Two of this city's more powerful agencies

The Internal Revenue Service and the Office of Management and Budget--are bound in a paper war to determine who will decide how burdensome the tax collector can be.

The issue is whether OMB's Office of Information and Regulatory Affairs has the right to review both old and new data-collection and recordkeeping requirements that IRS imposes or wants to impose on people and businesses.

The issue is being played out in both Congress and the Justice Department, and is important for at least three reasons:

* The Paperwork Reduction Act of 1980 requires OMB to reduce the government-imposed paperwork "burden" by 25 percent by Oct. 1, l983. Americans spend about 1.5 billion hours annually telling the government about themselves and their businesses, and almost half that time is spent with IRS forms. If OMB cannot reduce the time needed to answer IRS questions, it is questionable whether the 25 percent goal can be met.

* If Congress exempts the IRS from the Paperwork Reduction Act, the General Accounting Office has said, "We are concerned that such exemptions could undermine the entire framework for improving federal information resources. . . ."

* However, if the IRS is blocked or delayed by OMB from collecting data or requiring records, it would be more difficult to collect taxes, a result with obvious implications, not all of them happy.

Bills that would exempt the IRS from the paperwork limits have been introduced in both the Senate and House tax-writing committees, and there is strong suspicion among those who oppose the exemption that the IRS is working for it.

OMB Director David A. Stockman, in a "Dear Bob" letter, told Sen. Robert J. Dole (R-Kan.), chairman of the Senate Finance Committee, the Reagan administration "strongly opposes this exemption" because it "would eliminate any outside review of the most important source of complaints about excessive government paperwork."

IRS Commissioner Roscoe L. Egger Jr. and other IRS officials declined to be interviewed on the subject and referred all questions to the parent Treasury Department.

"There is some suspicion here that IRS is a little too defensive," a Treasury official said. "On the other hand, we're also concerned about OMB getting too deeply involved in IRS."

An exemption to OMB review for IRS is proposed in Dole's taxpayer-compliance bill, legislation that would increase requirements on employers, bankers and others to let the IRS know when people make money. It is all part of the government's effort to close the so-called compliance gap, the estimated $95 billion in uncollected tax revenue the government claims it could get if everyone were honest.

IRS is not fighting the notion that OMB has the right to review its tax forms; in fact, OMB went through all of IRS's 1981 forms. IRS is not even contesting the application of Executive Order 12291, President Reagan's famous administrative edict giving OMB the right to review almost any major new regulation. Compromises have been reached on those in bargaining between Egger and Christopher DeMuth, OMB's administrator for information and regulatory affairs.

The issue then, according to Peter Wallison, Treasury's general counsel, is "whether the Paperwork Reduction Act extends to regulations of IRS that are already in place. . . . The way I would look at the issue in your position is the old saw about who gets the last cut at the design of the car, the designers or the engineers." That, Wallison said, is a legal issue and has been submitted to the Justice Department for resolution. It resides there amid a stack of "no comments."

Supporters of a congressional exemption for IRS have argued that OMB's form readers are overworked, are not tax specialists and will get lost if they start mucking around in the tax code--all 2,000 sections of it. "Then when they need help," a Capitol Hill person noted, "they go to the special interest groups."

It is true that many in the business community oppose exempting the IRS from the paperwork restrictions. "We feel small businesses will probably be the most hurt by an action like this since taxes really impact them harder than larger businesses," said David Marsh, executive director of the Business Advisory Council on Federal Reports, which represents 125 companies and 90 trade associations.

Jim J. Tozzi, deputy administrator of OMB's Office of Information and Regulatory Affairs, the place that reviews IRS's handiwork, said, "I'm not aware of any action OMB has taken that has inhibited the Treasury from raising revenues." That, he said, should be the test.

Treasury officials said they could not think of any example either. Another source suggested that OMB had been sitting on a form that would be used to collect something known as the Generation-Skipping Transfer Tax. Tozzi was asked about that on Friday.

"The form came over late last fall," Tozzi said. "We reviewed it. . . . We thought the information requests were quite high. There have been discussions." Tozzi called early yesterday morning to announce that OMB had approved the Generation-Skipping Transfer Tax form. "There is a 7 percent reduction in burden" from the form as originally submitted, he said.