[Senate Hearing 107-543]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 107-543
 
                      CONCURRENT RESOLUTION ON THE
                      BUDGET FOR FISCAL YEAR 2003
=======================================================================

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION

                               __________

         January 23, 24, 2002--THE BUDGET AND ECONOMIC OUTLOOK

              January 29, 2002--THE BUDGET AND THE ECONOMY

   February 5, 6, 12, 13, 14, 2002--THE PRESIDENT'S FISCAL YEAR 2003 
                            BUDGET PROPOSALS

 February 7, 2002--THE PRESIDENT'S FISCAL YEAR 2003 BUDGET AND REVENUE 
                        PROPOSAL DEBT MANAGEMENT

   February 26, 2002--THE EFFECT OF THE PRESIDENT'S FISCAL YEAR 2003 
 BUDGET PROPOSALS ON THE ARMY CORPS OF ENGINEERS, THE FEDERAL HIGHWAY 
            ADMINISTRATION, AND THE DEPARTMENT OF EDUCATION

           February 27, 2002--THE LONG-TERM BUDGETARY OUTLOOK

 February 28, 2002--THE PRESIDENT'S FISCAL YEAR 2003 DEFENSE REQUEST: 
           WINNING THE WAR, TRANSFORMATION, AND REFORM ISSUES

   March 6, 2002--THE CONGRESSIONAL BUDGET OFFICE'S ANALYSIS OF THE 
               PRESIDENT'S PROPOSALS FOR FISCAL YEAR 2003






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                        COMMITTEE ON THE BUDGET

                  KENT CONRAD, North Dakota, Chairman

ERNEST F. HOLLINGS, South Carolina   PETE V. DOMENICI, New Mexico
PAUL S. SARBANES, Maryland           CHARLES E. GRASSLEY, Iowa
PATTY MURRAY, Washington             DON NICKLES, Oklahoma
RON WYDEN, Oregon                    PHIL GRAMM, Texas
RUSSELL D. FEINGOLD, Wisconsin       CHRISTOPHER S. BOND, Missouri
TIM JOHNSON, South Dakota            JUDD GREGG, New Hampshire
ROBERT C. BYRD, West Virginia        OLYMPIA J. SNOWE, Maine
BILL NELSON, Florida                 BILL FRIST, Tennessee
DEBBIE STABENOW, Michigan            GORDON SMITH, Oregon
HILLARY RODHAM CLINTON, New York     WAYNE ALLARD, Colorado
JON S. CORIZINE, New Jersey          CHUCK HAGEL, Nebraska

                Mary Ann Naylor, Majority Staff Director
                 G. William Hoagland, Staff Director

                                  (ii)








                            C O N T E N T S

                               __________

                                HEARINGS

                                                                   Page
January 23, 24, 2002--The Budget and Economic Outlook............ 1, 71
January 29, 2002--The Budget and the Economy.....................   117
February 5, 6, 12, 13, 14, 2002--The President's Fiscal Year 2003 
  Budget Proposals..............................169, 237, 311, 343, 375
February 7, 2002--The President's Fiscal Year 2003 Budget and 
  Revenue Proposals..............................................   277
February 26, 2002--The Effect of the President's Fiscal Year 2003 
  Budget Proposals on the Army Corps of Engineers, the Federal 
  Highway Administration, and the Department of Education........   431
February 27, 2002--The Long-term Budgetary Outlook...............   515
February 28, 2002--The President's Fiscal Year 2003 Defense 
  Reguest: Winning the War, Transformation, and Reform Issues....   553
March 6, 2002--The Congressional Budget Office's Analysis of the 
  President's Proposals for Fiscal Year 2003.....................   599

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman Co1, 71, 117, 169, 237, 277, 311, 343, 375, 431, 515, 553, 599
Senator Bond.....................................................   433
Senator Corzine..................................................   142
Senator Domenici....10, 73, 119, 180, 311, 372, 378, 435, 518, 555, 606
Senator Feingold..........................................115, 373, 421
Senator Frist....................................................   378
Senator Grassley.................................................   361
Senator Johnson..................................................   511
Senator Murray...................................................   512
Senator Smith.............................................168, 281, 397
Senator Snowe....................................................   421
Senator Stabenow.................................................   283

                               WITNESSES

Bixby, Robert L., Executive Director, The Concord Coalition......   250
Chase, Robert, President, National Education Association.........   466
Crippen, Dan L., Director, Congressional Budget Office..........13, 608
Daniels, Mitchell E. Jr., Director, Office of Management and 
  Budget.........................................................   183
Flowers, Robert B., Lieutenant General, Chief Engineer, United 
  States Army Corps of Engineers.................................   452
Greenspan, Alan, Chairman, Board of Governors of the Federal 
  Reserve System.................................................    74
King, Larry, Secretary American Association of State Highway and 
  Transportation Officals........................................   479
Lew, Jacob J., Executive Vice President for Operations, New York 
  University.....................................................   244
O'Hanlon, Michael E., Senior Fellow, The Brookings Institute.....   562
O'Neill, Hon. Paul, Secretary, United States Department of the 
  Treasury.......................................................   285
Orszag, Peter R., Senior Fellow, The Brookings Institute.........   131
Parker, Michael, Assistant Secretary of the Army Civil Works, 
  Department of the Army.........................................   445
Peters, Mary E., Administrator, Federal Highway Administration...   438
Powell, Hon. Colin L., Secretary, United States Department of 
  State..........................................................   314
Reischauer, Robert D., President, The Urban Institute............   121
Santos, Richard..................................................   217
Till, Thomas A., Executive Director, Amtrak Reform Council.......   488
Thompson, Loren B., CEO, Lexington Institute.....................   575
Thompson, Hon. Tommy G., Secretary, Department of Health and 
  Human Services.................................................   381
Walker, David M., Comptroller General of the United States.......   520
Wesbury, Brian S., Chief Economist, Griffin, Kubik, Stephens and 
  Thompson, Inc..................................................   144
Weston, Josh S., Former CEO, ADP Inc., and Co-chair, Tail to 
  Tooth Commission, Business Executives for National Security....   556
Wolfowitz, Paul, Deputy Secretary, United States Department of 
  Defense........................................................   345

               ADDITIONAL MATERIALS AND CHARTS SUBMITTED

Questions and answers--Committee members to witnesses, written:
    Chairman Greenspan...........................................   116
    Director Daniels.............................................   228
    Secretary O'Neill............................................   308
    Secretary Thompson...........................................   422

                                 (iii)













        CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2003
                      BUDGET AND ECONOMIC OUTLOOK

                              ----------                              


                      WEDNESDAY, JANUARY 23, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:02 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Hollings, Sarbanes, Murray, 
Feingold, Johnson, Byrd, Nelson, Stabenow, Clinton, Corzine, 
Domenici, Grassley, Gramm, Snowe, Smith, Allard, and Hagel.
    Staff present: Mary Ann Naylor, staff director; and Jim 
Horney, deputy staff director.
    For the minority: G. William Hoagland, staff director; and 
Cheri Reidy, senior analyst for budget review/revenues and Bob 
Stein, chief economist.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    First, I want to thank Director Crippen for being here 
today. We certainly appreciate the extraordinary efforts that 
you and your staff have made given the shortness of time 
between when Congress left town and the need to reassess our 
fiscal condition. We appreciate very much the efforts that you 
have extended as well as your excellent staff.
    As I look at the numbers, I'm reminded of the phrase ``What 
a difference a year makes.'' It really is quite startling.
    Last year, as we convened, we were told that we could 
expect surpluses of $5.6 trillion over the period of 2002 
through 2011. Now we see that that has been dramatically 
reduced to $1.6 trillion, a $4 trillion deterioration in 
projected surpluses.
[GRAPHIC] [TIFF OMITTED] 80544.001


    I want to be quick to point out that you warned us very 
clearly of the uncertainty of those forecasts. We have the fan 
chart that we discussed so many times last year, which you 
prepared, which showed the dramatic uncertainty of any 10-year 
forecast. And what we now see, the red line shows the new 
forecast in relationship to that fan forecast, which showed the 
range of estimates, what might happen. And what we now see is 
for the next several years we are actually at the bottom of the 
range.
[GRAPHIC] [TIFF OMITTED] 80544.002


    There were some of my colleagues who told me that the $5.6 
trillion of projected surpluses was understated. I remember 
many of my colleagues, some of them on this committee, who told 
me repeatedly, Oh, don't worry, there is going to be actually 
more money, that these forecasts are understated. Well, 
unfortunately, history has proved them wrong.
    Many of us repeated the warnings that you gave us last 
year. I remember showing that chart of uncertainty over and 
over in this committee and on the floor. But, unfortunately, 
the President told us and told the American people that we 
could have it all. He told us that we could have a massive tax 
cut that he proposed, that we could have a big defense buildup, 
that we could save every penny of the Social Security and 
Medicare Trust Funds and still be able to pay down the maximum 
amount of our debt. Unfortunately, he was wrong, and he was 
wrong by a country mile.
    The consequences of those mistakes are enormous for the 
Nation. So how did it happen? Well, the biggest reason for the 
disappearance of the some $4 trillion of projected surpluses 
was the tax cut. Our analysis of your numbers shows that some 
42 percent of the reduction is from the tax cut; 23 percent are 
economic changes; 18 percent is other legislation, largely 
spending as a result of the attack on September 11th; and 17 
percent, technical changes.
[GRAPHIC] [TIFF OMITTED] 80544.003


    So the biggest factor in the 10-year change is the tax cut. 
That is the tax cut itself, and, of course, the additional 
interest cost associated with the tax cut.
    If we are to look at just this year, we see a dramatic 
reduction from $313 billion of projected surplus to a $21 
billion deficit, a very dramatic change in our short-term 
circumstance. And when we look at the reasons for that 
reduction, it is different than the 10-year analysis. The 
biggest reason for the reduction this year are the economic 
changes. They account for 44 percent of the change; 28 percent 
is because of technical changes, things like capital gains 
realizations and growth in Medicare and Medicaid spending; 
other legislation, largely spending associated with the attack 
of September 11th, is 15 percent; and the tax cut is 13 
percent.
[GRAPHIC] [TIFF OMITTED] 80544.004


[GRAPHIC] [TIFF OMITTED] 80544.005


    So in the short term, the recession is the biggest reason 
for the decline in our projected surpluses. In the long term, 
the biggest reason is the tax cut.
    I think it is further important to understand that, without 
Social Security and Medicare Trust Fund moneys, the surpluses 
would be nonexistent. Now, this chart shows last year we were 
looking at, without Social Security and Medicare, $2.7 trillion 
of surplus. Without Social Security and Medicare, this year we 
would see that we would be $1.1 trillion in the hole.
[GRAPHIC] [TIFF OMITTED] 80544.006


    The consequences of these fiscal mistakes are serious and, 
unfortunately, long-lasting. Last year we were told that we 
would be debt free in 2008. Now we see, instead of being debt 
free, that we will actually be $2.8 trillion in debt. And, of 
course, consequences flow from those changes.
[GRAPHIC] [TIFF OMITTED] 80544.007


    The interest costs for the Federal Government increase by 
$1 trillion over what we were told last year. Instead of $600 
billion of interest cost over the forecast period, we now see 
interest cost to the Federal Government of over $1.6 trillion. 
And despite the President's pledge, which was no doubt well 
intended, not to invade the Social Security Trust Fund, 
unfortunately we now see that the Social Security Trust Fund 
will be invaded by over $700 billion. And in addition to that, 
over $380 billion of Medicare Trust Funds will be used to pay 
for his tax cut and other expenses of the Federal Government.
[GRAPHIC] [TIFF OMITTED] 80544.008


    I believe that is a profound mistake when the first baby-
boomers start retiring in just 2008. It seems hard to believe, 
but that soon the baby-boomers will start to retire, and then 
our fiscal challenges really begin.
    So the question before us now is: What do we do? I do not 
believe that raising taxes at a time of economic slowdown would 
be wise. I believe that would only deepen the downturn.
    Second, I believe we should pass a stimulus package this 
year to give lift to the economy.
    Third, for the longer term, we should restore the integrity 
of the trust funds of Social Security and Medicare, and we 
should do it as quickly as we can.
    On a final note, I want to make clear that this debate 
about budget priorities was never a question of the President 
being for tax cuts and Democrats being opposed. In fact, last 
year we proposed in our budget plan a larger tax cut for last 
year than the President did in his budget proposal. We believed 
a tax cut of $60 billion last year was important to give lift 
to the economy. But we proposed substantially smaller tax 
reductions over the 10 years because we feared the President's 
proposal endangered Social Security and Medicare.
[GRAPHIC] [TIFF OMITTED] 80544.009


    This last chart shows the difference between what we 
proposed, the $750 billion tax cut, not counting the interest, 
the associated interest cost. The President's proposal was for 
$1.6 trillion of tax cut, not counting the associated interest 
cost.
[GRAPHIC] [TIFF OMITTED] 80544.010


    So that is where we are. Obviously this leaves us with a 
very substantial challenge. And I think we are up to that. We 
certainly have dealt with fiscal difficulties before, and we 
have got somebody here as the ranking member of this committee 
who has deep experience and who we will be looking to for his 
wise advice as we proceed.
    Senator Domenici.

             OPENING STATEMENT OF SENATOR DOMENICI

    Senator Domenici. Well, thank you very much, Mr. Chairman 
and fellow Senators. I think it is a testimonial to the U.S. 
Senate that so many Senators are present today. For an opening 
hearing, frequently Senators don't assume that it is necessary 
that they be here. But I think this hearing, if we do it right, 
kind of sets the stage as to where and how we are going to 
proceed with the resources of the people of this great Nation 
in a very, very difficult and arduous time.
    Let me just tell you why I think current issues are 
difficult. First of all, we have at the same time, for all of 
us as Senators and our President, a war and a recession. There 
may be a few people in the U.S. Senate that think we shouldn't 
be in that war. I haven't heard from any yet, so I am going to 
assume that one thing that is very, very unique is that we are 
in a war.
    Now, either of those two events occurring in the United 
States give rise to some very exceptional concerns. If you are 
in a war, you most likely don't follow budgetary rules in terms 
of expenditures and the like that you would if you were not in 
a war. So if you are going to talk about the fact that we 
should not have deficits, remember that normally it is pretty 
difficult to conduct a war and not have some deficits.
    The second thing we have is a recession. I am so grateful 
to the people of the United States from what I see in most 
polls, Senator Gramm. The American people see right through the 
argument that our President is responsible for this recession, 
when an overwhelming percentage of the American people believe 
that recessions occur from time to time and we have now got 
one. And for all of the talk about our President being the 
person, the primary motivator of this because of tax cuts, we 
can continue to talk about it. But I think we ought to move to 
another subject if we want to talk about anything that is 
politically relevant to the American people.
    So the important thing is to take a good look as to where 
we are right now and what we ought to think about in terms of 
our governing responsibility.
    One thing I want to remind those who listened to the 
arguments of my good friend, the Chairman, is that he moves 
back and forth between 1 year and 10 years. So it would seem to 
me that everybody ought to understand we have to produce a 1-
year budget here in terms of a binding budget. Whether we 
produce a 5-year one accompanying it or a 10-year one--it is my 
understanding the Administration is probably going to produce a 
5-year budget this year. I hope that is the case.
    In any event, let me borrow a few words to tell you what I 
think is not the case. On January the 4th, the majority leader, 
Senator Daschle, said that ``Tax cuts enacted on a bipartisan 
basis last year caused the surplus to disappear and made the 
recession worse.'' This is not only ridiculous, but it also 
sets us off on a highly partisan path when on that issue we 
need not have a partisan situation. The facts do not support 
the majority leader's position, and the American people 
apparently have not bought the majority leader's position. 
These are the comments of political, not economic, advisers. 
Remember that the economy is measured by quarterly rates of 
growth. Industrial production and other factors actually began 
to decline in the summer of 2000. That is before this President 
was in office. There was no question about it. And everybody 
was looking at it right smack in the face deciding to do what 
they could and what they should. Whatever the President wanted, 
he tried to do. Nonetheless, we were looking at a recession. It 
continued on and eventually reached a full definitional 
recession just a little less than 1 year ago.
    Then about a week ago, another Senator, Senator Kennedy, 
whom I consider a friend, said that ``We should repeal elements 
of last year's tax cut law and spend the increased taxes on 
more government.'' I say to my friend, the Chairman of this 
committee, as we begin the process of crafting a budget for the 
upcoming year, if your leadership and the Democratic Caucus are 
going to insist on tax increases, then we will have a very, 
very long year in the budget trenches.
    We do not have a lot of time. Our legislative time is short 
because it is an election year. And I fear that if the majority 
pursues such an agenda of tax increases, then even if you could 
pass such a resolution out of this committee or out of the 
Senate, you would probably fail to get an agreement with your 
House Budget Committee counterparts, and we would go through a 
very lengthy and arduous debate, which would conclude, I 
believe, with no achievement at all.
    So I still believe in the process that we are involved in, 
and I still believe it is the best mechanism we have to set 
fiscal policy. The policy priorities before the country at this 
time seem very clear to me.
    Let me suggest that we are probably going to be engaged in 
a debate on priorities like we have never had before. First, we 
are going to have to say what is our highest priority in terms 
of spending money even if it is money that puts us in deficit. 
And I believe--I will propose--and I think if you propose it, 
you will win; if I do, I will win--that the highest priority is 
the war and the military needs of our country. If that has to 
go up anything like 9 or 10 percent or 12 percent, I believe 
that we will have to do that.
    Second, homeland defense will be the second priority, and I 
have no way of judging what that will cost, Mr. Chairman, but I 
believe the President will submit a homeland defense proposal. 
And so I think the Number 1 and Number 2 proposals will be set 
forth in that way for us.
    Then the third you alluded to very clearly, and that is to 
do something about the slow growth of the economy by passing 
very soon an economic stimulus package. I hope we do that and 
do it seriously. I am glad to hear that the majority leader has 
suggested that we do something and do it quickly. He wasn't in 
that frame of mind at the end of the first session of this 
Congress. Whatever, he now seems to say let's do something.
    What I have seen is his current proposal does not seem to 
me to be adequate, but maybe he has some other political 
strategy, Mr. Chairman, that I am not aware of that accompanies 
his four-point ``stimulus'' proposal. Nonetheless, we are going 
to spend in terms of our third priority on incentives to build 
back the American economy.
    There is no doubt in my mind that the fourth priority then 
will be the rest of government, and, frankly, I believe there 
will be money for some increases in the rest of government. But 
I do believe that we can't do everything, and we will have a 
significant deficit, the way I look at it, this year, this 
coming year, the year we are going to be budgeting. The choice 
is between having deficit and providing money for those 
priorities or trying to not have a deficit. If we choose not to 
have a decifit, we are not accepting those priorities that we 
must spend more money this coming year than we spent this year 
by a substantial amount and that we need an economic stimulus 
of a significant amount.
    That is how I see the set-up for this committee. I see 
members now on this committee that I have grown to know, even 
though we haven't been meeting on a regular basis because there 
was not anything to do. But I compliment a number of you on 
both sides of the aisle because you have expressed yourself 
with reference to the economy and how you help the economy in 
ways, a number of you, that I am very proud to be associated 
with. Clearly, on the Democrat side, there are some new 
Senators that are very informed and prepared on the American 
economy and what is the best thing to do. I know one of our new 
members who comes from the State of New Jersey and sits at the 
last seat surely understands the economy in ways that we ought 
to all be proud to have when a newcomer joins this committee.
    So, with that, I am prepared, we are prepared. We have a 
lot of people interested on our side in helping, sitting down 
and getting our work done, Mr. Chairman. I believe you when you 
say we have got to work and work as quickly as we can. And I 
think you are implicitly saying to us this is not going to be a 
process where anybody tries to sneak anything over on anybody. 
This is going to be a rather forthright one. I think we all 
know what the problems and the issues are, and I thank you for 
calling an early meeting. I also thank Mr. Crippen and his 
staff for preparing it, and surely from our standpoint, having 
been without an office for so long, Mr. Chairman, I believe it 
is imperative that we thank all of your staff and mine for the 
wonderful work that they have done in getting us here and 
getting us into our other offices.
    I notice all the staff are kind of excited, Mr. Chairman. I 
didn't think they loved their work so much, but they do. Maybe 
it is that they love their work if we do it in the right 
building or something. But, in any event, I think they are 
ready to go, and when you have all that put together, I think 
we have a year when we can get our job done.
    Thank you very much.
    Chairman Conrad. I thank the Senator from New Mexico, and 
we will go to Mr. Crippen. I want to, before we do that, just 
indicate the rules of the committee, just to remind people. We 
will proceed based on the longstanding rules of this committee. 
Before the gavel, we go in seniority order. After the gavel, it 
is order of arrival. On our side, Senator Hollings will be 
first. On the Republican side, Senator Grassley will be first, 
followed by Senator Gramm. On our side, Senator Corzine will 
follow Senator Hollings.
    With that, I want to again assure the ranking member, this 
Senator, as Chairman of the Budget Committee, has no intention 
of proposing a tax increase at a time of economic downturn. I 
don't think that would be wise. I do think it is critical that 
we think now about how we are going to restore the integrity of 
the trust funds now that we see, based on the budget plan that 
is in place, the law that is in place, that we are going to be 
taking over $1 trillion from Social Security and Medicare Trust 
Funds to pay for the previously enacted tax cut and for other 
government expenditures.
    With that, again, welcome, Mr. Crippen, and please proceed.

  STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET 
                             OFFICE

    Mr. Crippen. Mr. Chairman, Senator Domenici, members of the 
committee, I appreciate the opportunity to represent CBO this 
morning in presenting our current assessment of the economic 
and budget outlook. As you suggested, Mr. Chairman, what little 
I know today certainly is a product of hard work of a lot of 
folks, some of whom are here today as my colleagues.
    I might say that I am here today to reveal what appears to 
be the worst-kept secret in Washington, and that is probably 
saying something: that is, that our surplus estimates of a year 
ago have been, shall we say, diminished somewhat.
    As you said, Mr. Chairman, a year makes a lot of 
difference. I have heard it said that a year can be an eternity 
in the field of politics. This year proves it is also true in 
the pursuit of economics.
    As you are all aware, the results we present today are our 
current best estimate of the economics for the next 10 years 
and the associated budget outlook, with no change in policy; 
that is, no increased spending for the war on terrorism or 
homeland spending, homeland defense, no additional spending for 
farm programs, no additional reduction in taxes or other 
stimulus legislation beyond that already in law, no renewals of 
expiring tax provisions, including last year's tax cut, which 
is set to expire in 2010. So this, Mr. Chairman, as you know, 
is a policy-neutral, current-law baseline as best as we can 
tell it.
    These first two charts that Melissa will put up attempt to 
illustrate, both graphically and numerically, as you have seen 
in the testimony that we submitted, what has happened to the 
projected surpluses and why our projections have changed so 
dramatically [see Figures 1 and 2, attached]. As you said in 
your opening remarks, Mr. Chairman, the outlook for surpluses 
over the next 10 years has gone from $5.6 trillion to $1.6 
trillion over the comparable period of 2002 to 2011, a 
reduction of $4 trillion in only a year.
    The primary causes of that decline, the diminished 
performance of the economy and the passage of legislation, vary 
in importance over the next 10 years. In the near term, the 
biggest change since last January is indeed due to the economy. 
Instead of the 3.4 percent real growth in gross domestic 
product (GDP) we forecasted a year ago, similar at the time to 
most other forecasters, we now expect GDP to grow by less than 
1 percent this year. As a result of that change in economic 
circumstances and the mostly related technical adjustments 
associated with it, the balance for our current fiscal year 
will be something like $240 billion less than we forecast a 
year ago.
[GRAPHIC] [TIFF OMITTED] 80544.011



[GRAPHIC] [TIFF OMITTED] 80544.012


    Legislation enacted since last January will further reduce 
balances this year by around $90 billion (not counting the 
associated debt-service costs) one-third of which comes from 
reduced revenues and two-thirds of which is in increased 
outlays. Combined, those changes amount to a swing of over $300 
billion, as your chart indicated, Mr. Chairman, and they alter 
our baseline forecast from a $300 billion surplus to a small, 
perhaps $20 billion deficit. A similar pattern exists for 2003, 
with a resultant small deficit of $14 billion. By 2004, we 
forecast the emergence of unified surpluses, with on-budget 
surpluses developing again only near the end of the decade.
    Our projection of changes for the second half of the next 
10 years, of course, indicates the reverse. Changes in 
legislation have more impact than do changes in the economy. By 
2011, changes in law since last January directly reduce the 
surplus estimate by just under $200 billion, $120 billion from 
revenue loss and $70 billion from increased spending. Changes 
in the economic outlook and technical assumptions account for 
an additional $130 billion deterioration in 2011.
    Over the 10-year period, as your chart also indicated, Mr. 
Chairman, changes in the economy account for some 40 percent of 
the diminution in surpluses while legislation makes up the 
rest.
    This recession and its effects on the budget have been 
unusual in several respects. First, the downturn was 
precipitated not by the usual circumstances of demand 
outstripping supply, which increases inflation and causes a 
monetary tightening by the Federal Reserve to correct those 
imbalances; rather, this time a precipitous drop-off in capital 
spending and inventories by corporations of all types, 
especially for information technology (IT) products, caused 
about three-quarters of the decline in GDP growth. While the 
increase in consumer spending slowed somewhat, it still 
remained a source of strength through much of the year.
    Second, that overinvestment, if you will, was accompanied 
by a marked decline in equity markets, especially for high-tech 
stocks, which in turn meant fewer capital gains, a slowdown in 
capital gains realizations and, therefore, capital gains taxes.
    Third, the attacks of September 11th probably exacerbated 
the recession we were already in. Although most of the initial 
impact seems to have worn off, at least some industries, such 
as airlines, have not recovered. The possibility of future 
attacks has increased uncertainty and led to a significant and 
growing level of expenditures on security.
    Fourth, our current economic projections alone would not 
have reduced revenues as much as is implied by this forecast. 
Revenue collections are running lower than expected, even given 
the current anemic rate of growth. There are some phenomena 
here that we don't fully understand, Mr. Chairman. They may be 
temporary or permanent, but for now we assume them to be 
largely permanent.
    Finally, while not directly related to this downturn, the 
Bureau of Economic Analysis simultaneously and substantially 
reduced its estimates for the previous three years, reducing 
the level of capital investment, for example, which in turn 
lowered the base of expected growth of the economy.
    Given the nature of this recession--that is, the dearth of 
capital spending--the economy will likely be slow to recover 
after bottoming out. Only when consumption and inventory needs 
strain current capacity will it be profitable to invest again 
in capital stock, and only then will growth in the economy 
resume its 3 percent potential.
    Mr. Chairman, I know the committee has many questions about 
this forecast and its implications for overall domestic policy, 
and I won't try to anticipate them at this point. But before I 
relinquish the floor, I feel compelled to once again remind 
everyone, just as you have, that the 10-year period in our 
baseline will only begin to touch on the era of what is likely 
to be the largest actual, real, not merely projected, fiscal 
swing in our history. The retirement of my generation will 
double the number of retirees receiving Federal benefits, while 
the work force that must support it, that must pay our 
benefits, will grow only nominally.
    What this means, I believe, is found in this poor chart I 
drag around everywhere I go, namely, that these programs--
Social Security, Medicare, and Medicaid--will consume more than 
twice as much of the economy as is presently the case. There 
are a number of important implications, I believe, to take away 
from this chart [see Figure 3, below].
[GRAPHIC] [TIFF OMITTED] 80544.013


    First, there are really only two moving parts to this 
phenomenon: spending on the elderly and the size of the 
economy. While the operation of the trust funds is not wholly 
irrelevant, the most important thing we can do for our children 
and grandchildren is grow the economy, not the trust funds, and 
perhaps accept lower benefits for ourselves. When the day comes 
to collect my Social Security check, it matters less how the 
cash that I will spend and consume is generated than how much 
of what my kids are producing I will demand they hand over to 
me. Whether it is financed by taxes on them at the time, 
selling them stocks, or providing less in other government 
programs for them, they will fund my benefit.
    Finally, this growing wedge will consume nearly the amount 
of resources we now expend for all Federal programs. That 
means, quite simply, that other programs will need to be cut, 
taxes raised, or debt issued to the tune of nearly 10 percent 
of GDP. As this last chart illustrates, since World War II, the 
average Federal tax take has been 18 percent of GDP [see Figure 
4, below]. Even with last year's tax cut, revenues will remain 
well above the average. Put more starkly, Mr. Chairman, the 
extremes of what will be required to address our retirement 
needs are these: we will have to increase borrowing by very 
large, likely unsustainable, amounts; raise taxes to 30 percent 
of GDP--obviously unprecedented in our history; or eliminate 
most of the rest of government as we know it. That is the 
dilemma that faces us in the long run, Mr. Chairman, and these 
next 10 years will only be the beginning.
[GRAPHIC] [TIFF OMITTED] 80544.014


    Thank you.

 Prepared Statement of Dan L. Crippen, Director, Congressional Budget 
                                 Office

    Mr. Chairman, Senator Domenici, and members of the committee, I am 
pleased to be here today to discuss the current outlook for the budget 
and the economy. The Congressional Budget Office (CBO) will release its 
report on that topic, The Budget and Economic Outlook: Fiscal Years 
2003-2012, on January 31. My testimony today will summarize that 
report.
    The economic recession and recent laws have combined to sharply 
reduce the budget surpluses projected a year ago. In January 2001, CBO 
projected that under the laws and policies then in force, the Federal 
Government would run surpluses in fiscal years 2002 through 2011 
totaling $5.6 trillion.\1\  In CBO's new projections, that cumulative 
surplus has fallen to $1.6 trillion--a drop of $4 trillion (see Table 
1).
---------------------------------------------------------------------------
    \1\ That projection appeared in Congressional Budget Office, The 
Budget and Economic Outlook: Fiscal Years 2002-2011 (January 2001).

                                    Table 1. Changes in CBO's Baseline Projections of the Surplus Since January 2001
                                                                [in billions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                       Total,    Total,
                                    2002      2003      2004      2005      2006      2007      2008      2009      2010      2011      2002-     2002-
                                                                                                                                        2006      2011
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total Surplus as Projected in          313       359       397       433       505       573       635       710       796       889     2,007     5,610
 January 2001...................
Changes.........................
    Legislative.................
        Tax Act (a).............       -38       -91      -108      -107      -135      -152      -160      -168      -187      -130      -479    -1,275
        Discretionary spending..       -44       -49       -52       -54       -56       -57       -58       -59       -60       -61      -255      -550
        Other...................        -4        -6        -5        -3        -4        -2        -2        -2        -2        -2       -23       -33
        Debt service (b)........        -5       -12       -22       -32       -44       -57       -72       -88      -106      -124      -114      -562
                                 -----------------------------------------------------------------------------------------------------------------------
          Subtotal..............       -91      -158      -186      -197      -238      -268      -293      -317      -355      -317      -870    -2,420
    Economic....................      -148      -131       -95       -81       -75       -75       -76       -79       -82       -88      -530      -929
    Tehnical (c)................       -94       -84       -62       -51       -64       -64       -65       -64       -65       -45      -356      -660
                                 -----------------------------------------------------------------------------------------------------------------------
          Total Changes.........      -333      -373      -343      -330      -377      -406      -433      -460      -502      -450    -1,757    -4,008
    Total Surplus or Deficit (-)       -21       -14        54       103       128       166       202       250       294       439       250     1,602
     as Projected in January
     2002.......................
Memorandum:.....................
Changes in the Surplus by Type
 of Discretionary Spending......
    Defense.....................       -33       -29       -29       -29       -29       -29       -30       -30       -31       -32      -149      -301
    Nondefense..................       -11       -20       -23       -25       -26       -28       -28       -29       -29       -30      -106      -249
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.
Note: For purposes of comparison, this table shows projections for 2002 through 2011 because that was the period coverd by CBO's January 2001 baseline.
  The current projection period extends from 2003 through 2012.
a. The Economic Growth and Tax Relief Reconciliation Act of 2001, which was estimated at the time of enactment to reduce revenues by $1,186 billion and
  increase outlays by $88 billion between 2002 and 2011.
b. Reflects only the change in debt-service costs that results fron legislative actions. Other effect on debt-service costs are included under economic
  and technical changes.
c. Technical changes are revisions that are not attributable to new legislation or to changes in the components of CBO's economic forecast.

    About 60 percent of that decline results from legislation--the tax 
cuts enacted in June and additional discretionary spending--and from 
its effect on the cost of paying interest on the Federal debt. Changes 
in the economic outlook and various technical revisions since last 
January account for the other 40 percent of that decline.
    For both 2002 and 2003, CBO now projects that, instead of 
surpluses, the total budget will show small deficits, if current 
policies remain the same and the economy follows the path that CBO is 
forecasting. In 2001, by contrast, the Federal Government recorded a 
surplus of $127 billion (see Table 2).
    The deficit projected for this year--$21 billion--represents a 
change of more than $300 billion from last January's projection. Over 
70 percent of that reduction results from the weak economy and related 
technical factors, which have considerably lowered the revenues 
expected for this year and next.
[GRAPHIC] [TIFF OMITTED] 80544.022


    For the current 10-year projection period, 2003 through 2012, CBO 
estimates a total surplus of nearly $2.3 trillion. However, almost half 
of that total comes from the surpluses projected for 2011 and 2012--the 
last 2 years of the projection period and thus the most uncertain. The 
surpluses for those years also reflect the scheduled expiration in 
December 2010 of the tax cuts enacted last June.
    In CBO's new baseline, the off-budget accounts (which reflect the 
spending and revenues of Social Security and the Postal Service) run 
surpluses throughout the projection period. In the on-budget accounts, 
by contrast, surpluses do not reemerge until 2010.
    CBO's baseline projections are intended to serve as a neutral 
benchmark against which to measure the effects of possible changes in 
tax and spending policies. They are constructed according to rules set 
forth in law and long-standing practices and are designed to project 
Federal revenues and spending under the assumption that current laws 
and policies remain unchanged. Thus, these projections will almost 
certainly differ from actual budget totals: the economy may not follow 
the path that CBO projects, and lawmakers are likely to alter the 
Nation's tax and spending policies. Therefore, CBO's baseline should be 
viewed not as a forecast or prediction of future budgetary outcomes but 
simply as the agency's best judgement of how the economy and other 
factors will affect Federal revenues and spending under current law.

                           the budget outlook

    If current policies remain in place, CBO projects, the budget will 
be in deficit for the next 2 years. Those deficits are expected to be 
quite small, amounting to only 0.2 percent of the Nation's gross 
domestic product (GDP) in 2002 and 0.1 percent of GDP in 2003. After 
that, surpluses are projected to reemerge and gradually increase.
    For the 5-years from 2003 through 2007, CBO projects a cumulative 
surplus of $437 billion. That figure represents off-budget surpluses 
totaling more than $1 trillion offset by on-budget deficits that add up 
to $617 billion. For the 10-year period through 2012, the total budget 
surplus under current policies is projected to approach $2.3 trillion. 
Again, that amount is made up of surpluses in Social Security ($2.5 
trillion) offset by a cumulative on-budget deficit ($242 billion). 
Without the scheduled expiration of tax-cut provisions in 2010, the 
total 10-year budget surplus would fall to $1.6 trillion.
    The total surplus is projected to equal 1 percent of GDP by 2006 
and grow to 3.7 percent of GDP by 2012. Estimates of large surpluses 
should be viewed cautiously, however, because future economic 
developments and estimating inaccuracies could change the outlook 
substantially. In addition, future legislative actions are almost 
certain to alter the budgetary picture.

                        changes in the past year

    As an illustration of how quickly the budget outlook can change, 
CBO's projection of the cumulative surplus for 2002 through 2011 has 
plunged by $4 trillion in just 1 year (see Table 1).\2\  Some $2.4 
trillion of that drop can be attributed to legislative actions. The 
legislation with the largest effect was the Economic Growth and Tax 
Relief Reconciliation Act of 2001, enacted in June. That law is 
estimated to reduce surpluses by nearly $1.3 trillion over 10 years 
(not including associated debt-service costs).
---------------------------------------------------------------------------
    \2\ About 45 percent of that reduction results from changes made 
since CBO issued its updated Budget and Economic Outlook in August. The 
drop since August totals $1.8 trillion and is attributed, in relatively 
equal measures, to legislative, economic, and technical changes.
---------------------------------------------------------------------------
    Additional discretionary spending since last January accounts for 
another $550 billion reduction in the projected surplus for the 2002-
2011 period. That amount stems from both regular and supplemental 
appropriations. CBO's January 2001 baseline assumed that discretionary 
budget authority for 2002 would total $665 billion.\3\  The actual 
amount appropriated for 2002 in the 13 regular appropriation acts 
totaled $691 billion. In addition, the Congress and the President 
enacted $20 billion in supplemental budget authority in December as 
part of their response to the terrorist attacks of September 11--
thereby generating a total of $711 billion in budget authority for 
2002, $45 billion more than CBO assumed last January.
---------------------------------------------------------------------------
    \3\ That figure was calculated by assuming that the amount 
appropriated for the base year of 2001 would grow at specified rates of 
inflation.
---------------------------------------------------------------------------
    Under the provisions of the Balanced Budget and Emergency Deficit 
Control Act of 1985, CBO's baseline assumes that annual appropriations 
for discretionary programs continue at their current level, increasing 
only by the rates of inflation projected for each year. As a result of 
the appropriations enacted for 2002, projections of discretionary 
spending in the current baseline begin at a level that is $45 billion 
higher than a year ago.
    Furthermore, two supplemental appropriation laws enacted in fiscal 
year 2001--one for defense personnel and readiness programs and another 
in immediate response to the attacks of September 11--will generate 
outlays totaling around $25 billion in 2002 and beyond. However, budget 
authority from actions in 2001 is not carried forward into the baseline 
projections for future years because those appropriations occurred 
before the current year.
    Overall, legislated reductions in revenues, additional 
discretionary spending, and other laws with smaller budgetary effects 
have reduced projected surpluses--and thereby increased the 
government's borrowing needs--by $1,858 billion for 2002 through 2011. 
That increased borrowing is projected to result in an extra $562 
billion in net interest costs over the 10-year period.
    Changes in the economic outlook since January 2001 account for 
another $929 billion decline in the 10-year surplus. About three-
quarters of that total reflects lower revenue projections, mostly 
resulting from the substantially weaker economic growth expected in the 
near term and the slightly lower average growth rates projected for the 
following several years. Much of the rest of the decline attributable 
to the economic outlook represents additional debt-service costs 
resulting from the reduction in anticipated revenues.
    Technical changes--those not driven by new legislation or by 
changes in CBO's economic forecast--have reduced the projected 10-year 
surplus by a total of $660 billion since last January. As with the 
economic changes, revenues account for over 75 percent of the technical 
changes, and debt service accounts for much of the rest. The technical 
changes to revenues stem primarily from revised projections of capital 
gains realizations and adjustments for lower-than-expected tax 
collections in recent months.

                           homeland security

    Since the attacks of September 11, Federal agencies, State and 
local governments, and the private sector have perceived a heightened 
threat to the United States and a need to commit more resources to 
homeland security. On the Federal level, legislation following the 
attacks increased the budget authority provided for such security from 
$17 billion in 2001 to $22 billion for 2002. What level of resources to 
commit to homeland security will undoubtedly be a key issue as the 
Congress and the President make decisions about spending and other 
policies this year.

                      the outlook for federal debt

    In the January 2001 Budget and Economic Outlook, CBO estimated that 
Federal debt held by the public would reach a level in 2006 that would 
allow the Treasury to retire all of the debt available for redemption. 
At that time, CBO also projected that the statutory ceiling on all 
Federal debt (which includes debt held by government accounts) would 
not be reached until 2009. Now, CBO estimates that debt held by the 
public will not be fully redeemed within the 10-year projection period 
and that the current debt ceiling will be reached in the next few 
months. Nevertheless, if the surpluses projected in the current 
baseline materialize, debt held by the public will fall to about 15 
percent of GDP in 2010--its lowest level since 1917.

                          the economic outlook

    In CBO's opinion, the most likely path for the economy is a mild 
recession that may already have reached its nadir. CBO expects the 
annual growth rate of real (inflation-adjusted) GDP to accelerate from 
-0.2 percent in 2001 (measured from the fourth quarter of calendar year 
2000 to the fourth quarter of 2001) to 2.5 percent in 2002 and to 
accelerate further to 4.3 percent in 2003.
    Some unusual features of the current recession will cause it to be 
mild, CBO believes. Chief among those features are the rapidity of 
policymakers' responses, the moderating behavior of prices, and an 
early reduction in businesses' inventories. In less than 1 year, the 
Federal Reserve has cut the Federal funds rate 11 times--from 6.5 
percent to 1.75 percent. Also, the tax cuts enacted in June prevented 
consumption from slowing more than it might have otherwise, and 
additional Federal spending in response to the terrorist attacks will 
boost GDP in 2002. Lower prices for oil and natural gas and mild price 
increases for other items are supporting consumption by boosting real 
disposable income. Furthermore, businesses began to reduce inventories 
earlier in this recession than they did in past downturns, which may 
mean that fewer cuts in inventories remain than at this stage of the 
typical recession.
    CBO projects that weak demand in the short run will translate into 
weak employment, pushing the unemployment rate higher for the next 
several quarters while restraining inflation. With growth of real GDP 
near zero early this year, the unemployment rate is expected to 
increase to 6.1 percent in calendar year 2002 from 4.8 percent last 
year (see Table 3). The rate of inflation faced by consumers is 
forecast to fall from 2.9 percent last year to 1.8 percent in 2002. 
Lower oil prices account for most of the projected decline in 
inflation, although the recession also plays a role. As oil prices 
stabilize in CBO's forecast, inflation bounces back to 2.5 percent in 
2003.
[GRAPHIC] [TIFF OMITTED] 80544.023


    Looking out through 2012, CBO expects the growth of real GDP to 
average 3.1 percent during the 2002-2012 period--roughly the same as it 
projected last January for the 2002-2011 period. Nonetheless, the level 
of real GDP is lower each year than in last January's projections, 
primarily because actual GDP ended up much lower in 2001 than CBO had 
expected a year ago.

                     uncertainty of the projections

    CBO's baseline projections represent the midrange of possible 
outcomes based on past and current trends and the assumption that 
current policies do not change. But considerable uncertainty surrounds 
those projections for two reasons. First, future legislation is likely 
to alter the paths of Federal spending and revenues. CBO does not 
predict legislation--indeed, any attempt to incorporate future 
legislative changes would undermine the usefulness of the baseline as a 
benchmark against which to measure the effects of such changes. Second, 
the U.S. economy and the Federal budget are highly complex and are 
affected by many economic and technical factors that are difficult to 
predict. As a result, actual budgetary outcomes will almost certainly 
differ from CBO's baseline projections.
    In view of such uncertainty, the outlook for the budget can best be 
described as a fan of probabilities around the point estimates 
presented as CBO's baseline (see Figure 1). Not surprisingly, those 
probabilities widen as the projection period extends. As the fan chart 
makes clear, projections that are quite different from the baseline 
have a significant probability of coming to pass.
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[GRAPHIC] [TIFF OMITTED] 80544.030


                         the long-term outlook

    Despite the sizable surpluses projected for the later years of 
CBO's 10-year budget outlook, long-term pressures on spending loom just 
over the horizon. Those pressures result from the aging of the U.S. 
population (large numbers of baby boomers will start becoming eligible 
for Social Security retirement benefits in 2008 and for Medicare in 
2011), from increased life spans, and from rising costs for Federal 
health care programs. According to midrange estimates, if current 
policies continue, spending on Social Security, Medicare, and Medicaid 
combined will nearly double by 2030, to almost 15 percent of GDP.
    Taking action sooner rather than later to address long-term 
budgetary pressures can make a significant difference. In particular, 
policies that encourage economic growth--such as running budget 
surpluses to boost national saving and investment, enacting tax and 
regulatory policies that encourage work and saving, and focusing more 
government spending on investment rather than on current consumption--
can help by increasing the total amount of resources available for all 
uses.

    Chairman Conrad. Thank you very much, Director Crippen, and 
thank you especially for those final notes on what it is that 
we face in the long run, because the very harsh reality is that 
in the future, Congress is going to be faced with incredibly 
difficult choices--either massive cuts in benefits, massive tax 
increases, massive increases in debt, or some combination, none 
of which is desirable.
    That is the hard reality, and unfortunately, we have lost 
part of the opportunity we had to address those questions by 
fiscal mistakes that I believe were made last year, incredibly 
serious mistakes that deprive us of the opportunity to have the 
resources to fully prepare for what we all know is to come. And 
that is not a projection. As you indicated, the baby boom 
generation is born, they are alive today, they are going to 
retire, they are going to be eligible for Social Security and 
Medicare, and we are going to face extraordinarily difficult 
challenges in meeting those demands.
    I think we should restate the point that you made in your 
testimony. These estimates of future surpluses that you have 
made now, which show a $4 trillion reduction from what was made 
just 1 year ago, do not include changes in policy going 
forward. Isn't it correct that this does not include the 
President's proposal for increased funding for defense?
    Mr. Crippen. Yes, Mr. Chairman. We have not, of course, 
seen the President's budget yet, but if there is an increase 
over our baseline, it is certainly not included here.
    Chairman Conrad. And there wouldn't be in these projections 
any funding for additional resources for homeland security that 
we have been told the President will send us.
    Mr. Crippen. No, Mr. Chairman. We have included in the 
baseline the second $20 billion, of course, in supplemental 
appropriations that was enacted just before you all retired 
last year.
    Chairman Conrad. But it does not include any additional 
funding that it is widely reported in the press that the 
President will be seeking for homeland security.
    There is no provision here for a stimulus package; is that 
correct?
    Mr. Crippen. That is correct.
    Chairman Conrad. And there is no provision here for 
expiring tax provisions that we all know will be extended.
    Mr. Crippen. That is correct.
    Chairman Conrad. And there is no provision here for a farm 
bill over and above the so-called baseline.
    Mr. Crippen. No.
    Chairman Conrad. So in many ways, this is an optimistic 
forecast in terms of a projection of surpluses going forward.
    Mr. Crippen. Yes, sir. It may be optimistic relative to 
fiscal policy that you pursue; it may, frankly, be a little 
pessimistic on the economic side, but we will see that soon.
    Chairman Conrad. Can you remind us what your forecast was 
for the debt of the country last year, by the year 2008?
    Mr. Crippen. We said that by 2008, all available debt held 
by the public would be essentially paid off. There are some 
things, such as like savings bonds and a few other securities, 
that would not be, but most of the debt held by the public at 
that point would be paid off.
    Chairman Conrad. And what is the anticipation now in terms 
of the debt----
    Mr. Crippen. That result will not occur in this decade in 
our forecast. That is to say, if our projection is right, we 
will certainly be increasing debt held by the public for the 
next couple of years, and only then perhaps, depending upon, 
again, fiscal policy, starting to buy it back down. But 
clearly, we will not retire the available debt held by the 
public in this baseline in this decade.
    Chairman Conrad. And would it be fair to say that your 
numbers indicate that by 2008, the publicly held debt will be 
$2.8 trillion?
    Mr. Crippen. I am sure that is correct, yes.
    Chairman Conrad. In terms of your forecast for growth, 
maybe you could share with us what you are anticipating for 
this year in terms of economic growth, quarter by quarter?
    Mr. Crippen. I will look for the quarterly numbers--John 
probably has them here. We are anticipating that the recession, 
if it has not already reached its bottom, will certainly in 
this first quarter, and in the forecast, we are showing an 
essentially flat economy in the second quarter--this is real 
GDP now, not nominal--with growth of a couple of percent by the 
end of the year. So it is a fairly slow recovery, as I 
indicated in my opening remarks. We may already be in a 
recovery; we do not know for sure.
    Chairman Conrad. Thank you.
    Senator Domenici.
    Senator Domenici. I will come back to myself later and 
yield to Senator Grassley.
    Senator Grassley. I have forgotten--did you say we would 
have 5 minutes?
    Chairman Conrad. Seven minutes. We will go by what we have 
traditionally done.
    Senator Grassley. That is fine with me.
    Before I ask questions, you had a very interesting chart up 
there, and we have a handout here, of the taxes as part of GDP 
from 1944 through 2012, and the average for those 70 years 
would be about 18 percent. And obviously, they go up and down, 
but except in war time, there is not too much variation until 
recently. Since 1992, they have been way above the 70-year 
average, and at the peak of our tax cut legislation last year, 
they had reached a point as high as they were in World War II. 
Then, for the next 10 years, the tax cut comes down. But even 
in light of the second-largest tax cut in the last 50 years, we 
are still going to have taxes as a percent of GDP much, much 
higher than they have been in that 70-year average. Your chart 
shows that, and I just want to highlight that, because we hear 
so much about the tax cut being responsible for where we are 
today in our fiscal projections and budget balance projections. 
On the other hand, even after that large tax cut, taxes are 
still higher than they were in that 70-year average.
    The other thing that I would like to point out about the 
tax cut last year--we passed an approximately $1.3 trillion tax 
cut in a bipartisan vote. I think we had all but two 
Republicans, and I think we had 10 to 12 Democrats who voted 
for it, so it was very bipartisan. The last alternative offered 
by the other side was a tax cut of $1.265 trillion, or about 6 
percent less.
    I only point that figure out because the budget resolution 
for the Democrats had tax cut of $795 billion, but the one that 
got the most votes, 48 votes--at least 48 Democrats voted for 
it; I do not know if any of those 48 were Republicans, but if 
they were, it was one or two--so we have the vast majority, all 
except a handful of Senators out of 100, who have voted for tax 
cuts of at least $1.265 trillion and a bipartisan majority that 
voted for 6 percent more than that that was signed by the 
President.
    So the bottom line is if we have any problems between the 
tax policies of the other party and our party, there is only 6 
percent difference between them, and that 6 percent would be 
relatively insignificant talking about the 10-year projections. 
I just think I should lay that out on the table for the benefit 
of everybody so we know that there is not a lot of difference 
between Republicans and Democrats on that point of tax policy 
for the next 10 years.
    My questions to you deal with more arcane things than that. 
We hear that a policy has to take into consideration--
particularly our tax policies and fiscal policies--the impact 
on interest rates, particularly over the long term. So I would 
like to refer to a recent Washington Post editorial that 
stated: ``Future tax cuts exert upward pressure on long-term 
interest rates.''
    The Washington Post is not alone in its claims that tax 
cuts will increase the deficit and drive up interest rates. 
However, I note in your testimony today that ``Despite the fact 
that the projected 10-year budget surplus is now $4 trillion 
less than projected last year, CBO's projection of future 
interest rates on 10-year government bonds is either the same 
or lower than projected last year.''
    Do you agree that given the overall size of our global 
financial markets, there is no reason to believe that the tax 
cuts that Congress passed last year will result in higher 
interest rates?
    Mr. Crippen. Senator Grassley, the financial markets are 
subject to the same supply and demand phenomena as other 
markets are, but I think it is important here, especially when 
we are talking about loan rates, to understand that there are 
lots of things that can affect them, in particular investors' 
outlook for inflation.
    I remember my first mortgage in Washington was at 14 
percent. Debt issuance by the government wasn't the motivating 
factor; it was that inflation was very high.
    So there are lots of factors that can affect loan rates. As 
you have said, we now have worldwide capital markets. Other 
countries are unfortunately experiencing rather anemic growth 
as well, so there is surely not a shortage of capital.
    I think it is also important to note, Senator, that in some 
of the popular writing, as you have just quoted, that is only a 
piece of the analysis. We do not do dynamic estimates of 
legislative changes, as you know--sometimes to your 
frustration. So to say that it affects long-term rates, whether 
right or wrong, ignores all the other potential effects of the 
same legislation. The tax bill of last year, for example--and 
we said this back in July--on net probably has a positive 
effect on the economy, albeit a small one. But there are other 
changes that you implemented at that time that could offset or 
more than offset any damage done by an increase in loan rates.
    But ultimately, as you said, the facts seem to suggest that 
loan rates are about where they were a year ago, before the 
passage of this tax bill.
    Now, no one has found--and we certainly have not cracked 
the code, either--a strong causal relationship between loan 
rates and the budget balance or lack of it.
    Senator Grassley. So the difference of an estimate of $4 
trillion of budget surplus last year versus this year has not 
caused your agency to change their projections of interest 
rates. I thank you for that.
    In the CBO's recent Report on Economic Stimulus, I would 
like to quote: ``The bigger the chunk of their income that 
consumers are willing to spend instead of save, the more 
stimulus there will be. But households do not predictably spend 
a particular portion of extra income left in their hands. Their 
propensity to consume appears to vary with their income and for 
other reasons that are little understood.'' That is at page 
viii.
    The report goes on to note that ``In general, approaches 
with the greatest estimated stimulus are also the most 
uncertain in their effects.'' That is at page 26.
    So my question is this. It seems to me that CBO is telling 
us that nobody really knows whether a given stimulus policy 
will produce the intended results. Given this uncertainty about 
short-term stimulus, wouldn't it be better to focus on what 
would be the best for the economy in the long run and try to 
pass that as quickly as possible?
    Mr. Crippen. I certainly cannot disagree with your 
conclusion, Senator. As I have said here and many times before, 
for many of the long-term problems, we need to keep our eyes 
focused on economic growth. Stimulus, as you have just recited 
from our own report, can be both in the eye of the be holder, 
and somewhat uncertain. It depends a lot upon whom it goes to, 
and it depends a lot upon what form it takes.
    There are some studies that suggest that people respond 
differently if they get a lump-sum payments, as they did last 
year, as opposed to just having their paychecks increased. So 
there are different behavioral responses. The evidence is not 
very clear all the way around. We have a couple of theories, 
neither of which seems to match the data very well.
    So your essential conclusion I cannot object to, but we did 
define in that report, as the Chairman asked us to, stimulus as 
being what would increase demand in the short run, not what 
would grow the economy in the long run, and those are two very 
different questions, as you suggest.
    Senator Grassley. Thank you, Dr. Crippen.
    Chairman Conrad. Senator Hollings.
    Senator Hollings. Now I get my chance.
    Thank you, Mr. Chairman. Here we go again, as President 
Reagan said.
    I do not see much difference between this kind of 
presentation and consideration of budget responsibilities and 
Arthur D. Andersen.
    Mr. Crippen. We did not shred any documents, Senator.
    Senator Hollings. Let us go right to the record. The record 
shows, for example, that the debt--I want to answer Senator 
Domenici. On page 17 of ``The Budget and Economic Outlook'' 
that you presented last year, Dr. Crippen, the debt goes up 
over $1 trillion, from $5.6 trillion to over $6.7 trillion. 
That wasp ut out in January, and the President comes on 
February 27 and says there are surpluses as far as the eye can 
see, surpluses, surpluses--when you have already reported that 
we are borrowing money, that the debt is going up. And I quote: 
``My plan plays down the unprecedented amount of our national 
debt and then, when money is still left over, my plan returns 
it to the people who earned it in the first place.''
    Then, the next week, the recession started. Whereas all we 
had to do was read what you said, that we were not having any 
surpluses. That is my resentment of this charade that goes on. 
We all say we are not spending Social Security, and we are not 
going to touch Medicare and so on, and then we use that 
euphemism of the public debt, the private debt, the government 
debt, on-budget, unified budget, and every other darn thing, as 
whether or not you spent more than you took in. And that is 
what we have been doing since Lyndon Johnson.
    I have been trying my level best to speak one language, 
namely, trying to be fiscally responsible. Now, the 
distinguished ranking member says that what we have got to have 
as our priorities the counter-terrorism war and homeland 
security, and I agree with him--but we have got to pay for it. 
Where is the idea that we are going to pay for it by further 
tax cuts, running up the debt?
    For years on end, we have been trying to pay down the debt, 
and this gamesmanship--you do not put the debt in this 
particular document that you have given us this morning; it 
only says the baseline surpluses. But I think there is an 
increase in the debt. I think CBO will put that out maybe next 
week, or something like that. In other words, in 2001, it goes 
from $5.772 trillion to $7.644 trillion. Isn't that correct, 
Dr. Crippen?
    Mr. Crippen. That's correct.
    Senator Hollings. So that is almost $2 trillion. Here we 
go. And on this page here--that is what is misleading, and that 
is why I say Arthur D. Andersen. This is what we who bought the 
stock, if you know what I mean--and I did not buy any, but let 
us say we who bought the stock--on page 7, you have baseline 
projections of surplus, when the truth of the matter is that we 
are projecting that the debt is going up, up, and away to the 
tune of almost $2 trillion. And then to talk about mistakes--my 
point is, most respectfully, Chairman Conrad, that it is not 
mistakes, mistakes, mistakes. All we had to do was read what 
the gentleman put down there in his budget report--and read it 
next week when they give it to us, because we only have half of 
the audit--this is the Andersen audit--here this morning, and 
it talks about surpluses when the truth of the matter, and Mr. 
Crippen has just testified, is that it is going up just about 
$2 trillion. And these 10 years--according to your document, $4 
trillion in 1 year?
    Then, on the debt limit, isn't it true, Dr. Crippen, that 
you projected that we would not have to increase the debt limit 
until 2009?
    Mr. Crippen. It was not quite that long, but it certainly 
was a year or two from now, not next month.
    Senator Hollings. On, no. It was 2009, you said in your 
document.
    Mr. Crippen. Was it? I know it was several years from now, 
because we anticipated paying down debt. But at the same time, 
as you point out, last year as well--other debt will be going 
up.
    Senator Hollings. We will have to get for you, because I 
have looked it up specifically. In any event, by December, they 
were asking us to sneak it into an appropriation bill so that 
we would not have to politically face the music here next 
month. In February, we are going to have to increase the debt 
limit--while all the time talking about let us get stimulus, 
and we are going to have tax cuts--that we do not have. And 
yes, Dr. Crippen, I want to do away with all the remaining so-
called tax cut. I voted against it and tried to kill it last 
year. If we can do that, we can do just exactly what Governor 
Bush--he does not call it a ``tax increase'' when he deals his 
tax cut. Senator Domenici, you call it a ``tax increase.'' I go 
along with Governor Bush, not President Bush, who calls it a 
``tax increase.''
    And then we read in the morning paper where a dozen 
Governors are going to have to increase taxes even in light of 
a recession, because they have got to maintain fiscal 
responsibility, and that is the primary responsibility of this 
Budget Committee. And we do not answer to that responsibility. 
We engage in the charade and call deficits surpluses.
    On page 4 of the CBO testimony of Dr. Dan Crippen of 
January 23, 2002: ``At that time, CBO also projected that the 
statutory ceiling on all Federal debt would not be reached 
until 2009.'' So there, we have congealed it, bam, right into 
it. That is how far off we are.
    So unless we get serious about paying down the debt--I can 
see the Senator from Texas, who said, ``When you raise taxes on 
Social Security, they are going to be hunting you down in the 
streets and shooting you like a dog.'' That is what he told me 
and----
    Senator Gramm. That was close, Fritz, but not exactly; I 
think it was ``with dogs.'' [Laughter.]
    Senator Hollings. Oh, yes. And then we increased gas taxes, 
and we had an 8-year economic boom. Ever since we started on 
this thing after President Bush's election, that we are going 
to cut and give the people back their money, give the people 
back their money, surpluses as far as the eye could see, when 
as far as the eye could see, there was nothing but deficits.
    That is my point in coming here this morning. I want to see 
if we can get some kind of sobriety and reality to these 
proceedings as a Budget Committee, because when we join in and 
the press joins in and uses the same dichotomy that it is 
surpluses instead of deficits, we are in trouble.
    My time is up. Excuse me, Mr. Chairman.
    Chairman Conrad. That is fine.
    Senator Gramm.
    Senator Gramm. Well, Mr. Chairman, the public finds what we 
do to be unrealistic because we sit here and say you did, you 
didn't, you did, you didn't, you did, you didn't, but when the 
public has disagreements, they go and look up the contract. 
When somebody goes to the grocery store and picks something up 
and goes to the checkout counter, they do not argue about what 
it costs; they go back to where you got it, and they look at 
what the price was.
    It seems to me that a very instructive thing to do here is 
to go back to the contract. And I just want to make note that 
in the 1998 budget, this Congress on a bipartisan basis and the 
Clinton administration entered into a contract to balance the 
budget in 2002. That was the contract.
    And if you look on pages 58 and 59 of that budget, and you 
compare it to the numbers in the projection you gave us today 
for 2002, it is very, very instructive, it seems to me.
    The American taxpayer to balance the budget this year was 
supposed to put up $1,890,400,000,000. In fact, looking at your 
numbers, the actual number despite the tax cut turned out to be 
$1,983,000,000,000, so as compared to the contract to balance 
the budget, the taxpayer actually put up $93 billion more than 
we were counting on him to put up even with the tax cut.
    If you look at your chart, I think the reason is that the 
tax burden even with the tax cut is very high by historic 
standards.
    On the other hand, our part of the bargain in discretionary 
spending was that we were going to limit discretionary spending 
to no more than $561 billion this year. That is the 1998 budget 
agreement on page 59; that was going to produce the balanced 
budget.
    What did it turn out to be in your projections? It turned 
out to be not $561 billion, but $733 billion. So we spent $172 
billion more than we committed that we were going to spend to 
balance the budget when we entered into this agreement in the 
1998 budget.
    In fact--and I think it is very interesting--$127 billion 
of that $172 billion over overspending occurred before January 
1, 2001. In other words, it occurred under the previous 
Congress and the previous President. If you remember, we had 
that spending orgy in the last 3 months of the last Congress.
    So in regard to who did what and who is responsible, the 
point I want to make is that in this bipartisan agreement with 
the previous Administration, if you take it as the guideline--
like going to look and see what the can of peaches cost where 
you picked it up, or what the contract was--it seems to me that 
our problem is overspending.
    But here is the point that I want to make. Ultimately, many 
of our Democratic colleagues--and Senator Daschle is at the 
very top of the list--basically say that the tax cut is the 
embodiment of all evil in the country; it made the recession 
worse, and it produced all kinds of terrible problems. I think 
the problem with that approach is that ultimately, the American 
people are going to ask: Well, if it is so terrible, why don't 
you reverse it?
    I might also say, to make this somewhat bipartisan, that 
Republicans cannot sit here and say that spending is the 
problem and then keep voting for all this spending.
    Ultimately, it is not--and I have always, I think, 
consistently said this about the budget, and I believe it--what 
I have witnessed in my 24 years of dealing with the budget--and 
I have been involved in every budget for 24 years, and my 
mother once asked me if it bothered me that the deficit kept 
getting bigger, and I ran for Congress to get rid of it, and I 
always responded that, well, everybody knows what I am trying 
to do, and at one point, I actually thought we had gotten rid 
of it; it just did not last long.
    But here is the point. If we are going to sit here, and the 
Democrats are going to say the problem is the tax cut, but we 
do not want to reverse it, and the Republicans are going to say 
the problem is spending, but we do not want to control it, what 
is going to happen? Nothing.
    Ultimately in these budgets, it is not what the reality is 
that it seems to me is so important, it is what are we going to 
do about it. What are we going to do about it?
    I would just like to say, Mr. Chairman, that we can go in 
one of two directions here. We can have a partisan approach, 
and you all can try to write a budget, and you might be 
successful in writing it; or we could sit down on a bipartisan 
basis and see if we can write a budget.
    It seems to me that if we could do that, we would maximize 
the probability of one being adopted. I am very concerned that 
all of our spending constraint measures that we have put into 
place in the past that have given us all these budget points of 
order, which have not always been successful, but they have 
helped--they are all gone now. Unless we put them back into 
place, not only will we not have a fort to protect ourselves, 
we are not even going to have a good stone wall to our backs in 
a gun fight.
    It seems to me that, hopefully, we might be able to reach 
an agreement to write a budget that puts some of these 
constraints back.
    Let me also say that it is true that we are in a recession, 
it is true that we are in a war, but I would have to say that I 
still believe that there is a tremendous number of programs 
that we are funding that do not make sense in the modern 
context. As I looked at the defense appropriations bill, while 
there was much in it that I supported, there were many 
provisions in it that I thought had more to do with bailing out 
corporate America than they had to do with defending the 
country.
    So I believe that we can improve our situation by 
controlling spending, but in the end, I do not think we are 
going to get anywhere by just simply saying the big problem is 
the tax cut--of course, we are not saying that it is the 
embodiment of all evil and has produced all of our problems--we 
are not saying we want to change it, of course. We just want 
you to know what the facts are.
    And on our side, I think that if we are saying the problem 
is spending, we ought to be willing to do something about it.
    I did not get to make an opening statement, Mr. Chairman, 
so I just took this time to do that.
    Chairman Conrad. I thank the Senator, and I welcome his 
observations with respect to measures on constraint. I do think 
that we as a committee have a special obligation now that we 
are back in deficit to review the whole question of those 
constraints that are going to end this year. I look forward to 
working with Members on both sides. I think it is going to be 
critically important that we get those constraints put back in 
place.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman, and welcome, Dr. 
Crippen.
    I want to ask a couple of specific questions, and I have a 
statement for the record. I particularly want to thank you for 
pointing out that when you look at 2010 and beyond, you run 
right into that projected Federal spending on Social Security, 
Medicare, and Medicaid that is going to cause enormous 
constraints on our ability to make other choices. We are 
running roughshod into that box, and I think that is one of the 
reasons why there is so much emphasis on the tax cut. If we 
invade the Social Security Trust Fund and the Medicare Trust 
Fund now, we do not have the ability to deal with that.
    I have a couple of specific questions. First of all, are 
your estimates on interest rates averages over the year--they 
must be. I am presuming when you say short-term 3-month Bill 
rates are 3.4 in 2001, that must be the average for the year.
    Mr. Crippen. The average for each quarter.
    Senator Corzine. Quarterly averages. Because as I recall, 
interest rates at this time a year ago in the short-term area 
where roughly 6.5 percent on the Federal funds rate, and I 
think they have come down 4.75 percent. And the whole debate 
about long-term interest rates having an impact on the economy 
and having impact on budget projections and interest costs is 
the fact that they have not moved, and short rates have 
declined 4.75 percent in that timeframe. So it is the shape of 
the curve that I think people are emphasizing as the basis for 
why long-term rates are looking, at least to some extent, 
whether it is inflation or the inflationary impact of borrowing 
in the market. I wonder if you have made an estimate of what 
the difference--I think you mentioned this; I know that Senator 
Conrad did--the expected debt at the end of the decade is $2.8 
trillion as opposed to estimates last year of $600 billion; is 
that rightly right?
    Mr. Crippen. That's right--for debt held by the public.
    Senator Corzine. I would argue that for those who operate 
in the financial markets, $1 trillion tends to have some impact 
on people's expectations about where interest rates will be in 
the future, and I think that when we are looking at interest 
rates that have not moved in a year, that is a pretty dramatic 
statement in and of itself given that we have had a 4.75 
percent decline in short rates at the same time. I think that 
is impacting back into these budget projections, and I think 
that is worrisome, because it both leaves us with less 
resources to spend on whatever it is--homeland defense, 
national defense, or a prescription drug benefit--and I think 
is a potentially serious cost.
    If you have any comments on that, I would be curious.
    Mr. Crippen. As I mentioned earlier, Senator, there is not 
convincing, compelling evidence that we have found to link the 
budget deficits with interest rates. Clearly, there must be a 
supply demand phenomenon going on here, and if we are demanding 
more and selling more debt, that could have an impact. But 
there are lots of other things going on as well, not the least 
of which is the rest of the tax bill, which could have 
different offsetting effects.
    What we are focused on, and what is part of your question, 
is what does the implied increase in debt do to interest rates? 
That is an important question, but not the only one. We do not 
do dynamic estimates of the tax changes or spending changes in 
part because there are so many of them. So to focus on just one 
factor, I would suggest, whether you are right or wrong, 
whether that is the correct phenomenon, is not the whole 
picture, anyway.
    Senator Corzine. I would agree that there are other things 
operating, including the strength of the economy at the time, 
but $1 trillion is something that generally, people factor in--
it affects supply and demand.
    Do you have productivity assumptions built in that I have 
not been able to see? One of the most controversial elements in 
projections of the budget surpluses a year ago was productivity 
assumptions that were outside the range of what was seen, at 
least except in the last 5 years of the 1990's. I did not see 
them in there.
    Mr. Crippen. They may not be in what you got today; they 
certainly will be in the January 31 publication.
    Senator Corzine. Do you know what those are offhand?
    Mr. Crippen. We reduced them again somewhat. I think we 
took total factor productivity (TFP) 0.2 percentage points.
    Senator Corzine. So it still would be large relative to 
other periods in the last 20 years.
    Mr. Crippen. Relative to the 1970's, certainly, but smaller 
than the previous five years.
    Senator Corzine. One thing that I think we can all agree 
on--that fan-shaped analysis that you talked about is a real 
issue that we need to understand when we sit down and hammer 
out whether it is tax cuts or spending cuts or however we put 
the budget together. There is a broad range of probabilities 
that we need to assign, and one of the chief issues of debate 
is this productivity assumption, and it makes big swings in 
where we are. So interest rates and productivity are things 
that I am certainly concerned about.
    I understand that over the break, you did a review of some 
of the options on economic stimulus and recovery. I would like 
to know how you thought accelerating the marginal rate cuts 
that have been proposed would do with regard to short-term 
stimulus and the economy?
    Mr. Crippen. As I recall, we concluded that relative to its 
costs, it would not do a lot to increase demand in the short 
run.
    Senator Corzine. And were there particular initiatives that 
you thought would increase short-term demand?
    Mr. Crippen. The things in particular that put money into 
taxpayers' hands quickly. As I suggested earlier, the form of 
that can be important, too, whether it occurs in a lump sum, 
which does not appear to be consumed as quickly, at least, and 
probably not as much, or if it appears in payroll checks, where 
it has a higher tendency to be consumed.
    Senator Corzine. So, Senator Domenici's proposal with 
regard to a payroll tax holiday has a higher incentive?
    Mr. Crippen. Yes.
    Senator Corzine. Finally--and this is the hardest of these, 
and you will probably want to duck it, but I will ask it 
anyway--do you have a view on the question of whether a tax cut 
that is not implemented is a tax hike?
    Mr. Crippen. Well, I will duck it only a little in that it 
is kind of an existential question.
    Senator Corzine. But real for some of us with beards.
    Mr. Crippen. I understand. We have lots of things like this 
in the budget world--is a reduction in the increase in spending 
a cut or an increase--and we do a lot of dancing on the heads 
of pins.
    I can say that the rules that govern what we do and how we 
score things would clearly show a delay or an elimination as a 
tax increase or revenue increase, because our baseline assumes 
current law, and current law has the further reductions 
embodied in it.
    So for scoring purposes, I can tell you that we would show 
it as a revenue increase.
    Senator Corzine. Thank you.
    [The opening statement of Senator Corzine follows:]

              OPENING STATEMENT OF SENATOR JON S. CORZINE

    Thank you, Mr. Chairman, and welcome, Director Crippen.
    I personally want to thank you and your staff for your cooperation. 
I particularly appreciate your willingness to present an analysis that 
presents some bad news rather clearly--that last year's tax cut has put 
us on a path that will use Social Security funds over the next 10 
years, and beyond.
    Mr. Chairman, CBO's new report verifies what many of us have been 
suggesting for some time: the Federal Government's long run fiscal 
condition is much weaker than we thought last year, when we passed huge 
new tax cuts.
    Now we face the prospect of deficits for several years, with a 
significant invasion of Social Security and Medicare Trust Funds. And 
that's before we even consider new funding for national security, 
homeland security, prescription drugs and other legislative priorities, 
or an immediate economic recovery program that I believe all of us 
support.
    Mr. Chairman, throughout last year's tax debate, you and many of us 
sounded the alarm about the questionable assumptions underlying the tax 
cut. We said that 10-year forecasts were inherently uncertain. We said 
they failed to account for unforeseen security threats and other 
inevitable emergencies. We questioned the rosy productivity scenarios. 
And we pointed out that official baselines hid many other known costs 
and future liabilities.
    Unfortunately, these warnings were ignored or deflected by best 
case expectations. And now the chickens are coming home to roost, or at 
least they are standing on our doorstep.
    The world is a very different place than when Director Crippen came 
before us last year. We have a war on terrorism to fund. We need to 
beef up security here at home. Our economy is in recession. And the 
health care crisis is only getting worse.
    Mr. Chairman, a changed world means that our fiscal policy should 
change, as well. It's now clear that we simply cannot afford all of the 
huge tax breaks for high income individuals in last year's tax bill. If 
we don t revisit some of them, it is inevitable that we will both raid 
the Social Security Trust Fund now and into the future, but we will 
fail to provide a meaningful prescription drug benefit. We won't have 
the resources.
    Does that mean we should raise taxes in the middle of a recession? 
Absolutely not.
    Does it mean that we should raise one penny of taxes from 
struggling middle class families? Absolutely not.
    But does it mean that people with incomes over, say, $140,000 may 
have to wait before getting more tax cuts in the future? Yes. Frankly, 
the choice is between that and raiding Social Security. There's just no 
way around it.
    Mr. Chairman, based on recen headlines, for years, the Enron 
Corporation used phony accounting to hide the truth. In the past year, 
unfortunately, we've seen the Enronization of the Federal Government. 
If we don't confront the truth about our fiscal condition, and change 
course, the long term consequences could be similarly disastrous.
    With that, I look forward to hearing from Director Crippen and 
working with you and all my colleagues in the year ahead.

    Chairman Conrad. Senator Hagel.
    Senator Hagel. Mr. Chairman, thank you.
    Dr. Crippen, thank you. I do not often have the opportunity 
to listen to existential conversation.
    Mr. Crippen. We will get to metaphysical next.
    Senator Hagel. I will have to leave--but thank you for 
appearing. Your input is, as you know, very important.
    One of the points that you made as you presented to this 
committee projections for outyear spending on Social Security, 
Medicare, and Medicaid, that Senator Corzine was referring and 
others have referred to, is something that we have all been 
mindful of--sobering numbers. If I recall, a point that you 
made was that it is not just important that you maintain the 
trust funds, but the real issue is how do you grow the economy. 
Is that generally a correct paraphrasing of what you said?
    Mr. Crippen. Yes.
    Senator Hagel. And with that as kind of our baseline here, 
I would like to start where you left off with Senator Corzine 
on scoring tax cuts. It is my understanding that the Joint 
Committee on Taxation does most of that; they are looking for 
ways that might make more sense to improve the macroeconomic 
dynamic of tax cut scoring. I think you take into consideration 
some of the behavioral patterns that you can track through 
various sources.
    The first question about that is do you think it is 
important that your committee would eventually get to a dynamic 
scoring model to include the benefits of tax cuts--if there are 
any--to the economy? For example, you mentioned growing the 
economy. Is it important, as you responded to Senator Corzine 
about productivity, to factor in investment spending? Does that 
affect productivity? Does that affect economic growth? Does 
that then affect tax revenue? I am a bit biased because I think 
it does.
    Could you take us through that a little bit and explain 
what you are doing and what you are not doing? Are we losing 
something here by a static analysis of tax cuts? I think 
history is rather complete if you look at the last three rather 
sizable tax cuts, and in fact it has generated significant new 
tax revenues. I go back to the Mellon tax cuts from 1921 or 
1929, I think, generally in that area.
    I would be very interested in your thoughts about this.
    Mr. Crippen. Senator, currently, of course, as you already 
said, we do not generate the revenue estimates of changes in 
law; that is the Joint Committee's purview. On the other hand, 
it is not entirely their responsibility to assume fully dynamic 
estimates, because we would have to change our baseline if 
there were to be such an incorporation. And we have certainly 
been talking to them about what they see as compelling evidence 
one way or the other on certain tax effects.
    Having said that, though, we currently include in our 
harding assumptions what we anticipate the economy will be like 
over the next 10 years, and that would include any effect of 
tax revenues, up or down. In that sense, we incorporate 
legislation as we know it when it comes time to do the 
baseline.
    So there is a macro dynamic included in our baseline, and 
that is for current law. Now, if you propose further tax 
changes this year, we would not feed those back into our 
baseline and would not get a revenue estimate that is dynamic 
in the way that you are discussing.
    We tend to agree that there are some macrofeedbacks. As 
Senator Corzine was saying, it is possible that there is an 
increase in long-term interest rates involved here. We do not 
have compelling evidence for that, and we do not include it in 
the baseline at this point. And there are other things in the 
tax bill that would perhaps help economic growth.
    So the net of it is, we have a sense of--and the economics 
profession has some conclusion about--the direction of change 
with some particular types of taxes that will help or hurt, for 
example, economic growth or the labor supply or some other 
aspects; but we do not have any conclusion as a profession 
about the magnitude. So if we have offsetting effects, as we do 
in many cases, because it is not just a rate cut bill, and it 
is not just a rebate bill, it is hard to say on balance where 
it comes out.
    We do try, however, after the fact to qualitatively give 
you an assessment of what macroeconomics, at least as we 
currently practice it, would suggest. We did that in August as 
a qualitative statement about how the tax cut--the tax bill at 
that time--is likely to help economic growth in the long run, 
but probably by small amounts, in part because in truth, the 
annual amounts of the tax reduction are small relative to the 
size of the economy.
    Senator Hagel. Do you think generally that you can make any 
fair assessment one way or the other that tax cuts help 
economic growth or assist the economy in any way?
    Mr. Crippen. No. In general, the profession would say that 
certain kinds of tax cuts like marginal cuts----
    Senator Hagel. What we passed last year.
    Mr. Crippen. Some of that would, yes. As I said, there is a 
qualitative assessment that has been very public, that we put 
in our August update, talking about the various pieces of the 
tax bill and the kinds of effects they would have on the 
economy. But again, as you started out with and I concluded 
with, what we need to keep our eye on in most of these 
discussions is what effect do those things, whatever they are, 
have on the growth of the economy. Ultimately, it is the 
economy that is the trust funds. It is our kids who will be 
paying us, so the way we can help them is by growing the 
economy.
    Senator Hagel. One final question, since I think I have a 
minute left--or maybe not.
    The $40 billion that we passed last year in emergency 
supplemental spending after September 11--as you recall, we put 
$20 billion of that in fiscal year 2001 and the other $20 
billion in fiscal year 2002--how has that been scored?
    Mr. Crippen. The $20 billion that is in fiscal year 2001 
would not be extended in our baseline, because it was not for 
the current fiscal year, in effect. The rules tell us we have 
to include what is in 2002 and inflate it for the future. So 
the second $20 billion is included in the baseline as $20 
billion, and then it gets inflated.
    Senator Hagel. Where is that in your budget? Where is that 
located, under what----
    Mr. Crippen. It is split among the various agencies that 
received the appropriations. Only about $2.8 billion, as I 
recall, went to defense: the rest of it was split among 
domestic agencies of FEMA and HHS for bioterrorism and other 
things. So it was spread out across the budget, and we have a 
breakdown of that if you would like it, but that is where it 
shows up in the agencies.
    Senator Hagel. Dr. Crippen, thank you.
    Mr. Chairman, thank you.
    Chairman Conrad. Thank you, Senator Hagel.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman, for holding 
this, what I believe is a most important meeting that will set 
the stage for the entire year and, frankly, the decade into the 
future, and thank you to Dr. Crippen as well.
    I would like to step back and speak from a big picture 
standpoint. I agree with our esteemed ranking member, who 
certainly is an expert on budget matters, that when we look at 
our priorities right now, safety and security, the war on 
terrorism, homeland security certainly top our agenda; the 
economy, jobs, making sure that people are able to care for 
their families and make a living and create businesses and so 
on certainly top the agenda.
    When I listened to Dr. Crippen talk about the fact that 
within 10 years, on the course that we are headed, we will be 
looking at massive tax increases or debt or cuts which would 
include, I assume, defense and homeland security and education 
and other areas, if we do not deal with what is happening right 
now. So we have top priorities that we agree on, and we know 
that we are on a collision course in terms of the budget if we 
continue to use Social Security and Medicare funds, and yet we 
have not at this point been willing to look at all the 
decisions we have made in the last year and the impact that 
they have.
    I believe very strongly that it is irresponsible for us to 
move forward and not review decisions that we made last year 
concerning the phase-in of tax cuts which, frankly, Mr. 
Chairman, we all know that once we got beyond the $300, are 
very much geared to the top 1 or 2 percent of the public--the 
wealthiest Americans.
    Senator Hollings spoke about Arthur Andersen, and I want to 
make a comparison to Enron, not because they are connected at 
all. But in my home State of Michigan, there is a real feeling 
that this is a lot like Enron, where the folks at the top take 
their money out and leave the middle class taxpayers paying for 
it through their retirement funds and loss of 401(k).
    I would argue that what we have been told today is very 
much like that. The top one or 2 percent of the public will get 
major tax cuts, paid for by the retirement earnings of Social 
Security and Medicare by the majority of Americans. I believe 
that that is wrong, Mr. Chairman, and we need to reconsider and 
rethink that decision.
    I would urge us in that process to go back to something 
that Senator Snowe and Senator Bayh and I spoke about last 
year, which I believe we should have put in place, and it is 
not too late to do, and that is some kind of framework or 
budget trigger where we do not proceed with either a phase-in 
of tax cuts on spending if it dips into Social Security and 
Medicare.
    I would like to share with you what is happening in 
Michigan right now to demonstrate that this is not a partisan 
issue. We have a well-known Republican Governor, John Engler, 
and the cornerstone of his Administration has been tax cuts. 
The House and Senate of Michigan are a majority Republican. Yet 
when they put in place a 10-year phase-in of the elimination of 
the single business tax a couple of years ago, they put a 
budget trigger on that. They said that if the rainy day fund or 
the surplus of the State dipped below a certain amount, $250 
million, they would suspend the next phase-in of the cut until 
they could pay for it without the State of Michigan going back 
into deficit.
    This year, they are having to suspend that phase-in, that 
next step, as I understand it, in order to avoid going back 
into debt. I would argue that that is a good lesson for those 
of us here who care desperately about fiscal responsibility and 
keeping the budget balanced and, most important, protecting 
Social Security and Medicare.
    I would very much hope that in this debate, Mr. Chairman, 
we would have the opportunity to once again debate this 
framework of a trigger that puts in place the values of doing 
all we can to protect Medicare and Social Security and maintain 
fiscal responsibility as we move forward.
    Dr. Crippen, I do have a question for you that relates to 
your numbers. You have indicated that your 2003 to 2012 unified 
surplus projection is about $2.2 trillion, as I understand.
    Mr. Crippen. Yes.
    Senator Stabenow. However, you also stated in your 
testimony that this projection includes the gimmick that was 
passed last year in the tax bill, where all of the provisions 
of the tax cut sunset in 10 years.
    Could you speak to what ultimately happens if the sunset is 
eliminated and the tax provisions continue, and what that would 
do to our overall fiscal situation?
    Mr. Crippen. It would worsen it in the context that you are 
discussing by several hundred billion dollars; that is, if the 
tax changes are extended beyond their current expiration, 
surpluses would be smaller, and there would probably be no on-
budget surpluses in 2011. So it would increase the amount of 
debt, and it would reduce the surpluses.
    Senator Stabenow. So if we are having difficulty now just 
suspending the next steps in order to protect Social Security 
and Medicare, my assumption is that it would be difficult 10 
years from now in order to see those sunsets take place. So I 
think it is important for us to also see in the context of the 
concerns about Medicare and Medicaid and Social Security--they 
become, I believe you just said, several hundred billion 
dollars worse if the tax policies are extended beyond the 10-
year period. I would hope that we would consider that as part 
of the discussion as well, Mr. Chairman.
    Thank you.
    Chairman Conrad. Senator Allard.
    Senator Allard. Mr. Chairman, thank you very much, and Dr. 
Crippen, I appreciate your coming to talk to us at the 
committee today.
    I do want to talk a little bit about tax cuts, but I would 
like to make a point before we get too far. Whenever we get to 
talking about putting some kind of trigger in the budget, we 
always want to apply it to taxes, and we do not want to apply 
it to spending. It seems to me that there needs to be some 
balance in there if we are going to take the trigger approach, 
and I think that we certainly need to look closely at triggers 
on spending as well as triggers on tax cuts.
    There is a theory that some economists espouse, and I would 
like to hear you comment on, called the Laffer Curve. I do not 
think anybody on this committee has talked much about the 
Laffer Curve recently. It says that if you have 100 percent of 
income taxed, you do not expect any revenue to come in to the 
Federal Government because people would not have any incentive 
to work; they would not earn anything. If you did not tax 
anything at all, there would not be any income in government 
because you were not collecting taxes. But there was a bell 
curve that somewhere in between, you could reach a point on 
that curve where you had maximum revenue coming to the 
government, and if you stepped over that, it would reduce, and 
if you went down on the other side, you would not have the 
maximum amount of revenue that you would expect to come in to 
the government coffers.
    As the Chairman of the Finance Committee has said, taxes 
are at one of the highest points in the history of this country 
as far as gross domestic product is concerned. I cannot help 
but think that we are toward the top of that curve somewhere, 
and maybe even around the year 2000, looking at the charge, it 
looks like it is the highest it has been since World War II.
    Would you comment a little bit about where you think we 
might be on that curve, and maybe how you feel about that 
approach?
    Mr. Crippen. I think your setup of the Laffer Curve is 
absolutely true. Both extremes would give you zero revenue. But 
I do not know, frankly, and I am not sure our profession knows, 
a lot more about what the shape of that curve is or how it is 
constructed. That is, I do not know where we are currently on 
it, at it, or beside it.
    Senator Allard. Do you think it would be a helpful tool?
    Mr. Crippen. Well, if we knew with some certainty, sure, it 
would be useful. My guess is that although the research has 
been done, it has not really been able to nail it down. We have 
some general--some might call them platitudes--but general 
truths, if you will, that if you tax something, you will 
probably get less of it, so there is a diminishing return at 
some point on taxing labor or capital. On the other hand, there 
are collective needs of the government, so the appropriate 
level of revenue can be determined perhaps more by the needs of 
the government than a particular position on the Laffer Curve.
    So there are all of these trade-offs, but the short answer 
to your question is that I do not know.
    Senator Allard. OK. If we have spending at a high level, 
tax rates at a high level, it seems to me, to followup on your 
comment that we have two taxes, that if taxes get too high, it 
could have a depressing effect on government; but the inverse 
would also be true--you could also cut taxes and then stimulate 
the government. Would you admit that that could happen?
    Mr. Crippen. Sure, it could.
    Senator Allard. Capital gains has a record, for example--
during the Kennedy administration, President Kennedy proposed 
dropping capital gains, the Congress did it, and it increased 
revenue for him to have more spending. That happened during the 
Reagan administration, and it happened recently--when capital 
gains went from 28 to 20 percent, there was about $60 billion 
in unexpected revenues that was not accounted for--and I think 
at that time, it was just a straight line. I do not think in 
any of the projections that anybody was trying to project that 
it would have that positive impact.
    I am wondering, during these times when we need an economic 
stimulus, if you would view a drop in capital gains as one of 
the most beneficial things that we could do to stimulate the 
economy.
    Mr. Crippen. Given this recession, it is a more interesting 
proposition than it might have been--that is, that this 
recession seemed to be precipitated by a falloff in capital 
investment more than a lack of consumption, although 
consumption did slow.
    So if you were to change the taxation of capital writ 
large--and I will not speak just to capital gains, but to 
changing the taxation of capital--you might in fact get 
companies to invest. There were some proposals discussed last 
year about an investment tax credit, which we have not had for 
a while, which, if it were applied to only new purchases, might 
tip some companies into making capital purchases that they 
would not have before.
    But all of it is on the margin, and marginal impacts, of 
course, are important for economists, but even with an 
investment tax credit of 5 percent or 10 percent, that capital 
still has to produce a profit for that company in the future. 
The tipping point of what would induce an investment is not 
clear. This does not help you a lot--but in general, if you 
reduce the taxation of capital gains, you make capital cheaper, 
and there will be an incentive to use more of it. And the 
reduced demand for capital was the principal cause of this 
recession.
    Senator Allard. I brought up the issue of capital gains, 
and I appreciate your response on that. You also mentioned the 
investment tax credit, and I agree with you; I think there is 
perhaps an advantage there to help get our economy going. Can 
you think of any other tax reductions we could do that would 
have a stimulatory effect during a time of recession?
    Mr. Crippen. Well, it depends, Senator, too, on what you 
believe we need. As our response to Chairman Conrad over the 
break said, if you are trying to stimulate consumption, which 
may be the predicate needed to get companies to invest again, 
you need to put money into consumers' hands, and you need to do 
it quickly, and probably some ways are better than others.
    If you are looking to stimulate long-term economic growth 
as opposed to getting us out of the current recession, then you 
may have a whole different set of tax tools.
    And as you just suggested, lowering the taxes on capital 
may induce some companies who are close to investing anyway but 
have not yet done so, to do it.
    All of those could be helpful. As we know, there can be 
countereffects, but in the main, if you want to stimulate 
consumption, give money to consumers; if you want to stimulate 
capital, obviously, you reduce the taxes on new capital 
investment.
    Chairman Conrad. The Senator's time has expired.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Feingold.
    Senator Feingold. Thank you, Mr. Chairman.
    It is good to be back, although this hearing is a little 
depressing when you look at these numbers. It is not reassuring 
at all. The outlook for the budget both in the short term and 
over the next 10 years is troubling.
    You pointed out in your presentation, Mr. Chairman, what a 
contrast this is to a year ago when, even as late as last May, 
CBO was projecting a unified budget surplus totaling $5.6 
trillion over the next 10 years.
    And as we know, those of us who have been on the committee 
for a while, this committee holds this hearing about this time 
every year, and we get CBO's best guess as to the state of the 
budget and the economy over the next several years. And CBO is 
very careful to point out that the projections are only 
guesses, as educated as they may be, and that as such, they 
could be off and that they could be off by a lot. And I want to 
thank you, Director Crippen and others, for indicating that 
caution.
    In fact, in the past, the CBO has devoted an entire chapter 
in their budget outlook document to this very issue of 
uncertainty, and I have joked on occasion that maybe we should 
move it up to the front of the book, and now this seems a 
little more serious, just how dramatically important it is.
    This uncertainty obviously should not paralyze us. I have 
no doubt that we are getting the best estimates possible. But 
if nothing else, our experience of the past year should teach 
us that the policy course we choose should reflect the 
uncertain that is inherent in the CBO's budget projections and 
that when we craft a budget based on those projections, we 
should do so with humility.
    The President has used the word ``humility'' very 
effectively in other contexts. But last year, the President and 
the Congress did not treat those projections with humility. The 
policies enacted pursuant to that budget did not reflect the 
uncertainty of the projections, and as a result, we have an 
enormous budget hole to fill for years to come.
    I also want to compliment Senator Gramm's point about the 
expiring points of order. He is absolutely right. They are not 
a substitute for making tough decisions about which programs to 
cut, but they certainly help us to sustain any fiscal 
discipline we can achieve, and we need to extend them in some 
form.
    I came here in 1992, hoping to just get the deficit down, 
and I think those budget rules helped us go beyond that and 
actually get rid of it for a brief moment. We simply cannot be 
credible with the American people if we do not have those kinds 
of rules in effect.
    Let me ask two quick questions, and this one has already 
been asked in some other ways by both Senator Grassley and 
Senator Corzine. In a speech on January 11, Federal Chairman 
Greenspan said, ``Some of the firmness of long-term interest 
rates probably is the consequence of the fall of projected 
budget surpluses and the implied less rapid paydowns of 
Treasury debt.''
    Do you agree with Chairman Greenspan that interest rates 
are probably higher than they otherwise would be because the 
government has returned to running budget deficits?
    Mr. Crippen. Yes, with one caveat, and that is that the 
sentence, as I recall, that Chairman Greenspan uttered before 
the one you cited was that much of the run-up in loan rates can 
be attributed to the better economic outlook. So it certainly 
can be a factor. Again I would suggest that that would be an 
incomplete analysis--and I do not mean to chide the Chairman, 
but you will have him tomorrow, and he can get even--but that 
would be an incomplete analysis of the effects of the change in 
the budget outlook, and it could be positive or negative, but 
that one aspect alone does not tell you the whole story.
    Senator Feingold. Fair enough.
    In a report issued earlier this month, CBO said in part 
that ``Payroll tax holidays are likely to have the greatest 
bang for the buck of the proposals assessed in this report. 
Advancing the cuts in marginal income tax rates would have a 
relatively small bang for the buck because of the options cost, 
and repeal of the corporate alternative minimum tax would be 
least likely to generate significant stimulus.''
    First, do you stand by those conclusions?
    Mr. Crippen. Yes.
    Senator Feingold. OK. Then, based on this analysis, would 
we not expect to get the greatest bang for the buck, as your 
report put it, out of proposals like the one made by Majority 
Leader Daschle on January 4 and the one that former Chairman 
Domenici made last year that would cut the payroll tax, and 
that we would not expect to get a relatively small bang for the 
buck out of proposals like that passed by the House of 
Representatives on the last day of last year's session, which 
would advance marginal income tax rates and reduce the 
corporate alternative minimum tax?
    Mr. Crippen. I will leave those characterizations on the 
record the way you have stated them. It is certainly true, we 
believe, that if your point is to increase and stimulate 
consumption, then something like the payroll tax holiday, which 
puts cash into people's hands and does it in a way in their 
paychecks that we think will actually induce them to spend more 
than they would otherwise, is probably the best use of a 
stimulus dollar.
    The elimination of the corporate alternative minimum tax is 
probably the worst, because in many ways it is just changing 
the taxation of capital already in place; it may be meritorious 
on other grounds, but certainly not as a stimulus matter.
    Senator Feingold. And how do you rank the marginal income 
tax rate cuts as opposed to the payroll tax holiday?
    Mr. Crippen. The same way we in our report; it would be 
lower in terms of bang-for-the buck, not nearly as good as the 
payroll tax holiday.
    Senator Feingold. Thank you, Dr. Crippen.
    Thank you, Mr. Chairman.
    Chairman Conrad. Senator Snowe.
    Senator Snowe. Thank you, Mr. Chairman.
    As we begin this new year, I hope that somehow we can 
reconcile our differences and produce a bipartisan budget 
resolution. I could not help but think as well of the old 
cliche--what a difference a year makes. When we look back at 
the CBO report of last year, Dr. Crippen, that report indicated 
that ``The slowing economic data do not as yet constitute a 
strong reason to expect a recession.''
    We know that the world is of course radically different 
from that time a year ago, and certainly an already faltering 
economy was exacerbated by the devastating attack on September 
11. And I think the question is where do we go from here, and I 
think, like Senator Stabenow, with whom I worked on the 
trigger, that it is a policy mechanism that I do think is 
prudent and practical, and I think it is one that we should 
revive as we consider the budget this year.
    Obviously, as Senator Stabenow indicated, the State of 
Michigan has introduced a trigger mechanism; the State of Maine 
has done that on occasions. It is a great way of controlling 
events that you otherwise cannot control because it is very 
difficult to forecast and to foresee some of the events and 
circumstances that might be created.
    So I hope that we can look at that issue once again on a 
bipartisan basis--and it did include not only tax cuts, but it 
also included spending, because as Senator Gramm rightfully 
pointed out, he referred to the year 2000 and the changes that 
we made in policy that had an impact over 10 years of an 
additional $561 billion in increased spending. If you look at 
the 3-year total of changes in spending, it amounted to an 
additional $1.24 trillion in additional spending that had an 
impact over the next 10 years. So that clearly, spending as 
well has to be entered into the equation to see exactly what 
has occurred with the surplus.
    Dr. Crippen, I was interested in your economic forecast and 
your projections for economic growth, because I think that 
clearly, our goal has to be maximizing economic growth. I 
noticed that in the year 2003, you actually project higher 
economic growth than in the original forecast of January 2001, 
higher between the years 2004 and 2007 than the projection of 
this last year, and the same between the years 2008 and 2011. 
Are you suggesting, then, that what is affecting our surpluses 
is in the year 2002 and 2003 alone?
    Mr. Crippen. No, Senator. Our forecast, which you just 
cited, is clearly relative to last January. Growth is much 
weaker now, negative in parts of last year, at least. And the 
2003 that you cite is a bounce-back, if you will, from being 
well below what our normal growth would be. With inventory 
accumulation and other things, we forecast that we will get the 
4.7 percent or so growth in GDP that I think we suggested for 
next year.
    But the 10-year average is still lower than we forecast 
last January by several tenths of a percentage points, on 
average, so we are at a rate of about 3 percent total real 
growth. But the heart of your question, I think, is whether 
this is just a problem for the next year or two. In fact, the 
changes in economics have an effect over the longer term, both 
the changes themselves--we are starting from a lower base--and 
the revised data, which says we have less capital than we 
thought we did before, which would reduce growth as well. So we 
have taken growth down over the period as well as the revenues 
produced from that economy.
    I do not know if I have been responsive.
    Senator Snowe. I am interested because the report indicates 
that you expect economic growth to be roughly the same as was 
projected last January over the 2002-2011 period on an average. 
So what exactly would--is it the year 2002 and 2003 economic 
growth projections that are having the significant impact of a 
loss of 71 percent of the surplus over 10 years?
    Mr. Crippen. No. Certainly, the economy is the single 
biggest factor for the next two or three years. After that, the 
legislation, for tax cuts and revenue cuts and spending 
increases, starts to predominate as the single biggest factor. 
But the change in economics which accounts for some 40 percent 
of the $4 trillion reduction in the surplus, some of its 
effects are spread out over the entire period. Economic and 
technical revisions, taken together, amont to 40 percent of the 
$4 trillion revision. Many of the revisions labeled 
``technical'' have an economic source.
    Senator Snowe. Doesn't that provide a rationale for a 
stimulus package, I mean, to try to turn around the short-term 
nature of this economy? Irrespective of the fact that 
technically, we may emerge from a recession, the question is 
what type of recovery, and that could have a predominant 
influence on economic growth. If we have a jobless recovery 
that is similar to 1991, clearly, people are not going to feel 
that they have emerged from a recession, but it is also going 
to have an impact on our revenue picture as well.
    So wouldn't a stimulus package of some kind that could 
clearly influence the short-term behavior of this economy make 
a pronounced difference in the short-term projections and 
ultimately the bottom line?
    Mr. Crippen. If it could make a difference in economic 
growth, then yes, it would make a big difference to the bottom 
line. It is the weakness in the next year or two that could 
contribute substantially, particularly in the short run, to the 
change in our outlook.
    Senator Snowe. And you mentioned in the CBO Outlook of last 
year that a 0.1 percent change in growth can clearly have an 
impact on the surplus of $244 billion over 10 years. Is that 
pretty much true today?
    Mr. Crippen. Right. I think we stayed close to that number. 
It is in Appendix A. It will be in the first appendix of the 
report that will be published next week, but yes, it is about 
the same.
    Senator Snowe. So that obviously, our focus should be on 
changing those economic growth numbers this year and next 
particularly; would you agree with that?
    Mr. Crippen. I agree absolutely, wholeheartedly.
    Senator Snowe. OK. I appreciate it, Dr. Crippen. Thank you 
very much.
    Chairman Conrad. Senator Clinton.
    Senator Clinton. Thank you very much, Mr. Chairman, and 
thank you, Dr. Crippen.
    I am sorry that Senator Gramm has left. I thought that his, 
what I inferred to be an offer to repeal the tax cut and put 
new restrictions on spending sounded like a good place to 
begin, because basically, what I heard him saying was that we 
need to act on both sides of the ledger, which I think many of 
us around this table agree with. So perhaps, Mr. Chairman, we 
have the start of an agreement that we can work out.
    Also, I think the points made by both Senators Stabenow and 
Snowe need to be revisited, and I certainly, as someone who 
supported their work on the trigger, would believe that it 
should be on both sides--that there should be triggers on 
spending as well as on tax cuts. That is the way many States 
have to operate. That is, to reiterate Senator Hollings' point, 
why Governor Bush is having to postpone tax cuts, because you 
cannot run those sorts of deficits at the State level. I have 
long thought that we ought to be looking at similar mechanisms, 
understanding the more difficult challenges facing the Federal 
budget, but I still think there is some wisdom in the State 
that we ought to try to learn from.
    I have a couple of questions, Dr. Crippen, and I thank you 
for your testimony and for the work that you and your staff 
have been doing. But clearly, it is pretty breathtaking that in 
less than a year, $4 trillion of the projected surplus has 
disappeared. I do not think we should lose sight of the fact, 
as we go back and forth in our discussion, that that is really 
what you are talking about today. If you were to write a 
headline, it would be ``Four Trillion is Gone'' from the time 
that you sat here a year ago and made the projections with the 
very fair assessment of uncertainty that you put into those 
projections, but nevertheless $4 trillion is gone.
    Your caution about what that means for us not just in the 
short term but in the longer term is one that we disregard at 
our peril. It is something that really haunts me that we would 
be putting this load of debt and these extremely difficult 
political decisions on the backs of our children instead of 
facing up to them ourselves.
    I do not know whether Senator Gramm's idea of postponing 
tax cuts or even repealing them, along with stricter spending 
limits, following in the footsteps of both Senators Snowe and 
Stabenow will be heeded, but I certainly intend to do 
everything I can to make that case.
    I would appreciate, Dr. Crippen, getting the tax rates on 
your chart, ``Total Revenues as Share of GDP.'' Several members 
have made the point that the average of approximately 18 
percent has been exceeded, but what I am interested in is that 
my recollection of tax policy going back 30 or 40 years is that 
the relative burden borne by different segments of our society 
has shifted dramatically. I would like to get that information 
if I could, because I think that the corporate tax rate and the 
individual tax rates on the upper end have gone down 
dramatically, and in fact, middle-income and lower-income 
Americans are bearing a disproportionately higher share of the 
tax burden, and this revenue spike is due in large measure to 
that increased share. Particularly when my constituents pick up 
the newspaper and see that a company like Enron has paid no 
taxers whatsoever, that was not the case in the 1950's and 
1960's when corporate tax rates were both higher and tax 
collection was more strenuous.
    [The following was subsequently submitted for the record by 
Mr. Crippen:]

    In response to Senators Clinton's request for data on the relative 
tax burden borne by different segments of society over recent decades, 
we enclose Table G-1a from a recent study, ``Effective Federal Tax 
Rates, 1979-1997'' (October 2001). The study contains more detailed 
data on the distribution of effective tax rates and incomes, and it 
includes a discussion of methodological issues and a presentation of 
alternative measures.
[GRAPHIC] [TIFF OMITTED] 80544.018



[GRAPHIC] [TIFF OMITTED] 80544.019


    So if I could, I would like to see the correlation here, 
because I think one of the biggest lessons in this curve is 
that we have shifted the burden of taxation, and the tax cut 
that was passed last spring shifted it egregiously onto the 
backs of middle-income and lower-income taxpayers.
    My question goes to something that you alluded to earlier, 
and that is the intergovernmental impacts of what you are 
telling us this morning. I know that CBO does have a role in 
measuring these intergovernmental impacts. Have you done any 
estimates of State budget shortfalls?
    Mr. Crippen. Senator, we have not done any independent 
estimates. We have been talking to the many groups, like the 
National Association of State Budget Officers and the National 
Governors Association (NGA), to try to monitor as best we can 
the developments there. The December report from the NGA was 
quite instructive, and you probably know of the deterioration 
in surplus pictures for many of the States, and of course, in 
many of them surrounding Washington, we are seeing headlines 
every day about billions of dollars of budget shortfalls.
    So, yes, we are monitoring it, but we do not do independent 
estimates of what the States are going to have to face.
    Senator Clinton. Dr. Crippen, would the budget shortfalls 
and the unemployment increase, for example, require perhaps 
greater Medicaid outlays, and are those included in your 
baseline projections at this time?
    Mr. Crippen. Yes. We expect that both outlays for 
unemployment will be higher as well as Medicaid outlays, and 
they are included in the forecast today.
    Senator Clinton. And similarly, the impact on the States' 
revenues tied to Federal tax revenues, those declines, could 
you also give us some insight on that, because as some of these 
tax cuts kick in that were passed last spring, they are going 
to have a direct impact on State revenues.
    Mr. Crippen. We do not have an independent estimate of 
that, but we could probably provide you with one. You are 
absolutely right, of course, that as States mimic the Federal 
tax code, both in application and what the tax base ultimately 
is, if it changes at the Federal level, it could ultimately 
change States revenues as well and presumably in the same 
direction.
    [The following was subsequently submitted for the record by 
Mr. Crippen:]

    Dear Senator:

    At the Senate Budget Committee hearing on January 23, you asked 
about the impact of cuts in Federal taxes on the States, many of which 
base their income taxes on Federal taxes. Although a complete analysis 
of the State revenue effects is beyond our capabilities, we can provide 
information about which provisions of the Economic Growth and Tax 
Relief Reconciliation Act of 2001 (EGTRRA) would affect State tax 
collections. Some provisions would affect all States; others would 
affect only a few.
    We did survey other research organizations to determine whether 
they had examined the questions you posed. We found no estimates of 
EGTRRA's effects on State revenues. Much of the following discussion is 
based on work of the Center for Budget and Policy Priorities, only some 
of which is published
    The principal impacts of EGTRRA on State revenues are on individual 
income tax and estate tax revenues. The seven States that have no 
individual income tax are affected only by changes in Federal estate 
tax laws. The other 43 States and the District of Columbia are likely 
to lose both income and estate tax revenue, although some States have 
acted to limit those losses. Furthermore, nine States allow residents 
to deduct Federal tax payments in calculating taxable income.\1\  The 
income tax reductions in EGTRRA will lower those deductions and 
therefore increase State income tax liabilities.
---------------------------------------------------------------------------
    \1\ The nine States are Alabama, Iowa, Louisiana, Missouri, 
Montana, North Dakota, Oklahoma, Oregon, and Utah.
---------------------------------------------------------------------------

                              income taxes

    EGTRRA increased limits on contributions to retirement plans, 
including 401(k)s and individual retirement accounts (IRAs), as well as 
limits on benefits from defined benefit plans. For most taxpayers, 
contributions to 401(k)s and IRAs are ignored in calculating Federal 
taxable income; all States with income taxes except Pennsylvania follow 
the Federal rules for at least one program and will therefore lose 
revenues. Similarly, the higher limits on retirement benefits will 
reduce income tax revenues in all States with income taxes except 
Arkansas and Pennsylvania.
    EGTRRA expanded tax benefits for education in various ways: making 
permanent the exclusion from income for employer-provided assistance; 
raising the limit on contributions to education IRAs; broadening the 
rules for deducting interest on student loans; expanding tax-free 
distributions from qualified prepaid tuition plans; and allowing most 
taxpayers to deduct some higher education expenses (although that 
provision expires after 2005). Nearly all States with income taxes will 
lose revenues from the education provisions in EGTRRA.\2\ 
---------------------------------------------------------------------------
    \2\ Only New Jersey and Pennsylvania are unaffected.
---------------------------------------------------------------------------
    Other parts of EGTRRA affect income taxes in fewer States. Phasing 
out the limitations on itemized deductions will reduce revenues in the 
29 States (including New York) and the District of Columbia that follow 
Federal rules on itemized deductions. Similarly, the phasing out of 
limits on personal exemptions will affect revenues in 10 States 
(including New York). Increases in the standard deduction for married 
couples (beginning in 2005) will lower revenues in 10 States (not 
including New York). Earned income tax credit (EITC) changes in EGTRRA 
will increase State EITC benefits in 15 States (including New York) and 
the District of Columbia. Expansion of the Federal tax credit for 
dependent care will affect revenues in as many as 23 States (including 
New York) and the District of Columbia because those States use Federal 
definitions for their own dependent care credits. Finally, the higher 
exemptions allowed in the Federal alternative minimum tax (AMT) that 
lasts through 2004 will reduce revenues in the nine States (including 
New York) that levy an AMT based on Federal AMT calculations.

                              estate taxes

    Changes in estate and gift taxes made in EGTRRA will affect every 
State, although some States have acted to reduce or eliminate the 
impact on State revenues.\3\  Every State currently imposes a tax on 
estates that is at least as large as the credit allowed for State 
estate tax against Federal estate tax liability. Most States explicitly 
set their estate tax equal to the Federal credit. As the latter falls 
over the next decade, State taxes will generally fall. Furthermore, the 
credit phases out by 2005 when it is replaced by a deduction in 
calculating Federal estate taxes. If States act to maintain their 2001 
tax levels, loss of the credit against Federal tax will impose 
additional tax liabilities on estates and generate pressure to reduce 
State level estate taxes.\4\ 
---------------------------------------------------------------------------
    \3\ Elizabeth C. McNichol, Iris J. Lav, and Daniel Tenny provide an 
excellent discussion of the impact of EGTRRA's estate and gift tax 
changes on State revenues in States Can Retain Their Estate Taxes Even 
as the Federal Estate Tax is Phased Out, Center on Budget and Policy 
Priorities, January 31, 2002.
    \4\ In recent years, many States that imposed estate taxes in 
excess of the credit allowed against Federal estate tax have changed 
their tax to match the credit. For example, in 1997 (but not effective 
until 2000), New York lowered its estate tax to equal the Federal 
credit, effectively limiting the State tax to a transfer from the 
Federal Government and eliminating any effect of the State tax on the 
total tax paid by estates.
---------------------------------------------------------------------------
    The District of Columbia and 37 States impose estate taxes equal to 
the Federal credit. For some States (including New York), the State tax 
equals the credit effective on a particular date prior to passage of 
EGTRRA.\5\  The reduction and elimination of the Federal credit will 
not affect estate taxes in those States. Most States, however, tie 
their estate tax to the Federal credit in effect when the decedent 
dies. As the credit phases out over the next 4 years, estate tax 
revenues in those States will decline to zero, unless the States act to 
decouple their tax from Federal law. Already since the passage of 
EGTRRA, at least three States have set their estate taxes equal to the 
Federal credit before EGTRRA and thus protected their revenue streams. 
Other States are likely to follow suit.

    \5\ New York's estate tax conforms to the Federal tax as amended up 
through July 22, 1998, and therefore will not change as the provisions 
of EGTRRA phase in. Estates of New York residents dying after 2001 will 
not be able to claim a credit against Federal tax for the full amount 
of the State tax paid.
---------------------------------------------------------------------------
    Senator Clinton. I think that information would be helpful 
to us. Certainly my State is in a unique position because of 
the extraordinary revenue shortfalls from September 11 that 
directly impacted on both the city and the State. But as I read 
the press, in any event, this is a phenomenon that is 
widespread across the country. Many Governors and State 
legislatures are facing significant shortfalls. And I think we 
are going to be called on here in the Congress to respond in 
some way. I am hoping that whatever package of economic 
recovery is put together will include a recognition of 
increasing health care costs and the need to help on that front 
in many of our States that have been hard-hit.
    Dr. Crippen, I would also like to ask you about a comment 
that OMB Director Mitch Daniels made at a National Press Club 
speech back in November, in which he predicted deficits through 
at least 2005. He said that the new budget scenario called for 
``separating must-do from nice-to-do items.'' It is going to be 
difficult to have a good discussion about our budget when so 
much that is embedded in the budget already are must-dos. I 
mean, so many of the biggest spending items are required, they 
are mandatory, they are so-called entitlements, when we know 
that we are going to be asked for increases in defense 
spending, which many of us will be prepared to support. I know 
it would be hard for you to give me an exact number on this, 
but how much discretionary spending dollars are really in this 
budget projection that you are talking about in terms of what 
is available for non-defense, non-entitlement?
    Mr. Crippen. We assumed that this year's spending level, 
Senator, the level for the current year for all programs on the 
discretionary side, both domestic and defense, for purposes of 
today's forecast will grow only with inflation factors--
inflation in the economy, but also in wages. So in that regard, 
we have not built in any increases for programs, any increases 
for homeland security, or increases for defense. None of those 
is in our baseline. So anything that the Congress and the 
President add to that would make the deficits worse and the 
surpluses smaller.
    Senator Clinton. That is very important, because clearly, I 
think a lot of people do not know that.
    I have a statement\1\ , Mr. Chairman, that I would like to 
submit for the record, and I thank the Chairman for holding 
this hearing.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Clinton was not made availble 
by press time.
---------------------------------------------------------------------------
    Chairman Conrad. Without objection.

    Chairman Conrad. Senator Domenici.
    Senator Domenici. Thank you very much, and I will try my 
best to be brief.
    Mr. Chairman, I would just like one more time to put in the 
record my analysis, which I believe comes out of your report, 
of why the Congressional Budget Office budget projections 
changed. And if you would get a pencil and pad and just write a 
few numbers down to see if we are correct.
    First, the January 2001 projection was for a $313 billion 
surplus. The legislative changes--and I will just package them 
into four items--tax law--by that, I mean an actual tax change 
that reduced taxes--and my number is $38 billion for the year 
that we are in, for the year that everybody is complaining 
about and concerned about. So the tax impact in that year was 
$38 billion. Is that correct or close to correct?
    Mr. Crippen. I believe so, yes.
    Senator Domenici. Then, we had a defense appropriation and 
a non-defense appropriation, which were $33 billion and $11 
billion, respectively.
    Mr. Crippen. Right.
    Senator Domenici. Then, we got the giant of all giants, 
which we had nothing to do with, which the American people have 
kind of rightly understood, as I read what they are saying in 
the polls, and I would call that ``recession,'' but let us be 
more specific and say ``economic changes and technical 
changes.'' And I get two very giant numbers there--$148 billion 
and $94 billion.
    Let me say, then, that 100 percent of the changes amounted 
to the following. The changes in the tax law by a tax cut 
measure were 12 percent. And I would just like to repeat that 
for those who keep saying that it is the tax cut that affected 
the reduction in our surplus--for the year that we are in, it 
was $38 billion, or a 12 percent impact.
    Then, in the appropriated accounts, the defense 
appropriations and non-defense combined were $44 billion, which 
my number says 14 percent, Director Crippen.
    And then, if I take those two giant ones that came with the 
recession, the so-called economic changes which you have 
explained in numbers went from 3-plus in growth to negative 
growth.
    Mr. Crippen. Yes.
    Senator Domenici. That total number there is $148 billion 
plus $94 billion, so that is $242 billion.
    Now let us just take those in percentages so everybody will 
get it, and you see if you think these are right. The total 
changes in the surplus were as follows: 12 percent from the tax 
law changes, that is, tax cuts; 14 percent from increased 
appropriations, that is, we spent more money on both defense 
and non-defense, and that number is 14 percent. So, we have 12 
and 14. And then, the big ticket item that indeed changed 
everything, and that is the question of how long will it last--
that is, how long before we get out of a recession--and that 
total was 72 percent of the reduction or diminution in the 
surplus.
    Are we close to right, Mr. Director?
    Mr. Crippen. Yes, your numbers are right on.
    Senator Domenici. OK. That means that the projections will 
yield a $21 billion negative, in the red, under these 
projections and these events that have occurred and that are 
rather easy to project--we are not going to miss these very 
far. Is that pretty close to right, that last statement?
    Mr. Crippen. I hesitate to say we are not going to miss 
them by very far--I would like to think that is right, yes.

                     Changes in CBO's Baseline Projections of the Surplus Since January 2001
                                    (By fiscal year, in billions of dollars)
----------------------------------------------------------------------------------------------------------------
                                                                              Total          %            %
                                                                  2002    --------------------------------------
                                                                            2002-2011       2002      2002-2011
----------------------------------------------------------------------------------------------------------------
Total Surplus as Projected in January 2001..................          313        5,610
Changes a/..................................................
  Legislative...............................................
    Tax act b/..............................................         (41)      (1,657)          12%          41%
    Discretionary...........................................         (45)        (714)          14%          18%
    Other...................................................          (5)         (49)           1%           1%
      Subtotal..............................................         (91)       (2420)          27%          60%
  Economic and Technical c/.................................        (242)      (1,588)          73%          40%
        Total...............................................        (333)      (4,008)         100%         100%
Surplus or Deficit (-) as Projected in January 2002.........         (21)        1,602
Memorandum:.................................................
  Legislative changes to discretionary spending a/..........
    Defense.................................................         (34)        (396)          10%          10%
    Nondefense..............................................         (11)        (318)           3%           8%
SOURCE: Congressional Budget Office.
a. These estimates include the interest effects of changes
 assumed.
b. CBO cost estimate for the Economic Growth and Tax Relief
 Reconciliation Act of 2001 (P.L. 107-16). The estimate
 includes bota a reduction in taxes and an increase in
 outlays.
c. Changes not directly driven by new legislation or by
 changes in the components of CBO's economic forecast are
 considered technical.
----------------------------------------------------------------------------------------------------------------


    Senator Domenici. All right. I did this and did it slow. I 
think we will carry around a little chart so that when people 
give their speeches and say the Republican tax cut is what 
caused the recession and destroyed the surplus, I would like to 
put that up and each time say, well, what was it that brought 
the surplus to a negative number? I can go to these and say 
that as of this date, the neutral, independent body, the 
Congressional Budget office says--and right off, I want to 
repeat again, changes in the economy--that means you predicted 
3.4 percent growth, but it turned out there was a negative 
growth, it got into a recession--and that one and the things 
that go with it were 72 percent of the loss of this surplus.
    Now, there are people who really genuinely think we could 
have avoided that. I hear our Chairman say it, and I want to 
say that I look forward to working with him. But I really have 
seen nobody put forth a plan that would say that if we had 
followed this plan, we would never have had this problem.
    Look, we had 10 years without a recession, and most people 
assumed we would have one at some time. I think there were a 
few of us--and I will put myself at the front of the line--who 
actually thought, Dr. Crippen--and in those moments, I did not 
call you and ask you to rid my brain of such a stupid thought--
but I actually used to think that maybe we would not have the 
typical American downturn, and maybe it was gone forever--but I 
never said it publicly; whenever I said it, I said, of course, 
that is a pipedream, and it will come sooner or later. It came.
    Now let me ask four or five specific questions. One, just 
for background, in the most recent budget resolution, the one 
prepared last year by the Republicans, we added $73.5 billion 
for agriculture. That was on top of a current policy 
agriculture baseline that totaled $96.5 billion. Thus, the 
conjunction with the existing baseline at that time, the 
aggregate support totaled $170 billion over 10 years. Am I 
right so far?
    Mr. Crippen. So far.
    Senator Domenici. Question: What is the total amount of 
your most recent agriculture baseline?
    Mr. Crippen. It is very close to those numbers, at about 
$100 billion.
    Senator Domenici. OK. And Director Crippen, using the most 
recent baseline, what would be the cost of the current pending 
farm bill, Senate Bill 1731, that Majority Leader Daschle and 
Senators Harkin and Conrad have proposed to the Senate?
    Mr. Crippen. Senator, we have not priced the bill yet 
against the new baseline. We are, as you know, as of today just 
finalizing that baseline. I would guess, given the outlook for 
commodity prices, that it may well increase a little over what 
we said before, but that is only a guess.
    Senator Domenici. OK. Now, Director Crippen, with the 
higher total cost of agriculture, having that in mind, and 
lowered budget surpluses over the next 10 years, what would be 
the total Medicare and Social Security dollars spent should 
1731 pass the Senate?
    Mr. Crippen. I would like to avoid that question, but I am 
sure you will not let me. The----
    Senator Domenici. Fine. You can avoid it.
    Mr. Crippen [continuing]. No, no. It is impossible to tell 
in some ways. You cannot trace dollars. They are all fungible. 
The point is that we are going to have deficits, so whatever 
surpluses exist in those trust funds will effectively be spent 
for something.
    Senator Domenici. That answer is good enough for me. It 
just means that whatever we attempt to apply it to directly, we 
will have difficulty proving that it came out of Medicare or 
Social Security, and I think that is what you are saying.
    Congress enacted a $40 billion emergency supplemental to 
respond to the terrorist attacks. Of that, $20 billion counted 
as budget authority in 2001; the other $20 billion counted as 
budget authority in 2002. How does CBO treat the $20 billion in 
2002 emergency appropriations in this baseline that we are 
speaking to?
    Mr. Crippen. In this baseline, Senator, we add the $20 
billion, all of it, into the baseline and then inflate it for 
the future, just as we do other budget authority.
    Senator Domenici. All right.
    On railroad retirement, if there were not directed 
scorekeeping--and the Chairman and I voted not to direct the 
scorekeeping, not to tell them how to count it--if CBO had done 
scored the bill in the typical manner instead of a manner that 
worked in behalf of the bill, what would that have cost the 
budget baseline this year?
    Mr. Crippen. It would have increased the deficit by about 
$15 billion.
    Senator Domenici. So for those of us who said that, 
including the Chairman, we were correct on the floor when we 
said that.
    Mr. Crippen. Oh, absolutely. You agreed with us, so you 
could not help but be correct.
    Senator Domenici. OK. I have one on Medicare and Social 
Security, but I will save it for another time. Thank you, I 
have nothing further.
    Chairman Conrad. Can I just followup on the point that 
Senator Domenici made? The former Chairman is exactly right 
with respect to this year's effect of the tax cut, and I 
pointed that out in my statement. But I think we also have to 
look at the 10 years, and the 10-year effect is this. The 
biggest impact in the reduction of the surplus over the 10 
years is the tax cut and the associated interest cost. The next 
biggest is the economic changes, as pointed out in the CBO 
analysis. That is 23 percent. The next biggest is the 
legislation, largely the spending that was passed as a result 
of the attack on the United States on September 11. And the 
fourth biggest is the technical changes.
    But in fairness, I think it is absolutely correct to say 
that for this year, the biggest impact, the biggest reason, is 
the recession; but over the 10 years, the biggest reason is the 
tax cut and the associated interest costs.
    Senator Nelson.
    Senator Domenici. Senator Nelson, would you yield for 30 
seconds?
    Senator Nelson. Of course.
    Senator Domenici. Let me state for the record something 
that I did not say. We have heard a lot of negative talk 
because we have gone from a 330 surplus in this period of time, 
with the recession and other things, to negative numbers. 
Frankly, I would not want to let this event pass us by without 
saying that this is one Senator who has the greatest confidence 
in the American economy. We are besieged at this point by many 
things out of our control, not the least of which is a world 
economy led by Japan, and they are all taking a nosedive. It is 
very hard for us to stay positive in terms of numbers with 
those kinds of things. But I do believe that it is just a 
matter of time that this giant machine will come back to life 
and lead the world again. I am hopeful that we will be on the 
right track so that we do not impede that growth by our 
actions, and that means that we mean a stimulus package. The 
Chairman and I agree on that. We surely think that somebody 
ought to be looking at it in reality from the standpoint of 
doing some good--and I hope it is not political; I hope it is 
for doing some good.
    Thank you.
    Chairman Conrad. You bet.
    Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    In Florida, we have an expression: ``There is more than one 
way to skin a cat.''
    Senator Sarbanes. We have that expression in Maryland, too.
    Senator Nelson. I am glad to hear that. It is an American 
expression.
    Senator Domenici. Ours is a rabbit.
    Senator Nelson. You, Senator Domenici, have skinned the cat 
showing the most favorable light in the point that you are 
trying to make with regard to the first year, that the tax cut 
has only a minimal effect on changing a revenue surplus 
situation to a deficit situation.
    The Chairman has pointed out that over the decade-long 
period, the tax cut has an even greater effect, and we are 
still talking about whether we use the tax numbers that the 
Chairman is using plus the additional debt service as a result 
of the tax cut, or whether you just take the straight tax cut 
and you lump the whole debt service in your numbers later on as 
a result of tax cut and spending increases.
    The fact is that the tax cut is getting awfully close, as I 
read your testimony, to what we said earlier this year in this 
committee, that this was not going to be what it was being sold 
as, as a tax cut of $1.35 trillion over 10 years; but instead 
was going to be closer to a $2 trillion tax cut over 10 years 
given the fact that in the 10th year, the tax cut evaporates, 
and obviously, a future Congress is not going to allow that to 
happen, but a future Congress is going to keep that tax cut in 
place in the 10th year.
    So, looking at your figures and given the fact that in 
response to Senator Stabenow, you said that if the tax cut were 
continued for the 10th year like it is for years one through 
nine, there would be an additional deficit result of several 
hundred billion. That is what you said, is it not, Dr. Crippen?
    Mr. Crippen. For the two years, that is right.
    Senator Nelson. OK. Then, if you take the Chairman's 
numbers and your numbers that the tax cut is worth $1.275 
billion, and if you add the Chairman's increased debt service 
as a result--the Chairman's figure is about $389 billion--you 
are getting a tax cut in the range, rounded, of about $1.7 
trillion--specifically, $1.683 trillion.
    Mr. Crippen. I certainly cannot take exception to your 
total. I would say one thing only, and that is that we have 
changed the 10-year period, obviously, from when we were 
talking about 1.2 trillion or 1.3 trillion last year to 
whatever we are talking about now; we have added a very 
expensive year or a big number year and dropped a small number 
year.
    Second, while it is certainly true that these actions--
reduced revenues and increased spending--will increase debt-
service costs, I think it is not fair to conclude that that is 
a tax cut. That is to say, the effect of the legislation will 
be to reduce revenues and increase interest costs--that is 
certainly true--but I think that that interest cost is not 
going to anyone who is receiving a lower tax bill.
    Am I making any sense?
    Senator Nelson. Yes, you make sense, but it is a 
consequence of lessened revenue, so when we are looking at the 
question of surplus or deficit, it is a consequence of lessened 
revenue.
    Mr. Crippen. Absolutely.
    Senator Nelson. So if the Chairman's figures are correct, 
somewhere around $1.6 to $1.7 trillion of revenue consequence, 
and then--a future Congress is not going to let the tax cut 
evaporate in the 10th year; it is going to continue it--and you 
said that that is worth several hundred billion dollars' worth 
in the 10th year, then, Mr. Chairman, you are right at $2 
trillion, which is what we said instead of it being $1.35 
trillion, you are going to use up the surplus because the tax 
cut in effect is going to be about $2 trillion over 10 years.
    I would just make this additional point. At least in my 
campaign in the year 2000, and almost every other candidate 
running for office in the year 2000, a promise was made to the 
American people that we were not going to invade the Social 
Security or the Medicare surplus. It was put in terms that we 
will fence it off, we will wall it off, we will put up a 
firewall--we will not invade that surplus. And why? Why was 
there a consequence? Well, we said we do not want to fool with 
the Social Security surplus because that ought to be saved for 
Social Security and that if you do not spend the Social 
Security surplus, the result is that it is going to pay down 
the national debt.
    Mr. Chairman, the figures that you have come up with over a 
10-year period starting in 2002 to 2011 say that just the 
Social Security surplus, you are going to invade its trust fund 
moneys to the tune of $437 billion. And when you look at both 
of the Social Security and Medicare Trust Funds, you are going 
to invade it to the tune of almost three-quarters of a trillion 
dollars.
    Now, that is breaking faith with what we said--not only to 
protect Social Security, but what that also is saying is that 
we are paying down the national debt under these projections by 
not doing any more spending, not even taking into account the 
10th year of the tax cut that is going to have to be reenacted, 
we are still going to invade those surpluses and therefore not 
pay down the national debt to the tune of three-quarters of a 
trillion dollars over the 10-year period.
    Chairman Conrad. Would the Senator yield?
    Senator Nelson. Of course.
    Chairman Conrad. Actually, the most recent numbers based on 
the numbers we have gotten here today are even worse--even 
worse--because what we see now is that you will be taking that 
amount just out of Social Security and on top of that, another 
$380 billion of Medicare Trust Fund money. So the total now is 
$1.1 trillion taken from the trust funds of Social Security and 
Medicare to pay for the President's tax cut and to pay for 
other expenses of the Federal Government. So trust fund moneys 
are being used for purposes for which they were not intended 
and for which everybody, including the President, pledged not 
to do----
    Senator Nelson. Mr. Chairman, as a country lawyer, I would 
say I rest my case. We are going to continue this discussion 
quite a bit, but the numbers here are not only damaging, they 
are damning, from the testimony that came out of this committee 
a year ago.
    Chairman Conrad. I thank the Senator.
    Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Director Crippen, a year ago, what were the surplus or 
deficit figures you projected for the 10-year period?
    Mr. Crippen. For the 10-year period then, Senator, it was 
$5.6 trillion.
    Senator Sarbanes. A surplus of $5.6 trillion?
    Mr. Crippen. Over the 10 years, yes.
    Senator Sarbanes. That was before the tax cut was passed; 
correct?
    Mr. Crippen. Yes, that is correct.
    Senator Sarbanes. What are you projecting now for that 
period?
    Mr. Crippen. For the same period, $1.6 trillion, so $4 
trillion less.
    Senator Sarbanes. Your projections have dropped from $5.6 
trillion surplus to $1.6 trillion surplus?
    Mr. Crippen. Unfortunately, that is correct.
    Senator Sarbanes. Four trillion gone.
    Do you take issue with this chart that the Chairman 
prepared--this is for the 10-year period--that projects that 
the loss of surplus, the $4 trillion that has been lost--about 
70 percent of it, I guess, has been lost--that 42 percent of 
that, not quite half, but getting there, is as a consequence of 
the tax cuts; is that correct?
    Mr. Crippen. Yes.
    Senator Sarbanes. So the tax cuts--the economic changes are 
23--the tax cuts are about twice as significant as any other 
item in terms of explaining that drop; is that correct?
    Mr. Crippen. Yes.
    Senator Sarbanes. OK. Now let me ask you this question. 
What are you now projecting for the 10-year period in terms of 
the surplus?
    Mr. Crippen. $1.6 trillion over the same 10 years as 
comparable there.
    Senator Sarbanes. No--you now update it a year----
    Mr. Crippen. $2.6 trillion; right.
    Senator Sarbanes [continuing]. You come in a year later, 
and now you extend it out, so you do it from 2002 to 2012, I 
think.
    Mr. Crippen. That is correct.
    Senator Sarbanes. What do you project as the surplus over 
that period of time?
    Mr. Crippen. It is $2.3 trillion.
    Senator Sarbanes. $2.3 trillion?
    Mr. Crippen. Yes.
    Senator Sarbanes. How much of that is in the last 2 years 
of the 10-year period?
    Mr. Crippen. $1.1 trillion.
    Senator Sarbanes. $1.1 trillion of the $2.3 trillion is in 
the last 2 years?
    Mr. Crippen. Right.
    Senator Sarbanes. So roughly half of it is in the last 2 
years of the 10-year period; is that correct?
    Mr. Crippen. That is right.
    Senator Sarbanes. Of course, this tax cut that we have been 
discussing which has had such a profound effect is going to 
sunset in 2010; is that correct?
    Mr. Crippen. Yes.
    Senator Sarbanes. Supposedly.
    Mr. Crippen. Right.
    Senator Sarbanes. And I do not know of anyone who really--
in fact, I think there is an effort now on the part of some of 
my Republican colleagues to make it permanent right now, if I 
am not mistaken. But in any event, so when you project the 
surpluses in 2011 and 2012, the $1.1 trillion that is half of 
the surplus that you are projecting, that is assuming that the 
tax cut will in fact sunset because that is what the current 
law provides; is that correct?
    Mr. Crippen. Right.
    Senator Sarbanes. How much of this surplus that you are 
projecting will come from the Social Security Trust Fund of the 
$2.3 trillion surplus?
    Mr. Crippen. More than the total--2.5 trillion over the 10 
years--comes from Social Security.
    Senator Sarbanes. So you are projecting a $2.3 trillion 
surplus--that is unified surplus----
    Mr. Crippen. Right.
    Senator Sarbanes [continuing]. And you are projecting a 
$2.5 trillion surplus in the Social Security Trust Fund?
    Mr. Crippen. Yes, total off-budget, right.
    Senator Sarbanes. So you are projecting a deficit in the 
budget other than the Social Security Trust Fund; is that 
right?
    Mr. Crippen. That is right.
    Senator Sarbanes. So in order to avoid saying that we have 
a deficit, we in effect have to utilize the surplus of the 
Social Security Trust Fund; is that correct?
    Mr. Crippen. Correct.
    Senator Sarbanes. Mr. Chairman, I thought that everyone was 
making all kinds of undertakings and assurances that we would 
not be going into the Social Security Trust Fund surplus in 
order to achieve a budget surplus; is my recollection mistaken 
in that regard?
    Chairman Conrad. No. The Senator is exactly right. I think 
virtually everyone who is in public office promised not to use 
Social Security Trust Fund money for other purposes.
    Senator Sarbanes. So in effect, to avoid reflecting a 
deficit, which results 42 percent from these tax cuts, we are 
having to offset it with the Social Security Trust Fund 
surplus; correct?
    Mr. Crippen. That is correct.
    Senator Sarbanes. Intake into Social Security is from the 
payroll tax; is that correct?
    Mr. Crippen. Correct.
    Senator Sarbanes. And I think the payroll tax is generally 
recognized as falling most heavily on working people. It is not 
a progressive tax. It is seen as----
    Mr. Crippen. It is only a tax on labor, so it is not a tax 
on capital at all.
    Senator Sarbanes. No; it does not tax capital at all, and 
to the extent it taxes labor, it is a flat tax, which 
disproportionately affects lower-income people; isn't that 
correct?
    Mr. Crippen. It is capped somewhere in the neighborhood of 
$85,000.
    Senator Sarbanes. That is right. So above $85,000, you stop 
paying it; right?
    Mr. Crippen. Correct.
    Senator Sarbanes. So those taxes coming into the Social 
Security Trust Fund that create that surplus are being used to 
offset the deficit that is being run in order to give these tax 
cuts.
    Now, I ask the Chairman if my recollection is mistaken. I 
understood that well over 50 percent of the benefit of the tax 
cuts went to the very top 1 percent, I think, of the income 
scale; is that correct?
    Chairman Conrad. I do not recall the exact percentage, but 
a disproportionate amount of the tax reduction went to the 
wealthiest 1 percent, even disproportionate to the amount of 
taxes that they pay.
    Senator Sarbanes. And in order to in effect assert that we 
do not have the budget in deficit, and if we are using the 
Social Security Trust Fund surplus in order to do that, we in 
effect are using the revenues that are gained through the 
payroll tax, which disproportionately hits working people. So 
you have a double blow here. You have the revenue inflow used 
to try to create a surplus situation coming disproportionately 
from working people, and you have the tax cuts going 
disproportionately to people at the upper end of the income 
scale. So the working people get hit twice under this 
arrangement as I perceive it.
    Chairman Conrad. It is a perverse result of what has 
occurred, and in effect you are taking payroll tax dollars to 
fund in part an income tax cut that disproportionately goes to 
the wealthiest earners in the country.
    Senator Sarbanes. I am sure that we will explore that point 
further as we go through these hearings.
    Mr. Chairman, I see there is a vote on, and I know we have 
to draw this to a close, but I very much appreciate your 
yielding. And Director Crippen, we are pleased to have you back 
before the committee.
    Chairman Conrad. I want to thank all of my colleagues on 
the committee. We do have just a few minutes remaining in the 
vote, so we will have to leave. I want to again thank you, 
Director Crippen, for being here and for your answers to these 
questions. Obviously, we have differences of opinion on the 
issues, those of us who are seated here, but we very much 
appreciate your sharing your projections with us and the very 
hard work done by you and your committee staff to prepare this 
work on a timely basis for the consideration of the Congress.
    Mr. Crippen. Thank you, Mr. Chairman.
    Chairman Conrad. The committee is adjourned.
    [Whereupon, at 12:25 p.m., the committee was adjourned.]

