Taxing Transformation

he plot is a familiar one in Washington. An agency stumbles, is roundly denounced on Capitol Hill, and new leadership is brought in to attempt a fix. The IRS has added some new wrinkles to the old story in its efforts to modernize the tax system over the past few years. The IRS stumble was larger than most. Estimates are that the agency wasted $3.5 billion between 1990 and 1996 in an attempt to update its data processing systems, a project known as tax systems modernization. Because of the agency's size and notoriety, the systems modernization fiasco garnered an unusual degree of attention on Capitol Hill, culminating in an investigation and special reform legislation.

Most importantly, the nature and extent of the IRS fix set it apart from traditional cleanup efforts. The IRS is approximately two years into an eight- to 10-year effort to fundamentally change how it does business. Traditionally organized along geographic and functional lines, the agency is now divided into four operating divisions. Each one represents a different customer segment: individual taxpayers, small businesses, large corporations and tax-exempt organizations. As of Oct. 1, the former field structure, which featured four regional and 33 district offices, was dismantled. Employees now report up a chain of command in one or another of the new operating divisions: Wage and Investment Income, Small Business/Self-Employed, Large and Mid-Size Business and Government Entities/Tax Exempt. The agency has reduced management layers by half, from 10 to five; restructured managerial jobs; and instituted a system of organizational measures featuring balance among customer satisfaction, employee satisfaction and business results.

The IRS is moving aggressively to meet a congressional requirement that 80 percent of taxpayers file their returns electronically by 2007. The changes hold promise as one of the more significant management achievements in the annals of the executive branch. If outcomes even approximate what agency leaders have planned, the IRS will go from whipping boy to star pupil, from a symbol of bureaucratic incompetence to public service exemplar. But obstacles loom. One concern is that congressional support will wane. Also, observers are worried about whether the internal commitment will be sustained following the eventual departure of IRS commissioner and master strategist Charles Rossotti.

A Perfect Fit

Rossotti is former chairman of the board at American Management Systems, a large, Virginia-based consulting firm that specializes in "transforming large organizations into next generation enterprises." Rossotti's selection as commissioner was a departure from the long-standing tradition of appointing tax lawyers to the top post. The magnitude of the IRS' failures led former Treasury Secretary Robert Rubin to seek a management expert for the top job. Rossotti, one of those queried about prospective candidates, expressed interest in the position and was appointed commissioner in late 1997. With impressive credentials of his own, a network of business and consulting contacts on whom he could call for assistance, and firsthand knowledge of the federal environment from a stint at the Defense Department early in his career, Rossotti was a perfect fit for the job.

In 1997, when Rossotti took charge, the IRS had been traumatized by a series of attacks from Capitol Hill. As a result of the computer modernization fiasco, Congress created the National Commission on Restructuring the Internal Revenue Service. The commission's report, released in June 1997, became the basis for the 1998 IRS Restructuring and Reform Act, which was wending its way through Congress when Rossotti took office. What had been a relatively low-profile legislative item ended up on the front pages of the nation's newspapers and on the television news during Senate Finance Committee hearings in September 1997. At the hearings, a number of people alleged that IRS collection agents and investigators had mistreated them. Then-Deputy Commissioner Michael Dolan publicly apologized on behalf of the agency, pledging an immediate and comprehensive review of all allegations of impropriety. As a direct consequence of the hearings, extensive safeguards for delinquent taxpayers threatened with enforcement action were incorporated into the Restructuring and Reform Act.

After the hearings, it was clear that drastic action was needed at the IRS. Rossotti was willing to provide it. Observers say Rossotti spent six months before assuming office studying the problems at the IRS, talking with experts and writing a 50-page manifesto for change entitled "Modernizing America's Tax Agency." The five levers of change Rossotti identified in that document-creation of customer-based operating divisions, changed managerial roles, use of balanced performance measures, "revamped business practices," and new technology-serve as the basis for the transformation that's under way.

