Staff Paper Prepared for the President's Commission to Study Capital Budgeting

June 19, 1998

I. Description of Modernization Project

The IRS is partnering with the private sector to make technology investments in its primary business lines: customer service, compliance, electronic commerce, submission processing, corporate systems, and financial reporting. These investments are predicated on a systems architecture that integrates functional requirements with infrastructure and data security; a project sequencing plan that details the logical systems development roll out and phase out of legacy systems; and business cases that incorporate known outcomes of reengineering, electronic commerce, and redesign of work processes. The Modernization project has an estimated life of 15 years, with completion scheduled in 2013. The first phase of the project is a seven year effort which includes the development of the system infrastructure and several critical centralized applications. Current milestones under the Modernization Blueprint include:

The $323 million provided for in the President's FY 1999 Budget will be used by the prime contractor to undertake building the information technology identified in the Modernization blueprint. Current budget assumptions include additional investments of $323 million in Fiscal Year 2000 and another $323 million in Fiscal Year 2001.

II. Decisionmaking Process

A. History of Modernization Project. The IRS today processes 200 million tax returns annually from individuals and businesses, collects over $1.5 trillion in tax revenue, and provides a broad array of services to millions of taxpayers. To meet its considerable information storage and access requirements, the IRS relies heavily on a wide spectrum of information technology hardware and software, most of it developed in the late 1950's and 1960's. Many of these information systems and databases are now obsolete and are becoming increasingly balky and expensive to maintain, posing significant risks to the integrity of the Nations's tax system. They also limit the ability of the IRS to provide the types of services and information to taxpayers that the American public has come to expect.

The IRS has made a number of attempts over the past two decades to modernize its information systems, but, despite some notable successes in particular areas (e.g., the IRS' TeleFile system which allows taxpayers to file simple tax returns via the telephone), IRS tax processing activities are still largely paper driven, and the process for tracking cases and updating taxpayer accounts with the latest information remains cumbersome. Although certain hardware has been replaced, the overall system design and capability has essentially remained unchanged. Tax return and payment processing systems continue to deteriorate, causing excessive downtime and diminishing productivity. On-line systems for updating taxpayer accounts cannot adequately communicate with each other, and in some cases provide conflicting information. Reasons for the difficulties have been documented by the General Accounting Office and the National Academy of Sciences. These include IRS reliance on an "all or nothing" approach and the inability of IRS to adequately manage an enterprise of this size and complexity. IRS has spent close to $4 billion thus far on its efforts to modernize, with relatively modest results.

B. Current Effort. In 1996, IRS appointed a new Chief Information Officer (CIO) with the express charge of getting Modernization back on track. The CIO immediately began development of a new "Modernization Blueprint" for evolving from today's mix of outdated databases and stand-alone computer systems to a fully integrated, information systems environment. The Modernization Blueprint entails the rebuilding and renewal of virtually all major application systems and computing infrastructure. These include systems that: (1) receive tax data and issue tax refunds; (2) store and access taxpayer account data and case management information; (3) automatically manage and process cases, and resolve accounts; (4) provide research capabilities; and (5) reconcile and report taxpayer and revenue information. The Blueprint includes systems designed to enable and enhance the ability of taxpayers, tax preparers and employers, to file tax returns electronically and submit other forms of electronic information to IRS.

These systems are to be implemented in a series of integrated modules following an incremental process that reflects both IRS business priorities and systems engineering "best practices." It involves extensive use of contractors, and is designed to synchronize with the parallel effort to reprogram and replace existing systems to fix the "Year 2000 bug." It is based on a centralized approach to data processing, with a single master database for tax information, rather than the current distributed tax processing environment, with separate tax databases in each of the 10 IRS tax processing "service centers."

C. Planning/ Management of Modernization Project. In November 1996, the IRS initiated a comprehensive effort to document its current system capabilities and define a unified set of business requirements across all its functional areas, and to develop a "Sequencing Plan" for migrating to the new information systems environment incrementally, in a way that minimizes risk and relies where possible on recently modernized "stand-alone" systems. A contractor was used to develop the technical architecture for Modernization. An internal IRS working group provided oversight of this joint IRS/contractor effort and, with contractor support, validated the results. A Request For Proposals (RFP) was issued in January, based on the results of this effort. The RFP, structured around the "best practices" acquisition strategies outlined in the Federal Acquisition and Streamlining Act of 1994, calls for a single "PRIME" contractor to validate the overall Modernization design and develop a technical solution for the first Phase of the project -- a seven year effort which includes the development of the system infrastructure and several critical centralized applications. The PRIME contractor would be entirely responsible for day-to-day management of the Modernization project. The contract will be awarded this summer and the PRIME contractor will begin work in December 1998. It is a 15-year contract and will be in place through 2013.

