Treffer: A Historical Overview of the Computerization of the Internal Revenue Service

The Internal Revenue Service (IRS) is charged with enforcing the U.S. tax code and has historically fulfilled this charge efficiently. The IRS is among the most cost-effective government agencies, costing just 33 cents for each $100 it collects (Internal Revenue Service (IRS) 2021a). The effectiveness of the agency is associated with factors like a relatively high voluntary compliance rate and the use of technology to improve audits and enhance taxpayer service. Technology-supported audits have dual roles; they increase perceived detection, which deters noncompliance, and they increase actual detection, which identifies noncompliers; both roles help to improve revenue collection. Technology-supported taxpayer service increases the cost-efficiency of the agency and taxpayer satisfaction. This study provides a historical overview of the computerization of the IRS, noting obstacles, like budget constraints, politicization of the agency, historically short leadership tenure, risks associated with private-sector contracts, and taxpayer privacy concerns.

AN0173965627;bkx01dec.23;2023Dec05.04:54;v2.2.500

A Historical Overview of the Computerization of the Internal Revenue Service 

The Internal Revenue Service (IRS) is charged with enforcing the U.S. tax code and has historically fulfilled this charge efficiently. The IRS is among the most cost-effective government agencies, costing just 33 cents for each $100 it collects (Internal Revenue Service (IRS) 2021a). The effectiveness of the agency is associated with factors like a relatively high voluntary compliance rate and the use of technology to improve audits and enhance taxpayer service. Technology-supported audits have dual roles; they increase perceived detection, which deters noncompliance, and they increase actual detection, which identifies noncompliers; both roles help to improve revenue collection. Technology-supported taxpayer service increases the cost-efficiency of the agency and taxpayer satisfaction. This study provides a historical overview of the computerization of the IRS, noting obstacles, like budget constraints, politicization of the agency, historically short leadership tenure, risks associated with private-sector contracts, and taxpayer privacy concerns.

Keywords: income tax; Internal Revenue Service; technology; tax history; accounting history

I. INTRODUCTION

The mission statement of the Internal Revenue Service (IRS), the agency responsible for administering and enforcing the United States tax code, defines its objective to help taxpayers meet their tax responsibilities and to enforce the law "with integrity and fairness to all" ([35]). This study provides a historical overview of how the IRS has used computer technology to fulfill this mission statement over time.[1]

Since taxation has been allowed under federal and state law, even that which predates the IRS, tax authorities have utilized state-of-the-art technology in capturing noncompliance and serving its taxpayers. Technology-supported taxpayer service increases the cost-efficiency of the agency and taxpayer satisfaction ([32]). Technology-supported audit procedures have dual roles; they increase perceived detection, which deters noncompliance, and they increase actual detection, which helps identify noncompliers and collect revenue. Both of these effects help to close the tax gap, contributing to increased tax revenue for the U.S. government. The tax gap—the difference between taxes that are owed and those ultimately collected—is currently estimated by the IRS to be $496 billion annually, totaling approximately $7 trillion over the next decade ([36]; [58]). As taxes are the primary revenue source of the U.S. government, the stakes are high for maximizing the IRS' efficiency and effectiveness of its tax collection.

Technology is an important tool in maximizing the effectiveness and efficiency of the IRS. However, maintaining the agency's technology so that it is maximally useful to the agency is burdensome and not without challenges. These challenges include the costliness of modernization and related budget constraints, politicization of the agency, historically short leadership tenure, risks associated with private-sector contracts, and taxpayer privacy concerns.

This study views the IRS' computerization over time, from its initial implementation of automatic data-processing systems in the 1960s, through its struggles to modernize in the late 20th century, and, finally, to an update of the agency's use of technology today. Logging these developments chronologically, this study reviews how the IRS has utilized computerization in fulfilling its primary activities of tax enforcement and taxpayer service. The study concludes by documenting some of the hurdles that the agency has faced in its attempts to modernize its technology.

The study is organized as follows. Section II of this paper discusses precomputer technology and early implementation of mechanized data processing at the IRS, ranging from initial implementation through approximately 1975. Section III describes the IRS' technological developments between 1975 and 2000, including, most notably, the transition to electronic tax return filing. This section also describes the initial computer modernization projects undertaken by the agency. Section IV discusses the IRS' use of technology in the "information age," ranging from 2000 through today, and details more recent reorganization and modernization projects. Section V notes some of the barriers to the agency's technology modernization, including budgetary concerns, politicization related to funding the agency, historically short leadership tenure, risks associated with engaging the private sector on modernization projects, and taxpayer privacy concerns related to the maintenance of personal data. Section VI provides concluding remarks.

II. EARLY IMPLEMENTATION OF COMPUTERS: INTRODUCTION THROUGH 1975

A central component of the IRS' mission is enforcement. Enforcement helps to both discourage and detect evasion to support voluntary compliance. This is likely why some of the earliest use of technology by the IRS was designed to aid enforcement. Leveraging technology contributes in large part to why the IRS is today among the most cost-efficient of government agencies, spending just 33 cents for each $100 that it collects ([31]). The efficiencies afforded by the IRS' use of technology are evidenced by an analysis of this data point over time; the IRS has tracked its cost of collecting $100 since 1951. Figure 1 illustrates the overall decrease of this cost over time, which ranged from a cost of $0.49 to collect $100 in 1951 to a cost of $0.33 in 2021 ([26]).

