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No government agency knows more about American citizens than the IRS. It knows how much money they make, when they marry and get divorced and how many kids they have. It knows where they live.

By law, that information must be kept private and confidential. Now, it's Robert N. Veeder's job to make sure it stays that way.A former Air Force officer and Office of Management and Budget official, Veeder is settling in as the Internal Revenue Service's new privacy advocate.

He and a staff of about a dozen are supposed to make make sure the agency builds in privacy protections as it transforms a largely paper-based system into a modern, integrated computerized operation by 2001.

"If we develop systems without thinking about the privacy implications . . . until just at the end of the process, we're dead in the water," Veeder, named to the position last June, said in a recent interview.

Privacy isn't a new issue for the IRS. Restrictions on the use of taxpayer data go back as far as 1939 and were toughened by Congress in 1976 in reaction to Richard Nixon's use of his political enemies' tax returns.

But the agency moved to establish Veeder's office only after it became clear that rapidly advancing technology made it possible to manipulate masses of information. This raised privacy questions hardly envisioned two decades ago.

"We needed someone who would broker all the issues," said Deputy IRS Commissioner Michael P. Dolan. "We were looking for some expert advice as to how to best inculcate this larger privacy sensitivity into the organization,"

Veeder arrived at the IRS just a month before Sen. John Glenn, D-Ohio, revealed that 1,300 agency employees had been investigated since 1989 for illicitly snooping into the tax returns of celebrities and others.

The controversy underscores potential pitfalls ahead. The new computers that will make it easier for the IRS' 115,000 employees to serve the taxpaying public also will, by necessity, make it easier to for them to instantly call up taxpayers' records on a computer screen.

"You have to . . . empower the employees in order to get the answer to the question the taxpayer is asking," Veeder said.

But, he said new computer technology also will allow agency managers to more effectively limit file access to those who need to know and to detect a suspicious pattern of information use by employees with wider access.

"I think at that point what you've done is almost eliminate browsing. . . . I think it's a manageable issue," he said.

A far tougher issue, Veeder said, will be deciding on what exactly is a legitimate use of taxpayer data by other agencies. In the era of deficit reduction, agencies are under increasing pressure to be more efficient, and that includes sharing information, he said.

The IRS already is obliged to supply state agencies with information that could help them track down parents delinquent on child support payments and information used to verify applications for food stamps, Medicaid and other welfare programs. And agencies administering federally guaranteed student, veterans and farm loans have the right to intercept defaulters' tax refunds.

But, Veeder warned, there could be unintended consequences of such uses of tax data, no matter how worthy the purpose.

"Information is what this agency runs on. To the extent that it can't get good accurate valid information on taxpayers because they fear the data will be used for other purposes, then everybody loses. There won't be the money to fund child support or student loan programs," he said.

Privacy experts outside the IRS say ticklish issues also surround tax collectors' use of outside information to identify individuals who may be underreporting their income. A license issued by the Coast Guard, for instance, indicates an individual is wealthy enough to own a boat.

"We have to be very careful not to fall into a one-government mentality," said Washington attorney Ron Plesser of Piper & Marbury. "There is one government, but not for information purposes. . . . Information collected for one purpose should be used for that purpose only, unless the individual is given an opportunity to control that."

Even after the issues are sorted out, a daunting challenge remains: getting the bureaucracy of the IRS to focus on a concern that can conflict with its primary mission of ensuring Americans pay what they owe.