               Opening Statement of Senator Gordon Smith

    Good morning--and I'd like to thank you the Chairman and ranking 
member for the hearing and say that I'm looking forward to working with 
both sides of the aisle to produce a real bipartisan budget this year.
    Like many on this committee I want to produce a budget that will do 
much to protect our Nation, bolster our troops in the fight against 
terrorism and address a host of domestic issues at home--in my State of 
Oregon.
    I would also like to say at the outset that I'm against any 
increases in taxes--I strongly believe that the current tax cuts must 
stay intact and their effect will do much to bloster the pocketbooks of 
Oregonians who paid--sent their money, in good faith, to Washington, 
DC.
    One of my top priorites this year will be to direct funding toward 
the uninsured. It is nothing short of a moral outrage that so many 
Americans lack health insurance coverage even as they live and work in 
the wealthiest Nation on earth. I have worked in the past with my 
colleague and friend, Senator Wyden who also sits on this committee. 
And I can promise you that this year we will again join forces in the 
effort to bring health insurance to those in Oregon and across the 
Country who lack coverage.
    Mr. Crippen, I welcome you back before the Senate Budget Committee 
and I look forward to your testimony.
                               __________

              Prepared Statement of Senator Chuck Grassley

    With today's announcement that the Federal Government is once again 
facing near-term budget deficits, we're going to hear a lot of talk 
from the critics about the need to postpone or even repeal last year's 
bipartisan tax cut.
    The critics say we should revisit the tax cut for two reasons. 
First, they claim the tax cut is responsible for our return to budget 
deficits. Second, the critics claim the tax cut will jeopardize our 
long-term economic growth. Let's consider each of these claims in turn.
    According to the Congressional Budget Office's projections, the tax 
cut is responsible for less than 15 percent of the reduction in this 
year's surplus and less than 40 percent of the reduction in surpluses 
over the next 10 years. The slowdown in our economy and the additional 
spending enacted last year are responsible for most of the 
deterioration in our budget outlook.
    The second criticism is that the tax cut will reduce the surplus, 
thereby exerting upward pressure on interest rates, and thus reduce 
future economic growth. A recent report by the Joint Economic 
Committee, however, concludes there is no evidence to support this 
criticism. According to the JEC, ``empirical studies on interest rates 
have uniformly failed to find any statistically significant 
relationship between interest rates and the budget balance of the U.S. 
Government.'' This result is likely due to the fact that the deficits 
we have seen in the past were not large enough to affect interest rates 
given the overall size of our financial markets.
    If the tax cut is not responsible for rising deficits and higher 
interest rates, why do the critics still complain? One reason they want 
to delay or repeal the tax cut is because they want to spend the money. 
Some critics have already announced their plans to spend the tax cuts. 
As more of their spending plans become public, it will become obvious 
their cries for ``fiscal discipline'' are nothing more than crocodile 
tears.
    In addition to the critics who want to spend the tax cut, there are 
also critics who insist we cannot afford the tax cut because our long-
term budget projections show Federal spending will exceed revenue by 25 
percent within 50 years.
    To argue we cannot afford a modest tax cut today because we will 
need a huge tax increase in the future is to ignore the obvious. 
Congress cannot provide more government than taxpayers are willing to 
pay for. Throughout our country's history the Federal Government has 
never taken more than one-fifth of our Nation's income in taxes. If we 
are not willing to pay 25 percent more for government, why should we 
expect our children and grandchildren to do so? Our challenge today is 
to get beyond the rhetoric and begin to make government affordable once 
again.

                                    







                      BUDGET AND ECONOMIC OUTLOOK

                              ----------                              


                       THURSDAY, JANUARY 24, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:05 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Hollings, Sarbanes, Murray, 
Wyden, Feingold, Johnson, Byrd, Nelson, Stabenow, Clinton, 
Corzine, Domenici, Grassley, Bond, Gregg, Snowe, Smith, Allard, 
and Hagel.
    Staff present: Mary Ann Naylor, staff director; and Chad 
Stone, chief economist.
    For the minority: G. William Hoagland, staff director; and 
Cheri Reidy, senior analyst.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I want to welcome Chairman Greenspan this morning. It is 
good to have you here to testify before the committee. As many 
of us commented yesterday, what a difference a year makes.
    Last year, the Congressional Budget Office projected that 
we would be able to expect $5.6 trillion of surpluses over the 
next decade. Yesterday, the Director of the Congressional 
Budget Office sat in that chair, Chairman Greenspan, and told 
us that the $5.6 trillion of projected surpluses were reduced 
to $1.6 trillion, and that is before any additional defense 
buildup the President is apparently about to propose or any 
additional funding for homeland defense or any stimulus package 
or a farm bill or any other new spending initiatives.
    Last year, Chairman Greenspan, you testified that we were 
in danger of paying off the debt too quickly. And while you 
sounded cautionary notes, and sent many signals in your 
testimony that we have got to be careful not to return to 
deficits and debt, unfortunately very few in this town paid 
much attention to your cautionary notes.
    Many people heard what they wanted to hear, and they 
claimed that we could have it all: that we could have a massive 
tax cut, that we could have a major defense buildup, that we 
could protect every penny of the Social Security and Medicare 
Trust Funds, and that we could have a maximum paydown of our 
national debt. Unfortunately, we now know that was not true.
    As we heard yesterday in Director Crippen's statement, 
there would be no surplus over the next decade without the 
trust funds of Social Security and Medicare. In fact, instead 
of a $2.7 trillion non-trust fund surplus, we would have a $1.1 
trillion deficit.
    And last year, we were told that we would be debt free by 
2008, or effectively debt free. Yesterday, Director Crippen 
made clear that we will have $2.8 trillion in national debt 
instead of being debt free. The reasons for the change? Well, 
in Director Crippen's testimony, it was clear that over the 10 
years the biggest reason for the decline in the surpluses is 
the tax cut, accounting for 42 percent of the reduction. The 
other factors are on this chart. Economic changes account for 
23 percent; other legislation, largely spending as a result of 
the attack on this country, 18 percent; and technical changes, 
17 percent.
    So the question before this committee is: What do we do? In 
order to answer that question, we first have to analyze the 
current status of the economy. That is one reason you were 
invited here today, and we welcome your testimony.
    We see that unemployment is still rising. We are now at 8.3 
million people unemployed in the country. But at the same time, 
there are some hopeful signs. We see consumer confidence 
starting to rise. It is now ticking up. And so the fundamental 
question before us: What should the budget policy of the United 
States be in order to foster stronger economic growth and put 
this country in a position to meet its long-term obligations?
    I believe that fiscal discipline matters to the markets. 
That is something that you have made clear. In your remarks 
earlier this month in San Francisco, you said--and I just want 
to quote--``Some of this stimulus has been likely offset by 
increases in long-term market interest rates, including those 
on home mortgages. The recent rise in these rates largely 
reflects the perception of improved prospects for the United 
States economy. But over the past year, some of the firmness of 
long-term interest rates probably is the consequence of the 
fall of projected budget surpluses and the implied less rapid 
paydown of the Federal debt.''
    And, indeed, when we look to specific indicators and 
interest rates, what we see is that while you and your 
colleagues at the Federal Reserve have aggressively reduced 
short-term rates, long-term rates have stayed stubbornly where 
they were. We can see in 30-year conventional mortgages 
virtually no reduction over this period in which you and your 
colleagues have so aggressively used monetary policy to attempt 
to give lift to this economy.
    Mr. Chairman, in the past you have argued strongly about 
the desirability of paying down debt to help keep long-term 
interest rates down. Again, I turn to your words of just last 
year at about this time: ``All else being equal, a declining 
level of Federal debt is desirable because it holds down long-
term real interest rates, thereby lowering the cost of capital 
and elevating private investment. The rapid capital deepening 
that has occurred in the United States economy in recent years 
is a testimony to those benefits.''
    Now, I believe you were right then and you are right now to 
make that point.
    But there is another key reason for fiscal discipline and 
for attempting to rebuild surpluses, and that is the 
demographic time bomb that we face as we approach the time the 
baby-boomers will start to retire. This circumstance is 
fundamentally different than the budget crisis we faced in the 
1980's because then we had time to recover. Now there is no 
time to recover. The first baby-boomers start to retire in just 
6 years.
    As Director Crippen said yesterday, acting sooner rather 
tan later to address these long-term fiscal imbalances will 
make a real difference.
    Finally, Mr. Chairman, in your testimony last year, you 
warned us that budget projections are highly uncertain, and you 
urged us to have a plan to protect surpluses and debt 
reduction. You suggested something like a trigger. We did not 
follow that advice, regrettably. Some of us were strong 
advocates, including members on both sides of the dais here, 
certainly Senator Stabenow on our side and Senator Snowe on the 
Republican side warned us that we should take your advice and 
put in place such a mechanism.
    I think now the evidence is clear that that should have 
been pursued, and perhaps you can give us counsel on how we 
best do that now.
    Again, Chairman Greenspan, I welcome your presence here 
today and look forward to your testimony. I turn now to my very 
able colleague, the ranking member, the Senator from New 
Mexico.

             OPENING STATEMENT OF SENATOR DOMENICI

    Senator Domenici. Thank you very much, Mr. Chairman, and 
welcome, Dr. Greenspan. It is always good for us to have you 
here.
    I am told that this is your 18th appearance before the 
Senate Budget Committee, as the Chairman of the Council of 
Economic Advisers, as a private citizen, and as Chairman of the 
Federal Reserve. That is quite a record, although I am not sure 
whether to congratulate you or to pity you. In either event, 
you seem to like coming back, and we like to have you come 
back. So we are going to call it something to be congratulatory 
about.
    As the committee discussed yesterday, Dr. Greenspan, with 
the CBO Director Dan Crippen, things are clearly different than 
a year ago. The last time you testified before our committee 
was a year ago. At that time the Congressional Budget Office 
was saying that the 10-year baseline surplus was $5.6 trillion 
compared to a publicly held debt of $3.4 trillion. A year ago, 
you were concerned that the budget surplus might grow so large 
and be so persistent that there was a good, real possibility 
and threat of the Federal Government accumulating private 
assets, which you said would undermine long-term productivity 
growth.
    You were also concerned then that the Federal Government 
could end up paying large premiums to bond holders by trying to 
retire long-term debt before it matured. You recommended that 
we adopt a budget strategy that smoothed the glide path toward 
the minimum level of publicly held debt.
    You cautioned against coming upon the minimum debt level in 
an abrupt way in which the Government could only avoid 
accumulating assets by suddenly reducing taxes or increasing 
spending regardless of where the United States was in the 
business cycle.
    It seems to me that the combination of President Bush's tax 
cut, the war on terror, and the economic downturn have 
accomplished your goal of smoothing the glide path toward the 
minimum debt level.
    Last year, the baseline showed us---- [Laughter.]
    Senator Domenici. You want to laugh first?
    Chairman Conrad. Was it a joke?
    Senator Domenici. No, it wasn't a joke, but if you would 
like to laugh, it would be fine. Then I could complete it. 
Everything all right? [Laughter.]
    Senator Domenici. I didn't bring many of my people along 
today because I didn't get a chance to show them that, and I 
didn't know what their reaction would be. So I left them 
somewhere. They will be along shortly.
    So let me repeat. It seems to me that the combination of 
President Bush's tax cut, the war on terror, and the economic 
downturn have accomplished your goal of smoothing the glide 
path toward the minimum debt level. Last year, the CBO baseline 
showed us reaching a net debt of zero in 2009. Now the net debt 
is on a schedule to reach zero at 2014. For all the rhetoric 
about the end of fiscal discipline, the new CBO baseline shows 
publicly held debt dropping to about 7 percent in 2012, the 
lowest debt-to-GDP ratio since 1917.
    Some of my colleagues may try to get you to apologize or 
issue some sort of mea culpa for your testimony last year. But 
the way I see it, we are now in exactly the fiscal situation 
you suggested we should be in: a smoother glide path toward a 
minimum debt.
    It is true that in the near term we will experience 
deficits, and as you look back at your testimony, that is what 
was expected last year. But we have had a recession and a war, 
at least the beginnings of a war in between. If there is any 
time when a deficit is not just acceptable but probably 
preferable, it is when the country is at war and the economy is 
contracting.
    At this time we have to be focused on domestic programs to 
secure our citizens from terrorist attacks, securing their 
economic future, and providing our military with whatever it 
needs to fight this war and win it. It is our responsibility to 
produce a budget that preserves the security of our citizens on 
all these fronts: their national security, their personal 
security, and their economic security. Nothing much less can 
matter at this time.
    I hope we can work together on a budget plan that focuses 
on these three security issues. I look forward to the 
Chairman's testimony this morning, and in the oncoming days and 
weeks that we can work together here as a committee in a real 
way to do what I have just described would be done on your part 
and the executive branch.
    Thank you, Mr. Chairman. It is a pleasure to be here this 
morning.
    Chairman Conrad. Chairman Greenspan, we again welcome you 
to the committee and look forward to your testimony.

 STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF GOVERNORS OF 
                   THE FEDERAL RESERVE SYSTEM

    Dr. Greenspan. Thank you very much, Mr. Chairman and 
members of the committee.
    Mr. Chairman, I am going to excerpt from my prepared 
remarks and request that the full text be included in the 
record.
    Chairman Conrad. Without objection.
    Dr. Greenspan. This morning I would like to offer some 
general comments about the state of the economy before turning 
to the Federal budget. I want to emphasize here that I speak 
for myself and not necessarily for the Federal Reserve.
    It is clear that the United States economy went through a 
significant cyclical adjustment in 2001 that was exacerbated by 
the effects of the terrorist attacks on September 11. That 
adjustment was characterized by sharp reductions in business 
investment and pronounced liquidations in business inventories, 
and was compounded by the simultaneous economic difficulties of 
some of our major trading partners. But there have been signs 
recently that some of the forces that have been restraining the 
economy over the past year are starting to diminish and that 
activity is beginning to firm.
    One key consideration in that assessment is the behavior of 
inventories. Stocks in many industries have been drawn down to 
levels at which firms will soon need to taper off their rate of 
liquidation, if they have not already done so. Any slowing in 
the rate of inventory liquidation will include a rise in 
industrial production if demand for those products is stable or 
is falling only moderately. That rise in production will, other 
things being equal, increase household income and spending. The 
runoff of inventories, even apart from the large reduction in 
motor vehicle stocks, remained sizable in the fourth quarter. 
Hence, with production running well below sales, the potential 
positive effect on income and spending of the inevitable 
cessation of inventory liquidation could be significant.
    But that impetus to activity will be short-lived unless 
sustained growth of final demand kicks in before the positive 
effects of the swing from inventory liquidation to accumulation 
dissipate. Most recoveries in the post-World War II period 
received a boost from a rebound in demand for consumer durables 
and housing from recession-depressed levels in addition to some 
abatement of the liquidation of inventories. Through most of 
last year's slowdown, in contrast to the usual pattern, the 
household sector was a major stabilizing force. As a 
consequence, although household spending should continue to 
trend up, the potential for significant acceleration in 
activity in this sector is more limited.
    In fact, there are a number of pluses and minuses in the 
outlook for household spending. Low mortgage interest rates and 
favorable weather have provided considerable support to 
homebuilding in recent months. Moreover, attractive mortgage 
rates have bolstered both the sales of existing homes and the 
realized capital gains that those sales engender. They have 
also spurred refinancing of existing homes and the associated 
liquification of increases in house values. These gains have 
been important to the ongoing extraction of home equity for 
consumption and home modernization. The pace of such 
extractions likely dropped in response to the decline in 
refinancing activity that followed the backup in mortgage rates 
that began in early November. But mortgage rates remain at low 
levels and should continue to provide support to activity in 
this sector.
    Consumer spending received a considerable lift from the 
sales of new motor vehicles, which were remarkably strong in 
October and November owing to major financing incentives. Sales 
have receded some as incentives were scaled back, but they have 
remained surprisingly resilient. Other consumer spending 
appears to have advanced at a moderate pace in recent months.
    The substantial declines in the prices of natural gas, fuel 
oil, and gasoline have clearly provided some support to real 
disposable income and spending. To have a more persistent 
effect on the ongoing growth of total personal consumption 
expenditures, energy prices would need to continue declining. 
Futures prices do not suggest that such a decline is in the 
immediate offing, but the forecast record of these markets is 
less than sterling.
    Although the quantitative magnitude and the precise timing 
of the wealth effect remain uncertain, the steep decline in 
stock prices since March 2000 has no doubt curbed the growth of 
household spending. Although stock prices recently have 
retraced a portion of their earlier losses, the restraining 
effects from the net decline in equity values presumably have 
not, as yet, fully played out. Future wealth effects will 
depend importantly on whether corporate earnings improve to the 
extent currently embedded in share prices.
    Perhaps most central to the outlook for consumer spending 
will be developments in the labor market. The pace of layoffs 
quickened last fall, especially after September 11, and the 
unemployment rate rose sharply. Over the past month or so, 
however, initial claims for unemployment insurance have 
decreased markedly, on balance, suggesting some abatement in 
the rate of job loss.
    Although this development would be welcome, the 
unemployment rate may continue to rise for a time, and job 
losses could put something of a damper on consumer spending.
    The dynamics of inventory investment and the balance of 
factors influencing consumer demand will have important 
consequences for the economic outlook in coming months. But the 
broad contours of the present cycle have been and will continue 
to be driven by the evolution of corporate profits and capital 
investment.
    The retrenchment in capital spending over the past year was 
central to the sharp slowing we experienced in overall economic 
activity. The steep rise in high-tech spending that occurred in 
the early post-Y2K months was clearly not sustainable. The 
demand for many of the newer technologies was growing rapidly, 
but capacity was expanding even faster, exerting severe 
pressure on prices and profits. New orders for equipment and 
software hesitated in the middle of 2000 and then fell sharply 
as firms re-evaluated their capital investment programs. In 
most cases, businesses required that new investments pay off 
much more rapidly than they had previously. For much of last 
year, the resulting decline in investment outlays was fierce 
and unrelenting.
    These cutbacks in capital spending interacted with, and 
were reinforced by, falling profits and equity prices. Indeed, 
a striking feature of the current cyclical episode relative to 
many earlier ones has been the virtual absence of pricing power 
across much of American business, as increasing globalization 
and deregulation have enhanced competition. In this low-
inflation environment, firms have perceived very little ability 
to pass cost increases on to customers. The result has been 
that profit margins are still under pressure.
    Business managers with little opportunity to raise prices 
have moved aggressively to stabilize cash-flows by trimming 
work forces. These efforts have limited the rise in unit costs, 
attenuated the pressure on profit margins, and ultimately 
helped to preserve the vast majority of private-sector jobs. To 
the extent that businesses are successful in stabilizing and 
eventually boosting profits and cash-flow, capital spending 
should begin to recover more noticeably.
    Such success would likely be accompanied by a decline in 
elevated risk premiums back to more normal levels and, with 
real rates of return on high-tech equipment still attractive, 
should provide an additional spur to new investment.
    The evidence strongly suggests that new technologies will 
present ample opportunities to earn enhanced rates of return. 
Indeed, reports from businesses around the country suggest the 
exploitation of available networking and other information 
technologies was only partially completed when the cyclical 
retrenchment of the past year began.
    If the recent more favorable economic developments continue 
and gather momentum, uncertainties will diminish, risk premiums 
will fall, and the pace of capital investment embodying these 
technologies will increase. As we have witnessed so clearly in 
recent years, the resulting enhanced growth of productivity 
will lift our standards of living.
    The economic and financial developments I have described, 
of course, have important implications for the Federal budget 
and can help explain a significant portion of the shift in the 
budget situation over the past year. A year ago, the 
Congressional Budget Office expected the unified surplus to 
continue to mount if no new policy actions were taken and to 
cumulate to $5.6 trillion for fiscal years 2002 to 2011, as Dr. 
Crippen testified yesterday.
    As you know, if today's policies remain in place, CBO is 
currently forecasting a cumulative surplus over the same 10 
years that is $4 trillion below what had been anticipated in 
its baseline a year ago.
    Despite the erosion in the budget picture over the past 
year, our underlying fiscal situation today remains 
considerably stronger than that of a decade ago, when 
policymakers were struggling to rein in chronic deficits. The 
shift from a deficit equal to nearly 5 percent of GDP in fiscal 
year 1992 to a surplus equal to 2.5 percent of GDP in fiscal 
year 2000 was truly remarkable. Restraint on outlays accounted 
for about 40 percent of the fiscal reversal over this period, 
and revenue growth in excess of GDP growth accounted for about 
45 percent; the associated declines in debt service accounted 
for the remainder. The fall in non-interest outlay share of GDP 
largely reflected lower defense spending as the cold war came 
to an end, but other spending also was fairly well restrained. 
At least until the past few years, the statutory caps helped to 
hold nondefense discretionary expenditures in check, and the 
pay-as-you-go rules forced careful consideration of deficit-
expanding initiatives.
    The extraordinary rise in receipts over the past decade 
resulted from the exceptional performance of the United States 
economy and the associated rise in the market value of assets, 
which helped lift receipts from 17.5 percent of GDP in fiscal 
year 1992 to a postwar high of nearly 21 percent of GDP in 
fiscal year 2000. The increase in receipts in the second half 
of the 1990's was particularly impressive--especially for 
individual income taxes, which grew about 11 percent per year 
on average between 1995 and 2000. The surge in individual taxes 
was attributable in part to the strong growth in incomes from 
production and to the tendency of rising levels of income to 
shift a greater share of taxable income into higher tax 
brackets.
    But individual taxes also received a boost from the 
enormous rise in the value of financial assets during that 
period--directly through taxes on higher capital gains 
realizations and indirectly through the taxes collected from 
the exercise of stock options, from stock-price-related bonuses 
to workers in the financial industry, and from withdrawals from 
capital-gains-augmented IRAs and 401(k) plans.
    Estimates based in part on data from the Statistics of 
Income and other sources suggest that such market-related 
receipts accounted for only about 15 percent of total 
individual receipts in fiscal year 1995; but because they grew 
about 25 percent per year on average between 1995 and 2000, 
they accounted for more than one-third of the increase in total 
individual receipts over that period. Receipts that are more 
directly related to production in the broader economy--that is, 
those associated with wages and salaries, business and 
professional incomes, dividends, and interest income--rose 8.5 
percent per year on average between 1995 and 2000, one-third 
the pace of receipts on stock-market-related taxable incomes.
    Recent developments, of course, have reversed part of this 
fiscal bonanza. Tax cuts, the weakening in economic activity, 
and the sharp decline in stock prices have reduced individual 
tax receipts. In addition, taxes on capital gains realizations 
have become an increasingly important component of corporate 
receipts in recent years, perhaps as much as one-fourth. 
Consequently, declines in stock prices have exerted additional 
downward pressure on corporate receipts, which had already 
taken a large hit from declining profit margins.
    Increased funding for defense and homeland security and the 
higher expenditures on unemployment benefits and other 
cyclically sensitive programs are also pressing on our current-
policy fiscal balances. Such calculations, of course, do not 
include the additional expenditures that doubtless will be 
authorized as the year progresses.
    The current-policy budget outlook prepared by the 
Congressional Budget Office for the coming decade, though less 
favorable than a year ago, is still quite positive. CBO remains 
reasonably sanguine about the economy's growth prospects for 
the next 10 years, and this is reflected in the re-emergence in 
its current-policy projections of moderate unified budget 
surpluses by the middle of the decade. If realized, such 
surpluses, by lowering the publicly held Federal debt and 
freeing up private saving to be channeled into capital 
investment, would help us prepare for the considerable 
demographic changes that we face over the longer run. This will 
clearly be no simple task. As Dr. Crippen emphasized yesterday, 
the fiscal pressures that will almost surely arise after 2010 
will be formidable.
    Achieving a satisfactory budget posture will depend on 
ensuring that new initiatives are consistent with our longer-
run budgetary objectives. Indeed, as you craft a budget 
strategy for coming years, you might again want to consider 
provisions that, in some way, would limit tax and spending 
initiatives if specified targets for the budget surpluses and 
Federal debt were not satisfied.
    The significant improvement in the budget in the 1990's 
reflected not only decidedly positive economic forces but also 
much hard work and many difficult decisions on the part of this 
committee and others. Similar efforts will be required in the 
years ahead.
    Thank you, Mr. Chairman. I look forward to your questions.
    Chairman Conrad. Thank you, Chairman Greenspan.
    [The prepared statement of Dr. Greenspan follows:]

 Prepared Statement of Alan Greenspan, Chairman, Board of Governors of 
                       the Federal Reserve Board

    Mr. Chairman and members of the committee, in just a few weeks, the 
Federal Reserve Board will submit its semiannual report on monetary 
policy to the Congress. That report, and my accompanying testimony, 
will give our detailed assessment of the outlook for the United States 
economy and the implications of that outlook for monetary policy. This 
morning, I would like to offer some general comments about the state of 
the economy before turning to the Federal budget. I want to emphasize 
that I speak for myself and not necessarily for the Federal Reserve. it 
is clear that the United States economy went through a significant 
cyclical adjustment in 2001 that was exacerbated by the effects of the 
terrorist attacks on September 11. That adjustment was characterized by 
sharp reductions in business investment and pronounced liquidations in 
business inventories and was compounded by the simultaneous economic 
difficulties of some of our major trading partners. But there have been 
signs recently that some of the forces that have been restraining the 
economy over the past year are starting to diminish and that activity 
is beginning to firm.
    One key consideration in that assessment is the behavior of 
inventories. Stocks in many industries have been drawn down to levels 
at which firms will soon need to taper off their rate of liquidation, 
if they have not already done so. Any slowing in the rate of inventory 
liquidation will induce a rise in industrial production if demand for 
those products is stable or is falling only moderately. That rise in 
production will, other things being equal, increase household income 
and spending. The runoff of inventories, even apart from the large 
reduction in motor vehicle stocks, remained sizable in the fourth 
quarter. Hence, with production running well below sales, the potential 
positive effect on income and spending of the inevitable cessation of 
inventory liquidation could be significant.
    But that impetus to activity will be short-lived unless sustained 
growth of final demand kicks in before the positive effects of the 
swing from inventory liquidation to accumulation dissipate. Most 
recoveries in the post-World War II period received a boost from a 
rebound in demand for consumer durables and housing from recession-
depressed levels in addition to some abatement of the liquidation of 
inventories. Through most of last year s slowdown, in contrast to the 
usual pattern, the household sector was a major stabilizing force. As a 
consequence, although household spending should continue to trend up, 
the potential for significant acceleration in activity in this sector 
is more limited.
    In fact, there are a number of pluses and minuses in the outlook 
for household spending. Low mortgage interest rates and favorable 
weather have provided considerable support to homebuilding in recent 
months. Moreover, attractive mortgage rates have bolstered both the 
sales of existing homes and the realized capital gains that those sales 
engender. They have also spurred refinancing of existing homes and the 
associated liquification of increases in house values. These gains have 
been important to the ongoing extraction of home equity for consumption 
and home modernization. The pace of such extractions likely dropped in 
response to the decline in refinancing activity that followed the 
backup in mortgage rates that began in early November. But mortgage 
rates remain at low levels and should continue to provide support to 
activity in this sector.
    Consumer spending received a considerable lift from the sales of 
new motor vehicles, which were remarkably strong in October and 
November owing to major financing incentives. Sales have receded some 
as incentives were scaled back, but they have remained surprisingly 
resilient. Other consumer spending appears to have advanced at a 
moderate pace in recent months.
    The substantial declines in the prices of natural gas, fuel oil, 
and gasoline have clearly provided some support to real disposable 
income and spending. To have a more persistent effect on the ongoing 
growth of total personal consumption expenditures, energy prices would 
need to continue declining. Futures prices do not suggest that such a 
decline is in the immediate offing, but the forecast record of these 
markets is less than sterling.
    Although the quantitative magnitude and the precise timing of the 
wealth effect remain uncertain, the steep decline in stock prices since 
March 2000 has, no doubt, curbed the growth of household spending. 
Although stock prices recently have retraced a portion of their earlier 
losses, the restraining effects from the net decline in equity values 
presumably have not, as yet, fully played out. Future wealth effects 
will depend importantly on whether corporate earnings improve to the 
extent currently embedded in share prices.
    Perhaps most central to the outlook for consumer spending will be 
developments in the labor market. The pace of layoffs quickened last 
fall, especially after September 11, and the unemployment rate rose 
sharply. Over the past month or so, however, initial claims for 
unemployment insurance have decreased markedly, on balance, suggesting 
some abatement in the rate of job loss.
    Although this development would be welcome, the unemployment rate 
may continue to rise for a time, and job losses could put something of 
a damper on consumer spending. However, the extent of such restraint 
will depend on how much of any rise in unemployment is the result of 
weakened demand and how much reflects strengthened productivity. In the 
latter case, average real incomes could rise, at least partially 
offsetting losses of purchasing power that stem from diminished levels 
of employment. Indeed, fragmentary data suggest that productivity has 
held up quite well of late.
    The dynamics of inventory investment and the balance of factors 
influencing consumer demand will have important consequences for the 
economic outlook in coming months. But the broad contours of the 
present cycle have been, and will continue to be, driven by the 
evolution of corporate profits and capital investment.
    The retrenchment in capital spending over the past year was central 
to the sharp slowing we experienced in overall activity. The steep rise 
in high-tech spending that occurred in the early post-Y2K months was 
clearly not sustainable. The demand for many of the newer technologies 
was growing rapidly, but capacity was expanding even faster, exerting 
severe pressure on prices and profits. New orders for equipment and 
software hesitated in the middle of 2000 and then fell sharply as firms 
re-evaluated their capital investment programs. Uncertainty about 
economic prospects boosted risk premiums significantly, and this rise, 
in turn, propelled required, or hurdle, rates of return to markedly 
elevated levels. In most cases, businesses required that new 
investments pay off much more rapidly than they had previously. For 
much of last year, the resulting decline in investment outlays was 
fierce and unrelenting. Although the weakness was most pronounced in 
the technology area, the reductions in capital outlays were broad-
based.
    These cutbacks in capital spending interacted with, and were 
reinforced by, falling profits and equity prices. Indeed, a striking 
feature of the current cyclical episode relative to many earlier ones 
has been the virtual absence of pricing power across much of American 
business, as increasing globalization and deregulation have enhanced 
competition. In this low-inflation environment, firms have perceived 
very little ability to pass cost increases on to customers. Growth in 
hourly labor compensation has slowed in response to deteriorating 
economic conditions, but even those smaller increases have continued to 
outstrip gains in output per hour for the corporate sector on a 
consolidated basis. The result has been that profit margins are still 
under pressure.
    Business managers, with little opportunity to raise prices, have 
moved aggressively to stabilize cash-flows by trimming work forces. 
These efforts have limited the rise in unit costs, attenuated the 
pressure on profit margins, and ultimately helped to preserve the vast 
majority of private-sector jobs. To the extent that businesses are 
successful in stabilizing and eventually boosting profits and cash-
flow, capital spending should begin to recover more noticeably.
    Such success would likely be accompanied by a decline in elevated 
risk premiums back to more normal levels and, with real rates of return 
on high-tech equipment still attractive, should provide an additional 
spur to new investment. When capital spending fully recovers, its 
growth is likely to be less frenetic than that which characterized 1999 
and early 2000--a period during which outlays were boosted by the 
dislocations of Y2K and the extraordinarily low cost of capital faced 
by many firms.
    Still, the evidence strongly suggests that new technologies will 
present ample opportunities to earn enhanced rates of return. Indeed, 
reports from businesses around the country suggest that the 
exploitation of available networking and other information technologies 
was only partially completed when the cyclical retrenchment of the past 
year began. Many business managers are still of the view, according to 
a recent survey of purchasing managers, that less than half of 
currently available new, and presumably profitable, supply chain 
technologies have been put into use.
    If the recent more-favorable economic developments continue and 
gather momentum, uncertainties will diminish, risk premiums will fall, 
and the pace of capital investment embodying these technologies will 
increase. As we have witnessed so clearly in recent years, the 
resulting enhanced growth of productivity will lift our standard of 
living.
    The economic and financial developments I have described, of 
course, have important implications for the Federal budget and can help 
explain a significant portion of the shift in the budget situation over 
the past year. A year ago, the Congressional Budget Office expected the 
unified surplus to continue to mount if no new policy actions were 
taken and to cumulate to $5.6 trillion for fiscal years 2002 to 2011.
    As you know, if today s policies remain in place, CBO is currently 
forecasting a cumulative surplus over the same 10 years that is $4 
trillion below what had been anticipated in its baseline a year ago. 
CBO calculates that the now less favorable economic assumptions--
especially in the near term--contribute nearly $1 trillion--after 
taking account of the associated cost of debt service--to the downward 
revision in its 10-year surplus projections. In addition, more than 
$600 billion of the downward revision reflects CBO s view that the 10-
year estimates it made a year ago of receipts relative to taxable 
incomes were too high; the revision was based in part on the recent 
disappointing tax collections and lowered estimates of realized capital 
gains in the wake of stock market declines.
    If CBO had been able to employ what has been learned about recent 
developments and the long-term outlook in the past year--that is, if it 
had used its current economic and technical assumptions when it put 
together its budget projections last January--a still formidable 
surplus would have emerged. Instead of projecting a $5.6 trillion 
current-policy surplus, it would have estimated $4 trillion.\1\  Of 
course, legislated tax and spending actions over the past year, as 
estimated by CBO, have reduced the 10-year surplus by $2.4 trillion. 
This leaves a current-policy 10-year surplus expectation of $1.6 
trillion through fiscal 2011.
---------------------------------------------------------------------------
    \1\ That projection would have indicated a need for significant 
accumulation of private assets in Federal Government accounts by 2009. 
In the actual CBO estimates of January 2001, that date was 2 years 
earlier.
    In the absence of cuts in taxes or increases in outlays that are 
programmed and phased in well in advance, the avoidance of sizable 
private asset accumulation might require taking actions that would 
essentially eliminate the surplus as the Federal debt approached its 
irreducible minimum. As I argued a year ago, such actions could result 
in a fiscal policy wholly inconsistent with the state of the economy at 
that time. For reasons I discussed last January, I believe that cutting 
taxes is a far preferable way to reduce the surplus over time than to 
institute new expenditure programs.
    CBO's projections of a year ago, which implied a substantial 
shortfall of reducible debt as early as 2007, suggested to me some 
urgency in phasing down the surplus. If CBO had access to the economic 
and technical developments of all of 2001 last January, it would have 
projected a somewhat later date for that shortfall. In the event, of 
course, a considerable part of the current-policy surplus was used to 
reduce taxes and to increase spending so that the most recent current-
policy projections of the CBO do not anticipate a need for significant 
non-Federal asset accumulation until well into the next decade.
---------------------------------------------------------------------------
    Despite the erosion in the budget picture over the past year, our 
underlying fiscal situation today remains considerably stronger than 
that of a decade ago, when policymakers were struggling to rein in 
chronic deficits. The shift from a deficit equal to nearly 5 percent of 
GDP in fiscal 1992 to a surplus equal to 2-1/2 percent of GDP in fiscal 
2000 was truly remarkable. Restraint on outlays accounted for about 40 
percent of the fiscal reversal over this period, and revenue growth in 
excess of GDP growth accounted for about 45 percent; the associated 
declines in debt service accounted for the remainder. The fall in the 
non-interest outlay share of GDP largely reflected lower defense 
spending as the cold war came to an end, but other spending also was 
fairly well restrained. At least until the past few years, the 
statutory caps helped to hold nondefense discretionary expenditures in 
check, and the pay-as-you-go rules forced careful consideration of 
deficit-expanding initiatives.\2\ 
---------------------------------------------------------------------------
    \2\ Relatively favorable demographic trends helped to restrain 
spending on social security and health programs; and although health 
spending rose very rapidly in the first half of the 1990's, these 
outlays decelerated markedly in the second half as a result of both 
legislative actions and the cost-containment efforts in the medical 
sector.
---------------------------------------------------------------------------
    The extraordinary rise in receipts over the past decade resulted 
from the exceptional performance of the United States economy and the 
associated rise in the market value of assets, which helped lift 
receipts from 17-1/2 percent of GDP in fiscal year 1992 to a postwar 
high of nearly 21 percent of GDP in fiscal 2000. The increase in 
receipts in the second half of the 1990's was particularly impressive--
especially for individual income taxes, which grew about 11 percent per 
year, on average, between 1995 arid 2000. The surge in individual taxes 
was attributable in part to the strong growth in incomes from 
production and to the tendency of rising levels of income to shift a 
greater share of taxable income into higher tax brackets.
    But individual taxes also received a boost from the enormous rise 
in the value of financial assets during that period--directly through 
taxes on higher capital gains realizations and indirectly through the 
taxes collected from the exercise of stock options, from stock-price-
related bonuses to workers in the financial industry, and from 
withdrawals from capital-gains-augmented IRAs and 401(k) plans.
    Estimates based in part on data from the Statistics of Income and 
other sources suggest that such market-related receipts accounted for 
only about 15 percent of total individual receipts in fiscal 1995; but 
because they grew about 25 percent per year, on average, between 1995 
and 2000, they accounted for more than one-third of the increase in 
total individual receipts over that period. Receipts that are more 
directly related to production in the broader economy--that is, those 
associated with wages and salaries, business and professional incomes, 
dividends, and interest income--rose 8-1/2 percent per year, on 
average, between 1995 and 2000, one-third the pace of receipts on 
stock-market-related taxable incomes.
    Had equity asset values risen only as fast as nominal GDP between 
1995 and 2000--that is, about 6 percent per year--taxes related to 
stock-price levels would have been approximately $130 billion less in 
fiscal 2000, even without taking account of the reduced receipts that 
would have resulted from a presumably less buoyant economy.
    Recent developments, of course, have reversed part of this fiscal 
bonanza. Tax cuts, the weakening in economic activity, and the sharp 
decline in stock prices have reduced individual tax receipts. In 
addition, taxes on capital gains realizations have become an 
increasingly important component of corporate receipts in recent 
years--perhaps as much as one-fourth. Consequently, declines in stock 
prices have exerted additional downward pressure on corporate receipts, 
which had already taken a large hit from declining profit margins.
    Increased funding for defense and homeland security and the higher 
expenditures on unemployment benefits and other cyclically sensitive 
programs are also pressing on our currentpolicy fiscal balances. Such 
calculations, of course, do not include the additional expenditures 
that doubtless will be authorized as the year progresses.
    coming decade, though less favorable than a year ago, is still 
quite positive. CBO remains reasonably sanguine about the economy s 
growth prospects for the next 10 years, and this is reflected in the 
re-emergence in its current-policy projections of moderate unified 
budget surpluses by the middle of the decade. If realized, such 
surpluses, by lowering the publicly held Federal debt and freeing up 
private saving to be channeled into capital investment, would help us 
prepare for the considerable demographic changes that we face over the 
longer run. This will clearly be no simple task. As Dr. Crippen 
emphasized yesterday, the fiscal pressures that will almost surely 
arise after 2010 will be formidable.
    Achieving a satisfactory budget posture will depend on ensuring 
that new initiatives are consistent with our longer-run budgetary 
objectives. Indeed, as you craft a budget strategy for coming years, 
you might again want to consider provisions that, in some way, would 
limit tax and spending initiatives if specified targets for the budget 
surplus and Federal debt were not satisfied.
    The significant improvement in the budget in the 1990's reflected 
not only decidedly positive economic forces but also much hard work and 
many difficult decisions on the part of this committee and others. 
Similar efforts will be required in the years ahead.

    Chairman Conrad. As Dr. Crippen noted yesterday, we face a 
circumstance, where, instead of $5.6 trillion of projected 
surpluses over the 10-year forecast period, that has been 
reduced to $1.6 trillion. That is before the significant 
defense buildup that the President is apparently about to 
propose, or the additional funding for homeland security. Those 
initiatives will add hundreds of billions of dollars of cost 
that aren't in Dr. Crippen's analysis. We have many other 
things to address as well that are not included in those 
estimates. And yet even without those, we see that there are no 
surpluses without counting the Social Security Trust Fund. In 
fact, we see that we would really be running a deficit of $1.1 
trillion over this period if we didn't have the Social Security 
Trust Fund money to fill in the hole.
    And as Dr. Crippen noted yesterday, and as you have 
referenced in your testimony, we face a demographic time bomb 
because the baby-boomers are going to retired. And that is not 
a projection. That is not a forecast. Those people have been 
born, they are alive, and they are eligible for Social 
Security, they are eligible for Medicare. We know it is going 
to happen. And everything changes.
    And as Dr. Crippen testified yesterday, we will face 
dramatic cuts in benefits or huge tax increases or massive debt 
or some combination if steps are not taken.
    Yesterday, in our conversation you referenced the some $10 
trillion of so-called contingent liabilities that are out there 
that the Federal Government faces, and you and I discussed how 
really most of that is not contingent liability. Based on the 
political realities, most of those are real liabilities, and 
yet we have not faced up to them.
    In light of these facts, do you still believe that we 
should construct some type of trigger mechanism or some type of 
fast-track budget consideration to help build surpluses and 
more aggressively pay down debt?
    Mr. Greenspan. I do, Mr. Chairman. I believe that we are 
going to be facing very significant problems after 2010, and 
while clearly that is a decade away, it is something which we 
have to be acutely aware of, because how we phase into that 
decade is going to matter as to how we finance it.
    In separate testimony actually before this committee, which 
had a Social Security task force, I discussed the longer-term 
outlook for Social Security in terms largely not of looking at 
the question of the funding per se to which you referred, which 
is an important issue, but rather, to recognize that what 
really is involved here is a required level of economic output 
in the decade subsequent to 2010, which is adequate, one, to 
create a level of real resources which would allow retirees to 
retire with some dignity, but at the same time that allows 
those who are working to enjoy the benefits of rising 
productivity.
    This means that we need to have a fairly robust rate of 
productivity growth in this country as we move off into the 
next decade, which means that fiscal policy, to the extent that 
that is going to affect what those productivity numbers are, 
has got to be focused on those policies which augment capital 
growth, capital spending. And, clearly, what fiscal policy can 
do in that regard, either from the tax side or from the 
government saving side, is to either create incentives for 
capital investment on the one hand or supply the savings that 
are required to be employed to finance it on the other.
    And in that regard, in my judgment, the availability of 
some form of mechanism to fine-tune our longer-term commitments 
would be quite useful and, indeed, very important in this 
regard.
    So I would suggest to you that since an ever-increasing 
part of the budget process is long-term commitments, we no 
longer have the luxury, which existed 30, 40, 50 years ago, 
where you would run 1-year budgets and you could change the 
next year's budget fairly dramatically. We no longer have that 
luxury. And as a consequence, it is quite important to make 
certain that there is a structure in place which creates the 
type of outlook which the Congress really intended.
    Chairman Conrad. Well, I thank you for that. I think that 
is a critically important point, and I hope people are 
listening, because if nothing else comes from this hearing, I 
hope there is a renewed concern about our long-term fiscal 
circumstance and what mechanisms we might put in place to 
foster the surpluses that are going to be necessary to meet 
these long-term obligations.
    Can you tell us, when you mentioned last year some type of 
trigger mechanism, what did you have in mind?
    Dr. Greenspan. Mr. Chairman, I didn't have any particular 
mechanism in mind, and the reason is that there are innumerable 
variations, all of which can do the same thing. In principle, I 
think it gets down to what the trigger is. Obviously, if it is 
some statistic or something which human beings cannot change, 
then you could conceivably build it into the law in which a 
particular program is going forward.
    Chairman Conrad. Should it be structured based on surplus 
levels or debt levels?
    Dr. Greenspan. Well, there are lots of different types of 
triggers. My own view is it probably should be based on a level 
of the debt to the public. And I raise that issue because, as 
you know, Senator Hollings is using the other debt level, and I 
will raise the issue, as you have, that there is another level 
which relates to what he is suggesting, which is the contingent 
liability question.
    Chairman Conrad. And what are those contingent liabilities, 
as you see them? And how large are the contingent liabilities 
that we face?
    Mr. Greenspan. Let's remember what they are. If you create 
an accounting system which, rather than measures the benefit 
payouts at any particular time, endeavors to determine what is 
accrued--what the Federal Government under the code of law and 
reasonable expectations about long-term real wage growth will 
be--that creates an obligation on retirement and that number, 
that actual liability, whether you call it contingent or non-
contingent, is created currently. At the moment and for recent 
years and for a certain period ahead, accrued liabilities are 
higher than the benefits being paid out, and that is 
accumulating a debt.
    If you believed that the existing law will never be changed 
and, indeed, can't be changed, then it is no longer a 
contingent liability. The reason it is contingent is that the 
Congress can, with majority vote, alter benefit payments in the 
future.
    My own impression, having lived with this program for a 
very long period of time, is that the probability of a 
significant reduction occurring in those benefits over the long 
run is not very high, which means that the very large 
proportion of the contingent liability, as you pointed out, Mr. 
Chairman, is not really contingent in any realistic sense.
    I understand, for example, in the Federal Government's 
balance sheet we assume only 1 month's liability on Social 
Security benefits on the presumption that you can change it in 
30 days and eliminate the program. Well, I wouldn't want to bet 
the ranch on that.
    Chairman Conrad. I wouldn't either, and $10 trillion is 
approximately the----
    Mr. Greenspan. That is correct, sir.
    Chairman Conrad [continuing]. Current contingent liability.
    Senator Domenici.
    Senator Domenici. I am going to let Senator Hagel take my 
turn now, and I will get back to it in due course.
    Chairman Conrad. Very well.
    Senator Hagel. Thank you, Senator. Thank you, Mr. Chairman.
    Chairman Greenspan, welcome. In your testimony this 
morning, you said, and I quote, ``The retrenchment in capital 
spending over the past year was central to the sharp slowing we 
experienced in overall...activity.'' In light of that fact, in 
light of the current Enron investigation, auditors' 
relationships with their clients, and all the other dynamics 
that factor into that equation, I would expect to see--more 
importantly, I would like your opinion on this--that as 
companies scramble to clean up their balance sheets, take 
losses, get some of the bad news out of the closet, being 
concerned if for no other reason that they will be hauled 
before a committee next, questioning their auditor 
relationships, I suspect that does not produce a particularly 
viable atmosphere and market for formation of capital and the 
application of that capital to invest.
    And when you look out across our global economy and see 
that the world economic situation is not particularly stable, 
and you factor in that foreign investment in our stocks and 
bonds in the year 2000 reached about, I believe, half a 
trillion dollars, we have some rather immense challenges.
    I would like you to come at this in any way you would like. 
Are you concerned about that, at how that projects itself into 
growth over the next two or three quarters, maybe all this 
year? Also, if we are to do an economic stimulus package, then 
should we be focused in that economic stimulus package with 
economic stimulus measures like investment measures for 
business?
    Mr. Greenspan. Senator, I think you are raising a very 
important point, and, indeed, it could come out the way you 
suggest. I am actually increasingly inclined to take a somewhat 
different view. I am surprised, as I suspect most of us are, at 
the extraordinary interest that has been devoted to this 
particular episode. And I think it is a very good sign. It 
tells us that because the whole structure of American business 
is so fundamentally based on trust, that any evident abrogation 
of that trust creates a real furor, which it should.
    Think of the worst outcome, namely, that we went through 
this particular episode and nobody cared. I think there are 
other places in the world in which an episode like this would 
be shrugged off as normal business. This is not the case. It is 
essentially telling us that we are not an economy which takes 
erosion of reputations as a minor question. Indeed, I think one 
of the lessons that people should learn is that Enron, without 
a considerable amount of physical assets, created a very large 
market value on its reputation and its conceptual skills. And 
that is a very fragile evaluation.
    Reputation is something, unlike a petrochemical feedstock 
plant which cannot disappear overnight and its value will not 
disappear very quickly. Fifty years ago, we used to have steel 
complexes and motor vehicle assembly plants, and that is what 
the major part of the value of those firms were. The conceptual 
value, the managerial strengths, and the like, were important 
but they were a part, only a part of what the market value of 
those firms were.
    We are increasingly getting firms which are conceptual, and 
Enron is a classic case, whose value depends increasingly on 
reputation and trust. And if you breach that, that value goes 
away very rapidly. And I frankly find that the remarkable 
reaction to this event suggests to me that people realize that 
trust is such a crucially important issue with respect to 
transactions which we all have every day. And we deal with each 
other in an essentially honorable way, because honesty is a 
very important economic value, as is trust, and we capitalize 
it on our balance sheet and call it goodwill. And I think that 
an abrogation of that good-will clearly has happened in some 
form or another. And I don't know what the facts are and won't 
know until all the hearings are out of the way, but an 
abrogation of that has been taken very seriously by the 
American public, and I think that is very good.
    Senator Hagel. If you would respond to the second part of 
that question, economic stimulus package.
    Mr. Greenspan. The stimulus issue is a difficult one at 
this particular stage because, while three months ago it was 
clearly a desirable action in the sense that an insurance taken 
out for an economy which clearly had not found its legs in any 
respect whatever, was, I thought, a desirable thing. We didn't 
do that. Fortunately, it turned out that we didn't need that 
particular insurance. But looking forward, it is not clear that 
we might need that insurance.
    In my prepared remarks, I pointed out that the usual surge 
that we get after an inventory reversal in recessions of the 
past is unlikely to be as vigorous as it was in the past, 
largely because the household sector, which has been so 
important, did not go down as much in this recession. And so it 
is conceivable that we may need some additional stimulus, which 
would be helpful, coming into effect in the spring or the 
summer or something of that timing.
    I myself am conflicted on the issue. On the one hand, I am 
looking at the fact that we do have a budget which is very 
close to balance, and any stimulus program will clearly put us 
into deficit and go in the wrong direction that we were talking 
about.
    Second, any temporary stimulus program by its nature does 
distort the capital structure of the economy. If you are 
dealing with an issue where the economy is weak, very clearly 
stimulus programs are highly desirable to have, and they are 
important, even though they have negative long-term effects. 
But at the moment, I have not come to a conclusion on this 
particular one, and I think whether we do it or we don't, we 
have pluses and minuses.
    I do not think it is a critically important issue to do. I 
think the economy will recover in any event. But nor do I think 
that a temporary stimulus program, which, by definition, will 
phase out, is a long-term threat to the budget itself.
    Senator Hagel. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Hollings.
    Senator Hollings. The trust you talk about, that is why I 
am disturbed with respect to this committee, because we are 
charged with the responsibility fiscally, and there isn't any 
question to start this consumer confidence, as you pointed out 
and as the chairman emphasized--I didn't know we were going to 
have this here, but all else being equal, a declining level of 
Federal debt is desirable because it holds down long-term real 
interest rates, thereby lowering the cost of capital, elevating 
private investment, and so forth.
    Now, you have done everything on the short-term interest 
rates, 11 cuts in 1 year. But we have done absolutely nothing 
with respect to just that, the long-term, because--I said it 
yesterday--we act just like Arthur Andersen in our accounting. 
And it is not a laughing matter because here is what you do, 
Mr. Chairman.
    Mr. Greenspan. It is not.
    Senator Hollings. You call a budget--you just said it, a 
budget close to balance. We ended up with a deficit of $143 
billion this last year, $143 billion deficit. That was as of 
September the 30th. We only had 9/11 just 20 days ahead, so we 
didn't spend $143 billion. I mean, the economy was going down, 
it had been going down, and everything else like that, and we 
were continuing to spend. And the real devil in the details is 
this public debt and private debt specifically.
    While you talk about the public debt going down, the 
overall debt goes up, the Government debt, rather, and, of 
course, the overall debt. In other words, I have in my hand the 
CBO report, and yesterday that is why I called us the sort of 
Arthur Andersen, because we were only discussing surpluses. 
This document that the committee discussed yesterday, the 
budget and economic outlook for the fiscal years 2003 through 
2012, only talked about surpluses. They didn't talk about the 
deficit and the overall net figure. And the overall net figure 
went up, up, and away some $2 trillion.
    That is the course that we are on, and that is the way your 
Wall Street market looks at things. They look at the reality. 
If it is going up $2 trillion, the Government is going to be 
coming into that market with sharp elbows, as you say, at least 
holding the long-term interest rates up, and that is what has 
happened here over the past year, even though you have cut, 
cut, cut. And the long-term interest, 1.7, I think it is 5.4 or 
5.5, it is almost a full point spread in there. Isn't that the 
case? Isn't that the market--what the market is saying, they 
are not going along with this public debt/private debt. They 
are looking at over the net amount as to whether or not the 
Government is coming into the market to borrow.
    Mr. Greenspan. Well, Senator, I agree with your general 
overall approach. I don't agree with the particular accounting. 
As you know, over the years we have argued on this issue. The 
difference between us, as I think I reiterated last year, is 
that I would focus on the debt held by, the public; this does 
not include the debt held by the Social Security Trust Fund 
which is intragovernmental debt and part of the numbers to 
which you are referring.
    Senator Hollings. And that is the contingent liability.
    Mr. Greenspan. No, it is not. It is only a very small part 
of it. And I am suggesting to you that--the reason I agree with 
your broader question is I tend to add the $3.75 trillion, 
which is the debt directly to the public, to the $10 trillion, 
or $10 trillion less whatever the contingent would be, rather 
than add the amount of Treasury debt securities held by 
Government agencies, which, in my judgment, is the equivalent 
of intracorporate debt transfers, and in the consolidation they 
wash out. But the contingent liability does not wash out. And, 
indeed, the concerns that I think the markets have increasingly 
is that, as you move into the next decade, when those 
contingent liabilities are turned into actual debt to the 
public because you have got to cash them in. Then, I think you 
have got some real serious problems.
    Senator Hollings. But the actual--Mr. Chairman, I would ask 
unanimous consent that I include in here the table at this 
particular point.\1\ 
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    \1\ Information not available at press time.
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    Chairman Conrad. Without objection.
    Senator Hollings. The table I refer to has Social Security, 
Medicare, military retirement, civilian retirement, 
unemployment, highway, the airport that we owe those particular 
trust funds. And we right now owe Social Security as of this 
particular chart, a CBO figure, $1.5 trillion that we have 
spent.
    I remember Section 14 of the Greenspan report of 1983 that 
says put it off budget and don't spend it. And we passed 13-301 
in 1990, and we had Bush, Sr. sign it. And it is law, but it is 
disobeyed. But that contingent liability goes to $2.8 trillion, 
and I had it down here in a figure a minute ago. It is up to $6 
or $7 trillion--well, it is up to $6 trillion. You will owe 
Social Security by 2012 $3.8 trillion. That isn't any 
contingent. That is just the actual owing. And the overall, all 
of these trust funds, I $5.9 trillion. So that is the thing 
when you borrow from all of these particular funds, it is like 
borrowing from your American Express to pay your MasterCard. 
You owe the same amount of money. And owing the same amount of 
money, namely, the debt going up over the next 10 years, it is 
going up some few trillion dollars. The gross Federal debt goes 
from 5.7 to 6.7, just about--no, it goes from 5.7 to 7.6. It is 
1.9.
    So that is what I am--I am going with you, I am going with 
the Chairman, and that is the thing that has bothered me as we 
get this double talk about deficits and surpluses. And 
yesterday we had nothing but talk about surpluses, and the debt 
is going up, up, and away, and we are having to continue to 
borrow. Isn't that correct?
    Mr. Greenspan. Well, let me tell you where the difference--
--
    Senator Hollings. Is that correct or not? Am I saying 
something that is stupid?
    Mr. Greenspan. No. I am just basically saying that you----
    Senator Hollings. Is the debt going up in the----
    Mr. Greenspan. I am saying the number----
    Senator Hollings. Let me ask you this. Here is the CBO 
report. Does it project that the debt goes up and the 
Government will have to borrow over the next 10 years or not?
    Mr. Greenspan. It does, and it----
    Senator Hollings. It does.
    Mr. Greenspan. But wait a second. It is an underestimate of 
what is going to have to happen in the sense that the Social 
Security Trust Fund is not fully funded, meaning the total 
quantity of assets which are held in the trust fund are a small 
fraction of what a private insurance company would require to 
fund the same obligations.
    So I am not disagreeing with you. I am just saying 
basically that the numbers that you are using are not the 
numbers I would use because they are intragovernmental 
transfers, and what you want are the full funding numbers 
because they tell you really what the Federal Government is 
going to have to borrow. Those numbers are incomplete and 
largely incomplete because the trust funds that are built up in 
Civil Service, and Social Security, are based on a particular 
tax----
    Senator Hollings. Doctor, what about a target of a budget 
freeze? We just passed all the budgets last month, the major 
ones, just signed by the President. Why not take those budgets 
agreed upon for next year, save and excepting defense security 
and home security? We can all agree and sort of limit the yin-
yang that goes back and forth and the politics and everything 
else like that, and then really debate out what more is needed, 
if so, in defense and home security. What about that kind of 
target?
    Mr. Greenspan. Senator, if I were an elected official of 
the United States Government, I would answer that. But I am 
not.
    Senator Hollings. Well, you answered all the other targets.
    Mr. Greenspan. No, but you are asking----
    Senator Hollings. You have given me an affirmative answer. 
Thank you, sir.
    Chairman Conrad. Senator Smith.
    Senator Smith. Thank you, Mr. Chairman.
    Thank you, Chairman Greenspan, for being with us. In your 
testimony you noted the CBO reports that last year projected 
over 10 years a surplus of $5.6 trillion, and that in a year's 
time that surplus that is projected has fallen by $4 trillion, 
leaving over 10 years a surplus of $1.6 trillion.
    Now, I assume that is the accounting method--if you agree 
with this, you are using the accounting method that we are all 
assuming and not the one that Senator Hollings is talking 
about. My question is: If there is a $1.6 trillion surplus, 
that assumes, does it not, that there will not be any increases 
in spending or changes in tax policy? Is that correct?
    Mr. Greenspan. That is correct, Senator.
    Senator Smith. Sir, my experience only 5 years as a United 
States Senator is that there is on the Democratic side a 
reluctance to roll back the tax cuts, on the Republican side 
not very much will to resist spending increases. I have come to 
that conclusion because there doesn't seem to be much penalty 
around here for lowering taxes or increasing spending. In fact, 
that is how you are politically rewarded. So I guess what I am 
saying is I am not real optimistic that these policies are 
going to hold if what I have seen here the last 5 years 
continues.
    But if that is the case and we are now debating a stimulus 
package, you have testified this morning that retrenchment in 
capital spending over the past year was central to our economic 
slowdown. You have specifically cited that new orders for 
equipment and software, information technology, fell 
dramatically last year and that that is the reason why we are 
experiencing such a dramatic slowdown. Now I am going to ask 
you a tax question. As we debate this stimulus package, is 
there something we should be doing or considering with respect 
to depreciation schedules, specifically on high-tech equipment, 
to help to get that sector going again? Because you have said 
specifically in most cases businesses required that new 
investments pay off much more rapidly than they had previously. 
Should that be something we should be considering on the tax 
side?
    Mr. Greenspan. Well, Senator, if you are going to consider 
a short-term stimulus package, meaning something which has 
major loss in revenue up front and in a certain sense almost 
reversing as you go farther out, then a temporary acceleration 
of depreciation, either by actually changing the codes, which 
are very complex, or far more preferably, expense, say, a 
portion of capital outlays for a year or two, what that will do 
is create a presumed moving of expenditures from a subsequent 
period up front. In other words, you will very unlikely change 
the aggregate amount of capital investment over a period of 
time. You will just displace it in time. And, indeed, if your 
purpose is short-term stimulus, that is exactly what you want 
to happen.
    It is not, however, a long-term stimulus bill, and, indeed, 
as I said earlier, it is very likely that all short-term 
stimulus bills probably have a modest--not an important but 
certainly a modest negative effect over the long-term outlook.
    Senator Smith. Because they just move consumption earlier 
as opposed----
    Mr. Greenspan. They move it, exactly. And they move capital 
assets sooner than they otherwise would have been.
    Similarly, the types of tax policy which would enhance 
long-term capital investment are wholly different from the 
types of actions you would take for short-term stimulus. And, 
indeed, by definition, they have no short-term effects.
    So it is a choice of what you are trying to do, and I find 
mixing the long term and the short term is an ambiguous policy 
in that regard, and then trying to figure out how it works is 
extraordinarily difficult.
    Senator Smith. But at least I think what I am hearing you 
say is that for our purposes, we ought to be looking on what 
makes the most sense long term in terms of depreciation 
schedules in order to foster a healthy, reliable business 
climate.
    Mr. Greenspan. Senator, if you are going to think long 
term, then you think permanent, not temporary changes. And 
permanent will not have significant short-term effect. Indeed, 
it will have some effect, but what really causes a 1-year, for 
example, say, 30 percent writeoff of capital investment is you 
move investment from 2 and 3 years out up into the first year, 
and that will enhance capital investment and boost the economy 
in the short run, but it will be at the expense of the economy 
in the second and third year out, and over the 3-year period 
probably it is a small negative.
    Senator Smith. OK. Mr. Greenspan, I need to ask you a 
spending question. We are going to do a lot more on winning 
this war and protecting our country and homeland defense. 
Another priority of mine and my colleague Senator Wyden is with 
respect to the uninsured. We have a terrible--I am talking 
about medical insurance, the working uninsured of this country 
who fall through the cracks in our system and continually are 
resorting to get health care at the emergency rooms of our 
hospitals, and providing a very inefficient, very expensive way 
to receive basic medical care.
    A concern I have is that we not lose focus of this, perhaps 
looking for ways to incentivize businesses to provide more to 
employees, in some way giving them the incentives to make it 
available, and then employees to be able to afford their 
portion of it.
    I think another component may well be expanding our 
community health centers, and I am wondering if you have seen a 
model out there, something short of what Europe has, something 
more than what we have, that can more efficiently provide 
health care to our country and close this terrible gap of 40 
million Americans without health insurance.
    Mr. Greenspan. I must say, Senator, even though it is not 
something that I have time to spend a good deal of time on, it 
is a subject which does interest me, and, indeed, I think 
having been involved with the Social Security Commission almost 
20 years ago, inevitably we got involved in health problems and 
the structure back then, which is not all that different from 
the types of questions which arise today.
    I have not in my own mind found a simple way to convert 
what is the extraordinary medical technology which we have 
developed in this country into a functioning medical system. I 
know in many respects we perceive ourselves as not doing what 
other countries do. Our morbidity and longevity is not 
significantly different from those who spend very substantially 
less of their gross domestic product on health care. But it is 
very difficult to know why that is, in any meaningful way, and 
it is a subject matter which I must say I find very difficult 
to get conclusions where I am comfortable I would know how a 
model would turn out.
    I have struggled with it, and I can't say I have come up 
with something which I find useful.
    Senator Smith. Thank you, Mr. Chairman. Thank you very 
much.
    Chairman Conrad. Let me just make the observation that we 
have six questioners left on this side, we have eight left on 
this side, and on both sides we have been going over the 7 
minutes by a minute and a half or so because of the seriousness 
of the questions. Nobody has been imposing on a colleague's 
time, but I think maybe we are going to have to cut it back to 
5 minutes of questioning and statement time, or else people are 
just going to get left out here today.
    Mr. Greenspan. I will shorten my answers considerably, 
Senator.
    Chairman Conrad. If you could, that would be helpful as 
well. I appreciate that.
    Senator Sarbanes. That is an extraordinary contribution. 
[Laughter.]
    Chairman Conrad. Senator, we had indicated to the Chairman 
that we would seek, endeavor to be done at 12:30. That is the 
deadline that we are working against.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Chairman, when you spoke January 11th in San Francisco, 
stock prices fell pretty sharply during your speech. And in the 
days after January 11th, various Fed officials went out and 
said that those comments were misinterpreted. Newspapers 
carried headlines all over the country: Fed Chairman has been 
misinterpreted.
    I think it would be helpful if you could characterize today 
how you do see the economy. I don't want to try to lock you 
into a simplified debate about isms, whether you are showing 
pessimism or whether you are showing optimism. I think it would 
be helpful if you could clarify the message from January 11th, 
and obviously there was some concern from the Fed that day, and 
let me ask that to start with.
    Mr. Greenspan. Well, Senator, I tried to address that issue 
in my prepared remarks, and you will find that a considerable 
amount of what I had to say is quite repetitious of the speech 
I made in San Francisco.
    It is very difficult in giving any speech of, say, 20 
minutes, 25 minutes, to capture a particular view at a complex 
time such as this. What I was trying to do in that particular 
speech was to look at the American economy, which had been 
battered very brutally if I may put it that way, one, by a very 
sharp contraction in the rate of growth and fall in capital 
investment, profits, stock prices, and the like, and then, 
followed up in September with a tragic set of events, which in 
the past I would have suspected would have breached the 
underlying confidence both in the consumer and household sector 
and created a really serious, deep-seated problem for us.
    In the event, it didn't turn out that way. It turned out 
that we showed a far greater degree of resiliency and 
flexibility, and the economy stabilized. And I was trying to 
make that point without trying to get to an issue of whether we 
were going to snap back quickly or not so quickly. The markets, 
however, have been assuming a far more rapid snapback than I 
frankly think is likely to happen, largely because we haven't 
gone down very far. And that created, unfortunately, I think, 
phraseology which in retrospect I should have done differently, 
which sort of implied that I didn't think that the economy was 
in the process of turning. And I tried to rectify that in 
today's remarks.
    Senator Wyden. Let me ask one other question. My State has 
the dubious distinction now of having the highest unemployment 
rate in the country. People are really hurting, and I have said 
for purposes of this session that I am going to measure 
everything in terms of how much it will do to create good-
paying jobs and how quickly.
    Tell me conceptually, because you can't get into the merits 
of legislation, what your reaction would be to having a tax 
credit for businesses that hire workers, particularly displaced 
workers, someone who has been laid off. Conceptually, how would 
you assess that?
    Mr. Greenspan. It depends on whether you are thinking of it 
in terms of something to help those individuals who are in very 
dire straits or whether you're looking at it as an economic 
program. In my judgment, it is the former not the latter, 
because you cannot reverse cause and effect, so to speak, in an 
economy. Economic activity creates jobs. It is not the other 
way around. And, therefore, I would say that if we are 
interested in getting the unemployment rate down, what we have 
to do is to increase the rate of growth in output.
    Senator Wyden. One other question, if I might. I heard a 
lot of concerns in Oregon last week about our policy with 
respect to the dollar, and the concern was that our policy on 
the dollar was hurting Oregon companies, United States 
companies, in terms of being able to cap export markets. In our 
part of the world, one out of six jobs depends on that kind of 
export opportunity, and they pay well.
    Do you have any thoughts about what kind of policies would 
be appropriate with respect to the dollar so as to get the most 
opportunities for United States businesses to get more exports 
overseas?
    Mr. Greenspan. Senator, those of us who are involved in 
financial policy in the United States Government are acutely 
aware of the fact that we can only have one voice on exchange 
rate policy, because if you get a number of people or a 
cacophony of people talking about it, it would tend to undercut 
markets. So the Secretary of the Treasury has been our 
designated spokesman, and I have tried to adhere to not 
commenting on the issue of the dollar. And I hope that that 
policy over the years is to work to our benefit. I suspect it 
has.
    Senator Wyden. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. And, Chairman 
Greenspan, it is good to hear from you again.
    A couple years ago, you cautioned the Congress about 
irrevocable or almost irrevocable programs that were being put 
in place, and I heard in your comments today kind of a 
reference to continued concern in that regard. And then 
yesterday we heard from the Director of the Congressional 
Budget Office, Dan Crippen, who testified before this committee 
that since January 2001, Congress has increased discretionary 
spending to the tune of $44 billion in 2002, $49 billion in 
2003, and over a 10-year period, a total up to about $550 
billion.
    I would like to have you share your opinion on the long-
term risks involved in continually increasing discretionary 
spending, and then I have a second question.
    Mr. Greenspan. Senator, I think if there is one lesson we 
have learned from these most recent experiences, it is that 
while caps on discretionary spending actually work remarkably 
well in periods of deficit, they do not in periods of surplus. 
And, indeed, it is very evident that as the deficits turned 
into surplus, those caps eroded very rapidly. And I would hope 
that when the expiration of the existing caps, which is this 
September, occurs, that the Congress will be able to extend 
them and, indeed, trust that they work as well as they did in 
the past. I suspect they have a good chance of doing so, and I 
would think that that to me would be the best program that one 
could focus on to constrain the type of numbers you are talking 
about.
    Senator Allard. Second question. I would like to hear your 
comment on creation of new programs and more spending as a 
stimulus for the economy as opposed to tax cuts. And, more 
specifically, is this an appropriate time to consider reducing 
the capital gains tax even further because of its potential 
stimulatory effect on the economy?
    Mr. Greenspan. Well, Senator, as I have testified--I didn't 
realize it was 18 times, but I think you will find the one 
consistency through those 18 appearances is that I have always 
stipulated that I thought that if long-term fiscal balance is 
the basic purpose, that one should focus on holding spending 
down, and if you run into available surpluses, to try to remove 
them by reducing taxes. So I would say basically I would be 
mainly focused, as I have in the past, on that issue.
    Senator Allard. Comment a little bit on capital gains, if 
you would, please. We look at increased revenues----
    Mr. Greenspan. Yes, I have in the past argued that the 
capital gains tax is in my judgment an inappropriate means to 
raise revenue because its effect on the capital stock is very 
substantial, and that there is a big dispute within the 
economics profession because it is very difficult to actually 
make a determination whether the statement I just made is true.
    Having worked in the business arena for most of my life, I 
am convinced that it is. I think it is far better to raise 
revenue by other means. So I have always been in favor of 
eliminating the capital gains tax. Obviously, reducing it is 
preferable to not eliminating it, so I would always be 
interested in moving in that direction.
    If it turns out that you need revenues--if it creates 
serious fiscal problems, then I would argue pick up the 
revenues by another means.
    Senator Allard. Mr. Chairman, I see I am going to turn back 
30 seconds for my colleagues.
    Chairman Conrad. You are a hero. [Laughter.]
    Chairman Conrad. Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman.
    Thank you, Chairman Greenspan. It is an honor to see you 
here again today, and I just have to say, before I ask you a 
question, that it is amazing what a difference a year can make. 
I remember sitting in this committee a year ago when we were 
looking at surpluses and we had estimates showing that we would 
be able to buy down the publicly held debt by 2009, that we 
could strengthen Social Security and Medicare, that we could 
return a significant portion of the surplus to the taxpayers, 
and we were told that based on 10-year budget projections that 
we could have it all. And I remember cautioning every member of 
this Budget Committee to be very careful because what I saw 
happening in my own State a year ago I felt would soon be seen 
by the rest of the country.
    At that time we were facing a major energy crisis, as the 
entire West Coast was. We were worried about increased costs 
for all consumers in terms of energy and job loss. And I warned 
our comrades about that as we began the budget discussions 
about having a huge tax reduction at that time.
    And many of those predictions that I was concerned about 
have come true in my State. We have had tremendous job loss, 
especially in any industry that has high energy costs. Our 
aluminum companies, our cold-storage facilities have been shut 
down. Many of our small communities have high unemployment 
rates right now as a result of that--and that was before the 
effects of September 11th--on the aerospace industry that sits 
in my State, and 30,000 Boeing employees are now being laid 
off.
    We have the second-highest unemployment in the Nation right 
behind my neighbor Oregon to the south, as Ron Wyden alluded 
to. Consumer confidence in my State is very real. People are 
very concerned about whether they are going to keep their job 
or not. The dotcom industry has had a tremendous impact in all 
of our region. Our farmers have not been able to sell their 
products in Asia, which has been the market that they have 
counted on.
    So consumer confidence is way down, and I am extremely 
worried about that because everyone I know knows someone who 
has lost their job or has been given a pink slip.
    As we talk about this economic policy that we are--stimulus 
package that we are debating here in the Senate, I hear a lot 
about the stimulative impact of a tax cut and the debate on 
both sides of that. But I think it is also important that we 
deal with the consumer confidence. Extending the unemployment 
benefits, taking care of those people who have been laid off, 
who are concerned that they can't pay health care, establishing 
that kind of confidence that if you are laid off, that you 
won't be emptied of your bank account, that you will be able to 
hold it together for a while until things get back on track is 
very important to people in my State and I think across the 
country.
    What do you think of the stimulative effect of us making 
sure that those who have been laid off have extended 
unemployment benefits or health care coverage while they are 
out of work?
    Mr. Greenspan. Senator, I have always been in favor of 
extending unemployment benefits during periods of rising 
unemployment, largely because the purpose of having the 26-week 
limit, which is standard, is essentially not to get people 
involved in long-term unemployment insurance as an alternate to 
work. And, indeed, it works exceptionally well when the job 
market is functioning normally, but, clearly, you cannot argue 
that for somebody who runs past the 26-week level it is because 
of sloth or not looking for a job or not actively seeking to 
get re-employed. There just are no jobs out there.
    Consequently, to adhere to the 26-week limit doesn't serve 
its actual purpose, which is essentially to prevent a misuse of 
the unemployment insurance system. So I have always been in 
favor of extending benefits when the job market itself begins 
to dry up.
    Senator Murray. And the health care? Because that is an 
out-of-pocket expense that most people cannot afford.
    Mr. Greenspan. Well, I don't want to get into detailed 
general budgetary questions. Those are issues which I try to 
avoid if I can, and----
    Senator Murray. But you would agree that consumer 
confidence in their ability to survive tough times is an 
important part of economic recovery?
    Mr. Greenspan. I would say consumer confidence in general 
is clearly important, and the source of consumer confidence is 
broadly determined by an expectation that the economy is 
improving, that job prospects are favorable, that one can 
function and plan in an economy in which one is not concerned 
about losing one's job.
    Senator Murray. Thank you. And the other fear that I see 
now, for the first time in my life, is people's fear of 
retirement. That has been fueled by an Enron scandal that means 
people don't believe or are fearful that their pensions may not 
be there. They hear about a budget deficit here, that the long-
term prospects for Social Security and Medicare will be 
impacted by that. We still have the whole issue of prescription 
drugs that are an increasing out-of-pocket expense for senior 
citizens who aren't covered. And for the first time, I am 
hearing people who fear retiring. It is an issue of confidence 
that those protections will be there. And as we talk about now 
coming to a point where we have a budget deficit, from your 
point of view can we still protect the solvency of Social 
Security and Medicare? And how important is that as we look at 
our budget?
    Mr. Greenspan. Well, Senator, it depends on how one looks 
at those programs. I don't believe that, in the event that the 
Social Security Trust Fund were to go to zero, which would 
require a delay in the payments for Social Security, that it 
would ever actually occur in that sense. In other words, I 
don't believe that people really have need to be seriously 
concerned about getting Social Security benefits, because in my 
judgment I do not think that there is any likelihood that 
should the budgeted resources currently in place, which is 
essentially the Social Security Trust Fund, run out, that the 
Congress would allow benefits to somehow be altered in a 
significant way.
    I consider there are certain types of things we have in 
Government which are structures which will never be employed, 
and that particular rule, in my judgment, will never be 
employed.
    Senator Murray. Well, I would agree that the social 
conscience of the Senate would make it difficult for us to not 
do that, but I do think we have to look at it, Mr. Chairman, as 
part of what we have to protect in our budget as we move 
forward.
    Chairman Conrad. Thank you, Senator.
    Let me just say we are doing a little backsliding now on 
both sides. So if we are going to stay on for 12:30, we have 
got to try to be closer.
    Senator Snowe.
    Senator Snowe. I realize the pressure is on, Mr. Chairman.
    Chairman Conrad. Follow the example, the Allard example.
    Senator Snowe. I will try.
    Chairman Greenspan, earlier in response to the chairman's 
question regarding a trigger, you outlined some of the benefits 
that could be accomplished by such a mechanism. In fact, I 
recall a year ago you, in fact, suggested it in your testimony 
to this committee. Actually in response to that suggestion, 
Senator Bayh, Senator Stabenow, and I and others worked in a 
bipartisan fashion to establish a trigger that would tie 
spending and tax cuts to get reduction targets, and it would 
kick in in 2004. So even with this recession, it wouldn't send, 
I think, the wrong message and kick in. It would be forward-
looking.
    Do you think it makes a difference in how we structure this 
type of trigger?
    Mr. Greenspan. Not really, Senator, so long as it 
accomplishes its goal. The principle I would apply here is to 
be certain that there is a judgment of the Congress involved in 
the implementation of the trigger, unless you can find a 
trigger which is unrelated to policy decisions. In other words, 
you cannot, for example, make a CBO determination an automatic 
trigger on any program of the Federal Government, or put more 
exactly, you shouldn't.
    If you are going to do it--some States, for example, have 
triggers which effectively are determined by actual events 
within the State which are not subject to political 
manipulation--you have to be careful to be sure that something 
like fast-track would be the model I would think, if you are 
looking at a budgetary issue. You can't use a trigger in which 
something happens without the Congress doing something. But I 
do think that what a trigger ought to do is enforce that action 
be taken and probably be an up- or down-vote of a certain type, 
in a similar type of legislation, but not exactly, as fast-
track. And the crucial issue there is to make certain that the 
rules of the Senate and the rules of the House are employed in 
such a manner that they come together at the right--I should 
say approximately the same time.
    Senator Snowe. I see. So, in other words, that Congress 
obviously should be in a position--you have a mechanism in 
place so that Congress has to take a proactive action on such a 
trigger. You know, so if we have to suspend either spending or 
a tax cut that may be kicking in in the next year, that the 
House and Senate would both have to take that action.
    Mr. Greenspan. Correct.
    Senator Snowe. Vote on it. OK. Thank you. That is helpful.
    Last year, you mentioned that a tax cut may not prevent a 
recession, but it could lessen the impact or shorten the 
direction. You know, a tax cut could be helpful in that sense. 
Do you think that the passage of the tax cut at the end of May 
in the Congress had any role at all potentially in shortening 
the duration of this recession and mitigating the impact of 
this recession?
    Mr. Greenspan. I think it did, Senator. I think that the 
evidence of consumer markets in August and even early September 
was that there was some impact of that. Obviously, with 
September the 11th, the whole situation changed very 
dramatically, so it was very difficult to trace the effects 
after that. But from what I could see, it did have an effect.
    Senator Snowe. You mentioned that an economic recovery 
obviously is going to happen in any event. I think the real 
question is: What type of recovery? And one of the major 
concerns that we all have, of course, is this unemployment 
rate. So we could emerge from this recession and yet the 
effects could be benign because of the unemployment rate, and 
that that could continue to rise or jobs not created that will 
help those who have lost their jobs.
    So do you think a stimulus package of some kind could help 
to really turn around the behavior of this economy so it could 
mitigate those effects sooner rather than later?
    Mr. Greenspan. Well, Senator, I did respond to that 
question earlier and concluded that it is very difficult to 
judge. Clearly, as you point out, with the potential at least 
that the economy may be more tepid than we would like, later in 
this year some form of stimulus program probably would be 
useful. But we don't know that yet. In other words, it is very 
difficult to judge exactly how this year is going to develop. I 
think we do know--one of the very few things that economists 
know--is that inventories cannot get below zero. And that may 
seem like sort of a simplistic statement, but it does mean that 
inventory liquidation, which has been very large, must slow its 
rate of pace, meaning production must rise relative to 
consumption.
    But once you go beyond that, it is difficult to read the 
signals. It could go either way. And if the judgment is that it 
is going to be softer than the Congress would like, clearly a 
stimulus program would be helpful in that regard.
    Senator Snowe. Thank you.
    Mr. Greenspan. But I am not sure how one could argue either 
side very effectively.
    Senator Snowe. Thank you.
    Mr. Greenspan. Unqualifiedly, I should say.
    Senator Snowe. I appreciate that.
    Thank you, Mr. Chairman.
    Chairman Conrad. Senator Byrd.
    Senator Byrd. Thank you, Mr. Chairman. And thank you, 
Chairman Greenspan. As I said last year, I am always very 
impressed with your testimony.
    Mr. Greenspan. Thank you, sir.
    Senator Byrd. I wish we had more time, but I can understand 
the time constraint.
    This year promises to be a very difficult year for the 
budget and appropriations process. The projected return to 
deficit budgeting, the recession, the midterm elections, and 
the demands for increased homeland security and for supporting 
our military have left a very dark cloud looming over the 
entire budget process this year.
    The political cross-fire that we have seen so far will only 
serve to exacerbate the tensions between the two political 
parties and between the legislative and executive branches. 
Make no mistake, I am no supporter of the tax cut that we 
passed last year. I was one of its most vocal and fiercest 
opponents. My wife and I returned our rebate to the Bureau of 
Public Debt.
    But the reality of the situation as I see it os that 
today's political environment does not allow at this time for 
the repeal or delay of the tax cuts we enacted last year. That 
is not to say that some future Congress or President will not 
want to or have to revisit last year's changes to the tax code. 
It simply means that it is highly unlikely that the 107th 
Congress and this President will do it.
    And anybody who knows anything at all about the Senate 
rules knows that to be the case, and the President can say, 
``Over my dead body,'' to use his euphemistic approach, will 
they increase taxes. He can say that because it takes 60 votes 
in the Senate to pass such legislation repealing last year's 
tax cut. Sixty votes. The Democrats, if they all voted 
together, wouldn't have but 51 votes. So he can be sure that 
his body will not be dead and that the repeal of that tax cut 
will not be enacted, this year at least.
    What is more, it does no good to advocate unrealistically 
low spending levels that nobody expected to be enacted. It sets 
up a game of chicken, with the loser being the one who thinks 
he is first and admits the reality that spending levels have 
been set unrealistically low.
    I can see the handwriting on the wall. With the rhetoric 
that we have heard so far from the legislative and the 
executive branches, we are setting the stage for months of 
wasted time, feuding over proposals that have no chance of 
becoming law, and eventually will result in an omnibus bill at 
the end of the year, and that is a prescription for 
overspending.
    We need to focus our efforts on crafting a budget 
resolution that is practical and realistic in its assumptions 
about tax cuts and spending. Anything else only serves to 
exacerbate the contentious atmosphere that already surrounds 
this year's budget and appropriations debate.
    So with that said, Chairman Greenspan, I suppose you would 
agree that unnecessary delays in the budget and appropriations 
process, like we saw last year, is a negative overall for the 
economy.
    Mr. Greenspan. I agree with that, Senator.
    Senator Byrd. Second, under the Budget Act, reductions in 
taxes and increases in mandatory spending are supposed to be 
paid for. And yet, over the last 3 years, over $160 billion of 
tax cuts and mandatory programs expansions have been wiped off 
the so-called pay-as-you-go scorecard. So there is a free lunch 
without that scorecard.
    In your testimony, you indicate that Congress should 
consider mechanisms that would limit tax and spending 
initiatives. Do you believe the pay-as-you-go provisions of the 
Budget Act should be extended?
    Mr. Greenspan. I very much do, Senator.
    Senator Byrd. Mr. Chairman, I am getting clear answers to 
specific questions.
    Senator Sarbanes. It is a miracle. [Laughter.]
    Senator Byrd. Miracles do happen.
    Now, Chairman Greenspan, there has been talk here about 
trigger mechanisms, and Mrs. Murray raised the question with 
respect to Social Security as to whether or not there would 
come a time when the expected recipients, and especially those 
in the baby-boom generation, can look forward to receiving 
their check. I am paraphrasing it, changing it a little bit.
    Would the long-term problems facing the Social Security and 
Medicare system justify the trigger mechanism you mentioned in 
your testimony?
    Mr. Greenspan. You mean actually having triggers on 
benefits and the like? I am sorry. Is that the----
    Senator Byrd. Well, I am wondering if the long-term 
problems facing the Social Security and Medicare system justify 
a trigger mechanism that you mentioned in your testimony last 
year as well as in this year. We are all concerned about Social 
Security.
    Mr. Greenspan. I am sorry. I don't understand. Triggers can 
be on specific programs or be more generic. Are you referring 
to a trigger on the Social Security program or the broader 
trigger to protect Social Security?
    Senator Byrd. I think I am referring to the broader 
trigger.
    Mr. Greenspan. I do think that because so much of the 
Federal budget, as you know, has become nondiscretionary, which 
we used to call ``uncontrollables,'' that it is very important 
that we have a mechanism which enables the trend of receipts 
and outlays to match the goal of the Congress over a period of 
years. Since unlike, as you may recall, 40 years ago when you 
could pass 1 year's appropriations and do something wholly 
different the next year, because you didn't have a lot of 
continuing programs going on--because we don't have that, I 
think something of the nature of the trigger probably will 
ultimately turn out to be essential if the Congress is going to 
try to guide where the long-term fiscal programs are going to 
go.
    Senator Byrd. Mr. Chairman, I would like to ask one more 
question.
    Chairman Conrad. Go ahead. You didn't have an opportunity 
yesterday. You waited very patiently. Please, go ahead.
    Senator Byrd. Thank you, Mr. Chairman.
    Mr. Chairman, Dr. Greenspan, I strongly supported new money 
for homeland defense last year, and I would have utilized more 
of our resources for that purpose. The Administration opposed 
going beyond the $40 billion overall that we passed in the 
supplemental, of which, in the last $20 billion which was to be 
included in the last appropriation bill, and was, I sought more 
money for New York and for homeland defense. As I see it, there 
is no difference in homeland defense and defense in the usual 
sense. Homeland defense is something new, but it is defense. It 
is the defense of our country and our people.
    Now, having said that, the Administration opposed the new 
increase at that time. Now the Administration is coming back 
saying more, more, more, and I am likely to support more, more, 
more, because some of the same problems that existed when we 
had our appropriation bill last year still exist. Many of them 
do. So we will have to spend more for homeland defense.
    But this anticipated increase for the military side, I 
understand it may be $48 or $49 billion over last year. That 
would be a 15 percent increase over last year. In other words, 
2003, if we add $49 billion, which we hear the President may 
propose in his State of the Union address, or at least in his 
budget when he sends it up here, that would represent a 15 
percent increase over 2002. 2002 represented a 15 percent 
increase over 2001, and so here in 2 years, we are talking 
about increases of 10 percent and then 15 percent.
    This is something that I only raise here to indicate that 
we had better take a look, a close look, at what we are doing 
in defense spending. I hear a lot of talk about spending. I 
assume that those who are concerned about spending are also 
talking about defense spending. I am one of the hawks who have 
been around here 50 years this year when it comes to defense. 
But I am becoming a little nervous as I hear that we are going 
to spend more and more and more on the military.
    It is going to have to come out of somewhere, out of 
somebody else's hide. We have just established that we should 
stay with the pay-as-you-go theory. So I am not getting to a 
question, but I am just expressing some sense of caution.
    Finally, I hope that we Senators and all who have listened 
and those who have not had the privilege of listening to what 
you said today will go back and read again what you said. And I 
hope that those who talk about a stimulus package will 
particularly pay attention to what you have said today in your 
testimony concerning short-term stimulus, long-term stimulus, 
et cetera, et cetera. I think it is very worthwhile--not only 
very worthwhile reading but good advice.
    Finally, may I utter a word of caution? Do you, as someone 
for whom I have tremendous respect--you used the word ``fast-
track'' when you responded to a question here. I hope that you 
will not use the term ``fast-track.'' It is all right to use 
the term ``expedited,'' expedited rules or expedited handling 
of whatever legislation we are talking about. But I hope that 
you will not use the term ``fast-track'' in the sense that I 
think you used it, and that is with respect to trade 
legislation.
    Let me just read you one provision from the United States 
Constitution, and it comes from the first paragraph of Section 
7 of Article I of the United States Constitution. Here it is: 
``All bills for raising revenue shall originate in the House of 
Representatives; but the Senate may propose or concur with 
amendments as on other bills.''
    Now, there is the power, there is the origination, if I may 
use it, in the Constitution, the power of the Senate to amend, 
not only revenue bills but as on other bills.
    Now, when you are talking about fast-track--and we will get 
into this in another place, at another time, and it will be 
quite a long speech that I will be prepared to make on this 
thing. When we talk about fast-track, we are talking about 
denying the United States Senate its right, its authority, its 
power to amend trade bills, ``as on other bills.''
    I know there are those who would say, well, the Congress 
has a right to delegate. We are not delegating here. That is 
not delegating. Fast-track is taking away from the Senate a 
basic constitutional right and power, namely, the power and 
right and prerogative to amend.
    So if you would accept my suggestion in the spirit in which 
it is offered, please don't use the term ``fast-track'' in 
answering a legitimate question like that when it is being 
asked here concerning a trigger.
    That is all I have to say, except I would like to ask, if I 
might, how do you see the trade deficit in this whole equation? 
Last year, the trade deficit just in the month of November was 
$27.9 billion, and for the first 11 months of 2001, the trade 
deficit was $349 billion, and in the year 2000, it was $375 
billion. So it looks as though we are well on our way in 2001 
to eclipsing the trade deficit of $375 billion in 2000.
    Would you have any comment?
    Mr. Greenspan. Well, Senator, first let me say I heard your 
words, and the word ``fast-track'' will not re-emerge from my 
lips. [Laughter.]
    Senator Byrd. Thank you.
    Mr. Greenspan. I have been worried about the trade deficit 
for many years. It is a problem which should be creating more 
difficulty with respect to our international financial 
position, but it hasn't. And the reason it hasn't is that the 
investment capabilities within United States companies have 
attracted a sufficiently large amount of capital, investment 
capital from, abroad to maintain the financing year after year 
after year.
    I assume at some point it has to come to a halt, but I have 
been saying that for a number of years, and I am impressed with 
the attractiveness of American investment opportunities. It 
seems endless.
    Senator Byrd. Thank you. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Domenici.
    Senator Domenici. Let me say to my Senator on my side, I 
have not asked yet and I have to leave to get ready to go to 
New Mexico. So I will go as quickly as I can.
    First, Dr. Greenspan, within the last 2 or 3 years, as you 
testified before this committee and other committees of the 
United States Congress, you referred to the United States 
economy in very positive tones and positive words describing 
the phenomenon of about 10 years of sustained growth without 
inflation, with sustained productivity increases during that 
period of time, and you and many chose to call it ``a new 
economy.'' And----
    Mr. Greenspan. I don't think I ever used that term, but 
others have.
    Senator Domenici. What did you use to describe the kind of 
economy we had?
    Mr. Greenspan. An economy going through a major 
technological change, which occurs periodically. I wouldn't 
call it ``new'' because it has happened in the past.
    Senator Domenici. All right. So for that description and 
for those who call it a new economy, where are we now? Some 
things have been washed out and some things remain there, which 
would indicate that we have a very powerful American economy. 
How do you describe it now in terms of its potential for future 
things that are positive and good for America?
    Mr. Greenspan. Well, Senator, as I commented in my prepared 
remarks, by all of the evidence that we have, the exploitation 
of the major technological opportunities were only partially 
completed at the point when risk premiums rose and the cost of 
capital rose and we had a significant retrenchment.
    But even recent surveys suggest that plant managers 
indicate that of the technology available to them, only about 
half has been put in place, and so there is still a very 
considerable amount of opportunities, real rates of return out 
there, and in that regard I think that productivity gains will 
continue certainly in excess of what they did in the quarter 
century prior to 1995. And, indeed, the remarkable sustaining 
of growth in output per hour during the last year or two, 
during the period of significant retrenchment in economic 
growth, is suggestive of the fact that underlying this very 
significant weakness in economic activity there is still a 
strong underlying productivity growth.
    Senator Domenici. So as we begin to put together a budget, 
hopefully it could be done by working together on both sides, 
and maybe with the President, and have something harmonious, as 
we did immediately following the terrorist activity. I believe 
that was a short period of time, Dr. Greenspan, when the 
American people were most proud of us. I am not sure that the 
results will be as good as we had led everybody to believe when 
we were doing it. But at least we did it expeditiously, we did 
it together, and we did it with the President. I would hope we 
could do that again, but I have great doubts as to whether we 
can.
    But, in any event, Dr. Greenspan, is it your opinion that, 
based upon the current strength of the American economy, we 
should be able to put together a budget that is positive and 
that moves us in the right direction, all things considered, 
with reference to our economy?
    Mr. Greenspan. I would certainly think so, Senator.
    Senator Domenici. Could I, just as my last question, an 
observation for you? Do you think that the current situation 
with reference to taxation in America--there are some who say 
we ought to cut taxes more, there are some who say we cut taxes 
too much. I have looked at the tax rate imposed on the American 
people over the past 60 or 70 years, and I conclude that 
taxation has much to do with America's strength in the economy, 
that clearly we are still at a higher level of taxation in toto 
on the American people and institutions of productivity in 
America. We are at a higher level than we have been on average 
during the last 50 or 60 years. I kind of think one of the 
reasons we are superior in productivity and economic activity 
is because we start with the premise of not wanting to be a 
high-tax country with all the ramifications that come with that 
choice.
    Do you concur that, using an average, taxes are not low in 
the United States but year over year they are high?
    Mr. Greenspan. I would not describe them as low, but I 
would be a little careful about how one measures tax rates. You 
cannot use tax receipts over nominal GDP as a tax rate, and 
largely because a goodly part of the numerator are taxes not on 
the incomes that appear in the gross domestic product but are 
capital gains-type taxes.
    But having said that, clearly we have had a gradual upward 
move into upper brackets, which creates so-called bracket 
creep, which has had an effect of raising rates.
    Ultimately, the level of taxation should be what the 
population in a democratic society chooses, and ultimately, 
that is indeed what happens. And I agree with you in the sense 
that most of the surveys that I have seen suggest that the 
American people think that tax burdens are higher than they 
would like them to be.
    Senator Domenici. Well, my last observation, then, and 
question of you is this: We are engaged in a war, albeit a 
different kind of war. It costs a lot of money, and it is a war 
that you cannot decide today that you know exactly the status 
of the war in 1 year because it is a moving type of target with 
moving commitments and moving requirements.
    I seem to think of the American economy and our current 
situation of productivity and all those things that make it 
positive here in America, that we can afford this kind of war, 
albeit the surpluses are diminishing somewhat for various 
reasons. Would you concur that we can do that without harming 
the American economy?
    Mr. Greenspan. I would certainly hope so because the 
American economy is quite strong. I mean the resiliency which 
it has shown through this particular period, I find a very 
important indication of the underlying strength of our system. 
Clearly, the military has got the highest priority. National 
security is a necessary condition for the volubility of our 
economy. That is, we have seen what happened to parts of our 
economy as a consequence of September 11th. And it is important 
to have, as I said at the very early part of this hearing, an 
economy based on trust and voluntary exchange amongst the 
participants and to do so in tranquil circumstances. You cannot 
have a functioning market economy where there is great concern 
about violence, and to the extent that national security is 
required to support that, whether it is homeland or what we 
call defense budgets, clearly, that has got the highest 
priority.
    Senator Domenici. Mr. Chairman, I want to close by thanking 
you for the work you do for our country. As Senator Byrd did, I 
want to indicate to you that I have the highest regard and 
personal esteem for you.
    Mr. Greenspan. Thank you very much, Senator.
    Senator Domenici. For the short term here you obviously did 
whatever could be done to thwart the recession. You did what 
you could on short-term interest rates which had a very 
positive effect, coupled with the tax cuts. I believe that all 
had a positive effect. Things would be a lot better, different, 
negative in the American economy, but for that action, and the 
action of tax reductions as I see it. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Conrad. I thank the Senator and wish him a safe 
trip.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman, and I would echo 
what Senator Domenici has just said, Mr. Chairman, that I 
believe that your actions and the actions of the Federal 
Reserve have had a profound impact as we look at ability for 
consumers to purchase this year.
    I was pleased to notice in your comments, as you talked 
about consumer spending, receiving a considerable lift from the 
sales of new motor vehicles. As a member representing Michigan, 
we certainly invite people to continue to do that. We just came 
from a North American auto show that was outstanding. And I am 
hopeful that, as you have indicated, that as we are seeing 
slowing in the rate of inventories' liquidation, and if we can, 
as you have indicated, the slowing in the rate of inventory 
liquidation will induce a rise in industrial production if 
demand for those products is stable or falling only moderately. 
So to me, as I listened to your testimony today, which I 
greatly appreciate having had the opportunity to do again, I 
hear over and over again issues related to demand, consumer 
confidence. If people are wanting to buy automobiles, then we 
will make them, and there is a direct relationship there.
    I also appreciate your comment as it relates to pent-up 
demand in the business sector in terms of technology and 
equipment and other things, and that says to me in the short 
run bonus depreciation would certainly have impact; in the 
short run, understanding that there is a tradeoff for the long 
run, but I appreciate your comments related to that.
    And also, I very much appreciate your comments once again 
regarding a trigger, and hope that we can call upon you as 
Senator Snowe and I, and Senator Bayh and others, work through 
exactly how to do that, and my assumption is that we start from 
the basis of looking at the goal of a balanced budget and 
fiscal responsibility, and the extent to which we tie it to 
debt reduction versus balanced budget. I mean our trigger 
focused on both spending and tax cut phase-in last year, in 
order to be able to deal with both. I assume that you would 
suggest that as well, and I do not know if you have any further 
comments as it relates to the trigger, but certainly we want to 
be able to call upon you as we structure this because the 
concept certainly, I believe, makes sense, and we should have 
done it last year. But as we write the details--as you know, 
the devil is in the details--as to how that is structured in a 
way that allows us to keep the focus on fiscal responsibility.
    One other comment and then a question, Mr. Chairman, and 
that is, I really agree with your statements that it is a very 
positive thing that there was an outrage about Enron, that that 
is a positive value, the integrity in the system and the 
expectation that we have, that we can count on people's 
integrity and reputations and so on, and that that is a very 
good thing, and that in fact the actions, and I would argue, 
deceit of a few powerful people at Enron, are having a 
disastrous effect on people who work there and investors, on 
their lives and life savings, and that this is something we 
should all be outraged about.
    My fear is that while it is separate, that if we continue 
to move as we are in terms of not addressing the long-term 
impact on the baby boomers in 8 to 10 years, and that if we 
continue on this track of phasing in tax relief geared to the 
top 1 or 2 percent of the public, without addressing how that 
is paid for and in fact depleting Social Security, Medicare 
reserves known to do that, that in fact, in reality we are 
going to Enron American families, and I have great concern 
about the outrage down the road of this kind of situation.
    And I would ask--you mentioned a few moments ago that a 
private insurance company would have a different approach in 
terms of accruing--I assume you are referring to how they would 
handle reserves, liabilities and so on very differently, even 
though we in fact have the public's responsibility for Medicare 
and Social Security, and I agree with you, we are going to make 
those benefit payments, the question is how do we pay for that 
down the road? Is it massive debt? Is it massive tax increase? 
Is it massive cuts in defense or education or other parts of 
the economy? But could you speak for a moment, if we were 
coming at this from a private insurance company, of how that 
might look differently, when we look at our liabilities?
    Mr. Greenspan. Senator, a private insurance company can 
create a life insurance or a retirement annuity system rather 
simply. It essentially makes a mathematical determination of 
what is the distribution of the population with which it has to 
deal, what is its age distribution, what type of benefits would 
be required, then it works backward in time to find out what 
type of fund has to be built up at a specific rate of interest, 
which, at the point at which those payments have to be made, 
will find that the cash is available. And that is what the 
insurance industry is all about, it sets premiums in such a 
manner to accumulate the cash, which, with the rate of 
interest, will produce a level of retirement benefits that one 
is seeking.
    That is not the way we fund Social Security. We do it in a 
roughly similar way, but it is extraordinarily rough, and 
indeed, as I mentioned before, we are very significantly 
underfunded. In other words, we do not have the assets which 
will produce revenues of a type required for benefits.
    Now, having said that, I am not advocating that we set up a 
system in which private assets are accumulated in the Social 
Security Trust Fund. It is an issue which I think requires a 
very considerable amount of evaluation, but what is clear is 
for us to recognize that we are not fully funded, that unless 
we seriously believe we are going to cut back, that we had 
better try to replicate as best we can private insurance 
procedures.
    Senator Stabenow. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Bond.
    Senator Bond. Thank you, Mr. Chairman.
    Chairman Greenspan, my apologies for not being here for all 
of your testimony. Some of us were at the hearing of the Help 
Committee, where the First Lady, Laura Bush, testified, and as 
compelling as the testimony of the Chairman of the Federal 
Reserve is, the First Lady trumps all, and there were several 
of us who looked around and decided that we needed to be there 
as well. I do appreciate the chance to catch up on your 
testimony. I hope I do not go over things you have already 
covered.
    In the past when you have come before this Committee, you 
have noted the difficulty of getting tax cuts enacted or 
spending cuts implemented fast enough to provide an economic 
stimulus. In your speech to the Bay Area Council Conference 
earlier this month, you said, ``Despite the failure of Congress 
to enact further tax cuts and spending increases, the continued 
phase-in of earlier reductions in taxes and the significant 
expansion of discretionary spending already enacted, should 
provide noticeable short-term stimulus to demand.''
    In other words, you said we got lucky. But what we did, by 
enacting tax cuts, was a stimulus package, and through either 
superior prior planning or dumb luck--and I have been around 
here long enough to have a suspicion as to which it was--we 
provided a stimulus. Now, there are those who are talking about 
repealing the tax cuts. Is this not just about fumbling the 
good luck we have had and trying to undo the counter-cyclical 
stimulus that we have provided?
    Mr. Greenspan. Well, I think the Senator from West Virginia 
indicated that he did not think it was a feasible or plausible 
scenario, and for reasons which I am sure you are aware, so I 
think the question may be moot.
    Senator Bond. Well, I had a follow-on question, so I assume 
that you would--there is a keynesian theory that you should 
either increase spending or perhaps reduce taxes as a counter-
cyclical measure.
    Mr. Greenspan. Let me just say this, that budgetary 
problems that are going to exist are going to become 
increasingly more difficult to deal with, because as we get 
closer to the next decade, we have to make sure we phase in in 
an appropriate manner.
    I do not know what particular programs that Congress will 
decide to expand on, rescind or the like, but I would say that 
it is important that there be a general view of where it is you 
want to be in, say, 2015, and even though it is an awfully 
difficult forecast, you are making that forecast implicitly all 
the time, whether you do it consciously or otherwise. It is far 
better to try to plan what type of fiscal resources you want 
out in that particular period rather than leave it, as you put 
it, to luck.
    Senator Bond. Well, let me ask you on the short term. I 
agree with you on the long term, but there has been talk about 
a trigger mechanism, and some have actually proposed it, which 
would either be a triggered elimination of a tax reduction, in 
other words a tax increase, or a triggered elimination of a 
spending increase. And my question is: is this not Hooverism? 
Is this not the problem we got into in the Depression, where we 
were in a serious depression? We focused on balancing the 
budget. We have increased taxes, cut spending, which is a 
compounding rather than a counter-cyclical fiscal push. Is the 
trigger not in danger of being a bucket of water on a drowning 
swimmer, in other words, if you jack up the taxes or cut the 
spending? Is that not bad policy?
    Mr. Greenspan. But that is the reason, Senator, why I said 
it has to be or should be an explicit judgment of the Congress, 
not something that happens automatically on the basis of some 
predetermined external event.
    Senator Bond. And I would ask you another thing. If you are 
triggering on statistics, we have had all had the feeling for 
the last--at least the last 10 months that we are in a 
recession before the statistics finally confirmed it. We were 
probably at the bottom. And so I have another concern about 
triggering any kind of action. Because the statistics come in 
so late, you are likely to be past the action which you are 
supposed to be remedying.
    Mr. Greenspan. That is always a possibility, Senator, but 
the alternative is to assume that you cannot do something of a 
positive nature, and in my judgment, if you are doing long-term 
planning, a goodly part of it is going to turn out to be wrong, 
but it is far better to try to do it than to do nothing at all 
because you are making a forecast, you are acting on a 
forecast, whether you consciously make that judgment or not, 
and I would suspect that a properly constructed trigger is a 
definite net benefit and something which could be quite 
helpful.
    Senator Bond. On that I disagree, but thank you, Mr. 
Chairman.
    Chairman Conrad. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman, and it is great 
to see you, Mr. Chairman, and I compliment you on your efforts 
to move our economy forward. I think it is remarkable, the 11 
cuts. I wish I could ask you about shapes, the yields curves, 
long-term rates, the impact on the economy, some more about 
triggers and maybe the efficacy of various parts of the 
program.
    But I would like to dwell on an issue that has been touched 
on a number of times with regard to Enron. And I think the real 
issue is worrying about its impact on human lives, and there 
are a lot of people that have lost a lot in this process. But I 
think Senator Murray brought up a point that I think is real 
and is of a concern. And while I appreciate much of what you 
commented on with regard to outlook on the economy, are you not 
worried that Enron has the capacity--the issue, not the company 
itself, but the issue--of concern about the efficacy of our 
accounting statements, the efficacy of how people make 
judgments about investment, about whether the concerns and the 
issues that have been revealed here are not more broadly 
applicable in the economy, lead to a rise in the cost of 
capital, lead to serious concerns about foreigners wanting to 
continue to invest in America and the way that they have 
supported us with regard to our foreign trade balance? It just 
strikes me that this runs the risk of truly undermining 
business and consumer confidence in a way that is not given the 
centerpiece--a lot of talk about the details of what we ought 
to do about it. I certainly would love to hear your initial 
impressions on it. But what are the macroeconomic effects, and 
are you concerned about those issues within the context of the 
kinds of things that I mentioned?
    Mr. Greenspan. Well, Senator, your colleague, Senator 
Hagel, raised a similar issue early on, and expressed much the 
same concern that you are. I actually do not have that concern. 
Indeed, I think that, as I said before, the extraordinary 
response to Enron is something very helpful, and indeed an 
indication that the people in this society have required that 
we maintain a very high standard of trustworthiness in our 
business operations. And the response has been of a type which 
suggests to me that like a number of other societies, we do not 
tolerate a level of activity in--I do know how you would 
designate what that activity is, and I probably should not be 
saying it until we really know what the facts are. But clearly, 
if, to generalize it, everybody did what is alleged in the 
Enron accounting system, our system could not work. That is, if 
you have a system, market system, as you know better than 
anybody, it works off information. If you do not have a way to 
evaluate a particular asset, you cannot price it, and if you 
cannot price it, you cannot get the appropriate allocation of 
capital in a market economy, and you will not get a high 
standard of living.
    Senator Corzine. The issue of reputation does not really 
deal with the efficacy of accounting statements, where 
restatements of earnings occur on a very frequent basis.
    Mr. Greenspan. I think that was an egregious act. I tried 
as hard as I could to find an economic reason why those 
affiliates were constructed the way they were. The simplest 
explanation was the obvious explanation, that they did not want 
to indicate what their true earnings position was.
    Senator Corzine. You have no great concerns that that is a 
broad based----
    Mr. Greenspan. You know something? I would if there was not 
a reaction to it. But the reaction I think is going to create a 
really major rethinking in a lot of people about whether there 
is a spin game going on with respect to information coming out 
of a business into the investment community, and there has been 
an element of that. But I think everyone has been sort of aware 
of it and adjusted to it. I think we are going to find there is 
going to be a good deal less of that, and that the old issue of 
competing for reputation is going to re-emerge, and I think you 
are going to find at some point that there are going to be 
people out there who are going to say that our accounts you can 
rely on, and that probably will increase their price earnings 
ratios.
    Senator Corzine. Thank you.
    Chairman Conrad. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Chairman Greenspan, it is a new year and a new session of 
the Congress, and here you are back before the Congress again. 
I want to welcome you, and I know you will be before us many 
times over the next few months.
    I just want to take a moment to look back, because on 
Sunday, Glenn Kessler, writing in the Washington Post says--and 
I am now quoting him--``Five days after George W. Bush took 
office, Federal Reserve Chairman Alan Greenspan appeared before 
Congress and endorsed a large tax cut after years of preaching 
the virtues of debt reduction. As I noted''--this is Kessler 
talking--``As I noted in a Washington Post article at the time, 
Greenspan's new stance dramatically strengthened President 
Bush's negotiating position. You could almost hear the ice 
cracking across the Capitol.'' End of quote.
    And I remember that hearing and that testimony, and in 
fact, my comment on it; I remember saying to you that you had 
just taken the lid off the punch bowl, and who knew what 
excesses would follow?
    Well, the excesses followed to the point that we went from 
CBO projecting a budget surplus a year ago of $5.6 trillion, 
and now they say it is 1.6 trillion over the same period. And 
the changes in the total budget surplus--this is in an analysis 
developed by our very able Chairman--show that 42 percent of 
this loss in the surplus, by far the single most important 
factor, came from these excessive tax cuts, the ones that are 
already there.
    Now, less than 10 percent of that tax cut took effect in 
the first couple of years. There are those who argue we really 
provided stimulus to our economy. To the extent that is the 
case, that is less than 10 percent of the total tax cut. The 
rest of it, of course, is projected out into future years, and 
there is now an effort on the part of some to accelerate that 
forward. Others want to do yet another tax cut.
    So let me first ask you whether you think the ice ought to 
keep cracking and the lid ought to stay off the punch bowl; do 
you favor doing additional tax cuts, given the projections we 
now have with respect to the Federal budget surplus?
    Mr. Greenspan. Are you referring to the new initiatives on 
the tax side?
    Senator Sarbanes. That is right.
    Mr. Greenspan. That is up to the Congress, and I think 
that, just going back to your earlier statement quoting me last 
year, there is no question that my basic desire is for 
maintaining as low a level of the national debt as we can, 
because I think it has very great economic advantages. However, 
I, as you know, an also very strongly opposed to the 
accumulation of private assets by the Federal Government. If 
you believe the current policy projections of CBO, or even part 
of them, at that particular point those two goals, in my 
judgment, clashed, and----
    Senator Sarbanes. That was a year ago.
    Mr. Greenspan. That was a year ago.
    Senator Sarbanes. They do not clash today, do they?
    Mr. Greenspan. Well, to go back, I redid the calculations 
of what would have happened to the current policy budget as of 
January 2001 if you had the economic data that we have today. 
And what that would have done would be to move the point at 
which we would get to irreducible levels of Federal debt about 
2 years.
    Senator Sarbanes. There is a different policy budget now. 
They do not clash on the basis of the different policy budget, 
do they?
    Mr. Greenspan. You mean at the moment?
    Senator Sarbanes. Yes.
    Mr. Greenspan. Well, no, because basically the policy is 
changed.
    Senator Sarbanes. That is right.
    Mr. Greenspan. And----
    Senator Sarbanes. Now, I take it that you would come back 
to your traditional position of preaching the virtues of debt 
reduction ahead of either a large tax cut or large spending 
increases; is that correct?
    Mr. Greenspan. That is what I have done today, Senator.
    Senator Sarbanes. All right. I wanted to be clear on that. 
The reason I am trying to be clear on it is I am really struck 
by this interpretation of your San Francisco speech. And I know 
Senator Wyden asked you about it, but I am going to pursue that 
for just a moment.
    John Berry, in the Post, just a few days ago, talking about 
that speech, said, ``Part of the confusion over the speech was 
due to the subtlety of Greenspan's intended message. Greenspan 
chooses his words very carefully, keenly aware that his public 
utterances are closely parsed by the markets and often move 
global stock and bond prices. An economist who speaks in highly 
technical language about extremely arcane subjects, he also is 
so aware of his reputation for impenetrable prose.'' And of 
course that is a continuing problem; that is why I said it was 
a miracle when Senator Byrd said he was asking very 
straightforward questions and getting very straightforward 
answers. In fact, in some of the press leading up to this, one 
article is headed, ``What is Greenspan Trying to Say? Market 
Swoons on Debate. Tomorrow's Senate Testimony Could Clear up 
the Confusion.'' And I want to try to clear up the confusion.
    Berry says in this article, ``Greenspan's intended 
message''--because some have said, well, it was over 
interpreted--``intended message was that the recession was 
likely to end soon, but that a quick, sound rebound was not 
assured.''
    And later, in trying to interpret it, he says, ``However, 
in last week's speech, Greenspan cautioned that it was too 
early to be sure about the nature of the recovery''--and he 
quotes from your speech--``despite a number of encouraging 
signs of stabilization. It is still premature to conclude that 
the forces restraining economic activity here and abroad have 
abated enough to allow a steady recovery to take hold.''
    Now, is that an accurate portrayal of your position?
    Mr. Greenspan. I tried to, in my prepared remarks today, 
address the issue in the manner in which if there was any 
confusion, I tried to, as best I could, eliminate it. The 
difference between--what I was endeavoring to do back there in 
San Francisco was to indicate that something really quite 
important has happened in the past year or maybe the last 
several years. The flexibility and resilience of this economy 
has clearly improved immeasurably. And the reason we know that 
is that it has responded with such great flexibility to what 
has been a very severe set of pressures. I interpret that as a 
rather positive view of the world at large. And what I was 
endeavoring to do was to put it in context so we did not assume 
that everything forward is going to become a type of economic 
expansion which has occurred out of previous recessionary 
periods.
    Senator Sarbanes. Do you think it is premature to conclude 
that the forces restraining economic activity here and abroad 
have abated enough to allow a steady recovery to take hold?
    Mr. Greenspan. No. I do not think we are going to know that 
for several months.
    Senator Sarbanes. So you think it is premature?
    Mr. Greenspan. Well, we are just at this particular point, 
turning, as best I can judge. In other words, we are close to 
zero GDP change.
    Senator Sarbanes. Well, those are not my words that I asked 
you. Those are your words.
    Mr. Greenspan. I know, but what I am trying to say is that 
anyone who thinks they can state with great conviction at this 
particular point has not been in the forecasting business as 
long as I have.
    Senator Sarbanes. Mr. Chairman, could I just put two very 
quick questions?
    Chairman Conrad. Yes.
    Senator Sarbanes. In responding to Senator Allard, you 
indicated you were in favor of spending caps on discretionary 
spending. Is that correct?
    Mr. Greenspan. That is correct, Senator.
    Senator Sarbanes. Is that an implied criticism of the 
President's indication that he is going to ask for a 14 percent 
increase in the defense budget?
    Mr. Greenspan. The discretionary spending procedures 
basically are caps that the Congress puts on. I am just saying 
as the general procedure, that it is a very good idea to have 
caps. What caps do is to limit the spending off the Congress' 
and the Administration's priorities. I happen to think that 
defense expenditures are very high priority at this particular 
stage. And you do what you have to do, but that does not mean 
you should not try to cap other types of discretionary spending 
in order to keep the budget under reasonable control.
    Senator Sarbanes. Would you cap defense spending as well?
    Mr. Greenspan. I would not say that because defense 
spending basically----
    Senator Sarbanes. Well, we did it before.
    Mr. Greenspan. Well, what I am trying to say is that----
    Senator Sarbanes. The period that you reflect on, when we 
brought the budget into balance, I am sorry Senator Domenici 
left because he played a role in doing that--shifting over from 
a deficit equal to nearly 5 percent of GDP in fiscal 1992--this 
is your statement--to a surplus equal to 2-1/2 percent of GDP 
in fiscal 2000 was truly remarkable. And of course many of us 
here in this room shared in that achievement, as of course did 
President Clinton, I might note. Those years actually 
paralleled his presidency.
    Mr. Greenspan. The way that was done was by reducing the 
force structure and changing the underlying structure of our 
military posture. A great deal of spending that occurs in the 
Defense Department is longer term, especially in the 
procurement area, and even in maintenance and operations you do 
have long-term contracts involved, so that you can move defense 
spending down only with a significant lead, and you did have a 
significant lead, and the force structure was run down in a 
manner which enabled you to get to touch----
    Senator Sarbanes. Let me get this clear. Are you in favor 
of excluding defense expenditures from spending caps if we have 
spending caps?
    Mr. Greenspan. I might, yes. I think that they require a 
different type of evaluation than what we usually consider to 
be spending caps.
    Senator Sarbanes. And finally, what am I to make of your 
comment in the first paragraph of your written statement where 
you say, ``I want to emphasize that I speak for myself and not 
necessarily for the Federal Reserve,'' as a sort of headline--
--
    Mr. Greenspan. The reason I say that is that for a number 
of the questions that have been posed to me, which I choose to 
answer, I do not want to imply something that my colleagues 
necessarily agree with. I think that a large number of them do, 
but I do think it is important to remember that a number of 
these issues have not been vetted through the official policies 
of the Federal Reserve.
    When I come before your Committee, on so-called Humphrey 
Hawkins testimony, that is vetted testimony. At that point I am 
speaking for the Federal Reserve Board. Today I am not.
    Senator Sarbanes. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Clinton. And let me just say that 
this will be the last questioner as we have tried to adhere for 
your time for departure, Mr. Chairman.
    Senator Clinton. Thank you, Mr. Chairman. And I too was 
with Senator Bond at the hearing where Mrs. Bush appeared, and 
I apologize that I missed the beginning of your testimony and 
the questions that were asked.
    I agree with your framework of saying that our country 
needs to set objectives that we expect to be working toward 
achieving, and that we should do so by asking ourselves where 
we want to be in 2015, to pick a date. One could pick another 
date, but that was the one that you referred to, and I think 
that is a fair way to describe how we should go about 
determining our budgetary decisionmaking.
    And I am following up on Senator Sarbanes' points because 
when you were here last year, I think many of us, although we 
were facing some economic indicators that suggested a downturn, 
believed we had more control over our destiny than perhaps we 
do right now, that given surpluses and given the rapid rate at 
which we were paying down debt, that even in the face of an 
irreducible debt basis of your testimony, which led to the 
concerns you expressed, we could do the kind of planning that 
would get us to 2015, having dealt with, in a rational way, the 
demographic challenges that we faced.
    Yesterday when Dr. Crippen testified, and certainly given 
the uncertainty that you reflect on the future of the recovery 
and its pace, I think many of us believe we had lost some of 
that ability for the long term, that we have perhaps even given 
away the capacity to make the decisions that would put us in a 
better posture than we see currently available to us.
    Now, going back to the San Francisco speech, I just want to 
make sure that I understood something that I believe you said, 
because it relates to something we talked to Dr. Crippen about, 
that the diminished outlook for debt reduction has probably 
played a role in keeping long-term interest rates relatively 
high this year. Is that a fair inference from what was said in 
San Francisco?
    Mr. Greenspan. That is correct, Senator. I said that there 
are, in my judgment, two elements involved. One was the 
expectation of an imminent recovery in economic activity, which 
would move, other things equal, long-term rates up. But I also 
stipulated that a deterioration of the long-term fiscal 
situation was also a contributor.
    Senator Clinton. Well, I happen to believe that, and I 
think that the high long-term interest rates on a relative 
basis this year, despite your efforts at the Fed to use 
monetary policy on short-term rates, has had and will have a 
continuing negative impact on debt reduction which I think it 
is at least a fair bet will impede the recovery. I well 
remember the discussions that you were instrumental in in 1993, 
when the discussion about how we could craft a debt reduction 
plan that would lower long-term interest rates, spur economic 
growth, led to the decisions that were made in 1993.
    What I am concerned about now is that just as in 1993, some 
people criticized the Administration at that time for keying 
economic policies to bond traders, which I remember very well. 
It turned out to be a pretty smart bet.
    Now, my biggest problem with the tax cut last spring is 
that I do not think the bond traders were asleep, and whether 
my colleagues believed the projections of surplus and the 
impact on the debt as being overstated by those of us who 
expressed concern, I think the bond traders had a pretty clear 
and cold eye about what would happen. And as Senator Sarbanes, 
based on the Chairman's chart, has just reminded us, although 
in this first year the tax cut impact on the surplus has been 
minimal. The projected impact is as stated in that chart.
    So here we are. I accept those who say politically there 
will not be any change, there will not be any repeal, there 
will not be any serious effort to rethink our changed 
circumstances, but I do not think the market and the cold 
clear-eyed bond traders are going to be impressed by our 
failure to exercise responsible fiscal policy in the face of 
changed circumstances.
    So that leads me back to this discussion of a trigger, and 
I would just clarify, I think, a point that my colleagues, 
Senator Snowe and Senator Stabenow have repeatedly made, is 
that their idea for a trigger would not repeal a tax cut, but 
would delay one until it could be paid for, and the paid-for 
part of that would take into account the various factors that 
would be available at the time however it was constructed.
    And the final point that I just feel compelled to raise as 
well, following up on Senator Corzine's comment, is that I 
agree with your assessment, that the reaction to what has 
happened with Enron and Arthur Andersen is a healthy reflection 
of how much we value transparency and accurate information in 
order to have a functioning market system. But I do not think 
we are anywhere near the end of this story, and what will 
really count is what are the consequences. In fact we could 
further drag down business and consumer confidence, in my 
opinion, if the outrage is not followed by consequences. And 
one of my concerns is that at least at present, based on press 
reports, the discussion about the accounting information 
practices and how we go forward guaranteeing to people that 
their outrage is not misplaced raises some serious issues.
    And I would, if you believe it within your purview as 
someone who looks at the entire economy, go at Senator 
Corzine's question a little differently, which is when the 
outrage has exhausted itself, will it be important for the 
continuing functioning of our markets to have an accounting 
system that is understandable and regulated in such a way that 
people can put their confidence in the results of whatever the 
statements might be.
    Mr. Greenspan. It is hard to know what the next 2 years are 
going to unfold, or how they are going to unfold, but I think 
it is reasonably certain that what has come out of this 
particular event is going to alter the way not only accounting 
is done in a more transparent way, I think there are effects on 
corporate governance as well, because the incentive structures 
in audit committees within corporations, amongst accountants, 
at least in my judgment, are not optimum for the appropriate 
allocation of capital within our economy.
    Senator Clinton. Excuse me, Mr. Chairman. Are you 
suggesting that that will be a self-policing, self-regulating--
--
    Mr. Greenspan. I do not know.
    Senator Clinton [continuing]. Formation of human nature 
that will occur?
    Mr. Greenspan. No, it is not human nature. Well, in part it 
is. I mean it is called self-interest. There is a very 
important economic value in reputation, more so than it has 
been in recent years, largely because we are increasingly 
moving toward what I would call a conceptual economy in which 
physical assets are a decreasing proportion of the market value 
of firms, and, as I indicated earlier, this reputation, 
capitalized and placed on the balance sheet, is called 
goodwill. And it is a major competitive advantage to be able to 
say to somebody, ``Our accounts fully represent what is 
actually going on in our company.'' Indeed, those of us who 
have been involved in bank regulation are aware of the fact 
that those financial institutions which get into businesses 
which are somewhat obscure have found that the price-to-
earnings ratios of those institutions are less than those who 
are in businesses which are fully exposed to the light of day 
in their accounting systems and in the structure of the type of 
risks they take.
    There are going to be changes, and I suspect there may very 
well be changes in statutes because it is crucially important 
that the trust which is so fundamental to all transactions in a 
market economy be reinforced, and I do not know how that is 
going to happen, but I do know that the pressure to do that as 
a consequence of this event is going to be significant, and I 
think that is a very fortunate potential outcome of this rather 
unfortunate story.
    Senator Clinton. I agree with that. Thank you, Mr. 
Chairman.
    Chairman Conrad. Thank you. And we want to thank Chairman 
Greenspan for your appearance here today. We have held you 
somewhat beyond the time that we had agreed to, and I thank you 
for your patience.
    Chairman Conrad. Let me just say that I especially welcome 
your suggestion that we revisit the notion of a mechanism to 
adjust spending and revenue so that we do everything we can to 
aggressively pay down this national debt in expectation of the 
baby boom generation's retirement and the desirability of 
building surpluses in preparation for that time. I think that 
is a very constructive and important suggestion that you made 
last year that you have repeated this year, and hopefully we 
will proceed to try to find a way to get it enacted into law.
    I thank you again.
    [Whereupon, at 12:51 p.m., the Committee was adjourned.]