Graph: FIGURE 1 Dollars Spent to Collect $100 in Tax Revenue, 1951–2021(The full-color version is available online.)

Precomputer Technology in Enforcement and Taxpayer Service

In addition to basic audit procedures like recalculation and matching reported amounts against third-party documents, the U.S. tax authority—even that which predated the IRS[2]—leveraged state-of-the-art technology in its audit procedures. Before machine technology was available for this purpose, its absence was lamented for the inevitability of evasion. The first iteration of the U.S. income tax[3] that was instituted prior to the use of machines by tax authorities was described as though "the result must inevitably be an immense increase of evasion and undervaluation. With no machinery for checking the returns, and with no reliable estimates for gauging the value of the self-assessments, it is unfortunately only too probable that many of the doleful predictions made by the opponents of the measure will be verified" ([60], 646).

In February 1867, the Secretary of the Treasury implemented a hydrometer, a measurement device used to assess density, to inspect alcoholic spirits subject to tax; the 1867 Revenue Act authorized the Secretary of the Treasury to adopt this and other instruments to prevent and detect tax evasion by distillers (Figure 2) ([28]). Instruments such as these served the agency's enforcement arm. Other types of technology served to improve the IRS' ability to serve taxpayers and improve processing speed. When the agency moved into its new headquarters in 1930, the building was outfitted with state-of-the-art technology, including 1,400 telephones and a synchronized system of 861 clocks ([28]). A newspaper article detailing the move describes the transfer of "many machines for handling these (tax) records...Much of the statistical tabulation work is done by machine instead of by hand" ([73], B-1). Installation of punch-card equipment in 1948 improved the ability of agents to quickly process taxpayer notices, and photocopying technology supplemented the work of typists and stenographers. Shortly thereafter, these technologies were improved with electric typewriters, continuous forms, dual-roller platens, and posting machines ([28]). Advancements like teleprocessing, telecommunications, and office automation later evolved to help link the IRS district and regional offices to the National Office system to centralize the agency ([21]).

Graph: FIGURE 2 Hydrometer Used by Tax Authorities, 1867(The full-color version is available online.)

The Implementation of Computer Technology at the IRS

The most dramatic implementation of technology was the installation of computer technology. By 1950, the agency (at the time, the Bureau of Internal Revenue) first introduced computers for simple tabulation ([28]). Use of computers for audit-selection procedures followed in 1962 with the development of the Taxpayer Compliance Measurement Program (TCMP), which gathered data from previous audits for use as inputs in improving audit selection. This program provided the basis for the development of discriminant function (DIF) analysis in 1969, and though the inputs of the DIF have since evolved, the methodology is still used today. DIF methodology uses a computerized statistical calculation of a "DIF score," which assigns to a tax return a probability that it contains error or evasion. DIF scores are then used for audit selection. These technological developments transformed the efficiency of audit-selection procedures, and the IRS indicated at the time "they will have a considerable impact on IRS audit procedures" ([63]), with Commissioner Mortimer M. Caplin calling this "the biggest breakthrough in tax collecting since 1913" ([52], 4).

By the end of the 1960s, Congress and the Secretary of the Treasury had approved the installation of a nationwide automatic data processing (ADP) system at IRS headquarters and at each of its seven satellite locations across the United States (Figure 3). The IRS' use of computers was met with trepidation by taxpayers. As personal computers were not yet widespread, taxpayers' understanding of the capability and use of computers was limited. To explain the role of the computers within the agency, the IRS released films describing how ADP systems aided and improved IRS productivity. A film created by the IRS, estimated to have been released in 1953, describes the ADP system as "the newest tool of the Internal Revenue Service, and a new dimension in tax administration," and that "nearly everyone in the United States has some concern with this mechanical marvel and its electronic relatives." The film assures taxpayers of the usefulness of such machinery in "keeping the IRS current...giving the U.S. taxpayer the service and information to which he is entitled...to smooth the path of governance," which "to us, at IRS, seems a worthy goal" ([77]).

Graph: FIGURE 3 IRS Automated Data Processing System Center, c. 1960s(The full-color version is available online.)

A 1962 Harper's Magazine cover story details the changed environment initiated by the IRS' adoption of ADP, or "The Martinsburg Monster," lamenting that "the jig is up...The Martinsburg Monster is going to get us all" ([59], 33). The article describes the "electronic precision" of the machine's "magnificent electronic brain" and its taste for numbers such that "thus will die the beguiling possibility that the tax collector will overlook the dividends received at his office by J. Randolph Doe who files his tax return from home as John R. Doe" ([59], 33). The article also depicts the computers' promising abilities to expedite refund checks, equivalate taxpayers so that all pay their fair share, and improve customer service by freeing agents' time from manual labor. The tone of the tongue-in-cheek article indicates fear-mongering—a suggestion that the governments' computers are so powerful that the former problem of noncompliance will be replaced by the problem of the IRS as "big brother." The U.S. government recognized this concern. A report published by the [21], 60) described that there existed "often a general fear—in many cases unfounded—that increasing the use of computers by the IRS will eventually result in the erosion of taxpayer rights and privacy." Commissioner Caplin was "very conscious" of the perception of "big brother" watching over each taxpayer and attempted to humanize the computerization of tax collection. For example, one goal of the computerization process was to require that individuals report their Social Security Numbers on their tax returns[4] and send out automated letters to those who did not, "asking them, in a nice way, how come?" ([52], 4).[5]

Commissioner Sheldon S. Cohen, who succeeded Commissioner Caplin and completed the launch of the computerization of the agency, reflected a consistent message that computerization primarily served taxpayers in promoting uniformity. In demonstrating the "microfilm reader printer" in a 1965 testimony before the House Appropriations Subcommittee responsible for appropriating funds to the IRS, Commissioner Cohen stressed the fairness that uniformity would bring about, stating that "the taxpayer can feel that the taxpayer in San Francisco gets the same treatment as the taxpayer in Dallas" ([69], 19).

