 1982.
Over the years, IRS officials have frequently defended their relatively friendly approach to the business world, especially the major corporations. The government can pretty well assume the financial affairs of the large corporations are in order, the officials say, because of their association with the Big Eight accounting companies such as Arthur Andersen & Company, Peat Marwick, Main, Deloitte Haskins & Sells, and Arthur Young & Company.
But an examination of the major financial scandals of the United States since the end of World War II involving such well-known companies as General Electric, E. F. Hutton, Penn Square, and General Dynamics itself indicates that the accounting profession has frequently failed in its self-proclaimed role as corporate watchdog.
There are literally scores of documented cases where the most distinguished accounting firms have been named as coconspirators in tax fraud cases involving major corporations. One recent example came to light in 1988; it involved a scheme in which, the IRS alleged, a tax partner of Arthur D. Andersen & Company and more than a dozen senior officials of the Georgia Power Company, one of the nation’s leading utilities, conspired to defraud the government of $200 million in federal taxes. Spokesmen for both Georgia Power and Arthur Andersen in August of 1989 denied the still-pending IRS charges.
Further surprising evidence of the poor-quality work performed by many certified public accounting firms emerged in 1989, when the General Accounting Office conducted an intense audit of a sample of eleven savings and loan associations located in the Dallas region that had recently failed. “Based on our evaluation, we believe that for 6 of the 11 S&Ls in our review, CPAs did not properly audit and/or report the S&Ls’ financial or internal control problems in accordance with professional standards,” the GAO report said.
One of the most outspoken critics of the current ethical standards and practices of the accounting firms is Abraham J. Briloff, the Emanuel Saxe Distinguished Professor of Accountancy at the City University of New York. In testimony before Congress and speeches to professional groups, Briloff has outlined in excruciating detail how some of the most prestigious accounting firms have closed their eyes while their clients committed a variety of serious economic crimes against the public and their stockholders.
Briloff is outraged by the documented occasions when the nation’s leading accounting firms have been involved in swindles or in inadequate audits and is worried about the IRS’s assumption that it can rely on their supposed integrity to assure the proper collection of taxes. But he expresses sympathy for the IRS, which he believes has been asked to administer an impossible tax law with totally inadequate resources.
“Given the complexity of the laws, the abilities of the agents that the IRS normally attracts, and the sophistication of the corporate tax men, it seems to me that the IRS is unable to cope with today’s business organizations,” he said in an interview.
“The role of the IRS is made even more arduous,” he continued, “because the books and documents of most of the largest firms are scattered all over the globe, buried in computer programs which even the corporate auditors who are working on the inside have trouble in understanding.”
Despite his pessimism about the profound imbalance between the IRS and the corporations, Briloff argues that it remains important to hold the tax agency accountable. “I think we should measure the efficiency of the IRS in the same way we measure the efficiency of the New York City Sanitation Department,” he said. “The measure is not only the amount of garbage that the department picks up each day, but the amount of garbage that is left littering the city’s streets and parks.”