       The Prepared Statement of Senator Senator Russell Feingold

    Thank you Mr. Chairman, and thank you, Chairman Greenspan. It is 
always somewhat of an occasion to have you before us. We all recognize 
just how critical your own thinking and actions are to the economy. For 
that reason, it is extremely useful for us to hear directly from you.
    During the 1990's, you played an important part in our ability to 
get our fiscal house in order. Many of the individual decisions 
Congress made in trying to balance the Federal books may have been less 
than popular, but I think having heard from you about the need for 
fiscal responsibility made it easier to make the case that a greater 
good was being served. You convincingly made the case for how fiscal 
responsibility helped to strengthen our Nation's economy.
    Last year, we were presented with budget projections that in many 
ways did not seem real. We were shown budget surpluses that seemed to 
grow forever, and we were presented with the likelihood that we would 
actually be able to pay down the great bulk of our publicly held debt 
by 2006.
    At that time, perhaps because those budget projections seemed so 
unreal, a number of us on the Committee urged caution. We suggested 
that it would be a mistake to pursue a policy that relied so completely 
on those projections.
    To its credit, the Congressional Budget Office included cautionary 
language about those projected budget surpluses. It even provided a 
chart that graphically demonstrated the range of uncertainty in the 
projections.
    Unfortunately, as yesterday's testimony from Dr. Crippen 
demonstrated, CBO was right to be cautious. In fact, their projections 
were literally nearly off the chart. Looking at CBO's chart a year ago 
outlining the range of possible outcomes, the actual budget experience 
over the last year is at the extreme limit on the bottom end of that 
chart--in that portion of the graph that was characterized at the time 
as the least likely to occur.
    As I noted at yesterday's hearing, no one is to blame for 
inaccurate budget projections. We ask our professional forecasters to 
do the best job that they can, and they do that job extremely well. In 
fact, CBO does an excellent job of outlining the assumptions it uses in 
making these predictions.
    But if nothing else, our experience in the past year should teach 
us that the policy course we choose should reflect the uncertainty 
inherent in CBO's budget projections. As I said yesterday, we should 
treat them with a great deal of humility.
    That did not happen last year, and as a result, we have an enormous 
budget hole to fill for years to come.
    Chairman Greenspan, for me, one of the more memorable comments made 
at this hearing last year was made by our colleague, now the Chairman 
of the Banking Committee, Senator Sarbanes. After listening to your 
testimony, he expressed his concern that in effect you had given 
license to those who wanted to stray from the course of fiscal 
responsibility. The expression he used was that in effect, you had 
taken the lid off the punch bowl.
    In looking back over the last year, I think Senator Sarbanes used 
an apt analogy.
    Congress and the White House have engaged in a binge of spending 
increases and tax cuts that have left us with a serious budget mess. 
Some of it, but only a fraction of it, stemmed directly from the events 
of September 11. Most of it, though, did not.
    And apparently, we will be asked to do even more. Reports suggest 
that the President will be asking for significant increases in spending 
on Defense, as well as on non-defense. We are also being asked to enact 
even more tax cuts, in the name of stimulating the economy, many of 
which are ill-designed to do that job.
    With the sobering news about our budget position, one might think 
that Congress had learned a lesson. But it is the nature of things that 
people do not like to admit that they have made a mistake, and we may 
end up with more of the same--spending increases and tax cuts that we 
cannot afford.
    Many who voted for this kind of fiscal policy last year may, in 
fact, regret that support. Unfortunately, my guess is that they are 
also reluctant to admit they made a mistake, and would rather ride this 
policy bomb all the way into the ground, waiving their hats and 
whooping.
    If that happens, if we continue on this course, we will make a bad 
situation much worse.
    Yesterday, Dr. Crippen reminded us all of the challenge we face in 
the not too distant future. My generation, the baby boom generation, 
will start to retire, and we will begin to draw upon Social Security, 
Medicare, and Medicaid. Meeting the commitments those programs make 
poses an enormous challenge. We need to put the budget back on a path 
that will enable us to meet those commitments. Digging the budget hole 
even deeper will not help.
                               __________

   WRITTEN QUESTIONS FROM SENATOR BYRD TO CHAIRMAN GREENSPAN AND THE 
                               RESPONSES

    Question. Chairman Greenspan, I believe in productive public 
investments in infrastructure and human capital. Decades of economic 
growth have overwhelmed many of the Nation's sanitation, public 
transportation, and energy technology and delivery systems whose 
original designs back fifty to a hundred years.
    Would investments in modernizing and expanding this infrastructure 
contribute to stronger economic growth?
    Answer. There can be little doubt that investment in 
infrastructure--both public and private--is an important prerequiste 
for economic growth, and our Nation has benefited over time its high-
quality infrastructure. The evident acceleration in the growth 
potential of our economy in recent years likely has placed strains on 
some aspects of our infrastructure and correspondingly raised potential 
rates of return of return to additional investment. However, as a 
general matter, economists have had a difficult time establishing a 
clear-cut empirical link between public investment in infrastructure 
and economic growth. This difficulty almost certainly reflects, in 
part, the uneven rates of return to the public investments that have 
been undertaken in the past. As a consequence, there can be little 
substitute for an evaluation of infrastructure investment projects on a 
case-by-case basis.

                                    








                       THE BUDGET AND THE ECONOMY

                              ----------                              


                       TUESDAY, JANUARY 29, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Stabenow, Clinton, Corzine, and 
Domenici.
    Staff present: Mary Ann Naylor, staff director; and Chad 
Stone, chief economist.
    For the minority: G. William Hoagland, staff director; and 
Bob Stein, chief economist.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The committee will come to order.
    Senator Domenici is in an Energy Committee hearing 
elsewhere and will be joining us a little later.
    As you know, this is a very odd week because of the State 
of the Union today and because of party caucuses starting 
tomorrow. So it is an unusual week, and I apologize to the 
witnesses for that, but we think this is a very important 
hearing to talk about the economic conditions that we face.
    Today is really the third in a series of hearings on that 
question. We started with Dr. Crippen, Director of the 
Congressional Budget Office, who gave us an overview of our 
current economic condition and the fiscal condition of the 
country.
    We then followed with Chairman Greenspan of the Federal 
Reserve, who gave us a more detailed look at our current 
economic conditions and prospects going forward.
    The news so far has been dramatic. As Dr. Crippen 
testified, just a year ago, we were told that we would have 
surpluses of $5.6 trillion over the next 10 years. That has now 
been reduced, as the chart shows, to $1.6 trillion, a 
disappearance of some $4 trillion of budget surpluses.
    That has enormous implications. Instead of effectively 
eliminating the publicly held debt by 2008, as we were told 
last year, we now know that we will still have $2.8 trillion of 
publicly held debt by 2008. And of course, instead of building 
up some $2.7 trillion of surpluses outside of Social Security 
and Medicare, the new projection is that we will be running a 
deficit of $1.1 trillion. And those are of course baseline 
estimates--that is before any additional defense buildup, which 
we now know the President will call for in just the next few 
days; that is before his proposal for dramatic increases in 
homeland security; for a stimulus package or for prescription 
drug coverage for seniors, or other things that are not in the 
so-called baseline forecast.
    What caused these changes? CBO is clear that over the next 
10 years, the biggest reason for the diminished surplus is the 
tax cut, which accounts for 42 percent of the decline.
    The other factors are economic changes, the economic 
slowdown, which accounts for some 23 percent of the change; 
other legislation, largely spending as a result of the attacks, 
some 18 percent of the change; and then, technical changes 
which account for some 17 percent. Technical changes are things 
like a difference in estimations of Medicare and Medicaid 
expenses. The CBO has increased their estimates of the expenses 
in those areas.
    The question before this committee is what do we do now, 
what do we do going forward, what should our policy be.
    Clearly, the performance of the economy will affect the 
budget and vice versa. Chairman Greenspan indicated that he 
believed the worst of the recession is over, and the economy is 
beginning to stabilize. But even with that, we see the 
unemployment rate is still rising, with now 8.3 million people 
unemployed. We will get new data for January this Friday.
    At the same time, there are hopeful signs. We see consumer 
confidence starting to rise. For example, in the chart, we see 
the major indexes of consumer confidence showing a move up, and 
people are expecting a new reading from the Conference Board 
later this morning. When that news comes, we will report it to 
the committee.
    And of course, the Federal Reserve has cut short-term 
interest rates aggressively. That brings up an important 
question of why have long-term rates stayed up while the 
Federal Reserve has so dramatically cut short-term rates.
    This chart I think tells a very important story. We see the 
results of the Federal Reserve Board sharply cutting interest 
rates but long-term rates showing very little change. And this 
is true across a broad range of measures of long-term interest 
rates.
    There is another important point that I think needs to be 
addressed, and that is a point that Chairman Greenspan made in 
a speech in San Francisco earlier this month, and he repeated 
the point at our hearing last week--that one of the reasons why 
long-term interest rates have not come down is the falling 
surpluses and diminished prospects for paying down debt.
    Chairman Greenspan said in his speech in San Francisco, and 
I quote: ``Some of this stimulus has likely been offset by 
increases in long-term market interest rates, including those 
on home mortgages. The recent rise in these rates largely 
reflects the perception of improved prospects for the U.S. 
economy. But over the past year, some of the firmness of long-
term interest rates is probably the consequence of the fall of 
projected budget surpluses and the implied less rapid paydown 
of the national debt.''
    I think this is something that all of us have to be aware 
of as we fashion a policy going forward. The importance of 
fiscal discipline for promoting strong and sustainable growth 
is one of the issues I hope we will explore today.
    As Chairman Greenspan has said: ``All else being equal, a 
declining level of Federal debt is desirable because it holds 
down long-term real interest rates, thereby lowering the cost 
of capital and elevating private investment.''
    I believe that Chairman Greenspan has that right. I think 
that that is the correct analysis for economic policy.
    But there is another key reason for fiscal discipline and 
for attempting to rebuild surpluses, and that is the 
demographic time bomb that we all know that we face. The baby 
boom generation will start retiring in just 6 years. That is 
the leading edge of baby boomers who choose to retire at age 
62, and it will begin in just 6 years, and that is going to 
change everything.
    As Director Crippen said last week, ``Acting sooner rather 
than later to address these long-term fiscal imbalances will 
make an important difference.''
    Today we have three witnesses from outside Government to 
give us their perspective on the economic and budget outlook 
and to help us address these issues.
    Robert Reischauer is President of The Urban Institute and 
before that was Director of the Congressional Budget Office.
    Peter Orszag is a Senior Fellow at the Brookings 
Institution and was Special Assistant to the President for 
Economic Policy and a Senior Economist and Senior Advisor at 
the President's Council of Economic Advisers in the Clinton 
administration.
    Brian Wesbury is Chief Economist at Griffin, Kubik, 
Stephens, and Thompson, a Chicago-based investment bank, and 
served as Chief Economist at the Joint Economic Committee in 
1995 and 1996.
    We welcome all of you and thank you very much for coming.
    My very able ranking member, Senator Domenici, has arrived, 
and I will turn to him for any opening statement that he would 
choose to make, and then we will go to the witnesses.

             OPENING STATEMENT OF SENATOR DOMENICI

    Senator Domenici. Thank you very much, Mr. Chairman. I will 
not take a lot of time.
    I thank the witnesses for giving of their time here today. 
By coming here, you contribute a lot to our understanding of 
what we ought to be doing. Each of you has had very successful 
input and participate mightily in how things turn out and what 
we should be thinking about.
    In particular, Dr. Reischauer, I do not think I should ever 
let your appearance at the committee go without thanking you 
for the enormous amount of public service you have put forward. 
I do not want to start recalling the very important issues that 
were decided when you were CBO Director, but suffice it to say 
that you were the epitome of what that office should be, and I 
thank you for it then and thank you for it today.
    I have some prepared remarks, Mr. Chairman, and I will put 
those in the record.
    Frankly, I am convinced that we are going to return to 
surpluses of a significant amount as soon as the American 
economy turns around and goes from its current level of growth, 
which is nothing, to a level of 2.8, 3.5, and it might even 
during this recovery go up above that for short periods of 
time, although I do not see this recovery as being a raucous 
recovery that is going to be filled with bull markets month 
after month. But I believe that to talk about trying to get the 
surpluses back where they were without acknowledging that the 
principal reason we got them to the height they were was that 
we had a sustained growth economy--we need to get back to that.
    I have some indications in my opening remarks with 
reference to long-term interest rates, where they are going, 
where they are now, where they were during most of the Clinton 
time in the White House, and frankly, we are not doing so 
badly, and from what I can tell, we are doing pretty good.
    I do not believe there is anything that we can do in the 
next year or two that will dramatically alter those long-term 
interest rates, but I do believe they are going to ameliorate 
and get better over time, not worse.
    With those few words which, instead of me saying them, we 
ought to be asking you for your opinions, nonetheless I thank 
you again.
    And I want to say to the Chairman that I think I told you 
and told your staff and did tell the witnesses that I have a 
hearing in the Energy Committee on Enron, and I happen to be 
the second in charge on the Republican side, so I guess I had 
better go there, and if I can find time, I will run back.
    So I thank you much, and I will try my best to pass 
judgment on what you say here today by reading it and reviewing 
it with one of my trusted staff, so it will be attended to by 
me as if I were here.
    Thank you very much, and thank you, Mr. Chairman.
    Chairman Conrad. Thank you very much, Senator Domenici.
    [The prepared statement of Senator Pete V. Domenici 
follows:]

                     Statement of Senator Domenici

    Thank you, Mr. Chairman, and good morning.
    Once again, I'd like to thank everyone involved in the move of the 
committee out of the Russell Building and back into Dirksen. 
Specifically, I'd like to thank Lynn Seymour, George Woodall, Sahand 
Sarshar, Mandy Wimmer, and Tim Nolan.
    Now, I'd like to welcome all of our witnesses her today--a very 
accomplisjed group. Dr. Reischaeur, I'd like to welcome you back to 
Capitol Hill.
    I see Dr. Orszag is with us again after testifying three times last 
year.
    Mr. Wesbury also testified once last year and in the meantime won 
an award from the Wall Street Journal as the most accurate economic 
forecaster in 2001. Unlike most economists, who didn't forecast a 
recession until 6 months after it started, Mr. Wesbury forecast a 
recession as far back as January last year. That's impressive, although 
I think he knows that his is a humbling occupation. My former Chief 
Economist at the committee won the same top honors twice for her 
forecasts in 2000 but came in dead last on her predications for 2001.
    Today, we are here to examine the relationship between the economy 
and budget outlook.
    Listening to some of my colleagues, one might get the impression 
that we are moving toward some sort of fiscal collapse and that 
interest rates are going through the roof.
    But as Chairman Greenspan testified last week, ``our underlying 
fiscal situation remains considerable stronger than that of a decade 
ago.''
    The new CBO baseline from last week shows the debt as a share of 
GDP falling to the lowest level since 1917.
    And at only 5.1 percent, long-term interest rates are low--not 
high. In fact, rates are lower now than they were in 90 of the 96 
months of the Clinton administration.
    This does not mean we are without any fiscal challenges. Social 
Security and Medicare require long-term attention. Our ability to make 
these programs work depends heavily on strong economic growth.
    I believe the tax cut we enactd last year will enhance economic 
growth in both the short-term and the long-term, and thereby help 
address, in part, the future of Social Security and Medicare.
    Has our fiscal position changed since last year? Of course it has. 
We have had a recession and the start of a war. Under these 
circumstances, a couple years of deficits are, maybe not desirable, but 
appropriate.
    In the near term our fiscal policy must focus on national security, 
homeland security, and economic security.
    It is our responsibility to produce a budget that preserves the 
security of our citizens on all these fronts. As I have said before, 
nothing much else can matter at this time.
    Having said that, I hope we can work together--in a bipartisan 
manner--to produce a budget plan that focuses on these three security 
issues; and I look forward to hearing our witnesses this morning.

    Chairman Conrad. We will begin with Dr. Reischauer. 
Welcome. Please proceed with your testimony.
    My intention is to have the entire panel give their 
testimony, and then we will open it up for questions.
    Thank you.

   STATEMENT OF ROBERT D. REISCHAUER, PRESIDENT, THE URBAN INSTITUTE

    Dr. Reischauer. Thank you, Mr. Chairman.
    I appreciate the opportunity to appear before the 
committee. I will summarize my statement, which reviews the 
latest baseline budget projections, draws a couple of 
straightforward lessons from the experience of the last year, 
argues that fiscal discipline remains an important goal for the 
Congress and that you should work to extend and revise the 
procedures that have been used in the past to attain this 
fiscal discipline, and it makes the case for augmenting the 
fiscal flexibility that is available to lawmakers in the 
future.
    Last week, CBO reported to this committee a sharp 
deterioration in the budget outlook from the situation that 
faced the Congress just a year ago. In the short run, meaning 
the current year and next year, the major explanation for this 
deterioration is the weakness in the economy. In the long run, 
meaning 2009 through 2011, the dominant explanation is the tax 
legislation that was enacted last June, which accounts for 
roughly half of the deterioration that occurs during those 
years.
    While the baseline outlook certainly is less robust than it 
was a year ago, the Nation is not facing the budget 
difficulties that it faced from the early 1980's through the 
mid-1990's. During those years, the budget projections showed 
that deficits would grow unless Congress cut spending below or 
raised taxes above baseline levels.
    CBO's new projections how that the unified budget will 
return to surplus when the economy recovers if Congress adheres 
to baseline spending and baseline revenue numbers.
    However, as you know better than I do, it will be very 
difficult to keep spending or taxes at baseline levels over the 
next decade. If one adds to the baseline the amount necessary 
to complete the unfinished business that is before Congress 
now--and by that, I mean the farm bill, some disaster 
assistance, likely 2002 supplemental, and extension of the 
expiring provisions of the Tax Act--the outlook is nowhere near 
as rosy.
    Adding resources for new priorities such as a Medicare 
prescription drug benefit, increased medical research at NIH, a 
true fix for the AMT, and other items that are being debated 
would make the projections even less optimistic.
    Looking at that situation, I concluded in my statement that 
it will be a challenge simply to attain and then maintain 
balance in the unified budget over the course of the next 
decade.
    This raises the question of what the fiscal goal for the 
Nation should be. For many years, there was a consensus that we 
should try to balance the unified budget. Over the last 4 
years, however, a broad bipartisan consensus emerged around the 
notion that we could do better than that, that we should 
balance the non-Social Security portion of the budget at least 
in good times and devote Social Security surpluses to paying 
down debt or to investing in structural reform of those 
programs.
    Considering the challenges facing the Nation when the baby 
boomers begin to retire and the Nation's low personal savings 
rate, I think a fiscal goal like this, one that calls for a 
significant unified budget surplus in good times, is an 
appropriate goal; but the rough estimates of the realistic 
budget outlook facing the Nation that are in my testimony 
suggest that we are not going to be even close to this mark 
over the course of the next decade. In fact, we are likely to 
have on-budget deficits in the $100 to $200 billion range as 
far as the eye can see.
    If Congress wants to reserve some of the Social Security 
surpluses for debt reduction, it will have to take steps now to 
increase the fiscal flexibility that is available for the 
Nation in the future. I suggest in my statement that the most 
straightforward way of doing this would be to modify the 
provisions of the 2001 Tax Act.
    Specifically, I suggest making permanent and indexing all 
of the provisions that have been implemented to date and 
placing the remaining provisions on hold until we have restored 
a desirable level of fiscal flexibility. While some might 
characterize this proposal as a tax increase, it is in fact a 
tax cut for both 2003 and for all of the years after 2010 
relative to current law. It would also represent a tax cut in 
the intervening years for the majority of families who face 
either the 10 or the 15 percent marginal tax rate.
    This proposal, while not raising taxes above levels that 
people are currently paying, would restore sufficient fiscal 
flexibility so that Congress could address not only its 
unfinished business, but also the needs that will emerge over 
the course of the next decade.
    Thank you.
    Chairman Conrad. Thank you very much.
    [The prepared statement of Dr. Reischauer follows:]

             Prepared Statement of Robert D. Reischauer\1\ 
---------------------------------------------------------------------------

    \1\ President of the Urban Institute. The views expressed in this 
statement should not be attributed to the Urban Institute, its 
sponsors, staff, or trustees.
---------------------------------------------------------------------------
    Mr. Chairman and members of the committee, I appreciate this 
opportunity to discuss with you some of the challenges facing the 
Congress this year as it makes its decisions about the fiscal 2003 
budget. This statement:

 reviews the latest baseline budget projections and suggests 
    that the baseline may be outside the range of politically 
    attainable paths;

 draws some straightforward lessons from the sharp and 
    unexpected deterioration in the budget outlook over the past 12 
    months;

 argues that fiscal discipline remains important and that 
    Congress should revise and extend the procedures and mechanisms 
    that facilitated budgetary restraint during the 1990's; and
 makes the case for augmenting the fiscal flexibility available 
    to future lawmakers by modifying the provisions of the Economic 
    Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

                   what a difference a year can make!

    When the Congressional Budget Office (CBO) released its baseline 
budget projections a year ago, they showed growing surpluses over the 
2002-11 period in both the unified budget and the on-budget accounts, 
surpluses that cumulated to $5.611 trillion and $3.122 trillion, 
respectively, over the 10-years (see Chart 1). For many who had 
struggled through the dark decades of large and seemingly intractable 
deficits, CBO's January 2001 projections were like passing through the 
pearly gates to the promised land of fiscal plenty. Resources appeared 
to be available to address many of the Nations priorities 
simultaneously--to reduce tax burdens, strengthen defense, modernize 
Medicare, expand aid to education, reduce the ranks of uninsured, help 
farmers, boost national saving and so on. Spirited debates even 
developed over the maximum feasible pace at which debt held by the 
public could be retired and the investment dilemma Treasury would face 
when government ran surpluses after all of the public debt had been 
retired.
    Last week, CBO released its latest baseline projections before this 
committee. In sharp contrast to those of a year ago, they showed 
unified budget deficits for 2002 and 2003 and deficits in the on-budget 
accounts through 2009 (see Charts 2 and 3). The cumulative unified 
budget surplus for the 2002-11 period had shrunk to $1.601 trillion and 
the on-budget accounts were projected to have a cumulative deficit of 
$742 billion over the period (see Chart 1).
[GRAPHIC] [TIFF OMITTED] 80544.031

    CBO carefully enumerated the factors behind the sharp deterioration 
in the baseline outlook. Over the short run--2002 and 2003--the changed 
economic forecast is the dominant explanation, accounting for 40 
percent of the deterioration (see Chart 4). In the later years, the 
revenue loss attributable to EGTRRA and the associated debt service 
dominate, accounting for half of the total deterioration in the 
baseline budget outlook in the 2009-11 subperiod.
[GRAPHIC] [TIFF OMITTED] 80544.032

    While CBO's more pessimistic projections of January 2002 represent 
a sharp contrast to those it made a year earlier, they need to be kept 
in perspective. Notwithstanding the wailing of those who would like to 
convey a sense of extreme fiscal crisis, the new projections do not 
foretell a return to the budget dynamic of the 1980's and early 1990's 
when, unless Congress took steps to curb the growth of spending or 
raise revenues, already large deficits would grow inexorably. Under the 
baseline scenario, relatively small deficits, which should cause little 
concern while the economy remains weak, turn into surpluses as the 
economy strengthens. This means that, if the economy unfolds along the 
path expected by most economists, the budget will not get mired in 
large deficits again unless the 107th Congress and its successors pass 
legislation that reduces revenues or increases spending above baseline 
levels.
    However, as you know better than I do, it will be very difficult to 
adhere to the fiscal restraint implicit in the baseline and so the 
baseline projections may prove to be a somewhat misleading indicator of 
the attainable, let alone the likely, future budget outlook. Rarely 
have the policies underlying the baseline projections been as 
disconnected from the policy makers' agendas as they are today. The 
rules and conventions that govern the construction of the baseline 
budget appropriately do not take into account the partially completed 
business before the Congress, provisions of the tax code that expire 
but are likely to be extended, or initiatives with bipartisan support 
that seem highly likely to be enacted soon. A short list of such items 
before the 107th Congress would include the farm bill, a fiscal 2002 
supplemental of defense and homeland security, extension of expiring 
provisions of the tax code, and adequate resources to cope with natural 
disasters. The rather sanguine picture that the CBO baseline portrays 
for the second half of the decade deteriorates moderately if one adds 
to the CBO baseline reasonable amounts for these priorities. This 
scenario is portrayed, in a very rough fashion, in Charts 1 through 3 
by the bars and lines labeled ``more realistic'' projection. While the 
non-Social Security accounts remain in deficit throughout the 
projection period, small unified budget surpluses still characterize 
the second half of the 10-year projection period.
    Abstracting from the uncertainty surrounding budget projections, 
even this picture is probably too optimistic. It does not encompass an 
economic stimulus package, the possibility that Congress might increase 
payments to Medicare providers above baseline levels as MedPAC has 
recommended, a Medicare prescription drug benefit, or added resources 
for defense, NIH, Amtrak, those without health insurance, and other 
perceived priorities. Of course, above-baseline spending in these areas 
could be financed by restraining spending in other programs below 
baseline levels and by closing so-called tax loopholes. However, such 
tradeoffs are likely to be difficult in the current political 
environment where majorities are narrow and bipartisan consensus on 
policy matters elusive. In short, even without considering the 
unforeseen needs that inevitably will emerge as the decade unfolds, it 
will be a challenge just to maintain balance in the unified budget 
after the economy recovers from the recession.

                           lessons from 2001

    The experience of the past 12 months provides a textbook example of 
the uncertainties inherent in budget projections and underscores why 
such projections should be used with utmost caution when pushing 
forward legislative agendas.
    The budget outlook changed dramatically from that assumed in the 
January 2001 CBO baseline for three reasons. First, there was a 
deliberate, major policy change--the enactment of the Economic Growth 
and Tax Relief Reconciliation Act of 2001--in June. This legislation 
reduced revenues and increased debt service costs by some $1.7 trillion 
over the 2002-11 period. It also preemptively provided beneficial 
fiscal stimulus to an economy that was sliding into recession and 
introduced considerable uncertainty in the future fiscal picture. This 
uncertainty derived from the acts failure to extend the many provisions 
of the tax code that expire between 2002 and 2010, its creation of two 
new provisions (AMT relief and a deduction for education expenses) that 
terminate at the end of 2004 and 2005, respectively, and its 
``Cinderella's coach'' provision which has the tax code revert, not to 
a pumpkin, but to its pre-EGTRRA structure at midnight on December 31, 
2010.
    Second, contrary to the expectations of CBO, OMB and most 
economists in January 2001, the economy slid into a recession that the 
NBER has determined started in April 2001. The recession reduced the 
growth rate of nominal GDP for 2001 by 1.5 percentage points below 
CBO's expectations and caused a sharp drop in corporate profits. The 
continued slide in stock market values reduced capital gains 
realizations and the value of stock options. These developments 
depressed revenue growth.
    In July, when the Bureau of Economic Analysis issued revised 
national income and product account figures, it lowered its estimates 
of nominal and real GDP growth, investment, productivity increases and 
corporate profits for the 1998-2000 period. These revisions have cause 
some economists, CBO included, to dampen a bit their expectations about 
the economy's long-run growth potential. Less robust growth in the 
short and long run has reduced projected levels of nominal GDP and 
future budget surpluses.
    Finally, the terrorist attacks of September 11 caused a sharp shift 
in the Nation's priorities. The needs associated with an active 
military engagement abroad, the destruction and loss of life in New 
York, the Pentagon, and Pennsylvania, and increased homeland security 
and anti-bioterrorism measures became paramount. The President and 
Congress responded by appropriating for fiscal 2001 and 2002 tens of 
billions of dollars above baseline levels to meet these new priorities. 
And these amounts were viewed as only a down payment on a longer-term 
commitment.
    One clear lesson that can be drawn from the experience of 2001 is 
that there is no way to predict with certainty today the nature or 
magnitude of tomorrow's priorities. This suggests that, in long-run 
budget planning, Congress should leave a considerable margin of fiscal 
flexibility for future lawmakers. A second lesson is that the strength 
of the economy, which has such a crucial impact on the budget, is not 
only impossible to predict with any certainty over the long run but 
also can be difficult to forecast accurately even in the short run. 
This second bitter pill suggests that Congress should exercise caution 
in its budgetary decisions, especially when the economy seems to be 
approaching a peak or trough in the business cycle.

             establishing a framework for the budget debate

    Not only has the budget outlook changed dramatically over the past 
year, but the consensus framework in which budget issues were debated 
has dissipated and some of the procedures that restrained profligate 
behavior during the 1990's have expired. These developments will make 
it more difficult to maintain fiscal discipline in the future. 
Nevertheless, for several reasons, fiscal restraint should remain an 
important, if not paramount, goal of policymakers. First, healthy 
growth and economic stability are more likely if the Federal Government 
is not running large and persistent budget deficits. Second, the Nation 
will be better able to cope with the unavoidable challenges posed by 
the aging of the population if fiscal discipline is maintained and the 
government is not saddled with large and growing debt service 
obligations when the baby hoomers begin to retire. Third, policy 
choices tend to be more rational and debate less contentious when 
fiscal discipline prevails. In an environment of persistent deficits, 
policies designed to address the Nation's problems often are 
constrained or distorted and, therefore, less effective. Symbolic 
rather than substantive responses to problems are too often adopted. 
Finally, policymakers are less likely to resort to procedural 
gimmickry--such as Constitutional amendments requiring a balanced 
budget and lock box prescriptions--if fiscal discipline is maintained.
    The first step policymakers need to take to reestablish a framework 
for the budget debate is to agree on an appropriate fiscal goal for the 
Nation. From the end of World War II through the early 1960's, the 
consensus fiscal goal of policymakers was to balance the administrative 
budget, a target attained in 6 of the 16 years from 1947 through 1962. 
From the mid-1960's through the late 1970's, the goal was refined to be 
balancing the unified budget over the business cycle. In other words, 
deficits would be tolerated when the economy was operating 
significantly below its capacity but surpluses would be expected when 
the economy's resources were fully utilized. Only once during this 
period was the target achieved. As deficits persisted and grew, the 
goal became balancing the unified budget no matter what the state of 
the economy, a goal that was finally achieved, quite unexpectedly, in 
fiscal 1998.
    When rapid economic growth, a soaring stock market and political 
gridlock combined to generate surpluses in the government's non-Social 
Security accounts in fiscal 1999, policymakers began to consider 
raising the bar. By January of 2001, a broad bipartisan consensus had 
developed around the notion that, at a minimum, the Nation's fiscal 
goal should be to balance or maintain small surpluses in the non-Social 
Security accounts while devoting Social Security's surpluses to debt 
retirement or structural program reform. Some wanted to go farther and 
wall off the Medicare Hospital Insurance surpluses for debt reduction 
or Medicare reform. Lock box proposals, which the sponsors claimed 
would realize these goals, proliferated.
    After September 11 discussions about the appropriate fiscal goal 
for the Nation ceased. Nevertheless, the Budget Committees should, as 
part of their consideration of the fiscal 2003 budget resolution, 
attempt to develop a consensus around a long-run fiscal goal for the 
Nation. It could be to balance the unified budget, achieve balance in 
the non-Social Security accounts, or meet some other target. Of course, 
no single goal is analytically right or economically optimal. The 
choice of a target depends on judgments--how one values present versus 
future needs, how one values public versus private goods, and what one 
thinks is politically sustainable. What may be the appropriate goal for 
the current decade may be quite different from that which makes the 
most sense for the next 10 years. While the CBO projections suggest 
that Congress will find it challenging just to sustain balance in the 
unified budget, I would urge you to set your sights higher and strive 
to maintain unified budget surpluses of 1 percent to 1.5 percent of GDP 
during good economic times. Maintaining balance in the non-Social 
Security budget would be a slightly more ambitious goal, but one with 
more political appeal.
    Once a fiscal goal is agreed to, procedures must be established to 
achieve and sustain fiscal discipline. During the 1990's, this was 
accomplished through enactment every few years of multi-year deficit 
reduction packages whose terms were enforced by discretionary spending 
caps and pay-as-you-go (PAYGO) restraints on mandatory spending and 
revenue measures. The system worked fairly well from fiscal 1991 
through fiscal 1998 because the spending caps were achievable in the 
post-cold war environment, fear of deficits loomed large, the economy 
was strong, and political gridlock prevailed. After 1998, the 
effectiveness of this approach deteriorated. The spending caps 
established by the 1997 Balanced Budget Act, which called for real 
reductions in discretionary spending of roughly 10 percent between 1998 
and 2002, were politically unsustainable in an era of growing 
surpluses. The payment reductions imposed on Medicare providers were 
too deep for many to absorb at a time when their costs were beginning 
to rise rapidly and payments from other sources were constrained. And 
so Congress flouted the restraints of the Budget Enforcement Act. 
Nevertheless, gridlock on major initiatives and a strong economy kept 
the surpluses growing through fiscal 2000.
    Notwithstanding the record of the past 3 years, experience suggests 
that multi-year discretionary spending caps and PAYGO restraints can 
serve useful roles if Congress wishes to adopt procedures that lead to 
the attainment of a specific fiscal goal sometime in the future. 
Prospectively establishing caps on discretiorary spending several years 
in advance would almost certainly restrain spending below the levels 
that would result from a process in which limits were set annually 
through the budget resolution. To be effective, however, spending caps 
and PAYGO restraints must be realistic--they must reflect the overall 
budget situation, the fiscal goal, and changes in the political 
consensus. Both restraints must be flexible enough to accommodate the 
vicissitudes of the budget--they must be able to bend, but not too 
much.
    Should the budget outlook improve markedly to the point where the 
fiscal goal was likely to be exceeded--the situation Congress faced in 
early 2001--some more sophisticated process than that of the Budget 
Enforcement Act would be more appropriate. Elsewhere I have suggested 
that, under such circumstances, it would be prudent to limit each 
Congress' ability to encumber future surpluses that were projected to 
exceed the fiscal goal. For example, if the goal were to maintain 
balance in the non-Social Security portion of the budget and CBO's 
baseline projections showed large and growing on-budget surpluses, the 
budget resolution would be required to place limits on spending and 
revenue legislation so that new initiatives absorbed no more than 80 
percent of the surpluses projected for the next 2 years, 70 percent of 
the surpluses projected for the following 2 years--on down to 40 
percent of the surpluses projected for years nine and ten. Such a 
calibrated system recognizes that the uncertainty that surrounds budget 
projections increases the farther in the future one projects. It also 
reflects the reality that today's lawmakers may not be the best judges 
of the Nation's needs 5 or 10 years hence. If future legislators are 
left with some significant fiscal flexibility, they will be able to 
address the Nation's problems without raising taxes, reducing spending 
on necessary programs, or increasing the deficit.

              developing fiscal flexibility for the future

    Realistic estimates of the budget outlook, such as those discussed 
earlier in this statement, suggest that it will be a challenge to 
attain and then maintain balance in the unified budget if lawmakers 
complete the unfinished business before the 107th Congress. In other 
words, little if any of Social Security's surpluses will be available 
to pay down debt or invest in structural entitlement reforms over the 
next 10 years. And nothing will be available for emerging priorities. 
In short, taxes will have to be raised, program spending cut, or 
unified budget deficits tolerated to address future problems.
    Congress could avoid placing future policymakers in this painful 
predicament by adopting measures now that create greater fiscal 
flexibility in the future. The most straightforward approach would be 
to modify the provisions of the EGTRRA. From its enactment, this 
legislation was incomplete and required further action. The provisions 
that provide AMT relief and deductions for educational expenses 
terminate in mid-stream, and the entire act sunsets after 2010. With 
the deterioration in the long-run budget outlook and the emergence of 
new priorities, the uncertainty surrounding the level of tax relief 
that the Nation will consider prudent after 2010 has increased.
    To eliminate this uncertainty, consolidate the tax cuts that have 
already been implemented, and create greater fiscal flexibility for the 
future, it would be judicious to index and make permanent all of the 
currently effective provisions of EGTRRA and put the provisions that 
are not yet implemented on hold. As Congress debates the disposition of 
any future surpluses that exceed the agreed-upon fiscal goal, it would 
be free to activate the various frozen provisions. But they would have 
to compete with other national priorities for the available resources.
    Very rough estimates suggest that this proposal would provide well 
over $300 billion in increased fiscal flexibility over the 2003-12 
period relative to the CBO baseline. Compared to a scenario in which 
the AMT relief and education expense deductions are extended and EGTRRA 
is made permanent after 2010, the savings could well exceed $600 
billion. A very rough idea of how this proposal would change the non-
Social Security budget outlook is provided in Chart 5. Rather than 
facing continued budget deficits as depicted in the ``more realistic'' 
baseline scenario, on budget surplus would reemerge after 2010. These 
surpluses could be used for further tax cuts or other national 
priorities.
[GRAPHIC] [TIFF OMITTED] 80544.033

    Some will characterize this proposal as a tax ``increase.'' In 
fact, for both 2003 and for the period after 2010, it represents a 
reduction in tax burdens imposed by current law, in addition, 
throughout the whole period, indexing the bottom bracket would provide 
tax relief, relative to current law, to the majority of taxpayers who 
face the bottom two marginal rates.

                               conclusion

    The budget outlook is not as rosy as it was 12 months ago. 
Notwithstanding the deterioration that we have already seen, the Nation 
is in a far stronger fiscal position than it was anytime from the late 
1970's through the mid-1990's. If the Nation slips back into serious 
budget difficulties, it will be because of decisions yet to be made. 
With so many outstanding promises, however, it will be difficult to 
make the tough decisions needed to keep out of such difficulties. To 
strengthen its resolve and structure its actions, the Congress needs to 
lay out a clear fiscal goal for the Nation and revise the budget 
process so that it can help attain that objective.

    Chairman Conrad. Dr. Orszag, again, welcome. It is good to 
have you here. Please proceed with your testimony.

  STATEMENT OF PETER R. ORSZAG, SENIOR FELLOW, THE BROOKINGS 
                          INSTITUTION

    Dr. Orszag. Thank you, Mr. Chairman.
    It is an honor to appear before you and the committee to 
discuss the interactions between the budget and the economy.
    The focus of my testimony is the economic and budgetary 
effects of the tax cuts that were passed last year but that 
have not yet taken effect.
    Assuming that all the sunsets in the legislation are 
removed, the long-term cost of the tax bill is a little over 
1.5 percent of GDP. About half of that reflects the provisions 
that are already in place, and about half reflect the tax cuts 
that are yet to come, primarily in 2004 and 2006 and some 
estate tax changes thereafter.
    These future schedule tax cuts have some benefits, but 
their economic costs in my opinion outweigh their benefits in 
both the short run and the long run.
    First, the short run effects. The scheduled future tax cuts 
adversely affect the economy in the short run because financial 
markets are forward-looking, and the fiscal deterioration 
caused by the future tax cuts raises long-term interest rates 
today.
    It is perhaps instructive to review what has happened to 
interest rates during 2001. As you noted in your opening 
remarks, Mr. Chairman, over the past year, as the Federal 
Reserve has moved aggressively to bolster a weakening economy, 
short-term rates have declined sharply. Normally, when short-
term rates decline, long-term rates tend to do so as well. Over 
the past year, however, long-term rates have remained fairly 
flat. Indeed, the interest rate on 10-year bonds has actually 
increased slightly.
    This failure of long-term rates to decline with short-term 
rates has an adverse effect on the economy today. It represents 
a lost opportunity to reduce mortgage costs and spur investment 
spending, which would bolster the economy in the short run.
    A critical question is why long-term rates have failed to 
decline. To be sure, many factors influence interest rates, and 
it is difficult if not impossible to parse out precisely the 
specific impact of the various factors at play. Nevertheless, 
Federal Reserve Chairman Alan Greenspan, former Treasury 
Secretary Robert Rubin and others have concluded that the tax 
cut enacted last year appears to have played an important role 
in keeping long-term rates higher than they would otherwise be.
    Furthermore, every major macroeconomic model, such as the 
one used by the Federal Reserve, suggests that the tax cut 
would raise long-term rates relative to what they would be in 
the absence of the tax cut.
    In case you have any lingering doubts about the connection 
between long-term interest rates and fiscal policy, I would 
refer you to four other sources--the Reagan administration, the 
first Bush administration, the current Undersecretary of the 
Treasury, and Professor Marty Feldstein of Harvard, a leading 
conservative economist--all of whom are quoted in my written 
testimony to the effect that fiscal policy has important 
effects on long-term interest rates.
    For example, in the words of the first Bush administration, 
and I quote: ``Economic theory and empirical evidence indicate 
that expectations of deficit reduction in future years, if the 
deficit reduction commitment is credible, can lower interest 
rates as financial market participants observe that the 
government will be lowering its future demand in the credit 
market. Lower long-term interest rates will reduce the cost of 
capital, stimulating investment and economic growth relative to 
what would be predicted if expectations were ignored.''
    That same logic, again from the first Bush administration, 
would suggest that reducing future surpluses would raise long-
term rates today and potentially be contractionary in the short 
run.
    The bottom line is that unless every major macroeconomic 
model, as well as the analyses of the other prominent 
economists I just mentioned, are wrong, the conclusion must be 
that the tax cut has played at least some role in the failure 
of the long-term rates to decline over the past year.
    Indeed, my conclusion from the major macroeconomic models 
is that the tax cut as a whole may be keeping long-term rates 
between 50 and 100 basis points--that is between half a 
percentage point and a full percentage point--higher than they 
would otherwise be, and the components not yet implemented may 
be keeping long-term rates between 25 and 50 basis points 
higher.
    To give you some sense of the impact of these magnitudes, 
note that a decline of 100 basis points in mortgage rates would 
reduce the annual payment on a $150,000 mortgage by more than 
$1,000. So the lost opportunity there is a mortgage reduction 
of more than $1,000 per year for a family with a $150,000 
mortgage.
    Administration officials not only deny the adverse 
immediate consequences of future tax cuts through this interest 
rate effect. They also argue affirmatively that future tax cuts 
can spur economic activity in the short run, even before the 
tax cuts take effect. The argument that future tax cuts have 
significant positive effects on economic activity today is 
belied by several studies of previous policy changes that were 
also announced before they were implemented. These studies 
strongly suggest that people tend not to spend tax cuts 
prospectively. Instead, they largely wait until the money is in 
their pockets.
    For example, one recent paper examined the Reagan tax cuts. 
Those tax cuts took effect in phases, with one set occurring in 
October 1981, another in July 1982, and a third in July 1983. 
The paper found that households did not increase their spending 
until the tax cuts actually were in effect. In other words, in 
order to get households to spend, you cannot just show them the 
money, you actually have to give it to them.
    In summary, the overall net effect on the economy from tax 
cuts scheduled for the future is likely to be negative in the 
short run. The adverse effect from higher long-term interest 
rates is considerably larger than any small positive impact 
that may result from increased spending now in response to 
future tax cuts.
    These short-run economic costs of the future scheduled tax 
cuts may be worth bearing if in the long run, the tax cuts 
brought large and significant positive economic benefits. 
Unfortunately, however, the available evidence suggests that 
the long run benefits are also likely to be minimal, and their 
overall long run effect may even be negative.
    For example, the Congressional Budget Office has concluded 
that with respect to the tax cut as a whole, ``The cumulative 
effects of the new tax law on the economy are uncertain but 
will probably be small.''
    The reason that the impact is small is that the positive 
effect from reducing marginal tax rates, getting people to work 
more and perhaps take more risks, is offset by reduced national 
saving, so you have a positive incentive effect but an adverse 
effect from reductions in national saving, and the two factors 
offset each other, which is why CBO concluded that whether the 
tax cut will raise or lower real GDP in the long run is 
unknown, but any effect is likely to be less than half of a 
percentage point in 2011.
    Finally, it may be worth noting that whatever the effect of 
the tax cuts scheduled for the future on the economy in the 
long run, they have significant budgetary costs. Indeed, the 
cost of the tax cuts still scheduled for the future, assuming 
that the sunsets are removed, are larger over the next 75 years 
than the entire deficit in Social Security. That may help you 
to put the magnitudes in perspective. Again, the tax cuts that 
are not yet in place but that are scheduled under the previous 
tax legislation, assuming that we remove the sunsets, cost more 
over the next 75 years than the entire deficit in Social 
Security.
    In conclusion, the tax cuts scheduled for the future are 
likely restraining the economic recovery in the short run, by 
keeping long-term rates higher than they would otherwise be, 
and they would do little to boost economic output in the long 
run because any positive incentive effects would be offset by 
reduced national saving. They would also add significantly to 
the long-term budget challenge facing the Nation.
    In light of this, let me briefly share with you a possible 
compromise that my colleague William Gale and I have advocated.
    Basically, there are two things that both sides should 
agree on. First, whatever one thought about the affordability 
of the tax cuts last year, it has to be the case that they are 
less affordable now, given that we know that we will need 
homeland security and defense spending. Second, the tax cuts 
that have already been implemented will be extremely difficult 
to reverse even when they officially sunset in 2010 or before.
    In light of these lonely points of agreement, our 
compromise is simply this: Make the tax cuts that are already 
in place permanent, but postpone the other ones until the 
projected 10-year budget surplus outside of Social Security and 
Medicare grows to be at least as large relative to the economy 
as it was immediately following passage of the tax cut, when 
the Congress thought it was preserving that much room in the 
rest of the budget even after the tax cuts had been passed.
    Since about half of the long-term costs of the tax cuts are 
already in effect, the result gives each side of the tax debate 
half of what it wants--half of the tax cut would be made 
permanent, and the other half would be frozen until it was 
clearly affordable. Freezing the tax cuts until they are 
affordable, while also making the existing tax cuts permanent, 
would thus offer a little to both sides, and it would help to 
end the budget charade, which involves artificial cost 
estimates based on the official sunsets that has unfortunately 
confused the debate over the Nation's political and economic 
choices.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Dr. Orszag.
    [The prepared statement of Dr. Orszag follows:]

             Prepared Statement of Dr. Peter R. Orszag\1\ 
---------------------------------------------------------------------------

    \1\ The views expressed in this testimony are those of the author 
and should not be attributed to the staff, officers or trustees of the 
Brookings Institution. I thank Robert Cumby, William Gale, Robert 
Greenstein, Richard Kogan, and Gene Sperling for helpful discussions, 
and David Gunter and Jennifer Derstine for excellent research 
assistance. For further discussion of many of these issues, see Peter 
Orszag and Robert Greenstein, ``Future Tax Cuts and the Economy in the 
Short Run,'' Center on Budget and Policy Priorities, January 28, 2002.
---------------------------------------------------------------------------
    Mr. Chairman and members of the committee, it is an honor to appear 
before you to discuss the interactions between the budget and the 
economy. The focus of my testimony is the economic and budgetary 
effects of the tax cuts that were passed as part of the Economic Growth 
and Tax Relief Reconciliation Act of 2001 (EGTRRA), but that have not 
yet been implemented.
    An appendix table to this testimony presents the major provisions 
in EGTRRA by the year in which they take effect. Assuming that all the 
sunsets in the legislation are removed, the long-term cost of the tax 
bill as a whole is roughly 1.6 percent of GDP.\2\  About half of that 
long-term cost reflects provisions that are already in effect, and the 
other half reflects provisions that take effect after 2002.
---------------------------------------------------------------------------
    \2\ This figure reflects the present value of the tax cut relative 
to the present value of GDP over the next 75 years, using the same 
discount rate as applied by the Social Security actuaries under their 
intermediate cost estimates for that period and assuming that all 
sunsets in EGTRRA are removed.
---------------------------------------------------------------------------
    The tax cuts that have already taken effect have supported 
aggregate demand in the economy at a time when such stimulus was 
beneficial. For example, the rebates sent out in August and September 
provided timely stimulus to the economy by helping to boost consumer 
spending in a weak economy. The early evidence, however, suggests the 
beneficial impact was likely to have been quite modest. The evidence 
suggests that most households saved, rather than spent, the rebates.\3\ 

---------------------------------------------------------------------------
    \3\ See Matthew Shapiro and Joel Slemrod, ``Consumer kesponse to 
Tax Rebates,'' NBER Working Paper 8672, December 2001. It should be 
noted that the tax cuts already in effect have contributed to higher 
long-term interest rates (as have the tax cuts not yet in effect), so 
the net impact on the economy in the short run from the already 
implemented cuts is unclear and may not be positive.
---------------------------------------------------------------------------
    The focus of my testimony, however, is the tax cuts that are 
scheduled for future years, not the ones already in place. Although the 
future scheduled tax cuts have some benefits, their economic costs 
outweigh their economic benefits in both the short run and the long 
run.
 To summarize my results:
    The tax cuts scheduled for the future raise long-term interest 
rates and therefore impede economic activity today. The important 
linkage between future fiscal policy and long-term interest rates is 
recognized in all major macroeconomic models (such as that of the 
Federal Reserve), as well as in analyses by such noted policymakers and 
economists as Chairman Greenspan, former Secretary Rubin, the Council 
of Economic Advisers under the Reagan administration and the (first) 
Bush administration, Professor Martin Feldstein of Harvard, and 
Professor John Taylor (the current Undersecretary of the Treasury for 
International Affairs).

 Any short-run benefit from the scheduled future tax cuts--
    which could arise if the tax cuts induced households to spend today 
    based on the expectation of lower taxes in the future--is likely to 
    be minimal. Evidence, including from the phase-in of the 1981 
    Reagan tax cuts, strongly suggests that households do not respond 
    to tax cuts until they take effect. In any case, any potential 
    positive effect in the short run from future tax cuts is likely to 
    be dominated by the negative effect from higher interest rates.

 The long-run benefits of the tax cuts scheduled for the future 
    are similarly minimal because any positive incentive effects from 
    lower tax rates in the long run are offset by the adverse effects 
    from lower national saving. The overall effect of the yet-to-be-
    implemented tax cuts on economic activity in the long run may, if 
    anything, be negative. The Nation faces severe budgetary pressures 
    as the baby boomers begin to retire. The tax cuts scheduled for the 
    future make these budgetary pressures more severe. For example, the 
    tax cuts not yet implemented cost about 0.8 percent of GDP in 
    present value over the next 75 years, which is slightly larger than 
    the projected deficit in Social Security over the same period. In 
    addition, the future tax cuts disproportionately benefit high-
    income households, raising the issue of whether proceeding with the 
    scheduled reductions will benefit high-income families (who will 
    disproportionately enjoy the tax reductions) at the expense of low- 
    and moderate-income families (who may disproportionately bear the 
    burden of any spending reductions necessitated by the future tax 
    cuts and the desire to avoid excessive debt levels).

 In light of the long-term budgetary pressures facing the 
    Nation, as well as the confusion created by the sunsets in EGTRRA, 
    a possible compromise would freeze the tax cuts that have not yet 
    taken effect while also removing the sunset on the tax cuts already 
    in effect. More precisely, the compromise would freeze the tax cuts 
    that have not yet been implemented until the projected 10-year 
    surplus outside Social Security is as large as it was immediately 
    following passage of the tax cut. But to clarify budget accounting 
    and eliminate any ambiguity about whether the tax cuts already in 
    effect will be continued, the compromise would also remove the 
    sunsets on the tax cuts that have already been implemented.

        short-run economic effects of scheduled future tax cuts

    The scheduled future tax cuts adversely affect the economy in the 
short run because financial markets are forward-looking, and the fiscal 
deterioration caused by the future tax cuts therefore raises long-term 
interest rates today. The increase in long-term interest rates, in 
turn, increases the cost of business investment and home mortgages--and 
restrains economic activity.
    There are two ways to see how the scheduled tax cuts affect 
shorter-term interest rates in the future, and therefore affect longer-
term interest rates immediately:

 First, one effect of the future tax cuts is that the 
    government will be saving less than it otherwise would (i.e., it 
    will be running smaller surpluses). As a consequence, the pool of 
    saving available for investment will be reduced. Firms competing 
    for this smaller pool of investment funds will push up the price of 
    borrowing funds--that is, raise future interest rates.

 An alternative, but fundamentally equivalent, way of grasping 
    the relationship between the tax cut and interest rates recognizes 
    that the amount of debt the government is projected to pay down in 
    the future will be smaller (and the national debt will consequently 
    be larger) as a result of the tax cut. The amount of Treasury bonds 
    held by the public will therefore be higher in the future than it 
    would be without the tax cut. To persuade investors to hold more 
    bonds, the government will have to offer a higher interest rate.
 The scheduled tax cuts thus exert upward pressure on future 
    interest rates. Since financial markets determine long-term 
    interest rates today largely on the basis of what they expect 
    shorter-term interest rates to be in the future, the expected 
    increase in shorter-term interest rates in the future drives up 
    long-term interest rates now. By raising long-term interest rates 
    now, tax cuts scheduled for the future discourage investment and 
    interest-sensitive consumption, thereby impeding economic activity 
    today.
Recent interest rate movements
    It is perhaps instructive to review what has happened to interest 
rates recently. Over the past year, as the Federal Reserve has moved 
aggressively to bolster a weakening economy, short-term interest rates 
have declined sharply. Between the beginning of 2001 and the beginning 
of 2002, for example, the interest rate on 3-month Treasury bills fell 
from 5.5 percent to 1.7 percent.
    Normally, when short-term rates decline, long-term interest rates 
tend to do so as well. Over the past year, however, long-term rates 
have remained fairly flat despite the steep decline in short-term 
rates. The interest rate on 10-year Treasury bonds actually increased 
slightly during 2001, from 5.0 percent to 5.2 percent. In other words, 
short-term interest rates have declined substantially but long-term 
rates have not.
    Although the precise relationship may depend on many factors and 
fluctuates over time, long-term rates have tended to move by about half 
as much as short-term rates, on average, over the past two decades.\4\  
Based on this historical relationship, the 3.8 percentage point decline 
in short-term rates during 2001 should have corresponded to a decline 
in long-term rates of a bit under 2 percentage points. Instead, long-
term rates increased slightly. In other words, given the decline in 
short-term rates and the average historical relationship between 
changes in long-term rates and short-term rates, one would have 
expected long-term rates to be almost 2 percentage points lower than 
they are today. \5\ 
---------------------------------------------------------------------------
    \4\ A regression of the annual change in the 10-year constant 
maturity yield on the annual change in the 3-month constant maturity 
yield from 1982 to 2001 yields a coefficient on the change in the 3-
month yield of 0.52 (using the Prais-Winston transformed regression 
estimator to address serial correlation in the errors). The coefficient 
is slightly lower if the time period is restricted to the late 1980's 
to the present, but is roughly 0.5 if the time period is restricted to 
the 1990's.
    \5\ It should be noted that long-term rates did decline during 
2000, and part of that decline in long-term rates could have reflected 
an anticipated decline in short-term rates during 2001. But short-term 
rates appear to have fallen by more than had been anticipated in late 
2000. This story therefore does not explain the failure of long-term 
rates to decline in response to the unanticipated decline of short-term 
interest rates during 2001.
---------------------------------------------------------------------------
    An alternative perspective is obtained by examining what happened 
during the 1990-1991 recession relative to what has happened thus far 
during the current recession. The current recession began in March 
2001. In the 9-months since March, short-term interest rates have 
fallen by 280 basis points (2.8 percentage points) and long-term rates 
have risen slightly. In the 9-months following the beginning of the 
1990-1991 recession, by contrast, short-term interest rates fell by 200 
basis points (2 percentage points) and long-term rates fell by more 
than 40 basis points (0.4 percentage points). Based on this 
relationship from the 1990-1991 recession, we would have expected long-
term rates to fall by about 60 basis points since March 2001. Instead, 
they rose by about 20 basis points--so that 80 basis points is 
``missing.''
    The upshot is that given the declines in short-term rates, one 
would have expected long-term rates to be somewhere between 80 basis 
points (based on the relationship between short rate and long rates 
from the 1990-1991 recession) and 200 basis points (based on the 
historical average relationship over the past two decades) lower than 
their current levels. To be sure, long-term rates remain relatively low 
today, which has helped to shore up the housing market, but they would 
have been expected to be lower given historical relationships and the 
decline in short-term rates.
    This failure of long-term rates to decline with short-term interest 
rates has an adverse effect on the economy. For example, a decline of 
100 basis points in mortgage rates would reduce the annual payment on a 
$150,000 mortgage by more than $1,000. The substantial decline in long-
term rates that would have been expected, given the decline in short-
term rates, would also boost investment spending, thereby spurring the 
economy. A critical question is why long-term rates have failed to 
decline.
The tax cut and long-term interest rates
    Many factors influence interest rates, including fiscal policy, 
economic growth projections, investment expectations, savings trends, 
international capital flows, and expected inflation. It is difficult, 
if not impossible, to parse out precisely the specific impact of the 
various factors that affect interest rates. Nevertheless, Federal 
Reserve Chairman Alan Greenspan, former Treasury Secretary Robert 
Rubin, and others have concluded that the tax cut enacted last year 
appears to have played an important role in keeping long-term rates 
higher than they would otherwise be.
    For example, in a speech delivered on January 11, 2002, Chairman 
Greenspan noted that ``over the past year, some of the firmness of 
long-term interest rates probably is the consequence of the fall of 
projected budget surpluses and the implied less-rapid paydowns of 
Treasury debt.''\6\  In earlier Congressional testimony, Greenspan 
indicated there was ``no question'' that the tax cut enacted last year 
affected long-term interest rates.\7\ 
---------------------------------------------------------------------------
    \6\ Alan Greenspan, ``The Economy,'' Remarks at the Bay Area 
Council Conference, San Francisco, January 11, 2002. It is important to 
distinguish, as Chairman Greenspan does in his speech, the most recent 
uptick in long-term interest rates, which are now higher than they were 
in October 2001, from the fact that long-term rates failed to decline 
over 2001 as a whole. The more recent increase is likely tied to 
expectations of faster growth in the future, not the tax cut; the 
effects of the tax cut were already reflected in long-term rates by 
October and thus cannot explain the increase in rates since then. But, 
as Greenspan indicated, the tax cut likely played a significant role in 
keeping long-term rates as high as they already were in October.
    \7\ Testimony of Alan Greenspan before Committee on Banking, 
Housing, and Urban Affairs, U.S. Senate, July 24, 2001. 
---------------------------------------------------------------------------
    Secretary Rubin has similarly noted, ``If you look at interest 
rates over the course of the last year, market interest rates, they, 
basically, have not come down, 5-year and 10-year government rates. 
Fixed rate mortgages rates did not come down last year. They came down 
vs. 2 years ago, but they did not come down over the course of last 
year. And I believe one factor responsible for that was the enormous 
deterioration in our fiscal position over time. . .\8\ 
---------------------------------------------------------------------------
    \8\ Face the Nation, CBS, January 6, 2002. 
---------------------------------------------------------------------------
    Furthermore, every major macroeconomic model--such as the one used 
by the Federal Reserve--suggests that the tax cut would raise long-term 
rates relative to what they would be in the absence of the tax cut. \9\ 
 For example, previously published results from the macroeconomic model 
used by the Federal Reserve Board, adjusted to reflect the size of the 
tax cut passed last year, would suggest that the tax cut would raise 
10-year interest rates by between 56 basis points and 80 basis points 
after 1 year (i.e., by between 0.5 and 0.8 percentage point), and by 
between 77 and 112 basis points after 10 years.\10\  I should emphasize 
that these figures reflect an interpretation of previously published 
estimates from the Federal Reserve, roughly adjusted to fit the cost of 
EGTRRA; they do not reflect an official estimate from the Federal 
Reserve of the effects of the tax cut.
---------------------------------------------------------------------------
    \9\ See William G. Gale and Samara R. Potter, ``An Evaluation of 
the Economic Growth and Tax Relief Reconciliation Act of 2001,'' 
forthcoming, National Tax Journal.
    \10\ David Reifschneider, Robert Tetlow, and John Williams, 
``Aggregate Disturbances, Monetary Policy, and the Macroeconomy: The 
FRB/US Perspective,'' Federal Reserve Bulletin, January 1999, Table 4. 
The figures in the text assume the tax cut amounts to between 1.1 and 
1.6 percent of GDP. Over the next 10 years, the tax cut costs roughly 
1.1 percent of GDP; over the next 75 years, it costs roughly 1.6 
percent of GDP (in present value and assuming all sunsets are removed). 
See Richard Kogan, Robert Greenstein, and Peter Orszag, ``Social 
Security and the Tax Cut: The 75-Year Cost of the Tax Cut is More than 
Twice as Large as the Long-term Deficit in Social Security,'' Center on 
Budget and Policy Priorities, revised December 13, 2001.
---------------------------------------------------------------------------
    In 1995, the Congressional Budget Office evaluated the impact of a 
fiscal shift that was somewhat larger (amounting to a cumulative 
reduction in the 10-year budget balance of roughly 2.6 percent of GDP) 
than the EGTRRA produced.\11\ CBO concluded that the interest rate 
movement from such a fiscal policy change would not credibly amount to 
as much as 400 basis points (which was the estimate from the DRI 
macroeconomic model), but that ``those who expect [budget shifts] to 
have little or no impact on interest rates probably overstate their 
case as well.''\12\  CBO concluded that the budget shift it studied 
would change 10-year interest rates by 170 basis points after 5 years, 
with more modest interest rate changes in years one through four.\13\  
The implication is that EGTRRA would raise 10-year rates by about 90 
basis points after 5 years.
---------------------------------------------------------------------------
    \11\ See William G. Gale and Samara R. Potter, ``An Evaluation of 
the Economic Growth and Tax Relief Reconciliation Act of 2001,'' 
forthcoming, National Tax Journal.
    \12\ Congressional Budget Office, ``Analysis of the President's 
Budgetary Proposals for Fiscal Year 1996,'' April 1995, page 56.
    \13\ Congressional Budget Office, ``Analysis of the President's 
Budgetary Proposals for Fiscal Year 1996,'' April 1995, Table B-2, page 
53.
---------------------------------------------------------------------------
    In 1994, the Council of Economic Advisers used the Solow growth 
model, which is commonly used to study long-term economic performance, 
to examine the impact of the 1993 deficit reduction package on interest 
rates. It estimated that raising government saving by 1.75 percent of 
GDP would reduce interest rates by 200 basis points in the long-
term.\14\  The implication is that a permanent tax cut of 1.6 percent 
of GDP (as under EGTRRA) would ultimately raise long-term rates by 
about 180 basis points.
---------------------------------------------------------------------------
    \14\ Council of Economic Advisers, Economic Report of the 
President, February 1994, pages 81-87.
---------------------------------------------------------------------------
    Despite these results from mainstream macroeconomic models and the 
considered judgment of experienced market observers like Alan Greenspan 
and Robert Rubin, some officials have argued that the tax cut has not 
played any role in keeping long-term rates high. When asked recently to 
respond to Greenspan's comments on long-term rates, for example, one 
top White House official responded: ``I disagree with the implication 
here that it was the tax cuts.''\15\ 
---------------------------------------------------------------------------
    \15\ Novak, Hunt, and Shields, CNN, January 12, 2002.
---------------------------------------------------------------------------
    To support their argument that the tax cuts do not affect long-term 
interest rates, these officials contend that the econometric literature 
does not demonstrate a robust relationship between budget shifts and 
interest rates. To be sure, the results from the literature are mixed; 
one review of the literature noted that ``it is easy to cite a large 
number of studies that support any conceivable position.''\16\  But it 
is assuredly not the case that the literature conclusively demonstrates 
that fiscal policy does not affect interest rates. The wide array of 
results found in the literature simply suggests that efforts to 
quantify any relationship between fiscal policy and interest rates have 
been flawed. As two leading economists, Douglas Elmendorf of the 
Federal Reserve and Gregory Mankiw of Harvard, conclude in a summary of 
the literature: ``Our view is that this literature.  .  .is not very 
informative.''\17\ 
---------------------------------------------------------------------------
    \16\ B. Douglas Bernheim ``A Neoclassical Perspective in Budget 
Deficits,'' Journal of Economic Perspectives, Spring 1989.
    \17\ Douglas Elmendorf and Gregory Manldw, ``Chapter 25: Government 
Debt,'' in Handbook of Macroeconomics (1998), page 1658.
---------------------------------------------------------------------------
    In case you have any lingering doubts about the connection between 
long-term interest rates and fiscal policy, I would refer you to four 
impeccable sources: the Reagan administration, the first Bush 
administration, the current Undersecretary of the Treasury for 
International Affairs, and Professor Martin Feldstein of Harvard:

 In 1984, the Reagan administration wrote: ``Measures to reduce 
    the budget deficit would lower real interest rates and thus allow 
    the investment sector to share more fully in the recovery that is 
    now taking place primarily in the government and consumer 
    sectors.''\18\  The same logic would suggest that reducing future 
    surpluses would raise real interest rates and discourage 
    investment.

    \18\ Council of Economic Advisers, Economic Report of the 
President, February 1984, page 62.
---------------------------------------------------------------------------
 In analyzing the 1990 budget agreement, the Bush 
    administration--that is, the first Bush administration--wrote: 
    ``The new budget law, for example, reduces the budget deficit from 
    what otherwise would be expected. Economic theory and empirical 
    evidence indicate that expectations of deficit reduction in future 
    years, if the deficit reduction commitment is credible, can lower 
    interest rates as financial market participants observe that the 
    government will be lowering its future demand in the credit market. 
    That can mitigate a potential short-run contractionary effect. In 
    other words, expectations of lower interest rates in the future 
    will lower long-term interest rates today. Lower long-term interest 
    rates will reduce the cost of capital, stimulating investment and 
    economic growth relative to what would be predicted if expectations 
    were ignored.''\19\ 

    \19\ Council of Economic Advisers, Economic Report of the 
President, February 1991, page 64.
---------------------------------------------------------------------------
 John Taylor, the current Undersecretary of the Treasury for 
    International Affairs, constructed a sophisticated, forward-
    looking, multi-country model that contained strong linkages between 
    fiscal policy shifts and long-term interest rates. He estimated 
    that a fiscal policy tightening that amounted to 3 percent of GDP 
    would reduce long-term interest rates by more than 150 basis points 
    in the long run.\20\ 

    \20\ John Taylor, Macroeconomic Policy in a World Economy (WW 
Norton: New York, 1993), pages 270-273. It should be noted that Taylor 
explicitly modeled a reduction in government purchases, not a change in 
taxes.
---------------------------------------------------------------------------
 Professor Martin Feldstein of Harvard has attempted to 
    overcome one of the shortcomings of the econometric literature by 
    including a measure of projected deficits in his analysis. (One 
    reason that the literature is not particularly informative is that, 
    as noted above, expectations of future fiscal surpluses or deficits 
    have important effects on interest rates, but many econometric 
    analyses ignore them.) A paper by Feldstein finds a large effect on 
    interest rates; he concludes that ``each percentage point increase 
    in the 5-year projected ratio of budget deficits to GNP raises the 
    long-term government bond rate by approximately 1.2 percentage 
    points. . .\21\ 
---------------------------------------------------------------------------
    \21\ Martin Feldstein, ``Budget Deficits, Tax Rules, and Real 
Interest Rates,'' Working Paper No. 1970, National Bureau of Economic 
Research, July 1986, page 48.

 The bottom line is that unless the major macroeconomic 
    models--as well as the analyses of Chairman Greenspan, Secretary 
    Rubin, the Reagan administration, the (first) Bush administration, 
    Professor Taylor, and Professor Feldstein--are wrong, the 
    conclusion must be that the tax cut has played some role in the 
    failure of long-term rates to decline over the past year. indeed, 
    my conclusion from the major macroeconomic models is that the tax 
    cut as a whole may be keeping long-term rates between 50 and 100 
    basis points higher than they would otherwise be, and may 
    ultimately raise long-term rates by between 75 and 200 basis 
---------------------------------------------------------------------------
    points.

    The same reasoning suggests that the scheduled future tax cuts 
alone are keeping long-term rates higher than they would otherwise be. 
Indeed, since the scheduled future cuts represent about half of the 
long-term cost of the tax package as a whole, the estimates above would 
suggest that the scheduled future cuts themselves are keeping long-term 
rates between 25 and 50 basis points higher than they would be in the 
absence of the scheduled future reductions, and may ultimately raise 
long rates by between 35 and 100 basis points.
    The failure of long-term rates to decline impedes economic activity 
today. It raises the costs of home mortgages, and discourages both 
interest-sensitive consumption and business investment.
Positive short-run effects from future scheduled tax reductions
    Administration officials not only deny the adverse immediate 
consequences of future tax cuts through this interest rate effect. They 
also argue affirmatively that future tax cuts spur economic activity in 
the short run. For example, Bush economic adviser Lawrence Lindsey 
argues in a recent op-ed article that expected future tax reductions 
have a positive effect on the economy in the short run.\22\ 
---------------------------------------------------------------------------
    \22\ Lawrence B. Lindsey, ``Why We Must Keep the Tax Cut,'' 
Washington Post, January 18, 2002, Page A25.
---------------------------------------------------------------------------
    Some supporters of the future tax cuts are internally inconsistent 
on this issue. They simultaneously argue that the future tax cuts will 
not raise interest rates, by invoking a theory under which households 
offset expected budget shortfalls in future years by saving more today, 
and that the future tax cuts will spur spending today. But if 
households must raise their saving to fully offset the impact of the 
tax cut on the budget in future years, they could not also increase 
their spending today in response to the tax cut. These two arguments 
contradict each other.\23\ 
---------------------------------------------------------------------------
    \23\ It is also worth noting that a reduction in future tax rates 
could induce individuals to substitute work effort from the current 
period into the future period. Many supporters of EGTRRA believe that 
individuals are highly responsive to tax rates, which would make this 
concern loom larger than if individuals were (as my interpretation of 
the empirical evidence suggests) largely unresponsive to marginal tax 
rate changes.
---------------------------------------------------------------------------
    More importantly, the argument that future tax cuts have 
significant effects on economic activity today is belied by several 
studies of previous policy changes that were announced before they were 
implemented. These studies strongly suggest that people tend not to 
spend tax cuts prospectively; instead, they largely wait until the 
money is in their pockets.\24\ 
---------------------------------------------------------------------------
    \24\ One factor suggesting a somewhat stronger short-run effect 
from the future tax cuts is that those tax cuts disproportionately 
accrue to higher-income families, who are less likely to be liquidity 
constrained than lower-income families. On the other hand, higher-
income families may also have a lower marginal propensity to consume 
out of permanent income, mitigating the short-run impact.
---------------------------------------------------------------------------
    For example, one recent paper examined the Reagan tax cuts; those 
tax cuts took effect in phases, with one set of tax reductions 
occurring in October 1981, another set occurring in July 1982, and a 
third set of cuts taking effect in July 1983. The paper found that 
households generally did not increase their spending until the tax cuts 
actually were in effect.\25\  Another paper, by economist James Poterba 
of MIT, studied the 1975 tax rebate, which was announced before it was 
paid. This research, too, concluded that ``consumers do not adjust 
consumption in anticipation of tax changes.''\26\  Still other research 
by David Wilcox of the Federal Reserve Board suggests that households 
do not respond to announced changes in Social Security benefits until 
the cash is actually in their hands.\27\  The evidence strongly 
suggests that households do not respond much to tax cuts or other 
policy changes until the cash is in their hands. These findings suggest 
that any short-run stimulus to spending from tax cuts that will not 
take effect until future years is quite limited. And to my knowledge, 
the idea that future tax cuts will raise saving now receives no support 
from the literature whatsoever.
---------------------------------------------------------------------------
    \25\ Nicholas Souleles, ``Consumer Response to the Reagan Tax 
Cuts,'' forthcoming, Journal of Public Economics.
    \26\ James Poterba, ``Are Consumers Forward Looking? Evidence from 
Fiscal Experiments?'' AEA Papers and Proceedings (1988), pages 413-418.
    \27\ David Wilcox, ``Social Security Benefits, Consumption 
Expenditure, and the Life Cycle Hypothesis,'' Journal of Political 
Economy (1989), pages 288-304.
---------------------------------------------------------------------------
    In summary, the overall net effect on the economy from tax cuts 
scheduled for the future is likely to be negative in the short run. The 
adverse impact from higher long-term interest rates is considerably 
larger than any small, positive impact that may result from increased 
spending now in response to future tax cuts.

         long-run economic effects of scheduled future tax cuts

    The analysis above has focused on the short-run effects from the 
future scheduled tax cuts. This section briefly analyzes the longer-run 
effects. It first examines the longer-run economic effects from the 
future scheduled tax cuts, and then turns to the longer-run budgetary 
effects.
Economic effects in the long run
    The short-run economic costs of the future scheduled tax cuts may 
be worth bearing, even though the economy is currently in a recession, 
if the impact of those cuts on economic activity in the long run were 
positive and substantial. Unfortunately, however, the available 
evidence suggests that the long-run economic benefits from the future 
scheduled tax cuts are likely to be minimal, and the overall long-run 
effect may even be negative.
    Some proponents of the tax cut package--including the tax cuts 
scheduled for the future under EGTRRA--argue that it will significantly 
raise economic output in the long run by cutting marginal tax rates. 
For example, a Heritage Foundation report argued, ``Because of steep 
personal income tax rates, highly productive entrepreneurs and 
investors can take home only about 60 cents of every dollar they earn, 
not including State and local taxes or other Federal taxes. This 
reduces the incentive to be productive. Lower tax rates will reduce 
this `tax wedge' and encourage additional work, savings, investment, 
risk-taking, and entrepreneurship.''\28\ 
---------------------------------------------------------------------------
    \28\ Daniel Mitchell, ``Reducing Tax Rates Across the Board: A 
Cornerstone of Pro-Growth Tax Relief,'' Heritage Foundation Report No. 
711, January 16, 2001.
---------------------------------------------------------------------------
    The basic logic of this argument is that reducing marginal tax 
rates can increase the incentives to work, to take risks, and to save, 
all of which can encourage additional economic activity.\29\  The 
crucial question, however, is the size of these effects. The most 
recent academic evidence suggests that marginal tax rate reductions 
would have only modest effects on future economic activity in the long 
run.\30\ 
---------------------------------------------------------------------------
    \29\ It is worth noting that even theoretically, the impact of tax 
reductions on work effort, risk-taking, and saving can be ambiguous.
    \30\ See the summaries of the relevant literatures in Joel Slemrod 
and Jon Bakija, Taxing Ourselves: A Citizen's Guide to the Great Debate 
over Tax Reform (MIT Press: Cambridge, 1996).
---------------------------------------------------------------------------
    Tax cuts, furthermore, have an important downside from an economic 
standpoint: they reduce national saving. Tax cuts result in lower 
national saving because funds used for the tax cuts would primarily 
result in increased consumption, while funds used to pay down debt 
primarily increase savings. The fundamental benefit of higher national 
saving is that it will expand income in the future. Higher national 
saving leads to higher investment, which means that future workers have 
more capital with which to work and are more productive as a 
result.\31\  The increased productivity generates a larger economy, a 
higher national income, and a higher standard of living in the 
future.\32\ 
---------------------------------------------------------------------------
    \31\ More precisely, higher national saving today increases 
national income in the future regardless of whether the increase in 
national saving is absorbed in higher domestic investment or net 
foreign investment. In the latter case, the increase in future income 
would reflect an increase in receipts from abroad (relative to the 
baseline), rather than an increase in domestic output.
    \32\ For a specific application in the context of the recent budget 
debates, see Peter R. Orszag, ``The Budget and Long-term Fiscal 
Policy,'' Committee on the Budget, U.S. Senate, February 7, 2001.
---------------------------------------------------------------------------
    In evaluating the impact of the future tax cuts on long-run 
economic performance, one must include both any potential positive 
effects from reducing marginal tax rates and the negative effects from 
reducing national saving.
    Studies that have examined EGTRRA as a whole have generally found 
minimal long-term benefits.\33\ For example, an early paper that I 
wrote (before the tax legislation was passed) concluded that the 
benefits of the lower tax rates from EGTRRA would raise economic output 
in 2012 by 0.5 percentage points, but that the reduction in national 
saving caused by the tax cut could reduce real GDP in 2012 by between 
0.6 and 0.9 percentage points.\34\ The overall effect was thus a small 
reduction in GDP in 2012, because the benefits of the marginal tax rate 
changes were too small to offset the costs of the fall in national 
saving. The Congressional Budget Office has similarly concluded, ``The 
cumulative effects of the new tax law on the economy are uncertain but 
will probably be small. Labor supply may rise modestly as a result of 
the reductions in marginal tax rates (the rates that apply to the last 
dollar earned); however, national saving may fall. Whether the tax cut 
will raise or lower real (inflation-adjusted) gross domestic product 
(GDP) in the long run is unknown, but any effect is likely to be less 
than half of a percentage point in 2011.''\35\ Finally, an 
authoritative examination of the tax legislation by William Gale and 
Samara Potter of Brookings has concluded that the overall impact on 
economic activity in the long run will be minimal, and may well be 
negative.\36\ 
---------------------------------------------------------------------------
    \33\ These estimates apply to EGTRRA as a whole. But even if all 
the positive long-run benefits from EGTRRA arose from the tax cuts that 
are not yet in effect--which is clearly a gross overestimate of the 
economic benefits from those future tax cuts--the net effect of those 
future tax cuts on the economy in the long run would still be roughly 
zero. In other words, the available evidence suggests that the long-run 
economic gains from the future tax cuts would be minimal at best, 
because the adverse effects from reduced national saving offset the 
beneficial effects from reduced tax rates.
    \34\ Peter R. Orszag, ``Marginal Tax Rate Reductions and the 
Economy: What Would Be The Long-Term Effects of the Bush Tax Cut?'' 
Center on Budget and Policy Priorities, March 15, 2001.
    \35\ Congressional Budget Office, ``The Long-Term Macroeconomic 
Effects of the Economic Growth and Tax Relief Reconciliation Act of 
2001,'' Box 2-3, The Budget and Economic Outlook. An Update, August 
2001.
    \36\ William G. Gale and Samara R. Potter, ``An Evaluation of the 
Economic Growth and Tax Relief Reconciliation Act of 2001,'' 
forthcoming, National Tax Journal.
---------------------------------------------------------------------------
Budget effects in the long run
    In addition to its long-term economic effects, we should consider 
the impact of the future tax reductions on the budget itself. As 
Director Crippen emphasized in recent testimony before this committee, 
budgetary pressures are severe over the longer term. As he noted, 
``long-term pressures on spending loom just over the horizon. . .  
According to midrange estimates, if current policies continue, spending 
on Social Security, Medicare, and Medicaid combined will nearly double 
by 2030, to almost 15 percent of GDP. Taking action sooner rather than 
later to address long-term budgetary pressures can make a significant 
difference.''\37\ 
---------------------------------------------------------------------------
    \37\ Daniel Crippen, ``The Budget and Economic Outlook: Fiscal 
Years 2003-2012,'' Testimony before the Committee on the Budget, U.S. 
Senate, January 23, 2002.
---------------------------------------------------------------------------
    The tax cuts scheduled for the future under EGTRRA, assuming they 
are continued after 2010, are large relative to the projected fiscal 
gaps over the next 70 to 75 years. Economists define the ``fiscal gap'' 
as the magnitude of the immediate and permanent increase in taxes or 
reduction in primary expenditures that would be required to keep the 
long-run ratio of government debt to GDP at its current level given 
other current policies. In other words, the fiscal gap basically 
measures the projected long-term imbalance in the budget as a share of 
GDP.
    Alan Auerbach of the University of California at Berkeley and 
William Gale of Brookings have estimated the fiscal gap through 2070 
using CBO baseline assumptions about discretionary spending (which 
assume that discretionary spending remains constant in real terms for 
the next decade and then remain constant as a share of GDP 
thereafter).\38\ Before passage of EGTRRA, Auerbach and Gale estimated 
that the fiscal gap through 2070 amounts to 0.67 percent of GDP.\39\  
The provisions of the tax cut that have already been implemented more 
than double that gap, to about 1.5 percent of GDP. The tax cuts 
scheduled for the future would raise it still further, to about 2.3 
percent of GDP.
---------------------------------------------------------------------------
    \38\ Alan J. Auerbach and William G. Gale, ``Tax Cuts atid the 
Budget,'' Tax Notes 90, March 26, 2001, pages 1869- 82.
    \39\ This figure is subject to substantial uncertainty. For 
example, it is extremely sensitive to assumptions about discretionary 
spending trends: Assuming that discretionary spending would remain 
constant as a share of GDP from today forward, rather than only from 
2011 forward, raises the fiscal gap to 1.45 percent of GDP over the 
next 70 years.
---------------------------------------------------------------------------
    In other words, the tax cuts scheduled for the future would 
increase the long-term fiscal gap from about 1.5 percent of GDP to 
about 2.3 percent of GDP. To be sure, these types of calculations are 
subject to substantial uncertainty. But such uncertainty does not 
change the basic conclusion that the scheduled tax cuts represent a 
significant share of the Nation's long-term fiscal imbalance. In any 
case, uncertainty should make us even more hesitant to proceed with 
policy changes that significantly reduce revenue or raise 
expenditures.\40\ 
---------------------------------------------------------------------------
    \40\ See, for example, Alan Auerbach and Kevin Hassett, 
``Uncertainty and the Design of Long-Run Fiscal Policy,'' NBER Working 
Paper 7036, March 1999.
---------------------------------------------------------------------------
    Another perspective on the cost of the tax cuts scheduled for the 
future is that their cost over the next 75 years--about 0.8 percent of 
GDP--is slightly larger than the projected imbalance in Social Security 
over the same period.\41\ According to the Social Security actuaries, 
the 75-year projected deficit in Social Security (under the 
intermediate cost assumptions) amounts to roughly 0.7 percent of GDP. 
In other words, freezing the future tax cuts and using the funds 
instead as general revenue transfers to the Social Security System 
would eliminate the deficit in Social Security over the next 75 
years.\42\  To be clear, I am not advocating such a policy as the only 
``solution'' to addressing Social Security's deficit, but it does help 
to put the size of the scheduled tax cuts in perspective.
---------------------------------------------------------------------------
    \41\ For more on comparing the tax cut and the long-term deficit in 
Social Security, see Richard Kogan, Robert Greenstein, and Peter 
Orszag, ``Social Security and the Tax Cut,'' Center on Budget and 
Policy Priorities, Revised December 13, 2001.
    \42\ Under the Social Security actuaries' intermediate projections, 
the projected 75-year deficit amounts to 1.86 percent of taxable 
payroll. Over this 75-year-period, taxable payro1l will amount to 37.6 
percent of the Gross Domestic Product when both are expressed in 
present value. As a result, the 75-year imbalance amounts to 0.7 
percent of GDP, which is equal to 1.86 percent of taxable payroll 
multiplied by 37.6 percent. The figure of 0.7 percent of GDP appears in 
Table VI.E5 on page 150 of the Trustees Report of March 19, 2001.
---------------------------------------------------------------------------
    The Social Security comparison also helps to highlight a crucial 
distributional concern:
    The tax cuts scheduled for the future will accrue 
disproportionately to higher-income taxpayers. Yet the budget cuts that 
may be required if the tax cuts are implemented would likely be borne 
disproportionately by lower-income and middle-income families.

                               conclusion

    In conclusion, the tax cuts scheduled for the future are likely 
restraining the economic recovery in the short run--by keeping long-
term rates higher than they would otherwise be--and they would do 
little to boost economic output in the long run because any positive 
incentive effects would be offset by reduced national saving. They 
would also add significantly to the long-term budget challenge facing 
the Nation.
    Let me therefore put forward a possible compromise that my 
colleague William Gale and I have advocated. The tax cuts embodied in 
EGTRRA expire in 2010. The debate at this point is whether those cuts 
should be restricted or made permanent. Senator Kennedy recently 
proposed that some of the already-legislated future tax cuts for high-
income households be frozen to help pay for a variety of social 
programs. The Administration, however, opposes any trimming of the tax 
cut and instead wants to make the tax cuts permanent.
    Here are two things that both sides would have to agree upon:

 First, whatever one thought about whether the tax cuts were 
    affordable last year, it has to be the case that they are less 
    affordable now. After all, since then, the economic outlook has 
    soured, homeland security and anti-terrorism spending needs have 
    become apparent, and budget surpluses have withered.

 Second, the tax cuts that have already been implemented will 
    be extremely difficult to reverse, even when they officially sunset 
    in 2010.

    In light of these lonely points of agreement, allow me to put 
forward a simple compromise: Make the tax cuts that are already in 
place permanent, but postpone the other ones until they are affordable. 
The artificial sunsets of the tax cuts that are already in effect 
should be removed. But none of the future tax cuts should be allowed to 
take effect until they are affordable. Specifically, any tax cuts not 
yet in effect should be frozen until the projected 10-year budget 
surplus outside of Social Security and Medicare grows to be at least as 
large (relative to the economy) as it was immediately following passage 
of the tax cut.
    Since about half of the tax cuts are already in effect, the result 
gives each side of the tax debate half of what it wants: Half of the 
tax cut would be made permanent, and half would be frozen until it was 
clearly affordable. Freezing the future tax cuts until they are 
affordable--while also making the existing tax cuts permanent--would 
thus offer a little to both sides. And it would help to end the budget 
charade that has confused the debate over the Nation's political and 
economic choices.

   Year-by-Year Provisions Under the Economic Growth and Tax Relief 
                       Reconciliation Act of 2001

2001

 New 10 percent income tax bracket on the first $12,000 in 
    taxable income for couples, $10,000 for single parents and $6,000 
    for others (no indexing for inflation).

 Income tax rates of 39.6 percent, 36 percent, 31 percent and 
    28 percent each reduced by 1 percentage point, effective July 1, 
    2001--in essence, a half point reduction for calendar 2001.

 Child credit increased from $500 to $600, with expanded 
    refundability based on 10 percent of earnings above $10,000 (the 
    $10,000 figure is adjusted in future years for inflation).

2002

 Earned-income tax credit phase-out range increased by $1,000 
    for married couples ($1,000 is not indexed).

 Maximum expenses for child-care and maid-service credit raised 
    from $2,400 to $3,000 for one child under 13 and from $4,800 to 
    $6,000 for two or more children under 13; maximum credit rate 
    increased from 30 percent to 35 percent; credit rate phased down to 
    20 percent between $15,001 and $43,001 in income rather than from 
    $10,001 to $28,001.

 IRA annual contribution limit increased to $3,000 (from 
    $2,000). Limit on elective deferrals raised from $10,000 to 
    $11,000. Other retirement savings changes take effect.IRA tax 
    credits for lower-income workers established.

 Alternative minimum tax exemptions increased by $4,000 for 
    couples and $2,000 for singles.

 Top estate tax rate cut from 55 percent to 50 percent; 
    recapture of lower rates repealed; estate tax credit converted to 
    an exemption (worth more for larger estates) and exemption 
    increased from $700,000 to $1 million (double those amounts for 
    couples).

2003

 Limit on elective retirement savings deferrals raised from 
    $11,000 to $12,000.

 Top estate tax rate cut to 49 percent

2004

 Top four income tax rates cut by an additional percentage 
    point (to 37.6 percent, 34 percent, 29 percent and 27 percent).

 Limit on elective retirement savings deferrals raised from 
    $12,000 to $13,000.

 Top estate tax rate cut to 48 percent. Exemption increased to 
    $1.5 million (double that for couples).

2005

 Child credit increased to $700, with further expansion in 
    refundability, based on 15 percent of earnings above about $12,000 
    (the $12,000 figure will be adjusted for inflation in later years).

 Earned-income tax credit phase-out range increased by an 
    additional $1,000 for married couples ($2,000 total increase is not 
    indexed for inflation).

 Married standard deduction increased to 174 percent of the 
    single amount (up from 167 percent).

 Starting point for the 26 percent tax bracket for couples 
    increased to 180 percent of the single bracket starting point (up 
    from 167 percent under prior law).

 IRA annual contribution limit increased to $4,000. Limit on 
    elective deferrals raised to $14,000.

 Alternative minimum tax exemptions reduced by $4,000 for 
    couples and $2,000 for singles.

 Top estate tax rate cut to 47 percent

2006

 Top four income tax rates cut to 35 percent, 33 percent, 28 
    percent and 25 percent.

 Starting point for the 25 percent tax bracket for couples 
    increased to 187 percent of the single bracket starting point.

 Married standard deduction increased to 184 percent of the 
    single amount.

 Limit on elective retirement savings deferrals raised to 
    $15,000 (indexed thereafter).

 Current law's phase-out of the personal exemption and 
    disallowance of a portion of itemized deductions at high income 
    levels are reduced by one-third.

 Top estate tax rate cut to 46 percent. Exemption increased to 
    $2 million (double that for couples).

2007

 Starting point for the 25 percent tax bracket increased for 
    couples, to 193 percent of the single bracket starting point.

 Married standard deduction increased to 187 percent of the 
    single amount.

 IRA tax credits for lower-income workers eliminated.

 Top estate tax rate cut to 45 percent.

2008

 Earned-income tax credit phase-out range increased by an 
    additional $1,000 for married couples ($3,000 total increase is 
    indexed for inflation after 2008).

 Income amounts for the 10-percent tax bracket increased to 
    $14,000 for couples and $7,000 for childless singles ($10,000 for 
    single parents remains unchanged). Indexed for inflation starting 
    the following year.

 Married standard deduction increased to 193 percent of the 
    single amount.

 Starting point for the 25 percent tax bracket for couples 
    increased to double the single bracket starting point.

 IRA annual contribution limit increased to $5,000 (indexed 
    thereafter).

 Current law's phase-out of the personal exemption and 
    disallowance of a portion of itemized deductions at high income 
    levels are reduced by two-thirds.

2009

 Child credit increased to $800.

 Married standard deduction increased to double of the single 
    amount.

 Estate tax exemption increased to $3.5 million (double that 
    for couples).

2010

 Child credit increased to $1,000 (no indexing for inflation).

 Current law's phaseout of the personal exemption and 
    disallowance of a portion of itemized deductions at high income 
    levels are fully repealed.

 Estate tax fully repealed (gift tax retained; limited 
    carryover basis).


------
    Source: Citizens for Tax Justice

    Chairman Conrad. Mr. Wesbury, welcome to you as well. It is 
good to have you back before the committee. We appreciate your 
taking the time to be here.
    Please proceed.

STATEMENT OF BRIAN S. WESBURY, CHIEF ECONOMIST, GRIFFIN, KUBIK, 
                   STEPHENS & THOMPSON, INC.

    Mr. Wesbury. Thank you, Mr. Chairman and members of the 
committee. It is good to be here this morning to discuss the 
budget and the economy.
    I would like to request that my written testimony be 
submitted for the record, and I will summarize that this 
morning.
    Chairman Conrad. Without objection, that will be the case 
for all the witnesses. Written statements will be made a full 
part of the record, and we appreciate your willingness to 
summarize.
    Mr. Wesbury. Thank you very much.
    As we all know and as has been discussed here this morning, 
there have been many dramatic changes in the budget, monetary 
policy and the economy in the past year. We had a 120-month-
long recovery that ended in March of 2001. The Federal Reserve 
cut interest rates 11 times; as far as I can tell, that is a 
record in the last 40 years. And in addition, as we all know, 
the budget has changed dramatically, and we have swung from 
over $300 billion surpluses in 2002 to 2003 to expected 
deficits at this point.
    Together, all of these things are almost impossible to 
analyze because each one of them affects each other. We have an 
intertwined economy.
    But one thing we can say for certain, I think, is that if 
we had not entered recession in 2001, the budget would still be 
in surplus today. According to the CBO, total economic changes 
will subtract $148 billion from the surplus in 2002 and $131 
billion in 2003. Their forecasts of deficits right now are $21 
and $14 billion in those 2 years, and as a result, we would 
have surpluses of over $100 billion in each year, 2002 or 2003, 
if it were not for the recession.
    As a result, I think it is important for us to go back and 
look at what caused the recession. There are four basic 
theories about the cause of the recession today. Some believe 
that our recession is just an inventory correction or possibly 
caused by the attacks of September 11. Others believe that our 
recession is a bursting bubble of irrational exuberance and 
overinvestment, and that it was bound to happen regardless of 
what anyone did.
    One other explanation for our current recession is that the 
tax cut drove up interest rates, which slowed down our economy 
and created a recession out of what would have been a slowing 
economy.
    There is a final reason or thought about what caused the 
recession, and this is the one that I subscribe to--that our 
current recession has been caused by what I would call ``policy 
mistakes.'' That is, in 1999 and 2000, the Federal Reserve 
drove up interest rates to excessively high levels, and at the 
same time, in 2000, taxes reached a record share of GDP--20.8 
percent of GDP. The last time we saw taxes at anywhere near 
that level was in 1944, and the peak then during World War II 
was 20.9 percent of GDP. So we almost hit a record level of 
taxes as a share of GDP in 2000.
    When you combine high real interest rates and high taxes, I 
do not know of an economy in the world that can stand up to 
those kinds of problems. As a result, I think we ended up in a 
recession today.
    Just to quickly go through some of the characteristics of 
the recession, industrial production peaked in the middle of 
2000, well before the tax cut in May of 2001, well before the 
March 2001 starting date of the recession according to the 
National Bureau of Economic Research.
    Consumption, however, has stayed pretty strong, and I think 
there are a few reasons for that. Number one, we have 
countercyclical government spending programs in place. 
Unemployment insurance did go up. People filed for 
unemployment, and their incomes did not go to zero. In 
addition, privately funded or private companies gave very large 
severences early in the recession to the people that they laid 
off, and as a result once again, consumption and incomes did 
not drop to zero once a person was laid off.
    What is interesting about our current recession is that the 
strongest area of the economy in the past year has been 
housing. In fact, while many people may not know it, existing 
home sales hit a record high level, an all-time record high, in 
2001. New home sales were also very high, I think at their 
second-highest total on record in 2001.
    I would like to point out one fact about that that I think 
is often overlooked. In 1997, the tax bill of that year 
virtually eradicated capital gains taxes on home sales. Up to 
$500,000 in a gain per couple in a home that has been lived in 
for 2 years can now be taken tax-free. And interestingly 
enough, those lower taxes have created a boom in the housing 
market, and I think are one of the reasons why the housing 
market has been so strong throughout this recession.
    As a result, one of the things that I think is true about 
the future is that we need to do everything we can to keep tax 
rates and taxes as low as possible. Not only are the areas that 
face low taxes strong, but I believe that high taxes played a 
major part in the creation of our current recession.
    Growth is the key to our future, and this is kind of 
interesting, because when growth occurs, deficits tend to 
disappear and come to surplus. In fact, I think that is the 
story of the late 1990's.
    What is interesting is that now, as we are turning to 
deficits--I would like to focus on this for just a second--it 
used to be that economists would talk about deficits as being 
stimulative to the economy, and in fact, in periods of war or 
in periods of recession, it was highly suggested and 
recommended by most economists to run deficits to stimulate the 
economy, the thought being that that investment would pay huge 
dividends down the road, either bringing the economy out of 
recession or protecting the United States.
    Lately, however, in the last 10 to 15 years, this 
correlation between deficits and interest rates has become the 
model that most economists follow. While we have heard a number 
of times this morning that deficits play a big role in interest 
rates, I would like to suggest this morning that I do not 
believe that that is true at all. I am a professional in the 
bond business, and I have been an economist in the private 
sector for 20 years, I have followed the bond market and its 
relationship to deficits, and I find absolutely no relationship 
between the two.
    Let me give you some numbers. In January 1981, when Ronald 
Reagan took office, mortgage rates in our economy were at 14.9 
percent. In January 1993, when President George Bush 41 left 
office, mortgage rates were at 8 percent. We basically had a 7 
percentage point decline in mortgage rates in those 12 years, 
and deficits existed in each and every one of those years.
    When President Clinton left office in January of 2001, 
mortgage rates were at 7 percent. They had declined only 1 
percentage points in the 8 years of his term in office, despite 
the budget moving from deficit to surplus.
    Some people will say--and Alan Greenspan is very careful to 
say this--that real interest rate are the key. I would just 
like to give you two specific points on this. Between 1981 and 
1983, when the budget deficit averaged 3.1 percent of GDP, real 
30-year mortgage rates were at 8 percent. By 1993, when the 
budget deficit was 3.9 percent--in fact, it was higher as a 
share of GDP than it was in the 1981 to 1983 period--real 
interest rates had fallen from 5.6 down to 4 percent.
    I have a chart in my testimony that shows real interest 
rates, and they basically remain unchanged, with some small 
movements up and down, over the past 10 years, despite the 
budget going from deficit to surplus. I find absolutely no 
theoretical evidence to support the contention that deficits 
raise interest rates over time.
    Let me move forward and close very quickly and suggest to 
you that I believe our economy is on the verge of recovery. The 
interest rate cuts of this past year, the tax cuts of May 2001, 
are benefiting the economy as we move forward. My belief is 
that if we were to repeal those tax cuts, we would harm the 
economy and slow the recovery dramatically. The way to keep the 
deficit away and surpluses intact in the future is to keep 
growth up, and I believe that the way to do that is to cut 
taxes and allow the private sector to do its job.
    Thank you.
    [The prepared statement of Mr. Wesbury follows:]

 The Prepared Statement of Brian S. Wesbury, Chief Economist, Griffin, 
                  Kubik, Stephens & Thompson, Inc.\1\ 
---------------------------------------------------------------------------

    \1\ Brian S. Wesbury is the Chief Economist of Griffin, Kubik, 
Stephens & Thompson, Inc. a Chicago-based investment banking firm. Mr. 
Wesbury previously served as Chief Economist for the Joint Economic 
Committee of Congress in 1995 and 1996.
---------------------------------------------------------------------------
    Mr. Chairman, Senator Domenici, and members of the committee, I am 
pleased to be here today to discuss issues surrounding the economy and 
the Federal budget. I would like to emphasize that I speak for myself 
and not my employer, Griffin, Kubik, Stephens & Thompson, Inc.
    The past year has witnessed some dramatic changes in the economy, 
the budget and monetary policy. After expanding for 120-consecutive 
months, the longest period of sustained growth in U.S. history, the 
economy entered recession in March 2001. In reaction to the slowdown, 
the Federal Reserve cut interest rates eleven times in 2001, the 
sharpest drop in rates in over 40 years.
    In addition, both short-term and long-term estimates of the budget 
surplus underwent significant revisions. In May 2001, the Congressional 
Budget Office estimated that the surplus for 2001 would equal $275 
billion. Just 4 months later, the figures show that the actual surplus 
was $127 billion. At the same time, expected surpluses of over $300 
billion in 2002 and 2003 have given way to certain deficits. The 
recession, higher spending, and tax cuts reduced the 10-year estimate 
of the budget surplus from $5.6 trillion to $1.6 trillion.
    Analyzing these developments individually is impossible. The 
economy, the Federal Reserve and the budget are inseparably 
intertwined. The economy affects monetary and fiscal policy, while 
monetary and fiscal policy exert a large influence on the economy.
    For example, according to CBO analysis, the recession will reduce 
revenues and increase expenditures by a total of $148 billion in 2002 
and $131 billion in 2003. At the same time, the CBO estimates that 
deficits will equal $21 billion in 2002 and just $14 billion in 2003. 
Clearly, the economy would have experienced surpluses in both years if 
the recession had not occurred.

                  the causes of the current recession

    As a result, it is important to understand how the recession began. 
In this regard, there are at least four different explanations of the 
current downturn. Some suggest that it is a simple inventory correction 
made worse by the attacks of September 11. Others suggest that our 
current recession is the result of a bursting bubble of irrational 
exuberance and over-investment.
    Still others suggest that the tax cut of early last year, because 
it lowered the surplus and drove up interest rates, either caused the 
recession or made it worse. Finally, there are some who think that the 
recession was caused by policy mistakes. I include myself in this final 
group. High taxes and excessively tight monetary policy in 2000 are the 
real culprits behind our current economic downturn. In fact, it was the 
impact of these policies that led to my forecast in January 2001 that 
the United States would experience its first recession in 10 years.
    In 2000, the Federal Reserve increased real interest rates to their 
highest level since 1989/1990. High real interest rates were the 
visible evidence of an excessively tight monetary policy that created 
deflationary pressures. These deflationary pressures, evident in so 
many industries, undermined corporate profits and investment. At the 
same time tight money was creating havoc, Federal revenues rose to 20.8 
percent of GDP in 2000, a peacetime record.
    History shows that the combination of tight monetary policy and 
burdensome taxes eventually creates a recession. This was true in 1990/
91, in the early 1980's and also in Japan during the 1990's. High taxes 
reduce the capital available for investment, undermine incentives for 
research and development, and reduce output, while tight money robs the 
system of liquidity.

                    characteristics of the recession

    Industrial production peaked in June 2000 almost a year before the 
recession officially began and well before the tax cut passed in May 
2001. Employment peaked in March 2001 also well before the tax cut. 
Consumption slowed sharply in late 2000 and early 2001, but did not dip 
into negative territory until late 2001. Interestingly, housing 
activity remains very strong and existing homes sold at a record level 
in 2001.
    The areas of weakness and strength in the economy during the past 
year are somewhat instructive. Consumption did not fall as much as 
rising unemployment suggested it should because counter-cyclical 
policies worked. Unemployment insurance kept incomes from falling to 
zero and tax rebates added to near-term purchasing power. In addition, 
large, privately funded severance packages for many of those laid-off 
early in the recession kept incomes from falling.
    Strength in housing is a different story. Housing is one of the 
only tax-free investment vehicles available to Americans today. Due to 
changes made in the tax code in 1997, up to $500,000 in gains on the 
sale of a home, for a couple who has lived in that home for 2 years or 
more, are tax free. Mortgage interest is deductible from taxes as well. 
Beginning in May 1997, new and existing home sales shot upward and have 
literally defied demographic trends. Judging from this evidence it can 
be said that tax cuts do increase economic activity.
    To summarize, the recession was not caused by tax cuts, a bursting 
bubble, a drop in consumer confidence due to terrorist attacks, or an 
inventory correction. It was caused by policy mistakes, specifically, 
high taxes and an excessively tight monetary policy. In turn, the 
recession created our budget deficits.

                     focus on growth, not deficits

    Growth is the key to all budgetary and economic problems. And, in 
my opinion, historical evidence shows that countries with lower taxes 
and less spending grow faster than countries with high taxes and large 
governments. I believe the goal of fiscal policy should be to maximize 
the potential of the private sector to create jobs and wealth. And even 
if the ultimate goal is to eliminate Federal deficits and debt, the 
best way to achieve that goal is by encouraging growth.
    Historically, in periods of recession or war, economists have 
suggested that deficits are appropriate. In laymen's terms, running a 
deficit (or borrowing money) is an investment in the future of the 
economy. If that investment keeps our Nation safe from foreign attack 
or ends a recession, then the returns from that investment should 
outweigh the costs. However, in recent decades many economists have 
suggested that deficits have a detrimental effect on the economy 
because they push up interest rates.
    Despite the near universal acceptance of this theory, I find no 
evidence to support it. During the past 20 years, the Federal budget 
has moved from record deficits to record surpluses, but interest rates 
have not moved in the direction suggested by the deficit theory. For 
example, in January 1981, when Ronald Reagan became President, 30-year 
mortgage rates were 14.9 percent. Twelve years later, when George Bush 
left office and Bill Clinton became President, the 30-year mortgage 
rate was 8.0 percent. The economy experienced deficits in each of those 
12 years, yet mortgage rates fell by a total of 7 percentage points.
    When Bill Clinton left office in January 2001, the 30-year mortgage 
rate was 7.0 percent a decline of just 1 percentage point during his 8-
year tenure. This small drop pales in comparison to the declines of the 
1980's, despite record budget surpluses. The evidence suggests that 
there is no relationship between budget deficits and interest rates 
over long periods of time. (See Chart 1).
    The same is true if we analyze real (or inflation adjusted) 
interest rates. Between 1981 and 1983, budget deficits average 3.1 
percent of GDP and the real 30-year mortgage rate averaged 8.0 percent. 
In 1993, the deficit was 3.9 percent of GDP and the real 30-year 
mortgage rate was 4.0 percent. In 2000, when the surplus reached a 
record 2.4 percent of GDP, real 30-year mortgage rates were 5.6 
percent. And, in 2001, as the budget moved toward deficit, real 
mortgage rates fell back to 4.0 percent. (See Chart 2).
[GRAPHIC] [TIFF OMITTED] 80544.034

                            tax cuts are key

    Economic growth rates also show little correlation to movements in 
the deficit. The U.S. economy rebounded strongly from the early 1980's 
recessions even though deficits were high, and real GDP grew at a 4.4 
percent annual rate between 1982 and 1987. Between 1995 and 2000, 
despite moving from deficits to surpluses, real GDP grew at a slower 
4.1 percent rate. In addition, the economy fell into recession in early 
2001 despite a budget surplus.
    The driving force behind growth in both the 1980's and 1990's was 
the same high-tech investment and productivity. And, in my opinion, the 
shift in government policy that began during the late 1970's and 
accelerated in the early 1980's was the catalyst behind our long boom. 
Reduced marginal income tax rates, lower capital gains tax rates, and 
falling government spending as a share of GDP created a better 
environment for entrepreneurial success. As a result, the United States 
became the focal point of the information revolution and we have 
experienced two of the longest recoveries on our history during the 
past 20 years.
    In fact, it has been over 100 years since the United States 
experienced productivity growth as strong as we have seen in recent 
years. And according to my calculations, productivity growth reached 
higher levels in the late 1990's than it did in the Industrial 
Revolution. More importantly, the world is just beginning this 
revolution in technology. It has a long way to run.
    Anything the government can do to help increase incentives for 
creativity, innovation and investment will pay huge dividends down the 
road. In that regard, it is my advice that tax rates be kept as low as 
possible, spending increases should remain minimal and any concerns 
over the deficit should wait until after the United States exits this 
recession and has a chance to grow again.
    The Bush tax cuts of 2001 were perfectly timed to help the economy 
in the years ahead. However, because they were phased in over a decade-
long period they have only been a small help to the economy in the past 
year. It is my strong belief that the economy would already be in 
recovery if the Bush tax cuts had been fully effective in 2001.
    But that is water under the bridge, and we must look forward. 
Repealing the tax cut would be a huge mistake and could undermine the 
recovery already taking hold. I expect this recovery to start out 
slower than past recoveries, but build steam as 2002 unfolds. In 2003, 
the economy should once again grow at a 4.0 percent rate or higher. 
Unemployment will fall, tax revenues will pick up, counter-cyclical 
government spending will subside and the budget picture will brighten.
    In other words, despite the mistakes made in the past year, the 
economy remains on sound footing. As taxes head lower, foreign 
investment will continue to flow toward the United States, technology 
will continue to advance and living standards will rise.
    We are living through an exceptional period in history, and we 
should attempt, as best we can, to have faith in the American system of 
free markets. The entrepreneurial spirit remains strong and as history 
shows, the less the government interferes, the better. In fact, doing 
everything possible to reduce burdens on the private sector increases 
growth, and in turn, boosts the resources of government. What creates 
growth in the private sector is ultimately good for the public sector.

