United States. Congress. Senate. Committee on Gove.

Financial problems : are the agencies getting better? : hearing before the Committee on Governmental Affairs, United States Senate, One Hundred Third Congress, second session, July 28, 1994 online

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dures, and aggressively pursued collection of old receivables. According to Cus-
toms, this effort resulted in collections of about $32 million.

— Customs conducted the first nationwide physical inventory of its seized assets,
which include firearms, thousands of pounds of illegal narcotics, millions of dol-
lars in cash, and various types of other goods. It also evaluated the adequacy
of physical safeguards over these assets, constructed needed facilities in two dis-
tricts, and developed plans for renovating other facilities.

— IRS and Customs conducted physical inventories of their fixed assets, which will
provide better accountability over these assets and help ensure that they are
used effectively. In addition, Customs initiated monthly reconciliations between
its accounting records and its logistical records that identify where fixed assets
are located.

— IRS implemented a new integrated accounting and budget system agencywide
to provide critical supporting information for its administrative expenditures,
which was not available for our fiscal year 1992 audit. Also, IRS provided criti-
cal supporting information for revenue transactions, such as tax returns, cash
receipts, and refunds, which was not available for our fiscal year 1992 audit.



Progress was achieved, in large part, because IRS and Customs demonstrated a
sincere commitment towards developing reliable information. We met frequently
with key financial management officials at both agencies. Also, the Commissioner
of Customs met with us monthly to obtain prompt advice on how to correct prob-

However, despite these efforts, unresolved serious deficiencies in the supporting
information and in the systems that produce this information precluded us from pro-
viding opinions on IRS' and Customs financial statements for fiscal year 1993. ' For
example, for fiscal year 1993, we could not audit several important account balances
because supporting information was not available. Also, neither IRS nor Customs
had instituted adequate controls to safeguard assets, determine compliance with
pertinent laws and regulations, or assure that there were no material
misstatements in their financial statements.

Although efforts are under way to address almost all of the recommendations re-
sulting from our audits of IRS' and Customs' fiscal year 1992 statements, few have
been completed. As of May 1994, 4 of the 44 recommendations we made to IRS had
been completed, and actions were either in progress or planned for 38. At Customs,
11 of the 54 recommendations we made had Deen completed, and actions were either
in progress or planned for 38.

The most significant deficiencies are common to both agencies and seriously im-
pair their ability effectively to carry out their missions and reliably report on their
operations. Specifically, neither agency has instituted procedures to adequately en-
sure that

— all revenues due to the federal government are identified so that collection can
be pursued;

— errors in taxpayer and import information are detected and refunds of taxes and
duties are appropriate;

— seized assets, including illegal drugs seized by Customs agents, are accounted
for and protected from theft;

— appropriated funds are spent in accordance with applicable laws and accurately
accounted for; and

— sensitive computerized information, such as taxpayer records, import inspection
criteria, and law enforcement data, is protected from unauthorized access, dis-
closure, or modification.

These significant deficiencies require prompt attention. Many of them can be re-
solved quickly through (1) improved guidance and oversight to ensure that agency
staff understand and comply with existing procedures, such as properly performing
fundamental reconciliations and supervising and approving routine transactions, (2)
implementation of additional controls, such as new procedures for reconciliations
and approvals, and (3) proper analysis of data to be included in reported financial
management information. Other improvements, such as obtaining more useful infor-
mation on unreported taxes, will require longer term system changes.

IRS and Customs have developed many actions that can be implemented rel-
atively quickly. While we believe that these actions are appropriately focused, it is
important that they be implemented promptly and that IRS and Customs take steps
to ensure that the related problems do not recur. Further, we believe that there are
additional actions that can be taken in the short term, such as minor enhancements
to existing systems to mitigate some problems until broader system improvement
efforts are complete.

I would now like to outline the major deficiencies that we identified, the actions
that IRS and Customs plan to take, and additional short-term corrective measures

Better Information Needed to Collect
Unreported Taxes and Duties

At both IRS and Customs, we were able to confirm that the total reported reve-
nues for fiscal year 1993 were collected and deposited into Treasury accounts. How-
ever, neither agency was able to reliably determine the amount of revenue that
should have been assessed.

