Reducing the sample size would reduce the cost of TCMP audits. IRS' cost estimates for the 1994 TCMP were divided into two types, (1) staffing costs and (2) opportunity costs. Staffing costs reflect IRS' cost estimates for auditors to conduct the TCMP audits. Opportunity costs reflect IRS' estimates of the difference between revenue generated through the regular audit program and revenue generated by TCMP audits. According to IRS officials, TCMP audits generate less revenue because the returns are randomly selected rather than identified by using the DIF Score or as part of a special project and because the returns take longer to audit.

Table 1 shows how the variations in sampling methodology and characteristics change the sample size and cost estimates.

*Included in this sample is a 2 percent subsample of the no-change returns to validate the classification.

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Table 1: Changes to Sample Size and Cost Estimates Based on Changes to Sampling Characteristics
Dollars in millions

Changing the sample characteristics not only reduces the size but affects the usefulness of data from the sample. Each of the changes shown in table 1 has its own set of strengths and weaknesses that relate primarily to reliability and coverage. For example, reducing the sample to businesses only and reducing the precision would provide no information on nonbusiness individuals. Also, this sample would be of little use at the DORA level because it would not provide statistically reliable estimates of compliance below the national level. This sample could, however, provide some information on market segment compliance and be used to update the DIF formula for businesses and the return types where voluntary compliance is the lowest. Also, a business-only approach could be combined with a multiyear sample where the compliance of nonbusiness individual returns is evaluated in a future year. Although we did not fully evaluate the alternatives, the table in appendix I summarizes some of the more obvious trade-offs inherent in the alternatives discussed above.

Deciding how to change the sampling strategy to reduce the sample size would require careful evaluation of the tradeoffs. It seems reasonable, however, to consider that any new sample should, at a minimum, allow some updating of the DIF formulas, since this was to be the primary purpose of the original TCMP. To the extent that other purposes can also be

Long-Term
Compliance
Measurement
Considerations

Using Multiyear TCMP
Audits

Table 2: Example of a Multiyear TCMP
Effort

Because a significant portion of IRS' workload and future revenue depends
on compliance programs, it is important that IRS determine how to
measure compliance. Such measurements are an on-going need for any tax
system that depends on voluntary compliance. It is also important that any
long-term solution to obtaining compliance measurement information
address the issue of sustainability so that long-term consistent
measurement data are available. Sustainability means that the program's
costs, in terms of IRS' budget and perceived burden on the taxpayer, must
be clearly defensible. Additionally, to be efficient and effective, it would be
necessary to design a program that provides timely data and clearly
identifies the objectives and uses of these compliance data.

We identified several alternatives to the traditional TCMP that would meet
some of the data needs that were lost when TCMP was postponed, including
(1) conducting multiyear TCMP audits on smaller samples and combining
the results; (2) using operational audit data; and (3) conducting a mini
TCMP to identify compliance issues, with a more focused TCMP audit on the
identified issues. We discuss these three options below.

The multiyear TCMP alternative envisions annual TCMP-type audits on a smaller sample of tax returns which, over the course of several years, could be combined to obtain the required statistical precision. For example, IRS could disaggregate an entity type, such as individual taxpayers, into separate market segments or audit classes and conduct the audits of each segment on a 3-year cycle. Table 2 below shows an example of how such a program might operate.

Year Type of return audited

Number

23-595 97-21

of returns

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Using Operational Audit
Data

One benefit of such an approach to IRS would be that after the initial 3-year period, new and current data would become available for one of the segments every year, making it easier to fine-tune the compliance system. Such an approach, however, would require considerable effort from IRS' statisticians to ensure that the sample design was statistically sound. Also, it would require a long-term commitment from IRS managers to ensure that returns were audited regularly.

A second option is to use data from operational audits already being done. Using data from operational audits would provide a large amount of compliance data. This option is also probably the most sustainable of the three we discuss because it would be less burdensome on compliant taxpayers and have no marginal staffing and opportunity costs. However, there are weaknesses. IRS currently has no system to track operational audit issues. While such a system is currently being developed, it is not yet operational and testing is not planned to begin until later in 1996. According to IRS officials, this database is to identify audit issues as well as provide codes to identify the causes of noncompliance. Also, IRS officials believe that using a database of operational audit results could not be used for updating the DIF formulas, determining ways to improve voluntary compliance, or systematically identifying emerging audit issues because the audited returns would not be randomly selected.

Using a Mini TCMP

Conclusions

A third option is to periodically conduct a very small TCMP that covers all taxpayers and follow up with mini TCMP audits on specific issues identified as concerns. Using this approach, IRS may be able to reduce the sample size and focus the majority of the audits on less compliant taxpayers, thus reducing cost and taxpayer burden. This approach may also provide IRS with insight into the areas of greatest noncompliance because efforts would be more focused. IRS officials said that this approach, however, would probably not provide sufficient data to update the DIF formulas and may be of little use at DORA sites because too few randomly selected returns would likely be examined.

A significant proportion of IRS' present and future compliance programs have been predicated on the information obtained from TCMP. Benchmarking current compliance, validating the market segment approach, updating return selection formulas, researching noncompliance issues and developing programs to address them, and estimating the tax

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gap all depend on TCMP information. Without updated compliance data, increasing voluntary compliance, as envisioned by IRS, is less likely to

occur.

IRS has options to replace at least some of the data that would have been available from the 1994 TCMP audits. Auditing a smaller sample size by eliminating some return types and accepting a decrease in precision, is a factor in such options. While each of these alternatives has limitations, they would meet some of the data needs that were lost when TCMP was postponed. It is important for IRS to make a decision soon on how to replace TCMP data because it will take some time to implement a replacement, and IRS projects that the currently available 1988 data will be less effective by 1998.

If IRS does not develop a sustainable compliance measurement program,
IRS' compliance programs may be disrupted as the proportion of audits
that result in no-changes increases and IRS' access to information on
emerging compliance issues decreases. In the long term, such disruptions
are likely to result in increased burdens on compliant taxpayers as more of
them are selected for audit.

To provide the data necessary to help meet the objectives of IRS'
compliance strategies, we recommend that you

identify a short-term alternative strategy to minimize the negative effects
of the compliance information that is likely to be lost because TCMP was
postponed, and

develop a cost-effective, long-term strategy to ensure the continued
availability of reliable compliance data.

We requested comments from you on a draft of this report. Responsible IRS officials, including the National Director, Compliance, Research and National Director, Compliance Specialization, provided comments in a February 23, 1996, meeting. These officials agreed with our recommendations and provided some technical comments, which we have incorporated where appropriate. In a March 18, 1996, letter, you restated those agreement and indicated that over the next several months IRS would devote substantial effort to investigating all potential options for capturing reliable compliance information as an alternative to TCMP.