Computer-Assisted Audits

Before 1963, the IRS performed a visual screening process in selecting returns for audit ([85]). When it was introduced in 1963, the IRS' ADP systems became integral to its enforcement regime. In addition, taxpayers' own ADP system records became a valuable data source for IRS audits. A Journal of Accountancy article from August 1965 indicates that, during tax season 1964, more than 1,000 accounting firms nationwide processed approximately 100,000 tax returns using Computax, a computerized tax preparation service ([38], 15). The article summarizes commentary from preparers on their use of the program as generally positive, in that it decreased overtime and workload, saved money, and helped with the physical preparation of returns (i.e., collating and photocopying), with some concern about the computerization of confidential information. One preparer stated that "We were concerned about the confidential nature of the data with which we were working. We felt the burden was upon us to know something about Computer Sciences Corporation" ([38], 16).

The first rulings regarding the use of computerized records for IRS audit procedure purposes were issued in late 1970. Then, the IRS issued Rev. Rul. 71-20, which held that records within a taxpayer's own ADP system, including "punched cards, magnetic tapes, disks and other machine-sensible data media used for recording, consolidating and summarizing accounting transactions," are required to be maintained for tax auditing purposes ([63], 76). A summary of this ruling in a 1971 Journal of Accountancy article describes mixed taxpayers' reactions to the ruling ([63]). Although some viewed the move as a necessary step toward modernization of the Service that would contribute to audit efficiency and expediency, others demonstrated concern over costs associated with storage and retention. [63], 76) argues: "The IRS really has no choice but to begin using the computer to perform their tax audits more efficiently."[6] Computer-assisted audits at this point relied on "extraction programs," or programs designed to extract certain data from taxpayers' files based on agent-input criteria. Three types of extraction programs included (1) a special-purpose program written specifically for the task, (2) a prototype program written to automate routine extractions, and (3) a generalized program (similar to modern software) using a prewritten program (e.g., Auditape, Auditpak, and Audassist). This revenue ruling was recognized as the end to the era of a completely manual tax audit, acknowledging that "the full significance of using computer technology on tax audits is indeterminable...Equally important, and possibly of greater interest, are the plans which the IRS has for the administration of the ruling and for the use of these records for tax auditing purposes" ([63], 78).

Computer-assisted audits vastly shifted the amount of information that could be processed in an IRS audit. As the audit process was no longer limited to available manpower-hours, the capacity and scope of an audit changed significantly. Advantages of computer-assisted audits were broadly summarized as "time saved" for both the taxpayer and the IRS, but the agency indicated that also they result in a higher-quality audit based on improved data selection and search technology ([85], 216). Commissioner Johnnie M. Walters stated that computer-assisted audits enabled agents to "dig up information that would take agents literally months to hunt down" ([74], 19). A 1977 Journal of Accountancy article details CPAs' obligations to aid in IRS tax audits regarding the release of tax workpapers as a source of data for audit purposes. The article describes a trend of IRS requests for "unlimited access" to workpapers for a client under investigation and, further, how this "new aggressive policy" undermines a CPA's effectiveness by infringing on the confidential exchange of information between a tax client and a CPA ([22]). Court cases have established limitations to IRS audit requests for "unlimited access" (e.g., [78]) which block agents from "fishing," requiring requests to show that request information is material and relevant to the investigation ([22]).

Computerization of the IRS was not limited to enforcement services, and the 1970s saw a dramatic increase in computerization to improve taxpayer service at the agency. Commissioner Walters commented in 1972 that "we haven't been providing enough service for taxpayers so next year we'll provide more" ([71], 36A). Specifically, he discussed improvements to the computerization of each IRS office so that IRS agents would have access to a computer terminal from which to call up taxpayers' previous-year tax returns to respond to taxpayer questions via phone call, describing these improvements as "the greatest step forward" ([74], 19).

III. INITIAL MODERNIZATION EFFORTS: 1975 THROUGH 2000

Initial Modernization Efforts of the IRS' Computer Technology

By the 1980s, the procedures for the computer processing of taxpayer returns were better understood. The 1980 Annual Report of the Commissioner of the Internal Revenue Service depicts the "Processing Pipeline" to document the efficiencies gained by technology ([15]) (Figure 4). However, the same IRS computer technology described in 1962 as a "magnificent electronic brain" was now described as "grossly short of the capacity and modern state-of-the-art efficiency that is essential for an effective tax system in the 1980's" ([61], 1). As early as 1977, Commissioner Jerome Kurtz described the "aging behemoth of a computer system" as "held together with Scotch tape and bubble gum" ([68], 7-E). The computer system at this point was similarly likened by journalists to "an interesting museum piece, but not the equipment needed to handle routine daily workloads of the 1970s" ([68], 7-E). Barriers to modernization at the time were summarized broadly and included cost, privacy issues related to a large data-processing system, and time expenditure. IRS Assistant Commissioner for Data Processing Patrick J. Ruttle described the expected time investment as six to eight years "to change the clothes on a giant of this size" ([68], 7-E).

