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How We Transformed the IRS

 
3/7/2005
Dealing with the Internal Revenue Service is no fun, but it used to be even worse. Here's how former commissioner Charles O. Rossotti braved the ultimate management challenge. A book excerpt and Q&A.

April 15th is a date most Americans approach with fear and dread or at best tolerance and weary resignation. Let's face it—it will never be a pleasure to file taxes. But dealing with the Internal Revenue Service has gotten better since Charles O. Rossotti paid his dues.

Before Rossotti (HBS MBA '64) agreed to lead the IRS as commissioner from 1997 to 2002, he was successful in the private sector as co-founder, CEO, and chairman of American Management Systems (AMS). So at the IRS he faced a daunting task: Reinvent a despised organization. Public confidence in the IRS hovered at historic lows. Internally, the IRS was plagued by rock-bottom morale, an outmoded organizational structure, and decades-old technology.

Rossotti describes how he managed and survived in his new book, Many Unhappy Returns: One Man's Quest to Turn Around the Most Unpopular Organization in America. In the following Q&A, Rossotti details the management obstacles he encountered and his methods for solving some seemingly intractable problems. Writes Rossotti of the turnaround, "What made our program work was that there were enough people inside and outside the IRS who knew the IRS had to change, and who had the courage, skill, and dedication to the public good to commit themselves to making the change happen."

Today Rossotti is a senior advisor for the Carlyle Group in Washington, D.C.

Ann Cullen: Why did you write this book?

Charles Rossotti: I hoped that anyone charged with leading large-scale, meaningful change could benefit from my experience.

Many Unhappy Returns is a way for me to share my insights with readers, but it's also more than that. It's a way for me to state my deep conviction that any organization, even a tax collection agency, can serve its stakeholders at higher levels than it ever imagined—if its leaders resolutely and passionately set out to do so.

However, the story isn't over. Performance in any organization is ultimately limited by external constraints. In the case of the IRS, the two main limiters of performance are the tax code itself and the resources it is provided in its budget. It's time for all parts of this problem to be addressed before the cost to honest taxpayers becomes unbearable. And I wanted to use the book as well to make that case to the public.

Q: Your tenure at the IRS brought fundamental change to the way the IRS works. In a nutshell, what did you change and how did you change it?

A: The IRS is now running more like at twenty-first-century business than a 1950's style business. Here was this enormous and critical government agency struggling in the 1990s because it was laboring under a 1950s organization structure and business practices, and 1960s technology.

Eventually, we could replace "management" with real people relationships.

The result was that taxpayers were spending more time and money, and suffering more frustration dealing with the IRS than they needed to, and eventually the complaints became loud and clear. The IRS's obsolete compliance strategies made it seem like the IRS was picking on the little guy while letting the upper brackets get away with cutting corners.

Internally, we implemented a top-to-bottom reorganization, and began to bring business practices and technology up to date. We also implemented new strategies for service to taxpayers and for enforcing compliance. We upgraded traditional services on the telephones and in local offices, and offered new electronic services for filing, paying, and getting information. Speaking of which, I hope everyone is e-filing this year.

And America's taxpayers responded positively. In 2001, I chuckled at a story in USA Today reporting on a customer satisfaction survey which said that customers gave a higher rating to the IRS than to McDonald's. It wasn't that people like paying taxes more than eating a Big Mac: It was just that the IRS was doing a better job at dealing with taxpayers the way they expected to be dealt with—and that's what service is all about: meeting people's reasonable expectations.

You asked, too, about the IRS's employees. I can't say enough about them. Almost the entire initial change was accomplished by IRS front-line employees getting the message and taking their own steps to do whatever they could to do a better job for taxpayers. Later on we worked to give them better tools and training. We communicated honestly and openly with them. And morale went up. By early 2003 IRS employee "engagement" ranked in the 61st percentile in Gallup's database of all public sector organizations, up from the 44th percentile two years earlier.

Q: In your book, you write about how "relationships of distrust" were pervasive in the IRS you inherited. How did you turn these around?