"Modernizing America's Tax Agency" sets forth the scope of the task, saying, "It will require fundamental change in almost all aspects of the IRS." It also issued an implementation challenge, declaring, "This change must take place while the IRS continues to administer a very large, complex and ever-changing tax system." A key step toward meeting that challenge, according to several close observers, was the decision to give management consulting firm Booz-Allen and Hamilton a prominent role. Initially hired to "validate" Rossotti's design concept, Booz-Allen later took on the job of structuring and driving the change process. According to IRS Chief Human Resources Officer Ronald Sanders, Booz-Allen brought "a very effective discipline for getting issues on the table, getting them decided and getting them implemented. That sort of self-discipline is tough to enforce, and that has been one of their principal contributions."

At times, Booz-Allen has assigned as many as 150 people to work with the IRS modernization office to move the project forward and to involve employees. Deputy Commissioner for Modernization John Stocker estimates that about 10,000 IRS employees have worked on one of 16 design teams, assisted with pilot projects or participated in one of the many focus groups. The key decisions are made by the Executive Steering Committee, chaired by Rossotti, which includes approximately 30 top executives and representatives from the Treasury Department and the National Treasury Employees Union, the largest organization representing IRS employees.

The steering committee has provided a forum for Rossotti to exercise what several observers describe as a hands-on leadership style. John Dalrymple, commissioner of the new Wage and Income Division, says that Rossotti "thinks strategically, but he knows you have to get down and get your fingers dirty, roll up your sleeves and know what's going on. He has an innate ability to ferret nuggets of importance out of the bureaucratic morass." Larry Langdon, commissioner of the large and mid-sized business division adds, "he's always looking at what is happening next but he also has the ability . . . to dip down to a level of detail." NTEU President Colleen Kelley, a member of the steering committee, reflects on Rossotti's degree of involvement: "I remember one of the first teams coming in and thinking they would make a presentation and they would leave," she recalls. "[They] didn't get very far [before] Charles had a question because he had read all the pre-read materials; he knew everything that was going on. He was engaged, very engaged, and it didn't matter the division or the issue."

Of even greater importance to Kelley is what she regards as Rossotti's commitment to involving rank-and-file employees in design decisions. "From Day 1 he reached out to NTEU, made it clear that he knew we could help, that he wanted employees involved and that he wanted our help to get employees involved," Kelley says. While the union has long had a partnership agreement with the IRS, Rossotti went beyond the legalities of that agreement in soliciting union participation. According to Kelley, "Normally, when the agency makes a decision, then how it gets implemented is something we partner on. But that's been different in this organization. From the very beginning, there were NTEU members on these teams designing the whole concept."

Rossotti has made a strong impression in the managerial ranks as well. One longtime manager who preferred not to be identified says, "I've never met anybody who was ever exposed to him who didn't appreciate the pure intellect. Most of us don't give off that kind of praise. We just wouldn't say anything. But, you go to a meeting with him, and he grasps it very quickly, he understands it and he's moving to the next place." Former Chief Operations Officer Jim Donelson, now retired partly as a consequence of the changes Rossotti wrought, nonetheless offered the following observation: "You won't get a better individual or manager or a more honest person than Rossotti. He is an outstanding person, he is a brilliant guy, a quick study."

The Carrot vs. the Stick

Rossotti and his lieutenants set out to change not only the structure, but also the operating philosophy of the IRS. A premise of "Modernizing America's Tax Agency" is the need for the IRS to place more emphasis on "pre-filing" activities such as taxpayer assistance and education. According to Rossotti's report, the IRS has traditionally spent about 75 percent of its budget on "post-filing" compliance activities-including the auditing of returns and the collection of delinquent taxes-and less than 10 percent on pre-filing activities.

Rossotti and other members of the leadership team argue that it makes sense to use more of the IRS' limited resources to provide taxpayer assistance early in the process to reduce errors, rather than investing time and energy in costly audit and collection actions to penalize taxpayers for errors after the fact. Dalrymple, commissioner of the Wage and Investment Income Division, explains that "by delivering better service up front, we can save valuable compliance resources for difficult situations. It was a realization that by solving smaller problems before they become big, you save the organization a lot of money and a lot of burden for taxpayers."