    Chairman Conrad. Thank you all for excellent testimony. It 
is good to see the witnesses in such close agreement. 
[Laughter.]
    It was really excellent testimony from all three of you. 
What makes our system great is that we have the ability to 
debate these differences, and we can debate them freely and 
even vigorously. That is the health of our country, and we are 
lucky for it; we are lucky to have people like you who are 
willing to come before the committee and give your strong 
views. That is helpful to us, and we appreciate it very much.
    Dr. Reischauer, I would like to start with you, and I am 
going to be very brief in my questioning because I know that 
Senator Clinton has an obligation to chair at 11 o'clock, and 
Senator Corzine is next, and he has been in the bond business, 
and he has a different view, and I am sure we will get to that.
    Dr. Reischauer, you are saying to us, number 1, that we 
ought to set a goal and try to achieve consensus on what that 
goal should be. You are talking about something like respecting 
the Social Security Trust Fund as a possible goal and one that 
you say would have some political strength to it, and I believe 
that. I think that is an appropriate goal.
    You suggest that in the near term, to create more fiscal 
flexibility, we ought to consider deferring parts of the tax 
cut that have not yet occurred, but on the other hand, make 
permanent those parts that already have occurred and actually 
index them.
    Is that a correct interpretation of what you said?
    Mr. Reischauer. That is correct.
    Chairman Conrad. And Mr. Wesbury says no, you should not be 
doing that because that will harm the economy, as I hear Mr. 
Wesbury's testimony.
    What would your answer be to his assertion?
    Mr. Reischauer. That prospective reductions in taxes that 
may not be affordable really offer no strength to the current 
economy right now. There is a tremendous amount of uncertainty 
out there, and that uncertainty as to just what we do about the 
provisions of this tax bill is going to grow over the next few 
years, as to just what we will do about the provisions of this 
tax bill, because the tax bill disappears in effect at the end 
of 2010. The costs of continuing it rise through time, and at 
the same time, as Peter told you, the available resources just 
do not seem to be there. I think that with each year that goes 
by, it will become more apparent that if the tax cut is 
extended in all of its full flower, we will be in effect using 
the Social Security surplus to pay for tax relief, and that 
will be a very difficult decision for future Congresses to 
make.
    Chairman Conrad. So what if we are? If the evidence 
emerges, and it becomes even more clear that we are taking, in 
effect, Social Security Trust Fund dollars to pay for the tax 
cut, so what?
    Mr. Reischauer. Well, we are making a decision then that we 
would rather have lower tax rates now and higher tax burdens on 
our children and grandchildren, and a more contentious process 
of trying to accommodate the retirement of the baby boom 
generation one decade and two decades from now--the choices 
that you make all the time between the present and the future. 
It would seem to me that the appropriate one--although this is 
a value judgment--is to say that we want to help our children 
and grandchildren bear the burden which our decisions are 
imposing on them.
    Chairman Conrad. Is there a fairness question of taking 
people's payroll tax dollars, which are imposed on what most 
economists would say is a regressive basis, and using those 
dollars to give an income tax cut that goes disproportionately 
to the wealthiest among us? Do you think there is any problem 
with that?
    Mr. Reischauer. This is a complicated issue. I think that 
there really is not an issue unless you think that we will not 
respect the trust fund balances that are building up in Social 
Security.
    In other words, I think that as long as there are balances 
that are large, it will be very hard to cut benefits or raise 
payroll taxes, and what this is doing is substituting, really, 
for other borrowing.
    Chairman Conrad. Dr. Orszag, you have said here that there 
is a connection, as I heard your testimony and as I read your 
testimony, between interest rates, and deficits, and the debt 
of the Federal Government. Is that correct?
    Mr. Orszag. That is correct, and I will note again that it 
is not just me, but the Reagan administration, the first Bush 
administration, and a whole host of others.
    Chairman Conrad. So where do you think Mr. Wesbury goes 
wrong in his analysis? He has given a very compelling case here 
this morning. He has looked at past points where we had high 
deficits, high as a percentage of GDP, and yet interest rates 
were coming down, so he looks at the data--I assume the same 
data--and reaches a different conclusion.
    Can you help us understand?
    Mr. Orszag. Sure. I think the difficulty here is that as I 
mentioned in my testimony, interest rates are affected by a 
wide variety of factors including expected growth, savings 
trends, capital flows, and expected inflation. All of those 
things are moving at the same time.
    If you just look at one point in time and another point in 
time and say, oh, look, the deficit moved and interest rates 
did not move in the expected way, you have to make sure that 
you have controlled for all those other factors or else you are 
not isolating the impact of the budget itself on interest 
rates.
    After you control for all those other factors, which is 
admittedly a very difficult thing to do, market observers as 
well as the economists who pyt together macroeconomc models 
peceive a relationship between budget deficits and interest 
rates. The key is to isolate all the other factors, all the 
other things that are changingm and just lok at the shift in 
the budget deficit itself. Examining just two points in time, 
without adjusting for the other factors that are moving, is not 
valid because other factors are changing at the same time.
    When you do that--and that is a very difficult thing to 
do--but again in the judgment of many market observers and also 
the people who put together the macroeconomic models that you 
use here to base your budgets on, there is a connection there, 
so that once you isolate all the other effects, all the other 
things that are changing, and just look at the impact of the 
shift in the budget itself, there is a connection between that 
and interest rates and you get messed up when you just look at 
two points in time, because everything is changing at the same 
time.
    Chairman Conrad. OK.
    Mr. Wesbury, you are not saying that deficits do not 
matter, and you are not saying--well, let me not put words in 
your mouth. I assume that you are not saying that deficits do 
not matter, but is that the case? Do you believe that budget 
deficits matter, and if so, how, and if not, why not?
    Mr. Wesbury. Let me put it this way. I think deficits 
matter a whole lot less than much of my economic brethren 
believe. For example, if we just look at Japan very quickly, 
they have a debt of over 130 percent of GDP, they are running 
deficits of 6 and 7 percent of GDP every year, and yet their 
long-term interest rates are 1.5 percent, their short-term 
interest rates are zero, and their economy is in recession.
    Bottom line, when you look at that fact, deficits do not 
stimulate the economy, because they have not held Japan, and 
they do not hold up interest rates, because they are the lowest 
in the world.
    So at least when I look around the world, I see no 
correlation between deficits and the level of interest rates in 
different countries or deficits and differing growth rates in 
different countries.
    Chairman Conrad. Do deficits matter for any other reason?
    Mr. Wesbury. In fact, I think that what we should focus on 
over time is how to get the most growth in our economy. I think 
Milton Friedman used to put it this way. If we had a $10 
trillion economy, and the government spent $8 trillion, 80 
percent of that economy--so it would be equivalent, I suppose, 
tot he Soviet Union--and yet we took in taxes of $8 trillion at 
the same time, we would have a balanced budget, but we would 
probably have the same problems in our economy that the Soviet 
Union did--no growth, declining standards of living, falling 
productivity. Yet if we had a government in that same $10 
trillion economy who spent only $200 billion but to zero in 
taxes, we would be running a $200 billion deficit. I think you 
would agree with my analysis here, which really comes from 
Milton Friedman, that that would be an entirely different 
economy and I would argue a much stronger economy over time.
    So the point is that just by looking at the deficit, we are 
forgetting if we just focus on that one number what created 
that deficit or the surplus or the balanced budget to begin 
with. And as a result, my belief is that what we need to focus 
on is the level of spending and where that spending is taking 
place, and we need to focus on the tax rates and the level of 
taxation in the economy and how they are affecting our output, 
incentives, willingness to be creative, and how they affect our 
entrepreneurial base. That is what I think is important.
    Chairman Conrad. OK. Dr. Orszag, what would your response 
be?
    Mr. Orszag. Well, I actually think the Japanese example 
illustrates the basic problem here. Japan, in addition to 
running fiscal deficits, has a very high private savings rate. 
You have different projected demographics in Japan. There are a 
lot of things that vary between the United States and Japan. 
Just to look at one indicator and attribute all the interest 
rate differentials to that one indicator I think illustrates my 
point, which is that such analysis is unlikely to be valid.
    I would also agree that economic growth is essential to 
addressing many of the problems that the Nation faces. The key 
question is how are you going to get that economic growth. One 
thing you need to remember in evaluating these tax cuts, even 
in the long run, is that it is not clear that their net impact 
is positive. Again I will refer you to the Congressional Budget 
Office. You do have positive effects from lower marginal tax 
rates encouraging people to work, but the tax legislation only 
reduces marginal tax rates for about a quarter of the 
population. For 76 percent of tax filing units, this tax 
legislation does not affect marginal tax rates.
    Furthermore, you have the reduction in national saving, and 
that reduction in national saving adversely affects the economy 
by, again, driving up interest rates and harming investment. So 
it is the interplay between those two effects that determines 
the long run effects from the tax cut. It is not at all clear 
that the impact is positive. I concluded earlier last year that 
the impact may well be negative. The CBO suggests that it is 
not clear; it may well be negative. A new paper that my 
colleague Bill Gale from Brookings is putting out suggest that, 
if anything, the effect is negative.
    So I agree that the key question is economic growth, but it 
is not clear that cutting taxes is the right way to get there.
    Chairman Conrad. Dr. Reischauer, what would your response 
be to Mr. Wesbury's analysis? Do you agree that economic growth 
is the key that we are shooting for?
    Mr. Reischauer. Certainly it is; there is no question. But 
my response would be let us look at the decade of the 1990's. 
We had a period of very strong growth, a period in which tax 
burdens were increased in an effort to bring down deficits, and 
a period in which, surprisingly, the fraction of GDP devoted to 
Federal expenditures fell.
    So I say bring back the 1990's; do not try to recreate, 
literally, the 1980's.
    Chairman Conrad. All right. I am going to go to Senator 
Corzine now--Senator Clinton, do you preside at 11?
    Senator Clinton. I do. I am going to have to leave.
    Senator Corzine. Why don't you go ahead?
    Chairman Conrad. Why don't we recognize you, then, at this 
time for questions that you might have?
    Senator Clinton. Thank you, Mr. Chairman, and I thank our 
witnesses and appreciate the interchange that we have had. I 
think that is something that we should do more of, to have our 
witnesses respond to one another, because I think it helps to 
clarify a lot of these issues.
    I would have to say that there is a very big difference of 
opinions not only among the witnesses, or between two and Mr. 
Wesbury, but also on this committee and I think in our Congress 
and throughout the country as to what is the best way to 
stimulate economic growth. That is what we are interested in. 
What we want is a growing economy that enables even more people 
to work, creates the conditions for rising incomes. In looking 
at some of the statistics about Federal revenues being a high 
percentage of GDP, I think that, again, as Dr. Orszag reminds 
us, we cannot take any statistic out of context, because 
certainly median family income rose by over $6,000 over 
adjusting for inflation between 1993 and 2000. There were 
significant bonuses, not only in the financial services sector, 
but in many sectors of the economy, that pushed people's income 
tax burden higher.
    Indeed, though, Federal income taxes as a percentage of 
income for the typical American family dropped to their lowest 
level in 35 years. Now, this is not an argument for keeping tax 
rates higher than they need to be. I, among many of my 
colleagues, argued for a balanced tax reduction last spring. 
What I think we are concerned about is the impact of this large 
tax cut and the way that it was configured.
    So I guess my question, to go back to what is for me the 
most important issue, is what is it that we are trying to 
achieve. We are trying to achieve economic growth, and I think 
we should be trying to achieve some ability to deal with 
problems that we know are on the horizon. And the best way to 
do that is through growth and fiscal responsibility to be 
prepared.
    So I will just ask each of the witnesses, perhaps beginning 
with Mr. Wesbury, because I know that your view is different, 
as you look forward--and I do have to leave soon--as you look 
forward, Mr. Wesbury, and you see the demographic 
inevitability--I do not think there is any debate about that; 
we are going to have increasing calls on Social Security, 
Medicare, and other services that an aging population 
requires--how would you best prepare our country to deal with 
those problems?
    Mr. Wesbury. Thank you, Senator Clinton.
    First of all, let me suggest to you that I agree 100 
percent with you about the strength of the 1990's. It was a 
fabulous period in U.S. economic history. In fact, it was the 
longest economic recovery in our history.
    What is interesting, though, is that the period between 
1982 and 1990 was the third-longest economic recovery in our 
history. And when we go back and look at that period from 1982 
to 2001, we were in recession during that period only 3 percent 
of the time. No other 20-year period in our history have we 
ever experienced uninterrupted growth like we experienced in 
this 20-year period.
    What I would suggest is that we look at what caused that, 
and in my opinion what clearly caused that was an increase in 
technology, and the boom in productivity that slowly gained 
steam over the 1980's and into the 1990's.
    I am one of the economists who was out there in the past 5 
or 6 years talking about a so-called new era. I realize fully 
that we still operate under the old economic principles--they 
are still the same--but what we had done was pushed ourselves 
back to that kind of growth that we experienced in the 
Industrial Revolution or in the 1950's or early 1960's.
    This does not mean that we cannot have recessions. My 
belief is that the tax increases of 1993--they increased the 
number of brackets for taxpayers--and because we had such 
strong productivity growth, it boosted real incomes, as you 
pointed out very correctly, and those higher real incomes 
pushed people into higher and higher tax brackets. There was a 
tax increase on people throughout the 1990's, and by the time 
we reached 2000, those burdens reached such a high level that 
it was finally able to, I believe, topple the economy.
    And if I may point out, the bipartisan nature of the tax 
cut that was passed in May of 2001 at least suggests to me as 
someone who lives in Chicago that in Washington, people 
realized that people around the country wanted a tax cut, and 
that is why we got it, because taxes were too high.
    As a result, I think we are now on the way to recovery. My 
belief is that the best way to guarantee the safety of Social 
Security, the safety of Medicare, the safety of all the 
government programs that we have, is to work as hard as we 
possibly can and have faith in the American entrepreneur. And 
the way to do that is to increase incentives, and the way you 
increase incentives is to keep tax rates low and allow the 
entrepreneur to benefit from his or her efforts.
    We live in one of the greatest times in world history, in 
my opinion. Technology is growing faster than ever before, and 
that technology is coming from the private sector, and I want 
to see us support that and allow it to grow. It will make all 
of our problems, budgetary or otherwise, much less significant 
in future years if we do that.
    Mr. Orszag. I have a somewhat different view. I think the 
key objective in preparing for the longer-term challenges that 
we face is higher national saving. Basically, higher national 
saving will leave future workers with more productive 
equipment, higher levels of productivity, and an easier burden 
in meeting our future challenges.
    In my opinion, the best way to boost national saving is for 
the Federal Government to have a serious program of fiscal 
discipline. We have tried lots of other ways to get the private 
sector to save; they do not work very well. The most auspicious 
way of boosting national saving is through fiscal discipline.
    And I note that in the current environment, changing some 
of those longer-term fiscal discipline policies would have a 
short-term benefit. Just like we saw in 1993, when you have 
backloaded fiscal discipline, you can get short-term benefits 
from that in addition to the long-term benefits.
    So interestingly, normally, there is a tradeoff; right now, 
I do not think there is one.
    Senator Clinton. Dr. Reischauer, I am going to have to 
leave, but I know you can be succinct; I have seen it so many 
times.
    Mr. Reischauer. And you know I am going to agree with you, 
too.
    Senator Clinton. And I hate to miss that.
    Mr. Reischauer. Yes. What Peter said is a necessary but not 
sufficient answer to the question. We do need an increase in 
national saving, but we also need structural reform of Medicare 
and Social Security, and the two can go together.
    I just want to make a comment on Mr. Wesbury's view of the 
1990's. I am going to have to go back to my VCR and rewind the 
tape to see what it was really like. This notion that tax 
burdens rose to oppressive levels and in 2001 were crushing the 
American people is not supported by the data released by 
Treasury or CBO, which show, as you pointed out, that for the 
median family an 150 percent of the median family, tax burdens 
in fact were lower.
    It is true that revenues as a percentage of GDP were close 
to an all-time high, but there are some very peculiar reasons 
for that. One of the reasons is that when you have good times, 
and you have a progressive tax system, that is always true. But 
there is really more to it than that. This was a period of 
extraordinary increases in realized capital gains upon which 
taxes were paid. Realized capital gains do not appear as a 
component of GDP, so the revenues generated by them are in the 
numerator, but they are not in the denominator, and if one 
takes this out, the picture changes somewhat.
    It was also a period of extraordinary corporate profits, 
and we have a system in which, when corporate profits are 
extraordinarily high, believe it or not, some corporations even 
pay taxes, and that affects these numbers.
    So this notion that the boom came to an end because of 
oppressive tax burdens, I think is nonsense.
    Chairman Conrad. Let me turn now to Senator Corzine, and I 
want to thank him for his courtesy to Senator Clinton.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Mr. Wesbury, I will join you in saying that I traded bonds 
for far too long, and it is reflected in my hairline and my 
blood pressure, and for some reason, I got the idea as an old 
bond trader that when the Treasury announced what its financing 
needs were, it had something to do with what might be certainly 
the immediate if not long-term direction. And while I accept 
completely the idea that, other things being equal--and there 
are a lot of those things going on at the same time--maybe the 
most important is expectations, what people think is going to 
happen in the future, like are we going to have sustained 
periods of budget deficits, do we have this demographic bubble, 
what is going on with regard to productivity and the size of 
the economy.
    I do think there are plenty of times in history where you 
could make the case that you tried to make with 1983, 1993, and 
2000. When I was a fledgling bond trader in 1976, I think our 
budget deficits were something like $10 or $15 billion, and 
rates went from someplace like 6 percent on a nominal basis and 
about 3 percent real up to that 14 percent. It was quite a 
ride, and if I think there have been economic studies of that, 
a lot of that will be attributed first to inflationary 
expectations at that point in time and second, I think, to 
growing deficits that were unheard of in the minds of people as 
they tried to manage those.
    But that is an issue that I think needs to be sorted out. 
There are plenty of examples outside of Japan, and I agree with 
Dr. Orszag's analysis; I think that real rates are actually 
very high. They have deflation, if I am not mistaken, going on. 
But there are plenty of examples where other countries are 
running large percentages of GDP, where there are high 
correlations. But I think it is one of those things where the 
economists need to look at the correlations and over a period 
of time, other things being equal.
    I think that more interesting for today is this percentage 
of GDP tax issue that has come up before. There is certainly 
the issue of bracket creep, but capital gains is a substantial 
reason why we have seen the percentage. I would hope that one 
of you maybe had at the tip of your tongue how much capital 
gains were as a percentage of the growth in the percentages of 
the receipts of the Federal Government that are driving that 
percentage.
    Mr. Orszag. I believe Chairman Greenspan actually gave to 
you a number of roughly a third of the increase between 1995 
and 2000 being related to capital gains, either directly 
through capital gains taxes or indirectly through stock options 
and other indirect effects, so a substantial percentage. And in 
1995, those taxes were only 15 percent of the individual income 
tax take, so to get a third of the growth out of it shows how 
paramount that factor was.
    Senator Corzine. I think this is an important issue to 
learn how to frame in discussion with the American people, 
because I think we are seeing this percentage of GDP as the 
justification for tax rate cuts, which I really do not think 
that that is what it is addressing. One could argue about 
whether capital gains is an effective stimulator to growth or a 
depressant, but I think that we need to focus on the reality of 
what makes up that percentage of GDP.
    It certainly felt to me as a participant in the private 
economy in the 1990's that we had incentives that encouraged 
people to work and to invest and move forward, and I think it 
was reflected in the productivity growth that we saw as well as 
the growth in the size of the economy and therefore the growth 
in revenues which reduced the deficits.
    Let me ask a question that Chairman Conrad focused on, and 
that is payroll taxes, their regressivity and their linkage, 
since all money is fungible, to funding other things that we do 
in our budget.
    I think one of the real serious questions I have is how we 
can take the most regressive aspect of our tax structure and 
use it to fund deficits. When Mr. Wesbury talked about that we 
would have been in surplus save the recession in 2002 and 2003, 
I think we would have been in unified budget surplus, but I do 
not think we would have been, either with respect to Medicare 
or with regard to Social Security Trust Fund moneys. I think we 
would have been using it.
    What kind of implications for growth in our economy and for 
incentives to a large part of the population comes from having 
a highly regressive flat tax, if you will, imposed on 
individuals to transfer those moneys into higher income tax 
brackets do we think we are accomplishing, and isn't it 
actually a depressant for a large percentage of the overall 
population?
    I would ask any and all of you to respond.
    Mr. Wesbury. Shall we go that way?
    Mr. Orszag. We will start in the middle and go to the end.
    Just a couple of things. You are absolutely right--for 
something like two-thirds of American families, payroll taxes 
are larger than income taxes. In terms of their effect, though, 
I would try to separate a couple things. One is the real cost 
of running on-budget deficits or spending the Social Security 
surplus is that we are not saving the money. We are not 
boosting national saving in a way that we could. The 
distributional implications of that, as Dr. Reischauer noted, 
really depend on what gets cut ultimately or what else changes 
to make the whole system balanced. But the immediate effect, 
the visible manifestation of the cost of running on-budget 
deficits, is that we are not raising national saving as much as 
we could if we preserved the Social Security surplus.
    In terms of the incentives from the payroll tax, I agree 
that if you really worry about marginal tax rates, again, for 
the majority of families, the payroll tax can represent a 
higher marginal tax increment than the income tax.
    I would note that the analysis gets a little bit 
complicated because effectively, in exchange for paying those 
payroll taxes, you do get a future benefit in terms of Social 
Security benefits--and the question then becomes whether 
workers net out the future benefit that they get from paying 
the payroll tax, which would attenuate the incentive effects. I 
think most workers do not do that, but if you are in the hyper-
rational`` econ man'' world, people should be doing that, and 
that reduces the adverse incentive effect somewhat.
    Senator Corzine. I just find it confusing when we talk 
about incenting people to work that we have a regressive flat 
tax that does not change and applies to the vast majority of 
people and in fact is being used for other purposes to fund 
other things in the economy and in our government expenditures, 
some worthy, some maybe not so directly attendant to the needs 
of the people who are paying it, and we make the case over and 
over that marginal rate shifts are what is driving the economy, 
and I am not sure that I agree with that in the context of how 
well I think the economy did in the 1990's, but I think there 
is a disconnect between 75 percent or so of the population not 
really realizing significant marginal rate cuts and using that 
as a basis for incentives.
    I obviously want to hear Mr. Wesbury's comments.
    Mr. Wesbury. Well, at least being a proponent of the theory 
that marginal tax rates do create either incentives of 
disincentives in the system, a flat tax has no negative 
incentives for earning more income. So in essence and in fact, 
the Social Security tax goes away after a certain point of 
income, and as a result, it is not a disincentive to produce.
    I would also argue that taking any of our single, 
individual tax components out of the whole picture confuses the 
picture. In other words, we do not have a regressive income tax 
system, we have a progressive income tax system. It starts out 
with Social Security and no income taxes and builds until we 
now have a top rate of 38.6 percent.
    At given points on the tax curve, there are bumps where you 
can actually go from one place to another on taxes--because of 
the earned income tax credit, you can actually have a higher 
marginal tax rate to get from one income to the next highest 
income--but overall, I just disagree that we have a regressive 
tax system at all. It is progressive--and you have to put all 
of it together; you cannot just look at one.
    Just to go back quickly----
    Senator Corzine. That is in a macro sense, not as it 
relates to any one individual, isn't it?
    Mr. Wesbury. Right, exactly. You are absolutely right. And 
I am analyzing things from a macro sense.
    Senator Corzine. Since there are more people who fit into 
one box than fit into the macro box with regard to how it 
impacts them at a human level, one might wonder how it 
stimulates the kind of behavior you are talking about on an 
aggregate basis of the population.
    Mr. Wesbury. I guess what I am saying that if we took the 
payroll tax alone and that were the only tax system that we 
had, it would be a flat tax, and I think there would be no 
disincentives to work just from that flat tax, because you are 
not taxed at higher levels as you move to higher incomes. In 
fact, eventually, you are taxed at lower levels, so your 
incentive is to get to as high an income level as you can as 
quickly as you can, so it actually has positive incentives on 
work.
    Let me address this bond and deficit question and defer to 
your longer experience than mine in the bond trading world. I 
would argue that you are 100 percent correct when you say that 
if the traders sitting on the desk hear that the Treasury is 
going to issue $15 billion in 10-year Treasury notes next 
Tuesday afternoon instead of the $10 billion that the market 
was expecting at the moment of that announcement, interest 
rates will go up. In the short term, there are impacts on the 
economy from surprise announcements about the amount of 
issuance or the size of issuance coming out of the Treasury, no 
doubt about it.
    What I would argue is that over the long term--and I am 
talking about years--you can find no significant relationship 
between the level of the deficit or the surplus and interest 
rates.
    You brought up Japan, and let me quickly do the analysis. 
You are also correct in pointing out that they have deflation. 
Their 10-year bond yield in Japan is 1.5 percent. They have 
roughly 2 percentage points of deflation going on right now 
every year, which means the real interest rate is 3.5 percent.
    In the United States, our 10-year Treasury yield is about 5 
percent--I think it is 5.12 today. Our inflation rate is about 
1.5 percent. Now, this is taking PPI, CPI, all the different 
measures of inflation, averaging them out, and I get about 1.5 
percent. That means that our real interest rate is also exactly 
equal to Japan's at 3.5 percent.
    Now, this is strange to me. If the deficit theory held, 
excluding deflation--I want to add one other thing, and that is 
that Japan is in deep trouble today. We are seeing banks 
downgraded by Moody's and other analysts in the economy. In 
fact, you should see real interest rates rising in Japan as the 
risk of investing in Japan rises. And what we are seeing today 
is that despite their huge deficits and the risks of investing 
in Japan, their real rates are at exactly the same level as 
ours despite their massive debt as a share of GDP--130 percent 
versus our 34 percent.
    So again, while I believe you are 100 percent correct about 
the shorter-term moves in interest rates, in the long term and 
between various countries, I find no relationship between debt 
and interest rates at all.
    Senator Corzine. Well, there are interest rate parity 
theorems that allow for exchange rate depreciation and 
appreciation to match all those kinds of things. I think that 
most economists would argue that in the long run, real interest 
rates would match up in some form as you go through the 
adjustment process.
    I actually think that the case that those of us who think 
long-term rates are higher than we would have thought they 
would be is exactly an expectation argument. It is an 
expectation of looking at the demographics which everybody 
knows are real and are going to put enormous pressure on Social 
Security and Medicare costs in the next decade and the end of 
these tax provisions that no one knows how it is going to get 
adjusted unless they are going to be renewed, which is the 
likely case, and if that is the case, then, we go back to Dr. 
Orszag's case--we are going to have over the next 75 years more 
money in tax cuts than we are going to have for the money 
available for Social Security that we need to have.
    So I think the market is factoring those in. I think that 
is why we have those rates relative to where they would have 
been otherwise given what the Federal Reserve has done.
    I have taken too much time, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Corzine.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    I apologize for coming in late. We have a Banking Committee 
hearing going on just one floor down, which my colleague 
Senator Corzine is also a member of, so we trade back and forth 
on money-laundering. It is at moments like this that cloning 
actually looks appealing. [Laughter.]
    In have one question for the panelists but if I might just 
comment in general on all of the discussion, I find it 
interesting that we do not look at our own recent history in 
the last two decades and really look at the difference in what 
we are talking about today. To me, there is a very clear 
analogy between what happened in the eighties and what happened 
in the nineties. What I see now happening is a return to what 
happened in the eighties which, frankly, Mr. Chairman, was not 
very good for my State of Michigan or the country. So I would 
just observe that in the eighties there was the kind of 
approach that is used now, focusing on supply side economics, 
trickledown theory, which some folks in Michigan are still 
waiting to trickledown, and massive buildup in defense. And 
while I certainly support the efforts to focus on security and 
safety for the country, we have that analogy happening and 
tripling the national debt--tripling the national debt--and 
interest rates skyrocketed.
    Int he nineties, we saw an attempt to begin to get a handle 
on balancing the budget. We actually interesting saw in 1993 a 
tax increase on the top 1 percent, a tax cut by earned income 
tax credit and expanding that to low and middle-income 
taxpayers, an effort to focus on paying down the debt, 
balancing the budget; interest rates came down, economic 
activity grew, and we had a wonderful explosion of economic 
activity, and in fact we were able to balance the budget in 
1997 for the first time in 30 years, which I was pleased to be 
in the House to participate in.
    So in my mind, we have two different approaches--one that 
focuses more on fiscal responsibility, paying down the debt, 
more of a demand side approach to tax cuts on the one hand; and 
on the other hand, a supply side economics approach that 
disregarded the national debt--in fact tripled it--and also did 
not rein in spending. And as the Chairman has said numerous 
times, despite the rhetoric, the reality is that as a share of 
GDP, spending has gone down, and the efforts in the nineties to 
focus on restraining spending I think did make a difference.
    So I would just say that I am not an economist, but I do 
look, at least in my lifetime, at differences, and if the 
eighties had worked, I would be here advocating that we do it 
again. I did not see it work, at least not for Michigan, and 
certainly the people of Michigan do not want to go through the 
eighties again.
    That is why I come to where I am, and I will now ask my 
question. And this is not a new question, and the Chairman is 
probably tired of hearing me talk about triggers, but I do want 
to ask you if in fact we ought to have some return to fiscal 
responsibility and a balancing of the efforts to both restrain 
spending as well as issues of not returning to massive debt, 
which right now, we are headed in that direction. I would like 
the panelists' comments about the framework of putting together 
an economic trigger that first of all would not even come in as 
a factor until 2004, with the next step of the proposed 
decrease in the tax cut, but would give us a framework for 
looking to the future in terms of the potential massive buildup 
of that and the use of dollars that have been put aside for 
Social Security and Medicare, and in my mind, the effort that 
is coming which, while there is no relationship to Enron, I 
believe the analogy is correct of saying that if we continue on 
this track, we are saying that those at the very top, the top 
one or 2 percent of the public, ought to be able to get their 
money out in their pockets, and it will be paid for on the 
backs of the retirement system of the majority of Americans, 
which in this case is Social Security and Medicare, which I 
have deep, deep concerns about.
    I would welcome your thoughts about triggers.
    Mr. Reischauer. Senator, while I was listening to you 
compare the 1980's and the 1990's--and I certainly agree with 
your conclusion, I was struck by how you said that if the 
1980's had worked, you would be here defending the 1980's. I 
was thinking to myself you probably would not be here if the 
1980's had worked, for political reasons.
    Let me comment on your question about triggers. I think 
they are a second best. I think the best thing you can do is to 
ask how much of the tax cut that was enacted in June of last 
year, can we afford permanently now, knowing what we know now 
about the likely future of the economy and the other demands 
and needs of the Nation. As I suggested in my testimony, I 
think that would lead to a conclusion that we should freeze the 
tax cut at where it is now--I mean, the elements that have been 
implemented--and index those.
    To go to a trigger which would say that if certain 
conditions prevail, we will allow the next tranche of the tax 
cut to go into effect, introduces first of all a degree of 
uncertainty into the future and the possibility for gimmicking. 
It will be very difficult for whoever has his or her finger on 
the trigger to pull the trigger, particularly if it is a point 
at which an election is coming up, and the outcome of the 
election is somewhat in doubt. So I think you are better off, 
really, biting the bullet now as opposed to kicking the ball 
down the road, which so often is the easier political route to 
go.
    Mr. Orszag. I agree with what Dr. Reischauer just said. I 
would just add that one of the proposals that we have put 
forward is a sort of minimum, that after the Congress passed 
the tax legislation last year, there was a pot of money that 
was supposed to be left over outside of Social Security and 
Medicare, and at a minimum, one could argue that the rest of 
the tax bill should not go into effect until, after those 
future provisions come into effect, you leave the same amount 
of money.
    The Congress went through a variety of changes, including 
the sunset in 2010, in order to fit the tax legislation into a 
certain cost estimate in order to leave that residual or that 
insurance policy. That is now gone, and until that layer is 
back, the rest of the tax cut should not go into effect. That 
would be a minimum, and I think more is required, but there 
seems to me at least to be a certain logic to that.
    Senator Stabenow. I would just comment that that really is 
one form a trigger, to put in place a certain----
    Mr. Orszag. That is one form a trigger, yes.
    Senator Stabenow [continuing]. A certain surplus or debt 
reduction number or whatever, and then be able to make sure 
that in fact we have that insurance policy before we proceed 
with anything further.
    Mr. Orszag. That is correct. And if I could just add very 
briefly, Mr. Chairman, in the spirit of interplay between the 
witnesses, I just want to note two things. First, I am not 
going to buy into the simple comparison between the United 
States and Japan on real interest rates, but I think it is 
highly unlikely that U.S. inflation rates over the next 10 
years are expected to be 1.5 percent. If you look at the CBO 
numbers and any other private forecasters', over the next 10 
years, you are looking at about 2.5 percent, which then means 
that real interest rates in Japan under this comparison, which 
again I am somewhat reluctant to enter into, would be higher. 
And I guess I would be willing to put my money where my mouth 
is, and if Mr. Wesbury wants to take a bet on whether inflation 
will be 1.5 percent over the next 10 years, I would be willing 
to do that.
    I would also just note on the Social Security tax that only 
6 percent of workers exceed the Social Security payroll 
maximum. So for 94 percent of workers, they are facing that 
marginal tax rate. It is true that when you go over the cap, 
your marginal tax rate falls, but the vast majority of workers 
never get there.
    Thank you for indulging me on those two points.
    Chairman Conrad. Do you have other questions?
    Senator Stabenow. I do not know if Mr. Wesbury would like 
to respond; and then I have no further questions.
    Mr. Wesbury. I do have a brief response.
    Chairman Conrad. Absolutely. Mr. Wesbury, go ahead.
    Mr. Wesbury. Thank you, Mr. Chairman.
    Senator I have two brief comments. Your recollection of the 
eighties in my opinion does not fit with the data. Between 1982 
and 1987, when we had huge deficits, the economy grew on 
average 4.4 percent per year. Between 1995 and 2000, when the 
economy went from deficit to surplus, the economy grew 4.1 
percent per year--actually less than it did in the mid-1980's.
    Senator Stabenow. Let me ask two questions. Did we in fact 
triple the national debt in the eighties?
    Mr. Wesbury. Yes.
    Senator Stabenow. Were interest rates higher in the 
eighties or in the nineties?
    Mr. Wesbury. On average--on average--they were higher in 
the 1980's, but they came down significantly in the 1980's, 
from 15, 16, 18 percent down to, when they exited the 1980's, 7 
or 8 percent. They came down much more in the 1980's than they 
did in the 1990's.
    But one of the interesting things--and this is what you 
have to ask yourself--companies, people, borrow money all the 
time. We do into debt. I am sure you have some debt in your 
life. I have debt in my life. My company has debt to help it 
operate on a daily basis. And the reason why we go into that 
debt is because it promises something better in the future. And 
during the 1980's when we tripled the national debt--and I am 
not quite sure of the exact ratio, but I will buy the 
tripling--it went up by about $3 trillion, and our economies 
assets--total assets--housing stock, stock market, bond stock--
all the assets in the economy went up $10 trillion.
    So in other words, we borrowed $3 billion to create $10 
billion. That is a great tradeoff, and I do not know of a bank 
in the world that would not lend the money to a company that 
was able and promised to do that. The United States economy 
actually had a fabulous 1980's. I am from Illinois--we are not 
that much different from Michigan--and I think the unemployment 
rate came down, the inflation rate came down, interest rates 
came down, and growth picked up.
    So I just do not see what you see in the 1980's versus the 
1990's.
    Senator Stabenow. If I might comment, Mr. Chairman, and 
then turn it back to you--first of all, I would be happy to 
share with you what happened in Michigan in the 1980's. I do 
not know about Illinois, but I was in State government in the 
1980's and saw what we had to go through and what happened with 
unemployment, and I can assure you that if I were to ask people 
in my State if they would prefer the 1980's or the 1990's in 
terms of how it affected their family, their jobs, and so on, 
they would not pick the 1980's.
    But the other thing I would say on your analogy is that we 
all go into debt. I have a mortgage, I have a car payment, I 
have credit cards--most Americans do that. But we also know 
when we go into debt too far. If I am so in debt--if I have 
every credit card at the maximum, and I have a mortgage and two 
car payments and so on--and then, my mother needs to go into a 
nursing home and needs my help, I am going to be hard-pressed 
to be able to help her at that point, because I have leveraged 
myself so much and at that point may then have to go into much 
further, more extravagant debt that risks my family.
    That is what has happened here. We are placing ourselves in 
a situation where we are leveraging and potentially creating so 
much debt that when those of us who are baby boomers start 
bringing the bill due for Social Security and Medicare, we will 
jeopardize the future for our children by placing ourselves in 
a situation of having to go into massive debt or make other 
kinds of decisions that are not good for our families.
    So that is my objection to where we are going. Some debt is 
fine, but overextending the country, just as if I overextended 
my own family, would not be wise, and we would be held 
accountable, and I am fearful that in fact we will be held 
accountable.
    Thank you, Mr. Chairman.
    Chairman Conrad. Dr. Reischauer signalled me that he would 
like to address something that came up.
    Dr. Reischauer. I would just like to comment on the 
discussion of Mr. Wesbury about the 1980's and the 1990's. We 
should not confound cyclical growth with the potential growth 
of the economy, the long run potential growth.
    Mr. Wesbury compared growth between 1982 and 1989, which 
was a period that started at the depth of the second-deepest 
recession, or the deepest recession of the post-war period when 
we had an unemployment rate of over 10 percent with what 
happened during the 1990's. I think the proper comparison is to 
look at underlying rates of productivity growth in the two 
decades. There, you will find that there was a significant 
difference, particularly in the last half of the 1990's we had, 
for reasons that we do not fully understand, and I am in 
agreement with Mr. Wesbury about the important role of 
technology that has a long period of gestation, and the 
importance of low tax rates as well. But we did for reasons, 
some of which remain inexplicable, some of which we would like 
to attribute to the turnaround in fiscal policy during the 
1990's, enter into a period in which productivity growth seemed 
to be higher than it had been at any time from the early 1970's 
through the early 1990's. So from that standpoint, which I 
think is the important measure, the 1990's were really an 
improvement over the 1980's.
    Chairman Conrad. I thank Senator Stabenow.
    I think every committee of the Senate is meeting today 
because functionally, we will not be having committee meetings 
for the rest of this week; so that is part of what is happening 
here.
    I would like to continue this discussion for an extended 
period, because I think we are on what is a really critical 
issue going forward, and we have three of the best witnesses 
that I have heard in tandem on this subject. I really think all 
of you are excellent witnesses.
    Let me ask you this. We are in agreement that economic 
growth is really the key to meeting our obligations in the 
future for Medicare and Social Security. The question that will 
be before a future Congress is the size of the economy at that 
time and the ability to meet the obligations that have been 
generated.
    Alan Greenspan was very interesting on this subject last 
week, saying that he looks at not just the publicly held debt, 
he looks at the debt that is considered a contingent liability, 
some $10 trillion. It is considered contingent because the 
theory is that Congress could change the promise made in 
Medicare and Social Security at any time. That is really not 
realistic in his view, the notion that Congress could somehow 
change the fundamental promise that has been made. I think he 
is right, and on that basis, this contingent liability of $10 
trillion, the vast majority of it, he told me he thought that 
probably 95 percent of it or more, is a true liability, not 
contingent at all.
    So that is a reason he believes it is important to go back 
to running surpluses as we define them. We call them surpluses 
here. I do not really consider them surpluses; I consider them 
funds necessary to meet promises that have already been made.
    But if we are agreed that the size of the economy at the 
time that those liabilities come due is truly the key issue--
and I think we are basically agreed on that; if anybody 
disagrees, please say so--what would be your prescription for 
fiscal policy going forward? What do you think should be the 
outline of the fiscal policy going forward?
    Dr. Reischauer, you raised your hand first. Go ahead.
    Dr. Reischauer. This is on the issue of whether I think 
that whether the economy is 30 percent larger than it otherwise 
would be in 2030 really makes a difference for these 
liabilities. I guess my answer to that is that if that 30 
percent larger GDP is already committed to tax cuts, to program 
spending, to other things, politically, it will be just as 
difficult to transfer resources to the elderly as it would be 
if you had a smaller GDP, because people will be used to those 
lower tax rates or those higher spending levels and will regard 
it as a negative change.
    So what you want to do is build in some kind of fiscal 
margin and segregate the resources, either privately or through 
some government collective investment in private assets, which 
then can be drawn down for these purposes. But that really 
involves structural reform of these two programs.
    Chairman Conrad. You are talking about really treating 
trust fund moneys as if they were a trust fund.
    Dr. Reischauer. Basically, yes.
    Chairman Conrad. Dr. Orszag?
    Dr. Orszag. First, let me just say that while I think, as 
Dr. Reischauer noted, that the size of the economy is a 
critical component of the affordability of our future 
liabilities, it also matters how we spend that output. So 
having more output is great, but we also need to worry about 
how it is distributed to different purposes.
    I would also just note that while the figures that are 
being discussed are correct based on current expectations, 
these longer term projections, both for the contingent 
liability under Social Security and also the so-called fiscal 
gap, are very sensitive to the assumptions that are plugged 
into them. But that does not mean that we do not have a 
problem. It just means that we should be a little bit wary 
about the precise numbers; they can move around.
    On Social Security reform, as we have discussed before, my 
view is that the tax cut has impeded Social Security reform 
regardless of whether we have individual accounts or not; that 
we need some funds outside of Social Security to grease the 
wheels of the reform and get us on a more sustainable path; 
that without those funds, there is too much ``broccoli'' in the 
reform plan, and it will not get done, and for a period of 
time, you need money from outside Social Security to grease the 
wheels of the reform.
    So that in a sense, unfortunately, if the full tax cut does 
take effect, the longer-term legacy, in my opinion, may be that 
if impeded Social Security reform.
    Chairman Conrad. Let me just say that the broccoli people 
are calling now and are very unhappy with the negative 
reference. [Laughter.]
    Mr. Wesbury.
    Mr. Wesbury. As you mentioned in your introduction of me, I 
was here in 1995-1996 with the Joint Economic Committee, and I 
do not remember using ``broccoli'' in any of our--so that must 
be new.
    I will suggest that I am not an expert on the Social 
Security Trust Fund, and what I came to talk about was the 
interrelationship between the budget and the economy. In that 
regard, what I would suggest is that with all liabilities in 
the future, the key--and I am reiterating what I said earlier--
is the growth rate of the economy.
    In fact, because of the boom in growth in the late 1990's, 
we were actually seeing some estimates that problems with the 
trust funds were being pushed out by a couple of years. This 
was up about a year ago. Obviously, things have now changed a 
little bit. And I would argue that that shows us the power of 
growth; that if we can sustain 4 percent real growth or higher 
in the future, a lot of these problems and these liabilities 
will be taken care of.
    One statement about that. I do believe that giving 
individual ownership of private accounts a try is actually a 
good policy, and I hope we discuss that more in the future. By 
allowing individual ownership, we create all kinds of different 
incentives in the system, and we can actually lower that 
liability whether it is contingent or not as we move into the 
future.
    One last point, and that is that--I am blanking on my last 
point, so I will just stop there.
    Chairman Conrad. While you are thinking about it, let me 
just say this to you. I think Dr. Reischauer is wise to caution 
us that it is the case that economic growth has a bearing on 
our ability to meet these liabilities in the future. The 
political realities at the time are also critically important, 
and what the experience of people has been with respect to tax 
levels, with respect to benefit levels, with respect to other 
spending that the Federal Government is doing, whether on 
defense or homeland security or whatever the priorities are 
that are experienced at the time, will have an effect on the 
ability to meet those obligations and the perceived difficulty 
and sacrifice necessary to meet those obligations. I think that 
is the point that I heard you making, Dr. Reischauer.
    To me, there were tragedies in what was done last year on 
taxes. I was strongly in support of a tax cut last year; I 
proposed one which I thought was significant, $750 billion over 
10 years not counting the interest cost--with the interest 
cost, it would be about $900 billion. The President proposed 
$1.6 trillion not counting the interest cost--with the interest 
cost, that would be about $1.9 trillion.
    The difference was that I took the difference between those 
two, and I set the money aside so that you could establish 
private accounts in Social Security. In other words, I provided 
the money for the transition; whether they were add-on accounts 
or as part of an overall picture, I set aside the resources to 
do it. That was the first casualty of the process last year, 
and I think people will look back at some point and say that 
was a missed opportunity, and it is going to be hard to get 
back in a position to be able to do that--very hard. The 
President has said over his dead body to even any deferral of 
the future tax cuts. And you look at these numbers that CBO has 
come with, and frankly, in many ways they are optimistic 
because they do not contain things that we all know are going 
to happen. The President is going to ask for a substantial 
buildup in national defense, as he should--whether the exact 
number he is coming with is the appropriate number, I do not 
know; we have not gone through that yet--but he is going to get 
a substantial increase in national defense; is there anybody 
who doubts that? I do not think so.
    He is going to get a substantial increase in homeland 
security, and he should. I do not think there is any doubt 
about that.
    We are going to extend the tax provisions of the current 
code. That is not in these estimates. It is going to happen--we 
all know it--and it should happen--not every one of them; I 
think there are some of them that ought to be tossed out--but 
we know that most of them if not all of them are going to be 
approved.
    We know that a new farm bill is going to be passed. We know 
that some of these other matters are going to have to be dealt 
with. The alternative minimum tax on individuals--now they tell 
me that just to fix the impact of the last tax bill on 
individual alternative minimum tax is going to cost $300 
billion. Does anybody believe that we are really going to let 
tens of millions of people be caught up in the alternative 
minimum tax over the next decade? I do not think so.
    Where is the money coming from for all of these things?
    I guess I have never been more frustrated than when 
watching the news accounts of what is happening, because it is 
as if we are just kind of divorced from reality. I grew up in 
the Midwest. I grew up in North Dakota. I grew up learning that 
debt can be positive and that debt can have a vicious negative 
side to it.
    I remember my grandfather, who owned stock in the local 
bank, in the days of unlimited liability--when you owned stock, 
you were not limited by the liability of your investment--so 
when things turned sour in the 1930's--and in North Dakota, 
they turned very sour--the banker would call up my grandfather 
and say, ``Bring down some more money''--and it happened week 
after week after week. The banker would call up and say, 
``Bring down some more money.''
    And families all across our State were ruined. It took my 
grandfather a decade to recover. They did not believe in going 
bankrupt in those days. They did not do it.
    So debt can work both ways. Debt can be very positive in 
terms of enabling a company or a government to do things that 
would not otherwise be done. It can also, when it grows too 
much, reach a tip point and create enormous hardship. And I 
guess that is one reason why I am so focused on this question 
and very concerned about what I see as the direction of a 
country that for the moment just seems divorced from the 
reality of our obligations versus what we are willing to do to 
tax ourselves to meet those obligations. And there is now a big 
chasm here--a big chasm. And it is not just this year. I would 
be much less concerned if it were a one- or 2-year matter. This 
is not a one- or 2-year matter. We are talking about the next 
decade, trust fund deficits of enormous proportions.
    With that, we are just at the end of a vote on the floor, 
and I have got to go, but I do not want to leave here without 
again thanking each and every one of you. You have been really 
excellent witnesses, and I appreciate very much your time.
    The committee is adjourned.
    [Whereupon, at 11:47 a.m., the committee was adjourned.]









                    PROPOSED FISCAL YEAR 2003 BUDGET

                              ----------                              


                       TUESDAY, FEBRUARY 5, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:06 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Hollings, Murray, Feingold, 
Johnson, Nelson, Stabenow, Clinton, Corzine, Domenici, Gregg, 
Snowe, Frist, and Smith.
    Staff present: Mary Ann Naylor, staff director; Chad Stone, 
chief economist and Jim Horney, deputy staff director.
    For the minority: G. William Hoagland, staff director; 
Cheri Reidy, senior analyst and Bob Stein, chief economist.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The Budget Committee will come to order.
    We welcome Director Daniels to the committee to discuss the 
President's submission for the year.
    I am going to start out with a statement and then turn to 
my ranking member for statement, and then we will go to the 
director for his testimony. Then, as is our tradition, we will 
reserve 7 minutes for statements and questioning by each of the 
members, in order of appearance; as is our typical rule here on 
the Budget Committee, we follow the early bird rule.
    First of all, let us acknowledge that this is a dramatic 
change of circumstance from what we faced last year. Part of 
that is due to the war; part of that is due to economic 
downturn; part of that is also due to the tax cuts that were 
enacted last year.
    The President in his State of the Union message said: ``Our 
budget will run a deficit that will be small and short-term.'' 
If true, that would be understandable given the war and the 
recession. But let me put up what USA Today wrote in an 
editorial yesterday about that statement by the President.
[GRAPHIC] [TIFF OMITTED] 80544.036

    They said of the return to deficit spending that the 
President claimed would be small and short-term--their response 
was: ``Don't believe that for a moment. Even before the 
official numbers are released, one thing is clear--the deficits 
will be big and last for nearly a decade. Only by resorting to 
accounting gimmicks that would make Enron blush can Bush claim 
otherwise.''
    They go on to report that ``To make the deficits look 
smaller, Bush has included a $178 billion Social Security 
surplus next year, and the nearly $1 trillion of Social 
Security surpluses during the following 9 years. They say that 
is good short-term politics, making it seem as though all of 
this extra spending, on top of the oversize tax cut enacted 
last year, cost the Nation's fiscal future little.''
    But they say that ``In the long term, it amounts to a 
disastrous shift away from protecting the Nation's fiscal and 
financial security.''
    They conclude by saying: ``Remember that right up until 
September 11, Bush and just about everyone else in Washington 
were pledging to keep Social Security surpluses off-limits to 
tax-cutters and spendthrifts, and for good reason. Left 
unspent, these surpluses go toward paying down the Federal 
Government's debt. That would help cut interest rates, boost 
economic growth, and free up money to reform Social Security 
and Medicare.''
    What they are talking about is what we see. We do not see 
deficits as the President asserted, being short-term and small. 
What we see is an ocean of red ink. What we see is deficits 
right through the decade. What we see is the use of Social 
Security and Medicare Trust Fund money by over $2 trillion to 
fund tax cuts and other spending.
[GRAPHIC] [TIFF OMITTED] 80544.037

    Let me just put up what the President said last year with 
respect to protecting the surplus. The President said: ``To 
make sure the retirement savings of America's seniors are not 
diverted to any other program, my budget protects all $2.6 
trillion of the Social Security surplus for Social Security and 
for Social Security alone.''
[GRAPHIC] [TIFF OMITTED] 80544.038


    Now we see that that statement was in error. If we look at 
the next chart, which shows the percentage of Social Security 
Trust Fund surpluses being used for other Government spending, 
we see that in the bad, old days, we were using Social Security 
Trust Fund money for other purposes. That was dramatically 
reduced in the 1998 budget. We stopped using Social Security 
Trust Fund money for other purposes in both 1999 and 2000. In 
2001, we started going back the other way, and under the 
President's plan, in 2002, 2003, and 2004, 100 percent of the 
Social Security surplus is being used for other purposes.
[GRAPHIC] [TIFF OMITTED] 80544.039


    Last year, Director Daniels, you said in a news broadcast 
on Late Edition that ``having protected and set aside money for 
the needs of the country, having protected every penny of 
Social Security for Social Security, having spent every penny 
of Medicare receipts on Medicare, having set aside $1 trillion 
for new needs or contingencies, there is still $1.6 trillion 
that the taxpayers are entitled to.''
    Well, again, what we see in light of this new budget is 
that you have not protected Social Security or Medicare. 
Instead what this budget reveals is that you are taking $2.2 
trillion of Social Security and Medicare surpluses and using 
them to pay for tax cuts and other expenditures--something the 
President pledged not to do.
[GRAPHIC] [TIFF OMITTED] 80544.040

[GRAPHIC] [TIFF OMITTED] 80544.041


    There was also the assertion of last year that you would be 
paying down the maximum amount of national debt. The President 
said in his address to the Joint Session last year: ``We owe it 
to our children and grandchildren to act now, and I hope you 
will join me to pay down $2 trillion in debt during the next 10 
years.''
[GRAPHIC] [TIFF OMITTED] 80544.042


    Again, we see that that statement was inaccurate; that 
instead of paying down $2 trillion of debt during this period, 
the President's budget this year shows we will be paying down 
just over $500 billion of the debt.
[GRAPHIC] [TIFF OMITTED] 80544.043


    The result is that total Federal interest costs go up by 
over $1 trillion, this according to the Congressional Budget 
Office. Instead of paying $600 billion of interest over the 
next decade, we will be paying over $1.6 trillion in interest.
[GRAPHIC] [TIFF OMITTED] 80544.044


    When Director Crippen of the Congressional Budget Office 
came here to testify, he indicated that the surpluses which 
last year were projected at $5.6 trillion had been reduced to 
$1.6 trillion. And when we looked at the reasons, according to 
CBO testimony, what we found, despite the indications from the 
Administration that this was all related to the war and the 
economic downturn, was that in fact the biggest factor was the 
tax cut that the President proposed and pushed through Congress 
last year. Over the 10 years, 42 percent of the decline in the 
surplus was as a result of the tax cut; 23 percent, the 
recession; 18 percent, spending largely caused by the attack on 
this country on September 11; 17 percent, technical changes.
[GRAPHIC] [TIFF OMITTED] 80544.045


    All of this tells me that the prudent person putting a 
budget out this year would decide not to dig the hole any 
deeper. But what we see in the President's budget is to keep 
digging the hole deeper and deeper, taking more Social Security 
Trust Fund money to use for other purposes, taking all of the 
Medicare Trust Fund money to use for other purposes. In fact, 
instead of $5.6 trillion over the period of 2002 to 2011, the 
President's budget leaves something over $600 billion.
[GRAPHIC] [TIFF OMITTED] 80544.046


    I believe the truth is there are no surpluses because all 
of that money is fully committed. In fact, it is overcommitted. 
In fact, as Chairman Greenspan told us, these so-called 
contingent liabilities of the Federal Government are not 
contingent at all. We owe that money, and we are going to have 
to pay it. And to fail to acknowledge it puts this country in 
much the same position as Enron--not acknowledging the true 
debt that we face.
    So what does it all mean? Director Crippen when he was here 
concluded his testimony by saying: ``Put more starkly, Mr. 
Chairman, the extremes of what will be required to address our 
retirement are these. We will have to increase borrowing by 
very large, likely unsustainable, amounts; raise taxes to 30 
percent of gross domestic product''--we are at about 19 percent 
now--``obviously unprecedented in our history; or eliminate 
most of the rest of government as we know it. That is the 
dilemma that faces us in the long run, Mr. Chairman, and these 
next 10 years will only be the beginning.''
[GRAPHIC] [TIFF OMITTED] 80544.047


    I believe Director Crippen is telling it straight, and I 
believe the President's budget fails to address the long-term 
fiscal imbalances facing the country and as a result puts our 
financial security in jeopardy.
    I turn now to my ranking member, Senator Domenici, for his 
statement.

         OPENING STATEMENT OF SENATOR PETE V. DOMENICI

    Senator Domenici. Thank you very much.
    It is not often that we get the OMB Director here before us 
and that we have a whole morning, more or less, to inquire of 
him. I hope the members on our side, speaking just to them, 
will avail themselves of an opportunity to come down and get 
some of their thoughts on the record and get some of their 
questions asked.
    First, I might say to my good friend the Chairman that we 
have plenty of time--you have plenty of time. If, as a matter 
of fact, there is something wrong with this budget that ought 
to be corrected because it is perilous, as you have described 
it, you know that you are going to have plenty of time to fix 
it; and if you have a better way, I anxiously wait to see what 
it is.
    And at the end of my remarks, I was going to say--but I 
will say it now--that I look forward to working with you in an 
effort to put together a bipartisan budget if that can be done. 
You cannot count on me for just any, old budget that you would 
like to put together, but obviously, if you think you have a 
way of doing it better than the President, I stand first on the 
side, watching, and as you proceed with it, I will become 
involved to the extent that it may, as you suggest, make better 
sense for America than the budget we have here.
    However, I do not intend to hold my breath until that 
event, because I think that is going to be very difficult to 
do. I think we are going to have to decide that some of the 
basic concepts that the President of the United States has laid 
before us must be addressed and must be faced.
    Yesterday, we received the President's budget for 2003, and 
this budget shows that this President says what he means, he 
means what he says, and he does what he promises.
    When I met with the President a few weeks ago in the 
company of the House Budget Committee chairman--it was about 2 
weeks and a little bit ago--I said then and I say again that 
this budget is about setting priorities. Some might want it to 
be an exercise in dreaming, an exercise in coming up with ideas 
that sound good and that may indeed make people focus on 
something that is not the reality of this particular fiscal 
situation in which we find ourselves.
    President Bush's $2.1 trillion wartime budget sets as its 
first priority security of homeland, fundamental to our 
constitutional government. Without this security, as outlined 
by our Founding Fathers, democratic government as we know it 
cannot exist. The second priority is the further strengthening 
of our military, both intelligence and the military in general, 
to be ready to destroy those who threaten our government.
    The third priority is to restore health to the economy and 
provide the security of a paycheck to those who have been 
unemployed.
    The achievement of these three critical priorities takes 
precedence in the near term over maintaining a balanced Federal 
budget. I believe you have said that as you have analyzed the 
situation here in the United States. I will not choose to quote 
you today, but will in the event we have a little extra time.
    When you or those helping you pen items that explain 
something in a very good way, I save them--I ``rat-pack'' 
them--and then, every now and then, I read them and ask 
everybody to guess who said them because they are so good. The 
reason they are so good is that they are just like what I would 
say--but you are the Chairman, so you get to say it first.
    In any event, I think we would all agree that I join the 
ranks of only a few who have worked the hardest to get a 
balanced budget and to maintain it. As a matter of fact, some 
people think I was kind of a wild man to spend so many years 
trying to get that done. I wish we had not had a terrorist 
attack, and I wish we had not had a few of these other things, 
and that we could have lived the luxury for 6 or 8 or 10 years 
of this budget situation that was upon us but for that.
    This budget is tough enough. It achieves critical 
priorities, but it does not abandon fiscal discipline. Domestic 
spending grows, but the growth of domestic spending is kept 
particularly low. I am sure that every member of the Senate 
will find funding levels for their specific States or 
constituents or projects, programs, or activities that we will 
not like and that we will not be able to do.
    Nonetheless, we will work as we always have to accommodate 
as best we can what Senators on behalf of their constituents in 
their States think we should be doing.
    There is no question that we will have to work together, 
the Administration and Capital Hill, to produce a congressional 
budget that reflects the priorities outlined today. The OMB has 
made great strides in working to identify those programs that 
work and those that do not. You should continue this very good 
work, Mr. Daniels. There is no way out of it--that or some 
similar way of evaluating the program will have to be done by 
someone, and I personally look forward to what you think is the 
best way to handle the money that is left over after the three 
big priorities have done their job.
    I hope we can extend the welfare program and focus on 
special items that do affect our families, such as the Bayh-
Domenici proposal that encourages two-parent families. It is 
not a big program, but it is certainly something that we could 
say let us try to find the money to do that kind of thing.
    I know that we can fund those programs that will secure our 
nuclear stockpile and make the world a safer place.
    So all in all, this is not a usual year. This is a very 
unusual year. We are just coming out of a recession, and we are 
not too sure that we are coming out with a bang; it may very 
well be a slow, creeping, moving ourselves out of this 
recession.
    And obviously, right while that is happening, we are 
dealing with terrorists about whom we must learn much more and 
about whom we must do a better job of seeking them out and 
ridding countries of them.
    There can be no doubt--these two things happening 
simultaneously on the world scene is an enormous challenge to 
the American people, to our form of governance, and puts all of 
us in a very, very difficult, precarious situation.
    Again I repeat--I wish we would not be using that surplus 
for the high-priority items that our President asks us to use 
it for, but I challenge anyone who wants to build a budget on 
priorities to find a better way. And I speak for everyone on my 
side of the aisle. We anxiously wait to see if you have one. I 
do not know whether it is possible, but we are all ears.
    Thank you for calling the meeting so promptly in the year. 
Maybe this means that we can get our work done in a timely way. 
If that is possible, I will be here as much as I can to see 
that we move it in that way, with both of us pushing as we 
should, the Chairman and the ranking member.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Chairman Domenici.
    I appreciate as always the cooperative attitude that you 
bring to the work of this committee and the extraordinary 
leadership that you have given the country over an extended 
period of time. And I want to acknowledge the fact that you 
have been one who wanted to make sure that we were fiscally 
responsible in this country and that we reduced deficits at a 
time when there were some very painful decisions to be made, 
and you were there. I want to acknowledge that.
    I also want to say to Director Daniels that through you, I 
want to commend the President for his conduct of the war 
effort. On many occasions, he has made me proud as an American 
to watch the way he has conducted himself in these very 
difficult times.
    Our disagreement is a fundamental disagreement over long-
term fiscal policy. I do not have much disagreement over the 
budget for this year. There are obviously areas where maybe we 
could do things differently. My great concern is the long term 
and the fiscal course that he has put us on. I think it is a 
very serious mistake.
    I do want to indicate that with respect to this war effort, 
the President can count on us on our side to respond to his 
assessment of the need. We are going to be with him shoulder-
to-shoulder on providing the resources necessary to conduct 
this war. And our adversaries should understand that there is 
not an inch of room between us on that question.
    The resources that the President requests to conduct this 
war and defend this country will be made available to him and 
to our armed forces.
    With that, again, welcome, Mr. Daniels, and please proceed.

  STATEMENT OF MITCHELL E. DANIELS, jr., DIRECTOR, OFFICE OF 
                     MANAGEMENT AND BUDGET

    Mr. Daniels. Thank you, Mr. Chairman, and thanks to the 
committee.
    Senator Domenici is right that we do not often get this 
mutual opportunity. I hope you will understand if I say that 
from this chair, it feels often enough, but as you know, I am 
always glad and grateful for the chance to be here.
    As before, I would like to show what has become my 
customary mercy and dispense with the reading of the testimony 
which I have submitted and will gladly take your questions, of 
course. Let me just try to summarize it in the fewest words I 
can.
    Before turning to the business that will probably occupy 
most of our time, I would like to commend to the committee's 
and the Congress' attention the differences in this budget. The 
outstanding career professionals at OMB have worked very, very 
hard on some changes and we think some progressive improvements 
that they have looked forward to for a long time. This goes to 
the notion of becoming serious about the better management of 
the day-to-day business of the Federal Government; becoming 
serious about differentiating, as the Congress has instructed 
the Administration's executive branch of government to do, 
serious about measuring performance, separating programs that 
work from those that do not work as well, strengthening the 
former by drawing on the latter. This will make a very serious 
attempt to begin, and we do hope that you will spend some time 
examining those features as well, helping us begin to broaden 
the question that we meet about here from simply how much to 
how well, from how much will the government spend to how much 
will the government achieve, and how can we all work together 
to improve that.
    Mr. Chairman, the differences between now and the last time 
we met, even in midyear let alone a year ago, are of course 
profound. They do trace to the two events of a recession that, 
regrettably, no one saw and was already underway a year ago, 
and of course, to the attack on our country.
    We present this week a budget to win a two-front war, and I 
very much welcome, as I know the President will, your 
affirmation of your support and that of I know your colleagues 
on the Democratic side of the aisle for the President's conduct 
of the war and the resources necessary to prosecute it. I think 
that Americans have really been uplifted in the last 3 or 4 
months by the way in which the Congress has come together 
around that, and I thank you again for reminding us this 
morning that that will to win remains intact and bipartisan.
    We are asking for fairly aggressive spending increases, at 
least on the discretionary side of the budget--9 percent--2 
percent above what was agreed upon last year in more normal 
times. I would mention in passing that in part because of 
circumstance, in part because of reforms that this Congress has 
enacted, overall spending will grow at a much more modest rate 
of about 5 percent. This allows us, really, to deal with our 
new difficulties--our triple difficulties--of war, recession, 
and emergency while maintaining a fiscal posture and condition 
that our colleagues in other developed countries would envy.
    The budget doubles spending--slightly more than that, 
actually--for the new category that we call ``homeland 
defense.'' Here, as in the conduct of the war, the President's 
posture was to leave nothing to chance, and we do attempt to 
fund each of those activities that Secretary Rumsfeld and 
Governor Ridge on his front have certified to the President are 
required.
    That having been done, we believe that it becomes 
especially important that we are very careful about the rest of 
the Government. We suggest that it grow, but at the modest rate 
in the overall of 2 percent. Most American family incomes will 
not grow by more than that this year; many, of course, are not 
growing at all in this recession. We think that this 
Government, that part not directly involved in the conduct of 
the war, can live with 2 percent, too.
    The third priority of this budget is to attack the 
recession, which is the reason that we are not going to pay 
down debt this year as we would all like to do; which is the 
reason that our long-term best guesses as to total surpluses 
have changed. Here, the President says, as he has throughout 
his career, that while balanced budgets are a very fundamental 
objective of Government, there are three conditions which can 
justify temporary deficits--war, recession, and emergency. We 
have them all, and he would like to see the Congress pass the 
stimulus package that came so close to passage in December, or 
at least something very like it. We have made room in this 
budget for that, and our numbers do reflect the prospect that 
that will happen.
    Let me say finally that we associate strongly with the 
points that you have made this morning and on other occasions, 
Mr. Chairman. You are absolutely right about the importance of 
maintaining fiscal discipline and doing all that we can over 
time to accumulate surpluses and devote them to the reduction 
of our national debt. We look forward to the resumption of that 
goal as soon as possible, and nothing will bring it on faster 
than a strong and early recovery; hence, the President's 
continued request for a growth package.
    Nobody knows, frankly, what our long-term prospects will 
be. I will show you, if you want to dig deeper into the 
incredible range with which these projections have varied, even 
in recent years, the projection for this year over 10 years 
happens to be the second-biggest of all time. Everyone has 
focused on that it is different from last year, but if we had 
not made one last year, this one would now be seen as, I 
suppose, very, very encouraging. It is as large as the one made 
in the last Administration in 2000.
    So the point is we do not know and we cannot know how big 
our surpluses will be beyond the short term into the future. It 
depends so very much on the return of growth and on sustained 
growth over a long period of time.
    We look forward to working with this committee to make 
that, as well as victory in the war which circumstances have 
thrust upon us, a reality.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Daniels follows:]

 The Prepared Statement of Mitchell E. Daniels, JR., Director, Office 
                         Management and Budget

    Mr. Chairman:
    My colleagues at OMB and throughout the executive branch have 
worked hard to present this committee and our fellow citizens with a 
very different budget for the Fiscal Year 2003. Before turning to the 
traditional subjects of totals, balances, and specific policies, let me 
recommend to the Committee's attention some new features which I hope 
will now become part of your annual expectations and deliberations.
    This budget takes seriously the assessment of government 
performance, and its relationship to future spending. Activities where 
effectiveness can be proven are maintained and often reinforced; those 
that demonstrably fail, or can make no showing of effectiveness, in 
many cases are looked to as sources of funding. The days when programs 
float along year after year, spending taxpayer dollars with never a 
showing of reasonable results or return, must give way to an era of 
accountable government. This and all future budgets must no longer be 
permitted to answer only ``How much?'' They must also address the 
question ``How well?''
    This innovation responds to decades of calls by good government 
advocates. While long overdue, it is especially necessary at a time 
when the physical safety of Americans requires that the Federal 
Government take on many additional, expensive tasks.
    In the interest of both accuracy and sound management, this budget 
takes a major step toward full cost accounting of programs and 
departments by assigning the costs of health and retirement benefits to 
the places where those costs are created. At long last, the true cost 
of these programs will be visible, and managers will have full 
incentive to control the costs of additional personnel. Other disguised 
costs, such as the future liability associated with hazardous waste, 
remain and should be the object of further reforms.
The Unexpected Cost of the Recession
    It has been clear for months--since September 11th to be precise--
that our fiscal picture had changed in a fundamental way. The weaker 
economy erased $177 billion of revenues previously expected for 2002, 
and $120 billion for 2003. Additional spending to respond to the 
terrorist attacks in these years subtracted another $31 billion from 
the surpluses we all had anticipated. Over a 10-year period, for those 
still professing to find use in such numbers, changed economic and 
technical factors reduced the surplus by $1.345 trillion.
    The recession that began in the first quarter of 2001 was the 
largest but not the only economic factor reducing estimated surpluses. 
The revised outlook for near-term productivity growth reduced the level 
of GDP--and hence the receipts base--throughout the budget window. Both 
the recession and the impact it has had on budget surpluses took us all 
by surprise.
    As the Washington Post has noted, ``2001 was a nightmare for 
economists,'' pointing out that, almost without exception, forecasters 
failed to see recession or its effects coming. In our misjudgments, our 
economists were in large and renowned company. The good people at the 
CBO, and 51 of the 54 private forecasters in the Wall Street Journal 
survey, all missed the recession even as it was well underway. The fact 
that our assumptions were toward the conservative end of the 
forecasting spectrum did not protect us from a very large misestimate. 
May I add that when the Nation's economists are having nightmares, 
budget directors lose sleep, too. We ultimately must choose assumptions 
that we believe will be accurate, and it is no comfort later that the 
rest of the world was in error, too.
    The Administration stated from the outset that it would leave room 
for error, particularly when it came to longer-term projections. In 
mapping out long-term policy proposals, our Blueprint expressly marked 
off over $800 billion (15 percent of the total expected) as a 
Contingency Reserve in the event that the hoped-for surpluses did not 
materialize. At least as far as one can tell from the latest 10-year 
estimate, even this generous hedge was not enough.
    The 2001 experience casts further doubt on the entire idea of 10-
year budget forecasts. The attempt to see 10 years out began only 6 
years ago--prior to that time 5-year forecasts were the longest ever 
attempted--but already enough evidence is in hand to convict. The 
experiment with 10-year forecasts demonstrates that no one can reliably 
predict budget levels this far into the future. In fact, despite all 
the lamentations, this year's 10-year baseline surplus forecast is just 
as big as that of 2 years ago; even after tax relief, it is the largest 
ever except for last year's. If we had taken a 1-year timeout from 10-
year guesswork, no one would say that anything was ``missing.''
    Our budget extends 10-year forecasts at the top-line level, for 
those still determined to find them credible, but it drops them from 
the rest of the document. There we return to the wisdom of our 
predecessors by using 5-year numbers, which are plenty uncertain in 
their own right.
A Two-front War Against Terrorism
    Mr. Chairman, we present this week a budget for a two-front war. It 
proposes substantial increases, those the President believes necessary 
to deliver on the paramount duty of the Federal Government, to secure 
the safety of the American people.
    Last year's budget began the reconstruction of a neglected national 
defense base, and that project continues now with new urgency. The 
President asks Congress to support a 12 percent growth in base defense 
funding, part of this reflecting the new threats presented by a long-
term terrorist foe. He also requests an additional $10 billion, if 
needed, for the costs of continued hostilities at today's levels.
    Funding for the category of activities we now term ``Homeland 
Security'' will double under the President's plan: airline security, 
first responders, bioterrorism, border security and preventive law 
enforcement, are all scheduled for major increases as recommended to 
the President by Governor Tom Ridge.
    We have worked closely with the Office of Homeland Security to 
define and budget for these activities; an explanation of the 
definition of the Homeland Security budget is attached at the end of my 
testimony. We will guard against and oppose efforts to divert funds 
from Homeland Security requirements or to misclassify unrelated funding 
under Homeland Security's priority status.
    Winning our two-front war is not optional, and will be expensive. 
As in other times of national conflict, tradeoffs will be required. 
Other priorities will have to stand aside for a time, lest we commit 
the ``guns and butter'' mistake of the Viet Nam era. We propose a very 
reasonable level that allows spending not related to the war or 
homeland defense to grow by around 2 percent.
    Within this ``Rest of Government'' category the President proposes 
$355 billion of spending. It must be noted that the activities it 
encompasses have enjoyed rapid funding increases during recent years, 
growing by an average annual rate of more than 8 percent since 1998.
    Within this enormous sum, it is both possible and desirable to 
increase high priority programs of proven effectiveness, and this 
budget recommends many such increases. Dozens of programs across the 
government are scheduled for growth based on demonstrated results.
Measuring Performance and Delivering Results
    For decades, good government advocates have called for systematic 
measurement of government's performance, and its reflection in the 
allocation of resources. In 1993, Congress passed the Government 
Performance and Results Act (GPRA), which was intended to implement 
this reform, but this mandate has been virtually ignored. The 
President's budget for 2003 responds to Congress' instruction, 
differentiating where the facts are available between programs that 
work and those that do not.
    Many programs of proven effectiveness are strengthened, by shifting 
funds from those which can make no proof of performance. NSF, WIC, 
Community Health Centers, and the National Weather Service are among 
the best performers, based on clear targets they have set and hard data 
that says these goals have been met or surpassed.
    A serious attitude toward performance is long overdue, but takes on 
special urgency at a time when the demands of national security assert 
a heavy claim on our resources. We hope the findings of this budget 
will trigger interest in performance assessment, and bring forth much 
new information about that large majority of programs for which we have 
no useful data at all.
Restoring Economic Growth
    This budget funds a two-front war, but takes aim at a third 
priority as well, the struggling American economy. The President urges 
the Congress to act, and act quickly, on a jobs and growth package like 
that which passed the House but was blocked in the Senate just before 
Christmas.
    There are some encouraging signs of recovery, but the President is 
not satisfied to leave matters to chance. Government cannot ``manage'' 
the economy, but it should do what it can, and the President wants to 
act on a stimulus measure that might accelerate and strengthen 
recovery. While adding this action to his other budget proposals would 
likely make 2003 a year of a small deficit rather than a year of small 
surplus, the President favors the tradeoff in favor of jobs and growth. 
Past the short term, it is only rigorous economic growth that can 
restore surpluses in any event.
Conclusion
    In sum, we should count our national blessings. Despite 
simultaneous war, recession, and emergency, we are in a position to 
fund the requirements for victory, plus a stimulus package, and still 
be near balance. The deficit we project will be the Nation's smallest 
in times of recession since the early 1950's.
    Interest costs to the Federal Government will continue to decline; 
interest payments will fall below 9 cents of each budget dollar for the 
first time in 22 years. Despite everything, the outlook is promising 
for balance in the year after next, and for a return to large surpluses 
thereafter.
    The President's proposals thus do what must be done, while 
protecting our fiscal future. It is a privilege to submit them for the 
committee's review.

                      the homeland security budget

    To develop the homeland security budget, the Office of Homeland 
Security and the Office of Management and Budget (OMB) identified those 
activities that are focused on combating and protecting against 
terrorism and occur with in the United States and its territories. Such 
activities include efforts to detect, deter, protect against and, if 
needed, respond to terrorist attacks.
    As a starting point, funding estimates for these activities are 
based on data that has been reported since 1998 in OMB's Annual Report 
to Congress on Combating Terrorism, and include combating terrorism and 
weapons of mass destruction (WMD), critical infrastructure protection 
(CIP), and continuity ot operations (COOP)
    In addition, homeland security includes funding for border securty 
(i.e. Immigration and Naturalization Service's enforcement and 
detention activities, Customs enforcement activities. Coast Guard's 
enforcement activities, the Agricultural Quarantine Inspection Program, 
and State's visa program) and aviation security.
    Since homeland security focuses on activities within the United 
States, estimates do not include costs associated with fighting 
terrorism overseas: those costs are captured within the war on 
terrorism abroad category.
    The budget uses the Combating Terrorism Report's definitions for 
combating terrorism and WMD preparedness, CIP, and COOP. Combating 
terrorism includes both antiterrorism (defensive measures used to 
combat terrorism) and counterterrorism (offensive measures used to 
combat terrorism), and includes the following five categories of 
activities as they directly relate to such efforts:

  law enforcement and investigative activities:
  preparing for and responding to terrorist acts:
  physical security of government facilities and employees:
  physical protection of national populace and national 
    infrastructure; and
  research and development activities.

    CIP is defined as efforts associated with enhancing the physical 
and cybersecurity of public and private sector infrastructures, 
especially cyber systems that are so vital to the Nation that their 
incapacitation or destruction would have a debilitating impact on 
national security, national economic security, and/or national public 
health and safety.
    COOP refers to the capability of Federal agencies to perform 
essential functions during any emergency or situation that may disrupt 
normal operations.
    As the Office of Homeland Security develops a comprehensive 
national strategy to secure the United States from terrorist threats or 
attacks, it may refine the definition used to establish the boundaries 
of this category.

    Chairman Conrad. Thank you, Mr. Daniels, for that 
testimony, and thank you for being here today.
    While we stand shoulder-to-shoulder with respect to the 
defense of the Nation, we do have profound differences about 
the wisdom of the fiscal course that you and the President have 
charted.
    It struck me today, looking at your budget, that if you 
were in the private sector and proposed a budget like this one, 
you would be headed for a Federal facility--it would not be the 
White House, and it would not be the Congress of the United 
States--you would be headed for a Federal correctional facility 
because it is violation of Federal law for a private sector 
entity to take the retirement funds of its employees and use 
them for another purpose. It is against the law to take the 
health care funds of its employees and use them for another 
purpose.
    In fact, as I recall, the Reverend Jim Baker, who used to 
head the PTL organization, went to jail for raising money on 
one basis and using it for something else. In fact, he served 
his time up in our part of the country, in Minnesota.
    The thing that I find most troubling is that in your 
budget, you are talking about just over the next decade taking 
$2 trillion out of Social Security, out of Medicare, and using 
those funds not for those programs but to pay for tax cuts, to 
pay for other Government expenditures.
    I would be quick to acknowledge that I could live with that 
in a year of economic downturn and at a time of war, but you 
are not forecasting economic downturn even for later this year; 
you are forecasting economic recovery--and for the rest of this 
decade, you are forecasting rather strong economic growth. Yet, 
year after year, you propose taking money from Social Security, 
taking money from Medicare, to pay for even more tax cuts, 
making permanent existing tax cuts costing more than $400 
billion in 2002 through 2011, every penny of which will come 
right out of the Social Security Trust Fund--something the 
President promised not to do.
    How do you justify it?
    Mr. Daniels. Mr. Chairman, let me say first of all that you 
are a good guy and a person I enjoy. We are both baseball fans. 
And if I wind up in a correctional facility, you will be my 
cellmate, and that will be quite pleasant; and we will have a 
lot of company there because, as we have discussed before, 
nothing comes out of the trust funds under your approach or the 
President's approach. Every penny of Social Security and 
Medicare benefits of course will be paid this year and in all 
future years. We all know that. And the trust funds will be 
exactly as big--$1.33 trillion this year, $1.5 trillion next 
year--exactly as big, have exactly the same assets in them--
namely, debt certificates--under any of these approaches, 
whether we have a giant surplus, exact balance, or some kind of 
deficit, it will not change by one cent.
    As we have often discussed, the question is to what purpose 
will the extra funds that for now are coming in through payroll 
taxes and the interest that we credit on those taxes be put. So 
to use what I think is very inaccurate vocabulary, if we dip, 
you dip. The question is for what purpose do you dip. You would 
dip to pay off debt--a very good idea and a very high priority, 
but not as high, very honestly, in this Administration as 
winning the war against terror and defending Americans at home.
    We talk a lot about things we must protect, and of course, 
Social Security and Medicare are at the top of that list, but 
with them, the most solemn responsibility of Government and the 
reason we have a deficit in this budget is to protect the lives 
of Americans.
    Let me just show one chart----
    Chairman Conrad. Let me just say before you do that--
because we have a vote on now, and I am going to have to leave 
to vote; but we will have a rolling chair. Senator Murray went, 
she is voting, she will return. But let me just say, because I 
am going to have to go and vote, as will Senator Domenici, that 
we just profoundly disagree.
    When you raise money from people from payroll taxes for 
Social Security and for Medicare, and you then take those 
dollars and use them to fund a tax cut and other spending, that 
affects the ability to meet the promise on Social Security 
because you have not used the money either to pay down debt or 
to fund reform of Social Security and Medicare.
    In the budget that I proposed last year, I not only saved 
every penny of the Social Security and Medicare Trust Funds for 
those purposes, but I also designated another $900 billion to 
strengthen Social Security for the long term.
    What you are doing is taking virtually all of the Social 
Security and Medicare money over the next decade and using it 
to fund other priorities, so it is not available to pay down 
debt, which would strengthen our position to keep the promise 
in the future, it is not available to reform Social Security or 
Medicare. The money is gone. And what we will be left with is 
what Director Crippen described--if we could just put that 
statement up one more time--because here is where we are headed 
with the course that you have charged.
[GRAPHIC] [TIFF OMITTED] 80544.048


    ``We will have to increase borrowing by very large, likely 
unsustainable, amounts; raise taxes to 30 percent of GDP, 
obviously unprecedented in our history; or eliminate most of 
the rest of the Government as we know it. That is the dilemma 
that faces us in the long term, and these next 10 years will 
only be the beginning.''
    Now, that is not my description of where we are headed. 
That is the director of the Congressional Budget Office's 
description of where we are headed----
    Mr. Daniels. Yes, but it is not his description of this 
budget. That is his description of where we were heading 
already given the long-term problems in our entitlement 
programs.
    Chairman Conrad. Ah, but Mr. Daniels, you do nothing but 
dig the hole deeper in this budget. You spend another $700 
billion beyond the baseline; you have tax cuts of $600 billion 
more in 2003 through 2012. All you have done is dig the hole 
deeper and deeper, and you are leaving the country in a 
circumstance which USA Today describes as threatening our long-
term financial security.
    Now, look--I am with you on the war effort. I am with you--
--
    Mr. Daniels. Well, that is the money you just criticized us 
for spending.
    Chairman Conrad. No, no, no, it is not, no, no. I am with 
you on the war effort, but you have asked here to make the tax 
cuts permanent. The tax cuts you had last year were based on 
the notion that there were there would be $5.6 trillion of 
surpluses over the next decade. Now we know that that is not 
the case, that those assessments were overly optimistic. But 
now you come and ask for another $600 billion of tax cuts and 
$700 billion over the baseline on spending.
    On the spending for defense, I am with you, I will support 
you every inch of the way, but I really cannot endorse--I think 
it is profoundly wrong; I think it is irresponsible to be 
taking $2 trillion out of the trust funds to pay for other 
things. And there is no plan here by this Administration in 
this budget except to dig the hole deeper. I just think that 
that is profoundly wrong.
    Mr. Daniels. Well, actually, to repeat, nothing comes out 
of the trust funds. They are just as big as they would be under 
any other circumstance.
    Second, I do not know and you do not know--no one can 
know--what our 10-year prospects really are. Two years ago 
today, we thought there was $2.9 trillion--that was the 
forecast of the previous Administration--over 10 years. That 
was the biggest prospective surplus of all time. Again today, 
we think it is $2.9 trillion. To be honest--and we have said so 
in this budget--I think this experiment of the last few years 
of trying to forecast out that far is proving to be a pretty 
dead-end exercise, because the numbers wander all over the 
place. I could easily be back here next year with another $5.6 
trillion forecast. It all depends on what we think happens to 
economic growth over that timeframe.
    Chairman Conrad. I apologize. We have less than 2 minutes 
left in the vote. I am going to go vote. Senator Murray will 
take over. The next round of questioning is on the Republican 
side. I do not know, Senator Smith, if you have had a chance to 
go and vote.
    Senator Smith. No.
    Chairman Conrad. OK. I will leave it in the hands of 
Senator Murray, and we will return as quickly as possible.
    Senator Domenici. Senator Murray, before I leave--I am 
walking out right now and will take my turn in normal order--I 
just do not want to let the record stand with the statements 
made by the Chairman as if those who have been working on this 
for a long time agree with those assessments. I do not agree 
with them at all, so we will have our chance during the next 
couple of hours to try to explain why.
    In the meantime, we will go and vote, come back and take 
our turn.
    Senator Murray [presiding.] Senator Smith, do you want to 
vote and come back?
    Senator Smith. I will just take up one question, Senator 
Murray.
    Mr. Daniels, thank you for being here. For my own 
clarification, if we vote to dramatically increase the 
agriculture budget, as advocated by the Chairman of this 
committee, won't that dip into the Social Security Trust Fund 
as he is describing it?
    Mr. Daniels. Yes, if you accept his characterization. There 
is $73.5 billion of additional agricultural spending 
contemplated in this budget that is consistent with the 
resolution of last year and the agreement of, I think, the two 
agriculture committees. And yes, exactly the same comments 
could be made about those dollars.
    Senator Smith. What I want to make clear is that what he is 
disagreeing with as I understand it are your spending 
priorities--he does not like the money going to the tax cuts, 
but he does like it going to the agricultural programs--many of 
which I support--but they both dip into Social Security as he 
defines this problem.
    Mr. Daniels. Yes. I will just say again that there is much 
we agree with the Chairman and his allies about. And we would 
like and we look forward to getting back to surpluses and 
devoting those payments--again, they do not go in a vault 
somewhere; they go to o ne purpose or another--he would like 
them to go to debt reduction, and so would we.
    Let me just make a point for the benefit of the audience. 
We could have a surplus this year and continue to paying down 
debt. If that were the No. 1 priority above and beyond all 
others, this would not be hard to do. We have on our baseline 
numbers a $51 billion surplus. But that would mean that we 
would not rebuild our defenses and fight the war; we would not 
strengthen our homeland defenses--that will take you down to 
that 20 bar; we would freeze the rest of Government, including, 
I should say, the single biggest factor there, which is farm 
spending, to take you to balance, where it says minus 3 there. 
You could have a balanced budget even doing those things, but 
we propose that we do attempt to put America back to work 
sooner with a stimulus package.
    Senator Smith. I do suspect that given farm spending, which 
I support, and tax cuts, which I support, that tax cuts are 
going to be more stimulative to the economy and get us back to 
growth more quickly than the farm program.
    Mr. Daniels, one thing I would like to ask you specifically 
is about a recent trip that I took with President Bush to the 
Youth Opportunity Center in Northeast Portland in my State. 
This is a valuable, effective program aimed at youth from 14 to 
21 years of age, and about 1,400 youth are enrolled there. 
These are at-risk youth, and they are afforded the opportunity 
by the center to get back to school, obtain a G.E.D., or 
explore other workplace options. It was my impression that 
President Bush was very supportive of the program, but it is my 
understanding that the budget that you are proposing cuts the 
program that he visited and seemed to support.
    I am wondering if you can explain whether this is really 
being cut, because the press is having a field day at President 
Bush's expense in my State.
    Mr. Daniels. Well, I am familiar with the program. As it 
stands, it is part of a pilot program that, like much in 
Government, was supposed to have a limited life span. Many such 
programs discover the secret of eternal life, it appears, and 
this one might become one of those.
    The good news is on two fronts. One, there is a larger and 
permanent program for youth opportunities that involves State 
grants, very large ones, much, much larger than the program you 
are describing. And if this is a successful center, there is 
not a doubt in my mind that it will be funded through that 
ongoing program for youth opportunities.
    The second piece of good news here is I believe there is 
bipartisan agreement on the need for more job training, 
particularly in a time of slowdown, and the President proposes 
a dramatic, about a $3 billion, increase overall in job 
training funds.
    We would like to concentrate those funds in the programs 
that work best. We find 48 programs littered across the Federal 
Government in some very unlikely places, many of them, 
attempting to train Americans for work. We have identified 28 
that seem to work pretty well, and we would like to concentrate 
the spending there. One of them is the Youth Opportunities 
block grant or State grant that I mentioned.
    So I am sure that center is doing good things and will be 
doing them under the President's budget.
    Senator Smith. They are, Mr. Daniels, and I hope you will 
commit with me to one way or another make sure that this 
program is continued and funded, because it is working, and it 
is helpful. And through one fund or another, I am anxious that 
the President be able to keep his promise to the young people 
who are there. It is very, very important to me and to them and 
to our country that we get this kids back on the right road.
    Mr. Daniels. I am glad to work with you.
    Senator Murray. Director Daniels, thank you so much for 
being here today.
    In recent days and in your op-ed article that I read over 
this past weekend, you said that our country ``will need to 
make sacrifices on the domestic front to pay for the needed 
investments in security.'' And, as you noted, ours is not the 
first generation of Americans to face this kind of challenge. 
Our fathers and mothers, our grandparents, and other 
generations of Americans have really struggled to protect 
America's freedoms.
    In World War II and in the cold war, we faced a grave 
threat to our existence, and the people in my home State of 
Washington were asked to take up the challenge of the Manhattan 
Project. Throughout the cold war, the people of the Tri-Cities 
in Washington State produced the materials that went into our 
strategic arms. We won the war because of the sacrifice of the 
people in that community.
    One legacy of that sacrifice is the freedom we enjoy today, 
but there is another legacy that really weighs on all of us in 
the Pacific Northwest, and that legacy is nuclear waste. We 
have one of the most polluted sites in the world, the Hanford 
nuclear facility on the banks of the Columbia River. I know 
that my friend and colleague from New Mexico shares my passion 
for this particular issue, and he has been just great to work 
with and to help and support us with this.
    But unfortunately, President Bush's budget for the second 
year in a row underfunds the critical cleanup effort that is 
required at Hanford nuclear reservation. I think this is an 
example that is indicative of a larger problem with this 
budget. President Bush's priorities in this budget do not 
reflect the priorities of many Americans in this country, 
whether it is Hanford cleanup funds or Social Security and 
Medicare Trust Funds.
    The truth is we all know that we are in this position in 
part because of the recession, in part because of September 11, 
and in large part because of the President's tax cut, which all 
of you told us would get us out of this recession.
    Mr. Daniels, last year, when we heard rumors that the 
President's budget was going to cut Hanford funding, I called 
you, and you assured me that Hanford would not be cut; but when 
the budget came out, Hanford funding was cut and cut 
dramatically.
    Mr. Daniels, I want to ask you this morning--do you agree 
that given the sacrifice that the people of the Tri-Cities have 
made to help us win World War II and the cold war that we now 
have an obligation to clean up the waste at Hanford nuclear 
site?
    Mr. Daniels. Absolutely, Senator, and the good news I hope 
is that this Administration in this budget has launched a 
substantial reform of what has really been a poorly run 
program----
    Senator Murray. Are you saying that Hanford nuclear 
reservation has been poorly run?
    Mr. Daniels. I am saying that across the front of these 
environmental cleanups, it is unacceptable that we will still 
have nuclear waste lying around in 70 years, and that is the 
situation that this Administration found when it came to 
office. And in this budget, we propose, first of all, more 
spending; second, more importantly, a reform----
    Senator Murray. I am sorry, Mr. Daniels. The way I read 
your budget, Hanford gets a lot less money in this budget.
    Mr. Daniels. Well, we will work with you to find the right 
amount of money, but the most important thing is how we spend 
it, and we have been spending billions of dollars. We have had 
$73 billion in projected cost overruns across the front of 
these sites. This needs to be addressed, and Secretary Abraham 
has an aggressive plan to do it.
    The idea would be to get these sites cleaned up more 
quickly under new contracts, and if that costs a little more 
money in the short term, we will----
    Senator Murray. Mr. Daniels, aren't you aware that there 
are contracts in place that if we do not fund them correctly to 
begin with, those contracts are going to cost us more in the 
future. If we undo those contracts, take our name away from 
them, they are going to be renegotiated; and I have never seen 
a contract renegotiated for a lesser amount.
    Mr. Daniels. Well, I would recommend you talk with 
Secretary Abraham about it. He has a very active plan. These 
arrangements, as I said, are frankly unacceptable and I think 
would be to you, too.
    I do not know the end date for Hanford off the top of my 
head, but I know that many of the other sites would be sitting 
there for decades under the existing contracts. This is a 
terrible----
    Senator Murray. Well, Mr. Daniels, I will remind you that 
there is a tri-party agreement in place, and we are under a 
legal obligation to clean up Hanford nuclear reservation. My 
home State of Washington has been on the verge of a legal 
challenge to this for years, and none of us wants to go down 
that road; but if we do not fund the cleanup of Hanford, it not 
only puts the lives of the people in the Tri-Cities at stake as 
well as the entire Pacific Northwest, it does not fund a legal 
obligation that we have that may well see a challenge from the 
State of Washington, and it is the wrong message to everyone 
that we are asking today to make a sacrifice for the war that 
we are in today--that we are not going to be there to help you 
when that war is over.
    Mr. Daniels. Senator, our objective is to see these sites 
cleaned up more quickly. I think that would be your objective, 
too.
    Senator Murray. Well, it has been my objective and my 
State's objective, too.
    Mr. Daniels. This is not about how much money we can pour 
into bad contracts; it ought to be about how much we can spend 
more productively.
    Senator Murray. Are you saying the contracts that we have 
in place at Hanford today are bad?
    Mr. Daniels. That is a question for Secretary Abraham. It 
is his plan that our budget reflects.
    Senator Murray. Well, I certainly will ask him as well. But 
I will tell you, Director Daniels, that I will not let my State 
down on this. I am going to do everything I can to meet the 
obligation to the people of my State who sacrificed for our 
freedom.
    If my time is not up, I want to ask you one other question. 
Your budget assumes a major reduction in transportation 
spending. In Washington State, we have the second-highest 
unemployment in the Nation right now. We have the second-worst 
traffic in the Nation. This is putting a huge economic burden 
on our families and our businesses. It means less productivity, 
and it means less efficiencies. Businesses are leaving my State 
right now because of the lack of investment in infrastructure 
and transportation. Cutting the budget by $9 billion is not 
going to help.
    Does this Administration realize that transportation 
infrastructure affects our jobs, affects our productivity, and 
affects our future economic growth?
    Mr. Daniels. Yes. Let us start by dealing with some of 
those pesky facts, Senator. We have no discretion in this 
matter. Congress passed a bill--it was a good one, by the way; 
I think you voted for it--that matches spending with 
transportation tax and fee income, and we simply apply a 
formula. The Departments of Transportation and Treasury do 
that, as you know. And last year, that led to a gigantic 
increase in transportation spending, in highway spending 
specifically.
    Under that formula which Congress prescribed, as applied 
this year, we discover that we got way ahead of ourselves--$4.5 
billion ahead of receipts last year. And we have simply 
faithfully applied the same formula that led to a $4.5 
billion--I will not say ``windfall''--let us say ``advance''--
--
    Senator Murray. Investment in infrastructure.
    Mr. Daniels [continuing]. Well, let us say ``advance''--and 
now we are catching back up.
    The bill that Congress wrote is a good one. It has led and 
will lead through the end of this budget year to $9 billion in 
additional highway spending over the previous system. Up until 
a few years ago, as you know, gas tax revenues and other 
transportation revenues were used for other purposes, and you 
fixed that, but----
    Senator Murray. My time is up, Director Daniels, but I 
would just say that we did have an opportunity in this budget 
as presented by the Administration to help make up some of that 
shortfall if the priority was there from the Administration and 
understanding that investing in our critical infrastructure, 
our roads, our bridges, our highways, not only would help jobs 
today, which is an important part of economic recovery, but 
also would provide critical infrastructure for economic 
development in the future.
    Mr. Daniels. Well, we agree with the beneficial aspects and 
the importance of this spending. Over the 2-year period, the 
same amount of money will be spent, much more than previously. 
And incidentally, you might be happy to know that because we 
are talking here about how many new projects to start on an 
outlay basis--how much is spent, how many miles are actually 
paved, how many people are actually employed--it is virtually 
identical to last year, or I should say that fiscal year 03 
will be identical to the current fiscal year.
    So we think this formula that Congress wrote is a good and 
fair one. We have simply applied it as the law requires we do, 
but I think it is a little unseemly for road builders and 
others, who loved it when it led to a giant increase, an 
accelerated increase, to protest when the same formula corrects 
itself.
    Senator Murray. I am not a road builder, but I do care 
deeply about my State and its ability to have the 
infrastructure it needs for the future.
    Thank you, Director.
    Mr. Daniels. Thank you.
    Senator Murray. Senator Gregg.
    Senator Gregg. Director, as I was listening to this 
discussion, there seems to be a bit of a refrain that it is the 
tax cuts that are generating the reduction in the surplus and 
the deficit. And I have not yet heard anybody from the other 
side other than Senator Kennedy suggested that we should 
increase taxes, but that would appear to be the logical 
conclusion of some of the statements from the other side if 
they are going to continue to allege that it is the tax cuts 
that caused the problem.
    Let me just ask you a couple of questions on that point 
specifically. If I look at these budget numbers correctly, the 
Social Security surplus is $161 billion this year, $160 billion 
next year, and $178 billion in fiscal year 2004. The tax cut 
this year would represent $38 billion; in fiscal year 2003, it 
is a $91 tax cut; and in fiscal year 2004, it is $108 billion.
    So clearly, to the extent the Social Security surplus is 
being used, especially in this budget that you have presented, 
the tax cut represents a fairly small percentage of that, if 
you want to argue in those terms, and the larger percentage if 
obviously spending by the Congress.
    And as I listen to the members of this panel discuss this 
issue, it is clear that spending may not be enough according to 
some members of this panel. So it is an inconsistency that I 
think needs to be pointed out.
    Second, there is the argument that what we have lost here 
is the ability to reduce the national debt, which is true, by 
losing the surplus. But on the other side of the coin, if you 
eliminate the tax cut, you appear to be hitting the American 
people with a double hit--not only do they lose the reduction 
of the national debt, which is unfortunate, but they also lose 
getting the money in their pockets. Where does the money go? 
Well, it is going to be spent under the discussions that have 
been stated here. Any reduction in the tax cut clearly is going 
to be used for new spending; it is not going to be used to 
exaggerate the surplus, because under the numbers that we are 
looking at, $38 billion for this year, we would not cover the 
deficit--you would have to spend it.
    So there seems to be an inconsistency and a contradictory 
view there. I would be interested in your general reaction to 
these statements which we have been hearing.
    Mr. Daniels. I will not attempt to interpret the criticisms 
of the tax cut as a call to increase taxes, but there is some 
data that might be of some use, if I can get a little help.
    Senator Gregg. I am especially interested in your comments 
on whether we should leave the money in the American people's 
pockets as a tax cut versus taking it back into the Government 
and spending it.
    Mr. Daniels. I think you can guess my view on that, and I 
think it is particularly interesting to ask the question 
exactly whose tax cut would you take away--is it the single 
mother at $25,000 who, if we took the tax cut away now, would 
lose $305 in the next fiscal year? Is it the dependent child 
care credit that we would take away? Is it the marriage penalty 
repeal that we would reinstate? But the question is rarely 
asked that way.
    Let us just note that across this time horizon, revenues 
are growing very fast. Revenues are growing by 55 percent. And 
the tax cut itself makes very, very little difference in that 
for some time. Less than one-quarter of the tax relief comes in 
the first 3 years and only 40 percent in the first 5 years.
    So for those who believe that the American public is 
undertaxed, there will be multiple opportunities to espouse 
that point of view. Let us just look at where we stand as a 
taxpaying citizenry.
    After tax relief--after tax relief--the take on the 
American public remains historically high. The post-war average 
on the red line--you can see that we are still above it and 
will be consistently throughout this time period after the tax 
relief. It was necessary simply to hold the take on the 
American people at 19 cents on every dollar this economy 
generates. If I showed you the same chart for individual income 
taxes, you would find it remains at all-time highs after tax 
relief.
    So the President's point of view would be that our problem 
is not a lack of revenue or the fact that the American people 
are not being taxed aggressively enough. Our issues really are 
those of controlling spending and certainly of making sure that 
high taxes do not strangle the economic growth on which alone 
our hopes of big surpluses rest.
    Senator Gregg. On the first part of your comment there on 
the issue of economic discipline, as you know, the caps have 
been adjusted, and the caps have lapsed, and we have basically 
shredded the caps. And we have no enforcement mechanism on the 
economic discipline side.
    I am wondering how the Administration would react--assuming 
the Administration's budget were put in place--setting a new 
set of caps which would mirror the spending numbers in the 
Administration's position and putting in enforcement mechanisms 
such as sequester, which would be effective to enforce those 
caps.
    Mr. Daniels. Yes, Senator, we would be very amenable to 
that. The caps that have just expired, although they were often 
violated and were sort of a crude instrument, did have a 
beneficial effect, and we do believe the President would like 
to see some new mechanism put in place. The one that he has 
consistently proposed is to make the budget resolution a law, 
one that he would sign that would have binding effect probably 
stronger than the caps of old, and we would be happy to work 
with the Congress on that. Doing that would accomplish the goal 
that you just mentioned of locking in spending at the levels 
agreed to.
    Senator Gregg. I doubt that we will go the route of making 
it law, although I would be amenable to that in some ways, and 
when I served as Governor, of course, that is the way the 
budgets worked in the States; in almost all States, the 
Governor signs the budget. But I would be interested in getting 
some other proposals on caps and mechanisms for enforcement 
from you folks. I think we need to move that type of language 
with this budget resolution or possibly with other 
opportunities that are going to come at us here.
    Thank you.
    Chairman Conrad. Senator Feingold.
    Senator Feingold. Thank you, Mr. Chairman, and thank you, 
Director Daniels, for being here today to present the 
President's budget. We have had the document for less than a 
day, so I look forward to examining it in detail, but already 
an overall view of it gives me some concern.
    As others have noted, the President's proposal would result 
in deficits for each of the 5 years covered by this budget, and 
I understand that it is also likely that it would result in 
deficits for each of the next 10 years as well.
    This obviously is a tremendously different budget landscape 
from the one that was presented to us last year. CBO Director 
Crippen told this committee just a few days ago that there has 
been about a $4 trillion deterioration in the 10-year bottom 
line over the past year. Some of it is due to the slowing 
economy, but we also know that most of it was due to the 
spending and tax cut policies that were actually enacted last 
year. Only a fraction of that was in response to the terrorist 
attacks, and as the Chairman ably pointed out at the beginning, 
the great bulk of those policies came long before September 11.
    It is crystal clear that the policies enacted last year 
have resulted in a greatly diminished budget position, a 
greater debt burden for our children and grandchildren, and 
that in many ways, it has squandered the opportunity to address 
the long-term challenges of Social Security and Medicare, and I 
would certainly add to the list the very important and looming 
problem of long-term care.
    I regret that in too many ways, this budget proposal really 
offers more of the same. And clearly, some of us have a much 
different view of the direction we should be taking with the 
budget than the Administration, but I do look forward to a 
fuller discussion on our budget priorities as the committee 
works toward a budget resolution.
    On the positive side, though, I do want to take this 
opportunity to praise the Administration for their efforts with 
regard to earmarked unauthorized spending. Many of us on the 
authorizing committees enjoy our work very much and look 
forward to playing a role in reviewing proposals for 
authorizing spending. When a program is included in an 
appropriations bill without having been vetted by the 
authorizing committee, there is a much greater possibility of 
mischief. And beyond that, by ducking the usual scrutiny of the 
authorizing committees, these earmarks not only open the door 
to wasteful spending, they also undermine funding for other 
worthy programs.
    Let me note that many of these earmarked programs may well 
be worthy of taxpayer support. But taxpayers are better-served 
if proposed spending is subjected to regular congressional 
scrutiny and, whenever possible, a more competitive process. So 
let me applaud the Administration's efforts to crack down on 
this kind of earmark, and let me know what I can do to join in 
the effort.
    In that regard, I wonder if you could give us an idea of 
just how big the problem is of these earmarks.
    Mr. Daniels. I appreciate your comments very much, Senator, 
so let me just say that that makes two of us, and as far as I 
know, there may only be two of us.
    I believe this problem has to be kept in some perspective. 
Each time we have raised it, we have done so really in the 
context not of the phenomenon itself, which is as old as the 
Republic, but of the explosion in special projects over the 
last few years. We have now reached a state where in 5 years, 
they have multiplied 700 percent--7,803 of them that we can 
find in the budget just passed. We simply suggest that this 
trend ought to be flattened or moderated, and we are not having 
much luck with that so far.
    I do think that it is not good government, generally, to 
earmark; in some cases, 100 percent of the funds in programs 
that Congress has authorized have been earmarked. There is 
literally nothing for the executive branch personnel to do, 
because each dollar has been steered to some specific place.
    So we would hope in a reasonable way to simply persuade the 
Congress to rein this in. It has been with us and I am sure 
always will be, but we do think it has gotten out of hand, and 
we appreciate your advocacy very much.
    Senator Feingold. Are there any concrete steps that the 
Administration is likely to take to try to deal with this 
problem that you can outline?
    Mr. Daniels. I would like to proceed through reason and 
compromise, and as I said, it has not proven particularly 
successful so far, but we do hope that continued dialog will do 
a little good.
    Senator Feingold. Let me suggest you might need a little 
more than that, and perhaps we should discuss some 
alternatives.
    Mr. Daniels. I very much appreciate your advice.
    Senator Feingold. The other question I want to ask has to 
do with the fact that I know that the President supports moving 
to a biennial budget, and that is something that I have 
advocated and am pleased to join our distinguished ranking 
member as a cosponsor of the legislation that would move us in 
that direction.
    Could you say a little bit about why the President does 
favor moving to a biennial budgeting system?
    Mr. Daniels. Senator, the President does believe it would 
be an important reform, and given the size at $2.1 trillion of 
spending now, the complexity with over 2,000 separate programs 
and activity categories to deal with, and given the need to do 
a better job at oversight by the Congress as well as management 
by the executive branch of all those dollars and programs, if 
we were somehow able to agreed to this reform, it would leave 
more time for the Congress and for the Administration to tend 
to how the dollars are spent.
    Last year, obviously, events intervened, but once again, it 
was Christmas-time before we had the budget, and the Congress' 
and ours was consumed overwhelmingly with simply getting to 
that point.
    So trying to accomplish that in 1 year and being able to 
devote the rest of the time of a biennium to seeing that the 
money is spent well I think would be a great step forward. I 
know there is a lot of good faith opposition to the idea, but I 
appreciate your keeping it afloat.
    Senator Feingold. Thank you, Mr. Director.
    Thank you, Mr. Chairman.
    Chairman Conrad. Senator Clinton.
    Senator Clinton. Thank you, Mr. Chairman.
    I appreciate the comments that the Chairman made in 
response to this budget. Obviously, all of us are still 
digesting it as is the case with a very large and complicated 
document such as this. But I am particularly concerned that 
there is no direct reference to aid for New York in the Budget. 
And yesterday, Director Daniels, in discussing emergency aid 
for New York, you said, and I quote: ``It seems strange to me 
to treat this as a money-grubbing game.''
    Now, I have to tell you that we were shocked by that, and 
the shock was felt throughout New York; it was in the headlines 
of our newspapers, and the tabloids obviously had a field day 
with it, because it was so unbelievable that something like 
that would come out of the mouth of the OMB Director.
    Clearly, we have all recognized that the September 11 
attacks on New York were an attack on America. The majority of 
people who lost their lives that day were from the New York 
area--not all New Yorkers, but certainly predominantly. And New 
Yorkers were heartened on September 20, when the President 
promised to rebuild New York.
    Now, I know that the President is scheduled to visit New 
York tomorrow to salute the heroism of our police and 
firefighters and our first responders, and I appreciate your 
including the picture of Ground Zero and the firefighters in 
the budget. But my first question is do you speak for the 
President when you call New York's request for emergency 
disaster aid a ``money-grubbing game''?
    Mr. Daniels. Well, Senator, it is a very fair question. I 
remember that Winston Churchill once said that he frequently 
had to eat his words, and in general, he found it a wholesome 
diet; so maybe I am in that position.
    I regret if my comment was misconstrued, so let me tell you 
exactly what I think, and I think it is consistent with your 
views.
    The President's commitment to $20 billion of aid is both 
inviolate and, frankly, well within our view. It will take some 
years to get there because the commitments that the Federal 
Government made, the unprecedented commitments of support--100 
percent funding of infrastructure and other rebuilding and so 
forth--will in many cases take years to complete, and we will 
not know the real tally until that happens. But I do not have 
any doubt at all, as we have often discussed, that that will 
substantially exceed $20 billion, and it should.
    I expressed in a poorly chosen word, I think, only this 
frustration--I have been in lots and lots of meetings, and we 
are working hard on this; you have held our feet to the fire, 
and that is as it should be--that in many of the meetings with 
either reporters or advocates for New York, it is hard to get 
to the question on what are we trying to get done. People want 
to sort of start and stop with how many dollars.
    For instance, it would be terribly wrong if we got to some 
magic tally of $20 billion and quit and said, ``Good. Case 
closed.''
    Senator Clinton. Well, we do not expect that.
    Mr. Daniels. Right. And we do not intend that.
    So that is all I really meant, was let us try to focus more 
often on what are we going to get done together.
    I will give you the best example, as you well know, of some 
unfinished business. The President supported the Liberty Zone 
concept, $15 billion of investment that would be triggered by 
guaranteed loans for New York. It was in the stimulus package 
that did not quite get across the line in December, and we 
ought to get that done. That is the biggest missing piece now 
in a total package that is, again, I assure you, going to go 
well beyond $20 billion.
    Senator Clinton. I appreciate that clarification, and I 
will certainly work with you and the Administration and our 
colleagues here in getting that Liberty Zone tax policy 
through, because I agree with you--I think that is one of the 
missing ingredients.
    But I also just want to clarify for the record, Director 
Daniels, that you are therefore not counting the victims' 
compensation fund as aid for New York. That is a different 
category which is mandatory spending; is that correct?
    Mr. Daniels. Well, it is. I think that when history writes 
the story, it would be only fair to recognize this again 
unprecedented expression of compassion and support from the 
rest of the American taxpayers----
    Senator Clinton. I agree.
    Mr. Daniels [continuing]. But I think we are going beyond 
$20 billion before and without counting that. And please tell 
New Yorkers we love them, we admire them, and we are going to 
keep the President's commitment to the last.
    Senator Clinton. That is very welcome news, and I 
appreciate that tremendously.
    I just have a few other specific questions, and again, this 
may be easily answered in the budget, but I would like your 
guidance.
    I do not find in the budget any commitment to fund the SEC 
pay parity which Congress passed authorized increases for in 
December. And certainly in light of what we are going through 
now with Enron and the accounting issues that are being raised, 
it is very difficult to imagine that we are going to get the 
staff assistance that we need and keep down the employee 
turnover without that SEC pay parity.
    Is that in the budget, and I am just missing it, or is that 
a commitment that we can count on from the Administration?
    Mr. Daniels. A first step toward higher pay and perhaps 1 
day to parity is clearly in the budget. We have $19 million, as 
I recall, in unspent funds that we have authorized using for 
this purpose, as well as some new money. Going straight to 
parity by the definition at least of some people would lead to 
a dramatic increase in spending, and we do not think the case 
has yet been made, at least for what some people are calling 
for--dramatic, 20-plus percent increases for the entire agency. 
But we have had extensive conversations with the Chairman--he 
is an advocate of doing more faster than this budget suggests--
and we will be working with him over the days ahead to make 
sure he can keep the best people he has. We want him to be able 
to reward the best people that he has. Their work has never 
been more important.
    So I would characterize this budget as taking a first step, 
and we anticipate it is only the first step.
    Senator Clinton. Well, Director Daniels, I would just refer 
you to the legislation that we passed. Obviously, the Congress 
believed even before the Enron/Andersen matter was quite as 
difficult as it appears to be that we should have parity with 
other regulatory agencies such as the FDIC. I think it is 
certainly critical to be sure we do have the resources, so I 
hope that that can be moved on quickly.
    If I could, one last issue that I am concerned about--I am 
concerned about a lot of issues, and I join my colleagues in 
their concern about job training and Federal highway funding--
but I was surprised to see a dramatic reduction in Federal 
payroll tax revenues for the Federal unemployment system.
    As I read the budget, you are calling for a dramatic 
decrease in the annual payment per worker to support Federal 
and State unemployment, and in effect shifting much of the 
responsibility for funding unemployment operations onto the 
States. Is that a fair reading of the budget as it currently 
is?
    Mr. Daniels. Secretary Chao--and she is only the most 
recent person to propose this kind of reform--does suggest that 
we do undertake a fundamental reform of unemployment insurance 
to make it more flexible and to make it more effective, and 
accompanying this reduction would be a return of $9 billion in 
funds that have been collecting in the Federal fund for this to 
the States which we think they could use to begin strengthening 
their local systems as they see fit. We would like to see the 
States take over administration--actually, they have the 
authority or the responsibility for administration now--we have 
this sort of jury-rigged arrangement where the money comes to 
Washington and is then metered back out.
    So we think that at the same time that we--I hope--extend 
unemployment benefits to workers who lost their jobs in this 
recession, we ought to clean up and reform the system that gets 
those benefits to them.
    Chairman Conrad. The Senator's time has expired.
    Does Senator Snowe seek to use her time now, or would you 
prefer that we----
    Senator Snowe. Are you going to go one more round? Who was 
here previously?
    Chairman Conrad. Senator Hollings is next on our side, but 
you are next on your side, and we have been going back and 
forth.
    Senator Snowe. Senator Hollings can go ahead, and I will 
follow him.
    Chairman Conrad. All right.
    Senator Hollings. Thank you, Director Daniels.
    Is it the case that you have attested that you project for 
2002 a deficit of $106 billion?
    Mr. Daniels. Yes, sir.
    Senator Hollings. And yet I am looking at page 417 of your 
budget, and you show that the debt goes from $5.770 trillion to 
$6.137 trillion. In other words, the debt goes up $367 billion; 
yet you say it only goes up $106 billion.
    How do you explain that?
    Mr. Daniels. Both of your statements are correct, Senator. 
You correctly point out that when we also add to the operating 
deficit of the Government those accruing interest obligations 
we owe to the various trust funds, as we should, the overall or 
the gross debt, as we say, of the Federal Government does 
increase by that amount.
    Senator Hollings. Well, those interests costs, turning to 
page 347 and 348 of your allied document, you show the interest 
as credited to each one of the trust funds; is that correct?
    Mr. Daniels. Yes, sir.
    Senator Hollings. And then, on page 348, we find out that 
it is deducted from those in order to lower the deficit. In 
other words, you accredit it to the trust fund and then you 
accredit it to lowering the debt. That is correct, isn't it?
    Mr. Daniels. Well, sir, I think you have very helpfully 
drawn our attention again to the growing obligations that we 
have--the solemn obligations, but growing--in the various trust 
funds of Government, and that is accounted for in just the way 
you stated it.
    Senator Hollings. But that is a double entry. That is the 
kind of Enron bookkeeping that we are all looking at; isn't 
that right?
    Mr. Daniels. I do not agree with the characterization. It 
is the way the Government has always done this, and both 
numbers, of course, are accurate, and both are sound.
    Senator Hollings. Well, the debt is the debt, and as to how 
much the debt goes up, you sh ow it going up $367 billion, not 
$106 billion.
    Mr. Daniels. Yes, sir.
    Senator Hollings. And the only way you can get down to $106 
billion is to accredit the moneys to the trust funds on the one 
hand and then take it away on the other. You count it in two 
places--you count it to the trust fund, and you count it to the 
overall debt. That is double entry. That is exactly how you 
can--well, in fact, they wrote an article last week in Business 
Week entitled, ``Who Else is Hiding Debt?'' I looked to see 
whether our names were there, because we have been doing this 
in the Congress for quite some time, hiding the debt.
    The truth is that when you use the Social Security Trust 
Fund, under Section 13.301, you are forbidden to report a 
budget that includes the Social Security Trust Fund; isn't that 
correct? That is Section 13.301 of the Budget Act that we 
passed almost unanimously. There was only one dissenting vote 
in this committee when we passed it, because we were trying to 
get at that double accounting, and we accounted for Social 
Security, and then we accounted to reduce the debt, and that is 
exactly what we are talking about--hiding debt. That is the big 
problem right now with Enron; they hid the debt all the way 
down to the last quarter, and then it all collapsed. Isn't that 
correct?
    Mr. Daniels. Well, I do not think it is exactly hidden, 
Senator. You just found it and read it to us quite accurately. 
We will be dealing with it again fairly soon--``it'' here being 
the gross debt of the Federal Government--we will be dealing 
with it fairly soon, because we will be bumping up against a 
limit that relates to that.
    Some have suggested, and it is being suggested again now, 
that we ought to concentrate on the debt that Senator Conrad 
quite rightly wants us to pay, to pay down the outstanding 
debt, the public debt of the Federal Government, and that we 
ought to make that what we limit so as not to mix these 
concepts. But both are very important, and I appreciate your 
drawing our attention to them.
    Senator Hollings. Well, these trust funds--we owe them some 
$2.335 trillion right this year and next year--these are CBO 
figures, and maybe you would contest them; I do not know--
$2.558 trillion. Isn't that correct?
    Mr. Daniels. That is about right, yes, sir.
    Senator Hollings. That is about right, and that is what the 
market is looking at. If the debt is going up, and the interest 
cost goes up under your particular budget to $440 billion--it 
is right at $360 billion right now, and under your budget, it 
goes up to $440 billion--that is over $1 billion a day, and 
that is the first thing that Wall Street will say wait a 
minute--that Government is coming in here with sharp elbows, 
and they are going to be borrowing money, crowding out private 
capital, and they are all talking about consumer confidence, 
consumer confidence--it is market confidence. Isn't that our 
problem--paying down the debt? We did that for 8 years, it gave 
us an economic boom, and now we are increasing the debt--more 
tax cuts, more giveaways here, more tax cuts there--we 
eliminate all the revenues, and the debt goes up; isn't that 
correct?
    Mr. Daniels. In general, your points are well-made. Just 
for clarity, we will not be crowding out all that in the 
marketplace. We will have to borrow about $180 billion, which 
is flat, by the way, with last year.
    One of the many points of comfort that the committee should 
take and the American people should take about our current 
fiscal situation is that, thanks to the good work of the past, 
interest costs, the dollars we actually pay out, are not 
growing, and it is one reason that total spending is kept under 
some control. Because of debt paid out in the past and lower 
rates, we are going to spend only about the same amount, $180 
billion versus $178 billion, in actual interest costs.
    Now, the rest that you are talking about is a paper 
transaction. We credit faithfully interest to all the trust 
funds of the Government, some 109 of them, and that is an 
important number to keep an eye on, too. I will tell you what 
it really tells us. It tells us that we do not solve our long-
term Social Security and Medicare problems simply by paying 
down debt. If we do not reform those systems so they can meet 
those obligations, we will not be able to tax our way or borrow 
our way into solvency 1 day.
    Senator Hollings. But the point is that we really hide the 
debt, because the debt actually goes up $367 billion, not just 
$106 billion.
    Mr. Daniels. Well, we did not hide it too well, Senator. 
You did not have any trouble finding it--and thank you for 
identifying it for us.
    Senator Hollings. Thank you for acknowledging that, sir.
    Mr. Daniels. Yes, sir.
    Senator Hollings. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Snowe, and then Senator Nelson.
    Senator Snowe. Thank you, Mr. Chairman.
    Welcome, Director Daniels. I certainly want to commend the 
Administration for making the economic stimulus plan one of the 
centerpieces of your budget, and I notice that that is outlined 
as one of the three major objectives of the President's budget, 
to obviously try to stimulate a recovery even though there are 
at least some initial signs to suggest that we might be 
emerging from this recession.
    Two weeks ago, Chairman Greenspan testified before this 
committee, and he mentioned the fact, in response to whether a 
stimulus plan would be necessary, that the economy will recover 
in any event--although in response to my question, he also went 
on to say that with the potential that the economy more tepid 
that we would like later on this year, some form of stimulus 
program probably would be useful.
    It is interesting to note in the CBO projections of the 
surpluses and the decline in surpluses and economic growth that 
primarily in the next 10 years, the loss of surplus is 
occurring in 2001 and 2002 as a result of the recession and 
obviously what occurred on September 11 and the associated 
requirements to meet that challenge.
    That is why I happen to think in looking at those numbers 
that that is pivotal to enacting a stimulus plan the type, of 
course, that would produce a change in short-term behavior, 
because if in fact those numbers are correct even to a large 
extent, it means that we have to do all that we can right now 
to turn the economy around and have an impact on the deficit-
surplus picture in the short term that obviously would affect 
the long terms, because they project even higher economic 
growth than they did a year ago for years beyond 2005 to 2011.
    So I really do think that it is going to be essential to 
pass a stimulus package, and I know that many of the economists 
in the Administration have projected that we could double our 
economic growth, that we could produce 300,000 jobs--I think 
that was a White House projection--if we passed a stimulus 
package.
    To what extent have you factored this into the budget, and 
how essential is it to pass a stimulus plan to recover in terms 
of job creation?
    Mr. Daniels. Senator, the President would agree with you 
that this is worth doing and is important to do--not to leave 
it to chance. There are very encouraging signs that recovery is 
coming, but not sufficient for him to believe that it is smart 
for us to rest on our oars or trust to luck. If we can do 
something soon and something truly stimulating--I think it is 
very important that any measure that Congress passes actually 
have at its core the creation of new jobs--but if we can do 
that, the President very much favors it, and let me just 
illustrate the tradeoff it involves. We talked about it briefly 
earlier.
    We could have a surplus this year without question in our 
numbers, and we could use that money to continue paying down 
debt as we want to do--but three other priorities come first. 
If we want to wage the war on terrorism aggressively, if we 
want to defend our homeland, we will need to spend some money. 
That is the second bar from the left. The rest of Government, 
although we propose that it grow slowly, we still suggest that 
it be allowed to grow at a couple percent, and that is 
reflected in the third bar from the left.
    Then comes the stimulus plan. We would be in balance but 
for the stimulus plan. So it is a tradeoff. You will not be 
surprised to hear me say how little I like red ink; I probably 
have as much aversion to it as anybody in the room, including 
your Chairman. But the President would agree that under these 
circumstances, the best thing to do short-term for people who 
are out of work today or whose jobs are threatened, and long-
term in terms of getting us back on a path that produces big 
surpluses, is to act and act soon.
    Senator Snowe. That is certainly the view that I share, 
because frankly, I am concerned about what type of recovery. It 
could be a jobless recovery as some have suggested, similar to 
what occurred in 1991 when we were emerging from that 
recession. So that is why Chairman Greenspan said if you have a 
tepid recovery, which is in all likelihood, clearly, the kind 
of stimulus package that we would pass now--not 4 months from 
now or 5 months from now; it should have been done months ago, 
and it has not happened--clearly could have a material impact 
on the type of recover. Would you agree?
    Mr. Daniels. Yes, ma'am.
    Senator Snow. In addition, one other issue that Senator 
Stabenow and I have worked on consistently in this last year, 
along with Senator Bayh and others, is the issue of the trigger 
mechanism. Frankly, I feel even more convinced that this is 
absolutely essential for economic well-being and our fiscal 
health.
    Many people talk about Gramm-Rudman-Hollings and say it was 
not an effective mechanism. If you look at the numbers in terms 
of controlling fiscal spending back then, 5 years prior to 
Gramm-Rudman and the 5 years after, it was a dramatic 
turnaround in the impact that it had in terms of the growth of 
spending.
    So I think it is important that we move in that direction. 
In fact, those numbers would suggest that in the 5 years 
preceding Gramm-Rudman, discretionary spending grew by an 
average of 8 percent annually and 47 percent overall; in the 5 
years after, it grew only 2 percent annually and 11 percent 
overall.
    I think the point is that last year, we were talking about 
10-year projections, and we were worried about the 10-year 
projections. Now, we saw $4 trillion evaporate in 1 year, 
obviously for circumstances that we could not foresee or 
anticipate--but that is the point. That is the point of having 
a mechanism, and in fact, Chairman Greenspan was the one who 
suggested a year ago to our committee--in his testimony, he 
reiterated his support for a mechanism that would be automatic; 
it would have to be something that Congress would have to take 
a proactive stance on through a vote in both the House and the 
Senate of some kind.
    Why are you reluctant to support this kind of effort which 
clearly would make it, I think, a responsible approach to 
controlling spending as well as on the tax cuts? This is 
future--we are talking future--we are talking about future 
spending, before new spending kicks in, if we do not meet our 
debt reduction goals. And this would not be done now. It would 
start in several years.
    So what would be wrong with moving in that direction now?
    Mr. Daniels. First, Senator, I salute your leadership and 
your commitment to long-term fiscal prudence. This is something 
that we share, and I know that every member of this committee 
does.
    We worry about this particular mechanism being 
inappropriate to the mission. I think the single biggest 
problem that we find with it is that it would be, as the 
economists would say, pro-cyclical. It would deliver the wrong 
medicine at the wrong time. As we have just discovered, we get 
deficits when recessions come. The one we are in now happens to 
be the smallest one post-war, but each time a recession comes, 
we have found ourselves in deficit, and that is exactly the 
wrong time to trigger higher taxes; it is exactly the right 
time when you would want tax relief for the American people.
    So we think that although it has the best of intentions, it 
could have perverse and anti-job, anti-growth effects.
    Second, I think we need to be careful and ask ourselves if 
we create this trigger and pull it 1 day, who gets hit. The 
changes that are coming over future years have a lot to 
recommend them in terms of justice. I am thinking here about 
child care tax credits; I am thinking about the end of the 
marriage penalty and the other scheduled reforms that I think 
it would be very unfortunate if they were triggered off, 
particularly if we did not get better economics as an output.
    Last, I read very carefully what Chairman Greenspan said, 
and he plainly said that Congress might consider some mechanism 
that would sort of force the discussion--that did not 
automatically create an outcome, but forced a debate, a 
discussion, and votes about reexamining various things. 
Congress has that opportunity all the time, and will have every 
year.
    As I showed on one chart earlier, for those who believe 
that the tax relief was a bad idea and should not occur, the 
vast majority of it has not occurred and will not for years. So 
there will be multiple opportunities to choose higher taxation 
on an already heavily taxed public if that is the will of 
Congress.
    Senator Snowe. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    Mr. Daniels, I would like to ask you about that tax bill. 
Under current law in the present tax bill, how much does that 
tax bill cost us over a decade?
    Mr. Daniels. $1.345 trillion.
    Senator Nelson. And when you add debt service----
    Mr. Daniels. I am sorry, I have given you an inaccurate 
number, but it is in that neighborhood. And debt service would 
add on top of that another $200 to $300 billion.
    Senator Nelson. The figure that I have seen is about 1.6 
that has been published here.
    If you then make the tax bill permanent in the 10th year--
which in the cycle that we are looking at is the last 2 years 
of this 10-year cycle since we are starting with fiscal year 
2003--what is the cost of that tax bill over that 10-year 
period?
    Mr. Daniels. It would add another $345 billion, as I 
recall.
    Senator Nelson. So it is getting into the range of about $2 
trillion; that is basically the cost?
    Mr. Daniels. Or the benefit to the taxpayers of America--
depending on your point of view.
    Senator Nelson. Yes. I am just trying to--I am not putting 
any editorial comment--I am trying to get addition and 
subtraction to understand where we get with regard to this 
budgetary deficit problem.
    Mr. Daniels. Yes. I just flinch a little when we call it a 
cost, because from the taxpayers' point of view, it is more 
money they get to keep; it is only a cost when you look at it 
through the Washington end of the telescope.
    Senator Nelson. I understand, but looking at it through the 
Florida end of the telescope, I have a lot of folks who are 
telling me that they do not like deficit financing. They are 
telling me that they would like us to balance the books, and 
they are telling me that they had every reason to believe that 
we were going to balance the books, and now we are not.
    So looking at it through the Florida end of the telescope, 
they are telling me that they are not happy. That is why I am 
asking you for your opinion on the specifics.
    Now, let me ask you--I am getting ready to go; this is one 
of those days when four committee meetings are going on at the 
same time, and the one that I still have not gotten to is the 
Armed Services Committee, and I am going to go and talk to 
Secretary Rumsfeld, who I think is doing an excellent job, and 
I said that well before September 11, by the way, in the 
committee--but I note in the budget that there is a $10 billion 
item that is un-itemized for defense. And it struck me that 
that is a circumvention of the constitutional balance of checks 
and balances where, under the Constitution, Congress 
appropriates the money--the Administration requests, the 
Congress appropriates--and it struck me as a blank check 
request.
    Can you comment on that, please?
    Mr. Daniels. Yes, sir. It is a difficult question. The 
issue here that Secretary Rumsfeld and I have wrestled with is 
how can the flexibility of the President to deal with events 
that we cannot foresee or to take actions and decisions that he 
has not yet made be enhanced, while respecting the role of the 
Congress.
    The idea here would be that there would be an appropriation 
on a contingent or an emergency basis, subject to the 
President's declaration that certain conditions had been met 
that would trigger, and only that could trigger the spending of 
the money. This would be much akin to what was done in the 
emergency bill of last fall.
    But your concern is well-placed, and there ought to be 
clear definitions and restrictions before that money could be 
spent. But the idea is to enable the President as Commander-in-
Chief to move very quickly if he decides circumstances warrant.
    Senator Nelson. Well, I suspect that that is going to be an 
item that is not going to be particularly well-received here 
because of the traditional congressional process of 
supplemental appropriations bills, emergency appropriations, 
specific items that need to be enacted. Clearly after September 
11, the Congress gave the President the authority to spend the 
funds to wage the war. That is an appropriate legislative 
function under the Constitution and so too, I think, is the 
appropriation of the money to prosecute that war.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    Welcome, Director Daniels.
    Mr. Chairman, in thinking about the hearing today and the 
budget situation that we have in front of us, I was thinking a 
lot about Sunday's Superbowl. Before the game, the pundits said 
that the St. Louis Rams would beat the New England Patriots by 
14 points, but the Patriots defied the conventional wisdom and 
beat the Rams with a last-minute field goal.
    The lesson that we learned is that predictions do not 
always come true, and this is certainly the case with the 
budget proposals that were before us last year and the 
challenges this year.
    Director Daniels, as I know you remember, last year, you 
said that we would use all of the Social Security surplus from 
2002 to 2011 to pay down debt. You also indicated that we would 
have a $1.4 trillion contingency fund to pay for all of our 
future needs. You also projected that the 2002 budget surplus 
would be $231 billion. Finally, you stated that we would pay 
down the maximum debt possible over the next 10 years. I am 
sure you feel like those who predicted a St. Louis Rams victory 
in Sunday's Superbowl.
    Seriously, though, I am very concerned as we move forward, 
and I know that we all are, but despite the failure of many of 
last year's promises to come true, what I am most concerned 
about is the Administration continuing to move forward and 
advocate for very large tax breaks, supply side economics 
targeted to the wealthiest Americans, that are clearly now 
going to be paid for by using Social Security and Medicare 
Trust Funds.
    Director Daniels, that is why many of us talk about Enron. 
It is not that there is a direct connection, a legal connection 
or a factual connection between both of these situations, but 
because Enron is a good analogy for what is happening. We have 
those at the top, the wealthiest employees, the folks who were 
at the very top, making decisions and being able to receive 
large amounts of money, leaving the middle-class workers paying 
for it out of their 401(k)'s, their retirement systems. And I 
would argue that that analogy is in fact what is happening here 
if we continue on the track without any regard to fiscal 
responsibility or the long-term solvency of Social Security and 
Medicare.
    So I would ask you this. For the baby boomers who are going 
to be retiring very soon, in the first round, in 2008, 2009, do 
you think that they are better off today than they were a year 
ago?
    Mr. Daniels. I do. Let me explain why by responding to some 
of the interesting points that you made. I will say that in 
general, they are better off the more of their own money they 
are able to control now and in their retirement, and that is 
the direction of both tax relief and the proposal for long-term 
reform of our retirement programs.
    I think they will be much better off when they have more 
autonomy and are less dependent on the whims and winds of 
politics in Washington.
    Predictions are a risky business. Last year was described 
in The Washington Post as ``a nightmare for economists.'' They 
went on to point out that everybody missed the recession, both 
its coming on and its depth. Fifty-one of the 54 Wall Street 
Journal panelists missed it; CBO missed it; the Administration 
missed it. That alone took us well below the level of the 
Social Security surplus. There is nobody to be blamed for that; 
that is what happens in a recession.
    I freely confess that with all of our acumen and our 
forecasting models, we did not know that September 11 was 
coming, and that has made a very profound difference not only 
on this year's budget as we have illustrated, but in terms of 
what the President believes are the ongoing needs in defense to 
make sure that the first responsibility of Government, the 
safety of the American people, is met. That is a responsibility 
that he places even above surpluses and paying down our debt, 
as important as that is.
    Last, I would say be of good cheer, because we could be in 
far worse shape than we are. This is the smallest recession, 
this recession deficit, that we have seen, and the previous 
recessions did not have a war laid on top of them.
    I will give you a quick look at that. This chart shows this 
year, which is the trough; next year--and this again assumes 
that we pass a stimulus package, which we may not, but we 
certainly hope we do--back in balance as early as the year 
after next.
    I could easily be back here next year with--let us just 
remember how unique last year's number was. These are the 10-
year surplus projections for what they are worth. In the few 
years that we have told ourselves we somehow had the ability to 
forecast out this far--in fact, I submit to you we do not, and 
we ought to quit kidding ourselves--but here are the numbers. 
If we had taken a 1-year time out from 10-year numbers, we 
would be looking at the biggest one we had ever seen. So next 
year, that number could go back up. It is driven so completely 
by economic assumptions that if we can get growth going again, 
and if there is the prospect of somewhat higher growth over the 
time period, I do not doubt that we will be back into surplus 
sooner, and we will be back paying down debt, as you and we 
would like to do.
    Senator Stabenow. Listening to you makes me wonder, though, 
as we talk about projections and the fact that they are in fact 
just projections, and many of us on this committee argued that 
in the committee, on the floor, over and over again last year 
as we were moving ahead, that we should not lock ourselves into 
a 10-year course of action on any front, whether it be 
spending, whether it be tax policy, because we are spending 
dollars that we do not know if they will materialize. But 
listening to you makes me wonder why in fact you have been 
opposed to the notion of an economic trigger that Senator Snowe 
and I and Senator Bayh and others have put forward to focus on 
fiscal responsibility.
    The notion of an economic trigger is to simply say that we 
are going to keep a focus on balancing the budget and not 
spending Social Security and Medicare, and that if we are 
moving too far through tax policy or spending policy into that, 
we want an automatic way that forces us to come back and 
address that in a conscious way.
    I also believe that that would send a message of fiscal 
responsibility to those on Wall Street and others who are 
looking at long-term interest rates. And I am very surprised 
that in talking about how unpredictable the long-term 
projections are, you would not want to in fact then put some 
more predictability around it, or at least some mechanisms for 
that in terms of the budget triggers.
    Mr. Daniels. First of all, Senator, I will just point out 
that the Government under any circumstance, whether tax relief 
remains in place or is taken away by this or some future 
Congress, revenues are going to grow very, very fast--55 
percent over this time period. We will have all sorts of 
additional money available for all these purposes.
    The yellow bars here simply indicate the small amounts by 
which last year's tax relief will diminish what will remain an 
historically very high take--19 cents of every dollar Americans 
create in this economy. There will be lots and lots of chances. 
If the Congress should come to the conclusion that it must have 
this money and that it must not allow this relief to take 
place, the vast majority of it will not happen for quite some 
time. That took into account, one could say, the uncertainty of 
outyear projections.
    So it is not right to say, as some people kind of 
thoughtlessly do, that the money is gone; it is not at all.
    Senator Stabenow. Well, Mr. Daniels, if I may----
    Chairman Conrad. Senator, if I could just interrupt, 
because you have gone over your time. Maybe we could go to 
Senator Corzine and then get into the second round.
    Senator Stabenow. Absolutely.
    Chairman Conrad. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman, and welcome, 
Director Daniels.
    I want to follow on with some of the questions that I think 
have come up with regard to Social Security. First of all, in 
response to Senator Stabenow's question about are we better 
off, do we really believe that folks are better off with regard 
to the solvency of Social Security today than we were a year 
ago as we sat here? Are we as likely to be able to provide the 
benefits that are promised today as we were a year ago, given 
the track we were on with regard to paying down the debt and 
building up the surpluses in the Social Security Trust Fund?
    Mr. Daniels. I think we are in exactly the same position, 
really. I think there will not be a material difference until 
we reform and restructure Social Security. I know where your 
question heads. If, as still may be the case--I do not know, 
and you do not know--if we are able to pay down lots of debt 
over the next stretch of time until Social Security turns cash-
negative, that would be a good thing, but it will not solve our 
problems at all, and we will not be able to re-borrow our way 
around those problems. We are going to have to restructure the 
system in a way that makes it more self-sustaining.
    Senator Corzine. If you believe that----
    Mr. Daniels. I thought the Senator's question--and I 
probably did not accurately or fully answer it--was an 
interesting one. The basic reason I would answer in general 
that we are better off, Senator, is that I believe we are now 
more aware, tragically, of the dangers to our country, and we 
are in the process of making Americans much safer, and that is 
the most fundamental way in which we can be better off now than 
a year ago.
    Senator Corzine. I think anyone who would look at the 
actuarial projections would say that we have shortened the life 
of the ability of the trust fund to provide the benefits 
without changing other conditions, given that we have not been 
paying down the debt.
    I know the Administration is very much for moving toward a 
privatization of some element of Social Security. Have you 
allowed in your budget projections any allotment for the 
transition costs or expectations of what that would cost to 
move Social Security to the reform view, or at least as you 
would label it, a reform perspective on what Social Security 
should be?
    Mr. Daniels. No, sir, not at this time. As you know, this 
is probably going to be a long national conversation. The 
commission has spread a menu of options, and the President 
hopes to move that dialog ahead, but we do not have agreement 
yet on a plan, so we cannot cost or even estimate what the 
transition might cost.
    Senator Corzine. Do you accept the estimates that the 
transition cost might approach $1 trillion?
    Mr. Daniels. I do not know. Under certain kinds of reforms, 
that number would be very realistic, but I do not know what 
kind of reform we may finally be dealing with.
    Senator Corzine. Are you or the Administration willing to 
publicly reject some of the cuts in benefits that were proposed 
by the President's commission?
    Mr. Daniels. Well, I am not sure which ones you are talking 
about. The President made very, very clear----
    Senator Corzine. There was a very specific recommendation 
with regard to COLA adjustments that would cut benefits really 
quite substantially--estimates from as low as 24 percent for 
workers retiring in 2040 and 43 percent for those in later 
years--because of an entirely different formulation on how you 
increase payouts for benefits.
    Mr. Daniels. Well, the President's first principle when he 
started the commission was that all current promises, all 
benefits have to be paid, and I am sure that will be a part of 
any reform that ever wins his approval.
    Senator Corzine. So you are not yet in a position where you 
could say, though, that we would not be cutting benefits for 
future beneficiaries of Social Security.
    Mr. Daniels. I do not see this being the case. You know, 
the whole goal here, the principal objective, is to try to 
create a better deal for future beneficiaries who right now are 
trapped in a really losing game with very, very low returns, 
perhaps even negative under some scenarios, and the objective 
is to create a retirement system that gives them a fairer 
return when their retirement comes.
    Senator Corzine. Well, again, if one were to move to that 
system, most of the analyses that I have seen indicate that it 
is going to require huge transition costs which are going to 
exacerbate the kinds of problems that we are already talking 
about with forward looks at our budget position as we go 
forward.
    Do you buy the arguments that we are using Social Security 
payroll taxes to fund some of the other activities, 
particularly the tax cuts that we are implementing over the 
next 10 years?
    Mr. Daniels. I would remind the committee that we always 
use surplus revenues for some purpose, and that in this 
wartime, we will be using some of them to defend Americans as 
opposed to paying down debt, as we would rather be doing, but 
the dollars are used in any event.
    By the way, I would just point out parenthetically, because 
sometimes we overlook this, that almost half of the surpluses 
that we credit to Social Security--about $170-odd billion this 
year--is not payroll taxes. It is simply the interest we credit 
based on the sized of the fund at the time. So just for 
semantic purposes, we should be careful. But the general point 
that you make is accurate. We always have a choice to make 
about what to do with any excess funds there, and like you, we 
would like to be using it to reduce debt again as soon as 
circumstances permit.
    Senator Corzine. Director, I do not think anyone is going 
to argue about homeland defense or prosecution of the war on 
terrorism as a need for using the unified budget revenues, but 
I think there is a legitimate reason to have a debate about 
whether payroll taxes, which really fall most heavily on those 
at the lower end of our income scale, a more regressive tax to 
pay for tax cuts, is a questionable principle that we need to 
have debated. Whether one accepts that or not, it certainly is 
a fact that those funds in some way are sourcing or cutting 
back those revenues that would otherwise have been collected.
    So in some ways, we are funding these tax cuts, in one 
analysis, off the backs of payroll taxes.
    Chairman Conrad. Senator Domenici.
    Senator Domenici. Thank you very much, Mr. Chairman.
    I might say, Senator Smith, that if you would like to stay 
on in my stead, I understand the chairman may go around again, 
and I will try to keep my questions very short.
    First, let me ask you if you have a chart that shows the 
amount or percentage of tax take that the United States 
receives from the taxpayers over a sustained period of history? 
Did you bring that along?
    Mr. Daniels. It so happens I do, Senator.
    Senator Domenici. Fritz, we did not talk before.
    Senator Hollings. You should have.
    Mr. Daniels. Like the ad used to say, I do not leave home 
without it.
    I think it is worthy of keeping in mind that even after tax 
relief, Americans are paying historically very, very high 
amounts in taxes, well above the post-war average, which in 
previous time would trigger, under President Kennedy, President 
Reagan and others, reductions down below that about 18 percent 
average level. And even after tax relief, we are going to 
continue well above it.
    So I do believe that it is important to note that, absent 
tax relief, we would have been at all-time record levels of 
taxation, and that is probably not good for the economy, let 
alone fair to the American people.
    Senator Domenici. Let us just make it very simple. You have 
a chart that shows that. The tax take remains historically 
high, you say, and you show it with that chart.
    Now, there are probably some Americans who listen to the 
debate and discussion about are taxes too high, are taxes too 
low; did the 10-year tax cut which was implemented over time, 
most of which came in the last 3 or 4 years, but would come in 
over a period of time, giving them their taxes back--the 
question is being raised whether that was a mistake, whether it 
was too much. And I guess I would just like to establish once 
and for all, from my standpoint and perhaps from the record, 
that since there is no magic as to what level of taxation 
should be imposed on the American people--and by that, I mean 
nobody knows what the best level is, but I think it would be 
fair to say that everybody assumes from the standpoint of 
economic growth and prosperity the lowest level is the best 
level--prosperity with low levels of taxation is probably 
better for sustained economic growth than high taxes. In fact, 
the European countries are kind of struggling as to how to get 
out of the box they got themselves in because they went in the 
other direction.
    Now, having said that, in this chart, have you plugged in 
the tax cuts that will occur over the next decade as passed by 
both Houses of Congress and signed by the President? They are 
in there, are they not?
    Mr. Daniels. Yes, sir. They are on the blue line, and they 
are fully taken into account on the blue line.
    Senator Domenici. OK. Could you tell us, then--just give us 
3 or 4 years during that tax reduction cycle, and tell us what 
the percent of GDP is represented by the tax take from the 
American people and American business.
    Mr. Daniels. Yes. It is right around 19 percent 
consistently across the time period. It is right around a point 
to a point and a half above the post-war average.
    Senator Domenici. OK. And what does one and a half points 
mean in dollars?
    Mr. Daniels. Well, in today's economy, which is $10.2 or 
$10.3 trillion, a point and a half would be $150 billion, I 
guess.
    Senator Domenici. All right. We had a situation on the 
floor of the Senate post-September 11 where the Majority Leader 
brought to the floor three amendments that he wanted to take up 
in 1 week. They were an agricultural spending bill--you are 
aware of that----
    Mr. Daniels. I recall.
    Senator Domenici [continuing]. There was a railroad 
retirement bill----
    Mr. Daniels. I recall that very well.
    Senator Domenici [continuing]. And there was a stimulus 
package that Senator Byrd wanted to add about $15 billion to 
the President's request. Do you remember that?
    Mr. Daniels. Yes, sir.
    Senator Domenici. My arithmetic says that in pushing for 
those and offering them, that was a little bit over $100 
billion that, under these changes, was going to affect the 
surplus, if any; right?
    Mr. Daniels. Well, it would actually be more than that, 
conceivably, because if Senator Byrd's amendment had passed, it 
would have had continuing effects over the years. But just 
adding them up on the face of the bills, your number would be 
about right.
    Senator Domenici. OK. Now, many of the same Senators who 
voted for that are now suggesting that the President in his 
spending of money post-September 11 is taking money from the 
Medicare and Social Security Trust Funds. I ask you is there 
any other place that this $100 billion could have come from at 
that point in the fiscal condition of America?
    Mr. Daniels. Well, sir, it would have just the same effect 
of using funds for other purposes that could have theoretically 
been used or otherwise been used to pay down some debt.
    Senator Domenici. So I make those two points--one, that 
Americans are not undertaxed even when the 10-year tax plan is 
implemented, and it is a long way from getting there; and for 
those who want to change it, they have plenty of years to 
change it, because the biggest piece of it will not go into 
effect until the seventh, eighth, ninth, and maybe even tenth 
years of that tax plan. And second, when you find yourself in a 
war and in a recession, it is not unusual for you to have to 
use any surplus that had theretofore accumulated. That is what 
is happening to America right now. We had a surplus; we have a 
war that costs a huge amount of money; and if that is not 
enough, we have a recession on top of it that lost huge amounts 
of money.
    Is that a fair statement?
    Mr. Daniels. It is perfectly accurate.
    Senator Domenici. I have one last one, because people are 
somewhat confused as to which tax cut some people are talking 
about when they say it was a tax cut that this President 
imposed on the American people and on our economy, and it got 
rid of our surplus; it was the tax cut.
    Well, first, I would like to describe this just briefly in 
two ways. There is a tax cut that took effect for the year 
2002, and as I understand it, the surplus greatly diminished 
during a recession and a war at that point in time. I have a 
small chart--this was not made bigger, so I will just try to 
hold it up--if it gets on television OK, if it does not, I am 
pretty good at explaining.
    This red, which has a 72 up alongside of it, is 72 percent; 
and this green is 12 percent; the gray is 14 percent. What our 
experts, including the Congressional Budget Office, say this is 
is a pictorial of what happened to the surplus. Seventy-two 
percent of it went because we had a recession, and when you had 
a recession, huge amounts of money that would have come into 
the Treasury did not come into the Treasury, the biggest one 
being that we had all expected the economy to grow at more than 
3.5 percent, and that yields a very steady, strong, powerful 
revenue stream. As a matter of fact, that did not occur. It 
came down and at parts of that year was hovering negative 
rather than positive.
    So as any economist would have expected and just said as a 
matter of B follows A, this would be very big, and it is. That 
is where the surplus reduction, the surplus diminution, the 
disappearance of--that is the principal one.
    And lo and behold, the next one is green, 12, and that 
represents the tax cut, that is, the portion of the tax cut 
that was carried out for that particular year. The number is 
$38 billion; the percentage is 12.
    The next one is discretionary spending that was spent that 
was not contemplated to be spending but had to be spent because 
we had the war.
    Add them up, and there is the reduction in the surplus. It 
is nothing mysterious. It is not anything that is difficult to 
explain. It is something that it is very difficult to lay blame 
to anyone--an administration or a previous administration.
    And lo and behold, the American people after hearing all of 
us are coming to the conclusion in large droves that, number 
one, the recession was not caused by either Administration or 
any particular leadership. That is what Americans believe. 
Isn't it interesting? They are more right than the partisans 
who choose to lay blame someplace else. That is exactly right--
nobody caused it. It was a very long prosperous growth period, 
and it stopped for a while.
    I think we can be fortunate--and I will ask your views--
that this recession seems not to have been one that is going to 
go deep nor long. Qualify your answer however you wish, but is 
that a fair assessment of the recession as you see it now?
    Mr. Daniels. I honestly do not know, Senator. There are 
obviously some promising signs, but the President's point of 
view as we have discussed is not enough to rest on our oars, 
and therefore, let us try to do some more to bring the economy 
back quickly.
    Your analysis about the change in the surplus is exactly 
right. You know, revenues fell so far below what had been hoped 
for, they actually would have fallen year on year. Pretend 
there had never beenany tax relief--revenues would still have 
fallen. Pretend there had never been any tax relief--we would 
have still been well below--way below--the level of the Social 
Security surplus. And it is not anybody's fault. I think the 
President would agree with you that this is not about blame. 
Recessions do this--let alone recessions compounded by war.
    The question is how quickly can we come out of it, and what 
common sense steps can we take to make that happen.
    Senator Domenici. I want to close by asking your permission 
to make a statement a part of the record. It is from Richard J. 
Santos, National Commander of The American Legion, and it is a 
comment with reference to the President's budget on veterans' 
affairs.
    Chairman Conrad. Certainly.
    [The prepared statement of Mr. Santos follows:]

   Prepared Statement of Richard J. Santos, National Commanders, The 
                            American Legion

    Mr. Chairman and Members of the Budget Committee:
    The American Legion welcomes the opportunity to present its views 
on the fiscal year 2003 Budget Resolution. As you and your colleagues 
consider the President's recent budget request, I share the views of 
the Nation's largest wartime veterans' service organization.
    The American Legion's reputation as an advocate for maintaining a 
strong national defense is well documented, dating back to its very 
beginning in 1919 in Paris, France. As veterans of the War to End All 
Wars, The American Legion founders established an organization:

  To uphold and defend the Constitution of the United States of 
    America;
  To maintain law and order:
  To foster and perpetuate a one-hundred percent Americanism;
  To preserve the memories and incidents of our associations in 
    the Great Wars;
  To inculcate a sense of individual obligation to the 
    community, State, and Nation;
  To combat autocracy of both the classes and the masses;
  To make right the master of might;
  To promote peace and good will on earth;
  To safeguard and transmit to posterity the principles of 
    justice, freedom and democracy;
  To consecrate and sanctify our comradeship by our devotion to 
    mutual helpfulness.