A: The IRS situation was completely at odds with what I had learned in my parents' businesses long ago and had applied in my twenty-eight years with AMS: Relationships are the cornerstones of success. At the IRS we had relationships of distrust. And they were the root cause of many failures.

We tried to turn around this accumulated distrust. Of course, we couldn't immediately solve all problems and stop things from going wrong. But I could personally work on building direct, trusting relationships with a circle of people who were most important to the functioning of the IRS. Over time we could expand this circle by setting up the IRS so that more and more of IRS management built more and more direct, trusting relationships with people inside and outside the agency. Eventually, we could replace "management" with real people relationships.

Throughout the change program, I also established a policy of "engage and then decide" rather than "decide and then explain" with stakeholders, including dozens of groups representing taxpayers and employees, congressional committees, and oversight bodies. Although this policy has its costs and risks, most of the time it worked.

Q: You describe how performance measures in the past at the IRS had been too focused on enforcement revenues. How did you change the performance measures?

A: The power of performance measures is vastly underestimated. They have an enormous capacity to change an organization—for better or for worse. And for decades, one of the most powerful influences on the IRS's behavior was its practice of judging people's performance by using narrow, unbalanced, and frequently perverse—but easily gathered—statistics that focused almost entirely on revenue coming from audit assessments and property seizures.

Simply grafting new technology onto obsolete business practices would not work.

I believed that developing a more balanced set of measurements, one that included feedback from taxpayers and employees as well as measures of meaningful business results, not just measurements that were easy to count, was a critical step in changing attitudes.

And adopting measurements that are roughly right rather than precisely wrong was a difficult but essential part of changing the IRS, and is usually a crucial element in changing any substantial organization.

Let me make one last point. One of the hardest parts of raising the performance of any organization, including the IRS, is getting people inside and outside the organization to buy into the crucial idea that top-performing organizations don't accept the obsolete and fatally flawed either/or model of doing business. The perfect example is the notion that a company must choose between serving its customers well or making a profit. Insisting on the bedrock principle of raising performance across the board was the most fundamental part of what I tried to do at the IRS. It's the essence of successful change.

Q: Customer service was a key issue for improvement when you came to the IRS. How did you handle the magnitude of this operational issue, since every citizen of the U.S. is your customer? When you have a customer base that large, can you apply the same strategy that would be applied in the private sector?

A: America's taxpayers were indeed getting bad service. In one year, taxpayers calling the IRS in response to dunning letters got 400 million busy signals. And to make matters worse, most of them were customers of other organizations that provided world-class customer service, so they had ample room for comparison and ample reason to complain.

I believed that the most important step was to make a deep and lasting commitment to providing quality service. There were no quick fixes or silver bullets. The IRS would have to undertake the same long-term, painstaking process followed by other companies that have achieved quality customer service: understanding customer needs; setting out clear goals; organizing, motivating, and training employees; revamping plans and procedures; upgrading technology; measuring results; and learning from successes and failures.

However, before we began such an ambitious undertaking, we had to make some tangible improvements in service to taxpayers. Without visible evidence that the IRS actually was changing, the rest of our longer-term plans would lack credibility. So we extended the hours of telephone service and gave our customer service reps better desk guides. And as I mentioned earlier, taxpayers responded positively.

But at that point we were still tinkering at the margins of change. I concluded that changing the IRS structure so that its primary focus was on understanding and serving taxpayers would be one of the most powerful and lasting changes we could make to drive improved performance. And the IRS could draw from proven models for managing diverse customers and products.

Just as many large financial institutions have different divisions that serve retail customers, small to medium business customers, and large multinational business customers, the taxpayer base fell rather naturally into similar groups. Therefore it was logical to organize the IRS into four units, each charged with end-to-end responsibility for serving a particular group of taxpayers with similar needs.

Looking back, I think it's fair to say that the IRS successfully copied many of the things that well-run, big companies do. It's an objective that's often articulated but not often implemented in government. That's why I think most of the lessons learned from the IRS experience are useful for any public or private organization that faces a need to change in the wake of a crisis. And it's one reason that I wrote the book.