For many employees engaged in compliance activities, the shift in emphasis is perceived as a devaluing of that work. The underlying difference in philosophy between this group and agency leadership is over the most effective tool to promote taxpayer compliance. Should it be the carrot of improved education and assistance, or the stick of more audits? Advocates of the stick fear that more taxpayers will be tempted to cheat if word gets out about reduced compliance efforts. They further question the priority on the use of customer satisfaction as a measure of performance. A manager who asked not to be identified says, "If we do a good job of collecting taxes, people get mad at us. I don't see it as a negative. The employees know what they are doing. The people who want to change are amateurs rather than professionals and don't understand our goals here."

A contrary view is offered by Large and Mid-Size Business Division Chief Langdon, who acknowledges that, "The crooks are alive and well," but adds, "there is also a substantial number of taxpayers who want to comply with the laws." Rossotti adds, "Our goal here is to serve the honest taxpayer. It's just that there's more than one way you have to do it. One way you have to do it is by providing whatever services that people who are compliant taxpayers need, because if you don't provide it to them, you're sort of stupid. I mean they're trying to pay you money." At the same time, he notes, "You can't let everybody who doesn't feel like paying get away with it. You have to find a way to do both."

Te 10 Deadly Sins

The importance of the issue has escalated with disclosures that compliance activities dropped dramatically between 1996 and 1999. According to a May 2000 report issued by Treasury's inspector general for tax administration:

• Enforcement revenue ("any tax, penalty, or interest received from a taxpayer as a result of an IRS audit or collection action") is down 13 percent.
• Federal tax liens filed are down 78 percent.
• Levies on delinquent taxpayers' assets such as bank accounts, wages and accounts receivable are down 84 percent.
• Seizures of taxpayer property for nonpayment of taxes are down 98 percent.

The most controversial explanation has to do with Section 1203 of the Restructuring and Reform Act, which identifies 10 categories of employee actions that, if proved, result in automatic termination with appeal only to the commissioner. These have come to be known as the "10 deadly sins." The most controversial of the 10 requires termination if an IRS employee is found to have harassed a taxpayer. According to managers, employees involved in collection activities are concerned that any citizen who doesn't want to pay taxes can allege harassment, thereby prompting an investigation and delaying payment. The provision has induced an attitude of extreme caution on the part of revenue agents and officers. "If you don't follow the law or manual properly, you will be subject to disciplinary action or removal. The only person who can save you from removal is the commissioner," notes Jim Donelson, former chief operations officer, now retired. "That would chill you to the bone if you spent 25 years with the service."

Section 1203 is a target of almost universal condemnation. Mike Murphy, president of the Tax Executives Institute, says, "I don't see any benefit at all but to scare the hell out of employees." Ken McDaniels of the Federal Managers Association says, "1203 shouldn't have become law. That provision has really harmed us as an agency." Rossotti says simply, "We would have preferred to have the ability to deal with that in our own way rather than have it prescribed in the law." He adds, "I think we underestimated the impact of this 1203 . . . we probably did more harm throwing gasoline on what was already a smoldering fire by basically not having a good enough explanation in our initial training of people. That just took something that was kind of a fear and made it a huge fear."

Making the whole issue even more charged for employees involved in compliance was the release of a May 1999 report by the General Accounting Office concluding the allegations of taxpayer abuse made at the Senate Finance Committee hearings in 1997 and 1998 were unfounded. The GAO report has served as justification for those within the agency who don't think a complete overhaul of the organization was warranted.

Bob Wenzel, deputy commissioner for operations, notes that the hearings stimulated almost 7,000 pieces of correspondence, most of which related problems that individual taxpayers have had in dealing with the IRS. Wenzel says that going through the correspondence item by item made clear "the seriousness of problems with our systems and processes and how critical it is that we get the right kind of support to our employees so they can do their jobs well." Many of the complaints arose from incompatible data systems and poor communication among officials in different functional units, problems the current changes are directed at correcting.