Customs' programs for monitoring goods entering the United States did not pro-
vide reasonable assurance that carriers, importers, and their agents complied with
trade laws. As a result, revenue owed to the federal government may not have been

1 Our audit results and the status of our recommendations are discussed in detail in our re-
ports entitled Financial Audit: Examination of IRS' Fiscal Year 1993 Financial Statements
(GAO/AIMD-94-120, June 15, 1994) and Financial Audit: Examination of Customs' Fiscal Year
1993 Financial Statements (GAO/AIMD-94-119, June 15, 1994).


identified and quotas and other legal restrictions may have been violated. Moreover,
important trade statistics may not be reliable.

Customs does not yet have a means to reliably measure overall compliance with
trade laws. As it did in fiscal year 1992, Customs focused its fiscal year 1993 inspec-
tion efforts on high-risk shipments in an effort to release low-risk shipments as ex-
peditiously as possible. Consequently, most shipments were not inspected at all —
according to Customs, about 92 percent of imported cargo was released without ex-
amination during fiscal year 1993. And, because the shipments selected for inspec-
tion were not a representative sample of all shipments, the results of the related
inspections could not be used to estimate the overall effectiveness of efforts to en-
sure compliance with trade laws.

To reliably measure the level of compliance with trade laws, including payment
of duties, Customs has, within a relatively short period, designed and set in motion
a program of inspecting statistically valid random samples of imported goods and
related import documents. In 1993, these tests covered relatively few commodities —
five types of goods — and were limited to 45-60 day periods at selected ports. There-
fore, the results cannot be used to estimate overall compliance for that year. How-
ever, Customs expanded the scope of the program during fiscal year 1994, and, for
fiscal year 1995, Customs plans to begin nationwide, year-long tests of all major cat-
egories of goods. If conducted properly, these tests should allow Customs to reliably
estimate compliance levels and the amount of duties owed that is not being assessed
for fiscal year 1995.

Similarly, IRS needs more meaningful and useful information for determining the
amount of unreported taxes, referred to as the tax gap. For 1992, IRS reported an
estimated $127 billion in unreported taxes. However, this estimate is based pri-
marily on information obtained in 1982 — data that are too old to be meaningful con-
sidering changes in tax laws, economic conditions, and the composition of the tax-
payer population. Also, the information used for tax gap estimates is limited to in-
come taxes and does not include other taxes such as excise, employment, and gift

IRS recognizes its need for better information about noncompliant and delinquent
taxpayers. It has planned a comprehensive audit program of randomly selected tax-
payers to be performed in 1996, piloted models to estimate noncompliance for tax-
payers in specific groups and geographic areas, piloted an audit program focused on
specific noncompliant industry segments, and has begun to develop a system to as-
sess the collectibility of accounts receivable. Additionally, IRS has developed a long-
term strategic plan to increase compliance. However, these actions will not be fully
implemented for several years and will not be effective unless IRS begins to capture
reliable data. Developing reliable information requires major changes in IRS sys-
tems, which were not designed to provide the management information needed to
evaluate revenue-collection activities.

Improved Controls Needed to Ensure Accuracy of Taxpayer and
Import Information and That Refunds Are Proper

At both IRS and Customs, we identified control weaknesses that impaired their
ability to reasonably ensure that all revenues due were assessed and collected and
that refunds were appropriate. Also, we identified weaknesses in IRS' ability to
properly account for tax payments received. The most serious problems at IRS were
as follows:

— Controls over federal tax deposit (FTD) payments by businesses, the source of
most of the government's tax revenues, did not ensure that these payments
were properly applied to the appropriate taxpayer accounts. These errors are
causea both by taxpayers and by IRS. In fiscal year 1993, IRS corrected about
2 million misapplied FTD payments totaling $30 billion.