Q: Despite antiquated IT systems and widespread calls for their modernization, you took the stance of focusing on improving managerial and organizational issues first before overhauling the computer systems. Why did you approach the situation this way?

A: Simply grafting new technology onto obsolete business practices would not work. But that's what had been happening at the IRS. It was one of the root causes behind a previous multibillion-dollar computer modernization program that crashed and burned.

No matter how well the IRS performs, the tax code and the resources provided create a limit as to how well it can serve taxpayers.

And one of the main reasons I was recruited for the IRS job was my background in technology. But in any information-intensive enterprise, technology simply codifies its organization, practices, and strategies. A critical decision in any change program is assessing how these basic structural elements need to change to reflect current business objectives, best practices in similar organizations, and especially customers' current needs and characteristics.

I believe it's also critical to recognize that relatively large-scale business systems modernization programs almost always involve changing business as well as technology. It's changing the way people work and often the way they work with customers.

At the IRS, all of the structural elements, not just technology, were seriously out of date. A long-term, comprehensive program to modernize all of them was essential. I concluded that any attempt to change technology in isolation would be bound to fail, as would a program only of quick fixes. Indeed, I slowed down for a whole year the actual work on a huge new computer modernization program until we had our arms around the new customer-focused organizational structure.

Q: What's your advice to a business person who wants to "give back" as you did by going from the private to the public sector?

A: Have patience and leave your ego at home.

Seriously, I wholeheartedly encourage any business person to do so, but go in with your eyes wide open. And, in fact, more than thirty business executives from outside the government came into the IRS as part of the team while I was there.

As I left the government and returned to private business, I got questions such as, "Was it worth it?" and, "Did you enjoy it?" I didn't enjoy it like a day at the beach. But it was worth it because I believe that I was able to do what I came to do, to set the IRS on a course to perform better for taxpayers.

However, leading a government agency has important differences from running a corporation. For example, when I talked to business friends about my job at the IRS, they were always surprised when I said that the most intractable part of my job, by far, was dealing with the IRS budget. The reaction was usually: "Why should that be a problem? If you need a little money to bring in a lot of money, why wouldn't you be able to get it?" Unfortunately, business logic does not always carry the day.

As compared with the private sector, it was also a little harder to get change done in a setting where my every move was scrutinized. It was managing in a fish bowl. During my five-year term, I testified before Congress forty-eight times, answered criticism from 900 public audit reports, and [was the subject of] countless press stories.

But there are some real plusses that I hope they will discover as I did. What made our program work was that there were enough people inside and outside the IRS who knew the IRS had to change, and who had the courage, skill, and dedication to the public good to commit themselves to making the change happen. I will be forever grateful to them, and one of the great things about writing the book was the opportunity to thank them publicly.

Q: April 15th is close upon us. Has your time as commissioner changed how you view your personal tax obligations as a U.S. citizen? How do you see the IRS as an organization today?

A: To your first question, absolutely. Seen through the prism of IRS commissioner, I have a far greater understanding and sympathy for what honest taxpayers must go through to comply with a complex tax code that's not just burdensome and unintelligible, but is so corrosive that it's eroding the foundations of our tax administration system. No matter how well the IRS performs, the tax code and the resources provided create a limit as to how well it can serve taxpayers.

And how do I see the IRS today? In a very positive light. Government agencies don't have a profit and loss statement, but as the IRS emerged from the first few years of its massive change program, performance began to improve. Anecdotal and quantitative measures showed this improvement in nearly all of its activities, and these trends continued into 2003 and early 2004. Most importantly, public confidence in the IRS rebounded from the historic lows of the 1990s.

Now, no one claims all the IRS's problems are solved. Certainly, I don't. There's still a lot of work to make the IRS work better in all parts of its mission, whether it's improving customer service or enforcing compliance. But a very important difference is that managers, employees, and taxpayers are expecting this performance to continue to improve, because they have seen that it can.

[ Buy this book ]

Ann Cullen is a business information librarian at Baker Library, Harvard Business School, with a specialty in finance.