A structure is being developed to manage the Modernization investment, based on guidelines contained in the OMB Capital Programming Guide. Efforts are currently underway, with contractor support, to implement a comprehensive System Life Cycle (SLC) process, based on project management processes used by the Department of Defense. The SLC includes detailed processes and procedures for identifying IRS business requirements, justifying and approving investment proposals, tracking the progress of IT investment projects, and evaluating the results during and after the investment project is implemented. These will be applied throughout all of the five Phases (or Releases) of Modernization, spanning more than a decade. Based on the concepts espoused in the Capital Programming Guide, each Phase of Modernization is designed to be "economically separable" from the others, i.e., it can be implemented independently of the other Phases and can be justified economically on its own.

The IRS has an executive level Investment Review Board (IRB), chartered to make investment decisions and monitor spending. It is co-chaired by the CIO and the Chief Financial Officer (CFO), and has representatives from both IRS and Treasury, its parent agency. The IRB is responsible for approving all IT investments. Based on a certification review by the CFO, it recently approved the business case for the first Phase (Phase I) of Modernization. The Phase I business case, developed internally by IRS, with contractor support, is to be validated as part of the PRIME RFP. Based on the business case estimates, Modernization development costs for the first phase total $401 million and operations and maintenance costs total another $308 million.

D. Capital Budgeting for Modernization Project. Historically, Congress has been concerned that IRS was redirecting funding earmarked for Modernization activities to satisfy other agency priorities, and that IRS had included non-Modernization projects within the Modernization umbrella for budgetary purposes. For that reason, Congress and GAO have monitored IRS spending closely and have been extremely sensitive and watchful regarding how IRS funds are allocated and spent on individual IT investments. In addition, IRS has historically been unable to plan its investment program adequately because of its inability to "fully fund" information technology investments up front. Acquisition planning for Modernization requires long lead times whereas acquisition funding has been subject to the vicissitudes of the annual Appropriations process.

In 1998, the Administration requested, and Congress approved, a special, dedicated "Information Technology Investment (ITI)" Account to fund IRS Modernization which addresses many of these issues. The ITI Account will fund only Modernization activities, and will include funding for the PRIME contractor, as well as internal IRS costs (including ancillary business costs). It includes both development funding and operations and maintenance funding for Modernization, as well as funding for interim investment projects that will be required during the transitional phase leading to full Modernization. Costs for these interim projects are not included in the Modernization business case. The ITI Account is also partitioned into sub-accounts which distinguish appropriated funding, which must be obligated within a given time frame (multi-year), and funding which is not tied to specific fiscal years (no-year).

Despite the greater fiscal flexibility provided by the ITI Account structure, IRS will need to continue to work with OMB and Congress to ensure that the amounts in the ITI Account reflect actual Modernization funding requirements. The Modernization Phase I Business Case estimates were developed after the Fiscal Year 1999 Budget was submitted and therefore some variance exists between the ITI plan and the Business Case estimates. In addition, the PRIME contractor estimates for Modernization may not agree with the IRS estimates or the ITI budget authority.

III. Specific Factors

A. Linkage to Strategic and Long-Term Planning. Modernization is key to IRS' strategic and long-term planning, as without selected investments in key information systems, IRS' dated information infrastructure will cease to provide for the agency's operational needs.

B. Biases For or Against Program Compared to Other Agency Priorities. Until the development of the May 1997 Modernization Blueprint, IRS' modernization efforts have not been well executed. Funds appropriated for modernization sometimes have been used to satisfy other IRS needs and priorities.

C. Full Funding. Seeking full funding up front for the modernization effort is unnecessary as the staged implementation approach provides for development and roll-out of key project segments over the entire life of the project.

D. Spikes or Lumpiness. Funding lumpy capital investments is a challenge under current discretionary budget ceilings. However, staging investments by meaningful project segment can mitigate against some of the lumpiness associated with this program.

E. Benefit/Cost Analysis. Benefit/cost analysis is an integral part of the plan for investment decisions. A preliminary cost/benefit analysis has been completed for Phase I of the modernization effort. However, this analysis is preliminary and will be validated by the prime contractor.

President's Commission to Study Capital Budgeting