Only a year after Congress ordered a complete overhaul of the Internal Revenue Service, the House has voted to cut the agency's budget, a move that IRS officials and some Democrats argue could cause the reform initiative to collapse.

The amount of the cut--$135 million--is relatively small, given the agency's annual appropriation of $8 billion, but it comes after the agency asked for funding essentially unchanged from last year.

IRS Commissioner Charles O. Rossotti is scheduled to appear before a House Ways and Means subcommittee today to discuss the status of the IRS on the anniversary of the restructuring legislation. In a letter to House members on the eve of last week's vote to cut IRS spending, Rossotti warned that a cut of $135 million would "severely restrict, if not completely impair, IRS's ability to deliver on the Restructuring and Reform Act mandated by Congress in 1998."

The House approved the Treasury-Postal Service spending bill, which includes the IRS, on July 15. The Senate version passed on July 1 and would cut IRS spending by $57 million. Negotiators hope to resolve differences in the two bills before the Congress departs for its summer recess on Aug. 6, GOP aides said.

Beyond the dollars involved, there is immense symbolism in the budget cut.

After two years of steady criticism and bouts of political bashing, congressional critics, IRS officials and the Clinton administration appeared to have agreed on a plan for turning the agency into the modern, taxpayer-friendly tax collector that the critics say they want.

The administration brought in Rossotti, an acknowledged management and technology expert, to oversee the process and the computer modernization.

At the same time, the administration accepted a congressional package of restrictions on the agency and changes in tax laws designed to strengthen the taxpayer's hand in disputes with the IRS. As part of the deal, IRS officials expected bipartisan support this year for its budget.

Republican aides, however, said the proposed IRS cuts are not deep and that the agency can handle them by shifting its priorities for the coming fiscal year. "This is chump change," one GOP staffer said.

Republicans also noted that the IRS budget is part of the larger appropriations bill that finances other Treasury Department operations. Republicans were forced to find $312 million for the U.S. Customs Service after the White House wrongly assumed that Congress would raise a passenger fee for international travelers by July 1, they said.

That budget maneuver by the White House left Appropriations subcommittee chairman Jim Kolbe (R-Ariz.) with few choices when conservative Republicans demanded more spending cuts.

"I'm convinced that there is nothing we have cut that will do any serious damage to the IRS modernization schedule," Kolbe said. The cuts "do not fundamentally impair the ability of the IRS to collect taxes," he asserted, adding that in the case of the modernization plan, the reduction "does perhaps slow it down. I acknowledge that."

The cuts did draw bipartisan opposition on the House floor.

Rep. Steny H. Hoyer (D-Md.), ranking Democrat on Kolbe's panel, pointed out that a bipartisan commission had recommended that Congress provide the IRS with at least three years of stable funding "at current levels." But, he said, "Here we are less than a year later cutting funding for the IRS. You can't have it both ways."

And Rep. Rob Portman (R-Ohio), who co-chaired that commission, said the new funding level "will jeopardize the implementation of the very law we passed with so much bipartisan support and fanfare just last year."

According to IRS officials, the proposed $135 million cut was made in three primary program areas:

* Tax law enforcement. The cut of about $30 million in this program would likely lead to a decline in tax audits, eroding confidence in a system that relies on taxpayers to voluntarily pay their fair share.

* Tax processing. The cut of about $40 million will slow improvements in "customer service" required by last year's restructuring law and delay efforts to promote the electronic filing of returns.

* Year 2000 computer repairs. The $50 million cut will disrupt efforts to smash the Y2K bug at the agency, including a mainframe computer consolidation and the replacement of data entry machines that process returns and provide refunds.

Congress also appears ready to give all federal workers a 4.8 percent pay raise next year, an increase that would cost the IRS, which has about 100,000 employees, $16 million more than planned, officials said.

CAPTION: Commissioner Charles O. Rossotti says the House's budget cut for the IRS would "severely restrict" reforms.