Many Unhappy Returns

When newspaper editorials or political commentators occasionally criticize Congress for foolishly failing to provide enough money for the IRS to keep the tax system operating fairly and efficiently, members of Congress often react angrily, pointing out that they have "fully funded" the administration's budget requests. If the IRS couldn't do its job, they would say, it wasn't because Congress didn't provide the money requested.

And the numbers bore out this statement. For a few years in the mid-1990s, when Congress and the public were complaining about IRS management failures, Congress did appropriate significantly less than what was requested. But since 1998, Congress cumulatively passed more than 99 percent of the amount requested for the IRS. In 2002, in an almost unprecedented act, Congress actually passed slightly more money for the IRS than the president requested. If Congress was largely passing the IRS budget request, where then was the problem?

In the White House.

For five years, under two very different presidential administrations—one Democratic, the other Republican—I watched the process of deciding on how much IRS funding would be included in the president's budget work in the same, nearly mindless, way.

Every president wants to present a budget that appears fiscally responsible by holding the percentage increase in overall government spending to some politically acceptable number, like 4, 5, or 6 percent. After setting this ceiling, the president and his staff take dollars off the top for mandatory retirement and national defense programs and a few presidential priorities such as education or medical research. Then they give the small leftover slice to the Office of Management and Budget, the White House's budgeting arm, to allocate.

However, most of the other agencies competing for these OMB leftovers have influential supporters inside and outside the government. For these agencies, the OMB-approved budget, as the budget office itself well knows, is just a way station en route to Congress, where the budget is usually increased. But for the IRS, the OMB-approved leftovers are the end of the line. The IRS has no supporters lobbying members of Congress, contributing to political action committees, or knocking on doorbells before elections.

The result is an IRS budget that year after year barely covers mandated costs like pay raises. Its budget typically bears no relation to the responsibilities it is given by the tax code. Nor does the budget take into account the laws with which the public is required to comply, the growing volume of services the IRS is required to provide to citizens, or the tax revenues that these programs provide.

Incredibly, the OMB tries to appear fiscally responsible by neglecting the collection of its revenues and accounts receivable! No ordinary business in America could survive if it did this.

There is an old story about prisoners who have been locked up in jail together for so long that they don't need to tell jokes to each other anymore. All the jokes are numbered, and everybody agrees to laugh when somebody just calls out a number. The OMB budget process reminded me of that jailhouse story in one respect. Everybody in the IRS and OMB knew the jokes, which were OMB's budget evaluations, but everybody was required to repeat the shaggy dog stories every year, even though everybody already knew the punch line—no money.

One of the rituals every fall was a budget "hearing" in which each agency was given an opportunity to explain its budget request to the OMB officials responsible for evaluating the request. In October 2002, I trudged over to the OMB conference room near the White House for my last of these futile meetings. Four or five OMB budget staffers were on one side of the table with their boss, a midlevel political appointee. They looked very much like people who were doing their duty by attending the funeral of a distant relative but without wanting to hear anything much about the deceased. Although the meeting was scheduled for two hours, the OMB boss left after half an hour, and with only a few perfunctory questions, the meeting broke up another half-hour later.

I was shaking hands with one of the OMB analysts on the way out when he said, "I'm glad you will be gone before we have to give the IRS our passback," meaning that at least I wouldn't have to be there this year, when the OMB did what it always did—reject whatever the IRS requested. I replied that it would be better for everybody if the OMB just sent a cover note saying that there was no money available for the IRS budget request and eliminated the typical verbiage attempting to justify why the money was unnecessary. He said, "I understand that, but our bosses want us to write up a rationale for our numbers."

Sadly, I knew what he said was true. The OMB's staff had been reduced to thinking up so-called justifications for a budget that was actually driven by appearances and percentages. Their repertoire of techniques for such justifications was time-worn, proven to conceal what was really going on. One of the favorites was putting in money with attractive labels, such as "fighting tax shelters," while deliberately underestimating obscure things like the cost of legally mandated pay raises. They knew that, once the mandated expenses were paid, no money would remain for the advertised initiatives, but they insisted on including them, anyway.