Graph: FIGURE 4 The Processing Pipeline at IRS Service Centers, 1980Source: [15].

A New York Times article from 1997 describes that "when installed in the late 1950's, the I.R.S.'s keypunch computers were state of the art. And in the late 1960's, they could still handle the nation's taxes. But when it came time to replace the system in the 1970's, politics got in the way" ([10]). After two decades, the IRS' computer data facilities and hardware required updating, and the struggle to do so would plague the agency in years to come ([48]). In 1985, under Commissioner Roscoe Egger, the IRS faced significant difficulty in implementation of a new $103 million Sperry Univac 1100/84 computer system (Figure 5). Glitches in system implementation resulted in delayed tax refund checks, erroneous notices, and malfunctions so severe that the IRS recommend some taxpayers file duplicate returns in order to receive their refunds ([56]; [66]; [75]).

Graph: FIGURE 5 Sperry UNIVAC 1100/80 Computer System, c. 1970sSource: https://search.library.wisc.edu/digital/ANF32TBLXEDBIR8C

Described at the time as "the most turbulent tax-processing season in its history," the glitches were attributed to both programming errors and faulty tape drives, which sometimes accidentally erased computer-encoded copies of taxpayer returns ([56], 1). Representative Doug Barnard Jr. (D-GA) accused the IRS of "grossly inadequate planning" for the installation of new computers, including undertraining of employees and choosing a computer language inappropriate for the new system ([66]). As a result, and in response to a "sharply critical" opinion by three administrative law judges who reviewed the system failure, the IRS halted further implementation of the new system and cancelled its multimillion-dollar contract in January 1986 ([57]). In response to the turbulent tax season, the IRS printed an apology letter to taxpayers on the front of the following year's federal income tax forms and made a statement that "current computers are adequate for the time being" ([75]). In a November 1985 explanation before the Senate, Commissioner Egger reinforced to the Senate that he expected no repetition in 1986 of the "computer foulups and bureaucratic bungling," and that "the IRS is better prepared and making every effort possible" to prevent this type of breakdown again ([18], 4A). To this, senators responded "cooly," suggesting that a repetition could "undermine credibility and discourage voluntary compliance with income tax laws" ([18], 4A).

The IRS' Tax System Modernization Project began in 1987 with the intent of full implementation by 1998. With the previous system implementation from 1985 scrapped, improved technology and greater access to computers in the late 1980s prompted renewed interest in modernization. However, severe management problems at the IRS hindered the project, described within an internal IRS investigation as "a lack of technical expertise, an inability to keep track of project costs, and a failure to develop a unified plan describing how the agency's thousands of computers—mainframe, desktop, and portable—would work together under the new structure" ([11], 12). Likewise, the project was "sharply criticized" by the GAO ([70]). The project proceeded onward, but in 1997, the IRS conceded during testimony before the National Commission on Restructuring the IRS that "its $4 billion modernizing is a failure" and that the modern computer systems developed "do not work in the real world" ([70]). This failure resulted in the program's cancellation, with Assistant Commissioner Gross stating that, for the foreseeable future, the IRS "must continue to work with dozens of antiquated computer systems—some dating to the 1960's—that cannot trade information with one another" ([70]).

The Transition to Electronic Filing

Further contributing to the strain on the IRS' now-antiquated computer systems was an avalanche of data resulting from the transition from predominantly paper-filed tax returns to predominantly electronically filed tax returns. In efforts to simplify the tax code, Congress under President Reagan passed the Tax Reform Act of 1986 and introduced electronic filing of income tax returns (Figure 6).[7] Passage of this Act was pivotal not only in its content, but in that it marked the beginning of the progression from paper-based filing to electronic filing of tax returns in 1991.[8]

Graph: FIGURE 6 IRS Advertisement for Electronic Filing, 1987Source: https://digital.lib.uiowa.edu/islandora/object/ui%3Atestposters4%5f193(The full-color version is available online.)

In addition to lower operating costs and expedited receipt by the IRS, the transition to predominantly, "nearly universal," electronic filing provided for mass digitization of taxpayer data ([82], 48). Commissioner Egger predicted an embrace of the electronic filing system because taxpayers would have earlier access to their refunds and because the program would result in fewer operator errors ([39]). "Enthusiastic" responses to the initial pilot program offering electronic return filing encouraged the agency to expand the program thereafter ([84]).

Although proposed with the goal of tax simplification, [82] proposes that an unintentional consequence of the transition to electronically filed tax returns is a corresponding increase in the complexity of the income tax system. In his study, Walsh suggests that electronically prepared and filed income tax returns have the effect of shielding taxpayers from increasing complexities of the tax code via computer-based input and calculation, thereby decreasing the taxpayer pushback on legislative complexity of the tax code. Thus, increasing complexity in the tax code only made taxpayers more reliant on electronic preparation, then further incentivizing electronic preparation and filing and perpetuating the volume of computerized taxpayer data.

The IRS sought new technology to functionalize this newly acquired data and, in 1986, created an artificial intelligence laboratory to research how the data could be leveraged to improve tax processing and tax audit procedures ([27]). Increased data availability has been a help and a hindrance to the IRS over time; expanded access to taxpayer information produces better inputs to audit selection procedures, but also creates additional risks related to the confidential handling of such data and additional costs related to their maintenance.