Making Managers Compete

Morale problems among middle managers extend beyond disillusionment over Section 1203 and the perception that compliance activities are being given short shrift. As part of the restructuring, executives and managers were required to compete for their jobs. As a basis for selection, approximately 1,600 senior managers and executives applying for jobs in the new structure were asked to provide evidence of their competencies in areas such as leading people, business acumen, leading change and communication. The applications went to panels convened by the new operating division heads. Each panel conducted an extensive process of rating and interviewing the applicants.

"There was a lot of opposition," says Bobbie Kelly, director of the Personnel Policy Division in the Office of Strategic Human Resources. "The attitude of many managers was, 'I'm already a career executive, I've been given tenure. I've already competed. Why do I have to write up my competencies?'" But Wenzel argues that "the jobs in the new IRS are totally different than they were in the old. This is not a rollover of a district director position or a division chief position or a branch chief position. If you look at the new positions, they're different. All the position descriptions were rewritten. To be fair about the process, we needed to open this up and re-compete all the positions."

About 10 percent of the management corps opted to take buyouts rather than compete. Donelson was a member of this group. "I didn't want to go through that process," he says. "They knew what I could do . . . . [I thought that] if I'm not appreciated for who I am and what I've done, perhaps this organization is not the right place for me anymore." Another manager who opted for a buyout says, "I don't disagree with the structure, I'm not an advocate nor opposed. I've been through one too many reorganizations. I have yet to see one that has gone full circle that has been fully stabilized. I don't see this one as any different."

Managers say the competition would have been more traumatic had it not been managed as well as it was. All managers, including those not selected for new posts, were guaranteed jobs without loss of pay and without having to move. A mid-level manager who is staying with the IRS says, "One thing Rossotti did that had a dampening impact [is that] he emphasized over and over that if you do not get picked for this job, you will not be booted out on the street, you will be put in a pool with transition workers. We will find meaningful work for you." Daniels, whose managers' organization has many IRS members, says, "The organization did an exceptional job in making it as fair and stress-free as possible. [Managers] knew they wouldn't lose grade or pay, they could stay in the same geographic location. It is only a question of where they would work."

Employees as Strategic Assets

The job competition was managed by the Office of Strategic Human Resources, a unit that in many ways symbolizes the new values that Rossotti and his team are attempting to introduce. Heading the office is Ronald Sanders, former director of civilian personnel at the Defense Department. Implicit in the creation of the human resources office is the idea that employees should be regarded as strategic assets-an idea that has gained wide currency in the private sector but that has come only lately to government. "I am to people what the [chief financial officer] is on finance and the [chief information officer] is with regard to information," says Sanders. "It is a stewardship rather than a regulatory function."

The new philosophy is perhaps most apparent with regard to training matters. The IRS has dramatically increased its training budget and has encouraged employees to seek advancement and to develop their skills, competencies and careers within the agency. Employees can apply for financial support for training that is mission-related, but not necessarily job-related, from a new $1.6 million human resources investment fund. Employees are being given broad discretion in the types of courses being funded. Almost 4,000 employees applied for assistance under the program, of which about half were funded. The IRS intends to increase the funding level to $2 million for 2001.

An element of the new human resources philosophy is that when it is deemed critical that employees gain new competencies, the agency will provide training at its own expense. For example, the IRS has created a new position, taxpayer resolution representative, which corresponds with a previous position, customer service representative. The new job has a wider scope of responsibilities and requires a higher level of skill. The agency has accordingly imposed a requirement that employees transitioning to these positions either demonstrate competency in accounting or take six hours of accounting training. The IRS has made time and funding available for that training. Sanders cites this as an example of the new strategic orientation. He says that the attitude was, "Don't worry about the precedent, here's what we need to do, let's do it."

Sanders' office is attempting to move the organization to a competency-based human resources system. Such a system provides much greater specificity about the skills required for a position and how those skills are applied. It places greater emphasis on "soft" job elements such as teamwork, cooperation and the ability to communicate.