    The only common bond of all Legionnaires is honorable military 
service during a period of armed conflict. Legionnaires are men and 
women that belong to an organization based upon comradeship. This group 
of veterans is devoted to fair and equitable treatment of their fellow 
veterans, especially the service-connected disabled. Another group of 
veterans honored by The American Legion is those fallen comrades that 
are killed in action (KIA), missing in action (MIA), or those held as 
prisoner of war (POW). These service members often leave spouses and 
children behind. For those who have paid the ultimate sacrifice for 
freedom, The American Legion will honor their service by making sure 
this Nation fulfills its promises to their survivors. For those listed 
as MIA or POW, The American Legion will continue to demand the fullest 
possible accounting of each and every comrade.
                           National Security
    The deep-rooted interest of The American Legion in the security of 
the Nation was born in the hearts and minds of its founders and 
sustained by its current membership. The bitter experiences of seeing 
comrades wounded or killed through lack of proper training crystallized 
the determination of Legionnaires to fight for a strong, competent 
defense establishment capable of protecting the sovereignty of the 
United States. The tragic events of World War I, largely precipitated 
by unprepared military, were still vivid in the minds of combat 
veterans that founded The American Legion. After 22 years of repeated 
warnings by The American Legion, Pearl Harbor dramatically illustrated 
the cost of failed vigilance and complacency.
    For over 83 years, The American Legion's drumbeat on defense issues 
has remained constant. With the evolution of space age technology and 
scientific advancement of conventional and nuclear weapons, The 
American Legion continues to insist on a well-equipped, fully manned, 
and a properly trained fighting force to deter aggressors. The events 
surrounding September 11, 2001 publicly exposed a soft underbelly of 
America to acts of terrorism, especially the vulnerability to nuclear, 
biological, and chemical (NBC) warfare.
    America's armed forces must be well manned and equipped. not to 
pursue war, but to preserve the hard-earned peace. The American Legion 
is fully aware of what can happen when diplomacy and deterrence fail. 
Many military experts believe that the current national security is 
based on budgetary concerns rather than real threat levels to America 
and its allies. As the world's remaining superpower, America's armed 
forces need to be more fully structured, equipped, and budgeted.
    Defense budget, military manpower, and force structure are 
currently improving over the fiscal year 2001 levels. The current 
operational tempo of active-duty and Reserve and Guard forces remains 
extremely high and very demanding. The American Legion recommends:

  Active-duty personnel level should not be less than 1.6 
    million.
  The Army must maintain 12 fully manned. equipped, and trained 
    combat divisions.
  The Navy must maintain 12 aircraft carrier battle groups and 
    a viable strategic transport capability.
  The Air Force must maintain, at a minimum, 15 fighter wings, 
    a strategic bombing capability, its Intercontinental Ballistic 
    Missile capability and a global strategic transport capability.
  Deployment of a national missile defense system.
  The defense budget should equal 3-4 percent of the Gross 
    Domestic Product.

    The current active-duty personnel level is approximately 1.37 
million. Military leaders are making up the difference by increasing 
the operations tempo and by over-utilizing the Reserve components. 
Currently, American military personnel are deployed to over 140 
countries worldwide. Overseas deployments have increased well over 300 
percent in the past decade. Many of these personnel continue to come 
from the Reserve and Guard components.
    Cuts in force structure cannot be rapidly reconstituted without the 
costly expenditures of time, money, and human lives. Modernization of 
weapon systems is vital to properly equipping the armed forces, but are 
totally ineffective without adequate personnel to effectively operate 
the state-of-the-arts weaponry. The American Legion strongly recommends 
adequate funding for modernization of the services. America is losing 
its technological edge. No American soldier, sailor, airman, or Marine 
should be ordered into battle with obsolete weapons, supplies, and 
equipment. America stands to lose its service members on the 
battlefield and during training exercises due to aging equipment. The 
current practice of trading off force structures and active-duty 
personnel levels to recoup modernization resources must be 
discontinued.
    The American Legion recommends restoring the force structure to 
meet the threat level and to increase active-duty personnel levels. 
Ensuring readiness also requires retaining the peacetime Selective 
Service System to register young men for possible military service in 
case of a national emergency. Military history repeatedly demonstrates 
that it is far better to err on the side of preserving robust forces to 
protect America's interest than to suffer the consequences of ill 
preparedness. America needs a more realistic strategy with an 
appropriate force structure, weaponry, equipment, and active-duty 
personnel level to achieve its objectives.
    A major national security concern is the enhancement of the 
quality-of-life issues for service members, Reservists, National Guard, 
military retirees, and their families. During the First Session, 
President Bush and Congress made marked improvements in an array of 
quality-of-life issues for military personnel and their families. These 
efforts are visual enhancements that must be sustained. The cost of 
freedom is on going, from generation to generation.
    The President and Congress addressed improvements to the TRICARE 
system to meet the health care needs of the military beneficiaries; 
enhanced the Montgomery GI Bill educational benefits; and homelessness 
throughout the veterans community. For these actions, The American 
Legion applauds your strong leadership, dedication, and commitment. 
However, one issue still remains unresolved: the issue of concurrent 
receipt of full military retirement pay and VA disability compensation 
without the current dollar-for-dollar offset. The issue of concurrent 
receipt appeared in the fiscal year 2002 budget resolution and the 
fiscal year 2002 defense authorization act. Every day, new severely 
disabled military retirees are joining the ranks of American heroes 
being required, by law, to forfeit military retirement pay.
    Recently, 14 soldiers and 2 airmen were awarded Purple Hearts from 
the War on Terrorism. These newest American heroes would be the latest 
victims of this injustice should their war wounds result in 
debilitating medical conditions. During the State of the Union Address, 
one such future recipient, SFC Ronnie Raikes, was sitting next to the 
First Lady. Concurrent receipt legislation in both chambers (S. 170 and 
H.R. 303) has overwhelming support by your colleagues. With the 
President's proposed $48 billion increase in defense spending, The 
American Legion believes now is the time to correct this terrible 
injustice. Enactment of corrective legislative and fully funding 
concurrent receipt are actions to properly reward heroism and courage 
under fire.
    If America is to continue as the world's remaining superpower, it 
must operate from a position of strength. This strength can only be 
sustained through meaningful leadership and adequate funding of the 
armed forces.
                         Veterans' Health Care
    The American Legion believes that the primary mission of the 
Department of Veterans Affairs (VA) is to meet the health care needs of 
America's veterans. The American Legion believes that the VA should 
continue to receive appropriate funding in order to maximize its 
ability to provide world-class health care to the large number of aging 
veterans, while still maintaining services to a younger cohort of 
veterans who are using VA for the first time. The American Legion 
greatly appreciates the actions of all Members of Congress regarding 
the increase in VA Medical Care funding for fiscal year 2002. Now, 
please focus your attention to the increases in fiscal year 2003.
    Just like the Medicare and Medicaid programs, the VA health care 
budget requires an annual increase to maintain its existing service 
level and to fund new mandates. For years, VA managers were asked to do 
more with less. The recent funding increase now allows the Veterans 
Health Administration (VHA) to catch up with the growing demands placed 
upon the system and repair some of the problems related to long patient 
waiting times and limitations on access to care.
    The American Legion felt that the President's budget request last 
year failed to accurately reflect VA's fiscal year 2002 health care 
funding needs. VA's projections misrepresented the actual number of 
veterans seeking care. It appears that the President's budget request 
was based on a much lower number of patients projection (less than 3 
percent) than the actual number of users (closer to 11 percent). 
Fortunately, Congress added over $300 million to the President's 
original request; however, VHA is now faced with dealing with an 
inadequate fiscal year 2002 budget. The American Legion believes that 
close to 5 million veterans will seek care in VHA medical facilities in 
fiscal year 2003. Last year, The American Legion requested $21.6 
billion in fiscal year 2002; however, this year we recommend $23.1 
billion for VA medical care.
    Many factors are driving more veterans to use VHA as their primary 
health care provider:

  Many Medicare+Choice health maintenance organizations (HMOs) 
    withdrew from the program;
  Many HMOs collapsed;
  VHA has opened community based outpatient clinics;
  Double-digit increase in health care premiums;
  The dramatic fluctuations in the national economy make VHA a 
    more cost-effective option for veterans; and
  VHA's reputation for quality of care and patient safety is 
    attracting new patients.

    Where comparable data exist, VHA continues to outperform the 
private sector in all indicators in health promotion and disease 
prevention. The American Legion adamantly believes VHA is the best 
health care investment of tax dollars. The average cost per patient 
treated within VHA is unmatched by any other major health care delivery 
system, especially with comparable quality of care.
    Mr. Chairman and Members of the Committee, the reason VHA medical 
care continues to increase annually is not because of uncontrollable 
cost increases nor poor cost estimations, but rather because thousands 
of veterans are voting with their feet. More and more veterans are 
choosing to use their earned benefit--access to VHA. However, 
enrollment in VHA is limited to existing discretionary appropriations. 
The American Legion urges Congress to evaluate several options that 
would assure every veteran that wants to enroll in VHA can enjoy that 
earned benefit. The key factor driving the increases in medical care 
funding requirements has not been uncontrolled cost increases, nor has 
it been poor cost estimation processes--it has been the unexpected and 
dramatic increase in demand for care from the VA system.
    The overall guiding principle for VA must be improved services to 
veterans, their dependents, and survivors. This will require improving 
access and timeliness of veterans' health care; increasing quality and 
timeliness in the benefit claims process; and enhancing access to 
national and State cemeteries. Specific American Legion objectives for 
Congress include:

  Sound VHA funding for long-term strategic planning and 
    program performance measurement,
  Additional revenue for staff and construction,
  Medicare subvention,
  Pilot programs for certain dependents of eligible veterans,
  VA and DoD sharing,
  Reduce the claims backlog,
  Repeal bar to service-connection for tobacco-related 
    illnesses,
  Increase the rate of beneficiary travel reimbursement, and
  Allow all third-party reimbursements collected by VA to 
    supplement, rather than offset, the annual Federal discretionary 
    appropriations.

    The American Legion created the GI Bill of Health as a blueprint 
for meeting the current and future health care requirements of the 
Nation's veterans and for supplementing VA's annual health care 
appropriation. The GI Bill of Health, once fully implemented, would 
expand VHA's patient base and increase its non-appropriated funding 
through new revenue sources.
    As VHA continues to re-invent itself, change is not a defining 
event, but rather a series of small steps. Despite its recent 
successes, VHA still faces numerous future challenges.
    The American Legion believes VHA's long-term future must be clearly 
defined to be responsive to those who have ``borne the battle.'' All 
individuals, who enter military service, should be assured that there 
is a health care system dedicated to serving their needs upon leaving 
the military. That concept is especially important to disabled veterans 
and to retired service members. The GI Bill of Health would ensure that 
all honorably discharged veterans would be eligible for VA health care, 
as they will fall into one of the core entitlement categories and into 
a health insurance or buy-in category. A unique feature of the GI Bill 
of Health is that it will also permit certain dependents of veterans to 
enroll in the VA health care system.
    The American Legion commends VA for the changes made within VHA 
over the past few years. These changes include eligibility reform, 
enrollment, the reorganization of the 172 medical centers into 22 
integrated operating units, the elimination of certain fiscal 
inefficiencies, and the expansion of community based outpatient 
clinics. In some cases, The American Legion believes VA has gone too 
far in attempting to improve fiscal efficiency. Veterans should not 
have to increase their travel time for the benefit of the Department. 
Rather, VHA needs to improve its cooperation with other Federal, State, 
and private health care providers to improve the quality and timeliness 
of care for veterans and their families. The American Legion encourages 
VHA to continue to provide health care that is the highest quality to 
all veterans at the most reasonable cost.
    Two additional significant steps required to re-engineer VHA are 
Medicare subvention and permitting certain dependents of veterans to 
utilize the system.
    Unlike in the private sector, Medicare-eligible veterans cannot use 
their Medicare benefits in a VHA facility for treatment of nonservice-
connected conditions. When Medicare-eligible veterans receive health 
care treatment for any medical condition in the private sector, the 
Federal Government reimburses the health care provider for a portion of 
that service. When Medicare-eligible veterans receive health care 
treatment for the same medical conditions (nonservice-connected) within 
VHA, the Federal Government will not reimburse VHA for any portion of 
that service. This equates to a restriction on a veteran's right to 
access health care of his or her choice and using his or her Medicare 
benefit. The American Legion believes that Medicare subvention will 
result in more accessible, quality health care for all Medicare-
eligible veterans. Furthermore, Medicare subvention should greatly 
reduce incidents of fraud, waste, and abuse in billing because it will 
occur between two Federal agencies with congressional oversight. 
Today's fiscal realities requires VHA to seek other revenue streams to 
supplement the growing demand for service and not simply rely on saving 
more dollars to serve more veterans. The American Legion strongly 
recommends allowing Medicare subvention for Priority Group 7 Medicare-
eligible veterans enrolled in VHA.
    Allowing certain veterans' dependents access to health care within 
VHA will also help develop new revenue streams and will ultimately 
improve recruitment and retention within the armed forces. Service 
members need to know that their dependents have access to quality 
health care while serving on active duty. The American Legion believes 
that VHA can and should play a larger role in the provision of this 
care to active duty service members. Additionally, when service members 
leave active duty, this health care coverage should continue. VHA has 
the capacity and the capability to play a much larger role in the 
provision of health care to the beneficiaries of DoD health care 
system.
    VHA has six strategic goals through the year 2006:

  Put quality first.
  Provide easy access to medical knowledge, expertise and care.
  Enhance, preserve and restore patient function.
  Exceed customers' expectations.
  Save more dollars to serve more veterans.
  Build healthy communities.

    Unfortunately, nowhere in the list of VHA priorities are the goals 
of Medicare-subvention, the treatment of veterans' dependents, 
expanding the non-appropriated funding revenue base, and greater 
cooperation with the private sector and with DoD health care system.
                           Veterans' Benefits
    Given the number of veterans and other claimants who file claims 
each year and with an annual expenditure of over $25 billion in 
compensation and pension payments, it is imperative that Congress 
maintain strong oversight of the operations of Veterans Benefit 
Administration's (VBA's) Compensation and Pension Service.
    Over the last several years, the backlog of pending claims and 
appeals has increased dramatically and now exceeds over 660,000 cases. 
It routinely takes six months to a year or more to process disability 
compensation claims. In addition, annually, some 60,000 to 70,000 new 
appeals are initiated. After a wait of over two years for an appeal to 
reach the Board of Veterans Appeals (BVA or the Board), more than 20 
percent will be allowed and more than 22 percent will be sent back to 
the regional office for further required development and 
readjudication. Remanded cases may be pending for another year or two, 
in the regional office before returning to the Board. Sometimes, cases 
are remanded two and three times because the specified corrective 
action had not been completed, which adds several more years to the 
appeal.
    Unfortunately, there is a pattern of recurring issues, which 
continue to have a direct and adverse effect on the quality and 
timeliness of regional office claims adjudication. They relate to 
budget, staffing, training, quality assurance, accountability, and 
attitude. These findings confirm our long-held view that quality must 
be VBA's highest priority. Without guaranteed quality, thousands of 
claims will continue to process unnecessarily through the system; much 
of VBA's valuable financial and personnel resources will be wasted; and 
veterans will not receive the benefits and services they are entitled 
to and that Congress intended they should have.
    The American Legion believes VBA is committed to bringing about 
much needed change to the claims adjudication system with the overall 
goal of providing quality, timely service to veterans and its other 
stakeholders. In recent years, VBA's strategic plans have made many 
promises and we have, in fact, seen the implementation of a variety of 
programmatic and procedural changes. However, it is obvious that 
progress toward major improvements in service continues to be slow and 
that much remains to be done. The overall quality of regional office 
decision making remains problematic.
    Secretary Principi has identified many problems and is working 
diligently to find solutions that will provide improved service to 
veterans and their families. There are a spectrum of ongoing and 
planned initiatives, such as the Pre-Discharge Examinations, Personnel 
Information Exchange System (PIES), Electronic Burial Claims, Virtual 
VBA, Decision Review Officer (DRO) Program, and personal hearing 
teleconferencing, just to name a few. In addition, VBA has begun 
implementing the recent recommendations of the Secretary's Claims 
Processing Task Force focusing on improving the operating efficiency of 
the process and procedures by which claims are adjudicated. These 
involve special initiatives to better manage the claims and appeals. 
There will be an emphasis on better training for the many newly hired 
adjudicators. Performance standards are being implemented that provide 
for personal and organization accountability. VBA is continuing the 
development of its information technology program.
    While we support these much-needed changes, we are concerned that 
they only indirectly address the core problem of continued poor quality 
decision making. Without a vigorous, comprehensive quality assurance 
program, thousands of claims will continue to process needlessly 
through the regional offices, the Board of Veterans Appeals, and the 
courts wasting time, effort and taxpayers' money. Veterans have a right 
to a fair, proper, and timely decision. They should not have to endure 
financial hardship and delay before receiving the benefits to which 
they are entitled by law.
    The workload and budgetary requirements of National Cemetery 
Administration (NCA) will continue to grow over the next 15-20 years. 
The death rate of World War II veterans will peak in 2008, but the 
annual death rate of veterans will not return to 1995 levels under 
2020. The death rates of Korean and Vietnam Era veterans will greatly 
accelerate thereafter. The American Legion continues to fully support 
the further development of the State Cemetery Grants Program.
    The Veterans Millennium Health Care and Benefits Act (Public Law 
106-117) requires VA to provide long-term nursing care to veterans 
rated 70 percent disabled or greater. The new law also requires VA to 
provide long-term nursing care to all other veterans for service-
connected disabilities and to those willing to make a co-payment to 
offset the cost of care. Further, it requires VA to provide veterans 
greater access to alternative community-based long-term care programs. 
These long-term care provisions will place greater demand on VA and on 
the State Veterans Home Program for years to come.
    The American Legion believes that it makes economic sense for VA to 
look to States governments to help fully implement the provisions of PL 
106-117. VA spends on average $225 per day to care for each of their 
nursing care patients and pays private-sector contract facilities an 
average per diem of $149 per contract veteran. The national average 
daily cost of care for a State Veterans Home nursing care resident is 
about $140. VA reimburses State Veterans Homes a per diem of $40 per 
nursing care resident. Over the long term, VA saves millions of dollars 
through the State Veterans Home Program.
    The American Legion supports the State Veterans Home Program and 
believes the Federal Government must provide sufficient construction 
funding to allow for the expected increase in long-term care veteran 
patients.
    On September 11, 2001, I was about to present testimony before a 
Joint Session of the Veterans' Affairs Committees, when we were 
directed to evacuate the Cannon House Office Building. Like Americans 
around the world, I was shocked by the barbaric, terrorist actions 
taken against innocent airline passengers, those in the World Trade 
Towers, and those in the Pentagon. My heart swelled with pride as 
fearless rescue workers, fellow service members, and private citizens 
rushed to assist the victims, only to experience the heartache as the 
Twin Towers collapsed turning heroes into victims in a matter of 
seconds. At that specific moment, the importance of that testimony 
paled in comparison. The American Legion's efforts, like the rest of 
America, shifted to what we do best--helping at the community, State, 
and national level.
                                Summary
    Since I was unable to formally present my testimony, I did submit 
The American Legion's recommendations for the VA budget for fiscal year 
2003 for the record. Today, it is important that I share that 
information to this committee:

----------------------------------------------------------------------------------------------------------------
                                                                                             Legion's FY 2003
               Program                       P.L. 106-377             P.L. 107-73                Request
----------------------------------------------------------------------------------------------------------------
Medicare.............................  $20.0 billion..........  $21.3 billion..........  $23.1 billion
Medical and Prosthestic Research.....  $350 million...........  $371 million...........  $420 million
Construction.........................  xl.....................  xl.....................  xl
Major................................  $66 million............  $183 million...........  $310 million
Minor................................  $170 million...........  $211 million...........  $219 million
State Veterans' Home.................  $100 million...........  $100 million...........  $110 million
State Veterans' Cemeteries...........  $25 million............  $25 million............  $30 million
NCA..................................  $110 million...........  $121 million...........  $140 million
General Administration...............  $1 billion.............  $1.2 billion...........  $1.3 billion
----------------------------------------------------------------------------------------------------------------

    The American Legion believes that the true character of any 
democracy is best reflected in the way it treats its veterans of the 
armed forces--the true preservers and defenders of liberty.
    Mr. Chairman and Members of the Committee, that concludes my 
written statement.

    Senator Domenici. And Senator, I will not read this, but I 
would ask that it go in the record. This is your statement with 
reference to what the war and the recession did to the surplus 
and what we had to do----
    Chairman Conrad. It is an excellent statement. I am happy 
to put it in the record. We can spread it all across the 
record. [Laughter.]
    Senator Domenici. As a matter of fact, I believe that all 
Republicans would vote yes, since it says ``our concern for 
protecting the integrity of the Social Security and Medicare 
Trust Funds remains but must be achieved by returning to a 
policy of fiscal discipline over the long term.''
    In any event, thank you for the time today and for the 
excellent hearing. I am not going to stay any longer. I do not 
know what your plans are.
    Chairman Conrad. I have a lot of plans after what I have 
heard.
    Senator Domenici. I will stay, then.
    Senator Hollings. Senator Domenici, you say there is really 
no exact level or right level of taxation. Yes, there is. Every 
government knows exactly the right level, and that is the 
people want for the government provided, paid for--and in fact 
if they do not, of course, they lose their credit rating.
    Governor Bush knows down in Florida. He has canceled out 
tax cuts because he wants to hold that revenue and pay for the 
government that level of taxation. But up here, there is no 
tomorrow; we just keep on talking.
    You mentioned tax cuts from surplus. We have not had a 
surplus since Lyndon Baines Johnson in fiscal years 1968-1969. 
Last year, on September 30, we ended up with a $143 billion 
deficit. Where do you get all of this surplus?
    Right this minute, I asked them to go check, because the 
Secretary of the Treasury puts out the public debt to the 
penny, and the debt has gone up another $109 billion since 
October 1.
    So we are all talking about tax cuts and surpluses and 
everything else--that is old Kenneth Lay. That is what he 
said--man, this company is really rich, it is going big--right 
until the last quarter, people were buying the stock, because 
we were puffing the wares down there at Enron, and we were 
puffing the wares up here at the Federal level.
    Specifically, Mr. Daniels, you said a percentage of 
receipts or tax cuts did not really affect it, because it goes 
up, up, and away--but again, you are counting trust funds.
    If you turn to page 32 of your particular historic tables, 
you will see there that the individual income taxes from 2000 
went from $49.6 billion to $47.5 billion, and then the table 
shows that corporation income taxes go from $10.2 billion down 
to $9.7 billion--but it is only the social insurance and 
retirement receipts that go up, from $32.2 billion to $35.3 
billion. So that is what you are using. You are using the 
retirement funds to pay the Government debt.
    Are you familiar at all with the Pension Reform Act of 
1994?
    Mr. Daniels. Somewhat, yes, sir.
    Senator Hollings. It made it a felony to get at these 
rascals like Carl Icon and so on who had these corporate 
takeovers, and they would pay down the company debt with the 
retirement funds and then take the rest of the money and leave. 
So we made it a felony, and I have already said it--Denny 
McLean ad nauseam--the poor fellow has probably served his time 
and is out now, and more power to him. But we treated it as a 
felony for corporate America because we are all worried up here 
about Enron and not about ourselves. That is what gets me. We 
hear the talk. If I go home, and I run for Governor, I have got 
to pay the debt. We have got to maintain our AAA credit rating. 
But if I want to be elected Senator, I do not want to pay the 
debt, I want to have tax cuts, tax cuts, tax cuts.
    It is the same voter and everything else, because they do 
not understand what is going on. The debt is going up, up, and 
away, and the interest costs are going up, up, and away, and it 
is an absolute waste. For a sales tax, you might get a school; 
for a gas tax, you might get a highway. But the interest cost 
you cannot avoid. You have got to pay it, and it is right at 
$360 billion, and you project it is going to $440 billion. That 
is waste, fraud, and abuse.
    Do you disagree with that?
    Mr. Daniels. Well, yes, sir.
    Senator Hollings. Why?
    Mr. Daniels. Well, how much time do I have?
    Let me pick out the points I agree with. It is a very good 
idea to pay down debt when we can. We expect to be back to 
doing that as soon as the economy begins to grow again. That is 
what it all depends on.
    There are a couple of differences between here, your 
responsibilities, and the President's and those of the Governor 
of any State, starting with the fact that a Governor does not 
have to fight wars and does not have to defend the safety of 
the American people. This budget says----
    Senator Hollings. But in every war, we have really raised 
the taxes to pay for it.
    Mr. Daniels. Sometimes with bad consequences. I think the 
surtax of the late sixties was yet another mistake that was 
made in that time, when they paid for the war all right, but 
they let spending run as we propose not to let happen; they 
practiced the so-called guns-and-butter and piled extra taxes 
on top of it. I think it was undoubtedly another mistake that 
led to a very bad economic decade that followed.
    Again back to the analogy to the private sector, we have 
got to be a little bit careful because again, the private 
sector cannot take pension funds and pay off its bondholders, 
either. That is exactly what we do and what you are arguing 
that we should do--and it is the right thing to do, by the way, 
in the Federal context. I am just saying that the analogy is 
not a perfect one.
    Senator Hollings. Thank you.
    Chairman Conrad. The ranking member raised a number of 
issues that I want to address. He put up a chart talking about 
the biggest reason for the decline in the surplus for 1 year is 
the recession, and that is exactly the case. But that misses 
the point that over the 10 years, the biggest reason for the 
reduction in the surplus is the tax cut. The tax cut is 42 
percent of the reduction in the so-called surplus; 23 percent 
was the recession; 18 percent, the spending from the attack on 
the country; 17 percent, technical differences, largely 
Medicare and Medicaid expenditures being greater than 
anticipated.
[GRAPHIC] [TIFF OMITTED] 80544.001


    The Senator from New Mexico mentioned three items the 
Majority Leader brought to the floor--the farm bill, which is 
in the President's budget. He mentioned railroad retirement. 
That was supported by a strong majority of Republicans and 
Democrats in the House and the Senate. And he mentioned Senator 
Byrd's proposal for $15 billion of additional spending for 
homeland security. That is less than the increase for homeland 
security that is in the President's budget.
    So these spending initiatives have been endorsed by 
Republicans and Democrats. They were not a matter just 
supported by the Majority Leader.
    The thing that I find most troubling here today, and I do 
find it troubling, is that we are blithely going down the path, 
under the President's direction, of taking vast amounts of 
money from the trust funds of Social Security and Medicare and 
using it to pay for other purposes.
    I believe, Mr. Daniels, that you and the President will be 
judged very harshly by history with respect to your stewardship 
of the fiscal condition of the country, because while you say 
you are not letting spending go wild, you are letting deficits 
and debt go wild.
    When I was driving in yesterday, and I heard the 
description of Enron's circumstance, they were pointing the 
finger at the culprit as being a failure to deal with the 
debt--hiding debt, hiding it from creditors, hiding it from 
investors. And I really believe that the Federal Government is 
doing much the same thing here.
    You are basically covering your additional tax cut 
proposals and ones that you have already made and your 
additional spending by taking money from trust funds. You say 
it does not matter. You say the trust funds are fully credited 
with those moneys, so it does not matter how the money is 
actually used. Of course it matters.
    If you were in the private sector running a corporation, 
you could not take the retirement funds of your employees and 
use them to fund operating expenses or bonuses for the 
executives----
    Mr. Daniels. Or payments to bondholders.
    Chairman Conrad. No. You could not. That is the reason I 
set aside $900 billion last year to fund the transition of 
Social Security to deal with this long-term problem and to 
begin to deal with it.
    But now we are told that it just does not matter--you can 
take that money and use it for other purposes. That is going to 
come home to roost. Those chickens are going to come home to 
roost, and they are going to come home to roost in the way that 
Director Crippen described.
    A future Congress and a future President are going to be 
faced with extraordinarily difficult choices--massive increases 
in taxes, dramatic cuts in benefits, or massive debt. That is 
where we are headed, and you are not facing up to it in this 
budget; the President is not facing up to it. Instead, your 
proposal is to dig the hole deeper, with more tax cuts, more 
spending. And I believe that history will judge your harshly.
    Mr. Daniels. I believe that history would judge this 
President harshly if he did not defend this country, if he did 
not win the war against terrorism. That is what the spending is 
for.
    Chairman Conrad. Are the tax cuts for that, Mr. Daniels? 
Are the tax cuts that are 42 percent of the reason for the 
disappearance of the surplus what are being used to wage the 
war on terrorism?
    Mr. Daniels. First of all, Senator, you've got many, many 
chances to raise taxes on the American people. The moneys are 
not gone. Senator Domenici's numbers are unassailably correct--
--
    Chairman Conrad. For 1 year. You know, we are engaged in 
something more than 1 year. We are dealing with the fiscal 
direction of this country for years to come. You are not up 
here with a 1-year plan. You are up here with a 5-year plan 
with 10- and 15-year consequences.
    Mr. Daniels. Oh, I beg to differ. We are here with a 1-year 
budget and 5-year forecast, and I do not know how many years 
before I can go back to private life I will be sentenced to 
come here and discuss this stuff with you all, but as long as I 
am here----
    Chairman Conrad. Haven't you enjoyed this opportunity this 
morning?
    Mr. Daniels. I am just kidding. But undoubtedly, 
circumstances will change dramatically as they did last year. 
None of us could have foreseen the situation in which we would 
find ourselves, and it will change many times over the next few 
years.
    The single most important thing beyond protecting the 
safety of Americans, on which I believe this President will be 
judged, will be his ability to maintain the conditions where 
the American economy can thrive, and if it does, we will have 
very large surpluses, and we will be able to celebrate a quick 
return to paying down debt, which I commend you yet again for 
your determination to see us do. But we ought not lament that 
somehow we have lost our flexibility to deal with events. We 
have not at all. The tax relief that the President believes is 
both fair and appropriate for our economy has not happened yet. 
Eighty or 90 percent of it has not occurred. It can be 
revisited annually, and I would guess that this committee will 
seek to do that.
    Senator Stabenow. Mr. Chairman, if I might ask a question.
    Chairman Conrad. Senator Stabenow.
    Senator Stabenow. Thank you.
    Just as a followup to that specific point, Mr. Daniels, you 
have talked several times today about raising taxes, which no 
one that I have heard of on either side is proposing to do for 
the record. But I would like to ask you a question that relates 
to something that is happening in Michigan right now.
    A couple of years ago, the Michigan legislature, with the 
strong support of Governor Engler, passed a phaseout of what is 
called in Michigan the ``single business tax.'' It will be 
phased out in I think it is 10 years, every year going down by 
a certain amount. But they put in a budget trigger so that if 
their rainy day fund, surplus fund, went below $250 million, 
then, the next phase would not take place until they were able 
to keep a floor of $250 million in their rainy day fund. And 
this year, there is a question about that.
    I am just curious--do you think that Governor Engler and 
the Michigan legislature would be guilty of raising taxes if 
that trigger were to occur?
    Mr. Daniels. Senator, I am not particularly interested in 
the semantics of this or in debating that with you. I think the 
choice is one between higher taxation and lower taxation, and I 
have tried to make the case that ours is not an undertaxed 
society and that we have got to be careful about even higher 
rates of taxation if we want a strong economy, if we want the 
surpluses that only a strong economy produces.
    It is a strong economy that produces surpluses, not the 
other way around. So there are----
    Senator Stabenow. But in this case--because no one is 
talking about raising taxes; it is a question of how they 
phaseout and to whom, whether we have an alternative minimum 
tax so that everyone contributes to the national defense or 
not--but in this case, I assume, then, you would suggest or say 
that Governor Engler and the Michigan legislature would be 
raising taxes if the budget trigger were to take effect, and 
they would delay the repeal for a year. That is the same thin 
that you are saying here.
    Mr. Daniels. I leave this characterization to the people of 
Michigan. They have a great Governor, and I am sure they will 
come to the decisions that are right for Michigan.
    It is not a parallel. There are a lot of differences, as we 
said earlier, between State situations and the Federal. Many 
States have capital budget opportunities that are akin to the 
borrowing that the Federal Government does from time to time, 
and most fundamentally, only the Federal Government has the 
responsibility for the security of this country, and in a time 
like this, that comes first, even ahead of things as important 
as paying down debt.
    Senator Stabenow. Thank you, Mr. Chairman.
    No one was objecting to the issue of national defense.
    Thank you.
    Chairman Conrad. No--and I want to make that clear as we 
end here today. As I began this discussion, we praised the 
President and the Administration for their handling of these 
attacks against our country.
    I remember so well September 11. I was in the Capitol, and 
we were told by security people that it might be the focus of 
an attack. And no one knew where that fourth plane was headed, 
whether it was headed for the White House or perhaps another 
strike on the Pentagon or the Capitol complex itself.
    And as I said earlier today, I have been proud as an 
American of the way the President has conducted himself and the 
Administration in responding to these attacks; I genuinely have 
been.
    Where I believe you will be judged harshly and I believe 
the President will be judged harshly is taking us back down the 
road to deficits and debt--not on a 1-year basis, not this 
year, at a time of war and recession--but for many years to 
come, because you have not balanced the spending and the 
revenue of this Government. You have not. You are digging the 
hole deeper, and in this proposal you continue that practice. I 
think it is profoundly wrong. I think it is a huge mistake, and 
we will pay a great price in the future.
    And I say that to you just as directly as I can, without 
animus or anger, but with the belief that that is the fact.
    Again I thank you very much for being here today.

    [Whereupon, at 12:35 p.m., the committee was adjourned.]

  WRITTEN QUESTIONS FROM SENATOR SARBANES TO DIRECTOR DANIELS AND THE 
                               RESPONSES

                             SEC Pay Parity

    Question: Last year, the Congress passed the Investor and Capital 
Markets Fee Relief Act (P.L. 107-123) which reduced fees charged to 
investors and public companies by a projected $14 billion over 10 years 
and authorized the SEC to pay its employees on a par with the other 
bank regulators. Raising SEC employee salaries is critical to reducing 
turnover and maintaining the effectiveness of the agency, and would 
cost only $76 million for next year. And yet the Administration has not 
budgeted resources so that the SEC can actually exercise this authority 
and raise its employees' salaries. With growing concern about oversight 
of the accounting industry and the integrity of the markets, the 
strength of the SEC is extremely important. Why has the Administration 
not authorized funding of the SEC's pay parity authority?
    Answer: The Administration intends to phase-in a new compensation 
system for the SEC to ensure that it is merit based and not merely an 
automatic entitlement for each employee. In this regard, we are 
concerned that the SEC not repeat the mistakes of some Federal banking 
regulators who do indeed pay their employees more than other Federal 
agencies but who may not have effective performance incentive programs 
such as those that exist in the private sector.
    The Federal Deposit Insurance Corporation's recent announcement 
that buyouts are needed to transform that agency and the Office of 
Thrift Supervision's workforce reductions in 2001 and 2002 illustrate 
the personnel management difficulties that may arise if higher pay 
rates are not accompanied by such performance programs. While the scope 
and speed of the phase-in of the new pay and benefit provision will 
impact the Commission's budgetary requirements, more than $25 million 
in unobligated prior year funding may be available to test pay parity 
in FY 2003.
    The President's FY 2003 Budget includes $481 million for the SEC, 
which is $29 million or 6 percent above the FY 2002 enacted level. 
Included in that total are $164 million for enforcement and $67 million 
for disclosure, which is a 6 percent and 8 percent increase 
respectively over the FY 2002 enacted level. The Administration is also 
requesting $20 million in supplemental FY 2002 funding to increase SEC 
staffing by 100 full time employees (in FY 2002 and FY 2003) beyond the 
levels proposed in the President's FY 2003 budget. These employees will 
help SEC respond to the President's commitment to improving corporate 
governance. The SEC's FY 2003 Budget also includes $19 million for 
special pay, which allows for compensation beyond that provided to 
other general schedule and, executive schedule employees. The special 
pay funding along with any remaining unexpended prior funding is 
available to offset the cost of a phased-in compensation system in the 
next fiscal year.

   WRITTEN QUESTIONS FROM SENATOR WYDEN TO DIRECTOR DANIELS AND THE 
                               RESPONSES

                         FCC Spectrum Auctions

    Question: Last fall, in the Statement of Administration Policy on 
the Agriculture Appropriations Bill for FY 2002, OMB stated: ``The 
Administration would strongly oppose any amendment that would restrict 
the FCC's ability to assign, via competitive bidding, satellitel 
spectrum licenses that could be used by terrestrial (i.e., non-
satellite) services. Such a provision would interfere with the 
efficient allocation of Federal spectrum licenses, provide a windfall 
to certain users, and reduce Federal revenues.'' Does that remain the 
Administration's position today?
    Answer: Yes. The Administration continues to oppose any unnecessary 
restriction of the FCC's auction authority.
    Question: If the FCC decides to permit the use of satellite 
frequencies for terrestrial mobile services, would it be the 
Administration's intent to make that terrestrial service available to 
all qualified entities and to assign it via auction? Would the 
Administration position be the same with respect to terrestrial 
authorizations on any satellite band?
    Answer: If the FCC decides to permit the use of frequencies 
currently allocated for satellite services for terrestrial services, it 
is within the FCC's authority as an independent agency to devise the 
service rules for such frequencies, which will determine the qualified 
entities to use such spectrum, and to assign licenses to use such 
frequencies via auction under its statutory mandate to assign licenses 
for which there are mutually exclusive applications by competitive 
bidding. The Administration does not have direct authority to make such 
decisions but can attempt to influence the process through filings with 
the FCC and through legislative proposals.
    Question: What are the assumptions in the Administration's budget 
regarding spectrum auctions for fiscal year 2003? What are the 
assumptions for the outyears? Would those assumptions be changed if the 
FCC were to decide to allocate satellite spectrum for new terrestrial 
uses without assigning those terrestrial allocations by auction?
    Answer: The FY 2003 Budget baseline includes the following 
estimates for spectrum auction receipts:


                        (in millions of dollars)
    2003         2004        2005        2006        2007        2008
   4,510       10,565        8,770         675         680         685


    If the FCC decided to allocate spectrum currently allocated for 
satellite services for new terrestrial uses without assigning those 
terrestrial authorizations by auction, estimated future spectrum 
auction receipts would be reduced by several hundred million dollars.
    Question: Would the Administration's budget assumptions for 
spectrum auction revenue be different if the FCC proceeded to auction 
the 700Mhz band (channels 52-69) without first establishing an 
alternative plan for incumbent licensees that currently occupy that 
band?
    Answer: The FY 2003 Budget baseline estimate for the 700 MHz 
auctions assumes that the FCC will proceed with the auctions as 
currently planned. That is, that the auctions will be held without 
establishing plans for removing the broadcasters who currently occupy 
the band that are any different from what is currently foreseen under 
the FCC's rules for the 700 MHz auctions. Baseline revenue estimates 
for the 700 MHz auctions (channels 52-69 or 78 MHz of spectrum) are 
$5.4 billion. The proposal in the FY 2003 Budget to shift the auction 
deadlines and establish clearing procedures for channels 59-69 would 
increase receipts by an estimated $6.7 billion, for a total of $12.1 
billion for channels 52-69.

    WRITTEN QUESTIONS FROM SENATOR BOND TO DIRECTOR DANIELS AND THE 
                                RESPONES

                            HUBZone Program

    Mr. Director, I appreciate the President's request to fund the 
Small Business Administration's HUBZone program at $2 million for 2003. 
The HUBZone program is a particular interest of mine, since I wrote the 
HUBZone Act during my tenure as Chairman of the Senate Small Business 
Committee.
    I also commend the Administration, in general, for trying to 
identify underperforming programs and reforming them. But I was 
surprised to find the HUBZone program attacked, on pages 351-2 of the 
budget. The budget states:

        ``a recent study by the General Accounting Office cited poorly 
designed eligibility criteria and burdensome and costly application 
processes as barriers to small business participation in the HUBZone 
program.''

    Now, I was the one who commissioned that GAO study, and I know for 
a fact it does not say anything at all like that. The study notes a 
lack of certified HUBZone firms, but does not attribute this to overly 
strict eligibility criteria. Instead, this may be purely a function of 
eligible firms not knowing that they are in fact eligible.
    Second, the report says nothing--nothing at all--about a 
``burdensome and costly application.'' In fact, the HUBZone program's 
on-line application is something of a model for delivering Government 
services over the Internet.
    Instead, GAO noted a major problem was the Clinton administration's 
effort to subordinate the HUBZone program to the 8(a) program--a policy 
which is being reversed, thanks to publication of new HUBZone rules.
    I am concerned that, after generating a useful report in the 
HUBZone program, GAO is being characterized as making statements they 
did not in fact make. If the goal is to identify actual weaknesses and 
correct them, these statements in the budget are counterproductive.

    Questions:
  In the GAO report HUBZone Program Suffers from Reporting and 
    Implementation Difficulties, dates October 26, 2001 and released 
    publicly in November (GAO-02-57), where does GAO criticize ``poorly 
    designed eligibility criteria''? Please provide a page citation to 
    the report.   Also in the GAO report, where does GAO 
    criticize ``burdensome and costly application processes''? Please 
    provide a page citation to the report.
  In my view, the HUBZone program office has done an excellent 
    job of using Internet technology to bring this program to the 
    public, through its on-line application process. In your view, is 
    the HUBZone program's electronic application consistent with the 
    Administration's e-government initiatives?
  Has the 8(a) program begun incorporating a similar e-
    government approach? What portion of the 8(a) application, if any 
    is usable on-line? When do you expect that the 8(a) program will 
    make full use of the Internet to allow eligible firms to apply?
    Answers: In citing the HUBZone program in the Budget, our intention 
was not to find fault but rather to identify deficiencies either in 
design or execution that when corrected could help better deliver the 
services envisioned in the program's enactment. GAO did not 
specifically criticize ``poorly designed eligibility criteria'' or 
``burdensome and costly application processes'' in its review of the 
HUBZone program. However, GAO identified a number of areas for 
improvement in program reporting and implementation that SBA is now 
working to correct. The Budget document paraphrases some of these 
concerns.
    Specifically, GAO reported that agencies have trouble identifying 
qualified HUBZone firms. Contracting officers attribute this to the 
relatively small number of HUBZone certified businesses. In many cases, 
the information firms provide in SBA's PRO-Net database is not specific 
or reliable enough to ascertain the firms capabilities. SBA agreed with 
GAO's recommendation to help contracting officers identify firms 
capabilities and inform firms of the importance of maintaining timely 
and accurate information in the PRO-Net system. SBA will also intensify 
its efforts to increase the currency of PRO-Net records. In addition, 
GAO stated that agencies are unsure of what qualifies as a HUBZone 
contract due to the lack of SBA guidance. SBA has committed to 
developing guidance to clarify this issue.
    The HUBZone on-line application process is consistent with the 
Administration's e-government initiatives. In fact, SBA is using it as 
the model for all of its small business certification programs. It is 
our understanding that the electronic 8(a) application process proposal 
is being prepared for review through SBA's Capital Planning and 
Investment Control process, as required by the Clinger-Cohen Act. We 
anticipate that a substantial portion of the information currently 
collected in the paper application would be instead collected through 
an on-line application.
    On a broader note, we anticipate that the President's Small 
Business Agenda will increase contracting opportunities for all small 
businesses, including HUBZone firms.

                 Women-owned Business Contracting Goal

    As we ramp up our spending on defense and homeland security needs, 
the role of contractors must inevitably increase. It does no good to 
increase spending if we do not have a diverse vendor base able to sell 
the Government the goods and services it needs.
    I am concerned that small business will not get the fullest 
opportunity to participate in these contracts. Whenever contacting 
officers need to act quickly, they often turn to the same contractors 
they've used in the past, usually large ones. As a result, they often 
overlook the better values available from small firms--the source of so 
much innovation in our economy.
    In particular, I'm concerned about the 5 percent goal for women-
owned small firms to participate in Federal contracting. On October 18, 
2001, I wrote you about the need for the Government to get serious 
about this goal, and urged you to communicate this need to agency heads 
and put them on-notice that they will be held accountable for it. On 
November 30, you responded that OMB's Office of Federal Procurement 
Policy has begun ``working closely'' with the agencies. OFPP has also 
begun meeting with women business groups to improve outreach to those 
firms.

    Questions:
  What specific actions has OFPP taken to hold agency heads 
    accountable for the women business-contacting goal?
  What have you learned from meeting with women business 
    groups? What actions have you taken to implement their 
    recommendations?
  Will the Government meet the 5 percent women business goal 
    this year? If not, why not?
    Answers:
    The President recognizes the enormous role small businesses play in 
our national economy. The President's Small Business Agenda will give 
small business owners the jump-start they need to create new jobs, 
support their workers, and improve our economy. The Administration is 
committed to: providing new tax incentives; giving small business 
owners more power to provide health care for their uninsured employees, 
and improving the health care options for employees who already have 
insurance; tearing down the regulatory barriers and giving small 
business owners a voice in the complex and confusing Federal regulatory 
process; saving taxpayers dollars by ensuring full and open competition 
to government contracts; and providing small businesses with the 
information they need to succeed. OFPP and other Federal agencies are 
working to implement the President's Small Business Agenda. We 
anticipate that the President's Small Business Agenda will increase 
contracting opportunities for all small businesses, including women-
owned firms.
    Recently, the Department of Labor and the Public Forum Institute 
hosted the ``Women Entrepreneurship in the 21st Century'' Summit. Over 
1,000 women entrepreneurs participated in this forum to address the 
most pressing concerns of women business owners today. In a survey 
conducted at the summit, 59 percent of women business owners, when 
asked to project their level of participation in the Federal 
marketplace in the next 12 months, indicated that they needed more 
information. We recognize that more needs to be done to ensure that 
available information reaches women entrepreneurs. However, through a 
variety of resource partners, SBA already provides small business 
owners with information on how to contract with the Federal Government. 
SBA provides valuable information to women-owned small businesses 
through its Online Women's Business Center and through womenbiz.gov, 
the online gateway for women-owned businesses, which is co-sponsored by 
SBA's Office of Contracting Assistance for Women Business Owners.
    While the Federal Government did not meet the 5-percent women-owned 
small business goal in FY 2001, it did improve its performance. 
Preliminary estimates show that 2.45 percent of Federal procurement 
dollars were awarded to women-owned small businesses, an increase of 
$700 million over FY 2000. This is certainly a step in the right 
direction and we recognize that more needs to be done to understand the 
obstacles to increasing the participation of women-owned businesses in 
Federal contracting.

   WRITTEN QUESTIONS FROM SENATOR SNOWE TO DIRECTOR DANIELS AND THE 
                               RESPONSES

                         FCC Spectrum Auctions

    Question: What are the assumptions in the Administration's Budget 
regarding spectrum auctions for FY 2003, and for the subsequent 
outyears?
    Answer: The FY 2003 Budget baseline includes the following 
estimates for spectrum auction receipts:


                        (in millions of dollars)
    2003         2004        2005        2006        2007        2008
    4,510..     10,565        8,770         675         680         685


    Question: How would those assumptions be changed if the FCC decided 
to allocate 1satellite spectrum for new terrestrial uses without 
awarding those terrestrial authorizations by auction?
    Answer: If the FCC decided to allocate spectrum currently allocated 
for satellite services for new terrestrial uses without awarding those 
terrestrial authorizations by auction, estimated future spectrum 
auction receipts would be reduced by several hundred million dollars.
    Question: Further, how would the budget assumptions for spectrum 
auction revenue be different if the FCC proceeded to auction the 700 
MHz band (channels 52-69) without first establishing a definitive plan 
for removing the broadcasters who currently occupy that band?
    Answer: The FY 2003 Budget baseline estimate for the 700 MHz 
auctions assumes that the FCC will proceed with the auctions as 
currently planned. That is, that the auctions will be held without 
establishing plans for removing the broadcasters who currently occupy 
the band that are any different from what is currently foreseen under 
the FCC's rules for the 700 MHz auctions. Baseline revenue estimates 
for the 700 MHz auctions (channels 52-69 or 78 MHz of spectrum) are 
$5.4 billion. The proposal in the FY 2003 Budget to shift the auction 
deadlines and establish clearing procedures for channels 59-69 would 
increase receipts by an estimated $6.7 billion, for a total of $12.1 
billlion for channels 52-69.

                  Manufacturing Extension Partnership

    Question: Director Daniels, why have you decided to so 
significantly reduce the funding for a program that has been so 
successful, especially at a time of economic downturn when the Nation's 
small manufacturers are in need of the important technical assistance 
the MEP is in existence to provide?
    Answer: The Administration's priorities for the 2003 budget are 
combating terrorism, protecting the homeland, and strengthening the 
economy. These priorities reflect changing needs and require making 
difficult budgetary choices. After a careful reexamination of the 
program, the Administration decided to limit Federal funding for MEP to 
program coordination and support of newer centers in 2003.
    MEP's original design called for Federal funding for centers to end 
after six years. The intent was that the centers, which provide 
services similar to private consultants, would be self-sustaining after 
this start-up period. By 2003, most centers will be much more than six 
years old. It is reasonable to expect that fee receipts could replace 
Federal funding for the centers. The gains realized by small firms as a 
result of MEP assistance, such as improved productivity and efficiency, 
should increase profits and outweigh the cost of the services.

           ARS New England Plant, Soil and Water Research Lab

    Question: Could you give me assurances that the New England Plant, 
Soil and Water Research Laboratory will not only remain open and 
running with its current staff but will also include the agricultural 
scientist position and the funds for the expanded research on potato 
late blight research as appropriated in FY 2002? If you cannot respond 
today, could you please get back to me as soon as possible as the 
research laboratory is very important to me and to my State of Maine.
    Answer: As part of its effort to manage its field structure of 
research facilities in the most cost-effective manner and to maximize 
the ability of its scientists to undertake modern research activities, 
USDA has proposed to close or terminate research functions at 11 of its 
research facilities, including the New England Plant, Soil and Water 
Research Lab at Orono, Maine. Orono was proposed for closure for a 
number of reasons, including its small size and the fact that similar 
work was being performed elsewhere.
    When determining which facilities to close, USDA used 
recommendations included in the ``Report of the Strategic Planning Task 
Force on USDA Research Facilities''. This task force was authorized in 
the 1996 Farm Bill, and was tasked with developing a ``10 year 
strategic plan, reflecting both national and regional perspectives, for 
development, modernization construction, consolidation and closure of 
Federal agricultural research facilities and agricultural research 
facilities proposed to be constructed with Federal finds.'' The Report 
recommended that a number of facilities be closed, including the site 
in Orono.
    However, while the existing plant, soil and water research lab is 
proposed for closure, $5.5 million in FY 2001 and FY 2002 construction 
funds have been appropriated for the new Northeast Marine Cold Water 
Aguaculture Research Center that is to be located in Orono, Maine.

   WRITTEN QUESTIONS FROM SENATOR SMITH TO DIRECTOR DANIELS AND THE 
                               RESPONSES

                            Veterans Affairs

    Question: According to many VA sources, the FY 2002 VA medical care 
budget is about $800 million short. Last year, the President asked for 
a $1 billion increase and Congress increased that request by $300 
million. Yet, upon enactment of the FY 2002 budget, VA Secretary 
Principi was about to stop allowing enrollment of new Priority Group 7 
VA patients. Priority Group 7 includes recently separated veterans from 
the armed forces--our newest American heroes. Thankfully, President 
Bush directed Secretary Principi to continue enrolling all new VA 
patients. Why was the FY 2002 budget request for VA medical care well 
below the obvious need and will the Administration be seeking a 
supplemental?
    Answer: Prior to FY 1999, the care for higher-income, non-disabled 
veterans (Priority Level 7) was not 1directly funded in budgets 
submitted by Administrations or passed by Congress. These veterans were 
treated on a space-available basis. The Eligibility Reform Act of 1996 
allowed VA to treat all enrolled patients, and placed into effect a 
prioritization system to ensure that the quality of care for the 
highest priority of veteran was not jeopardized by opening up the 
system to these new veterans. The use of the VA system by this new 
group of veterans has grown from 2 percent of patients in 1996 to 21 
percent today, and it is projected to be 42 percent by 2010. This 
overwhelming response to care was not foreseen. In 2002, the VA medical 
care system is experiencing a 15 percent increase in patients over the 
budget estimate. VA estimated the FY 2002 shortfall to be $142 
million--and this amount is included in our recent supplemental 
request.
    Question: Several veterans' organizations have expressed to me that 
the $1.7 billion increase you are requesting in FY 2003 for VA medical 
care may still be inadequate. What changes did you make in determining 
the estimated cost of continuing to deliver quality health care to 
America's veterans?
    Answer: The Administration is proposing a new $1,500 annual 
deductible for lower-priority (PL 7) veterans (non-disabled and higher-
income). Under law, lower-priority veterans have always paid a portion 
of their care through co-payments. Escalating numbers of PL 7 veterans 
require their increased cost sharing in order to focus appropriations 
on the core veterans. PL 7 veterans would annually pay 45 percent of 
the charge for medical services until their out-of-pocket expenses 
total $1,500. If all projections, funding levels, and the new 
deductible are realized, VA should be able to continue open enrollment 
to all veterans in 2003. Without the deductible, VA would need $1.1 
billion more to continue open enrollment.
    Question: While the number of veterans is declining, the average 
age of veterans is increasing, meaning an increase in the number of VA 
patients. If the VA patient population is increasing at such a dramatic 
rate, why doesn t the VA budget reflect an equitable increase in health 
care professionals?
    Answer: The VA patient population is dramatically increasing mainly 
because of the influx of PL 7 veterans into the system who did not have 
access prior to 1999. The number and type of health care professionals 
is constantly assessed by VA given the anticipated population, the mix 
of contract and direct treatment care, and the ever-changing needs of 
the fast-moving health care environment. For example, VA (like the 
private sector) is moving away from institutional care and more towards 
outpatient and home health care to ensure that veterans are treated in 
the most practical and humane environment.
    Question: With enactment of the Veterans' Millennium Health Care 
and Benefits act (P.L. 106 117), VA has an obligation to provide long-
term care for more veterans. What funding in the FY 2003 budget 
provides for this Federal Mandate?
    Answer: The FY 2003 budget requests over $3.6 billion for 
geriatrics and long-term care. In addition, the Budget requests that VA 
be allowed to account for census increases in community and State 
nursing homes for FY 2003.
    Question: It is my understanding that it may actually save 
taxpayers if the VA served additional veterans whose care is currently 
paid by Medicare, and if the VA provided that care less expensively 
than other health care providers who would be reimbursed through 
Medicare. Would you support allowing veterans to use Medicare dollars 
at VA facilities without reducing the VA appropriation?
    Answer: This is a complex issue with a potential wide-range of care 
and market repercussions (locally and nationally). We are not prepared 
to endorse the initiative without a fill understanding of the 
consequences.
    Question: Every Member of Congress has heard from their veterans 
about fill concurrent receipt of military retirement pay and VA 
disability compensation without the current dollar-for-dollar offset. 
In essence, military retirees are paying for their own VA disability 
compensation with their longevity retirement paychecks. Does the FY 
2003 Defense spending request include funding for concurrent receipt as 
addressed in the FY 2002 Defense authorization act?
    Answer. The principle behind the prohibition is the idea that no 
one should be able to receive concurrent retirement benefits and 
disability benefits based upon the same service. A retired civil 
servant, for example, may not receive civil service disability benefits 
or workers compensation benefits in addition to civil service 
retirement benefits. A similar ban exists against concurrent payment of 
retirement and disability benefits by the Social Security 
Administration.
    On December 28, 2001, President George W. Bush signed into law the 
National Defense 1Authorization Act, 2002 (Public Law 107-107), which 
contained a provision removing one of the barriers prohibiting 
concurrent receipt of military retired pay and VA disability 
compensation benefits. However, the new law did not provide the 
additional funding needed to begin the concurrent payments, and it 
specifically requires additional legislative action that must be taken 
before any concurrent payments can be made. Concurrent receipt would 
cost $58 billion over ten years--$42 billion associated with the 
additional payment of retired pay, and $16 billion associated with 
payment of VA disability compensation under claims that would not 
otherwise be submitted. VA estimates that enactment would result in 
700,000 original claims and 118,000 reopened claims over the next five 
years. Adjudicating these claims without increasing existing backlogs 
and timeliness would require an additional 2,514 employees. This amount 
would require either increasing tax revenues or decreasing spending in 
other program areas in amounts 1equal to the extra costs.
    Question: I have heard from many veterans who experienced lost 
records when their records were transferred from the Department of 
Defense to the Department of Veterans Affairs. Will the FY 2003 budget 
allow for technological enhancements to improve the transfer of 
information so that future veterans will not suffer lost records?
    Answer: The President has two important information technology 
initiatives that should help solve this 1problem. First, the 
President's Management Agenda includes an initiative that would improve 
the VA enrollment systems. Such a system should make transition from 
active duty to veteran status seamless and include the eligibility and 
enrollment status for each of the numerous DoD and VA benefits. For 
over 20 years, the DoD has operated a centralized automated system to 
enroll and track individuals having entitlements to DoD benefits and 
services called the Defense Enrollment/Eligibility Reporting System 
(DEERS). DEERS is a large database that accurately records the benefits 
eligibility information for over 20 million beneficiaries in multiple 
government agencies and could be expanded to include VA. DEERS is 
uniquely positioned to bridge the gap between the two Departments. It 
already supports a modest level of real-time exchange of information on 
veterans, setting the stage for even closer cooperation. The 
Departments are exploring their mutual options in this area. While 
there may be some up-front costs of using DEERS for VA, there should be 
long-terms savings.
    The second key area of coordination of information technology that 
we are addressing is in the medical care area. Both DoD and VA create 
independent patient medical records when a beneficiary uses its health 
care systems just as files are created for you when you visit your 
doctor. Each Department has aggressively moved towards computerizing 
these records to allow all medical providers throughout its own system 
to access and rapidly update individual patient records. Since all 
veterans start out in the DoD system and hundreds of thousands of them 
use both systems annually, it is imperative that this effort be 
coordinated. This challenge can be achieved and would improve overall 
health care. Currently, if a patient sees a DoD doctor on Wednesday, it 
is very difficult to ensure that treatment and medication are 
consistent with those the patient obtained from a VA doctor on Monday. 
Managing care is critical to well-being. One of the Administration's E-
Government initiatives is Health Care Informatics, and development of a 
patient record system falls under its scope. Hence, developmental 
efforts in both Departments will focus on interoperable information 
technology solutions. This is a major effort, which will likely require 
a sustained, multi-year effort to implement completely.

                        Small Business Prpgrams

    Question: Two prime grants are currently supporting ten programs 
around the State (OR) in their efforts to serve disadvantaged 
microentreprenuers. These programs serve Lincoln City, Yamhill County, 
Northeast and Southeast Portland, Ontario, Lane County, Coos, Curry and 
Douglas Counties, and Josephine, Jackson Klamath and Lake Counties.
    Citing duplication, the budget would eliminate PRIME, as it 
proposed last year, but Congress restored modest funding. It is my 
understanding that PRIME is not duplicative, as suggested in the 
Administration's budget, rather it emerged from an extensive survey of 
microenterprise practitioners who cited the lack of basic business 
training and support for lower-income entrepreneurs. Unlike other SBA 
programs, PRIME's legislation targets low-income individuals, 
regardless of whether they take out loans. It serves a very important 
niche within the microenterprise market. PRIME has always enjoyed bi-
partisan support, it has never been controversial and yet, it seems 
this budget proposes to eliminate one of the most promising small 
business programs in the government. Do you really think it makes sense 
to reduce basic business training for people who have shown the desire 
and inclination to start a very small business? Doesn't this type of 
training make common sense and help very small businesses grow?
    Answer: The President's Budget does not request additional funding 
for the Program for Investment in Microentrepreneurs (PRIME) because we 
believe its objectives can be achieved through other Small Business 
Administration (SBA) programs. Specifically, SBA operates Business 
Information Centers (BICs) where entrepreneurs can get information and 
counseling by volunteers through the Service Corps of Retired 
Executives (SCORE) on a range of issues facing start-up and existing 
small businesses. SBA works with the over 1,000 Small Business 
Development Centers nationwide to provide management assistance to 
current and prospective small business owners. The SBDC network 
includes centers in the following Oregon cities: Albany, Bend, Eugene, 
Grants Pass, Gresham, Klamath Falls, LaGrande, Lincoln City, Medford, 
Milwaukie, North Bend, Ontario, Pendleton, Portland, Roseburg, Salem, 
Seaside, The Dalles, and Tillamook. SBDCs offer one-stop assistance to 
small businesses by providing a wide variety of information and 
guidance in central and easily accessible branch locations.
    Question: Mr. Daniels, the Microloan program has begun to flourish 
as demand for its services has increased dramatically over the past 
five years. This program now has $110 million in loans outstanding and 
will have more than $130 million next year. These funds are then relent 
by non-profit intermediaries--including three excellent programs in 
Oregon--in loans averaging just $15,000 which are followed by intensive 
technical assistance to grow these start-up businesses. This technical 
assistance has been key in building business and protecting the 
investment the SBA makes in them. Last year, the SBA ran out of loan 
capital. This year, technical assistance grants were cut by 40 percent. 
The budget figures you propose would cause organizational funding to 
fall even further. Why is the Administration not providing more support 
for a program that creates jobs and builds businesses--particularly in 
places like Oregon, which has the highest unemployment rate in the 
country?
    Answer: The President recognizes the enormous role small businesses 
play in our national economy. The President's Small Business Agenda 
will give small business owners the jump-start they need to create new 
jobs, support their workers, and improve our economy. The 
Administration is committed to: providing new tax incentives; giving 
small business owners more power to provide health care for their 
uninsured employees, and improving the health care options for 
employees who already have insurance; tearing down the regulatory 
barriers and giving small business owners a voice in the complex and 
confusing federal regulatory process; saving taxpayers dollars by 
ensuring full and open competition to government contracts; and 
providing small businesses with the information they need to succeed. 
We anticipate that the President's Small Business Agenda will assist 
entrepreneurs in every state start, maintain, and grow small 
businesses.
    In addition, the Administration is providing support for the 
Microloan program. In fact, the Budget includes $3.465 million in 
subsidy budget authority to support over $26 million in Microloans. We 
agree that the technical assistance portion of the Microloan program 
plays a significant role in increasing the likelihood of borrower 
success. As such, the Budget provides $17.5 million for technical 
assistance.

                    Bonneville Power Administration

    Question: I am pleased that the President's 2003 Budget request 
includes support for a $700 million increase in borrowing authority for 
the Bonneville Power Administration. It was my understanding that this 
increased borrowing authority would not subject to annual 
appropriations, just like BPA's current borrowing authority. Does the 
Administration support this increase in borrowing authority not subject 
to annual appropriations?
    Answer: Yes, the President's Budget, which proposes the increased 
borrowing authority, would be enacted in an authorizing bill, not 
through appropriations. Once authorized, the increase would be treated 
just as BPA's existing borrowing authority is treated and would not be 
subject to annual appropriations.
    Bush Administration officials claim that up to 6 million uninsured 
people would obtain health coverage next year under full implementation 
of a multi-pronged plan they outlined today to expand access to health 
care. Estimated to cost $110 (sic) over 10 years, the plan mixes 
coverage subsides for workers displaced by the recession, tax credits 
for those without employer-subsidized insurance, increased funding for 
community health centers, extended availability of State Children's 
Health Insurance Program funds, and a budget increase for the National 
Health Service Corps. . .all of which you have been publicly supportive 
of (just in higher $$ amounts).
    Question: I was very happy to see that the President has increased 
his request this year for funds for tax credits to help the uninsured 
obtain health insurance. Clearly he recognizes that the problem of the 
uninsured is sizable--and growing--and will not go away on its own. The 
President's proposal is a good start in addressing the issue, but by 
his estimates, if implemented, his proposal will only reach 6 million 
of the uninsured next year. There are 40 million uninsured people in 
this country--and the number is growing. I would like to work with you 
to find a way to cover the remaining 34 million uninsured, many of whom 
will be from my home State of Oregon. Can you tell me how we can go 
about this?
    Answer: I certainly agree with your interest in addressing health 
coverage for the uninsured. As a first step, the Administration 
introduced the Health Insurance Flexibility and Accountability 
Demonstration Initiative (HIFA) in August 2001 to give States new 
flexibility to increase health insurance coverage through support of 
private group health coverage through the Medicaid and SCHIP programs. 
Two states have HIFA waivers approved, and several states have 
submitted HIFA applications to the Department of Health and Human 
Services (HHS). The Administration will continue to build on the HIFA 
demonstration initiative in FY 2003 by developing proposals that 
encourage States to use program resources to reduce the number of 
people without health insurance coverage.
    The President has introduced a comprehensive set of proposals to 
ensure that all Americans have affordable health insurance coverage 
options, with a particular emphasis on creating affordable options for 
the uninsured. As you mentioned, the President's FY 2003 Budget 
includes $89 billion for health credits for the uninsured. The 
President's Budget also eases the restrictions on Medical Savings 
Accounts (MSAs) and Flexible Spending Accounts (FSAs) to encourage 
employers to offer health insurance to their employees, continues 
Medicaid coverage for families in transition from welfare to work in FY 
2003, and strengthens the State Children's Health Insurance Program 
(SCHIP) by making available an estimated $3.2 billion that under 
current law would return to the Treasury at the end of FY 2002 and 
2003.
    Finally, the FY 2003 Budget includes a $114 million increase for 
Community Health Centers to expand access to primary care and other 
health services. This increase builds on the Community Health Centers 
Presidential Initiative to increase and expand the number of health 
center sites by 1,200 and serve 6.1 million more patients by 2006.












           THE PRESIDENT'S FISCAL YEAR 2003 BUDGET PROPOSALS

                              ----------                              


                      WEDNESDAY, FEBRUARY 6, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senator Conrad.
    Staff present: Mary Ann Naylor, staff director; and Chad 
Stone, chief economist.
    For the minority: G. William Hoagland, staff director; and 
Bob Stein, chief economist.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. Why don't we begin?
    Senator Domenici will not be with us this morning. Senator 
Domenici went into the hospital last evening for some tests, 
and we certainly hope those tests find everything is positive 
and that he is on his road to recovery. We eagerly await his 
return to this committee where he plays such an important and 
productive role. And our thoughts are certainly with him, and I 
know I speak on behalf of every member of this committee that 
we wish him well and a speedy recovery.
    I want to thank the witnesses for being here. On our side 
we have six Senators who have indicated they will be here at 
various points. As you know, this morning turned out to be a 
very important morning with respect to votes on the floor. I 
regret that for the purposes of this Committee, but those were 
important votes to have and important debate to have as well. 
Virtually every committee is meeting on the Enron question, so 
those are all things that are occurring which we could not have 
predicted when we scheduled this hearing. But I want to thank 
our very distinguished witnesses for being here.
    I am going to make a very brief opening statement, and 
then, as others arrive, we will hear from them after we have 
gone to the witnesses. So let me just begin.
    The Director of the Congressional Budget Office delivered 
to us earlier the sobering news that much of the projected 
surpluses over the next 10 years have disappeared. Last year we 
were told there was going to be some $5.6 trillion of surpluses 
over the next 10 years. The Congressional Budget Office came 
back after their review, their most recent review, and said 
there is not going to be $5.6 trillion, there is not going to 
be $4.6 trillion, there is going to be $1.6 trillion. And that 
is before the President's defense buildup, before additional 
funds for homeland security, before his stimulus package, 
before a new farm bill, before a whole series of other spending 
initiatives that the President has proposed. And so that $1.6 
trillion is clearly optimistic.
[GRAPHIC] [TIFF OMITTED] 80544.049


    The other shoe dropped with the report to us yesterday by 
the President's Director of the Office of Management and 
Budget, Mr. Daniels, that with the President's budget, the $5.6 
trillion we were anticipating is now done by their 
calculations, using their budgets, to less than $1 trillion, in 
fact, about $600 billion. That, too, is probably overly 
optimistic. We are informed that when the Congressional Budget 
Office does their review of the President's proposal that it is 
more likely they will come in at about $200 billion because the 
President's budget has given an overly optimistic view of 
Medicare expenses and in other areas as well.
[GRAPHIC] [TIFF OMITTED] 80544.050


    The hard reality is that the non-trust fund surpluses that 
we were told about last year, some $2.7 trillion, is all gone. 
Instead, we see $2.2 trillion of deficits on the non-trust fund 
side of the ledger.
[GRAPHIC] [TIFF OMITTED] 80544.051


    What that means is very simple. It means that over $2 
trillion of trust fund money, Social Security and Medicare 
Trust Fund moneys, are being used to pay for the tax cuts and 
to pay for other expenses of the Federal Government. And that 
has got enormous implications for the future.
    The other hard reality is that last year we were told we 
would be virtually debt-free by 2008. The Congressional Budget 
Office told us last year by 2008 there would be virtually no 
debt. Now they are telling us, instead of no debt, we will have 
nearly as much debt as we have got now, some $2.8 trillion of 
debt in the year 2008.
[GRAPHIC] [TIFF OMITTED] 80544.052


    And, of course, that understates the debt because that is 
the publicly held debt. That does not acknowledge the trust 
fund debt, and that does not acknowledge what Chairman 
Greenspan talked to us about the other day as the long-term 
liabilities over and above the money that is due the trust 
funds. And that is in the trillions of dollars.
    That is one reason I said that in many ways we confront 
what Enron confronted. Enron's big problem and big 
vulnerability was the hiding of debt, and in many ways, the 
Federal Government is doing the same thing, with the same 
consequences, perhaps, for the country as for the company--that 
is, financial difficulties that will flow from a failure to 
fully acknowledge the debt the country is facing.
    The consequence of more debt is more interest cost. CBO 
told us last year we could anticipate some $600 billion in 
interest costs over the next decade. Now they are telling us it 
will be $1 trillion more, some $1.6 trillion of interest costs. 
That means that $1 trillion of additional interest costs will 
not be available for productive purposes, will not be available 
to increase the defense of the United States, will not be 
available to improve the homeland security, will not be 
available to educate our children or build roads or bridges or 
other worthwhile purposes. Instead, we will be making more 
interest payments, as at the same time we are taking money out 
of the trust funds of Social Security and Medicare to pay for 
other things.
[GRAPHIC] [TIFF OMITTED] 80544.053


    The President said in his most recent State of the Union 
that, ``Our budget will run a deficit that will be small in 
short-term.'' USA Today pointed out that that is simply not the 
case. It is not going to be small and short-term. Instead, it 
is going to be large deficits and over a very extended period, 
and that is what the next chart shows very clearly, that we now 
face a decade of red ink.
[GRAPHIC] [TIFF OMITTED] 80544.054


    We, after a lot of effort by many different people, were 
able to emerge from a long period of deficits and at the end of 
the 1990's go into surplus, and we were headed for substantial 
surpluses, and now we have been plunged back into deficit.
[GRAPHIC] [TIFF OMITTED] 80544.055


    And the President says the reason is recession and war, 
and, of course, in the near term, he is correct. For this year 
and next year, the biggest reason is recession and war.
    But over the decade, the biggest reason is something he is 
reluctant to talk about. The biggest reason over the next 
decade for our returns to deficit and debt is because of the 
tax cut the President proposed and pushed through Congress last 
year.
    In fact, CBO testified that over the next decade, 42 
percent of the disappearance of the surpluses is due to the tax 
cut, 23 percent is due to the economic downturn, 18 percent 
additional spending that came largely as a result of the 
attacks on this country on September 11th, 17 percent technical 
changes, largely underestimations of the cost of Medicare and 
Medicaid.
[GRAPHIC] [TIFF OMITTED] 80544.056


    Let me just go to the last chart, which shows the results 
of all this. The result is that the total trust fund surpluses 
used for tax cuts and other spending programs will total nearly 
$2.2 trillion over the next decade, $1.65 trillion will be 
taken from the Social Security Trust Funds and $523 billion 
from the Medicare Trust Funds to pay for tax cuts and the other 
expenses of the Federal Government.
[GRAPHIC] [TIFF OMITTED] 80544.057


    Some of us believe that is a profound mistake, given the 
fact the baby-boom generation starts to retire in just 6 years.
    Today we have the opportunity to hear testimony from 
outside budget experts. Jack Lew, who is currently the 
Executive Vice President for Operations at New York University, 
was President Clinton's last Budget Director and someone who 
enjoyed very high credibility on both sides of the aisle in 
both chambers. He presided over the budget during a period when 
the fruits of fiscal discipline practiced during the 1990's 
were realized, when the budget turned from deficit to surplus, 
and when we began to pay down the public debt instead of adding 
to it.
    Robert Bixby is the Executive Director of The Concord 
Coalition, which has a very strong record of advocating and 
defending fiscal discipline.
    We welcome you both. I very much look forward to your 
testimony, and we will proceed with Mr. Lew.

    STATEMENT OF JACOB J. LEW, EXECUTIVE VICE PRESIDENT FOR 
           OPERATIONS, DESIGNATE, NEW YORK UNIVERSITY

    Mr. Lew. Thank you, Mr. Chairman. It is a pleasure to be 
here with you today, and I want to join you in wishing my good 
friend, Senator Domenici, a quick recovery. We are all together 
hoping that he is going to be better very soon.
    I appear today for the first time as a private citizen, and 
the views I express are accordingly my own. I also learned over 
the weekend, sitting there with my hand calculator, how much I 
appreciated the very good work of the OMB career staff over the 
last 6 years.
    It is important to remember that deliberate policy choices 
were necessary to produce a surplus and begin to pay down the 
public debt. Similarly, deliberate policy choices in the budget 
presented this week chart a course in a very different 
direction.
    Budget projections changed dramatically over the course of 
the Clinton administration. At the end of 1992, there was an 
annual deficit of $290 billion that was projected to rise to 
$639 billion by 2003. Fiscal discipline, starting in 1990 with 
the Budget Enforcement Act, continuing through 1993 and the 
Balanced Budget Act of 1997, really made a difference. Markets 
responded with low interest rates; growth only accelerated the 
accumulation of a surplus. As a result, during the time that I 
was OMB Director, we were able to pay off $363 billion in debt. 
That is an accomplishment that would have been called 
impossible if you predicted it in 1992, and we were actually on 
a path toward eliminating the publicly held debt.
    A year ago, both the OMB and CBO projections showed that 
there would be a $5.6 trillion surplus over 10 years. There was 
broad consensus that there was sufficient resources to pay for 
a wide variety of initiatives and leave a cushion for the 
unexpected. The budget presented this week shows how quickly a 
surplus can be dissipated.
    Much has changed over the past year: the recession was 
deeper than expected; there was an attack on September 11th 
that caused the need for additional spending; and there were 
specific policy changes enacted into law, which you mentioned 
in your opening remarks.
    I think the trend from last year through this year really 
must be distinguished from the longer-term trend, as you noted. 
In 2002, instead of posting a surplus of $277 billion, there 
was a deficit of $106 billion. In 2003, the baseline shows that 
the surplus will drop from $307 billion to $51 billion. And 
with the policy proposals, it would go down to a deficit of $80 
billion.
    This is a very dramatic swing. One could raise questions 
about some of the need for provisions that are proposed for the 
next couple of years, particularly given the timing of them 
taking effect, the likely timing of a recovery, and the 
relatively poor targeting of some of them. But, nonetheless, I 
think that most budget analysts would agree that a tax cut in 
this short-term period does not mark a deviation from fiscal 
discipline. The unexpected did happen, and for those of us who 
oppose a balanced budget amendment to the Constitution, this 
was precisely the kind of circumstance where we expected that 
there might be a need to go back into deficit, war, recession, 
and the like.
    Far more troubling is the steady drift away from fiscal 
policy, well beyond the economic recovery. And while the 
administration proposes that the baseline surplus will shrink 
to $2.2 trillion over 10 years, as you noted in your opening 
remarks, CBO shows it coming down to $1.6 trillion. And with 
the difference in Medicare accounted for, it gets $300 billion 
smaller. When you add in the administration's policy changes, 
the surplus over the next 10 years is virtually gone.
    Neither the economic downturn nor military and domestic 
responses to September 11th really are sufficient to explain 
the longer-term trend. The single largest cause of the 10-year 
decline in the surplus is the tax cut enacted last year. I have 
looked at it using CBO numbers, which were a little bit 
different than the numbers you used, but they tell the same 
story. From 2002 through 2011 the tax bill costs $1.5 trillion, 
including interest costs. This budget proposes adding $600 
billion of additional costs, bringing the total to well over $2 
trillion between 2002 and 2012. In comparison, the 
administration's estimate of the increased spending for defense 
and homeland security over 10 years is $627 billion. So, 
clearly, the largest change in policy that has contributed to 
the shrinking of the surplus is the tax cut.
    The change in fiscal condition is even more dramatic when 
Social Security is separated from the rest of the budget. CBO 
projects that the unified budget, including Social Security, 
goes back into surplus, the baseline goes back into surplus in 
2004. But it is only because of the implicit assumption that 
Social Security funds will be available to support a deficit in 
the non-Social Security budget. The non-Social Security budget 
remains in deficit until 2009 in the CBO baseline, and the 
administration then proposes further spending and further tax 
cuts, which further draw down the surplus and drive up the non-
Social Security deficit.
    Under the administration budget, the non-Social Security 
budget remains in deficit for every year in the 10-year window. 
In 2008, the year when the baby boom begins to retire, the non-
Social Security budget will be drawing $143 billion from Social 
Security to finance current operations of Government. At the 
end of the forecast period, the annual non-Social Security 
deficit is still $75 billion. And, cumulatively, as you noted 
in your opening remarks, the publicly held debt remains very 
high. It doesn't fall below $3 trillion until 2010 with the 
policy the administration proposes.
    Dependence on the Social Security surplus to finance non-
Social Security expenses is a dangerous but familiar pattern. 
It is the pattern that from 1981 through the early 1990's led 
to high interest rates and constrained economic growth. It led 
citizens to worry whether their Social Security benefits would 
be paid when they retired.
    There is a sharp contrast to the virtuous cycle of the late 
1990's when declining debt meant declining interest payments 
and only accelerated the buildup of the surplus and we were 
able to pay down the debt.
    When the baby boom begins to retire in 2008, it will not be 
possible any longer to finance the non-Social Security budget 
out of a Social Security surplus. After 2016, the Social 
Security Trust Fund will first draw down the interest that is 
due it for past financing of non-Social Security expenses, and 
then it will need the principal just to pay the benefits as 
assumed in current law. This will only be possible if the non-
Social Security budget is balanced and runs a surplus at that 
time. Unfortunately, the administration budget takes a path 
that makes it a distant memory to save the Social Security 
surplus and pay down the debt.
    I would like to note a number of areas where the budget, I 
think, understates the extent of the problem. On the domestic 
discretionary side, there is--a little more than $200 billion 
of savings assumed in non-defense discretionary spending over 
10 years. That is a very significant reduction below an 
inflated baseline, and it means that programs like education, 
health, biomedical research would all be under intense 
pressure. There is also an assumption that savings will be 
garnered from reducing programs, including the highway trust 
fund, where I think a lot of us are skeptical that the savings 
will really materialize. In the event the savings don't 
materialize, it only puts more pressure on non-defense 
spending.
    In the tax area, while many of the tax provisions from last 
year's tax bill are extended, a number are not, and one in 
particular, the alternative minimum tax, is likely to cause 
extreme pressure on the system as millions and millions of 
middle-class taxpayers are forced into the alternative minimum 
tax after 2010. We have noted the Medicare baseline difference 
between the Congressional Budget Office and OMB. There also 
appear to be policy assumptions in here on Medicare which I 
personally am skeptical about, having seen the reaction to the 
Balanced Budget Act in 1997. The budget assumes that continued 
pressure on physician reimbursement and teaching hospital 
reimbursement will be successful. I don't think it is good 
policy at this point given the other strains on the system, and 
it is not very likely to be materialized.
    I will conclude just by noting that there is broad support 
for a number of important policies, including defense increases 
and a prescription drug program in Medicare. Unfortunately, the 
administration's tax policy leaves virtually no room to fund 
other priorities. The choices seem fairly straightforward to 
me: domestic priorities can be severely reduced; the Social 
Security Trust Fund, contrary to promises made, can be used to 
finance these activities; or provisions of the tax bill that 
have not yet taken effect can be deferred until we can afford 
them.
    At a time when there is increased understanding of the 
importance of clear financial projections, the integrity of a 
budget requires more than simple arithmetic. A budget must 
accurately detail the demand for Government services and the 
likely sources of revenue. While this budget paints a grim 
fiscal picture, it understates the true extent of the problem, 
and I believe it misstates the cause, which is not a war but 
tax policy.
    Mr. Chairman, I would conclude my remarks there and would 
welcome any questions that you have. Thank you.
    [The prepared statement of Mr. Lew follows:]

                 The Prepared Statement of Jacob J. Lew

    Thank you for inviting me to testify this morning. As Director and 
Deputy Director of the Office of Management and Budget, I appeared 
before this Committee many times, but today I appear for the first time 
as a private citizen, and the views I express are accordingly my own. 
It is also the first time I have prepared testimony for this Committee 
without the able assistance of the OMB career staff, which only 
heightens my appreciation for their outstanding service.
    It is important to remember that deliberate policy choices were 
necessary to produce a surplus and begin to pay down the public debt. 
Similarly, deliberate policy choices in the budget presented this week 
chart a path in a very different direction.
    Budget projections changed dramatically from the beginning to the 
end of the Clinton administration. At the end of fiscal year 1992, the 
annual deficit was $290 billion and it was projected to rise to $390 
billion in fiscal year 1998 and $639 billion in fiscal year 2003. 
Fiscal discipline, starting with the Budget Enforcement Act of 1990 and 
continuing with deficit reduction legislation in 1993 and the Balanced 
Budget Act of 1997, reversed twenty years of ballooning deficits. 
Markets responded with low interest rates which helped drive strong 
economic growth and accelerated the accumulation of a surplus. As a 
result, during my 3 years as Director of the Office of Management and 
Budget we were able to pay off $363 billion in debt, an accomplishment 
that would have been called impossible if predicted in 1992. We were on 
a path toward eliminating the publicly held debt.
    Last January I appeared here on the last full day of the Clinton 
administration to present our final baseline budget projections. At 
that time, the Office of Management and Budget and the Congressional 
Budget Office both projected a 10-year surplus of $5.6 trillion. The 
debate was whether it would be possible to eliminate the entire debt 
held by the public within 10 years or whether even with a surplus some 
debt could simply not be paid off. There was broad consensus that the 
projected surplus would both accommodate substantial new policy 
initiatives and provide a cushion against potential unexpected shocks. 
The budget presented this week includes a simple table that shows in 
black and white how quickly a surplus can be dissipated. According to 
Administration estimates, the baseline surplus has dropped to $2.2 
trillion and the proposed budget would reduce it further to only $665 
billion over the same period.
    Much has changed over the past year: the recession was deeper than 
expected; terrorist attacks on the World Trade Center and the Pentagon 
required a substantial commitment of new resources for defense and 
domestic security; and policy changes, in particular a significant tax 
cut, were enacted into law. To understand the change that has taken 
place and chart a path back to fiscal discipline, it is crucial to 
differentiate the impact of economic conditions, attacks that could not 
be predicted and policy changes that were deliberate decisions. The 
trend from last year through this year must be distinguished from the 
longer term trend. In 2002, instead of posting a surplus of $277 
billion, there was actually a deficit of $106 billion. In fiscal year 
2003, instead of a surplus of $307 billion, as projected last year, the 
current baseline shows a surplus of $51 billion. If the 
Administration's proposals are enacted, the 2003 deficit will be $80 
billion.
    This is a dramatic swing, and one could question whether additional 
economic stimulus is likely to have a positive effect before a recovery 
is already underway, particularly if the stimulus is not targeted well. 
Nonetheless, in the context of an economic downturn along with 
significant military and emergency expenses, a deficit in these years 
does not indicate a radical departure from fiscal discipline. In fact, 
the key argument against a constitutional amendment to balance the 
budget has always been the need to respond to unexpected and 
unpredictable events such as war and economic recession. Far more 
troubling is the forecast of a steady drift away from fiscal 
discipline, well beyond the economic recovery, which the budget 
presented this week only accelerates. While Administration projections 
show the baseline surplus over 10 years shrinking to $2.2 trillion, the 
Congressional Budget Office is even more pessimistic, forecasting a 
baseline surplus of only $1.6 trillion. One difference between the two 
forecasts that jumps out is Medicare spending, where CBO assumes over 
$300 billion of additional spending under current law. If CBO is 
correct, the Administration estimate of $665 billion remaining surplus 
over 10 years would be almost completely erased.
    Neither the economic downturn nor the military and domestic 
response to the September 11 attacks on the World Trade Center and the 
Pentagon are sufficient to explain this longer term trend. In fact, the 
single largest cause of the 10-year decline in the surplus is last 
year's tax bill. From 2002 through 2011 the tax bill will cost $1.5 
trillion, including higher interest costs due to the larger national 
debt resulting from the tax cut. In the current budget, the 
Administration proposes additional tax cuts, including an extension of 
provisions that were set to expire under last year's tax bill, adding 
over $600 billion in additional cost. This brings the cost of the tax 
bill to more than $2 trillion between 2002 and 2012. In contrast, the 
proposed increase for defense and homeland security from 2003 through 
2012 is $627 billion.
    The change in fiscal condition is even more dramatic when Social 
Security is separated from the rest of the budget. CBO projects that 
the unified budget, including Social Security, will return to surplus 
in 2004, but only because of the implicit assumption that the Social 
Security surplus will be used to finance non-social security tax and 
spending policies. The CBO baseline projects that the non-social 
security budget remains in deficit until 2009 and over 10 years 
projects a non-social security deficit of $742 billion. The 
Administration budget proposals would further reduce revenue and 
increase spending at the same time, driving the non-social security 
deficit to $1.7 trillion between 2002 and 2012.
    In fact, under the Administration budget the non-social security 
budget remains in deficit for the entire period. In 2008, the year when 
the baby boom begins to retire, the non-social security budget will 
continue to draw $143 billion in financing from the Social Security 
Trust Fund. At the end of the forecast period, the annual non-social 
security deficit would still be $75 billion. Cumulatively, shifting 
from a policy of saving the Social Security surplus and using it to pay 
down debt means that the publicly held debt will remain quite high, 
around $3 trillion throughout this period. Administration projections 
show that the publicly held debt will not fall below $3 trillion until 
2010. Consequently, interest payments instead of falling to near zero, 
will remain in the range of $150 billion a year even at the end of the 
10-years.
    Dependence on the Social Security surplus to finance non-social 
security expenses is a dangerous but familiar pattern. It is the path 
that from 1981 through the early 1990's led to high interest rates and 
constrained growth. It is also the path that led citizens to worry 
about the ability of the Federal Government to make payments for Social 
Security and other entitlements when the baby boom retires. Stubbornly 
high long-term interest rates today suggest that the financial 
community expects Federal borrowing to remain heavy for some time to 
come.
    We enjoyed a virtuous cycle in the late 1990's, as declining 
deficits permitted the repayment of debt and a further decline in 
interest costs. The non-social security budget no longer depended on 
Social Security financing to run a surplus and Federal outlays for. 
interest payments were rapidly shrinking.
    When the baby boom begins to retire in 2008, it will no longer be 
possible to finance the non-social security deficit from the trust 
fund. Starting in 2016, only 8 years later, in order to pay current 
benefits the Social Security Trust Fund will first spend the interest 
and eventually the principal, it is owed for past financing of general 
government expenses. This will only be possible if the non-social 
security budget can be balanced and eventually run a surplus. 
Unfortunately, the Administration budget takes a path which makes a 
distant memory the goal of saving the Social Security surplus to pay 
down the debt and protect Social Security.
    In a number of areas, this budget understates the true extent of 
the problem. For example, it assumes non-defense-spending cuts that 
appear unrealistic. After accounting for increases in homeland 
security, all other discretionary spending will be reduced by more than 
$200 billion over 10 years compared to the baseline, which keeps pace 
with inflation. Moreover, if specific proposals to reduce spending are 
rejected, such as the proposal to reduce spending from the highway 
trust fund, the cut to all other discretionary spending will only get 
deeper. With broad bipartisan support for education funding, biomedical 
research and other important domestic priorities, it is difficult to 
see how such deep reductions can or should be achieved. Yet if savings 
fail to materialize, the fiscal problem will only get more severe.
    On the tax side, the budget does not address issues that are likely 
to become increasingly troubling. For example, it does not recognize 
the fact that the individual alternative minimum tax, through a form of 
bracket creep, will cover tens of millions of middle income taxpayers 
over the coming years. In fact, the cost of the Administration's own 
tax cuts is reduced because of the assumption that the AMT will force 
more and more middle income taxpayers to give up some of their rate 
cuts through this back door. Tax experts agree that the individual AMT 
should be modified, but this budget does not leave room for the cost 
associated with such a change.
    As noted above, the budget forecasts a rate of Medicare spending 
which may be $300 billion too low if CBO is correct in its projections. 
Moreover, the Medicare proposals appear to count on continued savings 
from provisions that tightly limit reimbursement to physicians and 
teaching hospitals. In recent years, Congress has demonstrated on a 
bipartisan basis that these limits were too tight. At a minimum, 
funding for prescription drug coverage appears to be dependent on 
continuing these savings.
    There is also a distressing trend toward triggers that make 
spending and tax cuts appear to go away. As we see in this budget, 
policies that are assumed to disappear have a way of coming back.
    There appears to be broad support for a number of important 
policies, including increased defense spending and prescription drug 
coverage under Medicare. There should be sufficient surplus available 
to finance these investments without going back to deficit spending. 
Unfortunately, the Administration's tax policy leaves virtually no room 
to fund other priorities. The choices are actually pretty 
straightforward: domestic priorities can be severely reduced; the 
Social Security Trust Fund, contrary to promises made, can be used to 
finance these activities; or provisions of the tax bill that have not 
yet taken effect can be deferred or reconsidered.
    At a time when there is increased understanding of the importance 
of clear financial presentations, the integrity of a budget requires 
more than simple arithmetic, A budget must accurately detail demand for 
government services and likely sources of revenue. While this budget 
paints a grim fiscal picture, it understates the true extent of the 
problem. It also misstates the cause, which is not war but a tax policy 
that we cannot afford without turning away from the goal of protecting 
the Social Security surplus and paying down the debt.

    Chairman Conrad. Thank you very much, Mr. Lew. Thank you 
for that excellent, thoughtful testimony.
    Mr. Bixby, welcome. Good to have you here and please 
proceed with your testimony.

 STATEMENT OF ROBERT L. BIXBY, EXECUTIVE DIRECTOR, THE CONCORD 
                           COALITION

    Mr. Bixby. Thank you very much, Mr. Chairman, and I, too, 
would join in wishing Senator Domenici a speedy recovery and 
hope that he is back with the committee very soon. He has been 
a good friend to balanced budgets and to The Concord Coalition 
and to the cause of fiscal discipline.
    I am here representing The Concord Coalition, which is a 
bipartisan organization dedicated to strengthening the Nation's 
long-term economic prospects through prudent fiscal policy, and 
our organization is chaired by two of your former colleagues: 
Senator Warren Rudman, a Republican of New Hampshire, and 
Senator Bob Kerrey, Democrat of Nebraska.
    The President's budget message identifies five overall 
priorities: protecting the homeland, winning the war against 
terrorism, funding initiatives while moderating the growth in 
spending, returning to economic vitality. These are all worthy 
objectives, but to that list, The Concord Coalition would add a 
sixth critical objective: addressing the unsustainable long-
term fiscal challenge of our aging population. With the first 
of the boomers qualifying for both Social Security and Medicare 
within the coming decade, The Concord Coalition strongly 
believes that the long-term challenge is, by itself, a short-
term concern.
    Now, the short-term context in which this budget is 
presented by the President has changed in many different ways 
that were noted by Jack Lew and also by yourself, Mr. Chairman. 
Suffice it to say that we are in a new environment having to 
deal with a war against terrorism at home and abroad and a 
recession. These are things that we did not have to deal with. 
So it is not surprising that the budget--that there would be 
fiscal consequences to that.
    But, nevertheless, the numbers do demonstrate a startling 
turnaround. Not only the overall budget surplus is being 
declined, but the fact that the non-Social Security surplus has 
frankly disappeared over the 10-year period, we were looking at 
a post-policy non-Social Security surplus, a reserve fund, if 
you will, in last year's budget of $840 billion or so. And the 
non-Social Security deficit is now $1.6 trillion over that same 
10-year period. So that is a very significant swing, and it has 
serious consequences for the budget as we make these long-term 
plans.
    That having been said, The Concord Coalition is as strong 
an advocate of balanced budgets as there is. We recognize, 
however, that there may be times when a deficit is an 
appropriate response to pressing national needs. Fiscal years 
2002 and 2003 may fit that description. But the temporary need 
to run a deficit should not be taken as an excuse to abandon 
fiscal discipline, which is still needed to help prepare for 
the long-term challenges.
    In other words, the problem now is we don't want to dig 
such a large hole that it will be impossible to climb back out 
of before the baby boomers leave the work force and begin to 
cash in the trust fund IOUs for Social Security and Medicare. 
That is not a new bill that we have to pay, but one that we are 
already on the hook for.
    With that observation, let me turn to some of the policy 
prescriptions in the President's budget.
    First of all, there is obviously a big increase for defense 
spending. I think that given the circumstances, that is not too 
surprising.
    One caveat I would like to point out, it is possible that 
it may even be understated. If the extent of the effort is as 
long and as extensive as the President seems to indicate--and, 
you know, he has been pretty forthright about the fact that 
this is not going to be a short effort--it could be that the 
levels of spending for defense over the coming decade will 
actually be larger than these budget forecasts indicate.
    Looking at defense spending as a percentage of the economy, 
in the budget it pretty much keeps pace with the economy. Not 
so long ago, defense spending as a percentage of the economy 
was considerably higher, as early as the early 1990's when we 
were fighting the Gulf War. So while there is certainly a big 
defense here, I just want to lay out that as a possible caveat, 
that we need to be ready that there may be more coming.
    On the non-defense discretionary side of the budget, I 
think that the assumption here is clearly unrealistically low. 
I would agree with the administration that there is a need, 
given the short-term demands, to scrutinize the budget as 
carefully as possible and perhaps hold non-defense 
discretionary spending as low as possible in the current year 
or two, particularly as we also increase homeland security 
expenditures.
    But making an assumption that one can hold non-defense 
discretionary spending to a level that is below 2 percent 
growth for the fiscal years beyond 2004 is not just optimistic, 
it is wildly optimistic. I just don't think that is going to be 
done. And the problem with that is that it does produce in the 
baseline presumed savings that will never happen.
    I think back to the days when we used to do balanced budget 
plans, 5-year balanced budget plans, which we may have to start 
doing again. And they would always follow a similar path. They 
would go up in the first year or two, and then you would have a 
steep drop in years three, four, five, and that is where all 
the savings were. And if you look at the path of non-defense 
discretionary spending in the President's budget, that is the 
path that it follows.
    Economic stimulus. I would be just as happy if you didn't 
bother with that. I mean, we all want a strong economy, but an 
awful lot of fiscal stimulus is already in the pipeline through 
last year's tax cuts. I think the Republicans should claim 
credit for those tax cuts and say this was very well timed, and 
we probably don't need to do any more right now. There is a lot 
of new spending in the pipeline, so you look at the budget 
numbers, and it may just be that the fiscal stimulus bill that 
people are, for understandable reasons, wanting to do, may end 
up being unnecessary. But it would knock a hole in the budget 
in the next couple of years.
    The Concord Coalition feels similarly about long-term tax 
cuts. There are a lot more tax cuts in the President's budget, 
some $600 billion or so, probably best to leave those alone. I 
think that given the uncertainties on the war effort and how 
much that is going to cost, given the fact that a large tax 
increase is already in place--excuse me, a large tax cut is 
already in place, and the fact that the budget surpluses were 
back into spending the Social Security surpluses, it would be 
best not to enact any new tax cuts at this time. That includes 
extending the--or removing the sunset provision from last 
year's tax cut. Clearly, that is an issue that is going to have 
to be addressed at some point. It makes the baseline sort of 
skewed because you get huge surpluses in the last couple of 
years. So I don't think you should rely on a sunsetted baseline 
to make your policy decisions this year, but I don't think the 
sunset should be removed at this point because we just don't 
know what resources we are going to need out beyond those 10 
years. And as we look forward, if the deficits are long-lasting 
and deep, then we certainly will want to revisit those tax 
cuts. So it is probably best to leave the trigger--leave that 
in place as the ultimate trigger right now.
    Let me close by making a comment about the Social Security 
firewall. One of the most disturbing things about the budget 
and what has happened here is that that Social Security fiscal 
firewall has come down. Before September 11th, that was the 
strongest fiscal firewall there was. It was stronger than caps 
or pay-go or anything else, because it really has some 
political bite to it. I used to be field director for The 
Concord Coalition, and I can tell you that you go out and talk 
to people, you do radio call-in shows or whatever. There is one 
thing that Democrats and Republicans alike and the public is 
quite clear on, and that is that they do want the Social 
Security surplus saved and not used to fund other operations of 
Government.
    Now, for understandable reasons, we can't do that this 
year. Probably next year--it is going to take a while to climb 
back up to that goal. But we shouldn't abandon the goal 
altogether, and the President's budget implicitly does that 
because throughout the 10-year period, we never back into an 
on-budget surplus. So speaking of 5-year balanced budget plans, 
it might not be a bad idea to look at what it would take to get 
us back to an on-budget surplus, a new balanced budget plan 
using our agreed-upon definition of what the new balanced 
budget would be. And in that regard, everything really needs to 
be on the table.
    But the President's budget presents a clear choice in that 
regard. You can either do the tax cuts that have been enacted 
and the new spending that people want to do, or spend the 
Social Security surplus. I mean, something has to give in 
there. The President's budget is saying you can't do it all. 
And so whether it is this year or next year, or whenever, at 
some point everything needs to be put on the table to see if we 
can get back into that Social Security surplus.
    That to me is the most important thing about this. The mix 
of policy options is something that the Congress will come up 
with in the usual course of negotiations. But I think the most 
fundamental thing is we need to re-establish and reaffirm that 
goal and figure out a plan for getting back to achieve it, 
because the ultimate thing here is while we have lots of new 
problems that have come up over the past year, nothing has 
changed about the old problems. The boomers' retirement--when 
you and I reach retirement age, Mr. Chairman, and Jack Lew, 
too, those that come after us have already got a big bill 
coming due. And everything we can do now to increase savings in 
anticipation of that we should be doing.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Bixby follows:]

                 The Prepared Statement of Robert Bixby

    Mr. Chairman, Senator Domenici, and members of the Committee, thank 
you for inviting me to appear today to discuss the President's Fiscal 
Year 2003 budget. I am here representing The Concord Coalition, a 
bipartisan organization dedicated to strengthening the Nation's long-
term economic prospects through prudent fiscal policy. Concord's co-
chairs are former Senators, Warren Rudman (R-NH) and Bob Kerrey (D-NE).
    My testimony today will review the President's budget in light of 
the many new security and economic challenges presented over the past 
year and the familiar long-term fiscal challenges that loom just beyond 
the current 10-year budget window as the huge baby boom generation 
enters its retirement years. I will also discuss five policy guidelines 
recommended by The Concord Coalition to help ensure that the long-term 
fiscal health of our Nation is not sacrificed to short-term concerns.
    The President's Budget Message identifies five overall priorities: 
protecting the homeland, winning the war on terrorism abroad, returning 
to economic vitality, governing with accountability and funding other 
initiatives while moderating the growth in spending. These are worthy 
objectives. But to this list, The Concord Coalition would add a sixth 
critical objective: addressing the unsustainable long-term fiscal 
challenge of our aging population. With the first of the boomers 
qualifying for both Social Security and Medicare within the coming 
decade, The Concord Coalition strongly believes that the long-term 
challenge is, by itself, a short-term concern.

              I. The Short-term Context: A Dramatic Change

    President Bush's Fiscal Year 2003 budget is presented in a short-
term context that is far different from presidential budgets in recent 
years:

  We have embarked upon a worthy, but costly, effort to defeat 
    the worldwide terrorist network that launched a deadly attack on 
    our Nation last September.
  We have come to recognize the need to substantially increase 
    spending on homeland security.
  We are in an economic recession for the first time in 10 
    years.
  We have enacted a series of escalating tax reductions over 
    the next decade that will reduce revenues and increase debt service 
    costs by an estimated $1.7 trillion.
  As a result of the above factors, the huge surpluses, which 
    were projected just a year ago, have been diminished by about 70 
    percent
  The non-Social Security surplus has vanished, and for the 
    first time in many years there is no clear, agreed upon fiscal 
    policy goal to constrain spending increases and tax cuts.
  The budgetary enforcement mechanisms, caps on discretionary 
    spending and the pay-as-you-go requirement for tax cuts and 
    entitlement spending, no longer apply.

    The President's budget, like the January 2002 report of the 
Congressional Budget Office (CBO), clearly demonstrates the rapid 
decline in the government's fiscal position over the past year. Deficit 
spending will return this year for the first time since 1997, and 
continue through 2004 assuming enactment of the President's policies.

    The numbers demonstrate a startling turnaround:

  Last year the President's budget projected that even with 
    enactment of his recommended tax cut and other policy priorities 
    there would be a 10-year budget surplus of $3.4 trillion--enough to 
    eliminate the debt held by the public. This year's budget, assuming 
    enactment of the President's policies, projects a surplus ofjust 
    $665 billion over the same 10-year timeframe.
  Last year the President's budget showed a 10-year non-Social 
    Security surplus of $841 billion. This year's 10-year projection is 
    for a non-Social Security deficit of about $1.6 trillion over the 
    same period (Fiscal Year 2002-2011).
  In last year's budget, non-Social Security surpluses were 
    projected for every year. In the current budget, the opposite is 
    true. There is no year in which a non-Social Security surplus is 
    projected.