IV. MODERNIZATION IN THE "INFORMATION AGE": 2000 THROUGH TODAY

Just as the "machine age" was transformative to the IRS' physical technological capability, the "information age" has been similarly transformative to the IRS' access to information. The emergence of Big Data has changed the types and sources of taxpayer information available to the IRS, which, when combined with proprietary data collected from electronically filed income tax returns, creates an enormous database for IRS systems to maintain ([12]; [24]). The strain of maintaining this quantity of data has enhanced the urgency of calls to modernize the IRS' computer systems.

System Strain in the 21st Century

During the early 21st century, news sources documented increasing concerns that, under the strain of increased amounts of data, the IRS' four-decade-old computer systems would crash. A 2000 Barron's article describes the IRS' reliance on antiquated programming language, which has become "so complex, disjointed, and jury-rigged that large parts of it could crash at any moment" ([47]). The IRS' Individual Master File, the database that stores the tax history of individuals, corporations, and each IRS transaction since the 1960s, is the original iteration that was created for the IRS by IBM in the early 1960s ([4]; [9]; [37]; [80]). As predicted, systems failures have occurred as a result of aging systems. Failures have been initiated by both unintentional computer glitches ([8]; [23]; [46]; [50]) and malicious hacks ([3]; [51]). Systems overwhelm reached a recent acuity during a 35-day government shutdown between December 2018 and January 2019, during which time the agency would typically have been preparing for the upcoming tax season, but was unable to, resulting in over 5,000,000 unanswered pieces of mail ([64]).

The COVID-19 pandemic exacerbated strain on the agency due to physical office shutdowns, increased responsibility related to the issuance of stimulus payments, and the enforcement and interpretation of pandemic-related tax law (e.g., the Coronavirus Aid, Relief, and Economic Security (CARES) Act). Bloomberg Tax launched a series of articles in April 2022 examining how the IRS landed "in such a dire situation" ([25]). The series compiled interviews with current and former government officials, agency watchdogs, and tax professionals. Their findings describe a backlog of millions of unprocessed tax returns and billions of dollars of additional interest due by the U.S. government to taxpayers related to the delay in processing those tax returns and issuing timely refunds. In addition to processing delays, taxpayers and tax professionals face unprecedented delays in customer service (i.e., phone calls into the agency). The agency introduced voice and chat bots on its telephone lines and website in 2022 to decrease wait times ([34]), but substantial delays have become so pervasive that they have spurred a market for companies that promise customers the opportunity for quicker access to the IRS. The Bloomberg Tax series concludes that "the agency needs to confront the technology, workforce, and public perception problems at the root of its customer service struggles" ([25]).

In a May 2021 testimony before the Senate, Commissioner Charles P. Rettig highlighted several of these strains on the agency, citing them as evidence to increase Congressional budget appropriations to the agency. Specifically, the testimony calls to "overhaul outdated technology" and "improve taxpayer service," citing that "inadequate resources often mean that IRS employees are unable to provide taxpayers timely answers" ([54]).

System Modernization in the 21st Century

To address these strains, the IRS has launched several modernization projects. One such project is the replacement of the IRS' legacy system with a system called the Customer Account Data Engine 2 (CADE 2). This implementation began in 2009 and has been completed largely on schedule and within budgeted cost, though the program is not scheduled to be finished until 2030.[9] CADE 2 is designed to establish a single database housing all individual taxpayer accounts and provide the IRS with the necessary infrastructure for real-time taxpayer interactions and adaptability to legislative updates ([4]). CADE 2 will replace the current system configuration, in which taxpayer accounts are maintained in two systems: the Individual Master File (IMF) and the Customer Account Data Engine (CADE). The project will also populate the Integrated Production Model (IPM) analytical data store to provide users greater functionality with taxpayer data for compliance and customer service purposes. Given the scope of the project and the volume of the data, implementation is a substantial project comprising three phases—Transition State 1, Transition State 2, and Target State—which will complete the transition to target-state applications and database, retire all transitional components, and address financial and security weaknesses identified during the program's inception. Although both the IMF and CADE will be in use during the transitional phases, the target state will retain only CADE ([29]).

Agency Modernization in the 21st Century

In conjunction with system modernization, the agency itself has undergone transformation. The IRS Restructuring and Reform Act of 1998 modernized and reorganized the agency to imitate a private-sector entity, comprising four major business divisions. One element of this effort was the development of IRS.gov, the online home of the agency. The development of a website enabled the IRS to leverage technology in its service to taxpayers, providing digital tools for taxpayers to calculate withholding, track refund status, and file electronically online for free ([28]). Due to agency budget cuts in the 2010s and an ever-increasing number of tax returns processed, the agency turned to the web to bolster its taxpayer service offerings more efficiently. Commissioner John Koskinen described this strategy to "move as many people (online) as we can," using tools like Twitter, YouTube, and online website applications like "Where's My Refund?" ([44], 4B).

The Office of Compliance Analytics (OCA) was created in 2011 as a new division founded to develop an advanced analytics program to increase reliance on the use of Big Data and predictive algorithms in service of increased compliance. The OCA was merged with the Office of Research, Analysis and Statistics (RAS) in 2016 to form the new Research, Applied Analytics, and Statistics (RAAS) organization. The RAAS is a key driver of the IRS' adaptation of Big Data analytics in service of its mission to "lead a data-driven culture through innovative and strategic research, analytics, statistics and technology services in partnership with internal and external stakeholders" ([20], 5).