The OMB staff had become like the finance staff of a large corporation that gave up making the necessary investments for the long-term health of the business, and instead used its skills to make the numbers look good to Wall Street for that year or quarter.

Unlike most of the important problems that the federal government faces, it would not take enormous resources to turn around the dangerous downtrend in the tax system. It would simply take a decision by an incumbent president and his budget staff to put the modest allocations required in the president's budget and to support them as they move through Congress. As detailed in my 2002 report, my recommendations can be boiled down to two key items:

    1. Fund technology investment to increase productivity. In my report, I estimated that with extremely skillful management and adequate funding of technology, the IRS could potentially sustain a 3 percent per year increase in overall staff productivity. If achieved, this rate of productivity improvement would substantially exceed the average level achieved in the private sector over the previous decade. Over ten years, such productivity gains would produce the equivalent of thirty thousand additional staff-years of work, which would otherwise require around $3 billion per year in budgetary cost. The IRS was already realizing benefits from its technology investments. For example, it was closing paper-processing centers as electronic filing increased and answering more taxpayer inquiries through the Web site. Productivity gains of this kind would fill a major part of the gap in the IRS workload and would produce tens of billions of dollars per year in increased tax revenues.

      It is indeed difficult to manage such large-scale business and technology modernization programs, and some setbacks are likely to occur along the way. But the potential productivity gains are enormous. They cannot be achieved without investment in business systems modernization.

    2. Fund the IRS to rebuild staff each year for the remainder of the decade. The IRS must receive budgets adequate to gradually rebuild its staff. Because of the continued growth in its workload—which averages 1.5 to 2.0 percent per year—and the large accumulated deficit in work that should be done but cannot be, productivity growth alone, even at an aggressive level, cannot possibly close the gap. My report estimated that a net increase in staff of about 2 percent per year, together with a 3 percent per year productivity growth, could close the known workload gap by 2010.

      If the IRS staff were to grow by 2 percent per year through 2010, the total staff would still be smaller than it was twenty years earlier, in 1990, whereas the economy is projected to be 86 percent larger and the tax system far more complex.

      For this approach to work, the budget must provide for a net increase in staffing on a sustained yearly basis. In the past, projected net increases have not materialized, even when called for in the budget, because of OMB's numerous budget tricks, such as failing to pay for pay raises and other increased expenses. In other cases, increases in one year have been reversed by decreases the following year. In the IRS, "absorbing" a pay raise simply means cutting the number of staff-years available to do the work, which in turn means adding to the already large deficit in essential work that is left undone and taxes that are left uncollected.

Some critics argue that the IRS should solve its budget problem by reallocating resources from customer support to enforcement. In the IRS, customer support means answering letters, phone calls, and visits from taxpayers who are trying to pay the taxes they owe. Apart from the justifiable outrage it causes among honest taxpayers, I have never understood why anyone would think it is good business to fail to answer a phone call from someone who owed you money.

I am sometimes asked, "So why wait? Why not provide the money to close the gap now, as was attempted for the SEC?" In reaction to widely reported accounting scandals, the Security and Exchange Commission finally received a budget increase—63 percent in one year.13 A big onetime increase like this will not work for the IRS. It takes time and careful management to hire, train, and deploy qualified professional staff and to implement complex modernization programs. Consistent but modest annual increases (the very formula recommended by the restructuring commission in 1997) are what is needed.

The taxpaying public in 1997 had a right to insist that the IRS change. The agency has changed. And taxpayers today have a right to expect the IRS to continue to improve its performance on all of its goals: service, compliance, and productivity. But taxpayers also have a right to demand that the president and Congress change the tax code and the budget to provide a tax system that works for all honest taxpayers. It is time for all parts of this problem to be addressed before the cost to honest taxpayers becomes unbearable.

Excerpted by permission of Harvard Business School Press from Many Unhappy Returns: One Man's Quest to Turn Around the Most Unpopular Organization in America by Charles O. Rossetti. Copyright 2005 Charles O. Rossotti; all rights reserved.




Footnote:

13. Bloomberg News, "SEC Running Behind on Spending Its Budget," Los Angeles Times, 24 July 2003.