Our sample of 4,206 transactions contained 738 FTD payments, 124, or 17
percent, of which were applied to the wrong taxpayer accounts or periods, prin-
cipally due to taxpayer error. Although all but one were detected and corrected
by IRS, such errors can result in late and misapplied payments, inaccurate dis-
tribution of funds, unnecessary taxpayer contact, and time-consuming resolution
efforts. This is because significant delays often occur between the time FTD
payments are initially recorded and related errors are discovered.

IRS is exploring ways to better identify improperly applied payments, which
will likely require significant systems changes. In the interim, IRS should con-
sider revising the FTD process to capture more complete data on payments at
the time they are made.

— IRS did not have adequate procedures to effectively identify erroneous or fraud-
ulent claims for earned income credits (EICs). In fiscal year 1993, IRS granted
over $9.4 billion under this program. Of the 109 cases in our sample of tax re-


turns with EIC claims, 28 percent contained data that were either inconsistent,
incomplete, or inaccurate. IRS estimates that as much as 25 percent of EICs
filed in fiscal year 1994 will be improper due to taxpayer error or fraud. IRS
was aware of this problem and recently implemented procedures at each service
center to manually review all tax returns with EIC claims to identify potentially
erroneous or fraudulent claims, until longer term systems changes can be imple-

— IRS views electronic filing as a cornerstone of its future operations. However,
as we testified before this Committee on July 19, 1994, 2 IRS has not yet imple-
mented adequate procedures to detect electronic filing fraud. The growth rate
of detected fraudulent electronically filed returns is high, but it is unclear how
much of the growth is due to an increase in fraudulent activity rather than an
improvement in fraud detection. IRS has implemented several short-term meas-
ures designed to prevent refunds to fraudulent electronic filers. These include
restrictions on first-time filers and verification of taxpayers' names and social
security numbers before accepting their returns.

— As in fiscal year 1992, IRS continued to improperly and inconsistently calculate
interest on taxpayer accounts not subject to automatic calculation, which is re-
ferred to as restricted interest. These errors result in underassessment or
overassessment of interest and unnecessary contacts with taxpayers. Of the 45
restricted interest transactions in our sample, 16, or 36 percent, were improp-
erly calculated, with errors of up to $2.3 million. IRS was aware of this problem
as early as 1986 and has proposed solutions, such as developing standardized
personal computer software for calculating restricted interest, identifying areas
in which IRS could suggest simplification of existing and proposed legislation,
and improving available guidance and training. However, such solutions have
not been fully and effectively implemented. It is important that IRS promptly
implement solutions.

— Refunds, especially manually processed refunds, were not adequately controlled.
For instance, IRS sent a manual refund for over $2.3 million that incorrectly
included approximately $400,000 because IRS entered the interest amount in-
correctly. In another example, IRS erroneously issued duplicate refunds: a man-
ual refund of over $1 million, which included interest owed to the taxpayer, and
an automated refund of $465,995, which did not. In both cases, the errors were
identified by the refund recipient, who then notified IRS and returned the ex-
cess funds.

In addition, of the 118 refunds and credits greater than $1 million included
in our sample, 113, or 96 percent, were authorized by IRS without proper notifi-
cation of the Joint Committee on Taxation, as required by law. By implement-
ing appropriate procedures and controls, such as supervisory reviews, to ensure
that manual refunds are accurate and that the Joint Committee on Taxation
is notified, these problems can largely be eliminated without significant systems

— Due to limitations in IRS' matching of information reported on tax returns by
taxpayers and information provided by third parties, IRS is not identifying
many erroneous or fraudulent tax returns and is experiencing significant delays
in identifying others. Such matching does not occur until over a year after re-
turns are processed. Delays in matching diminish the likelihood that IRS will
fully collect any amounts identified as owed by the taxpayers. IRS officials say
that they plan to develop new procedures that will allow earlier matching as
part of Tax System Modernization (TSM).

At Customs, we found weaknesses in the agency's ability to ensure that all im-
ported goods were declared on import documents and that only those goods ap-
proved for release were entered into U.S. commerce. Our specific findings are de-
scribed below.