In 2019, the IRS released the IRS Modernization Plan, which includes dozens of initiatives to address the agency's taxpayer service and strengthen its cybersecurity and information technology systems over the succeeding six years. Within this plan, the IRS identified four "Modernization Pillars" that reflect how modernized technology will improve the agency's ability to fulfill its mission. These four pillars include: (1) expanded digital options to provide simplified services to improve the taxpayer experience; (2) integrated taxpayer account management, so that taxpayers have a complete and real-time view of their IRS interactions and taxpaying history; (3) modernized IRS operations, including Cloud, Agile, DevOps, and robotic process automation; and (4) improvement of cybersecurity and data protection to align with government-wide cybersecurity standards and priorities ([33]).

The IRS in the "Information Age"

By way of the IRS' Research, Applied Analytics, and Statistics organization, the agency has adopted Big Data analytics into its audit procedures. Big Data analytics utilizes data mining, which is the analysis of large sets of data for patterns and relationships. The IRS, as a government organization, has access to government data, publicly available data, and private data obtained through third-party contracts. From its own archives of former tax returns and previous audit data (i.e., the National Research Program and Individual Master File), the IRS maintains a mass amount of taxpayer data. Further, the IRS can mine data from public sources like social media outlets (e.g., Facebook, Twitter, LinkedIn, PayPal, and Venmo) and Google Maps. IRS training documents, obtained via a Freedom of Information Act (FOIA) request, identify Facebook, Myspace, and YouTube as sources of publicly available taxpayer information. Specifically, a 2009 IRS training document provides tips to agents on how to conduct searches, locate taxpayer information, narrow and refine results, and use Adobe's web-capture feature to document relevant findings. In one example, the training describes a scenario in which a taxpayer does stand-up comedy as a side gig and advertises his shows on his Facebook page. Agents are instructed to compare expected income from posted show dates to income on the man's tax return to identify possible underreporting ([81]).

In addition to publicly sourced data, the IRS maintains contracts with third-party entities. The U.S. government spending website indicates that the IRS has contracts with companies such as Chainalysis, which organizes data scraped from public forums and the dark web, and Coinbase, the largest domestic virtual currency exchange, which provides data related to cryptocurrency transactions ([79]). The combination of these various data sources enables the IRS to functionalize Big Data analytics techniques such as anomaly detection, advanced clustering, and neural networks to run pattern-recognition algorithms to identify patterns and relationships in the data ([20]). Jeff Butler, Associate Director of Data Management at the RAAS, identifies that, given historical budget constraints of the IRS, the importance of data analytics has become "more important than ever" to support the mission of the agency. The IRS' embrace of Big Data analytics reportedly resulted in a 2019 year-over-year increase in detection of tax fraud of more than 400 percent ([20], 5).

V. BARRIERS TO AGENCY MODERNIZATION

The preceding sections of this study have viewed the computerization of the IRS. Modernization of the IRS' technology has been costly and difficult to implement successfully. This section notes some obstacles toward modernization.

Budget Constraints at the IRS

This article has identified several instances in which tension has existed between the IRS and Congress related to the IRS' modernization plans. Although Congress has, at times, been critical of the IRS' management of resources, the IRS has suggested that inadequate resources contribute to the difficulty to modernize ([67]). "Underfunding" of the IRS is frequently noted as the root cause for many of the agency's struggles to keep up with the demands placed upon it. The Taxpayer Advocate Service (TAS), an independent organization within the IRS that advocates on behalf of taxpayers, identified significant underfunding of the IRS as one of its "Most Serious Problems" during the 2010s. The TAS comments that the IRS is materially different from other discretionary government programs in that "it serves as the de facto Accounts Receivable Department of the federal government" ([67]). Thus, underfunding the agency limits the ability of the agency to collect taxes due and, as a result, affects the entire U.S. government.

To examine the claim that the IRS is "underfunded," it is necessary to understand the totality of the IRS budget over time and its allocation amongst its primary activities: taxpayer services, operations support (including information technology), enforcement, and business systems modernization. Figure 7 illustrates the IRS' budget (funded by Congressional appropriations) from 1951 through 2021, in constant 2021 dollars. This figure documents a somewhat steady increase in the agency's budget over time, which correlates with a parallel rise in the number of tax returns processed, with appropriations peaking in 2010 at approximately $14.95 billion (in constant 2021 dollars). Reflected in this figure is the frequently cited budget decrease during the decade that followed. This particular decline reached a low in 2019, with appropriations of $12.30 billion (in constant 2021 dollars) before rebounding ([26]). Data related to the agency's $80 billion funding boost (spread over 10 years), provided as part of the Inflation Reduction Act in 2022, is not reflected in these historical data, but will provide an economically significant increase to this trendline (H.R. 5376–Inflation Reduction Act of 2022 ([76])).

Graph: FIGURE 7 IRS Annual Budget Appropriations, 1953–2021(The full-color version is available online.)

The IRS Data Book, the IRS' annual publication detailing the activities, expenditures, and collections of the agency, only began reporting the IRS' budget allocation by primary activity type beginning in 1999. Analysis between 1999 and 2021 indicates a largely stable allocation, with approximately 25 percent allocated to taxpayer services, 40 percent allocated to enforcement, and 35 percent allocated to operations support (including information technology). Beginning in 2005, the IRS Data Book began separately reporting budgetary appropriations allocated to Business Systems Modernization, and this allocation percentage has ranged from a low of 1.89 percent in 2009 to a high of 3.28 percent in 2016 ([26]).