    The policy initiatives in the President's budget respond to the 
challenges of the new environment. As the President notes, the 
government ``will have new bills to pay.'' These new costs, plus the 
proposed new tax cuts in the President's budget, are expected to 
produce deficits for the next couple of years. If so, they would be the 
first Federal budget deficits since 1997.
    The Concord Coalition is as strong an advocate of balanced budgets 
as there is. We recognize, however, that there are times when a deficit 
is an appropriate response to pressing national needs. This may well be 
true in fiscal year 2002 and perhaps 2003. But the temporary need to 
deficit spend should not be taken as an excuse to abandon fiscal 
discipline, which is still needed to prepare for the long-term 
challenges. We should not dig such a large hole now that it will be 
impossible to climb back out of it before the baby boomers begin to 
leave the work force and qualify for Social Security and Medicare. That 
is not a ``new bill,'' but one we are already on the hook for.
    With that observation, let me turn to some of the policy 
prescriptions in the President's budget. These will be general 
observations given the short time that has passed since the budget 
documents were published.
Defense increase
    The President's proposed increase in defense spending represents a 
substantial increase over the budgets of recent years. This is not 
surprising given that we are now engaged in an ambitious and worthy 
effort to defeat worldwide terrorism. Simply put, the peace dividend, 
which helped to control total discretionary spending in the 1990's, is 
over.
    Large as the defense increase may appear it is relevant to note 
that according to OMB tables, defense spending as a percentage of GDP 
would essentially remain constant at about 3.4 percent over the next 5 
years. As a point of comparison, defense spending was at 5.4 percent of 
GDP in 1991 when we were preparing for and fighting the Persian Gulf 
War. If the current war effort expands, the level of spending projected 
in the President's budget may well prove to be a down payment on even 
larger increases. In a time of such uncertainty, this possibility 
cannot be lightly ignored.
Non-defense discretionary spending
    This category includes homeland security, which deservedly gets a 
big boost in the President's budget. However, non-defense discretionary 
spending is assumed to grow at an average annual rate that is 
unrealistically low. After an initial increase of 6 percent in 2003 
non-defense discretionary spending is assumed to grow at 3.2 percent in 
2004 and by just 1.5 percent on average from 2004 to 2007. While the 
need to spend more on homeland security and defense should, as the 
President says, prompt a careful review of all other budgetary 
priorities, it is not prudent fiscal planning to assume large savings 
in the out years based on an assumption that future lawmakers will be 
able to achieve a level of fiscal restraint not achieved in the recent 
past. Baseline assumptions are highly dependent on the presumed growth 
of discretionary spending. Using an assumption that is too low will 
produce presumed budgetary resources that will never materialize. For 
example, if total discretionary spending grows at roughly the rate of 
GDP growth instead of the rate assumed in the President s budget it 
makes a difference of about $1 trillion over 10 years.
Economic stimulus
    The President's budget leaves room for an economic stimulus package 
of $77 billion in Fiscal Year 2002, $57 billion in Fiscal Year 2003, 
and $141 billion over the new 5-year budget window (Fiscal Year 2003 
through Fiscal Year 2007.)
    What leaps out from the OMB documents is that without the economic 
stimulus proposal the budget would be very close to balance in Fiscal 
Year 2003 and would be in overall surplus again by Fiscal Year 2004. 
This raises a very real question as to whether you should postpone the 
idea of a major stimulus bill and thus avoid larger deficits, or go 
ahead with a stimulus bill on the assumption that the economy needs it 
to recover. In recent months the economy has shown promising signs of 
recovery. While there is reason to remain vigilant at this point there 
appears to be diminishing need for an economic stimulus bill designed 
to ``fix'' an economy that seems to be fixing itself.
    If you do choose to go ahead with an economic stimulus bill, great 
care should be taken to front-load its cost and minimize the long-term 
budgetary drain. It is important to recognize that a great deal of 
fiscal stimulus is already in the pipeline. The tax cut enacted in June 
and the new spending approved since September 11 will provide stimulus 
along with the ``automatic stabilizers'' in the budget. Moreover, this 
fiscal stimulus comes on top of the substantial monetary stimulus 
provided by the Federal Reserve Board since last January.
New tax cuts
    The President's budget requests another $600 billion in new tax 
cuts over the next decade, including the stimulus package. The biggest 
initiative in this regard is his suggestion that the ``sunset'' 
provision of last year's tax bill be removed. This would make permanent 
all of the provisions scheduled to expire at the end of 2010.
    Obviously, the sunset provision should not be taken literally. The 
very absurdity of the presumption written into last year's bill that 
all rates and other provisions of the tax code would revert to their 
2001 status on midnight December 31, 2010, guarantees that it will 
never happen. The real significance of the provision is that it allowed 
lawmakers to temporarily avoid making hard choices about which tax cuts 
would have to be eliminated from the bill to fit within the carefully 
negotiated budget resolution limit of $1.35 trillion over 11 years.
    But it also serves a useful purpose--it is the ultimate 
``trigger.'' At some point the cliff effect of last year's tax cut will 
have to be addressed. As events unfold over the next year or two, and 
we see whether deficits are as short and modest as the President hopes, 
it may make sense to adjust the tax cuts accordingly--perhaps extending 
some of them permanently while limiting or delaying the effect of 
others. For that reason, The Concord Coalition does not, at this time, 
believe it would be a good idea to remove the sunset from the tax cuts. 
However, if Congress chooses to maintain the sunset provisions it 
should ensure that new policies be assessed against a baseline that 
accounts for the tax cut as if the sunset provisions didn't exist. The 
fiction that the sunsets will take place as planned should not be 
indulged to justify new initiatives.
    Regarding tax cuts, it should also be noted that the President's 
budget assumes that certain provisions of the tax code, referred to as 
``extenders,'' will not be renewed for the full 10-year window. This 
tends to overstate likely revenues. According to CBO extending all of 
the extenders for 10 years would cost $166 billion.
    Moreover, there are some mini-sunsets in last year's tax bill that 
also artificially depress its cost estimate. For example, the 
Alternative Minimum Tax (AMT) provision, which costs $14 billion from 
2001-2005, terminates at the end of 2004. A new above-theline deduction 
for higher education expenses is assumed to sunset after 2005. It is no 
more likely that these mini-sunsets will take effect than it is that 
the overall sunset will occur in 2010. And yet it does not appear that 
the President's budget includes the full cost of extending theses 
items, which according to the CBO would cost $194 billion over 10 
years.
    For purposes of comparison, the cost of extending all expiring tax 
provisions is estimated by CBO to be $735 billion, not including 
interest, over the next 10 years. The cost of extending expiring tax 
provisions in the President's budget is about $400 billion.
    It is important to note that problems with the alternative minimum 
tax do not begin or end with last year's tax cuts. The AMT, which was 
designed to prevent wealthy taxpayers from using a combination of 
deductions and tax breaks to pay little or no income taxes, is not 
indexed for inflation. Over the years, the number of taxpayers subject 
to the AMT has been slowly increasing. But without reform, the number 
of taxpayers subjected to the AMT will shoot up from 1.4 million this 
year to 35.5 million in 2010. Last year's tax bill is responsible for 
about 15 million of these prospective new AMT ratepayers. As a result, 
a growing number of taxpayers will not receive the full amount of the 
tax cut they have been led to believe they will get. Given that the 
goal of the tax cut is to give money back to the taxpayers, it seems 
unlikely that Congress will take away with one hand what it gives back 
with the other. Correcting this problem through 2010 is estimated to 
cost about $200 billion according to the Joint Committee on Taxation. 
Even with this correction, the number of taxpayers subjected to the AMT 
will rise to over 20 million by 2011. Thus, it is likely that 
additional modifications will have to be made to address the AMT 
problem that already existed before the tax cut. The President's budget 
sets aside no resources to deal with this brewing problem.
    With deficits back, and a large tax cut having been enacted last 
year based on surplus projections that were overly optimistic, The 
Concord Coalition strongly believes that this is not the year to engage 
in another round of major tax cuts. It's time to get back to the pay-
as-you-go principle that was so useful in constraining the growth of 
deficits before escalating surplus projections eroded that discipline.
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    Chairman Conrad. It was excellent testimony.
    What I would like to do is kind of enter into a dialog here 
with you on the series of issues facing this committee as we 
attempt to write a budget resolution for the year.
    Let me start with something that you mentioned, Mr. Bixby, 
and that Mr. Lew mentioned as well, and that is the whole 
question of using Social Security Trust Fund money for other 
purposes. As you know, that has become an area of debate now. 
Does it matter? Some assert that it really doesn't matter 
because the way the system works, the funds that come in from 
the payroll taxes for Social Security get credited to the trust 
fund, and then how the money is used, some say, really doesn't 
matter. The money is owed to the trust fund. It will have to be 
paid at a future point. And so how the money is used in the 
interim is not a relevant question to the long-term viability 
of Social Security.
    What would your answer be to that, Mr. Bixby? You are 
focused here on maintaining the integrity of the trust funds or 
returning to a time of respecting the integrity of the trust 
funds. Why is that important?
    Mr. Bixby. I think it is very important. We are running a 
deliberate surplus in the Social Security system right now. It 
is not an accident. The payroll tax is set at a higher rate 
than is needed to pay current benefits. That is done to attempt 
in some way to prefund future obligations, and the only way you 
can really do that is to use that money to increase savings. 
Paying down debt, for example, is a way to increase savings, 
increasing the resources the Government will be able to help--
increasing the resources the Government will be able to use in 
the future to pay these benefits.
    You know, many have suggested personal retirement accounts. 
Many have suggested using the money to invest in some way 
collectively on behalf of the trust fund.
    Whatever method you use with that Social Security money, it 
ought to be going to prefunding current benefits. Now, if you 
are just using it to fund other operations of Government or to 
offset tax cuts for the income tax, then it is a misuse of the 
payroll tax because you are using a regressive system of 
taxation that applies on the first dollar to everybody, 
basically not for the purpose--you are breaking faith with the 
people you are taxing. In other words, you are taxing them at a 
higher rate than you need, and you are saying we are going to 
use this to help fund your benefits in the future, but we are 
really not. We are using it--we are spending the money now. We 
are crediting it to a trust fund, which is something of a hoax 
if you are not really doing something to set the money aside. 
If you are going to take in the money, spend it, and then 
credit a bond to the trust fund, you are not doing anything to 
help the Government pay off that bond in the future. So I think 
it really does matter.
    Now, I look at it as a national savings account, and if you 
are dipping into it--you might have to do it in an emergency, 
like we have now. I think that is understandable. But you 
shouldn't continually get into the habit of using your savings 
account to buy your groceries, and that is the sort of problem 
that we face.
    Chairman Conrad. Mr. Lew, what would your answer be to the 
question of why does it matter whether you use the Social 
Security Trust Fund money to pay for tax cuts or other 
Government programs? After all, you have got more money coming 
in than going out--not this year and not next year, but over 
time. So since you are crediting the money to the trust fund, 
what difference does it make?
    Mr. Lew. Mr. Chairman, I think the real issue has to do 
with savings, as Mr. Bixby said, and paying down the debt 
enabled us to see a trend that was really going to make a 
difference in terms of our cash position at the point when the 
baby boom retires.
    If you think about the $3 trillion of national debt, if you 
are left with $3 trillion of debt instead of zero, at a 5 
percent interest rate you are going to be paying $150 billion a 
year in interest. By saving, paying down the debt, you avoid 
the need to have that annual expenditure, and at the point in 
time when you need that $150 billion to pay Social Security 
benefits, it is really there if you have paid down the debt, 
and it is not really there if you haven't.
    I agree that it is dangerous to get too mechanistic about 
the year-to-year issue. We are in a recession--we are coming 
out of a recession, I hope. We have seen an attack on the 
country that required emergency expenditures. But that is very 
different from charting a whole new course that says it doesn't 
matter if we pay off the debt. It is going to be exceedingly 
difficult to pay the benefits that are due under Social 
Security out of current cash-flow.
    Now, what does that mean? It means that when you get to the 
retirement of the baby boom, there will be legal obligations 
owed to the Social Security Trust Fund. But if you are not 
running a surplus, in order to pay them you will either have to 
raise taxes or cut spending. That is a very, very different 
situation from having a forecast where you are running a 
surplus and you can pay the Social Security benefits out of 
your running rate.
    I would hope that we get back on the path. I am not as 
optimistic as Bob that a 5-year plan will do it. I think that 
it will be very difficult to get back on the path.
    One thing we learned over the period of time when we were 
paying down the debt was that saving the Social Security 
surplus was the only hard line people could understand. If it 
were possible to have another--a path that got us back toward 
there, economically it would serve a lot of the same purpose. 
The problem is that if you don't save it all, it looks like we 
can't save any of it. That is what this budget shows. We have 
to get ourselves away from spending all of it and be on a path 
toward saving, if not all, most of it.
    Chairman Conrad. Let me ask you this. Another question that 
has come up is: Is there a Medicare Trust Fund? Put up the last 
chart there.
    If you look at the President's budget, it shows over the 
next decade that nearly $2.2 trillion of trust fund moneys are 
going to be used for other purposes: nearly $1.7 trillion of 
Social Security Trust Fund money, about $500 billion of 
Medicare Trust Fund money.
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    So now a novel argument has been devised in which people 
say, well, there is really not a Medicare Trust Fund; there is 
no Medicare Trust Fund because there is Part A and Part B, and 
one part is in surplus, and that is the trust fund; the other 
one is spending general fund money. Therefore, there is really 
no trust fund.
    What say you on that question, Mr. Lew?
    Mr. Lew. Well, Mr. Chairman, I would respond, this was 
something that last year's budget asserted as a principle, and 
I know I personally was one who took issue with it, because it 
is contrary to current law. Current law divides Medicare into 
two parts. There is a hospital part and a doctors' part. The 
hospital part has a trust fund, and that trust fund runs a 
surplus. The doctors' bills have always been paid and by law 
will continue to be paid largely out of general revenue. To 
assert that that general revenue expense draws down the trust 
fund is contrary to the way the program is set up. One could 
change the program. One could say we want to take the Medicare 
Trust fund for hospitals and spend it on the doctor bills. But 
that is a change in law. It is not just something one can 
assume through projections.
    I think that given the fact that in 1997 you and I and many 
others worked together to put Medicare, the Medicare Trust 
Fund, on a path toward long-term fiscal solvency, it is 
actually a fairly dangerous idea to just wave a wand and make 
that go away.
    If you go to any hospital in this country, there is serious 
change, and pain in many cases, because of the law that was 
enacted in 1997. To now say that the surplus is not really 
there is not a responsible way to run the program. You can't 
ask for partnership from the providers to take cuts in order to 
provide solvency for the trust fund, and then say now we are 
going to use it for something else.
    If anything, the criticism was we went too far in 1997 to 
get savings. I know you were concerned about the rural 
providers. Many on this committee were concerned about the 
impact on urban teaching hospitals. To say that the difficult 
changes were for nothing strikes me as being a bad public 
policy argument, and I don't think it reflects current law.
    Chairman Conrad. What would you say, Mr. Bixby, on this 
question of is there a Medicare Trust Fund and does it matter?
    Mr. Bixby. Well, there is a trust fund, and, yes, I think 
it does matter. You know, many of the same issues apply. If we 
are taking in more money on the Part A part of Medicare than we 
need, then the only way you can dedicate that to the future of 
the program really is to dedicate it to savings somehow. And so 
I think that it--you know, we advocated last year that, you 
know, it would be an appropriate goal to use both the Medicare 
Part A surplus and the Social Security surplus as a standard 
and to not dip into those over--not dip into that over the next 
10-year period. Of course, things didn't work out that way.
    I think on drawing a line, it is much clearer to do with 
Social Security. I mean, I just think that that is much more 
ingrained in people's minds. So in terms of--you know, first we 
have to get back to a unified surplus and then I think start 
talking about when we can get back to an on-budget surplus. 
Throwing in Medicare makes it more difficult, and if we try to 
achieve that standard--I mean, we probably should try to work 
toward that, but I would be reluctant to throw it into the mix 
right now because it might make--the goal seems so far off and 
so distant it couldn't be done.
    Medicare does work a little bit differently than Social 
Security. One of The Concord Coalition's concerns about talking 
about a Medicare surplus is that it may give people the 
impression that Medicare doesn't have fiscal problems because 
Part B is funded out of general revenues. It works different 
than Part A. But it does require--it has very substantial 
problems, Medicare does, facing us in the future. And so it has 
always struck us that maybe it would give the wrong impression 
to be talking about a Medicare surplus.
    But when you talk about it in the context of the budget, 
then I would agree with you it ought to be devoted to savings.
    Chairman Conrad.
    Let me ask you this. This Budget Committee has got to try 
to write a budget resolution.
    The President has sent his budget. The President's budget 
says increase spending dramatically, primarily for defending 
the Nation, improving homeland security. We all agree that 
those are the top priorities.
    The President's budget says we should also have a 
significant stimulus package for the economy because of the 
economic slowdown.
    The President says that because of those demands, it is OK 
to use Social Security and Medicare Trust Fund dollars, but he 
does not just do it for this year or even for next year. 
Instead, he does it for the next 10 years. The result is you 
take more than $2 trillion of trust fund dollars and use them 
for other purposes. You have just said, both of you, that that 
is not wise; instead, that money should be used to pay down 
debt, which expands the pool of societal savings, which means 
we should have more money available for investment, which means 
we should have more economic growth, which means we should be 
better able to meet those obligations in the future as I hear 
you discuss it.
    But that is not what the President's budget does. It takes 
virtually all--it takes all of the Medicare Trust Fund surplus 
and takes virtually all of the Social Security Trust Fund 
surplus.
    So the question is what should we do. The President says 
hold firm to the tax cuts that were passed last year even 
though the assumptions that undergirded that proposal have 
evaporated. He was talking about using one in every four 
surplus dollars, and he was counting Social Security and 
Medicare money in those surpluses. He said take one in every 
four and return it to the American people; that is not too 
much.
    With the new calculation, if we applied his formula, one in 
every four dollars, to $600 billion, which is what is left 
under his formulation, we would have a $150 billion tax cut, 
not a $1.6 trillion tax cut that he advocated.
    If we used his own formula, you would not have the tax cut 
that he proposed and pushed through Congress; you would not 
have a fraction of it. But that is where we are. He says that 
to do anything else would be to raise taxes.
    What would you propose? What would you say to this 
committee? What should be the fundamental principles that we 
apply in writing this budget?
    Mr. Lew, what would you do--not to put you on the spot.
    Mr. Lew. Well, I think it is a very difficult situation, 
and to some extent it is easy to put me on the spot because I 
am speaking for myself. Politically, the choices are very hard; 
analytically, I think they are less hard.
    First, I think you have to not make the mistake that was 
made last year. Last year, a tax cut was moved through before 
there was a full and open debate about all of the competing 
demands. The defense review that was announced in last year's 
budget did not come back until after the tax cut was enacted, 
and a lot of the spending increases that are proposed now in 
the name of responding to September 11 actually flowed out of 
that defense review. If one had waited and done the tax cut and 
the defense review at the same time, I rather suspect that last 
year's total fiscal package would have looked different than it 
does today because of the sequence being done tax cut first.
    What does that mean going forward? I think there are two 
areas where it is almost incumbent on the committee to think 
very seriously about changing how you think about the tax cuts.
    First, the next tax cuts have to be treated as new tax 
cuts. They cannot just be treated as an extension of current 
policy. The truth is that they are very expensive, and they 
should be competing with other things like a defense increase 
and prescription drug coverage and paying down the debt.
    I think harder than that is going back and looking at last 
year's tax cut. I think you can divide the question and say 
what has taken effect and what has not taken effect. There are 
a number of provisions of last year's tax cut that have not yet 
taken effect. On the rate side, it is the reductions in the 
highest income tax rates for the highest income brackets, and 
it is the estate tax provisions.
    I have not been able to see estimates that give a pinpoint 
estimate on what the savings would be from that--you may well 
have them already--but it is hundreds of billions of dollars.
    I am not saying that one should repeal last year's tax cut. 
I think the question that one has to ask is can we afford it on 
the schedule that was agreed to last year. Do some of the 
provisions need to be rescheduled so they can be held off until 
we know we can afford it.
    One thing I know for sure--once they take effect, it 
becomes far more difficult to reverse them, and if there is 
ever going to be a debate about the competing demands for 
scarce public resources, it is going to have to take place 
before all those provisions take effect.
    Now, I realize that politically, we are in an 
administration that says it would veto any change in last 
year's tax bill. That is a very difficult proposition, which is 
why I say that analytically it is a lot easier than it is 
politically.
    Chairman Conrad. Mr. Bixby, what would be your formulation? 
What would be your recommendation to this committee on what we 
should do in terms of fundamental principles to apply?
    Mr. Bixby. Well, I would get back to the idea of 
establishing that fiscal policy goal of balancing the budget 
without using the Social Security surplus. You might look at 
what it would take to do that over a reasonable period of 
years. It might take more than 5 years, but at least trying to 
make that the goal.
    Once that is established--because that goal has great 
bipartisan support; it always has--well, for the last 3 or 4 
years, anyway, it has--but I really think that that is the 
starting point, because if you do not have that goal, you sort 
of have ``anything goes'' budgeting, and it is really going to 
be very difficult to constrain spending or to constrain tax 
cuts, because then it is in the name of what--I mean, what are 
we trying to achieve here? So it is sort of everyone for 
himself.
    That is a goal that people can rally around and the public 
can support. Once you do that, I think that everything needs to 
be on the table, and some of the ideas that Jack talked about 
come into play at that point.
    I realize what the President has said, and that makes it 
difficult, but as his budget demonstrates, we cannot do 
everything he has recommended that we do and still wall off the 
Social Security surplus. So if the goal is to balance the 
budget without using the Social Security surplus, then, by 
definition you have to look elsewhere. And one of the things 
that is out there is the tax provisions that have not yet taken 
effect.
    Chairman Conrad. Let me ask you this. Is freezing taxes a 
tax increase, in your judgment? In other words, if you were to 
defer future scheduled tax cuts, is that a tax increase in your 
judgment?
    Mr. Bixby. Well, I think that is going to be a highly 
political and semantic judgment. I could take the Republican 
side of it and say that if what we did last year was cut taxes, 
then reversing that would be a tax increase.
    But obviously, it does not increase people's taxes from 
where they are now. I mean, the Concord Coalition's problem 
with last year's tax cut was not the short-term effect of it, 
not what has already taken effect--that seems to have been for 
the good--it is this idea of locking in large, escalating tax 
cuts over a 10-year period that is fiscally irresponsible. Now 
we know we are going to have to spend a lot more over that same 
period. So the playing field has changed dramatically.
    So I do not think it is really fair to talk about it as a 
tax increase, to talk about something that is putting things 
back on the table for 2004-2006. It seems to me more a matter 
of just being fiscally responsible than anything else.
    But I think those two things put everything on the table. I 
think you might look at some enforcement mechanisms like pay-
go. Caps are going to be difficult since we have an uncertain 
period on discretionary spending. But certainly that pay-as-
you-go discipline really ought to be applied now, because we 
are back to where we were before we had unified surpluses, so I 
think it is perfectly legitimate to do that.
    Chairman Conrad. Let me ask you this question. The 
committee is going to have to decide in the budget resolution 
do we make the tax cuts that were ut in place last year 
permanent. What would be your recommendation on that question?
    Mr. Bixby. As I said in the prepared testimony, Concord 
Coalition does not think that would be a good idea right now. 
At some point, we are going to have to revisit the tax cut, 
because the sunset is not going to take effect in 2010. We know 
that, so at some point, we are going to have to renegotiate 
this. Now is not the time to do it. In fact, let me just--I 
thought this was kind of amusing from the budget. They said 
that Washington's 6-year experiment with 10-year forecasting is 
proving to be a failure--``2001 showed how unreliable and 
ultimately futile such estimates are.'' So they are not going 
to make 10-year forecasts anymore.
    Well, it seems to me it is locking the barn door after the 
horse has escaped. So we have to look out those 10 years is 
what I am saying, and making those tax cuts permanent I think 
would compound the mistake from last year.
    Chairman Conrad. Mr. Lew?
    Mr. Lew. I think that at the core of my answer to that is 
that last year's tax bill was fundamentally a big gamble 
through triggers that had provisions take effect in the future 
and sunsets that many of us believed would never be allowed to 
occur. It shrunk the size into a box that fit the full estimate 
that was available, and everyone knew it was going to cost more 
than that and that if the surplus for any reason did not 
materialize, the triggers would still be very to likely go into 
effect.
    What did it do? It created a dynamic where the question 
that you are asking is the right question to ask--is it a tax 
increase to change those effective dates?
    The truth is it should not have been enacted in the first 
case with triggers. One ought to look at policies saying what 
do we know we can afford now, let us enact what we know we can 
afford now, and that is not the end of time. You come back the 
next year, and you ask what can we afford now, and you enact a 
new policy.
    Setting in place a series of things that are scheduled to 
go in I believe was done precisely to create this confusion as 
to what is a tax increase and what is not.
    For anyone who experienced the tax cut last year--and that 
is most taxpayers--their taxes will not go up if you delay some 
of the effective dates for processors that have not yet taken 
effect. For most people, they will not even see a change in 
their tax due, because it really affects people at the highest 
income brackets, which is not most taxpayers.
    I think that what it comes down to is that if you gave most 
Americans a choice and said on the one hand, here is something 
that is in current law that would cut people's taxes, and here 
is a way to defend the country, they would say we need to 
defend the country. If you gave people a choice saying here is 
a way to cut the taxes in the highest brackets, or here is a 
way to fund prescription drug benefits, I think most people 
would say you should fund prescription drug benefits.
    I actually believe that if you gave most people a choice 
that said should we pay down the debt or let the tax cut take 
effect as scheduled, most people have the common sense to say 
pay down the debt.
    It was a really remarkable----
    Chairman Conrad. Can I just interrupt you on that point? 
There was a very interesting front page story in the Los 
Angeles Times yesterday of a poll that was taken that showed 
that 84 percent of the American people would rather defer the 
future tax cuts to avoid using Social Security funds to pay for 
it.
    Mr. Lew. I did not see the article, but that certainly 
supports the view that I am speculating.
    I think that it is very important to get away from using 
triggers and sunsets the way they were used last year, because 
I think it is like time bomb that goes off, and you may or may 
not be able to handle the consequences.
    I personally believe that rescheduling things so that you 
can afford what the policy is and so that it puts us back on a 
path toward fiscal discipline would be much stronger, better 
policy, and most Americans would be better off if we did that.
    Chairman Conrad. Let me ask you this question. I have not 
heard anybody propose a tax increase. To me, a tax increase is 
when you increase the taxes that people are paying now. I have 
not heard anybody propose that.
    I have made very clear that I would not propose that in a 
budget resolution. I do not think it would be wise to raise 
taxes in the midst of an economic downturn.
    That does take us to the question of economic downturn and 
whether or not we should provide in the budget resolution 
resources for a stimulus package. I would be interested in your 
reflections on that.
    Chairman Greenspan, when he was here testifying before the 
committee, indicated that he is conflicted about that question 
now. He said that he strongly supported it last year, but in 
his judgment, the economy will recover whether we have one or 
not, and if we have one, it will have the negative consequence 
of adding to deficit and debt, which he does not want to see. 
On the other hand, he is not confident how strong this recovery 
will be, so perhaps having some stimulus package would be 
useful. But he said that he found himself very conflicted on 
the issue.
    Could you each tell us what you think should be done in the 
budget resolution with respect to making provisions for a 
stimulus package?
    Mr. Lew. Mr. Chairman, I think that by the time the budget 
resolution actually works its way through the Congress, we may 
well find ourselves at the beginning of a recovery. I certainly 
hope that is the case; there are some positive signs; there are 
mixed signs in the economy.
    But I think that that highlights the difficulty of timing a 
stimulus package to hit at exactly the right moment. I 
personally, for over 20 years, have watched every time there 
has been an economic downturn and have never seen it hit right. 
In 1983, we did not hit it right. I think that last year, it 
came closer to hitting right than usual. I think that probably 
would cease to be the case this year. So the likelihood of a 
package actually hitting the economy at the right moment has 
diminished greatly because we are farther forward in time.
    I think that as important as timing is the composition. 
Personally, if you look at what lags in a recession, there are 
problems for people who are unemployed, they are exhausting 
unemployment benefits. Would it be a good thing to extend 
unemployment benefits and provide access to assistance for 
health insurance premiums? That probably would be helpful if it 
could be done quickly, but if it comes after someone has gone 
back to work, it misses the mark.
    On the tax side, I think that investment incentives that go 
into the next year and the year after that will not have 
anything to do with the immediate recovery, and I think that 
ultimately, the tradeoff of making it a somewhat stronger 
recovery versus the effect on the deficit is a very tough call.
    My own sense, since I am not confident that the mix would 
end up being one that I thought was very effective, is that 
nothing is better than a badly targeted stimulus package. If 
you could do something small, quickly, particularly to help on 
the human side, it would probably be worthwhile, but if that is 
not possible, I would keep my eye on the fiscal impact.
    Chairman Conrad. Mr. Bixby, what would be your 
recommendation?
    Mr. Bixby. I think the case for an economic stimulus, 
particularly one the size that has been proposed, is getting 
weaker as time goes by, and I think that doing something to 
round off the rough edges, smooth off the rough edges of the 
recession, such as extending unemployment benefits, still makes 
some sense. But a large-scale stimulus package probably would 
be ill-timed. If it looked like the economy was getting worse, 
then the judgment might be different, but in the last couple of 
months, signs have been good--the slow, steady progress--it is 
not like there is going to be a big boom right around the 
corner, but I do think that in looking at the mix between the 
cost to the budget and the likely benefit to the economy, the 
factors are not weighted in favor of not having a stimulus 
bill.
    Chairman Conrad. All right. Let me make one mention--Mr. 
Bixby, you indicated that Republicans ought to take credit for 
the tax cuts that were put in place last year, at least the 
near-term part of it, because of the lift they gave the 
economy, the stimulus effect.
    Just for the record and to remind people of what occurred, 
there was actually bipartisan support for tax cuts in the first 
year, and actually for the 10 years. In fact, Democrats 
proposed much greater tax cuts for last year to provide 
stimulus to the economy than did the President's budget.
    You will recall that the President's tax cuts were very 
back-end-loaded; there was almost nothing for last year. In the 
budget that I proposed on behalf of Democrats in the Senate, we 
had $60 billion of tax cuts for last year to give lift to the 
economy.
    It was over the 10 years that we had much smaller tax cuts, 
because we thought that the President's proposal would threaten 
Social Security and Medicare, which has proven to be all too 
much the case.
    But the reality is that Democrats proposed and voted for a 
more aggressive package of tax cuts to give lift to the economy 
last year than the President proposed. It is true that we had a 
substantially smaller package over the 10 years because of the 
threat that we saw to Social Security and Medicare. Our package 
on a fair comparison basis to the President's $1.6 trillion was 
$750 billion of tax cuts over the 10 years. With debt service 
included, our package was $900 billion, and his was approaching 
$2 trillion.
    Let me ask you this on caps and pay-go, an issue before the 
committee. Do we reestablish caps and pay-go? What would 
Concord Coalition say to us on that issue, Mr. Bixby?
    Mr. Bixby. Well, I think you should. I think there have 
been effective enforcement devices, particularly when deficits 
were forecast, so the fact that they are expiring this year is 
somewhat troubling when we are looking at deficits again.
    The goal of the Balanced Budget Act in 2000 and 1997 was to 
achieve a balanced budget by 2002, and the irony is that we 
have had surpluses every year since then, and here we are in 
2002, and we are back into deficit.
    So I think that that is a good reason to renew caps and 
pay-go.
    Now, let me say on your earlier point, Mr. Chairman, that 
you are absolutely right, and your point is well-taken. I was 
giving gratuitous political advice and saying that perhaps they 
should leave well enough alone with the tax cuts and declare 
victory and get out. Your point is well-taken.
    One of our problems with the original tax cut as proposed 
by the President was that it had so little stimulus--almost 
nothing in the first year--and it was being billed as a 
stimulus. So that perhaps was not a serious comment on my part, 
but your point is well-taken, and I stand corrected.
    Chairman Conrad. Let me just ask you this. We have talked 
about the revenue side of the equation, but obviously, when we 
look at deficits and debt, there are two sides to that 
equation--the revenue side of the equation and the spending 
side of the equation--and both of them have to be dealt with if 
we are going to be successful. One of the interesting facts 
that emerges--we have just done an analysis of spending over a 
length period of time, Federal spending, total Federal 
spending, and what we see is that, of course, in dollar terms, 
it has gone up; but as a percentage of the gross domestic 
product, which economists say is the best way to analyze a 
budget over time to take out the effects of inflation, what you 
see is quite a different picture. You see that Federal spending 
as a share of our national income has been in quite sharp 
decline. In fact, in the early nineties, we were at over 22 
percent of gross domestic product for total Federal spending. 
That is down now to about 19 percent, a rather significant 
decline--a decline of almost 15 percent in real terms.
    Now, of course, we have seen a bump up with the 
requirements of defense and homeland security, but even with 
that, if you look at the President's budget, we will continue 
to see Federal spending as a share of gross domestic product 
continue to decline to the lowest level since sometime in the 
mid-sixties.
    Let me just ask for your analysis of what has happened to 
Federal spending in terms of that kind of analysis.
    Mr. Lew. Mr. Chairman, I think you are correct that 
spending has declined as a percentage of the economy. In terms 
of how one sets limits for discretionary spending, there is a 
real tension. If one tries to set a limit to hit an overall 
fiscal target, there is a temptation to treat the outyear 
numbers, anything other than the year we are in, as if savings 
are achievable when they may not be achievable. I think we have 
seen that in every budget agreement that I have ever witnessed. 
There is a tendency to say after 2 or 3 years that you can 
start holding it down more than it turns out you really can. 
And there is a reason for that. To keep discretionary spending 
growing below inflation means reducing it in real terms. If you 
are talking about a program that buys milk, like the WIC 
program, it means buying less milk. If you are talking about a 
program that buys any goods and services, you are going to get 
less if you do not allow for inflation.
    I think that that is what makes the assumptions in the 
budget so difficult, because it may not sound like that much to 
be cutting $200 billion over 10 years on something as large as 
the Federal Government, but what it means is holding to a rate 
at least one and maybe more than 1 percent below inflation on 
everything other than defense and homeland security. We have 
not seen that that is possible.
    Now, if it is not really achievable, to assume it gives you 
a false basis for making policy judgments. If you go back to 
caps, I would strongly recommend that you use caps that are as 
accurate as possible in terms of the likely required level. No 
one likes to be for undifferentiated pots that we can call 
``domestic spending.'' It is easy to stand up and say an 
increase in education or an increase in biomedical research. 
When it is just a big number that says ``domestic spending 
growing,'' it has a different character; but when you translate 
it, if the number is not big enough, then you cannot fund 
education, you cannot fund biomedical research or environmental 
protection.
    One thing that is interesting in terms of the response 
after September 11 is that there are a lot of functions that we 
used to consider core Government functions that people always 
said could be cut. Well, it turns out they cannot be cut, 
because those are being increased--whether it is Customs or 
airport programs--things that are not terribly glamorous until 
you have a crisis but that are the nuts and bolts that serve 
the American people for the most part quite well.
    If the pressure is to assume that it can all be constrained 
below inflation, I do not think that that goal will be 
realized, and I do not think that is a partisan issue. I think 
it is going to be just a reflection of reality. In order to 
start with an honest, accurate baseline, one has to confront 
that difficult issue.
    Chairman Conrad. You know, this is going to be an 
especially challenging time to write a budget, for the reasons 
that I have set out. Clearly, we have got to increase spending 
on national defense and homeland security. We are very much 
united on that question.
    I do not think it would be wise to increase taxes at a time 
of economic downturn, and I will not propose such a thing. But 
for the longer term, I must say I am very worried about the 
direction of taking $2 trillion out of the trust funds of 
Social Security and Medicare to pay for tax cuts and to pay for 
other Government spending. I think that is a profound mistake. 
I said that to Mr. Daniels yesterday, and I believe it.
    And what kind of choices does that leave us with? They are 
all difficult ones; they are all very difficult ones. And at 
this point, there is not much of a consensus on any of the 
questions before us that I have raised here today. There are 
differences with respect to a stimulus package. The President 
still believes that it is critically important to put one in 
place. Chairman Green said he is conflicted on the question. I 
have had a number of colleagues come to me in the last several 
days and say they now think a stimulus package would be 
counterproductive, that it would dig the hole deeper in terms 
of deficit and debt and would probably be too late to give lift 
to the economy.
    One of the things that we did as budgeteers was an analysis 
of past attempts by Congress to stimulate the economy at a time 
of economic slowdown. Do you know what we found? Every, single 
time, we have been too late. Every, single time, we have acted 
too late. It turns out that because on a bipartisan basis, we 
did push for tax cuts last year because we thought it was 
important to give lift to the economy, and because of the 
increased spending resulting from the attack on the country, 
those things did provide stimulus, in fact, very substantial 
stimulus last year--more than $100 billion of stimulus in this 
period.
    So the question is do we do more, and if so, what does it 
include.
    Let me just say that I very much appreciate the two of you 
being here to share your views with us. I wish more of our 
members had been here to have a chance to hear from you, but 
this is all part of the record, and their staffs are here and 
have been listening attentively, and I can tell you that your 
recommendations will be important to us.
    Before I end the hearing, let me ask you about the question 
of debt limit. Last year, we were told that we would not face 
an increase in the debt limit until 2008 or perhaps 2009. Now 
the Treasury is calling over here, saying you have got to 
increase the debt limit of the country as quickly as possible, 
and increase the debt limit by $700 or $800 billion.
    It is a stunning turnaround. Those who said last year that 
you could have it all, that you could have massive tax cuts, 
that you could have aggressive paydown--in fact, you could pay 
off as much of the debt as was possible to pay off--that you 
could have a major military buildup, that you could have 
protection for Social Security and Medicare were just wrong. 
They were just wrong. They have been proven wrong on every, 
single count. They are not protecting Social Security and 
Medicare. They are raiding Social Security and Medicare. They 
said you could have all of these additional spending items and 
tax cuts and still have maximum paydown of debt. That is all 
gone. Instead of paying down $2 trillion of debt, they are now 
saying that at most, they are going to pay down $500 billion, 
and the assumptions behind that are very murky and very 
doubtful.
    So the hard reality is that all of these things that we 
were told last year proved to be wrong. They said that we would 
not have to increase the debt limit of the country until way 
off in the future; now they are asking for an immediate and big 
increase in the debt limit.
    What would be your advice? Clearly, the Government of the 
United States has to meet its obligations. It would be a 
disaster for the Government to default. But should we have a 
big increase all in one fell swoop, or should we take repeated 
reviews of our debt situation?
    What would be your advice?
    Mr. Lew. The debt limit is one of the more vexing problems, 
because by the time you get to the debt limit, it is too late 
to really affect the policy that caused the need for the debt 
limit to occur. It is kind of a lagging indicator.
    I think that in the short term, there is really very little 
alternative but to, as you say, do what it takes for the 
Government to pay its bills. Default is not an option.
    I think that it is a point of leverage that has been used 
from time to time. My own personal is that it has been 
overused; it has made the orderly management of Government more 
difficult for both Republican and Democrat administrations. 
Years ago, when I worked in the House when the Democrats 
controlled the House and the Republicans were in the White 
House, we came up with an automatic mechanism for a debt bill 
to pass because we could never get anyone to vote for it, and 
we had this kind of crisis mentality around the debt limit.
    On the other hand, I personally would not have a huge 
increase, because you need to keep pressure on the system so 
that future policies can be made with an eye toward what the 
impact on the debt is. And at the point where you debate the 
budget resolution, I think it should be very much in front of 
this committee and the full Senate what the impact will be on 
the debt, and the decision on the policy ought to be made with 
an eye toward what it is going to require in terms of the debt 
limit when it comes up the next time.
    Chairman Conrad. Mr. Bixby, what would you say on the debt 
limit?
    Mr. Bixby. I think that having a huge increase in the debt 
limit at this time would be a mistake, because the fiscal 
outlook right now is very uncertain, or does not appear good. I 
would agree that once you get to the point where you are 
bumping up against the debt limit, it needs to be raised, but I 
would keep the increase to a fairly small level at this point 
so it would help keep control over fiscal policy a little bit 
better and act as a check, so we have to come back and look at 
it again.
    It is one of the ultimate ironies of this year that one of 
the justifications for the tax cut last year was that we were 
going to pay off the national debt too fast; and now, we begin 
this year by debating how soon we have to raise the debt limit. 
So things change very quickly, and I would keep the increase to 
a fairly small one.
    Chairman Conrad. All right. I think that is very good 
advice.
    Do you have any other last comments or last suggestions to 
us, things that we should keep in mind as we try to deal with 
this series of challenges?
    Mr. Lew. The one thing I guess I would say as a closing 
comment is that this is not the first time that a year after a 
large tax cut, it turned out not to work. In 1981, exactly the 
same thing happened, and to the credit of President Reagan and 
his administration, they worked with the Congress in 1983 and 
in subsequent years to be responsible about what the impact 
was. It obviously was not enough, and it took the better part 
of 20 years to really turn things around, but it would have 
been a lot worse if we had waited 10 years to get started.
    I would just hope that the model that is looked to in terms 
of how to deal with the consequences of policy decisions made 
is more like that than some other examples that are being used 
which would suggest that we just barrel ahead regardless of the 
consequences.
    Chairman Conrad. Dig the hole deeper. I think the most 
disturbing thing about the budget that I see coming from the 
President is that it just digs the hole deeper and deeper and 
deeper. There does not seem to be any plan at all to return to 
fiscal balance.
    Mr. Bixby?
    Mr. Bixby. The problem with getting back into deficits for 
a legitimate reason, whether it is war, recession, or a 
combination of both, is that once back into them, people get 
comfortable with the idea. It is like who cares about all that 
fiscal discipline stuff--yahoo, we are out of the lockbox.
    Getting back into that lockbox is going to be tough, and 
what The Concord Coalition is concerned about is the return to 
the old habit of let us cut taxes, increase spending, spend the 
Social Security surplus, and run up the debt. We just cannot 
afford to do that with the boomers beginning to collect their 
benefits by the end of this decade.
    So our strong plea is that this is a very crucial point for 
the fiscal and economic future of the country, and maintaining 
fiscal discipline is going to require some hard work, but it is 
work worth doing, because we are really doing it in the name of 
future generations, and we have always said that patriotism 
includes generational patriotism. We need to look out for the 
future of the kids and grandkids that we leave behind, and that 
now becomes a short-term concern of ours as you prepare your 
budget for this year.
    Chairman Conrad. Thank you for that.
    On that note, we will end the hearing, and I want to thank 
you both again very much for being advocates for fiscal balance 
and for paying attention to what really will make a great 
difference to the long-term fiscal security of the Nation.
    Thank you very much.
    [Whereupon, at 11:25 a.m., the committee was adjourned.]















           THE PRESIDENT'S FISCAL YEAR 2003 BUDGET PROPOSALS

                              ----------                              


                       THURSDAY, FEBRUARY 7, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Byrd, Nelson, Stabenow, Corzine, 
Snowe, Smith, and Allard.
    Staff present: Mary Ann Naylor, staff director.
    For the minority: G. William Hoagland, staff director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. Good morning, and welcome.
    It is good to have you here, Mr. Secretary. As I was 
describing to you, the leadership on both sides had indicated 
there was going to be a vote at roughly 10:05, so some of our 
members have gone to the floor in anticipation of that.
    They have now put that vote off for some indeterminate 
period, so I think we will press ahead and try to get through 
statements, and hopefully, we will be able to do that before 
the vote actually occurs.
    I want to acknowledge this morning that Senator Gordon 
Smith of Oregon will be serving as the ranking member in the 
absence of Senator Domenici, who remains in the hospital for 
tests. All of us on this Committee again send our best wishes 
to him. He is an invaluable member of this Committee and of the 
Senate, and we miss him, and we are hoping that these tests are 
completed successfully and that he is back with us very soon.
    I want to again welcome you, Mr. Secretary, for a return to 
the committee. We are delighted that you are here. We have been 
through a year of remarkable changes. I think we all have to 
acknowledge that and state it clearly.
    Last year, we were told that we were going to be blessed 
with extraordinary surpluses as far as the eye could see. 
Obviously, that course was altered in the first instance by 
recession, and war, which for this year and next played the 
biggest role in reducing those surpluses.
    But over the next 10 years, we see the biggest factor in 
the reduction of surpluses being the tax cut. CBO told us that 
about 42 percent of the change is as a result of the tax cut 
over 10 years; 23 percent, the economic downturn; some 18 
percent, spending that came about as a result of the attacks on 
this country; and 17 percent, technical changes, largely 
increases in Medicare and Medicaid expenses that were not 
anticipated.
    Last year, you came before the committee, and you were a 
staunch defender of the tax cut, which is understandable as a 
representative of the administration. I think that many people 
might have had a different view if they had known everything 
that was to come. Certainly if we had applied the President's 
own formula, which was one in every four surplus dollars for a 
tax cut, the tax cut would have been dramatically smaller, 
because we are now down to under, the President's budget, a 
$600 billion surplus over the 10 years, and one-quarter of $600 
billion would be a $150 billion tax cut instead of a $1.6 
trillion tax cut.
    But people were using what they thought were the best 
forecasts at the time.
    When you appeared before us last March, you used a 
reference that stuck in my mind ever since, a reference to a 
well-known fairy tale, and you talked about characterizing the 
tax cut plan as a ``Goldilocks'' tax relief plan--not too big, 
not too small, but just right.
    When you explained the math to the committee last year and 
you outlined it, as in this chart, you indicated that starting 
with the $5.6 trillion surplus, take away the $2.6 Social 
Security surpluses and $1.6 trillion for tax relief, and we are 
left with a $1.4 trillion cushion.
    Today, as I have indicated, we face a far different 
picture, with those surpluses largely disappearing. All of this 
tells me that a prudent person putting out a budget this year 
would decide not to dig the hole deeper. In fact, I do not 
think it would be a bad idea if the administration and Congress 
kept in mind the observation that you made earlier this week at 
the Finance Committee. You said that ``10-year projections ar a 
useful discipline, but they are not rock-solid predictions.'' 
This is a point that I tried to make last year and certainly 
alerted people to last year, that any 10-year projection is a 
crapshoot. I think we do need to remind ourselves of that fact.
    But in this context, the President now comes with a budget 
with another $600 billion of tax cuts, all of which is going to 
be coming out of Social Security Trust Funds. I personally 
think that that is a serious mistake in light of the fact that 
the baby boom generation starts to retire in just 6 years.
    In addition, the tax cuts that the President proposes are 
heavily backloaded. Maybe we could put up that chart. More than 
70 percent of the tax cuts being proposed by the administration 
will take effect in the second 5 years. More than 40 percent of 
the cuts take place only in 2012, the final year of this budget 
window. And the cost of these additional tax cuts in the second 
10 years is $4 trillion--right at the time when the baby boom 
generation is retiring and the fiscal condition of the country 
is dramatically altered by that fact.
    Leaving aside the tax policy problems with what the 
President has proposed, what is especially troubling to me and 
to many Members of the Senate is the taking of Social Security 
and Medicare Trust Fund surplus money to use for other 
purposes.
    Remember what you said last year to the Finance Committee 
on the subject of protecting Social Security--as a member of 
that committee, I remember it very well. You said: ``The Social 
Security dollars that are going to flow into the government 
over the next 10 years are safeguarded, lockboxed, fenced off, 
protected from all evildoers. I do not know if there are more 
strong ways to say it. Social Security dollars are set aside 
without any threat of encroachment.''
    Now, we look back, and we see that that is just not so. If 
we look at what we are faced with now, if we go back to the 
bad, old days, 1996 and 1997, we were taking all the Social 
Security Trust Fund money and using it for other purposes. We 
were able to reduce that in 1998. We were able to stop the 
practice completely in 1999 and 2000, when we took none of the 
Social Security surpluses for other purposes.
    But now we have seen a reversal. In 2001, it started in a 
relatively modest way, but the next 3 years under the 
President's budget, we are taking all of the Social Security 
surpluses to be used for other purposes. And over the next 
decade under the President's plan, $1.7 trillion of Social 
Security surpluses will be taken to pay for tax cuts and other 
expenditures of government.
    The President's plan has enormous consequences. Last year, 
you assured us that we would be able to pay down as much of the 
publicly held debt as was possible to do--some $2 trillion. And 
now, we see that instead of being able to pay down $2 trillion 
of debt, that is dramatically reduced to $521 billion.
    The result is that Federal interest costs go up 
dramatically. Last year, we were told that over the next 
decade, we would pay some $600 billion in interest costs. That 
has now been increased to $1.6 trillion. That is $1 trillion 
that is going out in interest costs that is not available to 
strengthen our national defense or improve homeland security or 
meet the other pressing needs of the country--or to pay down 
debt.
    I believe the truth is there are no surpluses left--none. I 
think their words mislead us, perhaps. I think they certainly 
mislead the American people. I believe that to the extent 
surpluses are from trust funds, that those funds are already 
fully committed and should not be designated as surpluses.
    Before Chairman Greenspan's testimony before this 
committee, he and I had a very interesting conversation. He 
said that one of the things that has concerned him is the 
liabilities that the Federal Government has that are not on the 
books of the Federal Government, and they are not on the books 
of the Federal Government because the theory is that the 
Federal Government could stop the programs of Social Security 
and Medicare, so those liabilities are considered contingent 
liabilities.
    As Chairman Greenspan said to me, in his judgment, the vast 
majority of it is not contingent at all. And that is why I 
liken this to the Enron theory. I am not accusing anybody of 
corruption here; that is not the point. The point is that as I 
understand it, the biggest problem with Enron is that they did 
not face up to their true debt. In effect, they were hiding 
debt from creditors, from shareholders, and perhaps even from 
themselves. Perhaps there were executives there who did not 
fully appreciate the amount of debt that they had. I would not 
be surprised by that. Frankly, I would not be surprised if 
there are colleagues who do not fully appreciate the debt that 
we have.
    So the use of language is important, and I have become 
increasingly concerned that when there is talk in Washington of 
surpluses, that sends a signal to people across the country 
that there is money here that is available for spending, that 
is available for tax cuts--that it is extra; that it is beyond 
what the need is. I do not think that is the case. I really do 
not think we have surpluses.
    In many ways, what I am talking about is a very 
conservative view. I can tell you that there are people who do 
not welcome it on my side of the aisle. But I believe that it 
is the case.
    Where will it lead us? CBO Director Crippen concluded his 
testimony here by saying ``Put more starkly, Mr. Chairman, the 
extremes of what will be required to address our requirement 
are these: We will have to increase borrowing by very large, 
likely unsustainable, amounts, raise taxes to 30 percent of 
gross domestic product''--we are at 19 percent now; that is not 
his quote, that is my statement--back to his quote now--
``obviously unprecedented in our history''--that is, to go to 
30 percent of GDP for taxes--``or eliminate most of the rest of 
government as we know it. That is the dilemma that faces us in 
the long run, Mr. Chairman, and these next 10 years will only 
be the beginning.''
    This is the reality that is just beyond this 10-year budget 
horizon, and I think it has got to inform all of our actions--
administration proposals, congressional action--and if we 
believe that that is the case, if we believe that that is where 
we are headed, that has got to put a brake on what we do on 
both the spending side and the tax cutting side. That is my own 
strongly held belief.
    I believe that Director Crippen gave us the hard truth, and 
as I have said before, I believe the President's budget fails 
to address that long-term fiscal imbalance facing the country. 
And I believe that his proposal--not so much the short-term; 
that is not to me the issue. I am much less concerned with this 
year's budget and even to some extent next year's budget. I am 
much more concerned about our long-term glide-slope here and 
where it is taking us.
    Mr. Secretary, that is my own view of our condition, and my 
disagreement with the Administration is a fundamental one. It 
does not flow from any disrespect or disregard. In fact, as I 
have expressed before and I have expressed to you, I have the 
highest regard for the President's management of the war effort 
and for the conduct of this Administration in facing this 
incredible challenge to our Nation.0
    I must say that there have been many times sitting at home 
where I have felt real pride in how the President has conducted 
himself, how you, Mr. Secretary, have conducted yourself, and I 
acknowledge that fully here.
    The disagreement I have is that I think we are on a long-
term course that does not add up and puts our long-term 
financial security in jeopardy.
    With that--well, that is more red ink--let me now turn to 
my colleague, Senator Smith, from Oregon, who is filling in for 
Senator Domenici. We welcome Senator Smith to this role. He is 
a very articulate and very knowledgeable member of this 
committee, and we will have time now for his observations.

               OPENING STATEMENT OF SENATOR SMITH

    Senator Smith. Thank you very much, Mr. Chairman.
    I appreciate your leadership on this Committee and your 
active use of the gavel to educate the American people of the 
choices that we have.
    I also thank you for your comments about Senator Domenici, 
and I think we all join in a prayer for his well-being and hope 
for the very best results from the testing he is having today.
    I honestly do not know of a better person in the United 
States Senate than Pete Domenici, and that is as high a praise 
as I can give, because I know many wonderful people in the 
United States Senate. So I do not suppose anybody feels more 
keenly the size of his shoes this morning than I do, because he 
has asked me to fit in them as best I can this morning.
    Mr. Secretary, I thank you for coming this morning. We have 
received the President's budget, and with some exception, I 
think it is an excellent budget. It is a war-time budget, and I 
think it lays out clearly the priorities that our Nation has to 
win the war, to better secure our homeland, and to restore 
economic health to our economy.
    It is a $2.1 trillion budget. That is a lot of money. And I 
know that you are having a lot of your statements held up to 
you this morning. My mother used to say ``Make your words soft 
and gentle, because tomorrow you may have to eat them.''
    I think the point that I would make to anybody who cares to 
be fair is that you made those statements before murderers 
crashed into our buildings and took us to war. That is an 
extraordinary circumstance that no one could have foreseen 
fully, and we are in an emergency, and the budget that you have 
submitted reflects that.
    I want to express publicly my disappointment that the 
Senate has failed to move a stimulus package to conference. I 
will admit to you, Mr. Secretary, that I voted for Senator 
Daschle's bill yesterday; I voted for the centrist bill 
yesterday; I voted for any bill that could get to conference 
where we could produce a product that the President could sign, 
because it does seem to me that your budget assumes that we are 
going to have from a stimulus package an additional 5 percent 
growth and an additional 300,000 jobs as a result of that 
stimulus.
    We are not going to have that now, and I am very 
disappointed in that, because I have never felt that either 
side here had a monopoly on the truth. It does seem to me that 
the Democrats have focused on the demand side in terms of 
unemployment and health care, and I support that. I have said 
it time and again on television and today. I support that, and 
that is why I voted for Senator Daschle's bill.
    But I think the Republicans had many good ideas with 
respect to the supply side, the tax side of the equation, that 
actually does stimulate the economy, and I felt that in 
fairness to both sides, we should pursue the best ideas on both 
sides.
    But I think it is fair to say that there is an honest 
disagreement between the parties when it comes to the budget 
and the role of Government. I listened to our Chairman, and 
with great respect, I simply feel that in an emergency like 
this, the green-eyeshade view of the budget, as though these 
numbers are static, frankly does not add up for me. It does not 
respond to the times that we are in.
    I do not believe that we can tax our way to prosperity. I 
believe we should grow our way back to prosperity and surplus, 
and I think that that is what the President is trying to do.
    I have a difference of opinion also on the tax cut that we 
passed. I truly believe that it is just right and just in time 
and that it can be helpful to making sure this recession is not 
too long and not too deep. So I am proud to have supported it.
    My view of Government, and frankly, the reason why I am a 
Republican, is the belief that if we leave more economic 
choices to the American people, we are going to have a freer 
society and a more prosperous economy because we will lift more 
people from the ranks of poverty because we provide them 
opportunity and freedom of choice.
    It does seem to me that when we have paraded through our 
office every manner of worthy cause that can be solved if only 
we can open the public purse just a little more, at the end of 
the day, it is hard to say now. I plead guilty to that. I do 
not like to say no. I would prefer to be Santa than Scrooge. 
That is a problem we have around here, and to that end, I 
really appreciate our Chairman because he is always reminding 
us of the black and white numbers. But I would just simply say 
for the record that the money that we have here, this $2.1 
trillion that we take and spend of the American people's, 20 
percent of our economy every year, that money is all fungible 
whether you have it on budget or off budget. Senator Conrad and 
I are both going to vote for the farm bill. We have similar 
feelings on farm policy. We are both going to vote for his 
transportation bill. We are every going to vote for his 
disaster relief for flooding bill. I am likely to vote for many 
of the things that he will vote for. But all of that, by the 
formula that he has laid out, takes away from the Social 
Security and Medicare Trust Funds just as the tax cut does 
under the criteria that he has laid out.
    So it just seems to me that our better macro policy is 
reflected in the President's budget, that we should grow our 
way to prosperity and not tax our way to prosperity--we cannot 
do it. We cannot centrally plan this Government and be serious 
about the freedom of the American people.
    Having said that, Mr. Secretary, there is one area that is 
a pet peeve of mine. It is about what I see as a moral omission 
in our country. And given how much we already spend for 
medicine in this country, it is an ongoing disappointment of 
mine that we continue to have 40 million of our citizens 
without health care, and that number is growing.
    It does seem to me that there ought to be ways--and I know 
the President has made a good start in his budget with some tax 
ideas on credits to help the uninsured to access health care--
but perhaps there is something more that we can do in terms of 
community health centers; maybe there is more that we can do in 
terms of incentivizing small businesses to be able to provide 
health care. It is a number that, again, I think is a moral 
omission in our country, an d we ought to address it more 
earnestly. And I think that for a Republican President, it 
would be like Nixon going to China, if you will, to take 
leadership on that issue.
    So I encourage that. I think we are spending a lot on 
medicine, and we are not getting the best bang for the medical 
buck, and we ought to figure out how to do that.
    I note that you and I were both at the Davos Forum in New 
York last week, and you had a certain Irish rock star who came 
out of the closet and announced that he was a Republican 
activist--I was surprised by that--by the name of ``Bono.'' You 
made a good friend there, and I understand that you will be 
going with him to Africa to work on the AIDS issue. I 
congratulate you for that, I encourage you for that, and I know 
that what we do to help on AIDS does also affect our trust 
funds; but we are in a real dilemma in terms of wrestling with 
this plague of our time to find a cure, and we need to do our 
part as a country.
    So Mr. Secretary, I admire you, I thank you for your 
service. You do not need this job, but you are doing a very 
fine job, and I am honored to have you here.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Smith.
    I just want to make clear that my concern about taking 
money from the trust funds to pay for other things is when I 
see the administration proposing to do it not at the time of 
recession--that I could live with, that I could accept--it is 
when they are forecasting strong economic growth. And it is not 
just temporary. It is not just now, in the middle of this 
conflict--and frankly, this conflict is not all that expensive; 
the recession has been more of a drain--but they are talking 
about taking $2 trillion out of the trust funds over the whole 
next decade, and they are forecasting strong economic growth 
during that period.
    I would just say to you that my own belief is that we have 
got to be willing to pay for what we want to spend, and that is 
especially critical when we have this baby boom generation 
poised to retire. That is going to change the fiscal outlook 
for the country. So I just think it is unwise to be taking 
money out of the trust funds for this entire decade, when it is 
the decade that the baby boomers start to retire.
    We are very close to a vote, and Senator Stabenow is going 
to have to preside, so I want to give her a chance to make a 
statement now.

             OPENING STATEMENT OF SENATOR STABENOW

    Senator Stabenow. Thank you very much, Mr. Chairman. I 
appreciate that.
    Mr. Secretary, welcome back to the Senate Budget Committee. 
Obviously, we are in a very different, dramatically different, 
fiscal situation than we were when you appeared before us last 
year, and as the Chairman indicated, we all share grave concern 
about the future as it relates to our economic situation and 
our budget situation.
    Our $5.6 trillion surplus is almost down to zero, which is 
astounding when you take into account the President's budget 
and the tax proposals.
    Today you come before us not just as the President's top 
tax policy advisor, but of course, you are also responsible for 
managing our national debt and for paying our country's bills, 
which is an incredible responsibility. In this light, you have 
a tough job ahead of you, and our country is now at war, and 
there is unanimous--unanimous--bipartisan support for our 
military efforts overseas. In addition, we are expanding our 
defenses here at home by vastly increasing our homeland 
security, and this is also widely supported on a bipartisan 
basis. The focus on safety and security, we all understand is 
critical for us.
    These efforts are necessary and of course are our highest 
priority. However, our war against terrorism requires us to 
closely examine our budget priorities now and over the next 
several years, and that is really what this committee is 
responsible for, as is the entire Congress, and that is what we 
wrestle with--good ideas, but all of which we cannot do at the 
same time. Can we fight the war? Can we also provide the large 
tax cuts passed last year which benefit the top one or 2 
percent of the public and at the same time pay down the 
national debt? Should we allow Social Security and Medicare 
Trust Funds to be used to pay for those tax cuts when the tax 
cuts benefit a few and Social Security and Medicare benefit 
everyone?
    That is really the question that I have, and I have to say 
no, that that is not acceptable as a tradeoff. And while I have 
said in the past that these are certainly not connected 
legally, it feels a lot like Enron to me, with the top one or 2 
percent taking money out of the company and leaving everybody 
else to pay for it with their retirement funds.
    So we have some tough decisions to make, and certainly 
there have been good ideas on both sides of the aisle with my 
colleagues, and I certainly send with my colleagues every best 
with to Senator Domenici, who is such an extraordinary leader 
on budget. He has had ideas, for instance, on payroll tax 
holidays that have had support on both sides of the aisle, and 
there are a number of ideas that put money in the pocket of 
business and individuals and do it in a way that are not a long 
term drain on Social Security and Medicare.
    So we have a lot of tough decisions. Our country is going 
to have to grapple with those. We welcome your leadership, and 
we have critical decisions to make that we need to make 
together in the best interests of all Americans.
    With that, the committee will take a short recess in order 
to vote, and then the committee will be back.
    Thank you.
    [Recess.]
    Chairman Conrad. On behalf of the committee, I want to 
apologize to the Secretary. You understand that this place is 
sometimes unpredictable with respect to votes, and that has 
been the case this morning.
    We hope now that we will have clear sailing for an hour or 
so. As is our standard practice and with the agreement of the 
ranking member, we will go to the testimony of the Secretary, 
and then we will have our usual practice of 7-minute rounds for 
each of the members.
    Mr. Secretary, please proceed.

  STATEMENT OF HON. PAUL T. O'NEILL, SECRETARY, UNITED STATES 
                   DEPARTMENT OF THE TREASURY

    Secretary O'Neill. Thank you very much, Mr. Chairman, 
Senator Smith.
    I want to join in the comments that each of the members 
have made so far in recognizing Senator Domenici who is not 
here today. He is a friend of long standing, and I agree with 
the sentiments expressed. He is a great human being, and I join 
you in wishing him well and a speedy return to his work here.
    If it is OK with the chair, I have a short statement, 7 or 
8 minutes' worth, that I would like to read if it is all right 
with you.
    First of all, thank you for inviting me to testify today. 
We have had a year to work together, and you know that I am an 
optimist about the United States economy, especially its long-
term prospects.
    I believe that we have a huge untapped potential that can 
and will be unleashed to spread higher levels of prosperity 
throughout our Nation.
    Even after a difficult year, my optimism about the 
fundamentals of the United States economy has not changed at 
all. I believe that we were on the verge of recovery before the 
September 11 terrorist attacks and that our resilience and 
determination have brought us back to the early stages of 
recovery today.
    We see more signs every day indicating that the seeds for a 
recovery are there and only need nourishing to speed the 
process of putting Americans back to work. I believe that we 
will return to prosperous economic growth rates of 3 to 3.5 
percent as soon as the fourth quarter of this year. I am 
disappointed that the Senate was not able to vote out a bill to 
speed job creation to more quickly return Americans to work in 
its actions yesterday.
    Strengthening our economy is the key goal of the 
President's budget. A return to our normal growth rates means 
jobs for the 1.4 million Americans who have lost their jobs 
during this recession. Just as strengthening our economy means 
greater prosperity for the Nation's people, it also means 
greater strength for our Government. It means greater revenues 
going into the Treasury without raising taxes, giving us the 
resources to address the Nation's needs and the retirement of 
even more Federal debt, leading to long-term economic security 
for our children.
    Even with all that must be done to enhance our security, we 
expect that a return to economic growth will bring us back to 
Government surplus in the year 2005.
    The economy's slowdown began in mid-2000, when GDP and job 
growth slowed sharply. Business capital spending began to 
plummet in late 2000 and accelerated its decline in 2001, 
dragging down the economy. In August, we were beginning to see 
the evidence of an economic rebound.
    I believe that had it not been for the terrorist attacks of 
September 11, we would have seen an end to the economic 
downturn and would perhaps have avoided a recession. The 
September 11 attacks created shock waves that rippled 
throughout all sectors of the economy. Financial markets were 
shut down for almost a week. Air transportation came to a 
standstill, and as a result, GDP fell 1.3 percent at an annual 
rate in the third quarter.
    By late November, the National Bureau of Economic Research 
declared that the United States was in a recession. They 
designated the end of the previous expansion to be March 2001, 
but they observed that the slowdown might not have met their 
qualitative standards for recession without the sharp declines 
in activity that followed the terrorist attacks.
    In sum, the scorecards for the economy in 2001 reflected a 
combination of adverse events: The private sector lost more 
than 1.5 million jobs; the unemployment rate rose 1.8 percent 
points; industrial production was off nearly percent during the 
year; and at the end of the year, industry was using something 
just less than 75 percent of its productive capacity.
    As bad as these numbers are, they could have been worse. 
The well-timed bipartisan tax relief package which you all 
voted put $36 billion directly into consumers' hands in the 
late summer and early fall--in fact, beginning on July 23, 
providing much-needed support as the economy sagged. It was, we 
believe, the right thing to do at just the right time.
    It is not surprising, then, that both the Congressional 
Budget Office and the Office of Management and Budget project 
deficits for this year and next as a result of the economic 
slowdown and the response to the September 11 attacks.
    The President has presented a budget to speed our recovery. 
First, the budget includes tax relief to stimulate job 
creation. Unfortunately, it now appears that we are not going 
to see the action the President began recommending on October 5 
which would have accelerated depreciation and speeded up the 
tax rates that had earlier been enacted for subsequent 
effectiveness, not providing checks in the form that I think 
was largely agreed on both sides of the aisle for those who 
were tax filers but did not participate in the tax rebate 
program of last year. I think it is too bad that we were not 
able to get those actions taken. But we do welcome the fact 
that by unanimous consent yesterday, the Senate did agree to go 
forward with an extension of the unemployment insurance 
benefits for 13 weeks.
    Second, the President's budget proposes strict fiscal 
discipline, increasing spending for national security and 
homeland defense, and holding the line on other spending. His 
management agenda calls for performance measures to be used to 
determine where budget increases are allocated so that our 
resources go into the projects and programs that make the 
biggest difference in people's lives.
    As the experience of the 1990's showed, this discipline is 
crucial to ensuring that we do not return to systemic deficits 
of the past. But fiscal discipline alone will not guarantee 
budget surpluses. We must return to 3 and 3.5 percent annual 
growth to ensure surpluses for years to come.
    The focus needs to be on restoring growth. Surpluses will 
then follow naturally. We believe that raising taxes would 
stifle the process of getting Americans back to work. We think 
that tax increases at this point in our recovery is a very bad 
idea.
    According to the 1999 data, the most recent available, 33 
million small business owners and entrepreneurs pay taxes under 
the individual income tax rates. They have made business plans 
that assume that the tax relief enacted last summer will take 
place as scheduled. And importantly, 80 percent of the benefit 
of cutting the top two rates goes to small business owners and 
entrepreneurs. They are the engines of job creation in our 
economy.
    We believe again that tax relief, if it were accelerated as 
the President proposed, would boost job creation. Such relief 
we believe would have no affect on long-term interest rates. In 
fact the Council of Economic Advisers estimated that a $1 
trillion change in the public debt over 10 years would tend to 
raise the long-term interest rates by 14 basis points. And 
importantly, since the tax cut last year, the 10-year nominal 
rate has averaged 4.93 percent--I think this morning, it was 
trading at 4.90--which is substantially below the 6.16 percent 
rate averaged from 1993 through 2000.
    Again, we believe that restoring growth is the key to 
America's future--restoring growth while ensuring we have the 
resources in Washington to fight the war on terrorism, to 
provide for homeland defense and provide the services the 
American people want and need and demand. We believe the 
President's budget will help to ensure that both peace and 
prosperity are restored to the American people as soon as 
possible.
    Mr. Chairman, that concludes my prepared statement.

       The Prepared Statement of Paul O'Neill, Treasury Secretary

    Good morning Chairman, Chairman Conrad, Senator Domenici and 
members of the committee. Thank you for inviting me to testify today. 
Now that we've had a year to work together, you should know that I am 
an optimist about the United States economy. I believe we always have 
untapped potential that can be unleashed to spread prosperity 
throughout the Nation. Never has that been more true than right now. 
Even after a difficult year, my optimism about the fundamentals of the 
United States economy has not changed. I believe we were on the verge 
of recovery before the September 11 terrorist attacks, and that our 
resilience and determination have brought us back to the early stages 
of recovery today. We see more and more signs every day indicating that 
the seeds for a recovery are there, and only need nourishing to speed 
the process of putting Americans back to work. I believe we will return 
to prosperous economic growth rates of 3 to 3.5 percent, as soon as the 
fourth quarter of this year. I'm disappointed the Senate was not able 
to vote out a bill to speed job creation to more quickly return 
Americans to work.
    Strengthening our economy must be our primary goal. It is the focus 
of the President's budget. That must be our goal, because a return to 
our normal growth rates means jobs for the 1.4 million Americans who 
have lost jobs during this recession. Just as a strengthening economy 
means greater prosperity for our Nation's people, it also means greater 
strength for our government. It means greater revenues going into the 
Treasury, without raising taxes, giving us resources to address the 
Nation's needs, and the retirement of even more Federal debt--leading 
to long-term economic security for our children. Even with all that 
must be done to enhance our security, we expect that a return to 
economic growth will bring us back to government surplus in 2005.
    The economy's slowdown began in mid-2000, when GDP and job-growth 
slowed sharply. Business capital spending began to plummet in late 
2000, and accelerated its decline in 2001, dragging down the economy. 
In August we were beginning to see the evidence of an economic rebound. 
I firmly believe that had it not been for the terrorist attacks of 
September 11th, that we would have seen an end to the economic downturn 
and would perhaps have avoided a recession. The September 11 attacks 
created shockwaves that rippled throughout all sectors of the economy. 
Financial markets were shut down for almost a week. Air transportation 
came to a standstill, As a result, GDP fell 1.3 percent at an annual 
rate in the third quarter.
    By late November, the National Bureau of Economic Research declared 
that the United States was in a recession. They designated the end of 
the previous expansion to be March 2001, but they observed that the 
slowdown might not have met their qualitative standards for recession 
without the sharp declines in activity that followed the terrorist 
attacks.
    In sum, the scorecard for the economy in 2001 reflected a 
combination of adverse events:
    The private sector lost more than 1.5 million jobs.
    The unemployment rate rose 1.8 percentage points.
    Industrial production was off nearly 6 percent during the year.
    Industry was using less than 75 percent of its capacity.
    As bad as these numbers are, they could have been worse. Our well-
timed bipartisan tax relief package put $36 billion directly into 
consumers hands in the late summer and early fall, providing much 
needed support as the economy sagged. It was the right thing to do, at 
just the right time.
    It's not surprising then that both the Congressional Budget Office 
and the Office of Management and Budget project deficits for this year 
and next as a result of the economic slowdown and the response to the 
September 11 attacks. Last April's budget forecast a fiscal 2002 
surplus of $283 billion. The Mid-Session review figures, released in 
August, took account of the impact of the President's tax relief 
package and projected a $195 billion surplus in fiscal 2002. The new 
budget forecasts a fiscal 2002 deficit of $9 billion, assuming no 
policy action to stimulate the economy. The reduced surplus estimates 
are the result of the economic downturn and the response to the 
September 11 attacks. CBO's projections confirm that tax relief played 
a minor role in the surplus decline in the next few years--accounting 
for less than 12 percent of the decline in 2002 and less than 28 
percent in 2003.
[GRAPHIC] [TIFF OMITTED] 80544.070

    The CBO budget projects a 10-year surplus of $1.6 trillion. Last 
August, after factoring in the tax relief package, the CBO projected a 
$3.4 trillion surplus for the next 10 years. The recession and the war 
on terrorism depleted the 10-year projections by $1.8 trillion. The 
lesson from these numbers is simple--10-year projections are a useful 
discipline but they do not predict the future. None of last year's 10-
year estimates foresaw the events of September 11 or a negative 
$660billion worth of ``technical changes'' that are now included in the 
new 10-year estimates by agreement among the technical experts. We do 
know about the here and now, and we should deal with the here and now, 
reigniting growth to restore long-term surpluses.
    The Administration's growth projections are similar to the 
consensus of private forecasts. Over 90 percent of the Blue Chip 
Economic Indicators panel members say the recession will end before 
April of this year. We share that assessment. Personally, I am 
optimistic that the economy will do even better than our budget 
assumptions suggest. For the near term, we expect the economy to grow 
2.7 percent during the four quarters of 2002. That projection includes 
the foreseeable effects on the economy of the President's economic 
security package.
    The lesson is clear. A strong economy is crucial to restoring 
budget surpluses. Some would suggest that we need surpluses to improve 
our economy. They have the logic backward. Growth creates surpluses, 
not the other way around.
    The Federal budget was in deficit every year from 1970 through 
1998. From 1970 through the early 1990's, government spending growth 
exceeded government revenue growth by \3/4\ of a percentage point a 
year, on average. Fiscal discipline was imposed by the historic Omnibus 
Budget Reconciliation Act, signed in 1990 by President Bush. With 
fiscal restraint made an integral part of the budget process, once the 
economy took off in the 1990's, revenue growth was double the pace of 
spending growth. It was the rapid economic growth of the 1990's that 
generated the burgeoning budget surpluses, which appeared even as 
Federal outlays grew about 3.5 percent a year from 1993 through 2000.
    Today the economy is recovering. The tax cut of last May helped to 
keep the economic downturn shallow and it will continue to help. Energy 
prices have retreated. The Federal Reserve has reduced short-term 
interest rates 11 times since the beginning of 2001. Measures of 
consumer confidence are bouncing back. The index of leading indicators 
increased sharply in December for the third straight gain. Motor 
vehicle sales have remained strong. And initial filings for 
unemployment benefits are in decline. But we all know that unemployment 
itself is a lagging indicator. Although the current trend is positive, 
too many people will remain out of work. And given the choice, they'd 
rather have a regular paycheck than an unemployment check.
    The President has presented a budget to speed our recovery. First, 
the budget includes tax relief to stimulate job creation as a crucial 
tool to speed our recovery and put Americans back to work. The 
President's proposals--accelerated depreciation, speeding up the 
reduction in the 27 percent income tax rate, reducing the corporate 
AMT, and checks to those who didn't benefit from last summer's tax 
rebates--enjoy bipartisan support in both houses of Congress. I'm eager 
to work with all of you to complete work on a package to create jobs 
and assist dislocated workers with extended unemployment benefits and 
temporary assistance with health care.
    Second, the President's budget proposes strict fiscal discipline--
increasing spending for national security and homeland defense, and 
holding the line on other spending. His management agenda calls for 
performance measures to be used to determine where budiget increases 
are allocated--so that our resources go into the projects and programs 
that make the biggest difference in people's lives. As the experience 
of the 1990's shows, this discipline in crucial to ensuring we do not 
return to systemic deficits of the past. But fiscal discipline alone 
will not guarantee budget surpluses. We must return to 3 to 3.5 percent 
annual growth to ensure surpluses for years to come.
    The focus must be on restoring growth. Surpluses will then follow 
naturally. Raising taxes would stifle the process of getting Americans 
back to work. This is a bad idea, as our recovery is struggling to take 
hold. According to 1999 data, the most recent available, 33 million 
small business owners and entrepreneurs pay taxes under the individual 
income tax rates. They have made business plans that assume that the 
tax relief enacted last summer will take place as scheduled. Eighty 
percent of the benefit of cutting the top two rates goes to small 
business owners and entrepreneurs. These are the engines of job 
creation in our economy.
    Tax relief should be accelerated, as the President has proposed to 
boost job creation. Such relief will have minimal, or no, effect on 
long-term interest rates. According to a recent analysis by the CEA, an 
expected $1 trillion change in the public debt over 10 years would tend 
to raise the long-term interest rate by 14 basis points. Since the tax 
cut last year, the 10-year nominal rate has averaged 4.93 percent, 
which is substantially below the 6.16 percent averaged from 1993 
through 2000.
    Restoring growth is the key to America's future. Restoring growth 
is the key to ensuring we have the resources in Washington to fight the 
war on terrorism, provide for homeland defense and provide the services 
the American people demand. The President's budget will help to ensure 
that both peace and prosperity are restored to the American people as 
soon as possible.

    Chairman Conrad. Thank you very much.
    I am going to defer my opening questioning and go to 
Senator Byrd on our side, and then we will come back for 
Senator Smith's determination of who will go first on their 
side.
    Senator Smith. Mr. Chairman, since I made an opening 
statement, I will defer my first questioning round to Senator 
Allard.
    Chairman Conrad. All right.
    We will start with Senator Byrd on our side.
    Senator Byrd. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary.
    On page 51 of the first volume of the President's Budget, I 
noted the picture of Gulliver being tied down by the 
Lilliputians. Here it is. The caption beneath it reads: ``Many 
departments are tied up in a morass of Lilliputian do's and 
don'ts.''
    This is not the first time that the Administration has 
invoked the word ``Lilliputian'' when referring to the 
priorities of Congress. It makes me wonder if the 
Administration may not be requiring the members of the Cabinet 
to read Jonathan Swift's masterpiece of satire.
    Last year, before the National Association for Business 
Economics, Mr. Secretary, you used the word ``Lilliputian'' in 
referring to the application of the Byrd rule on 
reconsideration bills. You were quoted as saying: ``The rules 
that have been created by just ordinary people are in some ways 
more and more like the Lilliputians tying us to the ground. I 
do not know why we have to live by these rules; after all, so 
far as I can tell, God did not send them.''
    Inasmuch as you have invoked the name of the Creator, I 
would say that God works in mysterious ways his wonders to 
perform. This is not my quotation, but he does. He believes in 
rules, too. He gave them to Moses on Mount Sinai--the Ten 
Commandments. They hang in my office. Those are rules. I feel 
that God had his hand upon the destiny of this country when 
those illustrious men gathered in Philadelphia to create the 
Constitution of the United States.
    I do not know whether or not you have read Catherine 
Drinker Bowen's book, but she says that ``At no other time 
could these men have written this Constitution, which has 
proved to be the earliest written Constitution in the world and 
the most successful one.'' She says that 5 years earlier, the 
people and their representatives who were at the Convention 
would not have experienced enough of the disadvantages or the 
shortcomings that they needed to have experienced to have 
written this Constitution. She says that were it 5 years later, 
the people would have been turned off by the French Revolution 
and the sound of the guillotine.
    So the clock struck just at the right time. As far as I was 
concerned, that was God's hand, if you want to invoke God's 
name; that was God's hand at work.
    You said ``The rules that have been created by just 
ordinary people''--the rules, Mr. Secretary, of the Senate have 
only had 7 revisions in the more than 200 years of the Senate's 
history. Their roots go back into the House of Commons in Great 
Britain. Their roots go back to the Continental Congress. Their 
roots go back to the Confederation.
    We are using rules of which the first 20 were written 
within the first 10 days of the Constitutional Convention's 
meeting. Those are rules.
    Let me tell you what Thomas Jefferson says about rules. Let 
us compare it with what you say. You said, ``The rules that 
have been created by just ordinary people are in some ways more 
and more like the Lilliputians tying us''--now, who is ``us''--
``tying us to the ground. I do not know why we have to live 
with these rules; after all, so far as I can tell, God did not 
send them.''
    Well, Mr. Secretary, I say with all due respect--and I have 
great regard for you--that you seem to have gotten off the 
track. You probably should have had a good study course in 
American history before you came here--I am not talking about 
the kind of history that comes up with cartoons like this. Many 
of the so-called history books of our present time are full of 
colorful cartoons just like this. They do not teach real 
history.
    I read Muzzi back in 1927, 1928, 1929, 1932, David Seville 
Muzzi. That was history. There were pictures. Now, you say, 
``The rules that have been created by just ordinary people''--
these were not ordinary people, the men who signed the 
Constitution. They provided for the rules of the Senate.
    The Congress and certainly this Senate is not ordinary, and 
it is certainly not Lilliputian. We are Senators. I have been 
before the people at the bar of judgment 29 times in these 50 
years, counting this year, that I have served in Congress--29 
times. I have taken the oath to support and defend this 
Constitution 16 times.
    I am not asking you to answer this question--but how many 
times have you been before the bar of judgment of the people? 
In what elections did you run in order to represent the people? 
You were appointed. We were elected by the people, directly by 
the people--not like the President, indirectly, by electors who 
were elected by the people--we were directly elected.
    Chairman Conrad. Senator, if I could say, I grant 7 minutes 
and my first round of questioning to the Senator so he can 
continue in his statement.
    Senator Byrd. Mr. Chairman, I thank you, and I will not 
dwell upon this any longer except to say that we are Senators, 
and you have been in this town 1 year. I have been in this town 
50 years. I have seen many Secretaries of the Treasury. And I 
just want to tell you that we Senators are here to look after 
the interests of the people of our States. They are not well-
to-do people--not all of them--in my State. They are not CEO's 
of multi-billion-dollar corporations. They cannot just pick up 
the phone call a Cabinet Secretary.
    In time of need--in drought, in floods, in famines, when a 
bridge is near collapse, when safe drinking water is not 
available, when health care services are endangered--they come 
to us. The people come to us. Yes, they are ordinary people. 
They are coal miners, they are farmers, they are 
schoolteachers, they are ministers, they are lawyers, they are 
bankers.
    This cartoon on page 51 and comments throughout this budget 
suggest that this Administration believes that so-called 
experts at bureaucratic agencies should determine the 
priorities of this Nation--not the Congress, not the people 
they represent. That suggests that the problems of the people 
are too little to deserve the attention of the Administration.
    Here is what the paragraph says by Dr. Gulliver: ``. . .it 
is critical that the government operate effectively and spend 
every taxpayer dollar wisely. Unfortunately, Federal managers 
are greatly limited in how they can use financial handling and 
other resources to manage programs. Federal managers lack much 
of the discretion given to their private sector counterparts to 
get the job done.''
    We have seen what discretion given to private sector 
counterparts has done. We saw that in Enron.
    This budget, wrapped in the American Flag, says: 
``Government is ineffective under these conditions. During 
wartime, turf protection cannot dictate the national interest. 
The Congress should remove barriers and give the Administration 
the tools to do the job that must be done.''
    So you say the Federal managers are greatly limited in how 
they can use financial resources. That is a good thing. These 
people, the so-called Federal managers, are not elected by the 
people, and we are talking about the taxpayers' dollars--the 
taxpayers' dollars. That is why there are rules. That is why we 
have rules.
    So you say ``Federal managers lack much of the discretion 
given to their private sector counterparts.'' Yes, because they 
are dealing with tax dollars, the American people's dollars.
    My question would be does this kind of nonsense belong in a 
budget document. Now, to be fair, if we are going to do that, 
let us have a little more fun. Why not refer to the territory 
that was called Brobdingnag. Swift also wrote about that. Dr. 
Gulliver visited Brobdingnag, where there were not pygmies, but 
giants as tall as church spires, and with respect to one step 
of those giants, that step covers 10 yards.
    I would refer to this since we are in the business of using 
Swift's satire. This budget is a Brobdingnagian budget, a 
Brobdingnagian budget. Not bad.
    If we want to continue this, we can do it after the 
meeting. I have been very generously given time at this point.
    I just want to remind you, Mr. Secretary, that a lot of us 
were here before you came, and with all respect to you, you are 
not Alexander Hamilton.
    I have a question. Steel company representatives and steel 
workers have worked through numerous hurdles and made a number 
of concessions to reach consensus on a plan to renovate the 
United States steel industry. They have let the Administration 
know that in order for this plan to work, the President needs 
to conclude the Section 201 investigation of steel importation 
at the earliest possible date, with a remedy of nothing less 
than a 40 percent tariff on steel imports.
    In addition, the steel companies and workers have asked for 
the Administration's help in removing barriers to steel 
industry consolidation in the United States and in relieving 
the costs to the maximum extent possible of health care and 
pension benefits to retirees.
    Steel industry representatives from my own State have 
expressed optimism that this Administration is working 
positively with them to advance such a multifaceted solution. 
In light of this very critical time for the steel industry and 
this window of just a few weeks that could mean a turning point 
to a revitalization of bankruptcy and collapse of an industry 
that ties under our national security, this Administration 
submits a budget that cuts the steel loan guarantee program by 
$96 million.
    I find it hard to share in the optimism, and I will just 
ask one question at this time, and I will have further 
questions that I will submit.
    What can you tell this Committee specifically about this 
Administration's intentions with regard to helping the steel 
industry with tariffs, reorganization, and legacy costs?
    Secretary O'Neill. Well, Senator, what I said to the 
National Association of Business Economists, I stand by, 
because what I had in my mind and what I deeply believe is 
this--that where we have rules made by men that restrict the 
realization of human potential, they should be changed.
    We had rules that said, ``Colored, do not enter here.'' 
That was a manmade rule. And there are lots of those same kinds 
of rules that limit the realization of human potential, and I 
have dedicated my life to doing what I can to get rid of rules 
that so limit human potential, and I am not going to stop.
    Senator Byrd. Mr. Secretary, I have been around for a long 
time, and I try to live with the rules. You were specifically 
talking about the Byrd rule.
    Secretary O'Neill. I was talking about all rules that limit 
human potential and the realization of human potential, and 
referring to something different is fine if you wish to do so, 
but I would also like to say, because there was an inference in 
your remarks that somehow I was born on home plate and thought 
I hit a home run--Senator, I started my life in a house without 
water or electricity. So I do not cede to you the high moral 
ground of not knowing what life was like in the ditch.
    Senator Byrd. Well, Mr. Secretary, I lived in a house 
without electricity, too, no running water, no telephone, and 
with a wooden outhouse.
    Secretary O'Neill. I had the same.
    Senator Byrd. I started out in life without any rungs in 
the bottom of the ladder. I am talking with you about your 
comments concerning the Byrd rule and the people who wrote 
these rules. I am not talking about putting a halter or a break 
on anybody's self-incentive or anybody's initiative. I have had 
that experience, and I can stand toe-to-toe with you. I have 
not walked in any corporate board rooms. I have not had the 
churning of millions of dollars into trust accounts.
    I lived in a coal miner's home. I married a coal miner's 
daughter. So I hope we do not start down this road, talking 
about our backgrounds and how far back we came from. I am 
citing to you what you said in response to a question about the 
Byrd rule. The Byrd rule has saved millions and millions and 
millions of dollars for this Government, and we ought to live 
up to it.
    Perhaps you ought to study the Byrd rule a little bit if 
you have not to the point that you can explain it. And just 
remember, the rule that I am talking about, those ordinary 
people--you are talking about Senators. They are ordinary 
people, and they are not going to let you get away with it. We 
are not going to let you get away with it.
    So if you want to answer my question on steel.
    Secretary O'Neill. All right. As you know because you have 
been in some of the meetings that we have been having on the 
subject of steel, we began last year to see if it was possible 
to create a basis for the world to adjust the arguably 30 
percent overcapacity that the world today has in steel, and 
through the President's efforts and administration work, we 
succeeded in getting the OECD to provide a structure for 
calling together the principal producers of steel in the world 
to try to get them to stipulate the need for capacity 
reductions, especially of capacity that is exporting its goods 
around the world with Government subsidies and undercutting the 
ability of almost any steel company in the world to make enough 
money to cover the cost of its capital, as a piece of a 
concerted, connected set of ideas about how we should proceed 
in this area.
    Subsequent to beginning that work, the President filed a 
201, and he has until March 6, I believe, to make a final 
decision on what level, if any, and kinds of combinations of 
tariffs and impositions he should put on imports in the United 
States to make sure that the world is fair in the way that we 
provide a basis for our own steel industry to make a living. 
There are day-by-day conversations going on to this issue of 
what tariffs or barriers or provisions should be imposed on the 
rest of the world, and as I say, the work will be done by the 
appointed date of March 6.
    Senator Byrd. I hope the President will act and act 
immediately and act forcefully. He was in West Virginia and 
told the steel workers that he would help them. The Vice 
President certainly was in West Virginia and told the steel 
workers he would help them. West Virginia went for Mr. Bush, 
else you would not be sitting there today if my State had gone 
for Mr. Gore.
    So the steel workers are hoping and praying that the 
President will act and act immediately to help them in this 
regard.
    Thank you very much.
    Chairman Conrad. Senator Smith.
    Senator Smith. Mr. Secretary, I was looking at your resume, 
and I believe you started your professional employment as a 
civil servant for the Office of Management and Budget. Is that 
correct?
    Secretary O'Neill. In fact I started at the Veterans 
Administration as a computer systems analyst in 1961 and 
completed my previous Government service at the office of 
Management and Budget as deputy director in 1977.
    Senator Smith. And you have served in the administrations 
of Gerald Ford, is that correct----
    Secretary O'Neill. That is right.
    Senator Smith [continuing]. And President----
    Secretary O'Neill. Kennedy, Johnson, Nixon, and Ford.
    Senator Byrd. Would the Senator yield to me?
    Senator Smith. I would be happy to yield, Senator Byrd.
    Senator Byrd. Since we are talking about how many 
administrations we have been in----
    Senator Smith. You can beat us all, I am sure.
    Senator Byrd. I have served with--not under--11 Presidents.
    Senator Smith. Well, I have great respect for Senator Byrd. 
I feel badly, though, if you feel demeaned appearing before 
this Committee in any personal way, because I just want to say 
again for the record as I did in my opening statement that you 
did not need this job, but you are doing a fine job, and I 
believe you have served in many administrations, and you left a 
very lucrative position because you wanted to make the world a 
better place. And I think that needs to be said again. So I----
    Senator Byrd. Would the Senator yield?
    Senator Smith. I would be happy to yield to Senator Byrd 
any time.
    Senator Byrd. May I just add a little footnote along that 
line?
    Senator Smith. Of course.
    Senator Byrd. I do not need to serve here, either. I 
believe I could retire and get more money in retirement than I 
earn as a Senator. I am talking about my retirement from the 
years I have served in Government.
    Senator Smith. I understand that.
    I thank you, Secretary O'Neill, for your service to your 
country, and I thank Senator Byrd for his service to our 
country as well.
    Mr. Secretary, I also had in my opening statement an 
ongoing concern about the uninsured in our country, and I note 
that in the budget, the President is proposing $89 billion for 
the uninsured. I think that anticipates insuring an additional 
6 million Americans.
    There are many ideas out there for how to do even better. I 
think this is a good beginning, but I wonder if you have in 
mind anything additional that we might look at on this 
Committee as we authorize the going forward of trying to 
eliminate this moral omission on our country's part. Expansion 
of Medicaid, SCHIP, as well as incentives to small business, 
expanding community health centers--all of these things--are 
there some ideas that you have and some direction that you 
might give us for how to do even better than eliminating 6 
millon from the rolls of the uninsured?
    Secretary O'Neill. This is really a very complicated 
subject. What I would like to do, if Committee members are 
interested in doing it, is I would like to organize a field 
trip to take you all to Pittsburgh and show you the future of 
how we can reduce the cost of medical care by 50 percent and 
stop hurting people in the practice of medical care and thereby 
free up the funds so that we do not have this problem of people 
without health insurance, because we will be able to afford it.
    There is a way to do that, and there are a few other places 
in the country where the work is going on to demonstrate that 
it is possible, for example, to eliminate people getting staph 
infections, what are called in the medical profession 
pneusacomeal infections in the hospital, which affect maybe 7 
percent of inpatients in United States hospitals--just 
something that the hospital did not bring with them that raises 
the cost of their medical care.
    There is a set of ideas that, practiced together, can 
produce this result. And I think that if you are looking for 
the single largest potential thing to do that will result in 
the effect that you are looking for, in effect, providing 
health care access for every American citizen, that the road by 
which we are going to get there.
    I would say--you mentioned Medicare and Medicaid--I think 
that all the things that have been done here since 1965, when 
these two programs were enacted, were done with good intentions 
and the best wishes for the population. It is unfortunate that 
so many of them have turned out to have had perverse effects, 
partly because the mindset that is brought to this subject from 
Washington is one that has in it the idea that if we do not 
treat medical care providers as though they are trying to rip 
us off, that in fact they will rip us off--and the consequence 
of that is indeed perverse, because it has led to reimbursement 
formulas that put the pressure and incentivize, for example, 
discharging patients against a statistical profile that says, 
for example, for bypass patients, it is on average 5.9 days for 
people to be discharged, and so our formulas provide economic 
ways to get people out of the hospital after 5.9 days. If you 
look at the data, what it tells you is that 20 percent of the 
people who are discharged before the statistically suggested 
number are readmitted to the hospital the next week, and a fair 
number of them die.
    Now, from the reimbursement formula point of view, we do 
not care, because manage to incentivize the target of getting 
patients discharged, and since we do not really pay attention 
to patients--we pay attention to episodes--our system drives us 
in a direction that is not about human value--and this, for 
example, Senator Byrd, is the kind of manmade rule that I have 
in mind when I am out there trying to change the way the world 
works. We created these rules that are anti-human being with 
the very best of intentions, and Medicare and Medicaid 
reimbursements, and they need to be changed by human beings, 
and they are only going to be changed as we reformulate how we 
think about the potential and the realization of higher levels 
of human enjoyment.
    Senator Smith. Mr. Chairman, I would suggest that we take 
the Secretary up on his idea of a field trip. I think it would 
be very helpful to have better in mind as human beings on this 
side of the table how we can cut through some of the red tape 
to actually help our citizens and close the ranks of the 
uninsured.
    I just think it is an ongoing national shame that we are 
not finding more creative ways to address this system of health 
care delivery.
    I only have one other questions, Mr. Chairman, for Senator 
Domenici, who asks: When will we breach the statutory debt 
limit?
    Secretary O'Neill. Before the end of March.
    Senator Smith. Before the end of March.
    Thank you, Mr. Chairman.
    Chairman Conrad. Can I just say that on the offer that the 
Secretary made, your staff director informs me that it would 
have to be on Treasury's nickel, because we are out of money.
    Senator Corzine.
    Senator Corzine. I guess that is appropriate for the Budget 
Committee. We are being very astute here.
    Mr. Secretary, I welcome you. I also, though, want to 
express sympathy with the context that sometimes I think in 
this political world that we live in, we use cartoons or label 
people obstructionists when they are really trying to do what 
is perceived as their rightful responsibilities and certainly 
their prerogatives and instructions. I think that sometimes the 
dialog covers up well-meaning people's intentions on a lot of 
things. So I know that we may have some differences of view 
about exactly how we look at this budget, but in the long run, 
we have to have the good will to understand that we are all 
looking after the same end product for the American people, and 
that is why we all are serving.
    In that light, I have serious concerns about the structure 
of our budget. It is troubling to me that even off the numbers 
we see, we are going to be using about $1.6 trillion from the 
Social Security surplus numbers, the payroll taxes, if I read 
these numbers right, running a unified budget deficit--a non-
Social Security deficit--of $1.5 trillion over the next 10 
years. I have a hard time understanding how we are going to be 
able to deal with the demographic bubble that is acknowledged 
by everyone, and I understand the administration and many have 
proposed the privatization of Social Security. That is not 
allowed for in this budget, and by any reasonable analyst, that 
is going to be a trillion-dollar transition cost--maybe $800 
billion, maybe more.
    I am troubled that we are working off of numbers that are 
not realistic with regard to how we are going to deal with the 
budgetary requirements and limitations that we have as a 
society going forward, and particularly, then, when we put it 
into the context of many things that I could talk about, 
whether it is with regard to the environment, health care, 
other issues that I think we need to seriously address, 
including our national defense and homeland defense.
    I am going to talk about one today; it is a small item, but 
I think it is very important in the context of the debate that 
exists in America today, that concerns the American people. It 
deals with the SEC budget. The SEC budget is not up at all this 
year, if I read these numbers right. It fails to include 
funding to bring pay and benefits for SEC employees up to 
levels that are equivalent of other regulatory agencies. And 
here, we have an incredible debacle, I guess is all you can 
actually label the Enron situation, but those of us who were in 
business also know that we have had more restatements of 
accounting statements of earnings in the last 2 years than we 
have had in the previous 10 years combined. We know that the 
SEC, which has responsibility--ultimate responsibility--for 
supervising this, does not have the resources. We have 22 
accountants--I think that is the number--in the Accounting 
Division of the SEC and a responsibility to supervise 3,000 
public companies.
    I do not understand how our priorities, given that we need 
to be able to have the efficacy of sound reporting and 
supervision of our securities markets, which are so fundamental 
to the raising of capital to the saving for pensioners and 
investors across this country, one of the fundamental 
dynamics--how we can be so limited in our investment in 
something that is absolutely essential to a strong economy.
    As a matter of fact, I am very fearful that while some of 
the members are looking good with regard to our economy now, we 
will see foreign investors and others losing confidence in 
America because they cannot interpret what it is we report in 
our corporations when we see changes in behavior of lenders and 
other investors.
    So, while it is a small piece, I think it is a very 
important piece in the current context of how the American 
economy is working, and I think it is indicative of this 
overlay of a program. Fundamentally, I think the tax cuts have 
a lot do with that, of how we are not prioritizing the kinds of 
things that will make America strong.
    And so I would love to hear your comments both about the 
privatization of Social Security and the transaction costs, 
which are completely left out of this budget, which we know 
have to be inputted, if that is the direction we take. I am not 
sure I would be supporting that. But how can we justify the 
kind of thing with regard to providing the security for our 
financial markets that I think is necessary for a sound 
financial system?
    Secretary O'Neill. Thank you very much.
    If I may, let me couple my answer to your questions with 
Senator Conrad's opening statements because he also talked 
about Social Security, and I think it is worthwhile, at least 
it seems worthwhile to me, to talk about the concept of where 
we are.
    You know, as I have appeared now eight and a half hours 
before three different Committees or four different Committees 
over the last couple of days, we have had ongoing conversations 
on every Committee about Social Security, and there are so many 
times when members say we are taking money out of Social 
Security. Well, we all know that is not right.
    And, again, to the issue that I was raising earlier about 
rules, and concepts, and the importance of getting them right, 
we all know that the trust fund is not a trust fund in the way 
you would understand it as a trust fund for your own children, 
which has real assets in it, and that is not to say that a 
piece of paper from the Government in a lock box from West 
Virginia is not a real asset because it is a real call on the 
future earning power of the country. So, in that sense, it is a 
real asset.
    But I, frankly, think we do a disservice to the American 
people when we talk about the shameless action of taking the 
people's money that they send in here, which they earned with 
the sweat of their brow, and send in $4,900 or whatever for a 
couple and leave them with the impression that we took their 
money and spent it on something else when, in fact, we did not 
really.
    We took it and bought Government securities and put them in 
a lock box in West Virginia, and then we said the total wants 
and needs of a country, from a cash-flow point of view, require 
more money than we have taken in for general revenue, so we are 
going to have to borrow some more money, and so we borrowed 
that money. We could, if you wanted to do a hand-washing 
transaction, we could go through the rigamorole of actually 
doing that, of buying and selling so that the cash is 
reflective of what is happening in the broader sense.
    Now it does not gain your point about the long-term, 
unfunded liability that we have for the trust funds, and so I 
have been saying, because I think this is right, we should have 
a balance sheet that is a real balance sheet in the Federal 
Government, and if we had a real balance sheet, we would find 
on it $10.5- or $11-trillion worth of unfunded liability, and 
it would call our attention every day to the obligation that we 
have created for the American society, which one way or 
another, we have to take care of.
    I think it would be very helpful to the debate and the 
people's understanding out there if they knew more precisely 
what this conversation was about, and we all stopped this, I 
guess it is a political conversation that really scares people 
out there. I know it scares people because I get letters from 
citizens saying I heard some Member of Congress say that you 
are using our Social Security money and maybe we are not going 
to get our payments. I do not think that is a healthy thing to 
do to people out there, especially when you see some of the 
people that are getting their checks, and they are in their 
upper years, and their hearing is not so good. And when they 
hear that maybe we are not going to meet our obligation in 
Social Security, it scares the hell out of them, and I do not 
think we ought to be doing that because that is not true.
    I cannot conceive of a United States Congress or an 
administration that did not fulfill the obligations people 
believe we have under Social Security. So I think we ought to 
set that aside, and then we ought to deal with the real problem 
which is an unfunded liability of very large proportions.
    Senator Corzine. Well, we are making that unfunded 
liability larger when we do not set aside or pay down the debt, 
in my view.
    Secretary O'Neill. No, we are not. Excuse me. I am sorry, 
Senator.
    Senator Corzine. It is money, if it were set aside, that 
actually could be utilized to compound and grow to meet an 
unfunded liability. Now that is the argument that we have in 
the political arena, but the reality is we are using Social 
Security payroll taxes and Medicare to fund all of these other 
choices that we have today because we use a unified budget in 
this country. Money is actually, since it is fungible, it 
actually goes to the other purposes, and we are funding tax 
cuts, we are funding expenditures on some things that some of 
us like with those resources today.
    Secretary O'Neill. I, respectfully, do not agree with you, 
sir. What we are doing is we are using the Federal Government's 
debt capacity to pay for things that we want, which we are not 
collecting enough money, either through income taxes or payroll 
taxes, to fully pay for, and the other is an accounting 
illusion.
    We are really using our debt capacity, and in this sense, 
if we were running ``surpluses,'' on a nonunified basis, on a 
trust fund basis, we would be reducing debt outstanding held by 
the public, and that would improve the Government's balance 
sheet, but it does not have anything directly to do with Social 
Security, except to the degree that the more flexibility we 
have in the size of our balance sheet, in effect, to borrow 
money, we are better off than that not; is that not right, 
Senator Corzine? I mean, you are a financial guy like I am.
    Senator Corzine. We have a difference in view in the sense 
that if you set up what is called a trust fund and actually set 
those dollars aside, whether they are invested in Government 
securities or not, they earn an interest rate or they earn a 
yield, and they grow. And if you set more of them aside, you 
have a greater opportunity to fund that unfunded liability than 
you would have otherwise.
    Secretary O'Neill. I agree with you, but that is not the 
way the system works today. By convention, by practice, by 
manmade rules, we do not actually put the money away, we put a 
piece of paper away.
    Senator Corzine. I agree with that, but that does not mean 
that it is not earning an interest rate. I do think that your 
point about us scaring and the political dialog, people, at 
least the current retirees, of their ability to get their 
benefits is a bad mistake.
    Chairman Conrad. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman, and I want to 
thank the Secretary for coming before this Committee. I think 
that you have a challenge ahead of you, and I, for one, respect 
your abilities and want to support you in every way I possibly 
can.
    Secretary O'Neill. Thank you.
    Senator Allard. Argentina is having some problems there, 
and I know that the administration has been in contact with 
them and how to help out, and we have a number of issues that 
come up, and what is happened is one is dollarization and 
whether that would help or not. There are a couple of countries 
who have used dollarization and been rather successful. Ecuador 
is one that comes to mind. I think El Salvador is the other. 
And then you have the issue of how much should we come in and 
help them out through the IMF.
    My hope, my personal view is that I hope that we can get 
some substantive reform within that country, the way they 
handle their banking system, the way they handle debt, before 
we give them any money. I just wish that you would kind of 
comment on that a little bit.
    Secretary O'Neill. Thank you, Senator.
    First, to the issue of dollarization. I think, if you look 
back a year, you could have made a plausible case that the 
Argentineans could have dollarized a year ago because they had 
enough dollar reserves to convert and support the alternative 
pesos that they had pegged and said the peso and the dollar 
will always be worth the same amount. In about September, maybe 
late September, the reserves necessary to be able to do a 
direct dollarization evaporated, and it is not really a 
feasible thing for them to do any more. And so they are in the 
process of converting to a peso currency, a peso-based 
financial system in their country.
    As you say, we have spent an enormous amount of time and 
are working with them, caring about them. They have had a 
succession of Governments. We want them to succeed, and I think 
this is not a partisan thing. In November of 2000, the Clinton 
administration supported an IMF program for Argentina, some $43 
billion. In April, they had run through that, and we, the Bush 
administration, supported a further IMF program of some $20 
billion, and by the end of August that was gone. And we finally 
supported an additional $8-billion IMF program, but as we did 
so, we said to the Government in power, you have simply got to 
change the way your system is working because it is not 
sustainable, and neither the American people nor the other 
support of the IMF are going to keep sending money as you fail 
to fix your system.
    As an example of the problem they have in Argentina, they 
have a system where their provinces, the equivalent of our 
States, are able to make binding obligation that become the 
duty of the Federal Government without the Federal Government 
having an opinion. Now, if you can imagine having your own bank 
account and having hundreds of people with credit cards that 
can go out and write checks on your account, and you are 
responsible for paying it, that is the situation, in a way, 
that exists in Argentina.
    They have a tax system that collects, today, it is maybe 40 
percent of what the tax system is intended to collect. As they 
fell into this morass, they were in a position where they had 
$140 billion worth of outstanding debt and enough revenue to 
service maybe $70- or $80 billion, and so it was clear that 
this was not a workable situation any more.
    Again, as I say, we have worked every day with them on a 
technical level. We have made it possible for technical experts 
from all over Latin America who have gone through these kind of 
things to be available to them on an accelerated everyday 
basis. I, myself, talked to Ramasses, who is the new finance 
minister. I have talked to him repeatedly. I talked to him the 
night before last, so we are indeed in touch with them and with 
the IMF.
    We are dedicated to the proposition that this important 
country in our hemisphere needs to be successful. But I think 
there is one important proviso. We can help them, but we cannot 
help them until the sovereign Government establishes rules and 
procedures that give them some chance of stability. It is not 
something we can impose from outside. It is something they must 
do for themselves.
    Senator Allard. Well, I am also concerned when I see, you 
know, countries like that, they devalue their peso, and then it 
makes it more difficult for us, for example, to compete on the 
agricultural sector. They produce a lot of agricultural goods, 
and I think it has, to some degree, some impact on our ability 
to expand our export markets in an agricultural area.
    Let me switch a little bit over to Government GSE's. These 
GSE's we have two right now, Fannie Mae and Freddie Mac, and my 
understanding is that they carry a considerable amount of debt 
in both Fannie Mae and Freddie Mac. The Government does not own 
any interest, any stock in it, but we have a lot of investors 
who do, and I think sometimes they feel that there is an 
implicit guarantee there that the Treasury will help them out 
if they get into trouble or even the Congress.
    Now a CBO study entitled, ``Federal Subsidies in the 
Housing GSE's,'' published last year indicated that this 
subsidy amounted to $6 billion in 2000. I wonder just what your 
thoughts are on GSE's and how we should account for the debt in 
some of our thinking.
    Secretary O'Neill. Let me say, first, on the consequence 
side of the GSE's, I think if you look at what has happened 
with a Fannie Mae and a Freddie Mac, it seems fairly clear if 
you look at the experience of other countries, that these 
financial intermediaries have played a really important part in 
bringing higher levels of homeownership to the American 
population than they otherwise would have had.
    As a matter of fact, this all started, in a way, in 1935, 
when Franklin Roosevelt, under his leadership at least. There 
was a change in the expectations--again, this is kind of an 
unwritten rule that existed that if you wanted to buy a new 
house, you had to be able to pay it off in 5 years, and 
basically you had to have cash to buy a house, and the 
invention of just an idea--this is the importance of ideas--
that people could be trusted to pay their mortgages over 20 or 
30 years revolutionized homeownership in the United States.
    Freddie and Fannie have been a part of that, and I think 
they are really a credit to going back as far as 1935 to the 
maturation of those institutions and to intermediaries that 
really do not exist in the same way in other countries.
    People have become more concerned that they have grown, and 
I think, as we observed in the book, and the number is not 
perfectly in my head, but they have now got something on the 
order of $1.4/$1.5 trillion worth of debt. Importantly, it is 
all collateralized by holdings. It is not as though it were 
supporting speculative commodity trades or something. It is a 
much more solid foundation than what you find in most any other 
institutions because it is so much a part of the life of the 
people who were on the other end of the debt instruments. So I 
do not think it has the risk associated with it. As long as the 
loan origination process is good out there in the country, they 
should be OK.
    But it is something that we have looked at, and I continue 
to look at and to wonder whether it is not time for some new 
ideas about these organizations work. It is true that I think 
under current law they have access to something on the order of 
$4 billion from the Treasury, but when you look at the size of 
their activity, it is clear the $4 billion is not mapped in 
their universe.
    Some in the financial markets argue that the $4 billion is 
really a marker for the idea that they are too big to fail and 
that ultimately the Federal Government must and would stand 
behind them in case there were a substantial collapse 
underneath Freddie and Fannie assets.
    So it is something we are continuing to look at. We are 
aware of the concerns that people have, and we are looking with 
them to see if there are ways that we could reduce the anxiety 
that people have without hurting the process of homeownership 
accumulation in the country. Because as a social value, we 
think it is a very, very important thing that people, where 
they have a financial wherewithal, are facilitated into 
homeownership.
    Senator Allard. I appreciate your response to that because 
that is getting more discussion. I think your thoughts needed 
to be heard, and I appreciate you sharing them with the 
Committee. I agree with you that homeownership has been kind of 
the thing that has kept our economy going during these times. 
It is the bright spot out there, and we want to be sure that we 
do not disrupt that.
    Mr. Chairman, if you would allow me, I would like to have 
one other question that I would like to place to Secretary 
O'Neill, and that has to do with the way that we look at 
Government, the impact of a tax cut on our revenues. I come 
from the State of Colorado. We use dynamic scoring. So we are 
capable of doing, and I think obviously that gets some 
discussion on how you are going to put it together, but it 
seems to reflect, in my experience, more correctly what happens 
with the budget when you cut taxes or increase taxes. We are a 
State that is known as a State that is pretty responsible with 
taxpayer dollars and whatnot. We do not--we are conservative in 
that regard.
    I am stymied that somehow or another you can make this work 
at the State level, but somehow or the other, the Federal level 
refuses to look at that dynamic scoring as a way of evaluating 
tax cuts or tax decreases. I think, frankly, that the way the 
process works now, it is prejudicial against tax cuts because 
it, somehow or the other, implies that there is going to be 
less revenue, where many times, in real terms, it ends up being 
an increased revenue.
    So I wish you would talk a little bit about whether you 
have any idea on how we may bring about dynamic scoring within 
the Federal Government.
    Secretary O'Neill. I appreciate the question, and I quite 
agree with you that it would be helpful if we had, and provided 
agreed that we would have a regular access to both static and 
dynamic scoring.
    You know, again, it is an area where I think we are bound 
by the conventions that we have adopted, and it is almost as 
though you would say to a carpenter, you know, you only get one 
tool, and it is a hammer, and if you need a screwdriver, you 
will have to figure out how to put the screw in with a hammer, 
which we all know is possible, but not particularly desirable.
    And so I, frankly, think not only in this area of scoring, 
but on broader issues of how our budget conventions work, that 
there would be real utility in looking together at other 
changes that might be considered as we do this important work 
that ends up in resource allocation decisions. I think maybe it 
is time to take a look and see, in addition to dynamic and 
static scoring, whether there are not some other things that 
would be beneficial to all of us and to the American people as 
we try to do their work.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Conrad. We have been liberal on both sides here, 
in terms of use of time, and I think that was fair, given the 
numbers of people here and the importance of the questions 
being raised.
    Let me take my time now in questioning. I know that you got 
a little exercised earlier----
    Secretary O'Neill. No, not really.
    Chairman Conrad. I get a little exercised listening to you.
    You disagreed with a statement that many of us have made 
that the Federal Government is taking Social Security money and 
using it for other purposes. You said we all know that is not 
true. I do not know that is not true. In fact, I believe that 
is exactly what we are doing. I believe it is clear from the 
Government's own documents that is what we are doing. I have 
got an OMB document here that they sent up with the President's 
budget that says exactly that. It says we are taking about a 
trillion and a half of Social Security surpluses over the next 
decade. We are taking those dollars and using it to pay for 
other functions of Government.
    Let us just put this up. It is confusing to people. I will 
grant you, and you say the system works a certain way today. 
That is true. Some of us have said we have got to change the 
system because we are headed for a train wreck. I think that is 
undeniable.
    Here is what happens today. A taxpayer sends his payroll 
taxes in, they get credited to the Social Security Trust Fund. 
That is absolutely true. And there are Treasury, special 
Treasury documents, bonds, that are assets that are being held 
in a vault in West Virginia that say the Federal Government 
will repay those borrowings in the future, and you are exactly 
right that that is going to have to be paid out of the future 
revenue flows of the Federal Government. We are in agreement so 
far.
    When the money gets credited to the trust fund, some of it 
goes out to pay current Social Security benefits. I think we 
would all agree with that. To the extent that those funds are 
in surplus today and are not used for other purposes, they go 
to pay down debt. That is why last year you were telling us we 
would be paying down some $2 trillion of debt over the next 
decade because Social Security funds were in surplus and were 
not being used for some other purpose.
    You could also use that money to prepay liability. We are 
not doing that.
    There is a another alternative. We could take that money, 
and this is what is being done, unfortunately, in large 
measure. In fact, 100 percent of the surplus is now being used 
to pay for tax cuts and other programs of Government, and, to 
me, it is undeniable. You say it is a disservice to the 
American people to say so. I think it is a disservice to the 
American people not to say so.
    My own view is it is necessary, but not sufficient, to save 
all of the Social Security Trust Fund dollars for Social 
Security now, but actually do more than that. In the budget I 
proposed last year, I actually transferred $900 billion of 
general fund money to start private accounts as a way of 
prefunding liability because we are headed for this train 
wreck.
    Last year, you seemed to think protecting Social Security 
had some merit and said it was being done, and I would go back 
to this quote. You said this in the Finance Committee, ``The 
Social Security dollars that are going to flow into the 
Government over the next 10 years are safeguarded, lock-boxed, 
fenced off, protected. I do not know if there are more strong 
ways to say it. Social Security dollars are set aside without 
any threat of encroachment.'' Now that has proved not to be the 
case.
    Secretary O'Neill. I think that is still the case.
    Chairman Conrad. Well, I do not. The only way you can make 
that argument is that the money is being credited to trust 
fund. Is that the argument that you make?
    Secretary O'Neill. It is. And if you would put up the other 
chart, I would introduce one more box.
    Chairman Conrad. Yes.
    Secretary O'Neill. Actually, what happens after the Social 
Security Trust Fund flow, the money goes into the cash accounts 
of the United States, and if you do a full depiction, the money 
is going to support the troops in Afghanistan, and the money is 
going to pay for HIV programs, and the money is going to pay 
for biomedical research, and the $50 billion worth of education 
we are going to----
    Chairman Conrad. Right, all kinds of meritorious purposes. 
But the truth is it is being taken to pay for other things. 
Now, look, there is no private sector firm in America that 
could take the retirement funds of its employees and use it to 
pay operating expenses of the company.
    Secretary O'Neill. They have real trust funds.
    Chairman Conrad. They have real trust funds.
    Secretary O'Neill. Right.
    Chairman Conrad. Some of us would argue, at this stage in 
our history, we need real trust funds, and I think the 
fundamental problem, the disconnect here is I believe that we 
are in just a different time than where we have been. We have 
never faced a demographic situation like the one we face today. 
We have got a demographic time bomb. Always before the 
succeeding generation was smaller than the one coming on. Now 
we have got this circumstance where everything is going to 
change, and yet we are running the railroad the same old way.
    And so I must say that I just profoundly disagree when you 
say that we are not taking Social Security money and using it 
for something else. I think that is exactly what is going on. 
Now that is the way the system is set up, but I do not think 
the system is going to work in this current circumstance, and 
it leads us--could we get Director Crippen's quote because 
where is all of this leading us to? It is leading to choices 
for a future Congress and a future President that Director 
Crippen described, and I think this is an accurate 
description--either huge taxes increases, dramatic cuts in 
benefits or massive debt.
    Do you agree or disagree with his characterization?
    Secretary O'Neill. I do not think that is the full range of 
choices. I think there is, in fact, a way for us to transition 
into a system that is worthy of building on Social Security to 
an even better idea, which is that every American, when they 
are 65, should have accumulated a million dollars' worth of 
money that they own in their own name, and with the amount of 
money that we are now collecting from individuals and families 
through Social Security, if that money were collected from age 
18 to age 65 and invested at market rates of interest, it is 
not beyond the possibility that we could deliver an American 
society that rises to the level of people being independent 
when they are 65, not dependent on a promise from the Federal 
Government.
    Chairman Conrad. But there is a cost.
    Secretary O'Neill. And it is----
    Chairman Conrad. There is a transition cost.
    Secretary O'Neill. The costs associated with that is paying 
off the accumulated liability that we have accumulated over the 
last 67 years, which our economic bounty, I believe, will 
permit us to do if we have the courage to think it.
    Chairman Conrad. Well, let me just say that I do not 
disagree that there is enormous potential, but the money has 
got to come from somewhere. And right now, under the 
President's plan, you are taking the money that could be used 
for that purpose, and you are spending it for all kinds of 
other purposes, and it is not available for that purpose.
    And the argument I hear from the administration is, well, 
we have got a recession and a war, and that is the reason we 
have had to back away from the clear pledge made by the 
President, the administration, the clear commitments that you 
were making last year. Look, I could accept that at the time of 
recession. Actually, the cost of the war is not the biggest 
part of the problem. But, goodness, you are not forecasting 
recession next year. You are not forecasting recession the next 
year or the year after that or the year after that, but you are 
taking the Social Security Trust Fund dollars in every single 
year of this decade.
    Secretary O'Neill. If the Senate or, actually, if the 
Congress does not proceed to spend the money that was decided 
yesterday not to spend on stimulus, we are probably going to be 
in surplus this year and next.
    I would make a broader point. If you do not like this 
year's circumstance, then we really have two choices, which the 
President has clearly said what he thinks. You could raise 
taxes. The President thinks that is a terrible idea, that we 
would raise taxes right now, or you could reduce the spending 
the President has proposed for a variety of dozens or hundreds 
of programs that are in the Federal budget.
    The President has gone systematically through all of the 
objects of expenditure and has recorded in writing his belief 
that the level of spending that he recommends is what is 
necessary to pursue the war on terrorism and to provide 
incremental, a total of $38 billion for homeland security and 
all of the other myriad of needs that we, as a people, believe 
we need to have.
    And so I do not think there are too many choices. Either 
one can choose to say we should raise taxes in order to have a 
higher surplus, if you believe the economy would actually 
produce a higher surplus if we put more taxes on it or we can 
reduce spending. The President has made his judgment very 
clear.
    Chairman Conrad. And, look, the 1-year question, as I have 
made clear, is not the big problem I have got with what you 
have proposed or what the President has proposed. My problem is 
you have got 10 years, and you just made the reference again. 
You said without that stimulus, you would be close to surplus 
this year. You are not going to be anywhere close to surplus, 
not true surplus, because what you define as surplus is taking 
every penny of the Medicare Trust Fund money, every penny of 
the Social Security Trust Fund money and use it for other 
purposes, and you call it surplus. It is not surplus. It is 
money that is already fully committed, in fact, it is 
overcommitted.
    And the use of surplus I think is the disservice to the 
American people because I think it fundamentally misleads them 
as to the financial condition of the country, and I think it is 
that use of language in there, and I am not just holding you 
out, that use of language that misleads people that is much of 
what happened at Enron. I believe this notion of not fully 
revealing debt to people leads them to conclusions that are 
mistaken, and I would just say to you I think this use of 
language is very important. Because I think when people hear 
there is surplus, they think, well, there is extra money here.
    Chairman Conrad.Senator Allard.
    Senator Allard. Do we not have a provision in law that says 
that if there is any money that his left over in Social 
Security, it is goes to the general fund? So is it not 
incumbent upon the Congress to change that law? How can the 
President not abide by the law that the Congress is forcing on 
him? And then if you do that, and I have looked at that, see if 
you agree with me, there is a fiscal note that comes with that. 
So the only way you make up for that fiscal note is a huge tax 
increase. So my suggestion is----
    Chairman Conrad. No, no, no. That's----
    Senator Allard [continuing]. Let us go ahead and change the 
law. And to correct the fiscal note, I would like to see you 
introduce a tax increase to meet the demands of that fiscal 
note.
    Chairman Conrad. Well, you introduce it. I am not proposing 
a tax increase----
    Senator Allard. Well, I am not--we have a provision in law 
that says that the surplus----
    Chairman Conrad. We have a provision in law that you are 
not supposed to count the Social Security Trust Fund moneys as 
part of the deficit calculation, but nobody pays much attention 
to it, unfortunately. And this President has sent up a budget 
that assumes that over the next decade you are going to take a 
trillion and a half of Social Security dollars and use them for 
other purposes. He is going to take $500 billion of Medicare 
Trust Fund dollars and use those for other purposes.
    Senator Allard. But the Congress, if you are going to 
expect that the President will put in a different package, a 
different budget, you have got to correct, Congress has to 
correct that one provision in there that says the surplus in 
Social Security has to go in the general fund. That is in law.
    Chairman Conrad. The law of the United States right now 
says that you are not supposed to calculate the deficit using 
Social Security surpluses, and we just had the Secretary of the 
Treasury describe this budget this year, without the stimulus 
package, as being in surplus, and the only way you can have 
that calculation is by taking every dime of the Social Security 
Trust Fund money. That is the Secretary of the Treasury 
describing that as surplus.
    Senator Allard. Are you denying that we do not have a law 
in there that you should not transfer the dollars from Social 
Security to the general fund?
    Chairman Conrad. Look, the problem that we have is what we 
are doing is taking the money and using it for other purposes, 
and----
    Senator Allard. And that law mandates that because it says 
you put it in the general fund.
    Chairman Conrad. Nothing required the President to send a 
budget to this Congress that took Social Security money and 
used it for other purposes. There is no law requiring him to do 
that whatsoever. And, in fact, last year he sent us a budget 
that did not. That is why the Secretary could last year tell us 
Social Security money was not going to be used for other 
purposes. Now every dime, not every dime for the whole 10 
years, but 70 percent of it is going to be used in that way. 
That is where we have----
    Secretary O'Neill. Mr. Chairman, we could fix some of this 
confusion if we could have, for example, we could agree in 
modifying the way we do budgeting so that we had a cash 
account, and then we could get rid of this question.
    Your question about Social Security I think is wholly 
appropriate, and I think all of us would agree we are going to 
have to do something about Social Security. I am one who 
believes the answer to Social Security is not eat your spinach 
and reduce benefits, it is use what we know about finance to 
create an even better future than what people can have with 
Social Security. So I do not think there is----
    Chairman Conrad. And there you and I may be closer to being 
on the same page than some others around this table, but that 
will be a debate, a discussion for another day.
    I know we indicated we would try to end this at noon, and 
we told colleagues we would. We are a little past that, and I 
appreciate your patience.
    Secretary O'Neill. Thank you.
    Chairman Conrad. And I appreciate your participation here 
today.
    Secretary O'Neill. Thank you.
    [Whereupon, at 12:13 p.m., the committee was adjourned.]

        WRITTEN QUESTIONS TO SECRETARY O'NEILL AND THE RESPONSES

    Question : The President's Budget proposes to use over $1.5 
trillion of the Social Security surpluses over the next eleven 
years. How does the Administration plan to address the 
extraordinary financial burden that will hit when the baby 
boomers begin to retire en masse starting in 2008?
    Answer: The Social Security Trust Fund continues to be 
credited with all Social Security payroll taxes as required by 
law. Despite recent events and the slowdown in the economy, the 
2002 report on the status of the Social Security Trust Fund 
recently issued by the Social Security and Medicare Board of 
Trustees shows that income to the Trust Fund will exceed 
outlays until 2017, one year later than that shown in last 
year's report. The Trust Fund's projected exhaustion date has 
been extended from 2038 to 2041.
    The welfare of future retirees and the economy are 
inextricably linked. Future retirees will enjoy substantial 
benefits from a stronger economy today. A stronger economy 
produces more tax revenue to help meet obligations to future 
retirees. A stronger economy also generates higher paying jobs, 
thereby allowing for a larger amount of resources to be saved 
for retirement. It also helps generate larger returns on the 
investments that millions of workers have made through 401(k) 
plans and other retirement plans. (The Administration's recent 
recommendations for reforming 401(k) plans will also help 
secure future retirement security.) Therefore, positive 
economic performance is a key ingredient to securing future 
retirement security.
    However, unless action is taken in a timely manner, 
retirement benefits that must be paid to future retirees have 
the potential to significantly impact the government's fiscal 
position. The Administration believes that the best action is 
to begin pre-funding some of these future obligations today 
rather than waiting until the time of reckoning is upon us, 
which will require much larger steps. Personal retirement 
savings accounts are the best way to begin setting money aside 
today.
    Question: Mr. Secretary, according to the National 
Conference of State Legislatures, forty-three States and the 
District of Columbia have reported that revenues were below 
forecasted levels in the opening months of FY 2002. Medicaid 
continues to exceed budgeted levels, proving to be an ongoing 
problem. At least 36 States have implemented or are considering 
budget cuts to address fiscal problems. Twenty-two States have 
implemented belt-tightening measures.
    State fiscal conditions continue to deteriorate under the 
weight of growing needs and responsibilities. States are asking 
the Federal Government for additional funds to avoid painful 
tax increases and additional budget cuts. Yet the President's 
budget includes a number of proposals to cut Federal funds to 
States for transportation, crime prevention, unemployment 
assistance, job training, and health care services.
    The fiscal health of the States is critical to the fiscal 
health of the national economy. How can this Administration 
work to improve the national economy while the State economies 
are weak and bleeding?
    Answer: In bipartisan fashion, Congress recognized this 
concern with the recent adoption of the President's economic 
stimulus proposals to create and maintain jobs, and help put 
the economy back on a path of higher growth. Higher economic 
growth is the best way to address the fiscal situation of the 
States. The broader economic challenge, however, is to not 
become complacent about economic security; which includes 
renewed higher rates of economic growth, gains in productivity, 
or successes in the international marketplace.
    Individuals and businesses make decisions based not only on 
today's information but also on expectations about the future. 
Prospects for lower tax rates in the future encourage 
individuals and businesses to undertake efforts today in 
anticipation of a higher after-tax rate of return in the 
future.
    For example, businesses will make more investment now in 
order to attain higher production and income in the future when 
tax rates will be lower. In the absence of the lower expected 
tax rates, the expected after-tax rate of return would be lower 
and current investment would be lower than with expected 
declines.
    Raising taxes by rescinding scheduled future tax cuts would 
further harm the prospects for higher economic growth. 
Individuals and businesses who are aware of the coming tax cuts 
and who are undertaking traditional investment and spending in 
expectation of higher future after-tax rates of return, would 
likely cut back on those plans and hurt current economic 
activity if the future tax rate reductions were eliminated.
    Staying the course on reducing income tax rates is an 
important part of returning the economy to robust economic 
growth, and a growing economy is the most important factor in 
returning the budget to surplus both in Washington, DC and in 
the State capitals.
















 THE PRESIDENT'S FISCAL YEAR 2003 BUDGET REQUEST AND REVENUE PROPOSALS

                              ----------                              


                       TUESDAY, FEBRUARY 12, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Byrd, and Gregg.
    Staff present: Mary Ann Naylor, staff director; and Dakota 
Rudesill, analyst.
    For the minority: G. William Hoagland; staff director and 
Bernadette Kilroy, senior analyst.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order. Welcome, 
Mr. Secretary. It is always a privilege to have you here before 
the committee.
    As you know, Senator Domenici has been advised by doctors 
to take it easy for a bit, and so he will not be with us today. 
He has a statement for the record that we will make part of the 
record at this point.
    [The prepared statement of Senator Domenici follows:]

             Opening Statement of Senator Pete V. Domenici

    Welcome once again to the committee Mr. Secretary.
    Let me begin by thanking you Mr. Secretary and your team at the 
Department of State for the dedication, very hard work and commitment 
you all have brought to this war on terrorism.
    I doubt any of us could have predicted--when you were before the 
committee a year ago--all the events that were to unfold in the world 
just a few months later.
    I believe this Congress, indeed the Chairman has so indicated, will 
support the President's budget request for the war on terrorism. The 
most visible budget aspect of this support is the Defense spending 
request of nearly $400 billion.
    Maybe the less visible--in budget terms for resources spent for 
this battle on terrorism is the internatonal affairs budget totaling 
slightly less than $24 billion--a small fraction of what we will 
allocate to the Department of Defense and about 1 percent of the total 
$2.1 trillion Federal budget request next year.
    Even more stark in dollar terms is the fact that your Department--
the State Department's total budget--totals less than $10 billion.
    I see in this morning's news reports that a coalition of some 160 
groups including Catholic Relief Service and CARE are describing your 
budget as ``inadequate'' and that the International Affairs budget 
request needs to be doubled.
    I know that a number of Senators have written the President and you 
stating the need for more funding in this area.
    Quite frankly, and being very honest, I do not know what the 
correct figure should be or if anyone can ever really know. I do not 
know what the correct balance is between using our superior military 
power to confront terrorism on the battle field versus what we should 
spend around a negotiating table to prevent future battles.
    In the end the right number is probably not as important as finding 
the right policy that will help to support--and I use this word 
guardedly--help to build and promote Civil Societies and Democratic 
Institutions where they do not exist and where terrorism, and 
misinformation is allowed to spread hate and death.
    You have I believe, along with the President, the most difficult 
job in the Cabinet. You have and will continue to receive advice from 
the Congress, from current and former foreign leaders, from general and 
ministers, journalists and academics throughout the world.
    My input, Mr. Secretary is that in the end I believe we must 
maintain and build on our alliance that you have successfully recruited 
in this war on terrorism--including and particularly Russia.
    I know our allies grumble about ``unilateralism'' and some fear we 
may ``go it alone'' with our military superiority in this battle. But I 
trust you Mr. Secretary and I know your counsel will be wise in these 
decision we are certain to confront.
    Finally, Mr. Secretary, prior to the events of last September the 
President referred to our bilateral relationship with Mexico as the 
most important relationship in the world. I know that President Bush 
will be meeting with President Vicente Fox in a few weeks. Our neighbor 
to the south--Mexico has been a friend and fellow combatant in this war 
on terrorism. Let's keep that bilateral relationship strong.
    Once again I thank you for your distinguished military service to 
the country in the past, and your continued service to the country 
today.

    Chairman Conrad. A number of our colleagues will be joining 
us. As you know, we are now all Enron all the time. And so I 
think there are maybe four or five hearings on Enron at 
different committees. We are not going to be talking about 
Enron here. We are going to be talking about the budget of the 
United States and how it relates to the 150 function and how it 
relates to the dramatic changes that we are confronting as a 
Nation since the attacks on this country on September 11th.
    First of all, I want to say to you, Mr. Secretary, how much 
we respect how the President and his Administration have 
conducted themselves in the face of this attack. And certainly 
we want to acknowledge the extraordinary efforts that you have 
extended to manage this crisis. Our respect for you, which was 
always very high, has done nothing but grow as you have managed 
to hold the coalition together and have dealt, I think in a 
very thoughtful way, with the many demands on your time and on 
your energies in this period. So we thank you for that as 
Americans.
    I have said from this podium many times that I have been 
proud as an American to see how we as a country have responded, 
and this hearing will be about other steps that are necessary 
and how they impact the budget. And I thought, just for setting 
the agenda, that I might go through what the President has 
proposed, what the priorities are that he has signaled to us, 
and then Senator Smith, who has been designated to fill in for 
Senator Domenici, is here and he will make his statement, and 
then we will hear from you. And then each of the members will 
have 7 minutes for their questioning and their comments. And if 
we have time for additional rounds, we will have them.
    We have been advised there will be a vote at about 10:45, 
perhaps a series of votes at 10:45. So we will proceed with 
dispatch.
    In the President's budget, this is what we see in terms of 
the percentage increases over the baseline. For those who are 
listening who aren't familiar with baseline, baseline takes 
previous budgets, adjusts them for inflation, adjusts them for 
increases in the number of people eligible for the various 
programs because of demographic changes.
    This shows the increases in spending requests over that 
baseline, and as we can see, the President is asking for the 
biggest percentage increase over baseline in homeland security, 
23 percent; a 10 percent increase over baseline for national 
defense; a 2 percent increase for international affairs; and 
all other domestic programs are being reduced 6 percent.
    Let's go to the next chart which shows the billions of 
dollars over baseline, instead of looking in percentage terms, 
looking at the billions of dollars over baseline. We can see 
homeland security is $5 billion over the Congressional Budget 
Office baseline; national defense is $36 billion over the 
baseline; international affairs, $400 million; and all other 
domestic programs being reduced $23 billion.
    Let's go to the next chart, international affairs 
priorities. Within the international affairs budget, this is 
what the President is recommending to us: Development and 
humanitarian assistance increased $114 million; international 
security, military assistance increased $417 million; all other 
activities reduced by $126 million.
    Let's go to the next chart. There has been a lot of 
criticism of the United States for not being a big enough 
contributor to international affairs aid, and No. 1 in the 
world is Denmark. They are contributing just over 1 percent of 
their GNP for these purposes, for foreign aid contributions. 
They are the leader in the world, the biggest percentage of 
their GNP going for this purpose.
    I am part Danish, and this summer my wife and I and my 
daughter went to the little village where my great-grandparents 
were married. And we had a chance while we were in Denmark to 
visit with them, and I tell you, this is a real source of pride 
in Denmark that they lead the world as a percentage of GNP in 
contributions to assisting other Nations.
    We are one-tenth of 1 percent, so we are 22nd in the world, 
to put it perspective. On the other hand, let's put up that 
next chart. In dollar terms, we are No. 2. That is, we are 22nd 
in percentage of GNP going for foreign aid; on the other hand, 
we are No. 2 in the world in total dollars going for foreign 
aid. We are providing $9.6 billion a year. The Japanese 
outstrip us; they are at $13 billion. No. 3 is Germany at $5 
billion.
    So that gives a bit of an overview, putting things in 
perspective as we move forward and consider the question of 
what the budget should be in this area.
    Mr. Secretary, when we get into the questions, there are 
going to be a number of things that I am going to inquire 
about. The President said in his State of the Union that we 
face an axis of evil of the North Koreans, the Iraqis, the 
Iranians. And so as we build a budget, we need to know what 
that means. What is it that we are going to confront? What is 
it that we need to consider as we write a budget?
    Second, as I indicated to you, in the paper this morning I 
noticed that there are a number of foreign assistance groups 
that are asking for a doubling of aid, and we will want to talk 
a little about that, and other matters as well. But at this 
point, Senator Gregg, would you like to make an opening 
statement?
    Senator Gregg. Actually, Mr. Chairman, I would like to hear 
from the Secretary, and so I will waive the opening statement 
and look forward to hearing the Secretary's comments.
    Chairman Conrad. All right. And we do have an opening 
statement from Senator Domenici, which I have indicated will be 
part of the record.
    So, with that, Mr. Secretary, again, welcome. It is always 
good to have you here, and please proceed. Then we will have a 
chance for questions.