Traditionally, "even if you had potential for advancing to another job, you didn't know what the competencies [were]," says O'Rourke. "That is the key. Employees and managers will know what the competencies are for successful work in that position. If you are in wage and investment income and decide, 'I would like a job in small business,' you can identify the competencies you will need. Within [the Office of Strategic Human Resources], we can identify a bridge position [and can say], 'you have to get to this position in wage and income before you can cross over to this other position.' "

For managers and executives, competencies now serve as a basis for appraisal and rewards as well as training. For bargaining unit members, however, competencies are being used only to identify training needs. "We have yet to be convinced of the validity of using competencies to determine performance or promotion potential," says NTEU's Kelley. "They haven't convinced us yet that it could be done in a fair and objective way for employees."

Jim White, director of tax policy and administration at GAO, identifies the new performance management system as IRS' most important human resources innovation. "That's where you create incentives that managers and employees will operate under," he says. "In the past, when revenue collection was emphasized, you had perverse results . . . . The hard part is creating a balanced set of measures to [provide incentives for] workers to provide good service and work to ensure compliance." The new system will feature balanced measures with emphasis on employee and customer satisfaction in conjunction with traditional business measures. Measurement is a particularly charged issue for the IRS. The purported abuses identified during the Senate hearings were, to a large extent, blamed on over-reliance on a measurement and reward system that pressured employees to use inappropriate collection tactics. As part of the new balanced measurement system, the agency has instituted regular surveys of both employees and customers.

The most problematic aspect of the new system is that it must simultaneously hold managers accountable for results, while ensuring closure of collection or audit cases. Customer satisfaction or employee satisfaction don't equate to specific performance rankings. Agency leaders are concerned about creating incentives for managers to cut corners in order to score highly and thereby achieve good ratings. Managers have therefore been directed to rate their subordinates on the basis of actions taken rather than results achieved. Now the question is whether managers and their supervisors will tend to revert to a reliance on numbers as a basis for making distinctions among employees and thereby promote inappropriate behaviors.

Turning the Titanic

Despite the vast changes and progress made, Rossotti and his team acknowledge that there is a long way to go. A great concern is that Congress won't sustain its support for the changeover. Compliance and service needs can be jointly addressed only if Congress is forthcoming with additional resources. In the fiscal 2001 budget process to date, however, Congress has been reluctant to provide the level of funding IRS leadership believes is necessary.

Rossotti had requested funding for an additional 2,800 positions to allow restoration of some compliance activities. The initial version of the Treasury appropriations bill included no funds for the additional positions, however, and approval of approximately 2,000 of the 2,800 positions came only after White House intervention. President Clinton vetoed the Treasury appropriations bill for reasons unrelated to the IRS, so at press time the issue was still unresolved. If approved, the 2,000 positions will alleviate short-term pressure, but the shortfall will make it more difficult to resolve the debate about the priority given service over compliance. And to the extent that the dispute signals a waning of congressional support for the transformation, the long-term prospects for obtaining needed funding dim.

IRS leaders also are concerned that Rossotti may not see IRS through the transformation. As part of the 1998 restructuring act, he was granted a five-year term, which ends in 2002. Even if he serves out his term, however, the reorganization will only be about halfway finished when he leaves. Confirmation of the new IRS Oversight Board by the Senate in September was a positive development. Rossotti anticipates that the board "will provide an element of stability and continuity that might not have been available otherwise."

While acknowledging that the IRS is off to a promising start and that leadership has been effective, the GAO's White emphasizes importance of follow-through at middle and lower levels of the organization to a successful outcome. "Does the management structure have the capacity to manage the transition, develop the details of the plans, implement the plans, and manage the new organization?" he asks. Michael Murphy of the Tax Executive's Institute similarly acknowledges the difficulties ahead. "The Titanic has turned, but the challenges remain," he says.

James R. Thompson is an assistant professor of public administration at the University of Illinois-Chicago.