To provide further context for the IRS' budgetary appropriation, a comparison of the IRS' budget with the budgets of like countries' tax authorities is appropriate. Given that tax burdens (i.e., total tax revenue as a percent of gross domestic product (GDP)) vary significantly by country, this study compares two countries similar to the United States in their level of development and in their total tax burden—Australia and Ireland. Australia's tax authority, the Australian Taxation Office (ATO), estimated its budget for 2021 to be about $14.4 billion USD ([5]). This budgeted amount represents approximately 2.7 percent of annual tax revenue and 0.9 percent of GDP. Ireland's tax authority, the Office of the Revenue Commissioners, estimated its budget for 2021 to be about $591.3 million USD, representing about 0.5 percent of annual tax revenue and 0.12 percent of GDP ([55]). In comparison, the United States appropriated $13.7 billion to its Internal Revenue Service in 2021, representing about 0.33 percent of annual tax revenue and 0.06 percent of GDP ([31]).

Classification as a nondefense discretionary (NDD) program is one reason that the IRS has faced budget cuts. Annual funding for NDD programs requires annual action by Congress, in contrast with funding for "mandatory" programs like Social Security and Medicare that is determined automatically by formulas. As concern about the federal budget deficit has risen in recent years, the IRS has been subject to the same funding rules as other such categorized programs and has had its budget limited accordingly. During a 2012 investigation of the budget issues of the IRS, the National Taxpayer Advocate met with 14 separate congressional staffs, including the House and Senate majority and minority staffs of the tax-writing committees, appropriations committees, budget committees, and tax counsels, and observed widespread consensus that the IRS is underfunded. However, these staffs consistently concluded that establishing new funding rules for the IRS would be a "heavy lift" ([67]).

Politicization of the IRS

ProPublica and The Atlantic copublished an article in 2018 describing some of the contributing factors toward budget and staffing cuts, both of which hindered the agency's ability to effectively modernize.[10] In this article, [41] identify factors like the political unpopularity of the IRS, the vilification of the IRS in some political campaigns, a series of Senate hearings in 1997 and 1998 publicizing alleged IRS abuses, and taxpayer protection laws, which limited the IRS' collection powers and independence, as contributors. Most notably, the authors document that the IRS' assignment to administer provisions of politically divisive legislation, like the Affordable Care Act (ACA) in 2010, heavily politicized the agency. Funding, or withholding funding, to the IRS became entangled with political strategy, rather than based on the needs of the agency itself. As a result, though the IRS has demonstrated itself to be a revenue-positive government agency, proposals to increase its funding have become complicated beyond the economics of such proposals ([13]; [41]).

Although the politicization of the agency, particularly in recent years, has been identified as an obstacle toward agency funding, it is worth noting that politicization of the agency is not an entirely new concept. The Commissioner of the IRS serves as the head of the agency, and although modern appointments to this role are not politicized, this was not always the case. An excerpt from a 1930 announcement of David Burnet as the newly appointed Chief of the Bureau of Internal Revenue notes Burnet as the first appointment of a civil servant to the position. The appointment was described as a departure by President Hoover from the tradition of giving this "lucrative and important" federal post as a reward for political services ([72], 1).

The Tenure of Leadership at the IRS

A review of leadership at the IRS illuminates the historically short leadership tenure of the Office of the Commissioner until it was legislated as a five-year term in 1998. Given the extensive time horizon of the IRS modernization projects discussed herein, relatively short leadership tenure was an obstacle in the management of various IRS technology modernization projects.

The Office of Commissioner of Internal Revenue was established by Congress on July 1, 1862, and the Office of Commissioner heads the agency still today. IRS Commissioners are nominated by the President and confirmed by the Senate, and, prior to the passage of the IRS Restructuring and Reform Act of 1998, which instituted a five-year term for Commissioners, the average length of a Commissioner's tenure was about three years. Between permanent appointments, the Office is temporarily filled with an Acting Commissioner.

Excluding temporary appointments, the IRS had three Commissioners per decade from the 1960s through the 1990s. Including temporary appointments, these appointments ranged from five to six Commissioners per decade, indicating a rapid pace of change, which slowed after the passage of the Restructuring and Reform Act in 1998. An article published shortly after the passage of this Act suggests that the Act would "provide much needed continuity within the IRS...provide more stability, allow needed reforms to be implemented, and provide more accountability within the IRS" ([43], 28).

Assistance from the Private Sector

Proponents of assistance from the private sector suggest that leveraging the private sector in modernization efforts "stands a better chance of success than previous efforts to modernize the agency" ([40], 529). Until 1998, modernization plans were primarily run in-house without contracting the private sector. In 1998, Commissioner Charles O. Rossotti awarded an IRS contract to a consortium headed by Computer Sciences Corporation (CSC) and comprising Northrop Grumman, KPMG Peat Marwick, UNISYS, IBM, Lucent Technologies, and Science Applications International. This contract was the first of its kind to utilize assistance from the private sector based on a goal to improve customer service and collect more tax.[11]

An explanation for the lack of private-sector involvement in modernization efforts prior to this point reflects back on the tenuous nature of budgetary appropriations and dependency of appropriations on the priorities of Congress. Members of the contract-winning CSC consortium exhibited concerns to this effect, stating their "fear that Congress will lose interest in the IRS modernization project and cut off funding before the upgrade is complete" and that "Congress might lose the political will to complete the modernization if it results in job cutbacks" ([40], 529). However, Representative Rob Portman (R-OH) applauded Commissioner Rossotti for seeking help from the private sector, stating that "the IRS has gotten much more sophisticated and much more willing to reach out...Charles Rossotti is the first IRS commissioner who truly understands the world of information technology" ([40], 529).

