worrying about that year 2000 too much. But I do want to know if the IRS has contemplated the costs that might be associated with the year 2000 problem, and if there are such costs envisioned in their unique entity, where they intend to get the monies to pay for them.

The first panel here is Ms. Valerie Lau, the Treasury Department Inspector General. We are glad to have you here. We also have Greg Holloway, the Director of the Government-Wide Audits of the General Accounting Office. We will have a second panel, Tony Musick of the Internal Revenue Service, the Chief Financial Officer.

I would suggest that we proceed. I do not know who would like to go first. I think we ought to listen to you first, Ms. Lau, if that is all right.

TESTIMONY OF VALERIE LAU,1 INSPECTOR GENERAL, U.S. DEPARTMENT OF THE TREASURY

Ms. LAU. I would be happy to. Chairman Stevens, thank you. I am very pleased to be here with you today to discuss IRS financial management issues.

My office has generally approached IRS issues through the lens of the oversight function. The Inspector General Act provides my office with oversight authority for the IRS Chief Inspector's Office, which performs the primary role of auditing IRS's internal matters. In addition, my office has the authority to directly audit any IRS issues that warrant our attention.

So far, I believe the work undertaken or in progress by the Chief Inspector and the General Accounting Office have provided extensive coverage of IRS's financial management activities. I have been careful, therefore, to avoid duplicating audit effort. Accordingly, I have directed my office's efforts to those areas most in need of Inspector General oversight. Today, I will discuss four efforts.

First, FMFIA, or the Federal Managers' Financial Integrity Act. Seeing to it that the weaknesses identified in the FMFIA process have been classified properly has required some assertiveness_by the IRS Chief Inspector's Office, which I have fully supported. Let me explain.

Management's conclusions concerning FMFIA compliance are based on self-evaluations, which, by their nature, are not exact and expose the process to subjectivity. In its 1995 assurance letter to the Secretary, IRS characterized the problems it is facing with TSM as an area of concern while the Chief Inspector's Office recommended TSM be classified as a material weakness. This may seem subtle, but the difference between an area of concern and a material weakness could be the deciding factor in whether or not IRS can provide reasonable assurance to the President and the Congress.

One year earlier, a similar disagreement occurred. In that instance, the Department did not report TSM as a material weakness but did include a statement in its assurance letter noteing my office's position that TSM was a material risk requiring close monitoring by senior departmental and IRS management. This issue

1 The prepared statement of Ms. Lau appears on page 233.

was also highlighted in my April 1995 semiannual report to Congress.

With the 1995 FMFIA cycle, however, I am pleased to report that our position was accepted by both the Commissioner and the Secretary. TSM is identified as a material weakness in the Department's 1995 assurance letter.

Second, we have reviewed the effectiveness of the Department's oversight of TSM. This review is conducted from fall 1994 to spring 1995. Our report called for improvements in the Department's oversight. The Department has since taken a number of steps to strengthen its effectiveness.

Third, we conducted a follow-up review of IRS actions to correct problems with employee browsing of taxpayer information. In 1994, we reported to the Chairman of this Committee that the Chief Inspector's efforts to address this problem had been extensive. Our follow-up report issued in March of this year summarizes the Service's progress in implementing our recommendation.

We found that the IRS had taken action to prevent further abuses. We made seven additional recommendations regarding systems security. IRS management agreed with our recommendations and detailed corrective actions, both planned and already_completed. We believe that those actions, when fully implemented, will correct the problems we noted.

Fourth and last, we have been working closely with the Chief Inspector's Office and with GAO in forming partnership arrangements. This summer, we will jointly audit the 1996 IRS financial statements. I have every confidence that this combined effort will contribute to continued progress in resolving IRS's financial management problems.

Also, together with the Chief Inspector's Office, we recently completed an analysis of the internal controls over the processing and issuance of income tax refunds totaling more than $96 billion for

1994.

Mr. Chairman, this concludes my statement. Thank you.
Chairman STEVENS. Thank you. We will get back to that.

Mr. Holloway, will you identify for the record the people you have with you, please?

TESTIMONY OF GREGORY M. HOLLOWAY,1 DIRECTOR, GOVERNMENT-WIDE AUDITS, ACCOUNTING AND INFORMATION MANAGEMENT DIVISION, U.S. GENERAL ACCOUNTING OFFICE; ACCOMPANIED BY DIANNE GUENSBERG, ASSISTANT DIRECTOR, GOVERNMENT-WIDE AUDITS, AND ELEANOR LONG, AUDIT MANAGER, GOVERNMENT-WIDE AUDITS, U.S. GENERAL ACCOUNTING OFFICE

Mr. HOLLOWAY. Thank you for this opportunity to come before you to talk about the results of our audit and the financial management issues that we found.

I have with me this morning Dianne Guensberg, who is our Assistant Director and has the principal responsibility for the performance of the audit of the Internal Revenue Service on my right, and on my left, I have Eleanor Long, who is our most senior man

1 The prepared statement of Mr. Holloway appears on page 240.

agement on the engagement and has been responsible for the revenue and accounts receivable-related issues, also.

We look forward to this hearing to talk about financial management because we believe it is a very important occurrence in government right now. I would like to briefly talk a little bit about just financial management and then more specifically about IRS and then give way to any questions that you might have.

Let me just first say that as I reflect on the history of financial management in government, and it has been an interesting history for me, having come from the private sector, is to say that in the government, and not only in the government but even in the private sector, there is no cure for making bad decisions. But one thing that is certain, when you have poor financial management, there is a much greater vulnerability to making bad decisions than when you have good financial management. So I think it is critical that we improve financial management in the government sector. You could have very effective operations, but if you have bad financial management in the private sector, it usually means you will end up going out of business. At an individual level, it probably means at some point you will become bankrupt. But in the Federal Government, it has basically meant that we have gotten $5 trillion in debt and probably a lot of people with very little confidence in government.