— Customs has no agencywide requirements for observing the unloading of car-
riers and determining that related documents provided to Customs are com-
plete. As a result, Customs did not have reasonable assurance that it was aware
of all goods arriving at ports of entry and entering U.S. commerce. As a short-
term measure, during fiscal year 1994, Customs began testing manifest com-
pleteness by observing the unloading of randomly selected shipments. Customs
has stated that it plans to perform such tests on a nationwide basis during fis-
cal year 1995. These tests will help determine if any further actions are needed.

2 IRS Automation: Controlling Electronic Filing Fraud and Improper Access to Taxpayer Data
(GAO/T-AIMD/GGD-94-183, July 19, 1994.)


— Customs was not taking advantage of its Automated Manifest System to mon-
itor the release of goods arriving at ports of entry. Of the 88 shipments we re-
viewed, 26 had not been properly accounted for in this system, and, as a result,
Customs could not readily determine whether these shipments had been re-
leased. Customs' compliance measurement tests during fiscal year 1995 should
help determine the severity of this problem. In the interim, Customs said that
it planned to remind all of its regions to promptly investigate and resolve ap-
parent discrepancies in the Automated Manifest System.
— Customs did not adequately monitor the goods that were moved to other ports
prior to their release or export. Under federal law, importers may transport
merchandise (1) from the initial U.S. port of entry to another port prior to pay-
ing duties and taxes or (2) through the United States for exportation to another
foreign country without the payment of duty. However, Customs personnel did
not consistently record departure and arrival data and investigate overdue ship-
ments of such transferred goods, which are referred to as in-bond transfers.

At the close of our review, Customs was planning compliance measurement
tests for fiscal year 1995 that would help determine the level of violations that
actually occur for in-bond transfers. Also, an In-Bond Task Force had been ap-
pointed and was considering changes to the processing of in-bond transfers.
Such changes, including consideration of modifications to legal provisions that
allow in-bond transfers, may be appropriate since the cost of monitoring them
and the risk of violations are likely to grow as international trade increases.

In the interim, we believe it is important for Customs to promptly implement
our recommendation to (1) distribute written guidance emphasizing to district
offices the importance of maintaining accurate data on in-bond shipments and
resolving discrepancies and (2) monitor the districts to ensure they comply with
related policies.
— Customs cannot reliably detect and prevent duplicate and excessive refunds of
duties, referred to as drawbacks, because its automated system could not link
drawback claims to related import entries or maintain a cumulative record of
the amount of duty refunded and goods exported or destroyed for each entry.
As a result, Customs processed about 49,000 drawback claims, totaling approxi-
mately $482 million, during fiscal year 1993 using manual procedures that were
ineffective because of the volume of transactions involved. These deficiencies in
Customs' accounting for drawback payments precluded us from determining if
all such payments made during fiscal year 1993 were appropriate.

Customs has acknowledged weaknesses in controls over drawback payments
but delayed action to correct them until passage of the Customs Modernization
and Informed Compliance Act in late 1993, which included changes to the draw-
back law. Customs plans to design new automated capabilities to address con-
trol weaknesses, but the improved systems are not expected to be implemented
until after fiscal year 1995. In the interim, Customs plans to implement, by the
end of fiscal year 1994, our recommendation to require use of representative
sampling procedures for reviewing drawbacks that involve too many trans-
actions to review completely.

Controls Over Seized Assets Were Weak

Neither IRS nor Customs had implemented adequate controls to account for the
assets they had seized as part of their enforcement efforts. However, IRS and Cus-
toms took important steps toward gaining such control. Customs conducted its first-
ever physical inventory of seized asset inventories, while IRS reconciled its detailed
records to the amounts reported in its financial statements. Controlling Customs'
seizures is especially important because of the thousands of pounds of illegal narcot-
ics and other contraband that Customs confiscates each year, in addition to millions
of dollars in cash.