Consultancy firms in the private sector have continued to take a driving role in global tax administration modernization. McKinsey & Company, Deloitte, Accenture, and EY, among others, have publications detailing the innovations reshaping global tax administration and their partnerships with global tax authorities in their modernization efforts. For example, Accenture boasts in a case study its 2018 "world first" voice bot partnership with Revenue, Ireland's tax authority. Whereas most AI usage by tax authorities is currently implemented through chatbots (i.e., where users type their questions), Ireland's Revenue implemented this project in order to meet its need to improve customer service with a technology-agnostic conversational AI ([1]). Other consultancy firm research suggests that tax authorities should consider innovation in certain key areas, including digitized interactions, advanced analytics, process automation, talent management, behavioral tax "nudges," and real-time data exchange ([6]; [7]; [83]).

Global tax authorities' maturity in each of these areas varies, but examples of their implementation in partnership with private consulting firms are plentiful ([6]; [7]; [83]). Ernst & Young authored a thought piece describing numerous examples of the possibilities enabled by such partnerships ([7]). For example, Brazil is using AI and geoprocessing to identify anomalies where taxpayers input information flagged as an outlier from the rest of their community. The Australian Taxation Office matches third-party data to deductions claims in real-time and "nudges" taxpayers to file accurate returns. The Israel Tax Authority has instituted smart cash registers connected directly to the tax authority to allow tourists point-of-sale value added tax (VAT) refunds and eliminate the need for VAT refunds at the airport. The Inland Revenue Authority in Singapore uses a digital identity framework to interact with other Singapore Government agencies to seamlessly pre-fill individual taxpayers' income tax returns so that they can file their taxes automatically through the Singpass mobile app ([7]).

Privacy Concerns of Taxpayers

Since the introduction of the income tax, U.S. taxpayers have been concerned over the privacy of their financial data in the hands of the tax authority.[12] The premium placed on taxpayer privacy, and privacy more generally, is relatively unique to the United States. Other countries maintain public tax records, either for all citizens (e.g., Norway) or for that jurisdictions' top earners (e.g., Finland, Japan) or legislators (e.g., Sweden) ([17]). Although some research documents an association between tax openness and increased compliance ([42]), the public response to data leaks releasing individuals' and corporations' private tax information (e.g., Panama Papers, ProPublica, etc.) highlights the importance of privacy that countries like the United States and the United Kingdom place upon financial information ([17]).

This premium on taxpayer privacy represents another obstacle toward the IRS' technology modernization, though a complex one. On the one hand, modernization of technology (e.g., the IRS Modernization Plan of 2019) has the capability to improve the cybersecurity surrounding private taxpayer data. On the other hand, modernization of technology can enable access to sometimes-controversial new sources of data.[13] Given U.S. taxpayers' propensity for privacy, taxpayers can perceive the IRS' access to data and use of advanced technology as invasive and at odds with its stated mission of fairness and integrity ([49]). For example, in response to concerns over the IRS' collection of sensitive biometric data obtained using third-party facial recognition software (i.e., ID.me) to access taxpayer accounts on its website, the agency discontinued use of the software. Commissioner Charles Rettig stated that "the IRS takes taxpayer privacy and security seriously" ([53]). Eric Goldman, co-director at the High Tech Law Institute at Santa Clara University, argues that the IRS needs to conduct due diligence of the security of such technology before widespread implementation ([53]).

VI. CONCLUDING REMARKS

The IRS follows a mandate to enforce U.S. tax law. Its primary activities in carrying out that mandate include tax enforcement and taxpayer service. Technology is a valuable and necessary tool in helping the agency to perform these functions effectively and efficiently, but the maintenance of such technology is costly. This article overviews the IRS' use of computer technology in enforcement and taxpayer service over time from the initial implementation of computer programs in the 1960s to its embrace of data analytics in the 2020s. This study reviews various modernization projects during that time and notes some of the obstacles faced by the agency in modernizing. These obstacles include budget constraints, politicization of the agency and its funding, historically short leadership tenure, risks associated with engaging the private sector, and, finally, taxpayer concerns over the handling of and access to their private data.

Of note, the IRS received supplemental funding related to many of the initiatives described herein as a component of the Inflation Reduction Act of 2022. This bill provides $79.6 billion in supplemental funding to the IRS—that is, in addition to its normal annual appropriations—between 2022 and 2031. The nonpartisan Congressional Research Service (CRS) indicates that the funding will be parceled out according to four key priorities, including taxpayer services ($3.2 billion, about 4 percent), enforcement ($45.6 billion, about 57 percent), operations support ($25.3 billion, about 32 percent), and business systems modernization ($4.8 billion, about 6 percent) ([16]). The results of this funding are yet to be determined, but may well play a significant role in the IRS' capabilities in years to follow.

By Erica L. Neuman

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