  STATEMENT OF HON. COLIN L. POWELL, SECRETARY, UNITED STATES 
                      DEPARTMENT OF STATE

    Secretary Powell. Thank you very much, Mr. Chairman. It is 
a great pleasure to be before the committee again, and I thank 
you for your gracious words at the beginning of this hearing 
with respect to the manner in which President Bush and his 
Administration have handled the crisis that engulfed us on the 
11th of September last, and I thank you for your personal 
comments with respect to me. But those comments are addressed 
really through me to the wonderful men and women of the State 
Department, who are doing such a great job at our missions and 
embassies and other facilities around the world. And I know 
that you travel, all of you travel from time to time, and I 
know that you share with me the admiration that we all have for 
the great job they do on the front line of ``offense'' of our 
national security efforts, as they like to say.
    I am pleased, therefore, this morning to have the 
opportunity to testify in support of President Bush's budget 
request for the Department for Fiscal Year 2003. It is the 
support that you have given us in Fiscal Year 2002, and why I 
am here to defend the Fiscal Year 2003 budget, that keeps these 
men and women motivated, equipped, trained, prepared, and ready 
to do the job that the Nation asks of them. They go into harm's 
way every day just as much as any one of the men and women of 
our armed forces. They take risks and sometimes pay with their 
lives, or pay with injuries. As we saw in our newspaper this 
morning, the story of the gentleman who was seriously injured 
in the embassy bombing a few years ago, how he is coming back 
and how we have to do a better job of taking care of people 
such as that brave soldier of the State Department.
    As many of you recall, in my first budget testimony to the 
committee last March--and I might digress for a moment, Mr. 
Chairman, to say that I do have a prepared statement which I 
offer for the record.
    Chairman Conrad. Without objection, that will be made part 
of the record.
    Secretary Powell. In my first budget testimony to the 
committee last March, I told you that the resource challenge 
for the Department of State had become a serious impediment to 
the conduct of United States foreign policy. I told you that it 
was a mystery to me how the great people at the State 
Department had continued to do their job, to do their work so 
very effectively over the past decade with such a low level of 
resourcing.
    You heard my testimony and you responded, and we are 
grateful for that response. As a result, we got a 6 percent 
increase in the International Affairs budget last year over the 
previous year, Fiscal Year 2001, and this year we are also 
asking for an increase.
    Mr. Chairman, I wish that it was twice as much, three times 
as much, four times as much. But within the limits that we have 
placed upon us by the ability of the Nation to fund all of our 
many activities, and after competing within the Administration 
for our allocation of available funds, and recognizing the 
important needs that the Defense Department has and the new 
need that we have for homeland security, I am rather pleased 
that we are still able to get a real increase in our budget for 
this year as well.
    I might also point out that even though the statistics you 
put up are quite correct, and the Danes can be very happy at 
being at the top of the pile--and we should be a little 
chagrined that only 0.1 percent of our gross national product 
goes to development assistance, at the same time the fact that 
we provide defense for the free world I think should also be 
taken into account. We spend more in defense than anyone else, 
and it is behind that screen of security that we provide for 
the civilized world that we are able to do the kinds of 
development activities that I talk about in my budget. And I 
think some consideration should be given to that, and, frankly, 
that is why the Defense Department was so deserving of a 
significant increase this year so that they can continue to 
perform that vital role for the free world.
    With respect to State Department operations, our three 
principal priorities last year were people, information 
technology, and embassy construction and security. Let me 
update you on how we are doing in these areas as I go forward 
to talk about our priorities in this budget.
    In new hires for the Foreign Service, we have made great 
strides. We have doubled the number of candidates for the 
Foreign Service written exam, and this year we will give the 
exam twice instead of just once. I am absolutely delighted with 
the turnout we are getting, youngsters showing up who want to 
serve their Nation as Foreign Service officers or in our civil 
service.
    Our new recruits reflect better the diversity of our 
country with nearly 17 percent of those who passed last year's 
written exam being minority members. We have tripled the number 
of African Americans who have applied to the Foreign Service.
    We have also improved civil service recruitment by creating 
new web-based recruiting tools and by vigorously asserting the 
truth. The truth, Mr. Chairman, is that we are a team at State 
and that the Foreign Service and the Civil Service are each 
important members of that team. And I am creating an 
environment down there of family and breaking down the barriers 
that might have existed in the past between what the Foreign 
Service and what the Civil Service does. We are all one Foreign 
Affairs team serving the Nation.
    Another improvement is that once we identify the best 
people, we bring them on more quickly--a great boom to hiring 
the best. For Foreign Service recruits, for instance, we have 
reduced the time from written exam to entry into the service 
from 27 months, where we were last year, to less than a year. 
And I want to drive it down even further. We don't have time to 
wait to bring these wonderful youngsters in. They have other 
opportunities. We want them to see that they are in a fast-
moving operation that wants quality people, and we are going to 
do everything we can to break down all of the walls and 
barriers that used to exist to accessing people into our 
service.
    We are also working with the Office of Management and 
Budget to create extensive new performance measures to ensure 
that the people we hire remain the best throughout their 
careers. We want to make sure they are motivated, they are 
trained, they are given leadership training, they are given 
jobs that excite them so that it is a team they want to remain 
a part of for the rest of their career.
    With respect to the next priority, information technology, 
we are well on the way to bringing state-of-the-art hardware 
and software to the entire Department. We have an aggressive 
deployment schedule for our unclassified system which will 
provide desktop internet access to over 30,000 State users 
worldwide.
    We are deploying our classified connectivity program over 
the next 2 years. Our goal is to put the internet in the 
service of diplomacy, and we are well on our way to 
accomplishing that goal.
    With respect to construction and security, we are right-
sizing, shaping up, and bringing smarter management practices 
to our overseas buildings programs, as I told you we would last 
year.
    The first change we made was to put retired General Chuck 
Williams in charge and give him Assistant Secretary equivalent 
rank. His Overseas Buildings Office has developed the 
Department's first master plan, which covers our major facility 
requirements through fiscal year 2007.
    The Overseas Buildings Office is using best practices from 
industry, new embassy templates, and strong leadership to lower 
costs, increase quality, and decrease construction time.
    As I told you last year, one of our goals was to reduce the 
average cost to build an embassy, and I believe we are well on 
our way to doing that.
    And General Williams is making all of our facilities, 
overseas and stateside, more secure. By the end of Fiscal Year 
2002, over two-thirds of our overseas posts should reach 
minimal security standards, meaning secure doors, windows, and 
perimeters.
    We are also making progress in efforts to provide new 
facilities that are fully secure, with 13 major capital 
projects in design or construction, another eight expected to 
begin this fiscal year, and nine more in Fiscal Year 2003.
    Mr. Chairman, all of these activities have improved morale 
at the State Department. Our people see things happening, 
things that enhance their quality of life, their security, 
their ability to do their jobs. Things like our interim 
childcare center at the National Foreign Affairs Training 
Center. It opened on September 4th and can handle a full 
complement of 30 infants and toddlers. Not something you would 
think a Secretary of State should worry about on a daily basis, 
but we do because it is important to the morale and welfare of 
the family members of the State Department team.
    This idea of teamwork, this idea of family and the quality 
of life that must always nourish it, even in the remotest 
stations, is uppermost in our minds at the Department. While we 
concentrate on the Nation's foreign affairs, we must also focus 
on taking care of those Americans who conduct it, as well as 
the many thousands of Foreign Service Nationals who help us 
around the world.
    The Foreign Service Nationals--not often spoken about--are 
an extraordinary group of people, Mr. Chairman. For example, 
our 60 Afghan employees in Kabul worked diligently to maintain 
and protect our facilities throughout the 13 years that the 
embassy was closed. They worked at personal risk. We made sure 
they were paid. They repaired the chancery roof when a rocket 
attack hit it. They did everything to make sure that they were 
ready for us when we returned.
    In fact, I love to tell the story of going to the embassy a 
few weeks ago and congratulating them and thanking them, and 
having our charge there, Ryan Cocker, tell me that in the 
garage in the basement of the building, they maintained all of 
our vehicles so that after all those years, when we finally 
were able to open it up and those vehicles were brought out, 
all they needed was a charged battery, and they all started up. 
And the joke in the story is that if you want to see the finest 
fleet of 1985 Volkswagen Passats in the world, they are located 
at the American Embassy, Kabul, and waiting for your use when 
you have a chance to visit, Mr. Chairman.
    But it is a team. It is the Foreign Service, Civil Service, 
Foreign Service Nationals all coming together. That is why for 
FY 2003 I will continue to drive these priorities, and I am 
going to be relentless as the CEO of the State Department as 
well as the Secretary of State worrying about foreign policy.
    So let me speak first as the CEO.
    The President's request for the Department of State and 
related agencies for FY 2003 is $8.1 billion. These dollars 
will allow us to continue to recruit, hire, train, and deploy 
the right work force. The budget request includes $100 million 
for the next steps in the hiring process that we began last 
year. With these dollars, we will be able to bring on board 399 
more foreign affairs professionals and be well on our way to 
repairing the large gap that exists in our personnel structure.
    We will also continue to upgrade and enhance our worldwide 
security readiness even more in light of our success in 
disrupting and damaging the al Qaeda terrorist network. The 
budget request includes $553 million that builds on the funding 
provided from the Emergency Response Fund for the increased 
hiring of security agents and for counterterrorism programs.
    We will also continue to upgrade the security of our 
overseas facilities. The budget request includes over $1.3 
billion to improve physical security, correct serious 
deficiencies that still exist, and provide for security-driven 
construction of new facilities at high-risk posts around the 
world.
    I might, as an aside, mention especially for Senator Gregg 
that General Williams reported to me that the average cost of 
our embassies has been driven down some 20 percent as a result 
of the efforts he has made and the work of his office over the 
past year.
    Next, we will continue our program to provide state-of-the-
art information technology to our people everywhere, as I 
mentioned earlier, and we have included $177 million for that 
purpose.
    We want to continue to enhance our Educational and Cultural 
Exchange Programs. The budget request includes $247 million for 
strategic activities that build mutual understanding and 
develop friendly relations between America and the peoples of 
the world. Such activities have gained a new sense of urgency 
and importance since the brutal attacks of September. We need 
to teach the world more about America, about our value system 
and what we believe in. President Bush in his State of the 
Union address, at the very tail end of the address, talked 
about values--values that are not just American values, but 
values that we believe are universal. And in order to share 
these values with the rest of the world, we have to do a better 
job with our Educational and Cultural Exchange Programs.
    We want to continue to meet our obligations to 
international organizations, which are also important in our 
war on terrorism. The budget request includes $890 million to 
fund United States assessments to 43 international 
organizations, active membership of which furthers United 
States economic, political, security, social, and cultural 
interests.
    We want to continue to try to meet our obligation to 
international peacekeeping operations. The budget request 
includes $726 million to pay our projected United Nations 
peacekeeping assessments--all the more important as we seek to 
avoid increasing even further our U.N. arrearages. And, Mr. 
Chairman, I ask for your help in getting the cap lifted so that 
we can eventually eliminate all of the arrearages.
    We want to also strengthen and enhance our public diplomacy 
effort. This goes along with our cultural exchange program, but 
we have got to do a better job in public diplomacy to eliminate 
support for terrorists and to deny them safe haven in countries 
where they are still received as some sort of false hero. The 
budget includes almost $518 million for international 
broadcasting, of which $60 million is for the war on terrorism. 
This funding will enable the Voice of America and Radio Free 
Europe/Radio Liberty to continue increased media broadcasts to 
Afghanistan and the surrounding countries and throughout the 
Middle East. These international broadcasts help inform local 
public opinion about the true nature of al Qaeda and the 
purposes of the war on terrorism, helping to build support for 
the coalition's global campaign.
    Mr. Chairman, let me just touch a little bit more on our 
public diplomacy efforts. The terrorist attacks of September 
11th underscored the urgency of implementing an effective 
public diplomacy campaign. Those who abet terror by spreading 
distortion and hate and inciting others take full advantage of 
the global news cycle. We have to do the same thing.
    Since September 11th, there have been over 2,000 media 
appearances by State Department officials. Our continuous 
presence in Arabic and regional media by officials with 
language and media skills has been unprecedented. Our 
international information website on terror is now online in 
seven languages. Internet search engines show it is the hottest 
page on the topic. Our 25-page color publication, ``The Network 
of Terrorism,'' is now available in 30 languages with many 
different adaptations, including a full insert in the Arabic 
edition of Newsweek. When the President gave his State of the 
Union speech, we had it simultaneously translated as he was 
speaking and downloaded on to on all of our websites and other 
media outlets throughout the world. And within an hour and a 
half after he was finished, we had a translated hard copy into 
seven different languages and had it downloaded all over the 
world. ``Right content, right format, right audience, right 
now'' describes our strategic aim in seeing that United States 
policies are explained and placed in the proper context in the 
minds of foreign audiences.
    Mr. Chairman, all of the State Department and related 
agencies programs and initiatives that I have touched on and so 
many others that are in the budget are critical to the conduct 
of America's foreign policy. And so as the State Department 
CEO, let me thank you again for what you have done to help us 
create such a first-class offense. And I want to ask you to 
continue your excellent support so we can finish the job by 
bringing the Department of State and the conduct of America's 
foreign policy into the 21st century.
    Now let me turn, Mr. Chairman, to the budget request for 
foreign operations.
    Over the past year, Mr. Chairman, I believe the broader 
tapestry of our foreign policy has become clear, to encourage 
the spread of democracy and market economies and to bring more 
nations to the understanding that the power of the individual 
is the power that counts, and when evil appears to threaten 
this progress, America will confront the evil and defeat it, as 
we are doing in the war on terrorism.
    In weaving this tapestry, we have achieved several 
successes in addition to the successes of the war on terrorism 
and the regional development that skillful pursuit has made 
possible.
    We talk about terrorism all the time, but we shouldn't 
overlook how much we have improved our relations with Russia, 
set a new and smoother course with China, the two major 
accounts that we really have to focus on, Russia, that land 
still of 11 time zones, nuclear-armed, but it has left the 
Soviet Union days behind. It wants to come West. It wants to be 
part of NATO, Russia at 20. It wants to integrate itself into 
the economies of the west. It still wants to have good 
neighborly relations with China, and it still worries about the 
Nations to its south, but it knows its future lies to the west. 
And it is cooperating with us in ways that we might not have 
imagined just a year ago, cooperating with us on the campaign 
against terrorism.
    We are able to move United States troops throughout Central 
Asia by telling the Russians that we are there to defeat a 
common enemy, terrorism, fundamentalism, not to threaten 
Russia's southern flank.
    I am able to talk to my Russian counterpart three, four, 
five times a week. We no longer even ask for talking points 
from our staff. My staff knows what I do now. I just call out 
to the front office, ``Get Igor on the phone,'' and within a 
few minutes, Igor is on the phone, Foreign Minister Ivanoff, 
and we talk. And he doesn't delay the phone call waiting for 
his talking points from the staff. We know what is on each 
others mind. We know what our two presidents want us to do to 
make this a stronger, better relationship.
    President Putin and President Bush have the same kind of 
relationship, and you saw it pay off when we faced the 
challenge of the ABM Treaty last fall. They disagreed. They 
thought we made a mistake by saying that we were going to leave 
the ABM Treaty. We thought they were wrong. We exchanged those 
views. At the end of the day, we agreed to disagree, and as 
President Putin said to me when I was explaining to him the 
President's decision and how we were going to implement it and 
choreographing with him what we would say, what they would say, 
he said, ``Fine. We disagree, but our strategic relationship is 
far more important than this disagreement, and now this 
disagreement is behind us. Let's move forward, and let's move 
forward to cut those strategic offensive forces that really 
threaten to kill people. And we will discuss more defenses 
which protect people.''
    So we have a strong relationship with Russia, and we are 
trying to develop a similar one with China, and we have had 
considerable success. People thought we were in trouble last 
April when we had the incident with the reconnaissance plane 
that the Chinese ran into and our plane landed at Hainan 
Island, but we got through that in a couple weeks time, and got 
our plane back.
    I had a successful trip last summer after this incident 
took place, and then the President had a very successful trip 
when he went to Shanghai for the APEC Summit. And he is looking 
forward to another successful meeting with President Chen Shui-
bian next week when we go to China again.
    The same applies to our relationship with Japan and Korea 
and our other friends in the region. They are all solid, and 
they are all growing. The President is very much looking 
forward to visiting South Korea to show that the bond between 
us and the South Koreans is as strong as ever. He will talk 
about North Korea. He will talk about the hope he has for North 
Korea, that some day the North Korean people will enjoy the 
kind of life that South Koreans have. His hope is that one day, 
a way will be found for these two Nations to, once again, be 
one people.
    They have been one people for most of their recorded 
history, and he will show his support for the policies of the 
South that are encouraging the North to come out of its 
isolation, but, at the same time, we will not shrink from 
pointing out the nature of the North Korean regime. It is a 
regime that does not benefit its own people. They develop 
weapons, weapons that they sell to other nations that are not 
interested in helping their own people.
    So the President has clearly identified the nature of this 
regime, but, at the same time, he has also said to the North 
Koreans, as he has said to the South Koreans, we are ready to 
talk to the North Koreans, we are ready for dialog anytime, 
anyplace, anywhere, with no preconditions.
    I repeat that again this morning, as the President will 
next week in Korea, and we hope that the North Koreans will 
take us up on it. We want dialog, but, at the same time, we 
will not deny the obvious truth as to the nature of that 
regime, and we will not step back from talking about programs 
that they have and things that they are doing which are not in 
the interest of the civilized world.
    So I think we have demonstrated that we are anxious to 
reach out to the world. We are not unilateralists pulling back. 
The President is going to Asia. The President has been to 
Europe several times. There is a steady stream of visitors in 
to see the President.
    Look at my calendar any week you wish to, Mr. Chairman, and 
you will see how many foreign leaders that I meet with, but 
where there is a matter of principle, where we believe strongly 
about something and we have to stick by our principles, we will 
do that and lead and try to convince others to go with us. This 
isn't unilateralism. This is leadership, and our friends, I 
think, are increasingly coming to the understanding that this 
is principled leadership, the kind that they should respect, 
follow where they think it is appropriate to follow, and where 
they think it is not appropriate to follow, let them make their 
own individual sovereign choice.
    But we are committed to the great alliances of which we are 
a part, and nowhere is that more the case than in Europe where 
the President is looking for the opportunity to expand NATO at 
the Prague Summit later this year, where he is anxious to read 
Russia into NATO, Russia at 20, hopefully by the Reykjavik 
Ministerial meeting this spring or in Prague this fall.
    We are active with our partners in the European Union to 
improve economic conditions for all the nations of Europe, and 
you can see that through the President's free trade agenda, we 
are anxious to reduce trade barriers so that nations around the 
world cannot just sit around waiting for aid, but can trade. 
Trade is better than aid, and they can all start moving up out 
of the poverty that afflict so many nations of the world.
    The President has the same view with respect to our own 
interest here in the Western Hemisphere. His agenda includes a 
Free Trade Area of the Americas. It includes passing Andean 
Trade Preferences Act again, so that we can help our friends in 
the Andean region. He wants a United States/Central America 
free trade agreement. He is going to the conference in Monterey 
next month on development assistance. We are engaged everywhere 
throughout the world, and I would be remiss if I didn't talk 
about Africa because it is an area that the President is also 
deeply interested in.
    The African Growth and Opportunity Act, we want to see that 
enhanced. We had the first forum on that act here in the United 
States last fall, right after September 11th. It was the first 
international meeting we had, right after September 11th, and 
that was to bring over 30 African leaders to the United States 
to talk about trade.
    He is looking forward to sending a strong delegation to the 
World Summit on Sustainable Development in Johannesburg, and 
demonstrating to Africa, the northern part of Africa, 
especially Sub-Saharan Africa, our interest in the continent, 
and nowhere, I think, is that more obvious in what we are doing 
with HIV/AIDS; over the last year alone, we have provided $500 
million for the global trust fund, in addition to many, many 
hundreds of additional million dollars on internal HIV/AIDS 
programs and other bilateral assistance that we provide to 
countries that are fighting this scourge.
    Mr. Chairman, all of these items and areas that I have 
touched on take money, and I think you will find in our budget 
a reasonable balance in light of the fiscal circumstances that 
the country finds itself in. And I am pleased that we were able 
to get real growth in our budget this year, and a number of our 
accounts have been able to go up. Some accounts have gone down, 
but, for the most part, I think we can make a case for why 
those accounts have gone down.
    So I am optimistic about the world that is ahead of us. We 
have a coalition fighting terrorism with the major countries of 
the world. We have good relations, but there are still some 
very troubling areas.
    The Middle East is a problem that dominates part of my day, 
every day, as we work hard to get a cease-fire in place to 
implement the Mitchell Peace Plan.
    The President remains engaged. He met with Prime Minister 
Sharon last week. We are in contact with Chairman Arafat and 
his closest associates to try to get more movement with respect 
to the arrest of terrorists and with respect to accounting for 
the Karin A, that ship that had the arms aboard, and Chairman 
Arafat wrote me a somewhat positive letter on this subject 2 
days ago, a letter which we are now examining.
    The President will not rest until we get a cease-fire and 
get negotiations started. We still have as the American vision 
two states living side by side in that troubled land, one, a 
Jewish state called Israel, the other, a Palestinian state 
called Palestine.
    We still have a problem with nations such as Iran and Iraq. 
The President did not shrink from describing the nature of 
those regimes as he talked about the axis of evil. I don't 
think I need to spend a lot of time on Iraq. We continue to 
develop sanctions and improve our sanctions regime toward Iraq 
to make sure that they do not succeed in their horrible quest 
to develop weapons of mass destruction. We also are examining 
options with respect to regime change because the people of the 
region, the people of the world, and the people of Iraq will be 
better off with a new regime.
    With respect to Iran, we have offered Iranians dialog. We 
do have ways of speaking to them, even though we don't have 
diplomatic relations with them. We are in touch with them. We 
do talk to them. I have taken note of the fact that they have 
played a helpful role in the Bonn Conference that set up the 
interim authority in Afghanistan. They played a helpful role in 
the Japanese reconstruction conference, and I thanked them for 
that helpful role, but, at the same time, we see the Iranians 
doing other things in Afghanistan that are troubling. And we 
are going to call them to account for these things, whether it 
is trying to gain undue influence or introduce arms into 
Western Afghanistan, or their attitudes toward the Karzai 
government.
    We have to take note of the fact that Iran continues to 
develop weapons of mass destruction and the means to deliver 
them, and by not shrinking from this reality, but calling this 
reality exactly what it is, I don't think this is a way of 
threatening the people of Iran. We want the best for the people 
of Iran, but at the same time, we must not shrink from the 
nature of the leadership, the unelected leadership of this 
country, and we should hope that the elected leadership of this 
country, which I believe holds views that are more beneficial 
to the people of Iran, will, in due course, see that their 
views prevail.
    I know you touched on the axis of evil earlier, Mr. 
Chairman. I wanted to end my prepared testimony by responding 
in kind by saying that I think that this is a clear-headed, 
realistic policy, even though it has caused some distress here 
and there. I think it is understood by most people, and I think 
most people understand the President is not looking for a war.
    We are looking for peace, but you don't find peace by 
sticking your head in the sand and ignoring evil where it 
exists, and I think President Bush has shown leadership in 
pointing it out so clearly in the actions we have taken 
previously, the policies that we are following, to see if 
dialog is possible, to see if peaceful solutions are possible, 
but, at the same time, not ignore our ultimate responsibilities 
if diplomacy and political action is not successful.
    Thank you, Mr. Chairman.
    [The prepared statement of Secretary Powell follows:]

  The Prepared Statement of Colin L. Powell, Secretary United States 
                          Department of State

    Mr. Chairman, members of the committee, I am pleased to appear 
before you to testify in support of President Bush's budget request for 
fiscal year 2003.
    Let me say at the outset, Mr. Chairman, before I go into the 
specifics of the budget request, that President Bush has two overriding 
objectives that our foreign policy must serve before all else. These 
two objectives are to win the war on terrorism and to protect Americans 
at home and abroad. This Administration will not be deterred from 
accomplishing these objectives. I have no doubt that this committee and 
the Congress feel the same way. As you will see when I address the 
details of the budget request, a significant part is related to 
accomplishing these two objectives.
    As many of you will recall, at my first budget testimony to this 
committee last March I told you that the resources challenge for the 
Department of State had become a serious impediment to the conduct of 
the Nation's foreign policy. I told you that it was a mystery to me how 
the great people at the State Department had continued to do their work 
over the past decade with so little resources.
    And you heard my testimony and you responded, and we are grateful.
    Because of your understanding and generosity, we have made 
significant progress. We will make even more in what remains of fiscal 
year 2002.
    With respect to State Department operations, our three principal 
priorities last year were people, information technology, and embassy 
construction and security. Let me update you on how we are doing in 
these areas.
    In new hires for the Foreign Service, we have made great strides. 
We doubled the number of candidates for the Foreign Service Written 
Examination--and this year we will give the exam twice instead of just 
once. Moreover, our new recruits better reflect the diversity of our 
country with nearly 17 percent of those who passed last September's 
written exam being members of minority groups. For example, we tripled 
the number of African-Americans.
    We have also improved Civil Service recruitment by creating new 
web-based recruiting tools and by vigorously asserting the truth. The 
truth, Mr. Chairman, that we are a team at State and that the Foreign 
Service and the Civil Service are each very important team members. No 
difference. Both are vital to our mission. And now both know it.
    Another improvement is that once we identify the best people we 
bring them on more quickly--a great boon to hiring the best. For 
Foreign Service recruits, for instance, we have reduced the time from 
written exam to entry into service from 27 months to less than a year. 
We are going to reduce it even further.
    We are also working with OMB to create extensive new performance 
measures to ensure that the people we hire remain the best throughout 
their careers.
    With respect to information technology, we are well on the way to 
bringing state-of-the-art hardware and software to the entire 
Department. We have an aggressive deployment schedule for our 
unclassified system which will provide desktop Internet access to over 
30,000 State users worldwide.
    And we are deploying our classified connectivity program over the 
next two years. Our goal is to put the Internet in the service of 
diplomacy and we are well on the way to accomplishing it.
    With respect to construction and security, we are right-sizing, 
shaping up and bringing smarter management practices to our overseas 
buildings program, as I told you we would do last year.
    The first change we made was to put retired General Chuck Williams 
in charge and give him assistant secretary equivalent rank. Now, his 
Overseas Building Operations (OBO) has developed the Department's first 
master plan, which covers our major facility requirements through 
Fiscal Year 2007.
    The OBO is using best practices from industry, new embassy 
templates, and strong leadership to lower costs, increase quality, and 
decrease construction time.
    As I told you last year, one of our goals is to reduce the average 
cost to build an embassy. I believe we are well on the way to doing 
that.
    And General Williams is making all of our facilities, overseas and 
stateside, more secure. By the end of fiscal year 2002, over two-thirds 
of our overseas posts should reach minimal security standards, meaning 
secure doors, windows, and perimeters.
    We are also making progress in efforts to provide new facilities 
that are fully secure, with 13 major capital projects in design or 
construction, another eight expected to begin this fiscal year, and 
nine more in fiscal year 2003.
    Mr. Chairman, all of these activities have improved morale at the 
State Department. Our people see things happening, things that enhance 
their quality of life, their security, their ability to do their jobs. 
Things like our interim childcare center at the National Foreign 
Affairs Training Center. It opened on September 4 and can handle a full 
complement of 30 infants and toddlers.
    This idea of teamwork, this idea of family and the quality of life 
that must always nourish it even in the remotest station, is uppermost 
in our minds at the Department. While we concentrate on the Nation's 
foreign affairs we must also focus on taking care of those Americans 
who conduct it, as well as the many thousands of Foreign Service 
Nationals who help us across the globe.
    These are an extraordinary group of people, Mr. Chairman. For 
example, our sixty Afghan employees in Kabul worked diligently to 
maintain and protect our facilities throughout the 13 years the Embassy 
was closed. They worked at considerable personal risk and often went 
months without getting paid. They even repaired the chancery roof when 
it was damaged by a rocket attack. This is the sort of diligence and 
loyalty that is typical of our outstanding Foreign Service Nationals.
    Our whole team at State is vital to mission accomplishment--Foreign 
Service, Civil Service, and Foreign Service Nationals. The dollars you 
helped to provide us last year allowed us to make our team more 
cohesive and more effective. We want to continue that process.
    That is why for fiscal year 2003 you will get no break from me. I 
am going to be as relentless as CEO of the State Department as I am as 
principal foreign policy advisor to the President.
    So let me speak as CEO first.
The Budget Priorities for Fiscal Year 2003: Department of State and 
        Related Agencies
    The President's request for the Department of State and Related 
Agencies for fiscal year 2003 is $8.1 billion. These dollars will allow 
us to:

  Continue initiatives to recruit, hire, train, and deploy the 
    right work force. The budget request includes $100 million for the 
    next step in the hiring process we began last year. With these 
    dollars, we will be able to bring on board 399 more foreign affairs 
    professionals and be well on our way to repairing the large gap 
    created in our personnel structure and, thus, the strain put on our 
    people by almost a decade of too few hires, an inability to train 
    properly, and hundreds of unfilled positions. In fiscal year 2004, 
    if we are able to hire the final 399 personnel, we will have 
    completed our three-year effort with respect to overseas staffing--
    to include establishing the training pool I described to you last 
    year that is so important if we are to allow our people to complete 
    the training we feel is needed for them to do their jobs. Next 
    February, I will be back up here briefing you on the results of our 
    domestic staffing review.
  Continue to upgrade and enhance our worldwide security 
    readiness--even more important in light of our success in 
    disrupting and damaging the al-Qaida terrorist network. The budget 
    request includes $553 million that builds on the funding provided 
    from the Emergency Response Fund for the increased hiring of 
    security agents and for counterterrorism programs.
  Continue to upgrade the security of our overseas facilities. 
    The budget request includes over $1.3 billion to improve physical 
    security, correct serious deficiencies that still exist, and 
    provide for security-driven construction of new facilities at high-
    risk posts around the world.
  Continue our program to provide state-of-the-art information 
    technology to our people everywhere. Just as I promised you last 
    year, the budget request will continue projects aimed at extending 
    classified connectivity to every post that requires it and to 
    expanding desktop access to the Internet for Department employees. 
    We have included $177 million for this purpose. Over the past 
    decade, we let the Department's essential connectivity ebb to very 
    low levels and we need to correct that situation.
  Continue and enhance our educational and cultural exchange 
    programs. The budget request includes $247 million for strategic 
    activities that build mutual understanding and develop friendly 
    relations between America and the peoples of the world. These 
    activities help build the trust, confidence, and international 
    cooperation necessary to sustain and advance the full range of our 
    interests. Such activities have gained a new sense of urgency and 
    importance since the brutal attacks of September. We need to teach 
    more about America to the world. We need to show people who we are 
    and what we stand for, and these programs do just that.
  Continue to meet our obligations to international 
    organizations--also important as we pursue the war on terrorism to 
    its end. The budget request includes $891.4 million to fund United 
    States assessments to 43 international organizations, active 
    membership of which furthers United States economic, political, 
    security, social, and cultural interests.
  Continue to try to meet our obligations to international 
    peacekeeping activities. The budget request includes $726 million 
    to pay our projected United Nations peacekeeping assessments--all 
    the more important as we seek to avoid increasing even further our 
    UN arrearages. And, Mr. Chairman, I ask for your help in getting 
    the cap lifted so that we can eventually eliminate all our 
    arrearages. These peacekeeping activities allow us to leverage our 
    political, military, and financial assets through the authority of 
    the United Nations Security Council and the participation of other 
    countries in providing funds and peacekeepers for conflicts 
    worldwide.
  Continue and also enhance an aggressive public diplomacy 
    effort to eliminate support for terrorists and thus deny them safe 
    haven. The budget includes almost $518 million for International 
    Broadcasting, of which $60 million is for the war on terrorism. 
    This funding will enable the Voice of America and Radio Free 
    Europe/Radio Liberty to continue increased media broadcasts to 
    Afghanistan and the surrounding countries and throughout the Middle 
    East. These international broadcasts help inform local public 
    opinion about the true nature of al-Qaida and the purposes of the 
    war on terrorism, building support for the coalition's global 
    campaign.

    Mr. Chairman, on this last subject let me expand my remarks.
    The terrorist attacks of September 11 underscored the urgency of 
implementing an effective public diplomacy campaign. Those who abet 
terror by spreading distortion and hate and inciting others, take full 
advantage of the global news cycle. We must do the same. Since 
September 11, there have been over 2,000 media appearances by State 
Department officials. Our continuous presence in Arabic and regional 
media by officials with language and media skills, has been 
unprecedented. Our international information website on terror is now 
online in seven languages. Internet search engines show it is the 
hottest page on the topic. Our 25-page color publication, ``The Network 
of Terrorism'', is now available in 30 languages with many different 
adaptations, including a full insert in the Arabic edition of Newsweek. 
``Right content, right format, right audience, right now'' describes 
our strategic aim in seeing that United States policies are explained 
and placed in the proper context in the minds of foreign audiences.
    I also serve, ex officio, as a member of the Broadcasting Board of 
Governors, the agency that oversees the efforts of Voice of America and 
Radio Free Europe/Radio Liberty to broadcast our message into South 
Central Asia and the Middle East. With the support of the Congress, our 
broadcasting has increased dramatically since September 11. We have 
almost doubled the number of broadcast hours to areas that have been 
the breeding grounds of terrorists. The dollars we have requested for 
international broadcasting will help sustain these key efforts through 
the next fiscal year.
    Mr. Chairman, all of these State Department and Related Agencies 
programs and initiatives are critical to the conduct of America's 
foreign policy. Some of you know my feelings about the importance to 
the success of any enterprise of having the right people in the right 
places. If I had to put one of these priorities at the pinnacle of our 
efforts, it would be our hiring efforts.
    We must sustain the strong recruiting program we began last year. 
We want to get to a point where our people can undergo training without 
seriously jeopardizing their missions or offices; where our men and 
women don't have to fill two or three positions at once; and where 
people have a chance to breathe occasionally.
    Out on the front lines of diplomacy, we want a first-class offense 
for America. As a soldier, I can tell you that quality people with high 
morale, combined with superb training and adequate resources, are the 
key to a first-class offense.
    So as the State Department's CEO, let me thank you again for what 
you have done to help us create such a first-class--offense and I want 
to ask you to continue your excellent support so we can finish the job 
of bringing the Department of State and the conduct of America's 
foreign policy into the 21st century.
    Now, let me turn to the budget request for foreign operations.
Foreign Policy: Successes, Challenges, and Opportunities
    Over the past year, Mr. Chairman, I believe the broader tapestry of 
our foreign policy has become clear: to encourage the spread of 
democracy and market economies and to bring more Nations to the 
understanding that the power of the individual is the power that 
counts. And when evil appears to threaten this progress, America will 
confront that evil and defeat it--as we are doing in the war on 
terrorism.
    In weaving this tapestry, we have achieved several successes in 
addition to the successes of the war on terrorism and the regional 
developments its skillful pursuit has made possible.
    We have improved our relations with Russia, set a new and smoother 
course with China, reinvigorated our Asia and Pacific alliances, and 
worked successfully with our European partners to ensure continued 
stability in the Balkans. Moreover, we reduced the level of concern in 
Europe over what some there thought was a United States go-it-alone 
policy, notwithstanding some recent comments from Europe with regard to 
President Bush's State of the Union address.
    Further, we have broadened our cooperation with Central Asia, and 
set a more effective policy in place for Africa based on good 
governance, reinvigoration of agriculture, and integration into the 
globalized world of trade and commerce. Plus, we are attacking HIV/AIDS 
in Africa and elsewhere with bilateral as well as international 
efforts.
    Add to these successes our constructive focus on our own 
hemisphere, from Canada to the Caribbean, from Mexico to South America, 
and you have a solid record of achievement.
    There are some dark clouds of course--in the Middle East, in South 
America, and in South Asia. But we are working these issues. There is 
effective policy in place and good people are pushing the policy.
    All of these efforts require resources. So let me turn to the 
specifics of our budget request for foreign operations.
The Budget Priorities for Fiscal Year 2003: Foreign Operations
    The President's fiscal year 2003 request for Foreign Operations is 
a little over $16.1 billion. These dollars will support the continuing 
war on terrorism, the work we are doing in Colombia and the Andean 
region at large, our efforts to combat HIV/AIDS and other infectious 
diseases, essential development programs in Africa, the important work 
of the Peace Corps and the scaling up of that work, and our plan to 
clear arrearages at the Multilateral Development Banks, including the 
Global Environment Facility.
War on Terrosim
    To fight terrorism as well as alleviate the conditions that fuel 
violent extremism, we are requesting an estimated $5 billion. In 
addition to the initiatives outlined previously under the budget for 
the State Department and Related Agencies, this funding includes:

  Foreign assistance--$3.6 billion for economic and security 
    assistance, military equipment, and training for front-line states 
    and our other partners in the war on terrorism. This amount 
    includes:

  $3.4 billion from Foreign Operations accounts such as the 
    Economic Support Fund, International Military Education and 
    Training, Foreign Military Financing, and Freedom Support Act.
  $88 million for programs in Russia and other states of the 
    former Soviet Union to reduce the availability to terrorists of 
    weapons of mass destruction. Ongoing programs engage former weapons 
    scientists in peaceful research and help prevent the spread of the 
    materials expertise required to build such weapons.
  $69 million for counterterrorism engagement programs, 
    training, and equipment to help other countries fight global 
    terror, thereby strengthening our own national security.
  $4 million for the Treasury Department's Office of Technical 
    Assistance to provide training and other necessary expertise to 
    foreign finance offices to halt terrorist financing.

    And Mr. Chairman, in the fiscal year 2003 budget request there is 
approximately $140 million available for Afghanistan, including 
repatriation of refugees, food aid, demining, and transition 
assistance. I know that President Bush, the Congress, and the American 
people recognize that re-building that war-torn country will require 
additional resources and that our support must be and will be a multi-
year effort. Moreover, we do not plan to support reconstruction alone 
and we will seek to ensure that other international donors continue to 
do their fair share.
    To meet our commitment to assist Afghanistan in its reconstruction 
efforts, we will need a supplemental appropriation this year. Also, 
there are other areas associated with the war on terrorism where we may 
need supplemental funding this year. Right now we are working the 
details with OMB.
Andean Counter-drug Initiative
    We are requesting $731 million in fiscal year 2003 for the multi-
year counter-drug initiative in Colombia and other Andean countries 
that are the source of the cocaine sold on America's streets. ACT 
assistance to Andean governments will support drug eradication, 
interdiction, economic development, and development of government 
institutions, in addition, the Colombians will be able to stand up a 
second counterdrug brigade. Assisting efforts to destroy local coca 
crops arid processing labs there increases the effectiveness of United 
States law enforcement here.
    In addition to this counterdrug effort, we are requesting $98 
million in FMF to help the Colombian Government protect the vital Cano 
Limon-Covenas oil pipeline, which in 2001 was attacked 166 times by 
FARC and ELN guerrillas, costing Colombia revenue, causing serious 
environmental damage, and depriving us of a source of petroleum. This 
money will help train and equip two brigades of the Colombian armed 
forces to protect the pipeline.
Global Health and HIV/AIDS
    In fiscal year 2003, we are requesting $1.4 billion for USAID 
global health programs. Of this amount, we are requesting $540 million 
for bilateral HIV/AIDS prevention, care, and treatment activities, and 
$100 million for the Global Fund to Fight AIDS, Tuberculosis, and 
Malaria. All of this funding will increase the already significant 
United States contribution to combating the AIDS pandemic and make us 
the single largest bilateral donor to the effort. I should add that the 
overall United States Government request for international HIV/AIDS 
programs exceeds one billion dollars, including $200 million for the 
Global Fund.
The Peace Corps
    All of you heard the President's remarks in his State of the Union 
address with respect to the USA Freedom Corps and his objective to 
renew the promise of the Peace Corps and to double the number of 
volunteers in the Corps in the next five years. We have put $320 
million for the Peace Corps in the fiscal year 2003 budget request. 
This is an increase of over $42 million over our fiscal year 2002 
level. This increase will allow us to begin the scaling up that the 
President has directed. The Peace Corps will open programs in eight 
countries, including the restablishment of currently suspended posts, 
and place over 1,200 additional volunteers worldwide. By the end of 
fiscal year 2003 the Peace Corps will have more than 8,000 volunteers 
on the ground.
MDB Arrears
    The fiscal year 2003 request includes an initiative to pay one 
third of the amount the United States owes the Multilateral Development 
Banks (MDBs) for our scheduled annual commitments. With United States 
arrears currently now totaling $533 million, the request would provide 
$178 million to pay one third of our total arrears during the fiscal 
year. The banks lend to and invest in developing economies, promoting 
economic growth and poverty reduction and providing environmental 
benefits. We need to support them.
Summing Up
    Mr. Chairman, you have heard from me as CEO of the State Department 
and as principal foreign policy advisor to the President. I hold both 
responsibilities dear. Taking care of the great men and women who carry 
out America's foreign policy is as vital a mission in my view as 
helping to construct and shape that foreign policy.
    As I told this committee last year and as I have already reminded 
it again this year, the conduct of the Nation's foreign policy suffered 
significantly from a lack of resources over the past decade. I have set 
both my CEO hat and my foreign policy hat to correct that situation. 
But I cannot do it without your help and the help of your colleagues in 
the Senate and across the Capitol in the House. I believe we have 
demonstrated in the past year that we are worth the money. I believe we 
have demonstrated that we can be wise stewards of the people's money 
and put it to good use in the pursuit of America's interests abroad. I 
also believe that we have demonstrated conclusively that we are 
essential to that process of pursuing the Nation's interests. With your 
able assistance, we will continue to do so in the months ahead.
    Thank you, and I will be pleased to address your questions.

    Chairman Conrad. Thank you, Mr. Secretary.
    As always, you have done just an excellent job of making 
the case, and we appreciate that.
    Let me say to you that the problem that we face as the 
Budget Committee and the problem that the Congress faces can 
perhaps be best summed up by this chart.
    Last year, when increases were provided, we had a forecast 
of surpluses, very substantial non-trust fund surpluses for the 
next decade. Now we see a complete reversal, and all we see is 
non-trust fund deficits for the next decade.
    So, when increases are asked for by any agency, all of that 
increase will be coming out of Social Security Trust Fund 
moneys, and so the question that we have to answer is what are 
the priorities. The American people have told us very clearly 
they don't want Social Security Trust Fund money used for other 
purposes, however meritorious. They don't want that.
    If we believe that, and I do, I think it is a serious 
mistake to use trust fund moneys when the baby-boomers start to 
retire in 6 years, and we all know where we are headed in terms 
of the demands on the fiscal resources of the Federal 
Government. The question comes when you ask for an increase, 
and you have done a superb job of justifying that request. I 
told staff here, I think you are the best witness that has ever 
come before this Committee, but with that said, it still leaves 
us with this fundamental question: where does the money come 
from.
    Do you believe that the priorities that you are asking for 
are sufficiently important that if we are not to take it out of 
Social Security, that we should either cut spending other 
places or raise the revenue to pay for it? So I would ask you, 
are these requests that you have made of sufficient importance 
that if this committee and the broader Congress determined we 
are not going to use Social Security money to pay for these 
increases, that we would have to cut spending elsewhere or 
raise revenue elsewhere? Would you support that?
    Secretary Powell. I think the request that I had made to 
you, that the President has made to you for my accounts, is 
reasonable. It is quite modest. I think it was decided at this 
level consistent with the needs of the other Departments, and 
so I support the President's priorities. And I could not 
identify somewhere else within the Administration's budget that 
it should be taken from. Everybody has made their case, and the 
President made the allocation he did.
    I think we are in a period of deficit spending, and I hope 
that as we prevail in this campaign against terrorism, as we 
build our defense, those kinds of claims against the budget 
will be reduced in future years. And I hope that the economy 
returns to a position of strong growth, which will also help 
eliminate the deficit, but right now I cannot give you an 
answer, since the President is not asking for increases in 
revenues. He is not asking for an increase in taxes, and, 
therefore, I don't have an answer for you as to where the 
source of the funding should come, except within the $2.1-
trillion amount that the President has asked for, for FY 2003.
    I think that the $25 billion-plus asked for by the 
Department of State is a reasonable investment in the foreign 
affairs activities of the United States Government.
    Chairman Conrad. Let me just say I understand your answer, 
but I have got to tell you, it does not solve the problem, and 
the problem is very fundamental. This is an ocean of red ink, 
and it is not just this year, not next year. It is the entire 
next decade, taking nearly $2 trillion out of the Social 
Security Trust Fund to pay for these other things, taking $500 
billion from the Medicare Trust Fund to pay for these other 
things. Some of us just don't think that is appropriate. It is 
a profound mistake for the economic future and fiscal future of 
the country.
    So, if we are going to reduce those invasions of the trust 
funds, where does the money come from? You have come here. You 
have made a very powerful case, as you always do. The question 
is: Where does the money come from? That is the question we 
have got to answer, and so I am asking for your help.
    If these priorities are critically important, as you 
describe, do we cut spending other places? If we don't do that, 
do we raise revenue to pay the bill? And your answer is?
    Secretary Powell. Or, do you increase the national debt? 
And I think where we are right now is that for the next several 
years, we may well have to increase the debt, as your chart 
shows, in order to deal with these priorities.
    I have restrained my appetite in presenting my case to OMB 
and to the President. I would like to have asked for a lot 
more. To some extent, I cut from what my staff thought was 
appropriate and what I thought was appropriate because I knew 
that there were limits to what the President could do. So I 
believe that my budget is a reasonable one. It shows some real 
growth, and it recognizes that a lot more growth is needed for 
homeland security and for the Defense Department.
    The President made a judgment that this combination of 
spending, which focused on homeland security, focused on 
defense, focused to a slight extent on foreign operations and 
the running of the State Department, cut other Departments, and 
also picked up additional debt for the American people, was the 
right allocation and the right way to go about it in the hope 
that economic growth would return quickly and it would cause 
there to be less debt on the American people as a result of the 
necessary expenditures.
    Your chart also showed that for the last 10 years and for 
many years before that, we were also running a deficit. We were 
fortunate to come out of that for a year or so, and now we are 
back down into a deficit-spending situation. I hope that we 
will see that black little hilltop you show return with the 
restoration of economic growth.
    To some extent, it was the terrorist incidents of last year 
which hurt the economy and probably kicked it into the 
situation we have now.
    Chairman Conrad. Let me just say to you, Mr. Secretary, 
that in these numbers, there is forecast of strong economic 
growth. The Administration is forecasting a 3.1-percent 
economic growth on average for the 10 years, and, yet, still we 
see massive deficits, and not just for the year or two, not 
just the time of economic downturn, but through the entire 
decade.
    As I indicated, $2.2 trillion under the President's plan is 
being taken for Medicare and Social Security Trust Funds to pay 
for these other things, that right at the time the baby-boom 
generation starts to retire. That is what leaves us with this 
very difficult set of choices.
    You come here and make a very strong and persuasive case 
for additional resources. We know that every dollar that you 
ask for of additional money comes out of the Social Security 
Trust Fund, and if we don't think that should be done and the 
American people tell us they don't think that should be done, 
that leaves us with only two options. If we are to grant your 
request, that means cutting spending some other place, or 
raising the revenue to pay for it.
    Your answer is add it to the debt, but that means taking 
out of the Social Security Trust Fund, which the American 
people have overwhelming told us don't do.
    So I say to you and through you to the Administration, I 
don't think they have come up with the right answer here as to 
how to pay for these things, and I think we have got an 
obligation together, if we say these things are needed, to pay 
for them and not just stick it on the charge card.
    Let me go to the other question, the statement that the 
President made about the axis of evil which you addressed in 
your opening remarks. Obviously, for us, we have got to 
determine how we translate what the President is saying into a 
budget, and should we be preparing a budget that anticipates 
conflict, military conflict with Iraq, Iran, North Korea. What 
would your advice be to us in terms of constructing a budget as 
to what we could anticipate or should anticipate?
    Secretary Powell. The President is not asking for a war 
budget. The funds that he has asked for the Defense Department 
essentially are funds needed for transformation, funds needed 
to deal with problems that hadn't been dealt with in recent 
years, and to make sure we are ready for whatever contingency 
may come along.
    He has no plan on his desk right now to begin a war with 
any nation. The nation that is of, perhaps, higher level of 
concern than others is Iraq. With respect to Iran and with 
respect to North Korea, there is no plan to start a war with 
these nations. We want to see a dialog. We want to contain 
North Korea's activities with respect to proliferation, and we 
are going to keep the pressure on them, but there is no plan to 
begin a war with North Korea, nor is there a plan to be in a 
conflict with Iran. There are many forces at work in Iran, and 
so I don't think that there is anything that translates into 
added budget requirements because of his speech.
    I think his budget presentation for FY 2003, speaks for 
itself as to what those funds are needed for.
    Chairman Conrad. You say that there is no plan for 
conflict, initiating conflict with Iran or North Korea.
    Secretary Powell. The President does not have before him 
right now, and if he did, I probably wouldn't tell you anyway, 
but he has no plan before him right now that is a plan for a 
conflict.
    Chairman Conrad. With Iran or North Korea?
    Secretary Powell. With anybody.
    Chairman Conrad. But you didn't make that differentiation 
in your remarks with respect to Iraq.
    Secretary Powell. I said that for Iraq, we are always 
examining options for regime change, but that's what we are 
doing is examining options. He does not have a recommendation 
before him that would involve an armed conflict tomorrow.
    Chairman Conrad. Well, tomorrow----
    Secretary Powell. The reason I answer that way, Mr. 
Chairman, is that there is this feeling in some quarters that 
we are at a point of starting a conflict, and the President 
does not have, as he has said, any such recommendation on his 
desk.
    Chairman Conrad. You know, the important thing for us to 
know is we have got to construct a budget for the country, and 
we have got to have some idea in the defense area of what is 
anticipated. I take your statement for what it is.
    I take from what you say that we have got no plan for Iran, 
for North Korea, and, as you have extended your remarks, no 
plan in the immediate future, perhaps foreseeable future, with 
Iraq, but the Administration is examining options with respect 
to Iraq.
    Secretary Powell. Yes.
    Chairman Conrad. I take that differentiation between what 
we are doing with respect to Iran and North Korea. I didn't 
hear that there is an examination of options per se with those 
countries.
    Secretary Powell. We already have existing policies with 
respect to both countries.
    With respect to North Korea, as I said in my testimony, we 
have offered dialog. We continue to support the framework 
agreement of 1994. We continue to provide fuel to North Korea. 
We are perhaps the biggest, I think we are the biggest, 
providers of food to North Korea. Those policies have not 
changed, and we keep 37,000 troops in Korea along with many 
more South Koreans as a deterrent to North Korean aggression. 
Those policies haven't changed. What the President did was make 
sure nobody forgot the true nature of this regime and why we 
have to be concerned about it.
    With respect to Iran, we have had policies in place for a 
long time. We have some sanctions with respect to Iran in 
place. We encourage moderate forces in Iran, and we have talked 
quite candidly to a number of our friends, particularly the 
Russians, with respect to Iranian ambitions on nuclear weapons 
development, but we are not at some point drawing up 
contingency plans to invade Iran.
    With respect to Iraq, it has long been for several years 
now a policy of the United States Government that regime change 
would be in the best interest of the region, the best interest 
of the Iraqi people, and we are looking at a variety of options 
that would bring that about. So Iraq is in a slightly different 
category than Iran and North Korea, but all bear similar 
characteristics with respect to the nature of their regimes and 
to some of the activities that they are conducting with respect 
to weapons of mass destruction and the means to deliver weapons 
of mass destruction. That is what sort of puts them in this 
category.
    Chairman Conrad. When you talk about regime change, I take 
that to mean some move to force out Saddam Hussein. Are you 
talking here about military means of bringing regime change? 
What does it exactly mean when you use those terms?
    Secretary Powell. He could leave in many different ways, 
from natural causes through other causes, but I don't want to 
get specific as to possible options. He is exactly the same age 
I am, and I am constantly looking at the actuarial tables. 
[Laughter.]
    Chairman Conrad. You look pretty healthy to me.
    Secretary Powell. I believe that I am healthier than he is. 
I hope I am, anyway.
    Chairman Conrad. Let me ask you one other question, and I 
referenced this earlier. In the paper today, a group of some 
160 organizations have joined together asking for a doubling of 
overseas aid. The article reports that the Administration has 
dismissed earlier calls for doubling of foreign aid. When 
Microsoft's Bill Gates chastised the United States Government 
for being a laggard in foreign spending earlier this month, 
Treasury Secretary Paul O'Neill replied that poor countries 
have collected trillions of dollars in aid over the years with 
precious little to show for it. Is there precious little to 
show for the aid that we have extended and the aid that you are 
requesting that we add to?
    Secretary Powell. I think there is a great deal to show for 
it, and to put Secretary O'Neill's comments in context, I think 
what Paul was essentially alluding to was the fact that, in 
some cases in the past, we did not get the best return on our 
investment when we provided foreign aid to regimes that were 
clearly despotic, or during the days of the cold war we had to 
support a number of regimes that were on the right side of the 
cold war, but on the wrong side of history. I know this very 
well, having been National Security Advisor in those days.
    We helped a lot of people that we would not have wanted to 
invite to dinner that night. That was the nature of it, but it 
is different now.
    Now the point I make to anybody who comes into my office 
and sits down from a developing country is I want to see the 
rule of law, I want to see a democratically elected government, 
I want to see transparency in your system, I want to see 
corruption dealt with. I want to make sure that you are not 
just interested in aid, except as a way to get to trade. So we 
can apply different standards now and different rules in this 
new 21st-century environment that will make sure foreign aid is 
used appropriately, and there is a return on the taxpayers' 
investment.
    The idea of doubling foreign aid is not a bad idea. I would 
like to triple it, but there is a reality as to what the budget 
can stand, as you just vividly pointed out with your very 
colorful charts. There is a limit.
    I believe that what the President has done for the past 2 
years, with real increases, is a responsible effort on his part 
to deal with the kinds of questions we get with respect to why 
aren't you doing more. And any aid, any money you give me in 
this Foreign Operations account, I believe it is my obligation 
to make sure that it is spent in a non-corrupt way and it does 
not go down a rat hole. Paul O'Neil was alluding to the fact 
that there have been many cases in the past where it did not 
pay off, it did not serve the interest of the people.
    Chairman Conrad. Actually, his point was precious little to 
show for trillions of dollars. As I hear you saying it, do you 
believe there----
    Secretary Powell. Oh, I think if we were to rack up the 
trillions of dollars over the years, Secretary O'Neil and I 
might have to debate that point.
    Chairman Conrad. Senator Byrd, let me just indicate there 
are a series of votes that have started on the Senate floor 
now, three votes. They just started the first one. So we will 
have to ask the other side what they would like to do when we 
go for these votes.
    Senator Byrd.
    Senator Byrd. Mr. Chairman, I hesitate to get started on 
these questions without knowing how far we are into the vote 
and what the prospects are for our missing vote.
    Chairman Conrad. We are about 3 or 4 minutes into the vote, 
which would mean we would have about 10 minutes for questioning 
at this point.
    Since there is going to be such a long gap, I hesitate to 
ask the Secretary to wait.
    Senator Byrd. Well, OK.
    I thank the Secretary, and I regret that we have scheduled 
our votes in such a way that we overlook the importance of 
these committees and the importance of the questions and the 
answers that may result in our attendance here and the 
imposition on the time of witnesses like Secretary Powell.
    Let me begin by saying that I join in the commendations 
that have been expressed by our Chairman. I have had a long 
service with Secretary Powell.
    When we debated the IMF Treaty in 1988, I believe it was, I 
was majority leader for the second time, and Secretary Powell 
at that time, I believe, was the National Security Advisor to 
the President.
    Secretary Powell complimented the Senate on the work that 
the Senate did on that treaty. I refused to be pushed and 
pressed and stampeded into a scheduling for debate of that 
treaty until we had resolved some very, very important 
questions raised by the then-Chairman of the Armed Services 
Committee, Senator Nunn, the then-Chairman of the Intelligence 
Committee, Senator Boren, the then-Chairman of the Foreign 
Relations Committee, Senator Pell. I recall that we waited 
until we got the answers.
    The Secretary of State, now-Secretary of State, at that 
time complimented the Senate on taking the time to resolve 
these important questions, and Mr. Powell at that time, I 
think, engaged himself and was active in helping to resolve 
some of these very important questions.
    So he is a man who has made command decisions. He has led 
men in war. I think he speaks independently. He has the kind of 
experience that affords him that view, that independence of 
thought. He doesn't have to just listen to what somebody else 
says in reports. He has analyzed many of these questions, and I 
compliment him on his great service to this country.
    Our time is limited. There are two questions I would like 
to ask. Let me premise the first one by what you have said with 
respect to the President has no plan to attack, there are no 
recommendations on his desk at this moment. Those are very 
carefully worded responses to the question by the Chairman, and 
those of us who have been around here any time at all recognize 
that they are not direct answers, and I can understand the 
Secretary.
    The President, let me say, though, has made some very bold 
statements about prosecuting those responsible for the 
September 11 attacks. The President said that the terrorists 
are on the run and they will find no safe haven. There is no 
cave that is deep enough.
    He said in the State of the Union Address that the 
terrorists will not escape the justice of this country. I am 
with the President 100 percent when it comes to punishing the 
individual terrorists, those who are still living--some of them 
died on September 11, which is 5 months ago yesterday--when it 
comes to punishing those terrorists for the acts of September 
11th.
    But the President has gone further in naming three states 
that comprise an axis of evil, and you have used that term, Mr. 
Secretary, already. Iran, Iraq, and North Korea, the President 
has said, are arming to threaten the peace of the world, and he 
will not stand by as peril grows closer and closer. The United 
States of America will not permit the world's most dangerous 
regimes to threaten us with the world's most destructive 
weapons. Those statements have left me wondering. Is the 
President signaling that we will attack one or more of these 
countries?
    Congress passed a resolution on September 14 to authorize 
the President to use force against those who carried out, 
assisted, or gave safe harbor to those responsible for the 
attack of September 11. Iran, Iraq, and North Korea are not 
named in that resolution. I have heard no evidence that this 
axis of evil was responsible for or complicity in the September 
11 attacks.
    If the President seeks to extend this war on terrorism, a 
case must be made before Congress and the American people that 
Iran, Iraq, or North Korea are a clear and present danger to 
our country.
    I, for one, am willing to listen to that case, but to carry 
out the war, the President will need the sustained support of 
the American people.
    We saw in Vietnam what the lack of support, sustained 
support for that war, resulted in. If the President wants to 
crystallize the support of the American people, he would be 
well advised to seek from Congress a declaration of war. After 
all, we are not talking about using our military against 
terrorist cabals. We are talking about war against one or more 
sovereign states.
    Reading many of the news stories about this subject, I have 
come to a conclusion that while there is no plan perhaps, while 
there is no recommendation upon the President's desk today 
perhaps, these matters are evidently being pursued. They are 
being discussed. They are being considered as options.
    Now, when it comes to making war, let's say on Iraq, having 
been here when you helped to direct the war on Iraq, I possibly 
could be convinced that we ought to vote. I would vote for a 
declaration of war, but we are not dealing with Afghanistan if 
we deal with Iraq.
    With respect to Iraq and North Korea, we are dealing with 
countries that have powerful military forces on the ground, and 
I would hope, Mr. Secretary, that before we venture into an 
attack or an invasion or whatever against anyone or more of 
these countries, the help, the support, the sustained support 
of the American people would be carefully sought through their 
elected representatives.
    We ought not to go around shooting from the hip, and I 
think that some of the statements that have emanated from the 
Administration have alarmed other countries, and they are 
alarming a lot of people in this country.
    Is the President signaling that we will attack one or more 
of these countries, if he is considering such an attack as a 
possible course of action? Do you believe, Mr. Secretary, that 
the President should seek a declaration of war from Congress 
before unleashing our military might on any one of these 
sovereign states?
    Now, I can understand the inherent powers of the commander-
in-chief. If there is an attack about to occur against this 
country, he has the inherent power to act, but we have time 
here to discuss these matters, to discuss the case, to debate 
pro and con, and I personally believe that the President, 
before he takes such a case, if that is being considered as an 
option, we had better be very careful to bring the American 
people in on making the case, and we had better seek a 
declaration of war from Congress in such a case. That is going 
to be a very costly venture, if it occurs. It is going to be 
costly in treasure and in blood, and you knew that as well, 
perhaps more so than I do.
    Unless he has that support, that sustained support, we will 
be engaged in another very costly and dreadful Vietnam-like 
venture where the support of the American people vanished. That 
is one question.
    Let me give you one other question, just to conserve my 
time, and then you can answer them as you see fit. My other 
question--well, perhaps you better try that one first.
    Secretary Powell. First of all, Senator Byrd, I could not 
even begin to answer this question without commenting on your 
opening remarks about the IMF Treaty. It is one of the more 
vivid experiences of my career to have been, shall I say, 
taught by you about the Senate's prerogatives with respect to 
treaties.
    I will never forget the meeting you and I and Howard Baker 
had in your chambers 1 day where you made it clear that the 
Senate had to give us advice and consent in a measured way only 
with full information, and I went off to Geneva the very next 
day to get that full information.
    If I may, I will never forget you looking at me and saying, 
``We will not be hurried by any summit meeting that you all 
have scheduled or anything else of that nature. We will do our 
job,'' and the Senate did do its job. And I thank you for that 
guidance and that support at that time.
    To get directly to your questions, the President's words in 
the State of the Union speak for itself. He did not declare war 
on anyone, nor was he saying he was getting ready to declare 
war on anyone.
    In fact, since the State of the Union, he has repeated what 
he had said two times before the State of the Union with 
respect to Iraq, let the United Nations inspectors in to 
determine whether or not you are doing the things we are 
accusing you of, and if you can establish that you are not 
doing these things, then the world will be a safer place and 
you will have dealt with the United Nations.
    We still think, it would be better if someone other than 
Saddam Hussein was running the country. So the President has 
made no decisions, to repeat myself, and there are no 
recommendations on his desk, even though as a matter of 
prudence we should be examining options with respect to all of 
these countries, but in the first instance we are looking at 
diplomatic and political means.
    We have been eyeball to eyeball with North Korea for 50 
years now and trying to make sure that they are contained, this 
regime that is a despotic regime. So I can assure you that the 
President is very sensitive first to the feelings and the views 
and the perspective of the American people, and he is very 
appreciative of the role that Congress plays in such matters. 
And I am sure that if he believes some action is taken or some 
action is required, he will consult with the Congress, and as a 
result of consultation will make a judgment as to how Congress 
should be involved in whatever actions are taken, whether it is 
by declaration of war or a resolution of the Congress 
supporting an action that is taken pursuant to some United 
Nations resolution or through the President's inherent right as 
commander-in-chief to engage the armed forces of the United 
States.
    You will recall what we did at the time of the Gulf War, 
Senator, with the United Nations resolution we then got a 
resolution from both houses. So I am sure the President would 
consult at an appropriate time and determine what he would ask 
Congress to do, and Congress has, of course, its own inherent 
power and right to do what it chooses to do.
    Senator Byrd. Mr. Secretary, I thank you for that response.
    Of course, you and I know that the Constitution does not 
speak about consultations, nor does it refer to United Nations 
resolutions. Those are things that have developed over a later 
time, but the Constitution still says that Congress shall have 
the power to declare a war, and I believe, as I said earlier, 
that if the President is contemplating attacking one or more of 
these countries, I would urge that he not just seek 
consultation, but he seek a declaration of war. And I might 
very well vote for that, depending on the case that is made at 
the time.
    My second question. I may miss this vote, and I do that 
with regret, but I am very appreciative of this opportunity to 
visit with you across the table and chair and to ask these 
questions.
    By the way, I have cast more roll call votes than any 
Senator in the history of this republic, and this is not a 
democracy. This is a republic. But I have cast more votes than 
any other Senator, and it is a long history. So I don't pass up 
a vote easily, but I will in this case if I have to.
    My second question is this. The President's fiscal year 
2003 foreign operations budget request reflects business as 
usual when it comes to United States aid to Egypt and Israel, 
but despite providing roughly $5 billion a year, how the 
Appropriations Committee would like to use that $5 billion a 
year to help some of the States in this country and the people 
throughout this country with some of their problems, $5 billion 
a year in economic and military assistance to the Middle East.
    The conflict between the Israelis and the Palestinians 
continues to worsen. It seems to me that our foreign aid 
dollars to the Middle East, which have no strings attached that 
I know about and are not conditioned on any progress being made 
in the peace process, are being squandered in pursuit of an 
increasingly elusive peace. This question isn't often laid on 
the table as plainly as we are doing right now, but I think it 
ought to be.
    Every year, we appropriate roughly $5 billion to these 
countries, with virtually on questions asked, and they look 
upon it, I think, as an entitlement, almost as an entitlement. 
They, I am sure from what I have read and learned, included in 
their budgets at the beginning of the budget process because, 
as I say, they look upon it virtually as an entitlement. They 
can be pretty sure of it.
    I think it is top time for questions to be asked. As a 
result of the current escalation of violence between the 
Palestinians and the Israelis, the United States seems to be 
increasing its historic tilt toward Israel and abandoning 
attempts to negotiate with Yasser Arafat.
    Given the continued terrorist attacks by the Palestinians, 
it is understandable that we are fed up with Arafat, but I have 
read in the media that even some Israeli reserve soldiers are 
refusing to serve any longer in the occupied West Bank and Gaza 
Strip citing the dehumanizing impact of the occupation.
    Do you have any concern that the perception of a greater 
United States tilt toward Israel could prove, and is proving to 
be, counter-productive by increasing anti-American and anti-
Israeli sentiment in the region, by emboldening hard-line 
Israelis who are opposed to the peace process, and by 
precluding the United States from fulfilling the role of honest 
broker in the peace process?
    I think, Mr. Secretary, that it is time to put some strings 
on our foreign assistance in the Middle East and to condition 
our assistance, to condition our assistance on evidence of 
progress in the peace process.
    I think that would be the axis of my questions. I think it 
is time to condition our assistance on evidence of progress in 
the peace process. We have a tool here. We don't seem to use 
it. Both sides are able to account on a continuation of this 
money every year, it seems to me. It isn't being used as 
leverage, as it should be, in pursuit of the peace process, 
which would be the greatest benefit to both of those countries 
and to our own country and to world peace.
    Yasser Arafat may be unwilling or unable to act on his own, 
but I have to believe that Egypt and Jordan and hopefully other 
Arab nations would apply considerably more pressure on the 
Palestinians if their foreign assistance dollars were at stake, 
and I have to believe that Israel might be more willing to 
discuss the issue of Israeli settlements, which are a real bone 
of contention, in disputed areas if their foreign assistance 
dollars were at stake.
    Mr. Secretary, this is my question. Why shouldn't we 
condition our assistance to the Middle East? Why shouldn't we 
use this tool? Why shouldn't we use this leverage on both sides 
to get them to the peace table and to make them understand that 
this money is just not going to be had there for the asking, 
that they have to produce some evidence, they have to show a 
willingness, they have to act in pursuit of that willingness? 
That is my question.
    Secretary Powell. Thank you, Senator Byrd.
    On the first question, as you know, the roughly 4.6 or 
close to $5 billion that is spent every year for Egypt and 
Israel in FMF and ESF funding, are the result of decisions that 
were made many years ago after the Camp David Accord, and there 
has been a balance between those two, and as a result, we have 
a peace agreement between Egypt and Israel. And as part of 
that, this funding was appropriate to let both sides develop 
and let both sides feel strong as a result of FMF funding which 
allows them to maintain their military.
    With respect to the situation with the Palestinians and the 
Israelis, I must say that Egypt has been enormously supportive 
of our efforts, and Egypt has been applying pressure on 
Chairman Arafat to get the violence under control, so that both 
sides can move forward to achieve the kind of peace that you 
talk about.
    With respect to wheter we should we use Egypt's money to 
pressure them, they are doing what we ask of them now with 
respect to this. They are putting pressure on Mr. Arafat. They 
are one of our strongest interlocutors with respect to how we 
deal with Mr. Arafat. We have not cut Mr. Arafat off. I am in 
touch with his closest associates, and I spoke to him about 10 
days ago.
    With respect to the Israelis, they are under attack from 
terrorist organizations that are linked to the Palestinian 
Authority. We saw the ship come in with 50 tons of military 
equipment that escalated the situation, or would have if it had 
arrived, and to say to them ``we are going to cut your funds 
while you are under these kinds of terrorist attacks unless you 
do something to reward these terrorist attacks,'' is not a 
strategy that I think will be successful.
    The strategy we are trying right now and applying right now 
is to remain committed to the vision of these two states living 
side by side, remain committed to the Mitchell Plan which 
provides a path to get there, and committed to the Tenet Work 
Plan which gets us into the Mitchell Plan, by getting a cease-
fire, by getting the violence down.
    In recent days, I have been in touch, once again, with the 
closest aides to Mr. Arafat, talking about the specific things 
that need to be done, so that we can get the violence down and 
then see an Israeli response because they now are confident of 
moving forward into the Mitchell Plan.
    The Mitchell Plan talks about settlement activity stopping. 
The Mitchell Plan talks about opening closures. The Mitchell 
Plan has everything we need to get the negotiations, 
negotiations which under appropriate U.N. Resolutions 242 and 
338 can lead to a settlement of this crisis and a peace between 
these two sides. But until Mr. Arafat really is able to crack 
down, if he can--and I think he still can. I still think he has 
that authority. People want to push him aside as a leader, but 
he is still the leader of the Palestinian people. They see him 
as such, and he is the elected leader of the Palestinian 
Authority. So I think he has to use his moral authority and his 
political authority to get the violence down, at which point we 
can get into a cease-fire and move toward the Mitchell Plan.
    We are constantly reviewing the level of funding for both 
Egypt and Israel, and there is a determination of how it should 
be allocated between FMF and ESF. We believe they both make 
solid cases to us every year that justifies the allocation that 
we have made to them, and that is the case again this year.
    We have not walked away from this, and we are always 
looking for a means by which we could encourage both sides to 
show restraint, both sides to do everything that is possible to 
get toward a cease-fire and progress into the Mitchell Plan.
    Senator Byrd. Mr. Chairman, I have signaled to the floor 
leadership that I am willing to give up that vote in order to 
have been here to ask these questions of Secretary Powell. I 
gave it up very reluctantly. My attendance record over a period 
of 44 years, my roll call attendance record, is 98.7 percent of 
the time. I wouldn't have done that for many Secretaries.
    Secretary Powell. I am honored, Senator Byrd.
    Senator Byrd. I thank you for your response to the 
question. I hope that there will be increased consideration 
given to my suggestions here as to the use of this assistance. 
It comes. The American taxpayers give up a lot. They give $5 
billion a year to these countries, and there needs to be a 
return on the taxpayers' investment, I believe, to use your 
words, in the Middle East. So I hope that there will be 
increased consideration of using this leverage, and also, Mr. 
Secretary, I hope you will convey to the President that we need 
to use our words with care. Words mean something, especially in 
this context.
    We cannot shoot from the hip if we are contemplating as one 
of the options going into either one of these countries or 
attacking them. This will be a very sobering, somber, serious 
matter, and I would appreciate it if you would tell the 
President about this.
    I am not out to pick on the President. I spoke on the 
Senate floor on Friday about the President and about his speech 
at the National Prayer Breakfast. I have many good things I can 
say about the President, but this is very sobering. Some of the 
words that have appeared to come from the hip from this 
Administration have caused considerable alarm. I don't have to 
tell you that. You sense that, I am sure.
    Secretary Powell. Senator Byrd, thank you.
    I have been through several crises with the President in 
our year together, some big, some small. There was the Soviet 
spy crisis of the early days of the Administration, then the 
Chinese reconnaissance plane, and then what we have done since 
September 11th. I have been through many crises in my career 
with several Presidents. This President does not shoot from the 
hip, and he does not act from the hip. He handles each one of 
these with a clarity of purpose, with patience, with prudence, 
listens to all of the advisors that he has in his 
Administration, and gathers the support of the American people 
and his coalition partners as he moves forward.
    I am sure that as new challenges arise in the future, 
particularly if they arise with these three countries or other 
countries, he will act in a similar manner.
    Senator Byrd. I hope so. Thank you.
    Chairman Conrad. Mr. Secretary, I wanted to ask you, as I 
have indicated before we began, about a comment that was 
attributed to the Attorney General. Cal Thomas, the broadcaster 
and journalist, said the Attorney General told him, ``Islam is 
a religion in which God requires you to send your son to die 
for him. Christianity is a faith in which God sends his son to 
die for you.''
    Yesterday, the Justice Department denied the columnist's 
report, and they said that Ashcroft's statement referred only 
to the views of terrorists and was not aimed at mainstream 
Islam or the majority of Muslims. Certainly, I don't know, and 
I am sure you don't know, what the Attorney General may or may 
not have said. We were not there. So we can't really testify to 
that.
    I would ask you in terms of the quote that is attributed to 
the Attorney General, ``Islam is a religion in which God 
requires you to send your son to die for him. Christianity is a 
faith in which God sends his son to die for you.'' That is 
certainly not the way the Administration would characterize 
Islam. I think the Administration has been very careful, very 
careful to make clear that this is not a conflict with all of 
Islam, that this is a conflict with terrorists, people who 
attack this country in a sneak attack that destroyed the lives 
of thousands of innocent people, but I wanted to give you an 
opportunity here.
    Secretary Powell. Thank you, Mr. Chairman.
    I believe the way the Justice Department responded is 
appropriate. I could see Attorney General Ashcroft suggesting 
that this is what these false leaders say to youngsters to get 
them to commit these terrible acts of violence, and I am quite 
sure that does not reflect his views. He has been in the 
forefront of reaching out to Islamic Americans and others 
around the world to say that this is a campaign not against any 
religion or culture or ethnicity. It is against evil people. It 
is against terrorists.
    I also know that John Ashcroft knows as well as I do, or 
you do, that Islam is not such a religion. It is a religion of 
peace. It is a religion of reconciliation. It is a religion of 
love, not a religion of sending people to die for false causes. 
So I think it must have been out of context, and I think the 
way the Justice Department handled it was the appropriate 
handling of the matter.
    Chairman Conrad. I thank you for it. I should add that 
according to this morning's paper, the Arab-American Institute 
called the remarks offensive and a horrible distortion of Islam 
and sent a letter to the President asking that the Attorney 
General be dismissed if he did not repudiate the statements.
    What would your answer be to the Arab-American Institute? 
Obviously----
    Secretary Powell. I don't know if they had benefit of the 
response of the Justice Department, but such views do not 
comport with my knowledge and friendship with John Ashcroft.
    Chairman Conrad. And they are certainly not the views of 
the Administration. Again, I think the Administration has made 
very clear----
    Secretary Powell. It is a little unfortunate, but those 
views, as put in context by the Justice Department, don't 
reflect the views of John Ashcroft. They reflect views that he 
was attributing to those who would send the young men to their 
death that way.
    Chairman Conrad. Very well. I think that is important to 
get on the record----
    Secretary Powell. Thank you.
    Chairman Conrad [continuing]. And certainly in a timely 
way, and I appreciate your doing that.
    There is another vote on the floor now, and we are not 
going to ask you to stay. You have been very generous with your 
time here today.
    Let me just conclude as I began by saying you do a superb 
job as a witness. You really do.
    Secretary Powell. Thank you, Mr. Chairman.
    Chairman Conrad. And I don't say that to many witnesses, 
but you just do an excellent job making your case.
    I make the case back to you, and I know this is not your 
responsibility in the Administration, but I don't see this 
budget plan as adding up. I really do not.
    If it was just this year, I could be more understanding 
because of the economic slowdown and the war, but we see here 
red ink for the next decade in terms of the non-trust fund 
accounts of the Federal Government. They are not just small, 
but huge, over $2 trillion being taken from the trust funds in 
the President's plan to pay for these other matters, a tax cut 
and other expenditures of the Federal Government. That is going 
to make future choices extraordinarily difficult for a future 
Congress and a future President.
    My own view is if we want to spend this money, we have got 
an obligation to pay for it. This generation just can't send 
the bill to our kids.
    Some people have asked me, why are you so fixed on this? 
Well, I am fixed on it because I have got a daughter. She is 
here in the audience, as a matter of fact, wanted to hear you. 
She has made a special study of Islam, learned Arabic. I know 
that some point down the road, she is going to turn to me and 
say, ``Dad, you were Chairman of the Budget Committee. What 
were you doing when you guys ran up these big debts?'' I want 
to be able to say I confronted it, I said what was going to 
happen and tried to do something about it, and I very much hope 
the Administration will come back with a plan as to how we are 
going to cope with these deficits and debt because I think just 
as it presented a huge problem for the company of Enron, it is 
going to present a huge problem for our country. This money is 
owed. It is ultimately going to be paid, and those that ran up 
the tab, I think, got the obligation to pay it.
    So, with that, again, Mr. Secretary, thank you.
    Secretary Powell. Thank you, Mr. Chairman. I will take your 
message back to my colleagues, and let me take this 
opportunity, again, to thank you for the strong support you 
have provided to the Department. It is very much appreciated, 
and your support of me as well, sir. Thank you.
    Chairman Conrad. Thank you very much.
    [Whereupon, at 11:33 a.m., the committee was adjourned.]











            THE PRESIDENT'S FISCAL YEAR 2003 BUDGET PROPOSAL

                              ----------                              


                      WEDNESDAY, FEBRUARY 13, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 11:19 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Murray, Byrd, Clinton, and 
Grassley.
    Staff present: Mary Ann Naylor, staff director; and Dakota 
Rudesill, analyst.
    For the minority: G. William Hoagland, staff director; and 
Winslow Wheeler, senior analyst.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    First, I want to apologize to the Secretary and Mr. 
Zakheim. There have been a series of votes on the floor, 
unfortunately, starting immediately this morning, and I had 
responsibility for carrying the debate on the first two 
amendments, and all of our colleagues are on the floor because 
of this series of votes. And we apologize very much for that. 
We had to delay the hearing until 10:45, and now here we are at 
11:20 and it has still not begun.
    I understand the Secretary has other obligations at 12:30, 
and we will respect that.
    I also want to indicate that Senator Domenici is again not 
able to be with us today because of health considerations. We 
wish him a very speedy recovery and anxiously await his return 
to the committee and the work of the committee.
    I am going to make a brief opening statement, and then we 
will turn to the Secretary for his statement and then go to 
questions.
    As we meet here today, we first have to acknowledge the 
circumstances that we confront as a Nation. Obviously 
everything changed after the sneak attack on this country of 
September 11th. That altered in a very dramatic way the 
priorities of the Congress and the President.
    We also have an obligation to talk about our long-term 
economic security, and this first chart shows the President's 
budget as his budget numbers describe it, and they show that we 
are going to be in deficit if we exclude the trust funds 
through this entire decade, and that we will be using $2 
trillion of trust fund money to pay for tax cuts and other 
spending. We are doing that right at the time the baby-boom 
generation is getting ready to start retiring. They will begin 
retiring in just 6 years. And so we have to have these 
fundamental facts inform the decisions of the committee.
    The implications of this dramatic turnabout in our budget 
circumstances are these: Last year, we were told we had $2.7 
trillion of non-trust fund surpluses over the next decade. Now 
we are told by the Congressional Budget Office we have $2.2 
trillion of deficits when we put aside the trust funds of 
Social Security and Medicare.
    That means every dime of that deficit is coming out of the 
trust funds of Social Security and Medicare, $2.2 trillion 
taken from those funds over the next decade. Obviously, that 
has major implications for the country.
    When we look to the President's budget and we look at the 
priorities, the funding over baseline--and the baseline is last 
year's spending amount adjusted for inflation, adjusted for 
number of people eligible for the various programs--what we see 
is the biggest increase goes to homeland security, some 23 
percent over the baseline; defense is 10 percent over the 
baseline. Let me make clear, defense is increased more than 
that over last year's spending, but the baseline adjusts last 
year's spending for inflation. And so this is the amount over 
the baseline. And international affairs has a slight increase 
over the baseline. All other domestic programs are reduced 6 
percent.
    Let's go to the next that shows the billions of dollars, 
and, again, this is over the baseline. Homeland security is $5 
billion over the baseline; defense, $36 billion; international 
affairs, $400 million. Everything else is being reduced by $23 
billion from the baseline.
    Now, the next chart looks at it in dollar terms, not in 
relationship to the baseline. This looks at it in dollar terms, 
and we have got a request from the President of $48 billion 
over last year: $10 billion of that is inflation, $5 billion is 
the change to an accrual system, moving from discretionary 
accounts--or from mandatory accounts to discretionary accounts, 
retirement costs of those who are working in defense. There is 
a $10 billion contingency fund and $23 billion of what we would 
call new spending.
    We do not have a supplemental for 2002 from the President. 
This is one of the curious elements of his budget. There is no 
supplemental before us for 2002. There is for 2003, but not for 
2002, and perhaps we can inquire about that today.

    Putting in perspective what we spend on defense, the 
President's request is a total of $396 billion, and if we look 
at that in comparison to the other major nations in the world, 
what we see is we are spending more than the next 18 combined. 
We are spending more than Russia, Japan, China, and the next 15 
combined. So we are making a very substantial commitment to 
national defense.
    Over the 10 years, we see the President requesting, over 
and above the baseline, $656 billion of additional spending for 
defense. This is an extraordinary buildup that puts us back to 
cold war levels of spending, and we are going to have to 
consider very closely how that all fits in with the need and 
the commitment not to take Social Security funds for other 
purposes. We are going to have to consider the other priorities 
of the Nation, the tax cuts that have been previously passed.
    Let me just go to a statement that was made by the former 
Vice Chairman of the Joint Chiefs of Staff, Admiral Owens, on 
February 4th of this year, when he said, ``Return to the 
defense spending heights of the mid-1980's is not necessary to 
win the war on terrorism or to transform our armed forces. In 
fact, it could be quite counterproductive. Availability of such 
large sums of money will reduce incentives to eliminate costly 
redundancies in our force structure tooth, but particularly in 
the tail of defense bureaucracy and support organizations. The 
truth is that we already have all the money for defense we 
need, so long as we undertake real reform and spend it 
better.''
    Well, that is the view of the former Vice Chairman of the 
Joint Chiefs of Staff, who has testified before this committee 
previously, somebody that I think all of us respect. He is a 
military leader who had a significant impact on the 
transformation of our military forces now underway.
    With that, Mr. Secretary and Comptroller Zakheim, thank you 
very much for being here. I especially want to thank you for 
your patience this morning, and we will turn to you now for 
your statements, and then we will go to questions.
    Again, welcome to the committee, and before you start, I 
would just like to thank you on behalf of all Americans for 
what has to have been an extraordinary period since the 
Pentagon itself was attacked, since we lost lives there, since 
the extraordinary decisions that have had to be made. We 
appreciate your service to the country, and we thank you on 
behalf of all Americans for what you have done.
    Mr. Secretary, if you would like to proceed?

STATEMENT OF PAUL WOLOWITZ, DEPUTY SECRETARY, UNITED STATES DEPARTMENT 
 OF DEFENSE, ACCOMPANIED BY DOV S. ZAKHEIM, UNDER SECRETARY OF DEFENSE/
            COMPTROLLER, UNITED STATES DEPARTMENT OF DEFENSE

    Mr. Wolfowitz. Mr. Chairman, since time is short and I know 
you read well, I won't try to go through the whole prepared 
statement, but if I might just sort of summarize what I 
consider some of the high points.
    First of all, to begin with the obvious, the world changed 
in dramatic ways on September 11th, and I think our attitudes 
toward defense changed in dramatic ways. I have to say that for 
those of us who were saying even before September 11th that we 
had to review affordability in light of what we were buying 
with our defense investment, it seems to me that, 
unfortunately, September 11th is a demonstration of the fact 
that these capabilities, while expensive, are a bargain when 
you consider what they buy the country in the long run, and 
that we are indeed investing in peace and security, not just 
for our generation but for our children and grandchildren. And 
it is an investment that we mustn't stint on.
    In the Defense Department today, because of September 11th, 
we are trying to do three things at once: to win the war on 
terrorism, to restore the capabilities of and maintain the 
capabilities of our current force by making appropriate 
investments in procurement, people and modernization, and by 
accelerating the transformation of that force to prepare for 
the challenges of the decades to come to really build the 21st 
century military.
    We can only accomplish that with appropriate investments 
over a sustained period, and we have to do it in an environment 
of rising costs, particularly rising costs for that most 
critical element of the force, our people.
    Mr. Chairman, you, like many others, have made the 
comparison of this budget with budgets of cold war periods. 
Frankly, it depends on which period you pick. There were times 
when I think we clearly underspent during the cold war, and to 
some extent we are now living off the investment that was made 
in the 1980's. But the point I want to make here is that we 
couldn't buy today's cold war forces at those old prices, and 
particularly we couldn't buy the quality people that we need to 
maintain this force, and we couldn't equip and train them 
properly at cold war prices.
    I think the comparison isn't terribly accurate. I believe, 
in fact, it is much more appropriate to talk, as we have been 
talking, about the much smaller burden as a percent of GDP that 
our current budget sustains.
    But as an illustration of those rising costs for people, 
the 2003 budget not only covers--and my number is a little 
different than yours. We can try and see where the difference 
lies. We say $6.7 billion of straight inflation, but another 
$14 billion in ``must pay'' bills for retiree health care and 
pay raises.
    If you add on to that the $7.4 billion to account for what 
we think was unrealistic prior estimates of costs for 
procurement and operation and investment for the war on terror, 
which is $19.4 billion, you actually come to a total of $47.6 
billion. So you can see that even though the President 
submitted a request for a $48 billion increase, a very large 
increase and the largest increase since the early 1980's, we 
have got to dig into current programs and find savings if we 
are going to actually make new investments.
    We have been able to do that. We have made new investments. 
I think we are, in fact, significantly changing the course on 
which the Department of Defense is steering. It is like 
steering a super tanker. You don't turn an establishment of 2 
million people, or 2 million-plus if we count all the 
civilians, overnight. You wouldn't want to. It would be a big 
mistake to try. But I think the Quadrennial Defense Review that 
was published at the end of September, but which was completed, 
largely completed before September 11th, sets a substantial new 
direction for the Department of Defense, one that was the 
product of literally hours of very close discussion and debate 
among the Secretary of Defense and his senior civilian and 
military advisers.
    I mention in the testimony some of the changes: the change 
from the two Major Theater War force sizing construct; the 
emphasis on a capabilities-based approach to account for the 
uncertainties of the future; and, third--and the one that I 
would like to elaborate on just briefly here--the effort to put 
some definition on what we mean by transformation. 
``Transformation'' is a popular word, at least in the defense 
policy think tanks. Lots of people mean different things by it. 
I would like to underscore it can't mean transforming 100 
percent of your force overnight. It means more something like 
transforming 10 percent of it by the end of a decade. But if 
you change that 10 percent, you, in fact, change the capability 
of the entire force, and that is what we aim at doing.
    One of the things we did in the QDR was to define very 
precisely the six highest priority areas of transformation, and 
as one of my coworkers who spent a good deal of time before 
coming to our office working on transformations on the Joint 
Staff said, having that kind of definition is very critical, 
that before that, people come up with a lot of ideas and they 
feel like they are spinning wheels. When you start to say which 
are the ideas that you are most interested in and you start to 
put money behind those ideas, you energize the system in a way 
that I don't think can simply be quantified.
    I am going to try to quantify it here a little bit, though, 
because in every one of the six categories that we have 
identified, we have significant increases in this year's 
budget.
    Overall, we have roughly a $21.1 billion investment in 
programs that, by a pretty strict standard, count as 
transformational programs. I might say that transformation may 
be in the eye of the beholder. If you asked an Air Force 
General, he might say that every dollar spent on the F-22 is 
transformational. We are not counting the F-22 as a 
transformational program, although it certainly transforms the 
way in which we will do air-to-air combat. But by this much 
stricter standard, some $21.1 billion, or 17 percent of the 
total we are spending on RDT&E and procurement, is in these 
transformational initiatives, and that is an increase of 
roughly 25 percent over what was in those programs in the 
previous FYDP. Thirty-five percent is a significant rate of 
increase, and the people working those programs I think realize 
that they are the stars of the Defense Department these days.
    Let me just go through them briefly. Again, you can read 
the statement. The first and highest priority, I think--and 
September 11th only confirmed what we had concluded before 
September 11th--is protecting our bases of operation and 
particularly our homeland. This year's budget not only includes 
$7.8 billion of investment in a refocused and revitalized 
missile defense program, but some $8 billion in support of 
defense of the United States homeland and forces abroad. In 
total, over the FYDP, a $45.8 billion increase in this 
category, and an increase of 47 percent over the previous 5-
year Forward Year Defense Program.
    In addition to that, under the homeland security category, 
there are other things that are funded in the costs of the war, 
particularly combat air patrols over United States cities.
    A second crucial transformational priority and one whose 
importance has been demonstrated very strongly in Afghanistan 
is our capability to deny enemies sanctuary and to do that 
particularly by exploiting new capabilities for a long-range 
precision strike. Some people, I think, thought long-range 
precision strike was just a new synonym for victory through air 
power. But, in fact, long-range precision strike involves 
ground forces as well and might sometimes be primarily ground 
forces. And what we saw in Afghanistan was the remarkable 
combination of very brave United States Army and Air Force 
people on the ground, literally on horseback, on a 19th century 
military capability, calling in strikes from 50-year-old B-52s 
and truly transforming the battlefield and transforming the 
course of the war.
    It is something that could not have been done without what 
modern communications and modern connectivity make available. 
But to a considerable extent, as that example demonstrates, 
transformation isn't just about new systems. It is about using 
old systems in new ways. And when Secretary Rumsfeld was asked 
about this project of bringing the horse cavalry back into 
modern warfare, he said, only half jokingly, ``It's all part of 
our transformation plan.''
    The budget also includes $1 billion to convert four Trident 
nuclear submarines from the cold war mission of delivering 
nuclear weapons to a 21st century mission of conventional 
strike from under the sea. That is truly transformational. It 
was a hard choice. We could have taken that $1 billion and 
built new ships and had a better looking shipbuilding program. 
We think on balance that investment in SSGN is a very important 
and valuable capability.
    And, by the way, to give you the illustration of the fact 
that we are not throwing everything and the kitchen sink under 
the heading of transformation, there is another $1.7 billion in 
this budget that isn't counted as transformational, but that is 
funding for JDAMs and other precision guided munitions that 
are, frankly, critical to making transformation work.
    Just by the stricter definition, we have $3.2 billion in 
programs in this category, an increase of 157 percent--$16.9 
billion of the FYDP, and that is an increase of 157 percent.
    The third category is countering anti-access efforts and, 
forgive me, ``anti-access'' I guess is Pentagon jargon. But 
what it refers to is the very determined effort by those around 
the world who wish us ill or think that they may oppose us at 
some point in the future to figure out to deny us access to 
operating areas, either by attacking our ships on the sea or by 
denying us bases. One of the answers to that is long-range. 
Another answer is stealth. Another answer is the ability to 
deploy ground forces rapidly and in a natural, flexible way. 
The budget requests $7.4 billion in programs in that category, 
$53 billion over the FYDP, and that is an increase of 21 
percent.
    Fourth, and very important, is leveraging information 
technology. That, in the example of the B-52s and horse 
cavalry, is in many ways the key to making that work. And I 
might also take the opportunity to point that transformation is 
also about cultural change. The more you have this ability to 
communicate, the more people's jobs change in dramatic ways.
    I had a briefing not so long ago by an Air Force group that 
included an F-15 pilot. This young woman had to be persuaded to 
not take a rated pilot's job and instead fly a Predator 
aircraft from a location in the United States. I suppose 
Admiral Owens would count her as part of the tail, but I think 
she is definitely part of the tooth.
    It is a whole different view in the Air Force of what a 
career as a fighter pilot can mean, and, believe me, it takes a 
lot of cultural change to persuade a hot-shot F-15 pilot to fly 
a Predator. But it is the kind of thing that we are doing. We 
have to do more of it.
    We are also investing to do that, and this year's budget 
includes $2.5 billion for programs to support this objective of 
leveraging information technology, $18.6 billion over the FYDP, 
and that is an increase of 125 percent.
    Again, there are very important things that are not fully 
covered in that $2.5 billion. Overall, I asked the staff to 
give me a total on what we are investing in command-and-control 
communications infrastructure in the 2003 budget, and the total 
comes to $5.5 billion. And in that total, to me what is most 
exciting is the investment in laser communications. Laser 
communications are a promising although still experimental 
technology that, if successful, would give wideband satellites 
the ability to pass data to each other at speeds measured in 
gigabits per second as opposed to megabits per second, which is 
currently the case. And anyone who knows the difference between 
a dial-up modem and a DSL line realizes that that kind of 
difference is dramatic in terms of what you can do. But beyond 
that, if you want to talk about very complicated, unmanned 
aerial vehicles, especially combat aerial vehicles, unmanned 
aerial vehicles, you have to have that kind of increase in the 
communications backbone.
    Fifth, conducting effective information operations. As we 
become more and more dependent on these very complex 
communications grids, information grids, we have got to be able 
to protect ours, and we have to be able to attack the enemy's. 
The 2003 budget requests $174 million for programs in this 
category and $773 million over the FYDP, an increase of 28 
percent.
    Finally, we identified space as a priority for 
transformation. Space actually played a role in the war in 
Afghanistan, but not a huge role. But space is the ultimate 
high ground, and one of our top transformational goals has to 
be to harness United States advantages in space to enable us to 
see what adversaries are doing around the world and around the 
clock. And in doing so, we must also ensure the survivability 
of our space systems.
    The 2003 budget requests about $200 million to strengthen 
space capabilities and $1.5 billion over the FYDP, an increase 
of 145 percent.
    As I said, the goal is not to transform the whole force or 
to do it all at once. Transformation, as the Secretary said, is 
not an event. It is an ongoing process.
    Let me just note briefly, but by no means to neglect its 
importance, that this budget continues to put its highest 
priority on taking proper care of our people. The budget 
requests $94.3 billion for military pay and allowances. It also 
includes $4.2 billion to improve military housing, putting the 
Department on track to eliminate most substandard housing by 
2007. We are also on track to eliminate all out-of-pocket 
housing costs for men and women in uniform by 2005 by 
increasing base allowance for housing.
    We worked hard to find savings. We are going to continue 
working hard in the future. The Secretary has emphasized that 
``because we are at war'' cannot become an excuse for paying 
for things that we don't need. Indeed, to the contrary, because 
we are at war, we have to take a very hard look at things that 
we don't need.
    In this year's budget, we canceled programs that we felt 
were not in line under the new defense strategy or were having 
difficulties. Those included the DD-21, the Navy Area Missile 
Defense, 18 Army Legacy programs, and the cold war Peacekeeper 
Missile. We also accelerated a retirement of a number of aging 
systems, including the F-14, the DD-963, and accelerated 
retirement of Vietnam-era helicopters.
    Overall, we were able to find some $9.3 billion in program 
savings and program adjustments, and, quite frankly, that is 
why we are able to do serious new investment despite those 
``must pay'' bills that I cited at the beginning of my 
testimony.
    Mr. Chairman, to conclude, let me just say that, yes, this 
is a big budget; yes, this is a big increase. But I think to 
compare it to what we spent in the cold war, as I said, is 
misleading because you can't buy cold war forces, even if they 
were the right ones to buy, and they are no longer the right 
ones to buy.
    It is also misleading, I think very much so, to compare our 
budget to other countries' budgets. We don't fight other 
countries' budgets. We fight their forces. The budget of the 
Taliban would have been a minuscule fraction of what the United 
States has. It was very important that we had the capability to 
deploy forces in a totally unforeseen part of the world on very 
short notice and do it with that kind of effectiveness.
    I think that we do have by far the best military in the 
world. We need the best military in the world. A budget of $379 
billion represents a great deal of money, but when you consider 
just economic costs alone of the September 11th attack and the 
economic importance of being able to prevent future attacks by 
going after the terrorists and taking down those terrorist 
networks, I think the investment is clearly worth it. When you 
consider the cost in human lives and the pain and suffering of 
so many thousands of Americans who lost loved ones that day, I 
think the value is incalculable.
    Quite frankly, since so much of this committee's focus has 
got to be on the long term and on the future of many other 
accounts, I would underscore that I think nothing is more 
important than preserving peace and security for future 
generations. And I believe that this, while a large investment, 
is an appropriate investment for that objective.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Wolfowitz follows:]

 The Prepared Statement of Paul Wolfowitz, Deputy Secretary of Defense

    Mr. Chairman and Members of the Committee: Given the many difficult 
choices with which you are faced, I appreciate the opportunity to 
return to this Committee to help you in your task by addressing the 
2003 defense budget. Since we met last summer, a great deal has 
changed, of course. I look forward to addressing some of these changes 
with you.
    One of the greatest--and gravest--changes was brought by September 
11th--a day that changed our Nation forever. September 11th has taught 
us once again that when it comes to America's defense, we must spend 
what is necessary to protect our freedom, our security and prosperity--
not just for this generation, but to preserve peace and security for 
our children and our grandchildren.
    Today, we are engaged in the enormously preoccupying task of 
fighting a global war on terrorism. As difficult as it is to think 
about other challenges in the middle of waging this war, it is 
essential that we think beyond this great effort if we are to face the 
security challenges and conflicts that are certain to arise throughout 
this century.
    The 2003 Defense Budget request meets the challenges of the current 
campaign as well as other priorities that are essential to ensuring 
that America's Armed Forces can manage the threats and challenges of 
the decades ahead.
    When the cold war ended, the United States began a very substantial 
draw down of our defense forces and our budgets. We cashed a large 
``peace dividend,'' lowering the level of our defense burden by half 
from the cold war peak. Much of that was an appropriate adjustment to 
the great improvement in our security that resulted from the end of the 
cold war. The draw down, however, ultimately went too far.
    While our commitments around the world stayed the same and even 
grew in some cases, our country spent much of the 1990's living off 
investments made during the cold war, instead of making new investments 
to address the threats of this new century. As I discussed with this 
Committee last year, even before September 11th, we faced the urgent 
need to replenish critical accounts. After September 11th, we find 
ourselves facing the additional challenges of accomplishing three 
significant missions at once:
  We must win the global war on terrorism;
  We must restore capabilities by making investments in procurement, 
    people and modernization; and,
  We must prepare for the future by transforming for the 21st Century.
    It will be difficult and demanding to tackle all three of these 
missions at once, but we must do it--and without delay. Even as we 
fight the war on terror, potential adversaries study our methods and 
capabilities, and they plan for how they can take advantage of what 
they perceive to be our weaknesses and vulnerabilities. Now is 
precisely the moment we must begin to build forces that can frustrate 
those plans and provide us with the capabilities we need to win the 
wars of the coming decades.
    We can only accomplish the Defense Department's three missions--
fighting the war on terror, supporting our people and selectively 
modernizing the forces we have now, and transforming our Armed Forces 
for the wars of the future--with proper investments over a sustained 
period. And we must accomplish these missions in an environment of 
rising costs, particularly for that most critical element of the 
force--our people--so vital to our success. The 2003 budget addresses 
``must pay'' bills such as retiree health care and pay raises ($14.1B); 
and other bills such as realistic costing ($7.4B); inflation ($6.7B): 
and the war on terror ($19.4B). Added together, these bills come to 
$47.6 billion. That is why President Bush sent to Congress a 2003 
defense budget request of $379 billion--a $48 billion increase from the 
2002 budget, and the largest increase since the early 1980's.
New Defense Strategy
    The 2003 budget request was guided by the results of last year's 
strategy review and the Quadrennial Defense Review (QDR), both of which 
involved an unprecedented degree of debate and discussion among the 
Department's most senior leaders. Out of this intense debate, we 
reached agreement on the urgent need for real changes in our defense 
strategy.
    I might add that our conclusions have not gone unnoticed. One 
foreign observer reports that the QDR contains ``the most profound 
implications'' of the four major defense reviews conducted since the 
end of the cold war. What is most compelling about this analysis is 
that it appears in a Chinese journal. That Chinese observer thinks the 
QDR's conclusions are important as a blueprint for where we go from 
here--and we think so, too.
    My statement today addresses how the President's budget intends to 
meet this blueprint, shaped by the needs of the environment we face 
today and the environment we could face in the decades to come.
    Among the new directions set in the QDR, the following are among 
the most important:
    First, we decided to move away from the two Major Theater War (MTW) 
force sizing construct, which called for maintaining forces capable of 
marching on and occupying the capitals of two adversaries and changing 
their regimes--at the same time. The new approach instead places 
greater emphasis on deterrence in four critical theaters, backed by the 
ability to swiftly defeat two aggressors at the same time, while 
preserving the option for one major offensive to occupy an aggressor's 
capital and replace the regime. By removing the requirement to maintain 
a second occupation force, we can free up resources for various lesser 
contingencies that might face us and also be able to invest for the 
future.
    Second, to confront a world marked by surprise and substantial 
uncertainty, we agreed that we needed to shift our planning from the 
``threat-based'' model that has guided our thinking in the past to a 
``capabilities-based'' model for the future. We don't know who may 
threaten us or when or where. But, we do have some sense of what they 
may threaten us with and how. And we also have a sense of what 
capabilities can provide us important new advantages.
    Third, this capabilities-based approach places great emphasis on 
defining where we want to go with the transformation of our forces. 
Transformation, as Secretary Rumsfeld has said, ``is about an awful lot 
more than bombs and bullets and dollars and cents; it's about new 
approaches, it's about culture, it's about mindset and ways of thinking 
of things.''
    We identified six key transformational goals that define our 
highest priorities for investments in the 2003-2007 FYDP.

  -First, to protect the United States homeland and forces overseas;
  -Second, to project and sustain power in distant theaters;
  -Third, to deny enemies sanctuary, or places where they can hide and 
    function.
  -Fourth, to protect information networks from attack;
  -Fifth, to use information technology to link up United States forces 
    so they can fight jointly; and
  -Sixth, to maintain unhindered access to space--and protect United 
    States space capabilities from enemy attack.

    We reached these conclusions before September 11th, but our 
experiences since then have validated many of those conclusions, and 
reinforced the importance of continuing to move forward in these new 
directions. The 2003 budget request advances each of the six 
transformational goals by accelerating funding for the development of 
the transformational programs and by funding modernization programs 
that support transformation goals.
    The budget requests $53.9 billion for Research, Development, Test, 
and Evaluation (RDT&E)--a $5.5 billion increase over fiscal year 2002. 
It requests $71.9 billion for procurement--$68.7 billion in the 
procurement title--a $7.6 billion increase over fiscal year 2002--and 
$3.2 billion in the Defense Emergency Response Fund. It funds 13 new 
transformational programs, and accelerates funding for 22 more existing 
programs.
    All together, transformation programs account for roughly $21.1B, 
or 17 percent, of investment funding (RDT&E and procurement) in the 
President's 2003 budget request--rising to 22 percent over the 5-year 
FYDP. Let me discuss the details of the $21.1 billion in each of the 
six categories that follow.

    1. Protecting Bases of Operation/Homeland Defense.

    It is obvious today that our first goal, protecting our bases of 
operation and homeland defense, is an urgent--priority especially since 
we know that both terrorists and state-supporters of terrorism are 
actively looking to build or buy nuclear, chemical and biological 
weapons of mass destruction.
    To meet our objective of making homeland defense the Department's 
top priority, the President's 2003 budget funds a number of programs. 
These include:
  $300 million to create a Biological Defense Homeland Security Support 
    Program to improve United States capabilities to detect and respond 
    to biological attack against the American people and our deployed 
    forces.
  $7.8 billion for a refocused and revitalized missile defense 
    research, testing and procurement program that will explore a wide 
    range of potential technologies that will be unconstrained by the 
    ABM Treaty after June 2002, including:
  $623 million for the Patriot PAC III to protect our ground forces 
    from cruise missile and tactical ballistic missile attack.
  $3.5 million for the Mobile Tactical High-Energy Laser that can be 
    used by United States ground forces to destroy enemy rockets, 
    cruise missiles, artillery and mortar munitions.
  $598 million for the Airborne Laser (ABL), a speed of light 
    ``directed energy'' weapon to attack enemy ballistic missiles in 
    the boost-phase of flight--deterring an adversary's use of WMD 
    since debris would likely land on their own territory.
  $534 million for an expanded test-bed for testing missile intercepts;
  $797 million for sea, air and space-based systems to defeat missiles 
    during their boost phase, which includes the $598 million for ABL.
    The budget invests $8 billion to support defense of the United 
States homeland and forces abroad--$45.8 billion over the 5-year Future 
Years Defense Plan (2003-7), an increase of 47 percent from the 
previous FYDP. In addition, the budget funds combat air patrols over 
major United State cities ($1.2B) and other requirements related to 
this transformation goal.

    2. Denying Enemies Sanctuary.

    The President's budget funds a number of programs to ensure 
adversaries know that if they attack, they will not be able to escape 
the reaches of the United States. As we root out al Qaeda and members 
of the Taliban, it is readily apparent how important it is to rob our 
enemies of places to hide and function--whether it be in caves, in 
cities, or on the run.
    Key to denying sanctuary is the development of new capabilities for 
long-range precision strike, which is not just about heavy bombers, but 
about linking ground and air assets together, including unmanned 
capabilities. It also includes the ability to insert deployable ground 
forces into denied areas and allow them to network with our long-range 
precision-strike assets.
    This is something we have seen in the campaign in Afghanistan. Our 
Special Forces, mounted on horseback, have used modern communications 
to communicate with and direct strikes from 50-year-old B-52s. 
Introducing the horse cavalry back into modern war, as Secretary 
Rumsfeld has said, ``was all part of the transformation plan.'' And it 
is. Transformation isn't always about new systems, but using old 
systems in new ways with new doctrines, new types of organization, new 
operational concepts.
    The President's 2003 budget funds a number of programs designed to 
help us meet our objective of denying sanctuary to enemies. They 
include:
  $141 million to accelerate development of UAV's with new combat 
    capabilities.
    $629 million for Global Hawk, a high-altitude unmanned vehicle that 
provides reconnaissance, surveillance and targeting information. We 
will procure three Air Force Global Hawks in 2003, and accelerate 
improvements such as electronics upgrades and improved sensors, and 
begin development of a maritime version.
    $91 million for the Space-Based Radar, which will take a range of 
reconnaissance and targeting missions now performed by aircraft and 
move them to space, removing the risk to lives and the need for over-
flight clearance;
    $54 million for development of a small diameter bomb, a much 
smaller, lighter weapon that will allow fighters and bombers to carry 
more ordnance and thus provide more kills per sortie;
    $1 billion for conversion of four Trident nuclear submarines into 
stealthy, high endurance SSGN Strike Submarines that can each carry 
over 150 Tomahawk cruise missiles and up to 66 Special Operations 
Forces into denied areas;
    $30 million for advanced energetic materials and new earth 
penetrator weapons to attack hardened and deeply buried targets.
    $961 million for the DD(X), which replaces the canceled DD-21 
destroyer program and could become the basis of a family of 21st 
Century surface combat ships built around revolutionary stealth, 
propulsion, and manning technologies. Initial construction of the first 
DD(X) ship is expected in fiscal year 2005.
    The 2003 budget requests $3.2 billion for programs to support our 
objective of denying sanctuary to America's adversaries, and $16.9 
billion over the 5-year FYDP (2003-7) an increase of 157 percent.

    3. Projecting Power in Anti-access Areas.

    Projecting and sustaining power in anti-access environments is 
another necessity in the current campaign; circumstances forced us to 
operate from very great distances.
    In many other cases, United States forces depend on vulnerable 
foreign bases to operate creating incentives for adversaries to develop 
``access denial'' capabilities to keep us out of their neighborhoods.
    We must, therefore, reduce our dependence on predictable and 
vulnerable base structure, by exploiting a number of technologies that 
include longer-range aircraft, unmanned aerial vehicles, and stealthy 
platforms, as well as reducing the amount of logistical support needed 
by our ground forces.
    The President's 2003 budget includes increased funds for a number 
of programs designed to help us project power in ``denied'' areas. 
These include:
    $634 million for an expanded, upgraded military GPS that can help 
United States forces pinpoint their position and the location of their 
targets with unprecedented accuracy.
    $5 million for research in support of the Future Maritime 
Preposition Force of new, innovative ships that can receive flown-in 
personnel and off-load equipment at sea, and support rapid 
reinforcement of conventional combat operations. Construction of the 
first ship is planned for fiscal year 2007.
    $83 million for the development of Unmanned Underwater Vehicles 
that can clear sea mines and operate without detection in denied areas;
    About $500 million for the Short Takeoff/Vertical Landing (STOVL) 
Joint Strike Fighter that does not require large-deck aircraft carriers 
or full-length runways to takeoff and land.
    $812 million for 332 Interim Armored Vehicles protected, highly 
mobile and lethal transport for light infantry enough for one of the 
Army's transformational Interim Brigade Combat Teams (IBCT). The fiscal 
year 2003-2007 Future Years Defense Program (FYDP) funds six IBCTs at 
about $1.5 billion each.
    S707 million for the Army's Future Combat System a family of 
advanced-technology fighting vehicles that will give future ground 
forces unmatched battlefield awareness and lethality.
    $88 million for new Hypervelocity Missiles that are lighter and 
smaller (4 ft long and less than 50 Ibs) and will give lightly armored 
forces the lethality that only heavy armored forces have today?
    The 2003 budget requests $7.4 billion for programs to support our 
goal of projecting power over vast distances, and $53 billion over the 
5-year FYDP (2003-7) an increase of 21 percent.

    4. Leveraging Information Technology.

    A key transformation goal is to leverage advances in information 
technology to seamlessly connect United States forces in the air, at 
sea and on the ground so they can communicate with each other, 
instantaneously share information about their location (and the 
location of the enemy), and all see the same, precise, real-time 
picture of the battlefield.
    The President's 2003 budget funds a number of programs designed to 
leverage information technology. These include:
    $172 million to continue development of the Joint Tactical Radio 
System, a program to give our services a common multi-purpose radio 
system so they can communicate with each other by voice and with data;
    $150 million for the ``Link-16'' Tactical Data Link, ajam-
resistant, high-capacity, secure digital communications system that 
will link tactical commanders to shooters in the air, on the ground, 
and at sea providing near real-time data;
    $29 million for Horizontal Battlefield Digitization that will help 
give our forces a common operational picture of the battlefield;
    $61 million for the Warfighter Information Network (WIN-T), the 
radio-electronic equivalent of the World Wide Web to provide secure 
networking capabilities to connect everyone from the boots on the 
ground to the commanders.
    $77 million for the ``Land Warrior'' and soldier modernization 
program to integrate the small arms carried by our soldiers with high-
tech communications, sensors and other equipment to give new lethality 
to the forces on the ground;
    $40 million for Deployable Joint Command and Control a program for 
new land-and sea-based joint command and control centers that can be 
easily relocated as tactical situations require.
    The 2003 budget requests $2.5 billion for programs to support this 
objective of leveraging information technology, and $18.6 billion over 
the 5-year FYDP (2003-7) an increase of 125 percent.

    5. Conducting Effective Information Operations.

    As information warfare takes an increasingly significant role in 
modern war, our ability to protect our information networks and to 
attack and cripple those of our adversaries will be critical.
    Many of the programs supporting this objective are classified. But 
the President's 2003 budget funds a number of programs designed to 
provide unparalleled advantages in information warfare, such as $136.5 
million for the Automated Intelligence, Surveillance and Reconnaissance 
System, a joint ground system that provides next-generation 
intelligence tasking, processing, exploitation and reporting 
capabilities.
    The 2003 budget requests $174 million for programs to support this 
objective--$773 million over the 5-year FYDP (2003-7) an increase of 28 
percent.

    6. Strengthening Space Operations.

    Space is the ultimate ``high ground.'' One of our top 
transformational goals is to harness the United States advantages in 
space where we can see what adversaries are doing around the world and 
around the clock. As we move operations to space, we must also ensure 
the survivability of our space systems.
    The President's 2003 budget includes funds for a number of programs 
designed to provide unmatched space capabilities and defenses. These 
include:
    $88 million for Space Control Systems that enhance United States 
ground based surveillance radar capabilities and, over time, move those 
surveillance capabilities into space;
    $103.1 million for Directed Energy Technology to deny use of enemy 
electronic equipment with no collateral damage, to provide space 
control, and to pinpoint battlefield targets for destruction.
    The 2003 budget requests about $200 million to strengthen space 
capabilities--$1.5 billion over the 5-year FYDP (2003-7) an increase of 
145 percent.
    Of course, we cannot transform the entire military in 1 year, or 
even in a decade nor would it be wise to try to do so. Rather, we 
intend to transform between 5-10 percent of the force, turning it into 
the leading edge of change that will, over time, lead the rest of the 
force into the 21st Century. As Secretary Rumsfeld has emphasized, 
``transformation is not an event--it is an ongoing process.''

                       People/Military Personnel

    While we transform for the future, we must take care of our most 
valuable resource: the men and women who wear our Nation's uniform. 
Military service by its nature asks our service members to assume 
certain risks and sacrifices. But, we should not ask those who put 
themselves in harm's way to forego competitive pay and quality housing.
    The President's 2003 budget requests $94.3 billion for military pay 
and allowances, including S. 1 .9 billion for an across-the-board 4.1 
percent pay raise.
    The budget also includes $4.2 billion to improve military housing, 
putting the Department on track to eliminate most substandard housing 
by 2007 several years sooner than previously planned. It will also 
lower out-of-pocket housing costs for those living in private housing 
from 11.3 percent today to 7.5 percent in 2003 putting us on track to 
eliminate all out of pocket housing costs for the men and women in 
uniform by 2005. This represents a significant change before 2001, out-
of-pocket costs were 18.8 percent.
    We stand by our goal of reducing the replacement rate for DoD 
facilities from the current and unacceptable 121 years, to a rate of 67 
years (which is closer to the commercial standard). We have dedicated 
some $20 billion over the 2003-7 FYDP to this end. But most of those 
investments have been delayed until the out-years, when BRAC is finally 
implemented and we will know which facilities will be closed.
    The budget also includes $10 billion for education, training, and 
recruiting, and $22.8 billion to cover the most realistic cost 
estimates of military healthcare.

                              Cost Savings

    We have taken a realistic approach in looking at a number of 
programs, and have found areas where we can save some money. We have 
proposed terminating a number of programs over the next 5 years that 
were not in line with the new defense strategy, or were having program 
difficulties. These include the DD-2 1, Navy Area Missile Defense, 18 
Army Legacy programs, and the Peacekeeper Missile. We also accelerated 
retirement of a number of aging and expensive to maintain capabilities, 
such as the F-14, DD-963 destroyers, and 1000 Vietnamera helicopters.
    We have focused modernization efforts on programs that support 
transformation. We restructured certain programs that were not meeting 
hurdles, such as the V-22 Osprey, Comanche, and SBIRS programs. 
Regarding the V-22, the production rate has been slowed while attention 
is focused on correcting the serious technical problems identified by 
the blue ribbon panel and a rigorous flight test program is to be 
conducted to determine whether it is safe and reliable. The 
restructured programs reflect cost estimates and delivery dates that 
should be more realistic.
    We are working to generate savings and efficiency in other programs 
as well. For example, today, the B-1 bomber cannot operate effectively 
in combat environment where there is a serious anti-aircraft threat. So 
the Air Force is reducing the B-1 bomber fleet by about one third, and 
using the savings to modernize the remaining aircraft with new 
precision weapons, self-protection systems, and reliability upgrades 
that will make the B-1 suitable for future conflicts. This should add 
some $1.5 billion of advanced combat capability to today's aging B-1 
fleet over the next 5 years without requiring additional dollars from 
the taxpayers. These are the kinds of tradeoffs we are encouraging 
throughout the Department.
    We are also proceeding toward our goal of a 15 percent reduction in 
headquarters staffing and the Senior Executive Council is finding 
additional ways to manage DoD more efficiently.
    The budget reflects over $9 billion in redirected funds from 
acquisition program changes, management improvements, and other 
initiatives savings that help to fund transformation and other pressing 
requirements.
    Currently, to fight the war on terrorism and fulfill the many 
emergency homeland defense responsibilities, we have had to call up 
over 70,000 guard and reserves. Our long term goal, however, is to 
refocus our country's forces, tighten up on the use of military 
manpower for nonmilitary purposes and examine critically the activities 
that the United States military is currently engaged in to identify 
those that are no longer needed.
    The Secretary of Defense and the Defense Department have made one 
of the highest reform priorities to put our financial house in order. 
We have launched an aggressive effort to modernize and transform our 
financial and non-financial management systems to include substantial 
standardization, robust controls, clear identification of costs, and 
reliable information for decision makers. Especially key is the 
creation of an architecture that will integrate the more than 674 
different financial and non-financial systems that we have identified.
    Congress's decision to put off base-closure for two more years 
means that the Department will have to continue supporting between 20-
25 percent more infrastructure than needed to support the force. The 
decision to hold up the process another 2 years will be a costly one 
for taxpayers. Additionally, because of the post-September 11th force 
protection requirements, DoD is forced to protect 25 percent more bases 
than we need.
    The 2-year delay in base-closure should not ibe taken as an 
opportunity to try to ``BRAC-proof'' certain bases and facilities. 
Earmarks directing infrastructure spending on facilities that the 
taxpayers of America don't need and that eventually could be closed 
would be compounding the waste that the delay in BRAC is already 
causing.

                               Trade Offs

    Throughout this budget process, we were required to make some tough 
tradeoffs. We were not able to meet our objective of lowering average 
age of tactical aircraft. However, we are investing in unmanned 
aircraft, and in the F-22 and JSF, which require significant upfront 
investments, but will not come on line for several years. While the 
budget proposes faster growth in Science and Technology (S&T), we were 
not able to meet our goal of 3 percent of the budget. And we have not 
been able to fund shipbuilding at replacement rates in 2003 which means 
we remain on a downward course that, if not unchecked, could reduce the 
size of the Navy to a clearly unacceptable level in the decades ahead. 
To sustain the Navy at acceptable levels, the United States needs to 
build eight or nine ships annually. The proposed Future Years Defense 
Plan budgets for procurement of 5 ships in fiscal year 2004, 7 ships in 
2005, 7 ships in 2006 and 10 ships in 2007.

                               Conclusion

    A budget of $379 billion represents a great deal of money. But, 
consider that the New York City comptroller's office estimated the 
local economic cost of the September 1th attacks on New York City alone 
will add up to about $100 billion over the next 3 years. Estimates of 
the cost to the national economy range from about $170 billion last 
year and estimates range as high almost $250 billion a year in lost 
productivity, sales, jobs, airline revenue, and countless other areas. 
The cost in human lives, and the pain and suffering of so many 
thousands of Americans who lost loved ones that day is incalculable.
    The President's budget address our country's need to fight the war 
on terror, to support our men and women in uniform and modernize the 
forces we have, and to prepare for the challenges of the 21st Century. 
This Committee has provided our country strong leadership in providing 
for the national defense and ensuring that taxpayers dollars are wisely 
spent. We look forward to working with this Committee in achieving both 
of these critical goals.

    Chairman Conrad. Thank you very much for your statement, 
and, again, welcome. We are glad to have you here.
    Let me go to your last statement. You indicate the 
importance you attach to the increase that is being sought. As 
I indicated in my opening, the President's budget indicates 
that all of this increase is going to be coming out of Social 
Security funds. Many of us, including the President, pledged 
not to use those funds for other purposes. If there is a 
determination by the Congress and by this committee not to fund 
it in that way, to fund the increase that you are seeking but 
not to fund it in that way, would you support cutting other 
programs that are in the President's budget or making revenue 
adjustments, increasing taxes in order to pay for this 
priority? Is it sufficiently important that it needs to happen 
and so important that you would support cutting other spending 
or raising taxes to get this job done?
    Mr. Wolfowitz. Mr. Chairman, I feel like we have a huge job 
in the Defense Department, not only making our contribution, 
which is a big one, to the war on terrorism, but trying to 
manage this budget, which is a big one, and make hard decisions 
about what to invest in and looking hard to find savings. I 
don't feel that that leaves me the time or the competence to 
make the kinds of decisions that Mitch Daniels has to make and 
the President himself has to make about balancing priorities.
    I appreciate very much the way in which they have found 
what I think are adequate resources for defense, and I know it 
hasn't been easy, and I know it is not easy up here for the 
Congress. I would just say that we in the Defense Department 
very much value the support that we are getting from the 
President and the support we have been getting from the 
Congress. And I am not going to try to venture into terrain 
that I am really not equipped for.
    Chairman Conrad. All right. We will put you down as a duck 
on that question. [Laughter.]
    Chairman Conrad. As we prepare this budget, the President 
has made very strong statements about Iraq and Iran and North 
Korea. Should we be preparing in this budget for conflict, 
military conflict with Iraq?
    Mr. Wolfowitz. Let me say that the $10 billion that we put 
in as a contingency fund for continuing operations into fiscal 
year 2003 really doesn't contemplate a large military conflict 
of the kind you refer to. It is based on what we think is a 
prudent assumption that this war isn't going to be over in 12 
months, that we are going to be continuing operations into 
fiscal year 2003, that we should make some provision for it 
rather than pretend that we are not going to spend any money 
and then come around at the last minute looking for additional 
funding.
    Ten billion dollars is an estimate based on the assumption 
that we continue at roughly the level of operations we have 
been conducting for the last 3 or 4 months, and that $10 
billion at that rate will get us almost halfway into fiscal 
year 2003.
    If those assumptions were different, for example, take the 
case that you hypothesize that we have a major war with Iraq--
and I think a war with Iraq would be a major war--then clearly 
we would have to be back for a different level of funding. But 
there is a limit to how much you can crystal-ball the future. 
We just thought it was appropriate to make some provision for 
the fact that we do think we are going to still be conducting 
an unusually high level of military operations in fiscal year 
2003.
    Chairman Conrad. What about 2002? You have got a 2003 
supplemental, but there is no 2002 supplemental. Does that mean 
you will not be seeking supplemental funds for 2002?
    Mr. Wolfowitz. No, it doesn't. We in effect do already have 
a 2002 initial supplemental. It is what is left over from the 
2001 supplemental that the Congress very helpfully passed and 
very quickly, and Dr. Zakheim can help us through how much of 
that is still left. A lot of it did carry over into this fiscal 
year. But it is only going to carry us for a little while 
longer. We will have to have supplemental funding in 2002 to 
continue operations and----
    Chairman Conrad. Why wasn't that in the budget? It is a 
very curious thing to us. It is a very curious thing. If the 
funds are needed, why wasn't it put in the President's budget 
submission to Congress?
    Mr. Wolfowitz. Because the President's budget submission is 
for fiscal year 2003, and we are now talking about supplemental 
funds for operations in 2002. It is really the same principle 
as what I outlined for the 2003 budget, which is a large enough 
supplemental so that you don't have to come up here at the very 
beginning of the fiscal year asking for supplemental funding. 
But you don't try to have such a large contingency fund that 
you will conduct a war for 12 months without an idea of what 
the circumstances are.
    Chairman Conrad. Do you have any sense of how big the 2002 
supplemental might be?
    Mr. Wolfowitz. We are working very hard on trying to define 
it. And, again, Senator, it is going to be a guess because we 
are talking about a very unpredictable course of military 
operations. We do know that just based on the current level we 
are going to need a supplemental probably before the middle of 
the year. We are going to need supplemental funding passed 
before the middle of the year. And we are working right now on 
what are the most plausible assumptions.
    Ideally, we would like to hit a number that is exactly 
right fiscal year 2002 so that we never have to come back 
again, but we also don't want to be excessive in what we ask 
for.
    Chairman Conrad. Could you give us some range of what that 
2002 supplemental might look like?
    Mr. Zakheim. Well, as the Deputy Secretary just said, it is 
hard to do. We know certain things already, Mr. Chairman. We 
know that in certain categories of the operation we are now 
undertaking, Joint Staff is telling us that they will be 
running out of funds as early as April. That sets a certain 
degree of urgency to what we are doing. But at the same time, 
the earlier we would come in with a supplemental, the less 
likely it is we can accurately predict how things would play 
out between whenever the supplemental is passed and the end of 
the fiscal year.
    So as the Deputy says, we are trying our very best to get 
our arms around just what exactly is needed to maintain the 
current level of operations between whenever the supplemental 
is passed and September 30th. That is, frankly, the reason why 
we didn't send anything up with the 2003 budget because we 
still had to see what were we doing in January and what would 
be doing in mid-February so that we could have the best 
possible estimate and the least possible distortion of what the 
supplemental would look like relative to the operations through 
the end of the year.
    Chairman Conrad. You know, it is unusual, let me just say, 
it is unusual for us to have a 2003 budget submission by the 
President and no 2002 supplemental or no heads-up on what that 
supplemental might look like. But I am not trying to be 
critical here. I understand the difficulties. You are trying to 
get a handle on it. It would be very helpful to us. We have got 
to write a budget, and we have got to try to understand the 
relationships between 2002 and 2003. And--the miracle of cell 
phones.
    It would be very helpful if we could get as soon as 
possible some indication on a range of what that supplemental 
might look like. I have heard--let me ask it this way: I have 
heard that we may be in the range of $20 billion. Does that 
seem in the ballpark, or is that much too low or much too high? 
Can you give us some sense?
    Mr. Wolfowitz. Do you want to take a guess?
    Mr. Zakheim. Sure. I am happy to guess as long as it is 
treated as a guess.
    We know that based on what happened in the congressional 
action on the 2002 budget, we were short $5.5 billion in 
operations and maintenance. That means that given the ongoing 
operation in Afghanistan, you can see that that is almost a 
baseline, if you will. Beyond that, what we are trying to do, 
first of all, is to make sure that what is in this supplemental 
really relates to the war, just like the previous supplemental 
did; and, second, that we bear in mind that we do have the $10 
billion contingency funding that begins on October 1st. And so 
we are really talking about something not for an entire year, 
but for a portion of the year.
    We would hope to get this to the Congress as soon as 
possible once we have our handle on a reasonable estimate, 
precisely for the reason you just gave. You have your regular 
order of business. You have to put a budget together. We 
understand that. We need your support on our 2003 budget, so, 
of course, we are going to try to do it as expeditiously as 
possible. We have to be responsible about the numbers.
    Chairman Conrad. But my question was, and I--that wasn't my 
question. My question was: What are we talking about? I have 
heard $20 billion through the grapevine. Is $20 billion in the 
range or is it way too high? Is it way too low? I mean, you 
must have some idea. Here we are, it is February, we have got 
to write a budget in the next 6 weeks.
    Mr. Zakheim. I am just very hesitant to--it is a guess. We 
will try to get to you very quickly with something that is 
better than a guess. I am very hesitant here in public to put a 
number out that then ultimately, you know, it is too high or it 
is too low, or it will be underbudgeted, it will be 
overbudgeted.
    Chairman Conrad. I am not going to press you further. I 
just say to you it would be very helpful to us if you could get 
us--we really--even a range would be very helpful because 
somehow we have got to try to get all this to add up, and we 
don't have much time.
    Mr. Wolfowitz. I understand that.
    Senator Byrd. Mr. Chairman, would you entertain a 
cumulative question on that point?
    Chairman Conrad. Yes, I would.
    Senator Byrd. Is this supplemental request going to include 
homeland security? Is there going to be a supplemental for 
homeland security?
    Chairman Conrad. Could the witnesses advise us of would it 
be strictly defense or would it be homeland security as well in 
this supplemental?
    Mr. Wolfowitz. I really can't speak for other departments 
or for OMB. I would be surprised if other departments don't 
also have some expenses that aren't properly covered.
    Chairman Conrad. Let me just say that if we could send a 
message to the Administration through you, it is really very 
important not only to this Committee, which must make judgments 
on budgets very quickly--we have a requirement to be done April 
1st, and you can see that we are up against an incredibly tight 
timeframe. It also has very significant impact on the 
appropriators, and the discussions that are going on right now 
between budgeteers and appropriators with respect to division 
of funds, that is a critically important piece, and we need to 
know quickly what the Administration will be asking for.
    Mr. Wolfowitz. We will certainly convey that, and we have 
the same interest you do, because if we don't have a clear idea 
pretty soon of when we are going to run out of money, we are 
going to have to start affecting the way we operate, and that 
is painful.
    Chairman Conrad. All right. Senator Grassley?
    Senator Grassley. I am going to use my time just to make a 
statement, Mr. Chairman.
    First of all, I want to compliment Secretary Rumsfeld for a 
really revolutionary attitude within the Department of Defense. 
And I don't want you to think I am getting soft when I 
compliment a Secretary of Defense. But he said this on 
September 10th last year: ``Every dollar we spend was entrusted 
to us by a taxpayer who earned it by creating something of 
value with sweat and skill. A cashier in Chicago, a waitress in 
San Francisco, an average American family worker works an 
entire year to generate $6,000 in taxes. Here''--meaning at the 
Pentagon--``we spend many times that amount every hour by 
duplication and by inattention. That's wrong. It's wrong 
because national defense depends on the public trust, and trust 
in turn hinges on a respect for the hard-working people of 
America and the tax dollars they earn. We need to protect them 
and their efforts.''
    I think 9/11 wiped out any lingering doubts that any of us 
had about the intentions of terrorists. It is crystal clear 
that they want to kill Americans, and as many as possible. And 
I don't doubt for a second that they will strike again and that 
we have to be prepared for it. We must not allow American 
citizens to live with constant fear that moment of terror will 
come again. This is a threat to our way of life. As Americans, 
we cannot accept that. The terrorist threats must be 
eliminated.
    I think President Bush is doing everything possible to 
restore and maintain our security at home and abroad. And I 
know that the war on terrorism is not going to be cheap. I 
accept that. Right now we have no choice. So I don't want to 
quibble with you and your budget, particularly on the details 
of them, because for winning the war you have to have all of 
our support.
    But I would like to take some time to warn about some of 
the things that Secretary Rumsfeld has alluded to, and that is 
about waste, and I am going to skip two or three pages about 
some history of my involvement with it because I don't think 
that is important right now. So I want to give kind of a 
warning, Mr. Secretary: Find a way to control waste. 
Unfortunately, you have a major obstacle to overcome before you 
can get a handle on waste. You can't begin to control waste 
until you know what things cost, and you will never get a 
handle on costs until your books of account are in order. Every 
shred of evidence that I have examined over the years tells me 
that the books at the Department of Defense are in shambles.
    The gentleman sitting beside you, your chief financial 
officer, I think knows exactly what I am talking about. The 
best barometer on the quality of bookkeeping at the Pentagon 
are the annual audits or the financial statements. The results 
are dismal because of over $150 billion in financial 
transactions for which there is no supporting documentation. 
Criminals could be tapping into your pipeline and you would 
never know it.
    During Secretary Rumsfeld's nomination hearing last year 
before the Senate Armed Services Committee, he was grilled by 
our colleague here, Senator Byrd, about the very same problem. 
As a result of that exchange, Senator Byrd and I cosponsored a 
financial management oversight initiative. It was enacted at 
Section 1009 of this fiscal year's defense authorization bill. 
Having accurate financial information at your fingertips is a 
key to controlling waste, and right now I don't think that the 
Department as it. You need to get it, and Senator Byrd and I 
and others want to help you get there.
    Mr. Secretary, obviously you and your colleagues have your 
work cut out for you. For starters, I think you need to get an 
IG in place, an inspector general in place. With the Pentagon 
money spigot being wide open now to win the warm on terrorism--
we accept that--I think there should be a new IG operating at a 
high state of alert. A 3-year oversight investigation of the 
IG's office tells me that it is not ready today. That office 
has serious management problems. The new IG would need to clean 
house.
    In sum, Mr. Secretary, I am asking you to control waste, 
clean up the books, get a handle on costs, and please don't 
fritter away this golden opportunity to rebuild the armed 
forces. Waste is a constant danger at the Pentagon. Secretary 
Rumsfeld said that in that statement I read from. When we send 
military personnel into harm's way, I want to be confident that 
they have what they need to get the job done, and if you allow 
waste to spin out of control, the troops will be the first ones 
to suffer.
    Thank you. And I would like to put a longer statement in 
the record.
    Chairman Conrad. Certainly that will be done.
    Senator Grassley. Thank you.
    [The prepared statement of Senator Grassley follows:]

            The Prepared Statement of Senator Chuck Grassley

    Mr. Secretary, the 9/11 attack wiped out any lingering doubts I had 
about the intentions of the terrorists. Their intentions are now 
crystal clear: Kill as many Americans as possible. And I don't doubt 
for a second that they will strike again when they think the time is 
right. We must not allow American citizens to live with constant fear 
that moment will come again. This is a threat to our way of life. As 
Americans, we cannot accept that. The terrorist threat must be 
eliminated.
    I think President Bush is doing everything possible to restore and 
maintain our security at home and abroad. I know the war on terrorism 
will not come cheap. I accept that. Right now, we have no choice. So I 
won't sit here today and quibble with the details of your budget. You 
have my support.
    But I want to warn you about waste. Big budgets breed waste, and 
the Pentagon has a world-class reputation for waste and mismanagement. 
Waste is lurking out there in the shadows--just waiting for you to open 
the money spigot. If you fail to keep a lid on waste, support for the 
Bush defense buildup will evaporate quickly. The troops in the field 
will end up on the short end of the stick. And the Senator from Iowa 
will be on your back.
    Mr. Chairman, a little piece of local history might help everyone 
in this room understand where I am coming from. Back in the early 
1980's at the height of the cold war, President Reagan launched a 
massive military military buildup that was fiercely debated in the 
Senate. Mr. Chairman, I want the witnesses to understand that this was 
a defining experience for me. It still shapes my thinking on defense. I 
was convinced--almost from day one--that President Reagan's defense 
Secretary ``Cap'' Weinberger [Cap the Ladle] was bent on throwing huge 
sums of money at problems better solved by structural reform and some 
real leadership. So I did what I could to stop it.
    As a conservative Republican, this was not easy to do. But I did it 
because it was right. And I ll do it again if I have to. I offered an 
amendment to freeze the defense budget. That was on the fiscal year 
1986 budget resolution. My amendment was adopted on May 2, 1985.
    That act alone threw a monkey wrench into the last big plan to ramp 
up the defense budget. But more than anything else, it was the spare 
parts honor stories in the early 1980's--the $750 pair of pliers, the 
$750 toilet seat, and the $7,000 coffee pot--that changed my thinking 
on defense forever. The spare parts horror stories were a turning 
point. They convinced me that the Pentagon's defense buildup was a 
colossal taxpayer rip-off. They undermined the credibility of the 
planned defense buildup and turned me into a defense reformer. They 
drove me to watchdogging, digging into waste, fraud and abuse at the 
Pentagon. And I am still at it today, and I will be at it again 
tomorrow.
    So, that is my warning to you, Mr. Secretary: Find a way to control 
waste. Unfortunately, you have a major obstacle to overcome before you 
can get a handle on waste. You can't begin to control waste until you 
know what things cost. And you will never get a handle on costs until 
your books of account are in order. Every shred of evidence I have 
examined over the years tells me your books are in a shambles. Your 
Chief Financial Officer--Mr. Zakheim--who is sitting next to you knows 
exactly what I am talking about.
    The best barometer on the quality of bookkeeping at the Pentagon 
are the annual audits of your financial statements. The results are 
dismal because of over $150 billion in financial transactions for which 
there is no supporting documentation. Criminals could be tapping into 
your money pipe, and you would never know it.
    During Secretary Rumsfeld's nomination hearing last year, he was 
grilled by Senator Byrd about the very same problem. As a result of 
that exchange, Senator Byrd and I co-sponsored a financial management 
oversight initiative. It was enacted as Section 1009 of the fiscal year 
2002 defense authorization bill. Having accurate financial information 
at your fingertips is a key to controlling waste, and right now you don 
t have it. You need to get it, and Senator Byrd and I want to help you 
get there.
    Mr. Secretary, you have your work cut out for you. For starters, 
you will need a junkyard dog. You need to get your IG nominee in place. 
With the Pentagon's money spigot wide open, I want the new IG operating 
at a high state of alert. A 3-year oversight investigation of the IG's 
office tells me that it is not ready today. That office has serious 
management problems. The new IG will need to clean house.
    In sum, Mr. Secretary, I am asking you to control waste. Clean up 
the books and get a handle on costs. Please don't fritter away this 
golden opportunity to re-build the Armed Forces. Waste is a constant 
danger in the Pentagon. When we send military personnel into harm's 
way, I want to be confident that they have what they need to get the 
job done. If you allow waste to spin out of control, the troops will be 
the first ones to suffer. And I will be on your back.
    Question?
    With the Pentagon money spigot wide open, how will you control 
waste? What exactly will you do?