So when you look at the criticality of financial management, I think some of the things that have contributed to that is the wrong reward system, and that reward system being the goal historically being to break even, whereas in the private sector it is to make money to stay in business. At an individual level, it is to have money to do the things in life we want to do before this life ends. So I think it is important that that model no longer be the success model for the Federal Government, and I think through efforts like these and others that have been made by this Committee, we are reshaping the focus of government and financial management in government to, hopefully, where now it is similar, that our goal is good financial management, that along with good decisions in the private sector means you will make money and be profitable and stay in business. At an individual level, you will be able to take vacations to places like Alaska in the summertime.

Chairman STEVENS. Our best friends visit us in the wintertime. [Laughter.]

Mr. HOLLOWAY. And it will result in good government, a government where you can make informed decisions. I heard on one occasion when I was in the audience of one of your hearings and I heard you talk about the need to have a good accounting system, where on a real-time basis you could have information to make decisions from. I am just a corny enough accountant that that means something to me, because I know the value of good information, having been in the private sector and now in the public sector. It is just critical, and particularly in these austere times.

So there is no substitute for good financial information. I think your leadership in this area is crucial because I think it keeps everybody pressing harder to the goal to know that Congress cares and that it is something they want.

I would like to talk a little bit about financial statements, because a lot of times in the Federal sector you always hear people say, why is it important to have financial statements? I think it is important for people to understand what financial statements do and do not do.

One of the things that financial statements do is provide a report card. It gives you something where management has to assert how they have performed and what they have done with the resources that have been entrusted to them. If you want to carry that, and I like to try to carry it to a personal level because it is easier to understand. In many respects, the tax returns that we all file every year is a financial statement and it attempts to show what level of resources we have that effectively are taxable. There is the expectation that we report that with integrity and that the numbers be reliable and supportable so as to allow for the proper amount of tax to be levied.

The reason that becomes important is because it allows those that have the responsibility of executing it and it allows the government to know that the amount of tax that we are collecting to operate our government with and that we are using in our operations is the right amount and it is the fair amount and it is the amount that it should be.

Likewise, in the Federal sector, as I sit here before you today, it is not only as a representative of GAO that did the audit of IRS but also as a taxpayer, and I believe personally that taxpayers have a right to know, and I think part of that right to know stems with knowing that as we invest in our government through taxes, how the monies are being spent, that they are being collected fairly and squarely, and a lot of that comes through as a result of reporting financial statements.

Financial statements are a minimum indicator, I believe, of an entity or an individual's capacity to execute good financial management. What I mean by that, if you could look at it at a personal level, when you think about your own personal finances, whether you are applying for a bank loan or preparing your tax return, you need to have the capacity to look at the transaction that you have done over a given period of time and to articulate that to a user of that information in a way that they can understand it and make some informed decisions about your financial performance and condition.

It is no different here. I think taxpayers have a right to know. I think they need to know what the distribution and share of taxes are, who it is coming from. They need to know how IRS is using the money that it is using and what they are getting for it, and that is what financial statements are designed to do.

But I think the most important thing to recognize is that they represent management's assertion, and in this case, IRS's management's assertion, of exactly what they have done.

The last example that I like to give in this scenario is I am mindful of when I was in the sixth grade, and there are not many things in my earlier life that I remember, but there are a few things that stay with you as a child. But I recall that I was getting a failing grade in a social studies class and my report card came home and my father saw it and he immediately took corrective action based

on that report card and effectively told me if I wanted to see sunlight again, I had better pick it up.

The significance of that is that in many ways, that was a financial statement. That was a statement to him on my performance and how I had done and it prompted action from him to create corrective action. I believe if there was ever a time in the Federal Government where we need that kind of information to address the financial concerns of this country, it is now.

So I think it is important to have those report cards. I think it is mindful, as you have discussions about tax cuts, about cutting programs, about expanding programs and whatever other choices that Congress might make, we need to really understand and focus that to whatever extent we allow poor financial management to continue to exist, that is $1 wasted that could be used to reduce taxes, that could be used to fund other initiatives, that could be saved and applied in other places. I think good financial management minimizes the opportunities for that to occur.

I would like to shift for a second to talk about what an audit is about because there is a lot of misunderstanding about what an audit actually does. Effectively, what an audit does is it attests to what management says is what occurred. Another simple illustration that I like to use is that many, many years ago, and several more pounds ago, when I was a youngster, I played Pop Warner football. One of the things they had in Pop Warner football was a weight limit so that the big kids could not crush the little kids, and the weight limit was 90 pounds.

The coaches had to provide a report that showed what each kid on the team weighed and that was the coach's assertion of what we all weighed. But they also had an audit. It was called a scale, and each of us had to stand on that scale to make sure none of us exceeded that weight limit. Now, obviously, today, I would have had trouble not exceeding that weight limit, but back then, I made it.

But the interesting thing about that is the reason that that became important and why it was so vital to that, and this migrates directly to the Federal Government, is that without that measure, I suspect that there might have been some coaches that would have had kids that were a little overweight that would have played and would have done some other things that would have altered the rules of the game.

One of the advantages of an audit is that it gives those that would use the information the assurance that everybody playing in the game is playing by the same rules and can be comparably measured as to their performance and what they have done with the resources that have been entrusted to them, and it gives you an independent verification beyond management's assertions that what they said occurred is true.

If you want to bring home a real illustration of that, and I am a studier of Presidential politics, back during the 1992 elections, there were a lot of discussions about the need to collect the accounts receivable of the Internal Revenue Service. It was a lot of discussion on a lot of bad information about how much was there to even be collected.