Customs' inventory of seized assets was conducted by approximately 200 Customs
employees at over 100 storage facilities located throughout the United States. Al-
though it was not performed until February 1994, it was intended to establish an
accurate baseline for monitoring and reporting seizure activity from that date for-
ward. As a result of the inventory, Customs was able to identify and correct many
significant errors in the recorded quantities and values of seized property. For ex-
ample, the records showed 51,600 pounds of cocaine and 65,800 pounds of marijuana
that could not initially be located. Labor-intensive procedures, involving the review
of over 100 case files, resulted in all but 86 pounds of drugs being accounted for
by Customs as having been destroyed or transferred to another agency or to a dif-
ferent Customs location prior to the inventory date. In several cases, we found that
the transfers were made more than 2 years ago, but the related records had not
been updated.


Conversely, the inventory showed that thousands of pounds of drugs held had not
been recorded in the inventory records. It is important that all discrepancies be
identified and corrected since they increase the risk that drugs could be lost or sto-
len without detection.

The inventory also identified counterfeit items and items prohibited for sale in the
United States that were recorded at a total value of over $20 million, even though
they have no resale value to the government. In addition, items valued at over $27
million were incorrectly included in the inventory records even though the items
were no longer in Customs' possession. Other items were overvalued by $15.7 mil-
lion because the values had not been adjusted when accurate assessments became

Now that Customs has taken the initial step of improving the reliability of its
seized asset records as of February 1994, it is essential that it develop and imple-
ment procedures to keep these records accurate and current. In this regard, Cus-
toms has stated that it plans monthly reconciliations of its seized asset inventory
records and plans an end-of-year inventory in September 1994. In addition, because
some locations did not effectively perform the inventory procedures designed to en-
sure that values were properly updated and that counterfeit or prohibited items
were not assigned a value, Customs needs to direct all locations to ensure that valu-
ations are properly adjusted prior to September 1994.

Customs also needs to continue strengthening security at many of its facilities
that store seized assets. For fiscal year 1993, despite improvements, we still identi-
fied physical safeguard weaknesses at 20 of the 21 facilities we visited. As of the
February 1994 inventory date, the 15 districts we visited held an average of 24,000
pounds of drugs that required safeguarding from theft and misuse. Over the past
several years, drugs and property have occasionally been stolen from Customs stor-
age facilities. For example, in fiscal year 1993, thieves broke into one facility and
stole 356 pounds of cocaine. This case illustrates the risks associated with Customs'
practice of storing large quantities of narcotics in facilities that do not provide ade-
quate security.

Also, we found that drugs used in undercover operations were sometimes lost due
to inadequate surveillance procedures and that losses from undercover operations
were not routinely accounted for and reported. For example, one region did not prop-
erly account for a 660-pound cocaine seizure that was being used in an undercover
operation, half of which was subsequently lost. By reviewing the enforcement case
file, we found that, although the seizure had originally been entered, it was subse-
quently deleted and then re-entered under a different seizure number, giving the
appearance that the two entries were not related. This case is currently under
grand jury investigation. In another undercover operation, Customs lost 220 pounds
of cocaine that was not accounted for in Customs' seizures records at all. This case
is currently being investigated by Treasury's Inspector General.

We also found that cash advances to undercover operations were not reliably ac-
counted for primarily because related transactions were not promptly recorded. Fur-
ther, in three of the eight undercover operations we tested, some amounts of drugs
or currency were not reliably accounted for. For example, we found that up to 631
pounds of high-purity cocaine had been held in a safe for one undercover operation
for a period of 8 months but had not been reported in Customs' accounting records.

To address problems related to its undercover operations. Customs said that it
has recently established a task force comprised of experts inside and outside the
government. Customs plans to defer corrective actions until the task force finishes
its work in September 1994.

At IRS, we were unable to audit amounts reported for seized assets because the
agency could not provide reliable detailed records that supported its reported bal-

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Online LibraryUnited States. Congress. Senate. Committee on GoveFinancial problems : are the agencies getting better? : hearing before the Committee on Governmental Affairs, United States Senate, One Hundred Third Congress, second session, July 28, 1994 → online text (page 8 of 18)