    Mr. Wolfowitz. Senator Grassley, if I could make three 
points very quickly, and I know Dr. Zakheim has some things to 
add. First of all, we feel as strongly about waste after 
September 11th as we did when the Secretary made that statement 
on September 10th. And he has repeatedly emphasized to people 
that the spigot isn't open, that now that we are fighting a 
war, waste is even more costly. I believe that it is a 
responsibility that lies with the Congress as well as with the 
Administration, and I can't help but register my unhappiness 
that the BRAC was delayed another 2 years. We are now spending 
some $4 billion to $5 billion in enhanced security for bases 
some 20 percent of which we don't need anymore. We need to do 
our work. We need cooperation from the Congress.
    Second, if I could appeal--because you are absolutely right 
about the IG. Now finally, I think our nominee has cleared both 
the Committees that have to review him, and we would appreciate 
speedy confirmation.
    Finally, on the very important point about financial 
management which you raised just now, and which I know Senator 
Byrd raised at length with the Secretary in his confirmation 
hearings, we have taken that message very seriously. I think we 
have invested money and time in trying to work at that problem. 
It is still pretty awful, but there is a lot of improvement, 
and I might ask Dr. Zakheim to hopefully talk more about the 
improvement, please, Dov.
    Mr. Zakheim. OK, sure. Senator, and Senator Byrd, I assured 
you both that this was going to be as high a priority for me as 
just getting a budget out the door, which has tended to be the 
way some of my predecessors looked at financial management as 
somehow second-order priority.
    We have done a number of things. I shook up my front office 
for starters. I have a new acting deputy chief financial 
officer. But more important than that, we have made some 
significant changes already in terms of how we are approaching 
the problem, both in the short term and in the long term.
    For instance, in the short term, we have set up new 
training courses for dealing with reconciliation with the 
Treasury books. There are people that actually know how to do 
this sort of thing, which many of them didn't. We are 
encouraging the Society of Military Comptrollers to get more 
people for training. Our people aren't as well trained as they 
should be, and we have certain limitations from OPM as to how 
we set up professional requirements for people that, quite 
frankly, I feel hamstrung, but within those limitations we are 
doing quite a bit more.
    We went to the Defense Contract Accounting Office, DCAA, 
our auditors, in effect, have--another part of my office that 
had never talked to the Financial and Accounting Service, and 
yet they were able to increase the level of competence of their 
people and I got them talking to each other, and DFAS has 
picked up on some of their changes.
    The standards for accounting, for years the Department of 
Defense resisted accounting for major end items. I did a 
complete 180 and instructed my staff to agree with the Federal 
Accounting Standards Board that we should indeed have valuation 
for major end items which then would show up on the balance 
sheets, and they will for the first time. This was a reversal 
of 10 years of absolute stonewalling by the Defense Department. 
I came in from business. I couldn't understand how you couldn't 
value assets.
    We have established, as I promised we would, a Business 
Practice Implementation Board, all people from the outside, 
from banking, from business, to come in and tell us what we are 
doing wrong, what we should be doing better. I have the 
Comptroller General of the General Accounting Office as ex 
officio on that board. I invited him. I have the Comptroller of 
OMB ex officio on that board.
    We are reaching out to the folks who have criticized the 
Department for years and said to them, OK, we are making the 
change, help us do it. Help be part of the solution, not part 
of the problem.
    I would also add that on acquisition----
    Chairman Conrad. Let me, if I could just ask that--we have 
got three Senators left, and you guys want to be out of here by 
12:30.
    Senator Grassley. I thank you all very much, and thank you, 
Mr. Chairman.
    Chairman Conrad. I thank the Senator for his excellent 
questions. The Senator from Iowa has been very dedicated to try 
to make certain that there is not waste and that we straighten 
up the financial management, and we recognize his 
contributions.
    Senator Murray.
    Senator Murray. Thank you, Mr. Chairman.
    Mr. Secretary, I believe that our fight against terrorism 
and homeland defense are inextricably linked, and to me one of 
the most obvious examples of this linkage is the question that 
is pending before the Department of Defense right now regarding 
the deployment of National Guard personnel to assist with 
security missions along our Northern and Southern borders.
    As you probably know, late last year Attorney General 
Ashcroft announced that the Federal Government would send the 
National Guard to our borders to supplement agents from the INS 
and Customs. In my home State, this news was met with an 
enormous relief because it had a serious impact on our borders 
with the lack of personnel. It has had an impact on our 
communities, their economies and families, and we were relieved 
to hear that.
    But since that announcement, the Federal Government has 
made very little progress toward actually deploying these 
National Guard personnel, and I understand the legal and 
organizational challenges when we are attempting to determine 
how to best deploy National Guard assets. But I want you to 
know that every day spent negotiating the fine print of an MOU 
is another day of gridlock and economic hardship for border 
communities across our country, but particularly in Whatcom 
County in my home State.
    Now, I know that the Department of Defense is very close to 
having in place MOUs with the Department of Justice. I think 
there is some work to be done with the Department of Treasury. 
But my question to you today is: Will you authorize the 
immediate training of National Guard personnel for the upcoming 
border missions? We want to do everything we can to speed the 
deployment, and it seems to me that if we begin the training 
immediately, that will be one way to get this moving quickly. 
Can you authorize that?
    Mr. Wolfowitz. Senator Murray, I don't know whether we can 
authorize it absent the memorandum of agreement. But I agree 
with you that those should get done and done quickly, and I, in 
fact, spoke with people just yesterday about my frustration 
that it is taking so long.
    I will look into the question of whether we could start the 
training in advance of the MOA's. That would make a lot of 
sense if we can speed up the process.
    Senator Murray. I would really appreciate it, and if you 
have the authority to waive them, if you can do that and move 
this along, we would greatly appreciate it. It is needed. If 
you don't, if you can tell us what we can do to make that 
happen or if the Secretary of Defense or Director Ridge or the 
President can do anything, we need to get this done and we need 
to get it done as quickly as possible. And the training, we 
don't want that to be a barrier to getting those folks out 
there.
    Mr. Wolfowitz. I guess I would also appreciate any help you 
can give us on making sure that those other departments start 
recruiting and training their own people because this is meant 
as a 6-month stop-gap until they have their own people. So both 
pieces of training need to get going, and going quickly.
    Senator Murray. I would agree. What we all want is the INS 
and Customs to have their own people in place. But in the 
meantime, we have tremendous economic hardship because we don't 
have enough people to do the job we are requiring them to do 
for homeland defense.
    I know that the MOU's are talking about 179 days. Can you 
tell me what the rationale on the 179 days is?
    Mr. Wolfowitz. Principally that that is the period of time 
for which we call up National Guardsmen and Reservists, and it 
seemed like a reasonable period of time for the INS and other--
I mean, I don't think we should start thinking of the men and 
women who volunteer to serve their country in uniform as just 
being a readily available pool of manpower. They are not.
    Senator Murray. And I would agree with you. But defending 
our borders is something that we need to do.
    Mr. Wolfowitz. We are going to step up to our piece of it, 
and it is very important, particularly when we look at the 
kinds of budget demands on this Department, it is very 
important that other agencies not just leave us holding the bag 
indefinitely.
    Senator Murray. Well, I would agree, but I hope we can work 
with you if we have to extend it beyond 179 days. I mean, our 
whole goal here is, of course, to fully staff Customs and INS. 
That is an appropriations and a budget issue as well. But if we 
can't, I hope we can work with you to make sure that the border 
is staffed and appropriately done so if it goes beyond 179 
days.
    And let me ask you about the reimbursement because I know 
that is one of the key issues that is holding things up. It is 
temporary, but it is a Federal responsibility, and I hope we 
don't let disputes over reimbursement prematurely end this 
deployment. And I hope the Department of Defense encourages the 
President to request supplemental funds for this mission, 
particularly if it goes beyond the 179 days.
    Mr. Wolfowitz. I will check into that.
    Senator Murray. OK. I would appreciate that. Again, Mr. 
Secretary, I can't emphasize enough the importance of this 
issue to my constituents and really to people all along the 
Northern border. It is a very real Federal issue, and it is 
having an enormous impact on our border communities. You know, 
it is not a debate among military lawyers in my State. It is 
about people who are losing their jobs and their livelihood and 
our communities losing our tax bases. And we have got a lot of 
people who are waiting to see if the Federal Government is 
going to follow their commitment on this.
    Mr. Wolfowitz. Well, I appreciate hearing that from you, 
and it may help us clear away a little bit of the bureaucracy. 
It is important.
    Senator Murray. Good. I hope so, if we can get it done 
quickly. Thank you.
    Mr. Wolfowitz. Thank you.
    Chairman Conrad. Senator Byrd.
    Senator Byrd. Thank you, Mr. Chairman. And I thank you, Mr. 
Secretary. On several occasions today, you have suggested that 
it is your hope that the Congress will support your budget, 
that you would need Congress' support. And as one who has been 
here 50 years, I have seen Congress giving the Defense 
Department support. Over these 50 years, we fought a cold war 
during which Congress provided the wherewithal needed to wage 
that cold war, and eventually that cold war was won through our 
efforts.
    So when you keep referring to the need for congressional 
support, remember, it is a two-way street. And the Chairman has 
just a minute ago brought forth--and no one answered--the two 
questions, the accurate responses to which this Committee 
vitally needs. So let's phrase that as a two-way-street 
approach. We need your support in helping us to understand what 
we are going to be asked for and when. We can't just give you a 
blank check. We can't just say, yes, you will have our support. 
We were elected by the people, and we will need your support 
and getting these answers to us so that this Committee can do 
its work.
    Let me raise again the question concerning the big budget 
that has been presented to the Committee. Here we are being 
asked for a 15 percent increase for defense over last year. And 
last year we provided a 10 percent increase over the previous 
year. And we are being told that domestic discretionary 
spending is going to be limited to a 2 percent increase, 
generally speaking. We are being asked for a budget that 
amounts to more than $1 billion a day. That is a big number.
    And we are also being asked for a $10 billion fund that I 
suppose it is expected, we will be expected to say yes to that 
without knowing more about the details. I am a little reluctant 
to go down that road without more information than we have.
    About 6 or 8 months ago, I talked with Secretary Rumsfeld--
or maybe it was a lot longer ago than that--about the fact that 
in the defense budget the Defense Department could not account 
for, I think it was, $3.5 trillion out of a $7.6 trillion 
account. And Secretary Rumsfeld indicated he was going to try 
to get to the bottom of that, and he has tried. I think 
Congress has provided the Department's request for $100 million 
to tackle this serious accounting problem.
    I want to say again that Secretary Rumsfeld was disturbed 
about that. It didn't happen on his watch, but he indicated he 
was disturbed, and he was going to do something about it. And 
he has been working on that. So I compliment him.
    Can you tell us how this $100 million is being used? And 
will you need more in the fiscal year 2003 budget?
    Mr. Wolfowitz. Let me ask Dr. Zakheim to answer that 
specific question, but I would like to say very clearly, 
Senator Byrd, I don't know what I said that left a different 
impression. I believe we have had outstanding support from the 
Congress in this war and over decades, and I am not trying to 
flatter you. I know you personally have been a great supporter 
of the Defense Department. I didn't mean to imply anything 
other than the fact that I think we are in this together. We 
have had great bipartisan support, and we need to keep it up. 
And when it comes to difficult decisions that involve cutting 
out things that we don't need to do anymore, that is often a 
special problem up here because it may be something that we 
don't need to do anymore, but it involves jobs and involves 
closing bases.
    I in no way meant to say we know what--that we have any--I 
think it is just an outstanding relationship, and I could not 
be happier with the support we have had from the Congress over 
the last few months since September 11th.
    Senator Byrd. Thank you.
    Mr. Wolfowitz. On the specific issue of the $100 million, 
let me ask Dr. Zakheim to address that.
    Mr. Zakheim. Very briefly, Senator, what we are doing with 
that is creating a blueprint that will guide the way we invest 
in the future. You are absolutely right, huge sums of money 
unaccounted for. Part of the problem is that our systems are 
too numerous and too old and don't talk to one another. We have 
already catalogued them, 674 of them. So there is room for so 
much in the way of error, and, frankly, our civil servants are 
very honest. But, boy, is there room for fraud, Senator.
    So we are trying to clean that up. We are using the money 
for that. We are asking for an additional $97 million this 
year. It is going to take time and money. But we do have a 
blueprint, and we will be happy to brief you, either directly 
or for the record, to give you more details.
    Senator Byrd. Well, thank you. If the Defense Department 
can't account for $3.5 trillion--and I think there is a more 
recent report on that. For example, the Department of Defense 
Inspector General reported in September that out of $4.4 
trillion worth of accounting interest--now, this is a later 
report, you see. Out of $4.4 trillion worth of accounting 
interest processed by the Department, $1.1 trillion were not 
supported by proper research, reconciliation, or audit trails.
    Now, if the Department of Defense can't account for these, 
can't account for this huge inventory that it has, doesn't know 
where the pieces are, what pieces are there, what pieces are 
missing, how can the American taxpayers expect the Department 
of Defense to spend and increase budget of the kind that is 
being presented to this Congress? There needs to be better 
accounting. We have talked about this before. You are trying. 
But this is our problem, too. How can we go forward and 
appropriate these huge increases in the defense budget while 
letting many other important policies and budgets throughout 
the Government be starved of funds, in some cases reduced? How 
can we be expected--what do the taxpayers of America expect us 
to do?
    We need answers to these questions. Here we are presented 
with a huge budget, and I also can remember when Secretary 
Rumsfeld was before the Committee, and I complimented him on 
this review that he was beginning, the review of the current 
systems in the Defense Department. I complimented Secretary 
Rumsfeld. I said I think you are doing the right thing. There 
are too many rivalries between and among the branches. There is 
too much overlapping. So go to it. Let's have this kind of 
review.
    Well, the review started. It was going forward. It has been 
delayed. But then came September 11. I don't know what happened 
to that review. I am wondering whether or not the Deputy 
Secretary could tell the Committee at this point--perhaps he 
may need a while to collect his thoughts and his facts, and he 
may to followup on this question for the record. But what among 
the old systems did that review indicate should be changed or 
should be perhaps ended? It seems to me that when September 
11th came, the review stopped, and as I look at the increased 
budget request for defense, I wonder if we aren't still going 
pell-mell down the same old road, supporting the same old 
systems that were intended for the cold war, which was won, and 
then we are not going to have the benefit of the transformation 
that the Secretary was expecting to be able to recommend.
    Mr. Wolfowitz. Senator, I think actually you came after my 
opening statement. We have, I think, a number of ways of 
identifying the results of that review, and the Secretary is 
very determined to continue down that road. He does have his 
hands full playing his role in managing the war, but he has 
kept the pressure on about transformation. He has kept the 
pressure on about looking for savings. He has kept the pressure 
on about not simply insisting on increases in manpower, 
although there are definitely increases in what we are asking 
the military to do today. And he has put a lot of emphasis on 
working on cleaning up that backlog that you correctly pointed 
to in his confirmation hearing.
    Many of those are, I think technical issues that can be 
cleared up, where it is not a matter that no one has any idea 
what the money went to, but that the documentation hasn't been 
assembled properly. My understanding is it is an embarrassingly 
large number, but it is now down below $1 trillion. It is $700 
billion. And Dr. Zakheim is working on bringing it down 
hopefully as fast as possible and to build new systems so that 
we don't start accumulating another large backlog of that kind.
    But you are absolutely right that this is hard-earned 
taxpayer money and we better be able to explain where it goes. 
And it should----
    Senator Byrd. Mr. Chairman, do I have time for another 
question?
    Chairman Conrad. You do, sir.
    Senator Byrd. I thank the Chairman.
    Mr. Secretary, there are a couple or three questions I 
would just ask, and I know we don't have time for you to answer 
them, but there is one I want to get into a little bit. One of 
those questions I would like to delve deeply into is with 
respect to the $10 billion reserve fund. This is, in effect, a 
request for Congress to write a very large blank check to the 
Pentagon. For the moment, I will put that question aside, and 
we will have opportunities when we have hearings in the 
Appropriations Committee.
    Another question I would like to develop but won't have 
time for here is the matter of having this four-star general 
for homeland defense. This is a matter I would like to go into 
at another time. Perhaps I won't have the opportunity here, but 
there will be other forums.
    The one thing I would like to touch upon is a question 
which I touched upon yesterday with Secretary of State Colin 
Powell. And I read a story in the New York Times this morning 
about our policy toward Iraq. The article says that over the 
next 3 months the President will make a big push to get U.N. 
weapons inspectors back into Iraq, and they really expect 
Saddam Hussein to throw up the same roadblocks that led to the 
expulsion of the inspectors in 1998. The article goes on to say 
that the President will use this as justification to pursue 
more forceful action against Iraq.
    Now, I don't shed any tears for Iraq, and I don't have very 
much sympathy for the regime there and for the way it forced 
the expulsion of the inspectors. And so it might be that there 
will come a time when a good case could be made for an attack 
against Iraq. I am led to believe by my reading between the 
lines that this Administration is considering an attack as one 
of the options. It hasn't been reduced to a full plan yet, nor 
has it been reduced to a ``recommendation on the President's 
desk.'' But apparently this is being discussed.
    There have been some statements, I think, that have not 
been overly carefully worded in meetings with the 
Administration with respect to Iraq and Iran and North Korea. 
When you talk about Iraq, especially, and North Korea, we are 
talking about huge land forces. This would be a major 
undertaking, I am sure, if we ever start down that road.
    What I am saying is I hope that this Administration will 
keep in mind that there is still a Constitution around these 
days, and I hope that this institution here, we in the 
Congress, both Houses, will keep in mind that there is still a 
Constitution. Anyway, we all want to join with the President 
and his desire to seize these terrorists and to bring them to 
justice. We join with him in that. But words do matter. Words 
do have consequences.
    I notice that the expression concerning the ``axis of 
evil'' resulted in Iran in huge crowds in the millions going 
into the streets yesterday to protest the use of these words. 
And whereas there seemed to have been a moderate group in Iran 
that was beginning to emerge, I would hope we would be careful 
in what we say. I think we Senators have to be careful, too. 
That goes with the territory.
    But when it comes to attacking any one of these states, I 
would hope the Administration would be prepared to make this 
case to the Congress and to the American people and to keep in 
mind the eighth section of Article I of the United States 
Constitution which gives Congress the power to declare war, to 
raise and support armies, to provide and maintain a Navy, 
because without the support of the people behind a venture of 
that dimension, the President would soon find himself on pretty 
thin ice. We found out about that in the Vietnam War. The 
President did not have the support of the people for the 
prolonged effort that that was becoming, and we saw what 
happened.
    I hope that this Administration--and you are part of it, 
and you would have a big voice in it, and your voice will be 
needed, too. And I hope that this Administration keeps in mind 
that it cannot go it alone. If it starts down that road, 
actually, of a war with a State, a sovereign state, it will 
need the support of the Congress. And it will need it at 
takeoff as well as on the landing. And the American people have 
to be behind it, and the way to have the American people behind 
it is to come forth to the American people and make the case 
and ask the Congress for a declaration of war. And I maybe will 
vote for that if a case can be made for it. I may not. But I am 
thinking, one, there is a country here or there that I might do 
that at a given time. But it is certainly needed that Congress 
cannot be just a silent partner that is consulted. The 
Constitution doesn't say anything about ``consultation.''
    So take that, think about it, if you will, and as you are 
within the high councils of the Administration and pondering 
these deep matters, consider the fact that there are some 
people up on the Hill who have been elected by the people, and 
there is a Constitution.
    And what would you think? Do you think if we venture into a 
situation like that the Administration should have a 
declaration of war? I am talking about an attack on any one of 
these ``three evil states.''
    Mr. Wolfowitz. Senator, I am in the medium-level councils, 
and I take very seriously everything you have said. I think we 
are talking about the gravest possible issues, and they are 
deep constitutional issues.
    I would point out--and you have already said it--there is a 
bit too much loose talk on the subject. I don't want to add any 
embellishments of my own. I think what the President did do was 
to identify three countries that pose serious problems for us 
because of the nature of their policies and the capabilities 
they possess. And I think it gives an opportunity--I have said 
this to some of our allies, who say as though he went from that 
to immediately deciding what to do, I think it is an 
opportunity for a debate, for registering the kind of 
fundamental points that you have just registered. I don't think 
he meant it all, but because they share those common 
characteristics that, therefore, you have the same policy for 
all three of them. I don't think he has drawn conclusions on 
any of them about exactly what to do. But I think we would all 
agree that countries that are hostile to us and that are 
developing weapons capable of killing hundreds of thousands of 
people are a serious problem, and that it seemed a bit 
theoretical before September 11th. It is not theoretical at 
all, anymore, and I think that is the important point.
    Senator Byrd. But let's all keep in mind that diplomacy, 
diplomacy, diplomacy, might and patience, along with 
preparations, might save us from having to use the weapons of 
war.
    I thank you, Secretary. Thank you, Mr. Chairman.
    Mr. Wolfowitz. Thank you, Senator Byrd.
    Chairman Conrad. Thank you. And I would say to the Senator, 
West Virginia always has wise advice.
    Let me just say this to you: We are together. And no 
adversary should doubt that Congress stands shoulder to 
shoulder with the President and this Administration on this 
question of combating terrorism. And I hope it is very, very 
clear that we are going to provide the resources necessary to 
defend this Nation.
    At the same time, we have got an obligation and you have an 
obligation, the Administration has an obligation to use the 
funds entrusted to us carefully. And when I look at the out-
year effect of the President's request, as we look at it, the 
is asking for, when inflation is considered, the largest amount 
of money in the year 2012 for defense that we have had in any 
year in 50 years, with the exception of 1985. That is a lot of 
money.
    I think we are going to have to as a body look very 
carefully at the long-term impact of what is being recommended. 
But I want to make it very clear to anyone who is listening 
that we are going to stand very clearly with this President and 
this Administration in prosecuting this war against terror. Let 
there be no doubt that the resources to defend this Nation are 
going to be provided by this Congress and certainly by this 
Committee.
    Again, we thank you----
    Senator Byrd. Mr. Chairman, would the Chairman allow me 
just a postscript?
    Chairman Conrad. Certainly. I just would alert the Senator 
that we are now down to seven and a half minutes on a vote.
    Senator Byrd. OK. I thank you.
    Let me also join the Chairman in reassuring the Secretary, 
I hope I didn't say anything that would leave any doubt as to 
where I stand. I have pretty good credentials when it comes to 
supporting the defense of this country. I was fighting 
communism a long time ago, 50 years ago, when I came here, when 
I started. I was very opposed to the entry of Red China into 
the United Nations. I supported Mr. Johnson in the war in 
Vietnam. I was practically the last man out of Vietnam. I 
offered an amendment in the Senate to express support for 
President Nixon in his attacks on the Viet Cong enclaves in 
Cambodia that were allowing men to slip across the border of 
South Vietnam to kill Americans. And I offered an amendment 
which my own majority leader--I was the Democratic whip at that 
time. I offered an amendment which my own then-majority leader, 
Mr. Mansfield, for whom I have great respect for his 
patriotism, opposed. But I offered it, saying that the 
President has a duty to do whatever it takes to get our boys 
back home, to keep them safe. I lost on the amendment because I 
was--I couldn't beat my own majority leader and the others, 
Frank Church and so on.
    So I have a good record of support. I have been on the 
Appropriations Committee now for 50 years, too. And I think I 
voted for almost every weapons system that ever came down the 
pike. I have been on the Armed Services Committee with Senator 
Russell and Senator Stennis when they were chairmen. So I have 
good credentials on that.
    But I tell you one thing else. I am alarmed by, I am 
concerned about some of the things that are being said and the 
words that are being used by this Administration in so high 
places. And I just want the Administration to just--I just want 
to call its attention to the fact that there is a Constitution 
and that unless the American people through their elected 
representatives are in the takeoff, no President can sustain a 
prolonged conflict if the American people go sour. These are 
the things I am asking.
    Mr. Wolfowitz. I appreciate it, Senator. You have a long 
memory. I think you have known some of the people who have 
underestimated the will of this country in the past. One of my 
favorite quotes is one from Churchill's memoirs where he 
describes his feelings on December 7th or December 8th, right 
after the attack on Pearl Harbor, and he says, ``I can't 
conceal the fact I was overjoyed at this'' because it meant the 
United States was in the war. And he said it reminded him of 
what Earl Grey, the British Foreign Minister at the time the 
Americans entered World War I, had said to him. He said, ``The 
United States is like a gigantic boiler, and once you get the 
fire lighted, there is no estimating the power it can 
generate.''
    I think these terrorists will be added to the list of 
people who underestimated the strength and will of this 
country, and it comes from our Constitution and this 
constitutional system. And we will work with you in 
strengthening it. Thank you.
    Senator Byrd. Thank you. Thank you, Mr. Chairman, for your 
kindness and courtesies to me.
    Chairman Conrad. Well, thank you for your wise words, and I 
thank both the witnesses. I apologize. We are little beyond the 
time that we had agreed to. I hope it doesn't inconvenience you 
too much. There are just a few minutes left in this vote, so we 
will close the hearing.
    Mr. Wolfowitz. I will tell Secretary Rumsfeld it is all 
your fault, Senator.
    Chairman Conrad. Thank you.
    [Whereupon, at 12:41 p.m., the committee was adjourned.]

             Opening Statement of Senator Pete V. Domenici

    No Senator needs to be reminded that this Nation is at war with 
terrorism, and no Senator needs to be told that to win this war we must 
give the men and women in the Armed forces every form of support we 
can.
    I say ``no Senator'' needs to be reminded of these things because 
everything I have heard from both Republicans and Democrats in Congress 
tells me that there is virtually unanimous support for the President's 
National Defense budget request.
    What President Bush has requested for the Department of Defense 
matches what Ronald Reagan received at the height of the Cold War. 
Then, we had a super-power opponent, the Soviet Union. Today, no 
sovereign nation s defense budget even begins to match the United 
States, and our defense budget exceeds that of just about every major 
regional power in the world today. . .combined. Moreover, our Armed 
Forces are now just about half of what they were during the Reagan 
administration, and we can spread that same amount of money over a 
smaller force.
    These are the arguments that we used to hear when someone wanted to 
reduce spending for the Armed Forces. Those arguments are now overtaken 
by the events of September 11. We rarely hear them any more, and when 
we do, they sound out of place.
    The current circumstances--a very large defense budget and 
overwhelming bipartisan support for it--might make observers think this 
hearing will be a ``love-in'' with the representatives we have here 
from the Defense Department.
    I support the President's National Defense budget, but I also 
believe there are some issues that this Committee must address. In my 
judgement, those issues are the following:

      First, large as it is, is this defense budget large enough? 
Various defense analysts have identified areas where this budget 
provides disturbingly low levels of support. These areas include naval 
ship building, Navy flight hours, training and depot maintenance across 
all the military services, the ``Science and Technology'' and Military 
Construction budgets, and the Defense Activities of the Department of 
Energy.
      Second, are there areas in this defense budget that may or may 
not be getting too much money? The President has requested an emergency 
$10 billion fund fight the war on terrorism, but the budget materials 
did not tell us where, when, and how the funds will needed. I am sure 
whatever the President needs to fight this war Congress will provide--
and, at the time of the emergency, $10 billion may not be enough--but 
as an emergency must it be provided at this time? Should we attempt to 
pay for unknown military operations now or only when we all know and 
can support the President's decision?
      Third, do the priorities need to be adjusted? Some have suggested 
that this budget fails to ``skip a generation'' of weapons to enable a 
``transformation'' to prepare for the Twenty-first century, as the 
President promised. Some suggest there remain conceptually obsolete 
weapons in the budget, such as the Army's ``Crusader'' artillery system 
that are designed to fight the last war, not the next one. Can those 
funds be better used elsewhere? These are criticisms that have to be 
considered.
      We have also heard some ideas I believe we must immediately 
reject: some have suggested that now that we have fully funded the 
Defense Health Program, we should raid it for funds for other programs.
    Thus, at a time of strong bipartisan support for the increases that 
the President has requested for the National Defense budget, there are 
some difficult issues that this Congress and this Committee must 
consider.
    To help us do that it is a pleasure to be able to hear two of the 
prime architects of this budget. Thank you for being with us today, 
Deputy Secretary Wolfowitz and Under Secretary Zakheim. I look forward 
to hearing your analysis of the issues before us.

           Prepared Statement of Senator Russell D. Feingold

    Mr. Chairman, thank you. The world is a very different place than 
it was when we met last July to discuss the President's fiscal year 
2002 request for defense.
    That request included a $26 billion increase that the 
Administration said was necessary to begin a new military 
transformation that would modernize our Armed Forces for the new 
challenges of the 21st century.
    Those challenges were deadlier than any of us could have imagined. 
The events of September 11 galvanized our countray and our allies in a 
global fight against terrorism and those who would shelter, support, 
and finance those who carried out these acts. There can be no doubt 
that Congress should provide the resources necessary to fight and win 
this war. There should also be no doubt that this war should not be 
used as an excuse to drastically increase an already bloated defense 
budget.
    Mr. Chairman, I commend our men and women in uniform for their 
tireless efforts to find those responsible for these crimes. But as 
laudable as it might be for the United States to root out all bad 
actors around the globe, such action would be both outside the scope of 
the use-of-force resoulution that Congress passed, and beyond our 
financial means.
    This time of previously unimaginable challenges to our country 
demands that we scrutinize carefully how we spend our scare resources.
    The budget request includes a $48 billion increase for the 
Department of Defense--to $379 billion. And there is an additional $17 
billion for defense-related programs at the Department of Energy and at 
other Federal agencies, for a grand total of a $396 billion for defense 
activities for next year.
    Just how big is this budget request?
    This would be the largest one-year increase in defense spending 
since the height of the Cold War.
    This request is 15 percent higher than the average Cold War budget.
    It is three times the defense budgets of Iran, Iraq, Libya, North 
Korea, Cuba, Sudan, and Syria combined.
    It exceeds the Gross Domestic Product--the whole economy--of two-
thirds of the countries of the world, including Cuba, Israel, Kuwait, 
Lebanon, North Korea, Saudi Arabia, Pakistan, and Vietnam.
    And the Administration projects that the budget request for defense 
would grow to $451 billion by fiscal year 2007.
    Mr. Chairman, we should not allow fiscal responsibility and 
congressional oversight of the President's budget request to fall by 
the wayside as fight the war on terrorism. A strong national economy is 
also importatn to our national security. The war on terrorism does not 
require Congress to abdicate its responsibility to review closely the 
funding requests of the President, and it does not prohibit discussions 
about the direction of Federal spending, including defense spending.
    As we begin the discussion of the fiscal year 2003 defense budget, 
I would like to outline some of my priorities. We should ensure that 
our National Guard and Reserves, more than 75,000 of whom have been 
called to active duty as part of Operation Noble Eagle or Operation 
Enduring Freedom, are adequately compensated for their service and 
sacrifice. These men and women are one of the cornerstones of our Armed 
Forces, and we should ensure that they have adequate pay and benefits.
    Congress should carefully scrutinize the procurement budget and 
take a hard look at the utility of continuing to fund Cold War-era 
weapons systems. We should work to ensure that no weapons systems 
enters full production before it has been fully test to ensure that it 
will perform its intended mission in a safe and cost-effective manner 
and that it does not duplicate the mission of existing weapons systems. 
We should not spend taxpayer dollars on ``next generation'' weapons 
systems that are not significantly better than existing systems.
    And we should work with the Department of Defense to make sure that 
Congeress and the American people get an accurate accounting of how 
defense budget is being spent. Secretary Rumsfeld told the Armed 
Services Committee last week that his Senior Executive Council is 
studying ways to run the Department more efficiently. Time and again we 
hear about duplication of effort, antiquated accounting practices, and 
mismanagement at the Pentagon. I am deeply troubled that millions of 
taxpayer dollars continue to go unaccounted for each year.
    A report issued last year by the Business Executives for National 
Security's Tail to Tooth Commission outlines in detail the myriad 
accounting and inefficience problems at the Pentagon and offers 
recommendations onhow these problems could be addressed. While each of 
usmamy not agree with all of their recommendations, we can all agree 
that this problem needs to be addressed.
    I urge the Department to do more ensure that this situation is 
rectified. It is possible that the $48 billion increase that they seek 
for next year--and then some--may already exist within the current the 
Pentagon budget.
    Thank you. Mr. Chairman.













            THE PRESIDENT'S FISCAL YEAR 2003 BUDGET PROPOSAL

                              ----------                              


                      THURSDAY, FEBRUARY 14, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:04 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Murray, Wyden, Byrd, Nelson, 
Stabenow, Corzine, Grassley, Bond, Gregg, Snowe, Frist, and 
Smith.
    Staff present: Mary Ann Naylor, staff director; Sue Nelson, 
deputy director; and Jennifer Cantrell, javits fellow.
    For the minority: G. William Hoagland, staff director; and 
Kathleen Weldon, senior policy analyst for health.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order. I want to 
begin by welcoming our witness, Secretary Tommy Thompson, for a 
return visit to this committee. Welcome, Mr. Secretary. As the 
Secretary of Health and Human Services, you manage over 300 
separate programs and the largest budget of any Cabinet agency, 
about $460 billion a year.
    Let me just say that, as I continue to examine the budget 
that the Administration has sent us, I believe it simply does 
not add up, that it plunges us back into deficits not only this 
year and next year, but for the entire next decade. As this 
chart indicates, if we set aside the trust funds of Medicare 
and Social Security, there is red ink as far as the eye can 
see.
    In addition--let's go to the next chart--it breaks the 
promise that was made by the President and made by virtually 
everyone in elected office not to invade the trust funds of 
Social Security and Medicare.
    Last year, we were told there were non-trust fund surpluses 
of $2.7 trillion over the next decade. Now we see, instead of 
surpluses, $2.2 trillion of deficits in the non-trust fund 
accounts. That means the trust funds will have over $2 trillion 
taken from them to pay for tax cuts and other expenses of the 
Government.
    Last night, as I examined the budget submission of your 
agency, I came to the conclusion that somebody in the 
Administration has cooked the books and cooked them big time 
with respect to Medicare. The Congressional Budget Office says 
this budget understates the costs of Medicare by $300 billion 
over the next decade.
    The New York Times wrote, and I quote, ``Assuming a slower 
growth rate for Medicare has the same effect as cutting the 
Medicare budget. It saves money. But it avoids the political 
uproar that would surround a proposal for large cuts in 
Medicare.''
    Mr. Secretary, I direct your attention to this chart that 
shows the difference between what others are saying will be the 
increase in medical costs over the next decade and what this 
budget is saying.
    The private health insurance spending per capita estimate 
for 2003 to 2010 says health care costs will increase at 6.1 
percent. The CBO Medicare estimate is for 5 percent growth. The 
OMB, the Office of Management and Budget, Medicare estimate is 
for 3.5 percent growth. Medical inflation in 2001 was 4.7 
percent. I believe the folks over at OMB have cooked the books 
to make this budget look like it adds up better than it really 
does.
    Mr. Secretary, I doubt very much these are your numbers. I 
have got strong respect for you and the job you have done 
especially since the very difficult events of September 11th 
and the pressure that that has put you and your agency under. I 
think you have conducted yourself admirably and I think, as I 
have said many times from this podium, that the President and 
this Administration has conducted themselves in the best 
American tradition in responding to the attack on the country.
    But I don't have that feeling about the budget that has 
been submitted by the Administration. As I look ahead, I think 
it is putting us in a position for the future in which a future 
Congress and a future President is going to face excruciating 
choices.
    The Director of the Budget Office, Mr. Crippen, has come 
before this committee and said that we were going to face 
either massive cuts in benefits, huge tax increases, or massive 
debt because of the retirement of the baby-boom generation. And 
the budget that this President has set up here doesn't deal 
with it at all. In fact, it abandons the fiscal discipline that 
virtually all had agreed to--that we would save the Social 
Security Trust Fund moneys for the purposes intended, not use 
them for other purposes.
    And once you go through that line in the sand, there is 
nothing that stops those who want more tax cuts and more 
spending, and I can tell you, after meeting with colleagues, 
the flood gates are wide open. They are wide open. Every tax-
cutting scheme, every spending idea is being promoted, and 
being promoted with vigor, because once you cross the line on 
the question of Social Security, there is no line. There is no 
line. And that is what I am finding.
    I tell you, the consequences for this country are enormous, 
and what people don't seem to get is that we are in a 
fundamentally different circumstance than we have ever faced 
before. This is a demographic time bomb. We have never faced 
anything like this before in our history. And we ought to be 
getting ready for it, and that means we ought to be saving 
Social Security and Medicare surpluses, use that as a line in 
the sand, and on top of that, we ought to do more because 
saving the trust fund moneys is necessary but not sufficient.
    But I tell you something, there is very little stomach for 
what needs to be done here. And because the President sent up a 
budget that doesn't seem to care, nobody else does either. I 
can tell you, colleague after colleague tells me, well, the 
President has crossed the line; it doesn't matter to him if we 
use Social Security money; so let's all get in on the party.
    I don't know how this is--you know, here we are, somebody 
told me this is like the 1980's. Oh, no, this isn't like the 
1980's. This is much worse than the 1980's. In the 1980's there 
was time to recover. We had 20 years before the baby-boomers 
started to retire. There is no time to recover this time. These 
fiscal mistakes are really going to come home. The chickens are 
going to come home to roost.
    So, Mr. Secretary, you know, I am expressing myself this 
morning. You are here. I don't think you are really the one 
that is the culprit here. In fact, I know you are not. But as 
we start to write a budget resolution here, I really am worried 
about the attitude I am finding. And it starts right at the top 
with the President of the United States. He sent us a budget. 
It doesn't come close to adding up. It isn't in hailing 
distance of adding up. And that has encouraged everybody else 
to abandon the fiscal discipline that we had all agreed to put 
in place. That is what I am finding. And I am having meetings 
with individual members every day. It isn't pretty, what I am 
finding.
    With that, I will turn it over to our colleague and 
indicate that Senator Domenici is again not with us today. He 
is, as you know, recovering from ill health, and we miss him, 
and we hope for his swift recovery. And we very much hope he 
will be back with us soon.
    Filling in very ably for him is Senator Frist from 
Tennessee. Perhaps others don't know this, but Senator Frist 
sends us all, Members of the Senate, a letter on our personal 
health every year. I tell you, that letter is on the 
refrigerator in my house, and he is our doctor, in essence, the 
only medical doctor in the Senate. So he is not only 
Tennessee's doctor, he is the Nation's doctor.
    Senator Frist. Mr. Chairman, there are ten things on that 
list, do all ten of them. It doesn't matter if it is sitting on 
the refrigerator. You got to do those ten things.
    Chairman Conrad. That is right.
    Senator Frist. You don't have to answer yet. Let's see how 
the hearing goes.
    Chairman Conrad. Let me just tell you, on one matter, the 
matter of a proctoscopic, the colonoscopy, Senator Dorgan went 
to the Capitol physician, and it was recommended that he have 
one, and he immediately said, ``Has Senator Conrad had his?'' 
And he told him, ``You schedule me right after you schedule 
Senator Conrad.'' [Laughter.]
    Senator Frist. It is a good test, and not as bad as people 
think.
    Thank you, Mr. Chairman. And I will---- [Laughter.]
    Senator Frist. Did you have yours this morning? Is that 
what it is?
    Chairman Conrad. No. I read the budget. It was even worse.
    Senator Frist. Thank you, Mr. Chairman.
    I do ask unanimous consent that we enter Senator Domenici's 
opening statement into the record.
    Chairman Conrad. Absolutely.
    [The prepared statement of Senator Domenici follows:]

           The Prepared Statement of Senator Pete V. Domenici

  Good morning, Secretary Thompson. Thank you for joining us 
    this morning.
  We are here today to discuss the fiscal year 2003 budget for 
    the Department of Health and Human Services, the second largest 
    department in the Federal Government (after the Social Security 
    Administration) with a proposed budget of $492 billion.
  Your budget is larger even than the Pentagon's proposed 
    budget of $379 bililion for next year.
  Your Department plays a vital role in promoting the health 
    and security of our citizens through a vast range of programs and 
    services.
  Over the last few months, you have taken the lead in the 
    fight against bioterrorism. The President has proposed $5.9 billion 
    in spending to fight bioterrorist attacks, and more $4.3 billion of 
    this goes through the various agencies of your Department, 
    including the Centers for Disease Control, the National Institutes 
    of Health, and the Food and Drug Administration.
  But in addition to protecting the Nation from extraordinary 
    threats, the HHS budget provides vital basic services to promote 
    the health and welfare of some of our most vulnerable citizens.
  For example, the President's initiative to increase the 
    number of Community Health Centers will provide direct healthcare 
    services to millions of the uninsured.
  And the budget makes great strides toward reducing the number 
    of uninsuired by proposing health insurance tax credits that will 
    help up to 6 million people acquire health insurance.
  We are all aware, Mr. Secretary, of the primary role that you 
    played as Governor of Wisconsin in shaping the 1996 welfare reform 
    legislation. This landmark legislation has reduced welfare 
    caseloads by more than 50 percent and also led to higher incomes 
    and lower poverty rates for many recipients.
  I am pleased the President has continued his support for 
    welfare reform and also for the supplemental grants that aid poor 
    States like New Mexico. But, I am hoping that today you might 
    elaborate on the Administration's plan to address the last 
    remaining task of welfare reform: encouraging the formation and 
    maintenance of two-parent families.
  Finally, one of the top issues that will face this Congress 
    will be providing a prescription drug benefit for Medicare. The 
    President has allocated $190 billion over 10 years for Medicare 
    reforms, and has taken a sensible first step to increasing 
    prescription drug coverage by proposing a drug subsidy for low-
    income seniors.
  We may differ on the amount of money that needs to be 
    allocated to Medicare, but I think that we can all agree that we 
    need to address both the fiscal challenges the program faces and 
    the gaps in its benefits package. And these issues need to be 
    addressed together--it would be irresponsible of us to enact a new 
    universal drug benefit without also taking steps to reform Medicare 
    to make it solvent for future generations.
  Secretary Thompson, thank you for joining us here today. I 
    look forward to hearing your testimony.

               OPENING STATEMENT OF SENATOR FRIST

    Senator Frist. Mr. Chairman, thank you for holding this 
hearing. I am going to focus a little bit more on the issue at 
hand. The opening statement just made was on the big issues, 
but I do want to focus on the issues that will affect every 
single American alive today, will affect our seniors, will 
affect all of us in this room, and will affect future 
generations in ways that you can see in the budget, but in many 
ways you can't see directly. Things like research and 
development investment create the potential of cures for 
everything from cancer to heart disease to HIV/AIDS. We also 
need to look at the uninsured, which is a problem that has 
increased dramatically over the last 7 to 8 years that I have 
been here.
    Well over $400 billion, the budget of Health and Human 
Services accounts for a significant proportion of the overall 
budget, second only, as the Chairman mentioned, to the Social 
Security Administration.
    It includes Medicare, the program for individuals with 
disabilities and our seniors, Medicaid, Assistance for Needy 
Families, the Ryan White Act, which addresses the HIV issues, 
health centers, the National Health Service Corps, and the 
tremendous investments in our National Institutes of Health. 
Doubling funds at NIH, a commitment of the President, will 
encourage many people who are listening now, who have spouses, 
loved ones, parents and grandparents with illnesses, looking 
for that cure that we are always reaching out for.
    Secretary Thompson, over the last 2 days, you and I have 
seen each other many times; we have been at many hearings. 
Yesterday testified before Foreign Affairs on the issue of HIV/
AIDS internationally. I each time have seen you, you have 
mentioned organ transplantation. I just want to say thank you 
on behalf of all of us in the United States Senate for your 
personal commitment and service.
    These are difficult economic times. There is a clear need 
for this Nation to devote resources to the emergency, to the 
war itself, and to what we can do in terms of stimulating the 
economy and creation of jobs as we go forward, given the fact 
that we have been in a recession.
    Amidst all of these priorities which have been so radically 
defined or redefined in recent months, I am delighted to see 
significant investments in the pressing domestic priorities 
which are outlined in the budget.
    The doubling of funding at the NIH to over $27 billion is 
something that 5 or 6 years ago I would have said, Impossible. 
There is no way when I first came to the United States Senate 
that I thought we'd see that sort of investment, and because of 
the work of this Committee and the leadership now of you and 
President Bush, it is a reality that will help us fight the 
sort of diseases of heart and lung and other types of diseases, 
but also will translate into the future cures for the incurable 
diseases of today: HIV/AIDS, 40 million people, 27 million 
people dead. There is no cure, there is no treatment. Opening 
up the possibility of reversing the greatest pandemic that this 
world has ever seen.
    Our public health system, again, true strengthening in this 
budget. That public health system which for the last 15 or 20 
years has simply been neglected.
    I mentioned the uninsured, 40 million Americans without 
insurance today. When you look at what the Administration 
proposes in terms of the medical savings accounts, National 
Health Service Corps, community health centers, Medicaid, 
caregiver assistance, the State Children's Health Insurance 
Program, all of these work in a direction to make health care 
more affordable.
    Medicare, and, again, as we look at slides in terms of 
projections over the next 5 years or 10 years, it's useful to 
do, and that's what budgeting is all about, and it's critical. 
But it drives home to me, as a physician, as someone who has 
been responsible for some of that, when I do a heart 
transplant, it is very expensive, but it is also life-saving. 
When I prescribe thousands of prescription drugs, which I have 
done, it is very expensive. And then you look at the figures 
and the projections, which I agree with in terms of the 
projections, it shows that we have got to engage in, again, 
what you and the President have been leaders on and have stayed 
out there on, and that is comprehensive modernization of 
Medicare, which recognizes that we have to do something which 
doesn't just make us feel good, like add prescription drugs, 
but we have to do it in a sustainable way as we project ahead. 
And we are not going to be able to accept costs of increases in 
prescription drugs of 20 percent year after year after year, or 
even some of the figures that have been presented earlier. So 
we really do need to have comprehensive Medicare reform.
    Prescription drugs is an issue that must, I believe, be 
address as part of that comprehensive Medicare reform, but an 
issue that we have to address head on today. I am sure we will 
come back and talk about the progress and the importance of 
having prescription drugs as part of that overall plan.
    Let me just briefly show again--because the President as on 
a regular basis outlined this agenda, but it gives a large 
framework, not of the overall budget but of where we are going 
as we budget for the future. President Bush's agenda for 
improving health security, providing Medicare prescription 
benefits for seniors and individuals with disabilities. Again, 
it is not there today. I believe it has to be there as part of 
overall Medicare reform.
    Strengthening Medicaid, S-CHIP, and the health care safety 
net, the President spoke to that just last week. Expanding 
biomedical research, which I mentioned, and expanding 
affordable--really, this whole affordable health care, how we 
address that both in Medicare and Medicaid and in the 
uninsured. Specific proposals have been on the table for 
medical savings accounts, for health credit, and for 
association in the health plans.
    Let me just close with bioterrorism because it is an issue 
that received a fair amount of press, but it does show the 
challenge that we have as we look at the budget itself. 
Bioterrorism, we didn't think very much about it. We have 
neglected our public health infrastructure. So now as a 
priority, a shifting priority but a very appropriate priority, 
we are having to address support of our public health 
infrastructure, prevention, research, and response to a 
biological attack. We will see more biological attacks in this 
country, period. We need to respond to that. We need to respond 
today.
    Increasing State and local capacity, research and 
development, fortifying Federal response capabilities, 
improving communications and surveillance, and I will close 
just with the last slide because it does show the response of 
this Administration.
    This is from 1998 to 2003. The yellow is the proposed 
budget for bioterrorism preparedness. This has been put on the 
table. I support it 100 percent, and I think it is something 
that will have to be sustained over time. Again, I appreciate 
the Administration recognizing that in the past we have 
inadequately invested, that a new investment is going to be 
required today, and as part of that, we have to look at new 
priorities just like we have to look at Medicare and 
strengthening Medicare in a new way, a new paradigm so that we 
can modernize Medicare and include prescription drugs.
    Mr. Secretary, thank you for being with us today, for 
testifying today. Thank you for your leadership in 
strengthening our public health system and our acute and 
chronic medical health care system.
    Chairman Conrad. Thank you, Senator Frist.
    Mr. Secretary, why don't you proceed with your statement? 
The typical procedure for this Committee is, after you have 
concluded, we will go to questioning rounds. Each Senator will 
have 7 minutes for a statement or questions or however they 
choose to use the time.
    Please proceed.

 STATEMENT OF HON. TOMMY G. THOMPSON, SECRETARY, DEPARTMENT OF HEALTH 
                           AND HUMAN SERVICES

    Secretary Thompson. Thank you so very much, Chairman 
Conrad, and thank you for your very kind words. I appreciate 
that very much. I was a little bit concerned that you would not 
be here this morning because I know of your love for baseball. 
I thought since it was the opening day that you might attend 
one of those spring camps. But I am very appreciative that you 
are here, my friend.
    Chairman Conrad. I am headed there tomorrow. [Laughter.]
    Secretary Thompson. Senator Frist, thank you so very much 
for your leadership. I appreciate it very much, and thank you 
for your counsel and your assistance, and all the members of 
this Committee, thank you so very much for giving me this 
opportunity.
    Please express my appreciation to Senator Domenici, and I 
wish him well. I called him and was hoping he would be here, 
but I know he is recovering and I wish him well.
    As I begin this morning, Senators, let me mention that 
today is National Donor Day. Encouraging a donation is a 
priority of my work. It is one of my passions. As Secretary of 
Health and Human Services last year, we launched the national 
Gift of Life Donation Initiative to encourage Americans to 
donate organs and tissues and to make it easier for them to do 
so.
    I hope all Members of Congress have signed donor cards. I 
also hope that you will wear the donor pins that you have been 
given to show your support.
    Organ donation saves and transforms lives. We can all join 
in this wonderful effort, and I thank all of you for supporting 
this very important endeavor.
    And let me thank you for your commitment to this issue, 
Senator Frist. I understand that you introduced legislation on 
donation yesterday with Senator Dodd. I look forward to working 
with you on this important issue, and hopefully we can get it 
passed this year.
    President Bush has identified several critical priorities 
for America at this time in our history. They include winning 
our war on terrorism, defending the homeland, creating jobs, 
and securing a healthy future for everyone in this country. As 
he said earlier this week in my home State of Wisconsin, ``The 
role of Government in health reform is to fix the system where 
it is failing, while preserving the quality and innovation of a 
private, patient-centered medical system. All reform should be 
guided by some goals.'' The President's HHS budget goes a long 
way toward meeting that standard.
    The HHS budget furthers the work of preparing America for 
bioterrorism, as Senator Frist has said. In total, we are 
calling for $4.3 billion--an increase of 45 percent over the 
current fiscal year, and I know this is something Senator Gregg 
has led the effort on many times as well, and I applaud him for 
it. This effort is to support a variety of critical activities 
to prevent, identify, and respond to incidents of bioterrorism. 
We are building up our national pharmaceutical stockpile, 
increasing assistance to State and local governments, preparing 
the Nation's hospitals, and doing more to protect America's 
food supply, something that, Senator Conrad, you have taken the 
lead on, and I applaud you.
    In the President's budget, we have reduced the number of 
HHS personnel offices from 46 to 4. We are realigning and 
consolidating throughout the Department. We are able to save 
the equivalent of 705 full-time positions. And we have launched 
a regulatory reform initiative to reduce the paperwork burden 
on physicians and hospitals.
    Our budget meets the President's commitment also of 
doubling funding for the National Institutes of Health by 2003. 
It provides the support for childhood development while 
delivering responsible management of HHS resources. And we 
provide $20 million for our new Healthy Communities Initiative, 
which will concentrate Department-wide expertise on the 
prevention of diabetes, asthma, and obesity. Our plan confronts 
the challenges of today as well as tomorrow while enhancing the 
health of ever citizen of our great country.
    Mr. Chairman, as you have mentioned, the total HHS request 
for fiscal year 2003 is $489 billion in outlays, an increase of 
$29.2 billion, or 6.3 percent over the comparable fiscal year 
2002 budget. The discretionary component of our budget totals 
$64 billion in budget authority, an increase of $2.4 billion, 
or 3.9 percent.
    There is much that could occupy my oral comments, but let 
me highlight three areas of special concern to this Committee: 
specifically, the President's plan to continue extending 
coverage to the uninsured, strengthening and modernizing 
Medicare, and taking our successful efforts in reforming 
welfare to the next level.
    Before I discuss those issues, let me briefly discuss 
something I know is of great concern to you, Mr. Chairman: 
Medicare reimbursement in rural areas. I come from the city of 
Elroy, Wisconsin, population of 1,500. Rural health is of 
personal concern to me. When hospitals and other providers 
struggle to survive in a rural community because Medicare 
payments systems fail to reflect local conditions, people 
suffer. It is not the providers' fault.
    We have monitored this problem, and we are committed to 
working with you, Senator Conrad, and with Congress to see that 
it is resolved. This is a statutory matter that must be 
addressed by legislation. I wish I could tell you here that we 
have an immediate answer to this problem. I can't. But I can 
tell you that I will work with you to address this matter 
fairly and effectively.
    Let me now discuss our initiatives to help the uninsured. 
There are about 40 million Americans who lack health insurance. 
That is simply too many in a Nation as compassionate and as 
well-off as America.
    That is why during the first year of the Bush 
Administration, we have made great strides in extending access 
to health care to Americans. For example, since January of this 
year, we have approved State plan amendments and Medicaid and 
S-CHIP waivers that have expanded opportunity for health 
coverage to 1.8 million Americans and improved the existing 
benefits to 4.5 million individuals.
    But we must do more for those who need help the most--
working American families that lack access to quality health 
care. So in this budget, we increase access to quality health 
care for all Americans.
    The President's outreach includes a significant investment 
in community health centers, which provide quality, family 
oriented, preventive, and primary health care to over 11 
million patients annually, regardless of people's ability to 
pay Senator Bond has taken a leadership role in this area, and 
I compliment him. Currently, we have 3,300 community health 
centers nationwide. This budget seeks $1.5 billion to support 
the President's plan to impact 1,200 communities with new or 
expanded health centers by 2006. This is a $114 million 
increase over fiscal year 2002 and would support 170 new and 
expanded health community centers and provide services to 1 
million additional patients. The President's long-term plan is 
to double the capacity of our community health center system, 
expanding access to care for an additional 6 million 
individuals by 2006.
    In addition, the President has proposed providing $89 
billion in new health credits to help families lacking other 
insurance. This plan would help an estimated 6 million 
Americans get health insurance, and it includes some very 
important changes from last year. We listened to the concerns 
of this Committee and Congress in general. So, for example, the 
President's plan increases the maximum credit to $3,000 for 
families with children and provides the credits up-front so 
families can meet monthly premiums.
    Medicaid and S-CHIP provides benefits to low-income 
Americans, primarily children, pregnant women, the elderly, and 
those with disabilities. The HHS budget proposal strengthens S-
CHIP by allowing the States to use an estimated $3.2 billion in 
unused funds that otherwise would return to the Federal 
treasury. These additional matching funds will enable all 
States to expand coverage to the uninsured, in addition to the 
more than 4 million children covered under S-CHIP today.
    We are pursuing innovative ideas for providing health 
coverage to families, tackling the issue of the uninsured from 
multiple angles. Our plan builds upon the principles 
established last year by the President for modernizing 
Medicare. It employs some of the best ideas of Republicans and 
Democrats, including ideas developed in this Committee. It 
takes advantage of what both Government and the private sector 
have to offer.
    Helping meet the health needs of the uninsured is part of 
our larger effort to strengthen the entire health care system. 
Modernizing Medicare is another key component of this effort. 
Since becoming Secretary, I have begun to modernize the very 
structure of the Centers for Medicare and Medicaid Services. 
Reforms have occurred, and there are a lot more to come.
    These reforms are essential to the continued success of the 
Medicare program, which is why this budget is such a 
significant step forward. It dedicates $190 billion over 10 
years for immediate targeted improvements and comprehensive 
Medicare modernization, including a subsidized prescription 
drug benefit and better insurance protection and private 
options for all beneficiaries.
    This budget also proposes a subsidized drug benefit as part 
of modernized Medicare, but also providing better coverage for 
preventative care and serious illness. We also propose that 
preventive benefits have zero co-insurance and be excluded from 
the deductible. We must make these improvements to more 
effectively address the health needs of seniors today and in 
the future. For years, we have debated Medicare reform in this 
Committee and in Congress in general as an all-or-nothing 
proposition that has only so far produced failure. We have to 
act, and the President's plan, I believe, shows us the way.
    This year, HHS will continue working to implement the 
President's proposed Medicare-endorsed prescription drug card. 
The card will give beneficiaries immediate access to 
manufacturer discounts on their medicines and other pharmacy 
services.
    Assistance, however, will not come only through the 
prescription drug card program. The budget proposes several new 
initiatives to improve Medicare's benefits and address cost, 
and offers additional Federal assistance for comprehensive drug 
coverage to low-income Medicare beneficiary up to 150 percent 
of poverty, about $17,000 for a family of two.
    This policy helps to establish the framework necessary for 
a Medicare prescription drug benefit and is essentially a 
provision that is in all of the major drug benefit proposals 
before Congress.
    Recently, I announced also a model drug waiver program 
called Pharmacy Plus to allow States to reduce drug 
expenditures for seniors and certain individuals with 
disabilities with family incomes up to 200 percent of the 
Federal poverty level. This program is being done 
administratively. In Illinois, the waiver we approved about 2 
weeks ago will give an estimated 370,000 low-income seniors new 
drug coverage. The Illinois initiative illustrates how we can 
expand coverage to Medicare beneficiaries in partnership with 
the Federal Government.
    So we are moving forward with strengthening Medicare. But 
just as Medicare needs renewal, so welfare reform must be 
ongoing as well. As you know, welfare reform is one of my great 
passions. In Wisconsin, we devoted substantial resources to 
helping people get the training, health insurance, child care, 
and other services they needed to go from welfare to work.
    Welfare reform has exceeded expectations, resulting in 
millions moving from dependence on AFDC to the independence of 
work. Nearly 7 million fewer individuals are on welfare today 
than in 1996, and 2.8 million fewer children are in poverty due 
to welfare reform.
    But we are not done. There is a clear and important next 
step to welfare reform. This budget boldly takes that next 
step, which requires us to work with States to help those 
families that have left welfare to climb the job ladder and 
become more secure in the work force. And while doing so, we 
must not leave behind those still on our caseloads.
    But, ultimately, welfare reform is not about numbers on a 
chart. It is about restoring hope and dignity to human lives. 
It is about restoring the promise of the American dream to 
people trapped in dependency. And as President Bush has said, 
we are committed to leaving ``no child behind.''
    Our budget takes those goals seriously. It allocates $16.5 
billion for block grant funding, provides supplemental grants 
to address historical disparities in welfare spending among 
States, and strengthens work participation requirements. The 
budget provides $100 million in broad demonstration authority 
focused primarily on encouraging healthier families. In 
addition, we will be submitting a proposal to create a matching 
State grant program to strengthen families and reduce out-of-
wedlock births.
    While this represents level funding for TANF, it provides 
the funds that States can spend on helping workers remain in 
the work force. States will be able to apply the savings gained 
from caseload reduction to new programs that help workers 
thrive in the work force. We are giving States the flexibility 
they need to mix effective education and job training programs 
with work, and we are providing States money to strengthen 
families and reduce illegitimacy.
    We hope to work with you in Congress to more specifically 
shape the next step in welfare reform. In doing so, however, we 
cannot get away from the foundation of welfare reform's 
success--work. Work must remain at the core of TANF, for work 
is the only way to climb out of poverty and become self-
sufficient. We must continue to help working families remain 
employed and advance their jobs by providing the proper child 
and health care programs.
    President Bush's budget helps by providing an additional 
$350 million in Medicaid benefits for those in the transition 
from welfare to work.
    The budget request includes an additional $130 million for 
the promoting safe and stable families program bringing it up 
to its auth level of $505 million. These funds will move 
children to adoption more quickly so they can become part of 
safe and stable families as well as enhance preventive efforts 
to help families in crisis.
    Mr. Chairman, the President's agenda is compassionate, 
financially sound, and far-reaching. The President's investment 
in the health security of America is tremendous given the 
pressing needs for the investment in national defense and 
homeland security. We are moving across a broad range of 
endeavors to provide the people of our country with affordable, 
accessible, and accountable health care.
    Working with you and the members of this great committee, 
Mr. Chairman, I am confident that we can make dramatic progress 
in reaching that objective for every American. Thank you again, 
and I look forward now to your questions and our discussion.
    [The prepared statement of Secretary Thompson follows:]

  The Prepared Statement of Tommy Thompson, Secretary, Department of 
                       Health and Human Services

    Good Morning Chairman Conrad, Senator Domenici and members of the 
Committee. I am honored to appear before you today to discuss the 
President's fiscal year 2003 budget for the Department of Health and 
Human Services. I am confident that a review of the full details of our 
budget will demonstrate that we are proposing a balanced and 
responsible approach to ensuring a safe and healthy America.
    The budget I present to you today fulfills the promises the 
President has made and proposes creative and innovative solutions for 
meeting the challenges that now face our Nation. Since the September 
11th attacks we have dedicated much of our efforts to ensuring that the 
Nation is safe. HHS was the first agency to respond to the September 
11th attacks on New York City, and began deploying medical assistance 
and support within hours of the attacks. Our swift response and the 
overwhelming task of providing needed health related assistance made us 
even more aware that there is always room for improvement. The fiscal 
year 2003 budget for the Department of Health and Human Services builds 
on President Bush's commitment to ensure the health and safety of our 
Nation.
    The fiscal year 2003 budget places increased emphasis on protecting 
our Nation's citizens and ensuring safe, reliable health care for all 
Americans. The HHS budget also promotes scientific research, builds on 
our success in welfare reform, and provides support for childhood 
development while delivering a responsible approach for managing HHS 
resources. Our budget plan confronts both the challenges of today and 
tomorrow while protecting and supporting the well being of all 
Americans.
    Mr. Chairman, the total HHS request for fiscal year 2003 is $488.8 
billion in outlays. This is an increase of $29.2 billion, or 6.3 
percent over the comparable fiscal year 2002 budget. The discretionary 
component of the HHS budget totals $64.0 billion in budget authority, 
an increase of $2.4 billion, or 3.9 percent. Let me now discuss some of 
the highlights of the HHS budget and how we hope to achieve our goals.

               Protecting the Nation Against Bioterrorism

    Mr. Chairman, as you know, the Department of Health and Human 
Services is the lead Federal agency in countering bioterrorism. We are 
responsible for preparing for, and responding to, the medical and 
public health needs of this Nation. The fiscal year 2003 budget for HHS 
is $4.3 billion, an increase of $1.3 billion, or 45 percent, above 
fiscal year 2002. This budget supports a variety of activities to 
prevent, identify, and respond to incidents of bioterrorism. These 
activities are administered through the Centers for Disease Control and 
Prevention (CDC), the National Institutes of Health (NIH), the Office 
of Emergency Preparedness (OEP), the Substance Abuse and Mental Health 
Services Administration (SAMHSA), the Health Resources and Services 
Administration (HRSA) and the Food and Drug Administration (FDA). The 
efforts of this agency will be directed by the newly established Office 
of Public Health Preparedness (OPHP).
    In order to create a blanket of preparation against bioterrorism, 
the fiscal year 2003 budget provides funding to State and local 
organizations to improve laboratory capacity, enhance epidemiological 
expertise in the identification and control of diseases caused by 
bioterrorism, provide for better electronic communication and distance 
learning, and support a newly expanded focus on cooperative training 
between public health agencies and local hospitals. Funding for the 
Laboratory Response Network enhances a system of over 80 public health 
labs specifically developed for identifying pathogens that could be 
used for bioterrorism. Funding will also support the Health Alert 
Network, CDC's electronic communications system that provides Internet 
connectivity to public health departments in ninety percent of our 
Nations' counties. Funding will be used to support epidemiological 
response and outbreak control, which includes funding for the training 
of public health and hospital staff. This increased focus on local and 
state preparedness serves to provide funding where it best serves the 
interests of the Nation.
    An important part on the war against terrorism is the need to 
develop vaccines and maintain a National Pharmaceutical Stockpile. The 
National Pharmaceutical Stockpile is purchasing enough antibiotics to 
be able to treat up to 20 million individuals in a year for exposure to 
anthrax. The Department is purchasing sufficient smallpox vaccines for 
all Americans. The fiscal year 2003 budget proposes $650 million for 
the National Pharmaceutical Stockpile and costs related to stockpiling 
of smallpox vaccines, and next-generation anthrax vaccines currently 
under development.
    Another important aspect of preparedness is the response capacity 
of our Nations hospitals. Our fiscal year 2003 budget provides $518 
million for hospital preparedness and infrastructure to enhance 
biological and chemical preparedness plans focused on hospitals. The 
fiscal year 2003 budget will provide funding to upgrade the capacity of 
hospitals, outpatient facilities, emergency medical services systems 
and poison control centers to care for victims of bioterrorism. In 
addition, CDC will provide support for a series of exercises to train 
public health and hospital workers to work together to treat and 
control bioterrorist outbreaks.
    Today, the United States has one of the world's safest food 
supplies. However, since the September 11 attacks, the American people 
have a heightened awareness about protecting the Nation's food imports 
and food supply at home. The fiscal year 2003 budget supports a 
substantial increase in the number of safety inspections for FDA-
regulated products that are imported into the country. Physical 
examinations of food imports will double in fiscal year 2002 over the 
previous year, and double again in fiscal year 2003. We anticipate 
further progress as new staff becomes fully productive.
    Our budget also provides support for national surveillance and 
infectious disease detection. This includes efforts to reduce emerging 
infectious and foodborne diseases, improve patient safety, and provide 
laboratory support for HIV/AIDS, tuberculosis and immunization 
programs. This funding will continue to provide assistance to States 
and local communities to detect and prevent the spread of infectious 
diseases. Funds will also help prevent and control Hepatitis C, and 
combat antimicrobial disease strains.
    The fiscal year 2003 budget also includes $184 million to 
construct, repair and secure facilities at the CDC. Priorities include 
the construction of an infectious disease/bioterrorism laboratory in 
Fort Collins, Colorado, and the completion of a second infectious 
disease laboratory, an environmental laboratory, and a communication 
and training facility in Atlanta. This funding will enable the CDC to 
handle the most highly infectious and lethal pathogens, including 
potential agents of bioterrorism. Within the funds requested, $12 
million will be used to equip the Environmental Toxicology Lab, which 
provides core lab space for testing environmental samples for chemical 
terrorism. Funding will also be allocated to the ongoing maintenance of 
existing laboratories and support structures.

                    Investing in Biomedical Research

    Advances in scientific knowledge have provided the foundation for 
improvements in public health and have led to enhanced health and 
quality of life for all Americans. Much of this can be attributed to 
the groundbreaking work carried on by, and funded by, the National 
Institutes of Health (NIH). Our fiscal year 2003 budget enhances 
support for a wide array of scientific research, while emphasizing and 
supporting research needed for the war against bioterrorism.
    NIH is the largest and most distinguished biomedical research 
organization in the world. The research that is conducted and supported 
by the NIH offers the promise of breakthroughs in preventing and 
treating a number of diseases and contributes to fighting the war 
against bioterrorism. The fiscal year 2003 budget includes the final 
installment of $3.7 billion needed to achieve the doubling of the NIH 
budget. The budget includes $1.7 billion for bioterrorism research, 
including genomic sequencing of dangerous pathogens, development of 
zebra chip technology, development and procurement of an improved 
anthrax vaccine, and laboratory and research facilities construction 
and upgrades related to bioterrorism. With the commitment to 
bioterrorism research comes our expectation of substantial positive 
spin-offs for other diseases. Advancing knowledge in the arena of 
diagnostics, therapeutics and vaccines in general should have enormous 
impact on the ability to diagnose, treat, and prevent major killers-
diseases such as malaria, TB, HIV/AIDS, West Nile fever, and influenza.
    The fiscal year 2003 budget also provides $5.5 billion for research 
on cancer throughout all of NIH. Currently, one of every two men and 
one of every three women in the United States will develop some type of 
cancer over the course of their lives. New research indicates that 
cancer is actually more than 200 diseases, all of which require 
different treatment protocols. Promising cancer research is leading to 
major breakthroughs in treating and curing various forms of cancer. Our 
budget continues to expand support for these research endeavors.

             Building Upon the Successes of Welfare Reform

    President Bush has said that American families are the bedrock of 
American society and the primary source of strength and health for both 
individuals and Communities. Our budget includes a number of new 
initiatives that support this principle by targeting resources to 
strengthen our Nation's families. We look forward to working with the 
Committee in considering the next phase of welfare reform and other 
elements of the President's proposals to help America's low-income 
families succeed.
Temporary Assistance for Needy Families
    As a former Governor, I can tell you that the Temporary Assistance 
for Needy Families program--or TANF--has been a truly remarkable 
example of a successful Federal-State partnership. States were given 
tremendous flexibility to reform their welfare programs and as a 
result, millions of families have been able to end their dependency on 
welfare and achieve self-sufficiency.
    Since 1996, welfare dependency has plummeted. As of September of 
2001, the number of families receiving assistance, which represents the 
welfare caseload, was 2,103,000 and the number of individuals receiving 
assistance was 5,343,000. This means the welfare caseload and the 
number of individuals receiving cash assistance declined 52 percent and 
56 percent, respectively, since the enactment of TANF. Between January 
and September of last year national caseloads actually declined about 2 
percent, and while the July to September statistics indicate a slight 
increase, the figures are still well below the previous year's caseload 
levels. The general trend suggests the national caseloads are not 
rising but, instead, have stabilized.
    In New York City, where we are understandably most concerned about 
job opportunities, they have achieved more than 53,000 job placements 
for welfare recipients from September through December 2001. While the 
number of TANF recipients increased briefly directly because of the 
tragedy on September 11, by December there were about 15,000 fewer TANF 
recipients on the rolls than there were in August. Indeed, in December 
the City had its lowest number of persons on welfare since 1965.
    Some other positive outcomes we have seen since the law's passage 
include:

  Employment among single mothers has grown to unprecedented 
    levels.
  Child poverty rates are at their lowest level since 1978. 
    Overall child poverty rates declined from 20.5 percent in 1996 to 
    16.2 percent in 2000. The poverty rate among African American 
    children declined from 39.9 percent to 30.9 percent--the lowest 
    level on record. The poverty rate among Hispanic children declined 
    from 40.3 percent to 28.0 percent--the largest 4-year drop on 
    record.
  The rate of births to unwed mothers has not increased.

    But even with this notable progress, much remains to be done, and 
States still face many challenges. Last year, I held eight listening 
sessions throughout the country to discuss the state of their TANF 
systems and understand the new challenges they are facing. The States 
overwhelmingly support this program. While keeping the basic structure 
and purpose of the program, States, administrators, recipients, 
employers, and advocates have provided valuable insight into where we 
could make the program even more responsive to the needs of families.
    In the near future, we plan to unveil our reauthorization proposal 
to build on current successes of the program. Our reauthorization 
proposal embraces the needs of families by maintaining the program's 
overall funding and basic structure, while focusing increased efforts 
on building stronger families through work and job advancement and 
adding child well-being as an overarching goal of TANF.
    Our budget proposes $16.5 billion each year for block grants to 
States and Tribes; $319 million a year to restore supplemental grants; 
$2 billion over 5 years for a more accessible Contingency Fund; and a 
$100 million a year initiative for research, demonstration and 
technical assistance primarily to promote child well-being through 
strengthening family formation and healthy marriages. In addition, our 
proposal will call for modification of the bonus for high performance 
to reward significant achievement in promoting employment of program 
participants.
    We maintain State flexibility, but include important changes to 
improve the effectiveness of the program. We will also expect States to 
engage all families they serve and help them make progress toward their 
highest degree of self-sufficiency--even those cases that may appear 
hard to employ. We will eliminate the separate two-parent work 
participation rates and give States more flexibility in designing 
productive self-sufficiency activities while ensuring that the 
participation rate requirements are meaningful. We will also ask States 
to set performance goals for their TANF programs and report on their 
progress toward meeting these goals.
    I look forward to working with the Committee on reauthorization of 
this hallmark program. I am confident that together we will witness 
even greater achievements under the TANF program.
Other Programs Supporting TANF Goals
    The President's budget also includes funding for several other 
programs at the State and Community level that work to support the 
goals of TANF. The Job Opportunities for Low-Income Individuals program 
(JOLI), provides grants to non-profit organizations to create new 
employment and business opportunities for TANF recipients and other 
low-income individuals. Our budget provides $5.5 million to continue 
this valuable program. The Individual Development Account (IDA) 
demonstration program similarly seeks to increase the economic self-
sufficiency of low-income families by testing policies that promote 
savings for post-secondary education, home ownership, and micro-
enterprise development. The President's budget calls for $25 million to 
support IDAs. More broadly, the Social Services Block Grant (SSBG) 
provides a flexible source of funding for States to help families 
achieve or maintain self-sufficiency and provide an array of social 
services to vulnerable families. The President's budget request for 
SSBG is $1.7 billion.
Child Care
    Child Care has played an important role in the success of welfare 
reform by providing parents the support they need to work. The 
President's budget recognizes this critical link and maintains a high 
level of commitment to childcare. Continuing the substantial increase 
in funding the Congress has provided over the last several years, the 
President's budget includes a total of $4.8 billion in child care 
funding in conjunction with our request to reauthorize the mandatory 
and discretionary funding provided under the Child Care Development 
Block Grant and the Child Care Entitlement. States will also continue 
to have significant flexibility under the TANF program and under the 
Social Services Block Grant program to address the needs of their low-
income working families. These additional funding opportunities have 
substantially increased the amount of resources dedicated to child care 
needs. For example, in fiscal year 2000 States transferred $2 billion 
in TANF funds to the Child Care and Development Block Grant.
Child Support Enforcement
    The Child Support Enforcement program offers another vital 
connection to families' ability to achieve self-sufficiency and 
financial stability. The President's budget proposes to increase child 
support collections and direct more of the support collected to 
families transitioning from welfare--goals this Committee has supported 
vigorously. Under our proposal, the Federal Government would share in 
the cost of expanded State efforts to pass through child support 
collections to families receiving TANF. Pass through payments enhance a 
family's potential for achieving self-sufficiency while also creating 
incentives for non-custodial parents to pay support and custodial 
parents to cooperate in securing support. Similarly, States would be 
given the option to adopt simplified distribution rules that ease State 
administration but, more importantly, benefit families that have 
transitioned from welfare by directing support otherwise retained by 
the State and Federal Governments to these families.
    Overall collections would be increased by expanding our successful 
program for denying passports to parents owing $2,500 in past-due 
support, requiring States to update support awards in TANF cases every 
3 years, and authorizing States to offset certain Social Security 
Administration payments when they determine such action would be 
appropriate to collect unpaid support. Our child support legislative 
package would also impose a minimal annual processing fee in any case 
where the State has been successful in collecting at least $500 of 
support for the year on behalf of a family that has never received 
assistance.
Strengthening Families
    The fiscal year 2003 budget contains funds for four competitive 
grant programs, targeted at community and faith based organizations, to 
assist in delivering innovative services, to strengthen families and 
help change lives. The Compassion Capital Fund, at $100 million, will 
expand the capacity of groups and organizations willing to step up and 
help provide these critical social services. $20 million is included to 
encourage and help fathers improve their ability to manage family 
business affairs. Children who have parents in prison are in need of 
mentoring support by a caring adult, $25 million is requested for this 
effort. Finally, young pregnant mothers and their children will be 
provided safe environments through the $10 million included for 
Maternity Group Homes.
Promoting Safe and Stable Families
    I appreciate this Committee's tremendous support for our efforts to 
help American families, most recently your work shepherding through to 
enactment the President's initiative to reauthorize and expand the 
Promoting Safe and Stable Families Program. The President's budget 
would increase the funding level for this program to $505 million, 
fully supporting the increased authorization included in the new law. 
These funds will be used to help promote and support adoption so that 
children can become part of a safe and stable family, as well as for 
increased preventive efforts to help families in crisis.
    Our budget also supports the new authority for funding the 
mentoring children of prisoners initiative included in the legislation 
and advanced by the President in last year's budget. The budget 
requests $25 million for grants to provide a range of activities to 
mentor children of prisoners.
    This landmark legislation also authorized a new program to provide 
vouchers to youth who are aging out of foster care so that they can 
obtain the education and training they need to lead productive lives. 
The President's budget includes $60 million for these vouchers, 
bringing the total request for the Foster Care Independence Program to 
$200 million.
Child Welfare/Foster Care/Adoption
    Our budget framework includes resources for a number of additional 
programs targeted to protecting our most vulnerable and at-risk 
children. Foster Care, Adoption Assistance, Adoption Incentives and 
Child Welfare Services are designed to enhance the capacity of families 
to raise children in a nurturing, safe environment. The President's 
budget provides resources to help States provide safe and appropriate 
care for children who need placement outside their homes, and to 
provide funds to States to assist in providing financial and medical 
assistance for adopted children with special needs who cannot be 
reunited with their families, and to reward States for increasing their 
number of adoptions. At the same time, the budget also supports Child 
Welfare Services programs with the goal of keeping families together 
when possible and in the best interest of the child.
    The budget provides nearly $4.9 billion for Foster Care, $1.6 
billion for Adoption Assistance, and $43 million in Adoption Incentive 
funds. In addition, the President's budget seeks almost $300 million in 
funding for child welfare services and training. Together, these funds 
will support improvement in the healthy development, safety, and well 
being of the children and youth in our Nation.
Abstinence Education
    The President's Budget proposes to reauthorize $50 million in 
mandatory funding for Abstinence Education grants to States. These 
resources complement Abstinence Education grants to community-based 
organizations ($73 million). Both grants will continue to support the 
message, through mentoring, counseling and adult supervision, that 
abstinence from sexual activity is the only sure way for teens to avoid 
out-of-wedlock pregnancies and sexually transmitted diseases.
Repatriation
    Finally, our commitment to supporting America's families does not 
stop at our borders. The President's budget seeks $1 million in funding 
for the Repatriation program to assist United States citizens and their 
dependents returning from foreign countries under extreme 
circumstances.

                    Increasing Access to Health Care

    The issues that have confronted the Nation in the past 6 months 
will have far reaching effects. Of all the issues confronting this 
Department, none has a more direct effect on the well-being of our 
citizens than the quality and accessibility of health care. Our budget 
proposes to improve the health of the American people by taking 
important steps to increase and expand the number of Community Health 
Centers, strengthen Medicaid, and ensure patient safety.
    Community Health Centers provide family oriented preventive and 
primary health care to over 11 million patients through a network of 
over 3,400 health sites. The fiscal year 2003 budget will increase and 
expand the number of health enter sites by 170, the second year of the 
President's initiative is to increase and expand sites by 1,200 and 
serve an additional 6.1 million patients by 2006. We propose to 
increase funding for these Community Health Centers by $114 million. 
Our long-term goal is to increase the number of people who receive high 
quality primary healthcare regardless of their ability to pay. With 
these new health centers we hope to achieve this goal.
    The Medicaid program and the State Children's Health Insurance 
Program (SCHIP) provide health care benefits to low-income Americans, 
primarily children, pregnant women, the elderly, and those with 
disabilities. The fiscal year 2003 budget we propose strengthens the 
Medicaid and SCHIP programs by implementing essential reforms.
    As a first step, we propose to build on the Health Insurance 
Flexibility and Accountability (HIFA) demonstration initiative, which 
would give states the flexibility they need to design innovative ways 
of increasing access to health insurance coverage for the uninsured. In 
addition to HIFA, the Administration's plan would allow those who 
receive the President's health care tax credit to increase their 
purchasing power by purchasing insurance from plans that already 
participate in their State's Medicaid, Children's Health Insurance, or 
State employees' programs.
    This could help keep costs down and provide a more comprehensive 
benefit than plans in the individual market.
    We also need to make an effort to narrow the drug treatment gap. As 
reflected in the National Drug Control Strategy, Substance Abuse and 
Mental Health Services Administration estimates that 4.7 million people 
are in need of drug abuse treatment services. However, fewer than half 
of those who need treatment actually receive services, leaving a 
treatment gap of 3.9 million individuals. Our budget supports the 
President's Drug Treatment initiative, and to narrow the treatment gap. 
We propose to increase funding for the initiative by $127 million. 
These additional funds will allow States and local communities to 
provide treatment services to approximately 546,000 individuals, an 
increase of 52,000 over fiscal year 2002.

                         STRENGTHENING MEDICARE

    The fiscal year 2003 budget dedicates $190 billion over 10 years 
for immediate targeted improvements and comprehensive Medicare 
modernization, including a subsidized prescription drug benefit, better 
insurance protection, and better private options for all beneficiaries. 
Last year, President Bush proposed a framework for modernizing and 
improving the Medicare program that built on many of the ideas that had 
been developed in this Committee and by other Members of Congress. That 
framework includes the principles that:

  All seniors should have the option of a subsidized 
    prescription drug benefit as part of modernized Medicare.
  Modernized Medicare should provide better coverage for 
    preventive care and serious illness.
  Today's beneficiaries and those approaching retirement should 
    have the option of keeping the traditional plan with no changes.
  Medicare should make available better health insurance 
    options, like those available to all Federal employees.
  Medicare legislation should strengthen the program's long-
    term financial security.
  The management of the government Medicare plan should be 
    strengthened to improve care for seniors.
  Medicare's regulations and administrative procedures should 
    be updated and streamlined, while instances of fraud and abuse 
    should be reduced
  Medicare should encourage high-quality health care for all 
    seniors.

    The improvements the President and I have proposed include not only 
a subsidized drug benefit as part of modernized Medicare, but also 
providing better coverage for preventive care and serious illness. 
Thus, we propose that preventive benefits have zero co-insurance and be 
excluded from the deductible. We must make these improvements to more 
effectively address the health needs of seniors today and for the 
future.
    Let me assure you, the President remains committed to the framework 
he introduced last summer, and to bringing the Medicare program up to 
date by providing prescription drug coverage and other improvements. We 
cannot wait: it is time to act. Recognizing that there is no time to 
waste, the President's Budget also includes a series of targeted 
immediate improvements to Medicare.
    As you know, last year the President proposed the creation of a new 
Medicare-endorsed prescription drug card program to reduce the cost of 
prescription drugs for seniors. This year, HHS will continue working to 
implement the drug card program, which will give beneficiaries 
immediate savings on the cost of their medicines and other valuable 
pharmacy services. The President is absolutely committed to providing 
immediate assistance to seniors who currently have to pay full price 
for prescription drugs.
    Assistance, however, will not come only through the prescription 
drug card program. The budget proposes several new initiatives to 
improve Medicare's benefits and address cost. This budget proposes 
additional Federal assistance for comprehensive drug coverage to low-
income Medicare beneficiaries up to 150 percent of poverty--about 
$17,000 for a family of two. This policy would eventually expand drug 
coverage for up to 3 milllion beneficiaries who currently do not have 
prescription drug assistance, and it will be integrated with the 
Medicare drug benefit that is offered to all seniors once that benefit 
is in place. This policy helps to establish the framework necessary for 
a Medicare prescription drug benefit and is essentially a provision 
that is in all of the major drug benefit proposals to be debated before 
Congress. That is, the policy provides new Federal support for 
comprehensive prescription drug coverage for low-income seniors up to 
150 percent of poverty. And in all the proposals, the Federal 
Government would work with the States to provide this coverage, just as 
we are proposing with this policy.
    Recently, I announced a model drug waiver program--Pharmacy Plus--
to allow States to reduce drug expenditures for seniors and certain 
individuals with disabilities with family incomes up to 200 percent of 
the Federal poverty level. This program is being done administratively. 
The recently approved Illinois initiative illustrates how states can 
expand coverage to Medicare beneficiaries in partnership with the 
Federal Government. The Illinois program will give an estimated 368,000 
low-income seniors drug coverage. The model application I have 
announced is easy to understand and use, and the Centers for Medicare 
and Medicaid Services is working with numerous States--at least 12--
that have already expressed interest in this program. Making it easier 
for States to take similar steps to help their citizens who need help 
the most is the goal I believe we all share.
    The President's budget also includes an increase in funding to 
stabilize and increase choice in Medicare+Choice program by aligning 
payment rates more closely with overall Medicare spending and paying 
incentives for new types of plans to participate. Over 500,000 seniors 
lost coverage last year because Medicare+Choice plans left the program. 
Today over 5 million seniors choose to receive quality health care 
through the Medicare+Choice program. Because it provides access to drug 
coverage and other innovative benefits, it is an option many seniors 
like, and an option we must preserve. The President's budget also 
proposes the addition of two new Medigap plans to the existing 10 
plans. These new plans will include prescription drug assistance and 
protect seniors from high out-of-pocket costs.
    Some of these initiatives give immediate and tangible help to 
seniors. But, let me make clear: these are not substitutes for 
comprehensive reform and a universal drug benefit in Medicare. They are 
immediate steps we want to take to improve the program in conjunction 
with comprehensive reform, so that beneficiaries will not have to wait 
to begin to see benefit improvements. I want to pledge today to work 
with each and every member of this Committee to fulfill our promise of 
health care security for America's seniors--now and in the future.

                     Supporting Healthy Communities

    The fiscal year 2003 budget includes $25 million for a Healthy 
Communities Innovation Initiative--a new interdisciplinary services 
effort that will concentrate Department-wide expertise on the 
prevention of diabetes and asthma, as well as obesity. The purpose of 
the initiative is to reduce the incidence of these diseases and improve 
services in 5 communities through a tightly coordinated public/private 
partnership between medical, social, educational, business, civic and 
religious organizations.
    More than 16 million Americans currently suffer from a preventable 
form of diabetes. Type II diabetes is increasingly prevalent in our 
children due to the lack of activity. In a recent study conducted by 
NIH, participants that were randomly assigned to intensive lifestyle 
intervention experienced a reduced risk of getting Type II diabetes by 
58 percent. The Healthy Communities Initiative makes preventing Type II 
diabetes in kids a priority. HHS plans to reach out to women and 
minorities to help make this initiative a success.

          Improving Management and Performance of HHS Programs

    I am committed to being proactive in preparing the Nation for 
potential threats of bioterrorism and supporting research that will 
enable Americans to live healthier and safer lives. And, I am excited 
about beginning the next phase of Welfare reform and strengthening our 
Medicare and Medicaid programs. Ensuring that HHS resources are managed 
properly and effectively is also a challenge I take very seriously.
    For any organization to succeed, it must never stop asking how it 
can do things better, and I am committed to supporting the President's 
vision for a government that is citizen-centered, results oriented, and 
actively promotes innovation through competition. HHS is committed to 
improving management within the Department and has established its own 
vision of a unified HHS--One Department free of unnecessary layers, 
collectively strong to serve the American people. The fiscal year 2003 
budget supports the President's Management Agenda.
    The Department will improve program performance and service 
delivery to our citizens by more strategically managing its human 
capital and ensuring that resources are directed to national 
priorities. HHS will reduce duplication of effort by consolidating 
administrative management functions and eliminating management layers 
to speed decision-making. The Department plans to reduce the number of 
personnel offices from 40 to 4; centralize the public affairs and 
legislative affairs functions; and consolidate construction funding, 
leasing, and other facilities management activities. These management 
efficiencies will result in an estimated savings of 700 full time 
equivalent positions, allowing the Department to redeploy staff and 
other resources to line programs.
    HHS continues to be at the forefront of the Government-wide effort 
to integrate budget and performance. We were one of the first 
Departments to add tables to its GPRA Annual Performance Reports that 
provide summary tables that associate resource dollars and performance 
measures HHS-wide. Although we work in a challenging environment where 
health outcomes may not be apparent for several years, and the Federal 
dollar may be just one input to complex programs, HHS is committed to 
demonstrating to citizens the value they receive for the tax dollars 
they pay.
    By expanding our information technology and by establishing a 
single corporate Information Technology Enterprise system, HHS can 
build a strong foundation to re-engineer the way we do business and can 
provide better government services at reduced costs. By consolidating 
and modernizing existing financial management systems our Unified 
Financial Management System (UFMS) will provide a consistent, 
standardized system for departmental accounting and financial 
management. This ``One Department'' approach to financial management 
and information technology emphasizes the use of resources on an 
enterprise basis with a common infrastructure, thereby reducing errors 
and enhancing accountability. The use of cost accounting will aid in 
the evaluation of HHS program effectiveness, and the impacts of funding 
level changes on our programs.
    HHS is also committed to providing the highest possible standard of 
services and will use competitive sourcing as a management tool to 
study the efficiency and performance of our programs, while minimizing 
costs overall. The program will be linked to performance reviews to 
identify those programs and program components where outsourcing can 
have the greatest impact. Further, the incorporation of performance-
based contracting will improve efficiency and performance at a savings 
to the taxpayer.

                 Government Performance and Results Act

    HHS is committed to continual improvement in the performance and 
management of its programs and the Administration's efforts to provide 
results-oriented, citizen-centered government. The budget request for 
fiscal year 2003 is accompanied by annual performance plans and reports 
required by the Government Performance and Results Act (GPRA). The 
performance measures cover the wide range of program activities 
essential to carrying out the HHS mission. Some notable fiscal year 
2001 achievements include:

-Reducing Erroneous Medicare Panents: CMS has continued to reduce the 
    payment error rate from 14 percent in fiscal year 1996 to 8 percent 
    in fiscal year 1999 and 6.8 percent in fiscal year 2000 and 
    exceeding its targets in both fiscal year 1999 and fiscal year 
    2000. CMS, with the assistance of the Office of the Inspector 
    General, is committed to further reducing the error rate to 5 
    percent by fiscal year 2002.
-Moving Families Toward Self-sufficiency: ACF reported that 42.9 
    percent of adult recipients of TANF were employed by fiscal year 
    1999. This is a primary indicator of success in moving families 
    toward self-sufficiency. It improves on the fiscal year 1998 
    baseline of 38.7 percent and exceeds the target of 42 percent.
-Families Benefiting from Child Support Enforcement: The Child Support 
    Enforcement program broke new records nationwide in fiscal year 
    2001 by collecting $18.9 billion, one billion over fiscal year 2000 
    levels. In one such initiative in fiscal year 2000, the government 
    collected a record $1.4 billion in overdue child support from 
    Federal income tax refunds, and more than 1.42 million families 
    benefited from these collections.

    These are just a few of the dozens of impressive success stories 
found in the 13 performance plans and reports. GPRA has been and will 
continue to be an important part of our effort to improve the 
management and performance of our programs.

         Working Together to Ensure a Safe and Healthy America

    Mr. Chairman, the budget I bring before you today contains many 
different elements of a single proposal; what binds these fundamental 
elements together is the desire to improve the lives of the American 
people. All of our proposals, from building upon the successes of 
welfare reform, to protecting the Nation against bioterrorism; from 
increasing access to healthcare, to strengthening Medicare, are put 
forward with the simple goal of ensuring a safe and healthy America. I 
know this is a goal we all share, and with your support, we are 
committed to achieving it.

    Chairman Conrad. Thank you, Mr. Secretary. Thank you for 
that testimony. Let's go to the question that I raised in my 
opening statement that is of great concern to me. Could we put 
up that chart?
    Could you tell me how is it--and I know this is over in 
OMB, they came up with these numbers. I said I believe they 
have cooked the books here. I don't know what other conclusion 
one would come to, when they have got an estimate for increases 
in health care that we have not seen in anyone's recent memory, 
and no objective observer believes they are credible.
    Compared to the Congressional Budget Office, OMB has 
underestimated the cost of Medicare over this decade by $300 
billion, and here is why: Medicare costs under OMB are 
projected to go up 3.5 percent a year. CBO says they are going 
up 5 percent a year. Private health insurance spending on a per 
capita basis is going up 6.1 percent a year. Last year medical 
inflation was 4.7 percent.
    These sound like small differences. These small differences 
add up to huge amounts of money.
    Secretary Thompson. Yes.
    Chairman Conrad. Do you have any understanding of how they 
justify this?
    Secretary Thompson. Senator, let me attempt to explain to 
the best of my ability. It is my understanding that over the 
next 10 years, the growth estimated by our actuaries at the 
Centers for Medicare Services is 5.7 percent. CBO's is 7.2 
percent. That makes a difference over 10 years of $359 billion, 
as you have indicated.
    I have the actuary here from the Centers for Medicare and 
Medicaid Services, Rick Foster, who has been the chief actuary 
for Medicare cost analysis for the last several years. He is 
the same individual that the Clinton administration used, the 
same one the we are using. OMB took the figures directly from 
the actuaries. These are professional individuals. They have, I 
think, some of the best analysts possible. We have 50 
individuals that have analyzed it, and they have indicated that 
these are the figures.
    Some of the reasons--I asked the same questions you did, 
Senator Conrad. How could that possibly be? One of the things 
that they have indicated is that the level of medical usage is 
stabilizing, and they expect more stabilization in the outer 
years.
    Second, the prospective payments for doctors, which went 
down 5.4 percent, were included in the analysis of CMS, which 
was not included, to the best of my knowledge at this time, at 
CBO. And it is also my understanding that CBO is going to make 
some adjustments, some modifications in their figures in March 
of this year, and will also be working with the actuaries at 
CMS.
    So if, in fact, CBO still has those same figures in March, 
I think we are going to have to sit down with CMS and make some 
reconciliations. But right now CMS, as of last night when I 
talked to them--and Rick Foster (who is the chief actuary) is 
here--stands by his numbers, and these are the exact numbers 
that he gave OMB and OMB put them in the budget. And as I 
understand it, OMB in the Clinton administration, the OMB in 
the previous Bush administration, and this current Bush 
Administration takes the actuary numbers from CMS directly and 
never changes them or modifies them at all.
    Chairman Conrad. Let me just say that I think a reality 
test, just kind of a common-sense reality test, would say it is 
very unlikely. I am told our people have done an analysis that 
these assumptions would say Medicare will grow more slowly in 
the next decade than it has in any 10-year period since its 
creation. Is that credible? Here we are, the baby boomers start 
to retire in 6 years, they become eligible for Medicare, and we 
are saying that the costs of the program that is the biggest 
program that they are eligible for other than Social Security 
is going to grow at the lowest rate since the inception of the 
program?
    It is not credible with me, and it is not the CBO's 
analysis. And I can tell you, I have had outside experts that 
we have consulted who term this estimate laughable. Laughable. 
These are outside health experts who have looked at this, 
looked at the trend lines in terms of the number of people 
eligible, and they say this is a vast understatement of what 
the costs will be.
    Secretary Thompson. Senator Conrad, all I can say is that I 
have turned to the economists and the chief actuary of CMS, and 
as I understand it, it is the same actuary system that has been 
used by this Congress and by previous Administrations and the 
current Administration, and I looked to him, and I asked him 
again last night, was this credible, and he nods in the 
affirmative. And so I have to rely upon my expert, Senator 
Conrad, and that is what I am relying on.
    Chairman Conrad. Well, I understand. I am just saying I do 
not think it is credible. I think a common-sense reality test 
would tell us it is not credible. And you know, I believe this 
is how we get into trouble, understating what costs are going 
to be.
    Let me go to the prescription drug question.
    Secretary Thompson. OK.
    Chairman Conrad. Because that has been raised. Let us put 
up that chart that shows prescription drug costs. The President 
is calling for $190 billion for prescription drugs. Last year's 
budget resolution agreed to in the House and the Senate 
provided $300 billion, so this is a 37 percent cut from what 
Congress provided last year. And it is an estimate and a 
provision of a 37 percent reduction from what Congress did last 
year at a time the costs are skyrocketing. They have told us 
that providing the same benefit $300 billion would have 
provided last year would cost $400 billion now. And yet the 
President provides $190 billion.
    Again, the reality test. I went and asked how much it would 
cost to provide the same prescription drug benefit that all 
Federal employees are eligible for. The answer was $750 
billion. Seven hundred and fifty billion to provide the 
prescription drug benefit that Federal employees have. That is 
the column on the right.
    Last year's budget, prepared by Congress, provided $300 
billion. The President's budget is $190 billion. How are you 
going to provide any kind of serious prescription drug benefit 
with about a quarter of the money that it would take to provide 
the benefit every Federal employee has, that the President has, 
that you have, that I have, that every member of this panel 
has?
    Secretary Thompson. Senator, the President feels and the 
Administration feels very strongly that we have to start 
someplace, and $190 billion is, we think, a tremendous effort 
on the part of this Administration for developing prescription 
drug coverage and at the same time strengthening Medicare.
    If it was only prescription drug coverage, I could 
understand that your figures would be much more in line, but if 
you do the necessary reforms, the necessary strengthening of 
Medicare, and add some of the other things and make some of the 
adjustments, we feel that we can develop a very comprehensive 
package at $190 billion over 10 years, and that is where we got 
our figures, once again, the Center for Medicare and Medicaid 
Services. It went through OMB----
    Chairman Conrad. These are the same actuaries?
    Secretary Thompson. We used the same actuaries, Senator, 
and----
    Chairman Conrad. I think we had better get some new 
actuaries over there. Let me go to----
    Secretary Thompson. I have known them for many years, sir, 
and they have always proven to be correct, and I have a great 
admiration for their professionalism, Senator.
    Chairman Conrad. Well, I appreciate your confidence in 
them. I don't share that confidence, and I doubt very much that 
what we face in the future will match their numbers.
    Let me go to the final question I have, and that is, absent 
from this budget is any funding for provider payment 
adjustments, despite the Medicare Payment Advisory Commission's 
recommendations last month for increases in Medicare's provider 
payment systems.
    Chairman Thomas of the House Ways and Means Committee 
expressed concern about this matter.
    Secretary Thompson. He did.
    Chairman Conrad. And we have an indication from him, they 
anticipate it may cost as much as $174 billion over the next 10 
years, and there is no provision for it in the budget. Can you 
explain that?
    Secretary Thompson. Well, Senator Conrad, the reason being 
is we had to make some tough choices. And number 2, we complied 
with the law in making the prospective payments adjustments, 
evidenced by the law that was passed in 1989, modified in 1997 
and 1999, and we complied with that law. When you have an 
uptick in the economy, the prospective payments show increases. 
When you have a downturn, which we have had this past year, 
there has been a reduction in the payments to doctors, which is 
a reduction of 5.4 percent, which brought this to the 
forefront.
    Chairman Conrad. But there is no legal requirement that you 
provide for adjustments that are recommended by your own 
commission.
    Secretary Thompson. That is very true. But when we looked 
at it, we did not have the money available for making any 
further adjustments. We tried to come in with as close to 
baseline as we possibly could. We also told Chairman Thomas 
that we would work with the Ways and Means Committee, and that 
same promise I give to you, Senator, and to this Committee, 
that we will work with you. But I think it is important if we 
are going to look at the prospective payments for doctors, we 
should look at the prospective payments for all the providers, 
put them all on the table, work together in a comprehensive 
manner to see if we cannot solve it. Because the law right now, 
the way it is written, creates some problems for making the 
prospective payments. I am not blaming anybody. I am just 
saying this is the law, and I would like to work with you to 
try and improve it and to modernize it wherever we possibly 
can.
    Chairman Conrad. Let me just say I appreciate your 
attitude. I just say to you that I just don't see this budget 
as adding up. I honestly do not, and it starts at a much higher 
level than you, and that involves most directly the Office of 
Management and Budget. But I see this as just filled with 
problems, and it is going to be very difficult to craft a 
budget when this is the thing that has been sent to us. And I 
do not think it is a realistic proposal. I think it badly 
understates the costs of Medicare. I think it is completely 
inadequate with respect to prescription drugs, and there is no 
provision for adjustments to providers that are recommended by 
your own commission, and these are tremendous amounts of money.
    With that, we will go to--Senator Frist was going to ask 
Senator Smith to go next on your side.
    Senator Smith. Thank you, Mr. Chairman. I have an opening 
statement. I would like to include it in the record, and my 
questions will incorporate some of it.
    Chairman Conrad. Without objection.

               Opening Statement of Senator Gordon Smith

    Good morning Mr. Secretary and fellow Senators.
    Mr. Secretary, I am glad to welcome you before the Senate Budget 
Committee this morning of all mornings--Valentine's Day--a day when 
people around the world show how much they care for others--a day when 
we should not be afraid to show that we have a heart.

                             the uninsured

    Last Monday we received President Bush's budget for 2003. I would 
like to express my appreciation to the Administration for taking a 
strong leadership role in the proposed fiscal year 2003 budget with 
regards to the uninsured. I am impressed by your initial size and 
apparent scope of the Administration's commitment to decreasing the 
numbers of uninsured Americans. Setting aside $89 billion is a good 
start in our efforts to provide health care coverage to the most needy.
    However, even according to the Administration's own estimates, his 
proposal will only reach 6 million of the uninsured next year. There 
are 40 million uninsured people in this country--and the number is 
growing. Just yesterday, families USA released the finding that 2.2 
million Americans lost their health coverage last year because of 
layoffs. This is the biggest yearly jump in the uninsured population in 
a decade.
    And this is a conservative estimate! it only approximates the loss 
of health coverage caused by job layoffs. It does not include any 
effect of increased health care costs, or State medicaid program 
cutbacks.
    Therefore, as a result of the 2001 increase, the number of 
uninsured people in America now exceeds the cumulative population of 23 
States plus the District of Columbia. I want to urge everyone listening 
to read more about this problem. Go to www.coveringtheuninsured.org.
    I have long fought for greater awareness of breast cancer--and 
there is a horrifying statistic on that website women with breast 
cancer are 49 percent more likely to die if they are uninsured.
    We MUST do something THIS YEAR to address this growing problem. In 
the past, I have worked with both Republicans and Democrats on this 
important issue, and this year I intend to seek bipartisan support 
again for setting aside additional funds to cover the uninsured.
    I believe we must commit a greater sum of money if we are to make a 
realistic effort to cover all 40 million--and growing--uninsured 
Americans. It is a national disgrace that so many people who live and 
work among us do not have affordable access to this most basic human 
need.
    While there is no agreement as to exactly how to expand coverage 
for all Americans, it seems fairly clear that the only feasible way is 
through some combination of private incentives and public expansions. 
We must be prepared to work together to find compromise if we are going 
to ever do more than simply talk about the uninsured.
    Mr. Secretary, I'm very happy we've begun to address the problem of 
the uninsured, but we are only helping 6 million people this year .  .  
.it reminds me of the school children on Valentine's Day who only bring 
Valentine's for a selected few in their class, leaving the others empty 
handed. Let's send a Valentine to every child--we need to insure all 
Americans.

    Senator Smith. Mr. Secretary, thank you for being here. I 
think your record as the Governor of Wisconsin in health care 
reform is wonderfully propitious for our country's sake, and I 
think the job you are doing, both in the reform front and the 
war front, on the homefront, is very much appreciated by this 
Senator.
    I wrote yesterday, Mr. Secretary, a letter to President 
Bush about my ongoing concern for the issue of the uninsured, 
and I do think your budget has made a very good start on 
closing this gap. I have referred to 40 million uninsured 
Americans in the past as a moral omission on the part of our 
country.
    I would like to propose to you that if President Bush as a 
Republican would grab as his own the issue of eliminating the 
ranks of the uninsured, it would be his version of Nixon going 
to China, and I would like to suggest that would be good for 
our country.
    As I understand your budget, we are going to cover an 
additional 6 million Americans. That leaves 34 million 
Americans still uncovered. I have worked in the past with 
Senator Wyden, my colleague from Oregon, and other Republicans 
and Democrats to try and figure out a more comprehensive 
approach to eliminating this moral omission that would include 
not only health care credits that you are providing but also 
deductions for small businesses that don't now offer health 
care, and an even more significant expansion of community 
health centers. Perhaps with some combination like this, we 
could answer the question to the rest of the world that the 
greatest Nation in the world does provide health care to all of 
its citizens.
    I wonder if you are open to working with us, not in future 
years but this year, to find a more comprehensive package than 
has been proposed in the budget of credits, deductions and 
expanded health care centers. You can help us to figure out how 
to pay for it and identify some efficiencies that our system 
does not allow now.
    We are spending an awful lot on health care. It does seem 
to me that with what Wisconsin has done, what Oregon has done, 
there are ways to get more people insured with the dollars we 
are already spending.
    I wonder if you would work with us, to that end, and if you 
have any thoughts you could share with me today.
    Secretary Thompson. Well, thank you very much for the 
question, Senator Smith, because, you know, this is something 
that needs to be done. We need to look at the uninsured and 
find ways in which we can solve this particular problem. And I 
think we have to do it on a bipartisan basis, and I think there 
are a lot of individuals on both sides who would like to do 
something.
    I would like to point out that $89 billion in health 
credits is a giant step forward.
    Senator Smith. It is big.
    Secretary Thompson. It should cover 6 million Americans, 
and it also allows you to go in right away and get the credit 
and then take that credit to your insurance agent and buy 
health coverage.
    The second thing I did not mention, which is also going to 
be very helpful, is allowing small businesses to form pools, 
and not only within the particular State of Oregon, but go into 
the State of Washington and Idaho, and so on and so forth, and 
get an expanded pool so that small businesses would have a 
better opportunity to do it.
    Three, expanding community health centers is something 
tremendously needed, and you did not mention the $77 billion 
for immediate help in regard to prescription coverage for those 
that are on Medicare.
    Senator Smith. Yes.
    Secretary Thompson. Up to 150 percent of poverty. The 
Federal Government will pay 90 percent between 100 and 150 
percent.
    I also would point out for you a program that I started in 
Wisconsin--and I know Oregon has now got a waiver in front of 
the Department that we are reviewing, or will be reviewing. We 
have also expanded that Badger care kind of coverage in 
Massachusetts and in New York where there are going to be 
650,000 more low-income families covered. It was also approved 
in California and Arizona and Utah. We have been able to expand 
that by 1.8 million Americans by allowing waivers to be used 
under the S-CHIP program to give low-income working parents an 
opportunity to be covered as the children, with the State 
assuming a good share of the responsibility. But it extends it, 
and this is a program that has tremendous potential nationally, 
and I would like you to take a look at that.
    Senator Smith. I would be happy to look at that with you.
    Secretary Thompson. I do want to work with you, absolutely.
    Senator Smith. Well, we want to do this. I met with Tom 
Scully the other day, and he had many ideas as well.
    Secretary Thompson. We are not short of ideas over in the 
Department.
    Senator Smith. We just need to implement them, because I 
think for all of our great credits as a country, our lack of 
health care coverage for the working uninsured is not one of 
those credits. It is certainly a debit in my mind.
    Can you describe in more detail what the Administration has 
in mind in terms of approaches to Medicaid and S-CHIP without 
seeking waivers? Is that the proposal on the table?
    Secretary Thompson. There is no expansion of S-CHIP right 
now. I certainly think we should be looking at that. But there 
is nothing in this budget to expand the S-CHIP program except 
for the $3.5 billion that would go back to the Treasury for 
States that had not used that money. The President has 
indicated it is a great program, and that money should be left 
out there for the States to use to cover children, and 
hopefully we can also cover low-income working families, 
because I have found from the experience that I have had, both 
as Governor and now as the Secretary, that more families are 
willing to take their children to get covered if, in fact, they 
are ale to sign up for coverage as well.
    In regard to the $77 million. That is for prescription 
coverage. It is not Medicaid or an S-CHIP. It is a new program 
in which the States will receive the regular the Federal MAP 
rate up to 100 percent, and then receive 90 percent FMAP from 
100 to 150 percent, which will help a lot of States in offering 
prescription drug coverage for seniors and those that are 
disabled.
    Senator Smith. Mr. Secretary, just a closing comment that I 
had. I recently visited a community health center in Clackamas 
County, Oregon. They indicated to me they could serve so many 
more people if there were more resources from the Federal 
Government to counties, and somehow we have got to redirect the 
thinking of the uninsured not to go to the emergency room, but 
to go to a community health center.
    Secretary Thompson. Absolutely.
    Senator Smith. And I do not know how you get there, but 
somehow there needs to be coordination with emergency rooms to 
tell people, If you don't have an emergency, go to the 
community health center. It is there, it is available, it is 
inexpensive. We just need more of them.
    Secretary Thompson. We have got 3,300 right now. We are 
going to add an additional 170 in this budget if Congress goes 
along with the President's recommendation. Congress has been 
very generous. Last year we asked for 125 and Congress came in 
with 175 million. We have been able to add an additional 200. I 
know Senator Bond has led this effort, and I cannot tell you 
how impressed I am with the care, the quality of care that 
people receive at the community health centers. It is 
excellent.
    Senator Smith. It is.
    Secretary Thompson. We need to do more, and by this budget 
and by the President's commitment, your commitment, and the 
bipartisan commitment, I am fairly confident we will meet our 
goal of going from 11 million people in America being able to 
utilize community health centers to 20 million. That is the 
goal, and we are looking to expand the numbers by 1,200 over 
the course of the next several years, and I think that is going 
to encourage more people to use them, keep them out of the 
emergency rooms and get them into the community health centers 
where they get primary care which is very good care for them.
    Senator Smith. Thank you, Mr. Secretary. Thank you, Mr. 
Chairman.
    Chairman Conrad. Senator Byrd.
    Senator Byrd. Thank you, Mr. Chairman. Thank you, Mr. 
Secretary.
    Last year I proposed a $4 billion supplemental as Chairman 
of the Appropriations Committee for bioterrorism, focusing on 
developing the capacity of the State and local hospitals and 
clinics to respond to bioterrorist attacks and to purchase 
smallpox vaccine and anthrax antibiotics. Dr. Frist says we 
need to respond today.
    The President opposed that package. He opposed it as being 
too large and too early. Now the President is requesting over 
$4 billion for fiscal year 2003 for bioterrorism programs at 
HHS, but under his 2003 request this funding would not be 
available for almost a year. If he had not opposed the funding 
that I proposed last year, it would have been available now. 
That funding went down on a 60-vote point of order, and 
Senators walked in lockstep to the President's leadership in 
opposing that money at that time.
    I find this mystifying. The money would have been available 
now.
    We are right now working under the fourth alert. We are 
under an FBI alert now, and yet that money was opposed by this 
Administration. They said it was too large, too early.
    Don't State and local governments need these resources for 
their hospitals and clinics this year to respond to the 
terrorist threat, Mr. Secretary?
    Secretary Thompson. First let me congratulate you, Senator 
Byrd, on your leadership on this bioterrorism initiative. You 
and I have talked about it, and I compliment you for it.
    Senator Byrd. Thank you.
    Secretary Thompson. As you know, we received $3 billion on 
the supplemental appropriation which was signed into law on 
January 10th. We are sending out $1.1 billion. We sent out the 
letters within 21 days. We are sending out 20 percent of that 
money, and we will be sending out the balance of the money 
within the next 60 or 70 days, as soon as they deliver a plan. 
We want to make darn sure that money gets out there into the 
States and into the localities for communication, for 
education, for planning, for surge capacity for our hospitals 
and so on.
    The President feels that we have to get the planning done 
before we go to the next step, which is the $4.3 billion that 
he is requesting in fiscal year 2003.
    I also want to point out that we will have 286 million 
doses of smallpox vaccine by the end of this year, enough for 
every man, woman, and child.
    We have also have in this budget $250 million set aside to 
purchase a new anthrax vaccine which Dr. Tony Fauci at NIH is 
working on.
    We have also just approved Bioport, and they have met the 
inspections put out by FDA, Senator, and they should be able to 
produce 2.5 million doses of anthrax vaccine this year and 3 
million doses next year.
    So we are in the process of all of these steps that you are 
very interested in, and I applaud you for it. We think we are 
going in a very systematic and very comprehensive way.
    I would like to point out that we have not invested, as you 
know, in our local and State public health system for many 
years, neither at the Federal level nor at the State level. And 
now one of the good consequences of 9/11 is we have an 
opportunity to build a good, constructive, and very visionary 
State public health system, something that you have wanted for 
a long time, and I compliment you on it. I want to make sure 
that we deliver it for you, sir.
    Senator Byrd. Well, I would hope you deliver it a little 
faster. I am troubled, if not baffled, that the Department of 
Health and Human Services has decided to release only 20 
percent--only 20 percent--of the $1.1 billion. You said earlier 
that you released 20 percent. Twenty percent of the $1.1 
billion that Congress appropriated for shoring up our State and 
local public health infrastructure.
    Now can you explain to me and to this Committee why States 
are forced to run a bureaucratic gauntlet before you surrender 
the remaining 80 percent of these desperately needed funds? Why 
are we waiting? Here you are--I shouldn't say that. It sounds a 
little overly personal. But here we are, we would have 
appropriated that money last year. I offered a package to do it 
on the floor, and sitting on a 60-vote point of order killed 
it, said no. And the President led the Administration--this 
President led the fight against that effort, and you would have 
had money earlier by far and the people at the State level 
would have had more money, and earlier, by far than is going to 
be the case.
    Why are the States being forced to run this bureaucratic 
red-tape gauntlet before you surrender the remaining 80 percent 
of these desperately needed funds?
    Secretary Thompson. Senator, we want to make sure that this 
money is well spent. We want to make darn sure that it is 
accountable and that we are responsible for developing the best 
State public health system we can.
    The President signed a bill on January 10th. We sent out 
the letters by the 31st, which is 21 days. We are sending out 
the 20 percent this Friday or next Monday. We are asking them, 
the State health departments, to come in and meet with the CDC, 
the doctors that I have assembled at the Department of Health 
and Human Services on February 25th. We have got four regional 
meetings set up by CDC to go out and talk to health 
departments. We are pulling together the best practices on 
communication, emergency ward operations, and we are sending 
those to the State health departments, and we want them to 
develop the plans by March 15th. They will receive the balance 
of the 80 percent after they get their plans in, and we have a 
chance to work with the State health departments so we can 
develop not only a good State system but a system that will be 
national in scope so that if something happens in the state of 
West Virginia, the State of Virginia could also pitch in, or 
the State of New York, whatever, to help the State of West 
Virginia.
    We want a comprehensive plan that is going to be something 
that you are going to be proud of, and that is why we are doing 
it. And we are also going to be able to send out that 80 
percent within 60 days after March 15th, and we feel that the 
States, working with us, we can develop the best comprehensive 
plan available for a strong local-State system that will work 
together in cooperation to develop the national system 
necessary to protect all of our citizens.
    Chairman Conrad. Mr. Secretary, might I say that I 
appreciate your desire to answer fully. The problem we have is 
a time constraint with 7-minute rounds.
    Secretary Thompson. I am sorry.
    Chairman Conrad. And with the number of Senators who are 
here----
    Secretary Thompson. I will reduce my answers significantly, 
Senator.
    Chairman Conrad. Thank you.
    Secretary Thompson. I have got so much to say. I am sorry.
    Chairman Conrad. Senator Bond.
    Senator Bond. Thank you very much, Mr. Chairman.
    Mr. Secretary, I commend you for all the kind words you 
said about community health centers. We are going to sign 
Senator Smith up on the community health center caucus.
    As Senator Hollings on this Committee and I have said over 
the years, the community health centers are the most important 
part of the safety net. They are really the web of the safety 
net, and I have visited community health centers all over my 
State, from the inner city to the suburbs to the most isolated 
rural areas of the State. When there is somebody with no health 
insurance or somebody who might even (under one of the safety 
net programs) get health insurance, if they don't have some 
place to go where the services are available, the payments, the 
insurance, does them no good. And in every nook and cranny and 
every downtown street and every hill and hollow in our State, 
the community health centers are the safety net, so they should 
be there.
    I would bet, I know it is the same in Wisconsin, in Oregon, 
in Iowa, in North Dakota and West Virginia. And I commend you 
for the good things you said about it. But as you pointed out, 
last year, again with the leadership of Senator Hollings and 
the support of Senator Frist, we upped the OMB request to $175 
million because we were trying to get on a path to double the 
provision of service by community health centers in 5 years. 
Your budget is not going to keep us on the path from 10 million 
to 20 million in 5 years. You say in here you go up about 6 
million patients.
    This, to me, is a start, but I am disappointed when there 
is so much emphasis on the safety net that we cannot get it up 
there, and frankly, we are going to work as best we can to make 
sure that we get the CHCs on that path to doubling in 5 years, 
because there is nothing more important than covering the 
remaining areas that are not covered by CHCs with that kind of 
available, most efficient, low-cost but effective health care 
service.
    I would appreciate your comments on it.
    Secretary Thompson. All I can say is I salute you for what 
you stand for in accomplishing that. Last year we put in $125 
million, and the Congress raised it to $175 million. We got 
over 200 new community health centers. The 114 is going to give 
us 170 new or remodeled community health centers or expanded 
community health centers in America. And we are trying to look 
at the resources that we have. If we had more resources, we 
certainly could have used it for community health centers, but 
when you have a budget, you have to put it together, making the 
tough decision, Senator, and we feel that we are on our glide 
path to reach our necessary doubling. And so that is the 
reason, Senator.
    Senator Bond. Well, I appreciate your commitment. I 
disagree with OMB's actions on it. And I will tell you, there 
is one other area where OMB--and I believe it is OMB that has 
cut back. It is going to cause a real crisis in health care, 
and this is something that I have worked on with Senator 
Collins, with Senator Kerry, Senator Feingold, Senator 
Mikulski, and that is home health care.
    Home health care is now scheduled on October 1, only 8 
months away, to be cut another 15 percent. I think Congress 
probably was justified in saying back in 1997 that home health 
care was growing too fast, so we told HHS and what is now CMS 
to save $16 billion in home health care.
    Well, your predecessors in HHS and what was then the 
infamous HCFA--we changed the name, we have repainted the 
outhouse, we have not changed what goes on there--they have cut 
the budget so much that the cuts will--the ``savings'' will 
exceed $70 billion between 1998 and 2002.
    Well, as a result, some 3,500 home health agencies have 
either closed or stopped serving Medicare patients; 900,000 
Medicare beneficiaries were eliminated from the home health 
benefit.
    I went into a small county in northwest Missouri, and I 
said ``your home health care unit shut down because it was 
costing $400,000. What happened to the 40 patients that you 
were seeing in home health care?''
    Well, some of them died prematurely. Some of them were 
suffering without home health care, but the rest of them had to 
go into nursing homes, and the public tab for the ones that had 
go into nursing homes (who had been served by the $400,000 the 
home health care unit was receiving in Medicare) are now 
costing the public tab $1.4 million.
    Now, for the life of me, I cannot see why CMS has not 
gotten the message from Congress that that 15 percent cut, 
additional cut in home health care, would be disastrous.
    Recently MedPAC voted unanimously to recommend that 
Congress eliminate the additional 15 percent cut, extend the 10 
percent add-on to PPS payment for rural beneficiaries by 2 
years, eliminate the 1.1 percent reduction in the home health 
care market basket.
    I mean, this makes sense. We see it work. It is the most 
efficient, effective way of providing service to people who 
don't really need institutionalization. What data does HHS or 
CMS have that resulted in OMB's failure to eliminate the cut 
and provide the additional assistance that MedPAC recommended?
    Secretary Thompson. Well, Senator, we look at the 
directions that Congress has given us, and all the prospective 
payment limits, and we try to comply with the law. And I think 
it is important for you and for this Congress to sit down with 
us and look at all the provider payments and see how we can 
modernize and improve them, along with Medicare in general. And 
I think that would benefit your home health as well as the 
doctor payments, the hospital payments, and so on. We have to 
do that.
    All we are doing is following the law right now and trying 
to make sure that we comply with it.
    I do disagree with you in regard to CMS being the same as 
HCFA. We have made tremendous changes, and we are making more 
changes each and every day, and I think you are going to be 
well satisfied by the time we get done with the more efficient 
and more responsive CMS than it has been in the past. And I can 
guarantee you it is going to happen. We need to modernize it, 
and we are in the process of doing that. We need your help to 
do that, like we do on the prospective payments, Senator.
    Senator Bond. Mr. Secretary, I appreciate that, and look 
forward to working with you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Bond.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Mr. Secretary, I welcome you, and I also want to commend 
you for your real care about our communities and innovation 
that you have brought to a lot of the efforts, and so I look 
forward to working with you over the years on this.
    That said, I want to identify with the remarks that Senator 
Conrad made, and I think the discussion we have already had 
today sort of reinforces the issue that our overall budget 
number do not seem to add up, whether it is the Medicare growth 
rates, which we talked about in actuarial sense, or whether it 
is reimbursement rates for providers, hospitals, doctors, home 
health care centers, home providers, and I think it is 
dangerous that we set up expectations that certain things are 
going to happen, but we are not going to have the resources to 
do it. And I think it is extremely tough on the ground for 
medical providers to make actual plans for how these things are 
going to roll out. And, you know, I think it is even harder for 
our seniors with regard to prescription drugs. $190 billion in 
no way is meeting the kinds of expectations that I think people 
are going to count on.
    So there is a whole host of areas that I think our 
projected budget numbers do not meet what reality is going to 
be, and I think we are sort of kidding ourselves about where we 
are going to be over the next decade with regard to costs, and 
it is extraordinarily dangerous.
    In that same vein, last year--and I will change subjects 
because I think Senator Conrad went through that--the State 
spent 2 billion more on TANF funds they received from the block 
grants. I know you care about this program. And we have frozen 
TANF numbers as we go forward in the budget, and this is an 
excruciating problems for our States that already have serious 
budget problems in the current environment. And I cannot 
imagine that you are not concerned, as a former Governor, about 
the freeze levels, funding, that we have on these programs 
given the need to continue to improve this welfare-to-work 
initiative that you have taken. And in many ways I am very 
supportive, but I think that making sure that Welfare to Work 
is appropriate is certainly another case.
    And I just say you can go through the S-CHIP programs and 
see the same sorts of things. New Jersey uses all of the funds 
and gets reallocated funds from other places, other States. It 
is very unclear whether that is going to continue. We need to 
understand that for planning purposes. I just do not think we 
are talking about truth in what is going to be spent in these 
programs if we are truly committed to them.
    So with regard to TANF, I would love to hear your comments. 
With regard to freeze levels, I certainly would like to hear 
about this reallocation of CHIP's money that is unexpended by 
some States, but other States are way over utilizing some of 
those excess appropriations, and particularly important for my 
State.
    Secretary Thompson. Let me quickly, I think you raised 
three things. Let me see if I can tick them off very quickly 
and give an answer so I do not get in trouble with the 
Chairman.
    Senator Corzine. I will try to protect you on that score.
    Secretary Thompson. First on the Medicare assumptions, I 
would like the have a group of the Senators sit down with the 
actuary staff at CMS, and Rick Foster. He would like to, 
explain how they got those numbers, and give you their 
assumptions. They have gone through it with me and it is a very 
educational thing and I think it would be very helpful if you 
would have the time for them to come in and do that, Senator 
Corzine.
    In regards to TANF I negotiated the first TANF bill with 
Congress when I was Chairman of the National Governors 
Association, and we reached an agreement of $16.4 billion and 
we said we would not ask for inflation if they did not cut us. 
And so that was the agreement back in 1995 and 1996 when we 
negotiated with Congress, and I was a Governor then, leading 
the negotiations.
    Right now a lot of people would like to have an 
inflationary increase in the $16.5 billion base, but the 
caseload has been reduced by about half. And there are some 
people that believe that we should cut the TANF. Other people 
like you think we should have an inflation increase. Ben Cardin 
from Maryland does, and he is leading the efforts in the House 
for the Democrats. But other people believe we should cut it. I 
felt very comfortable when I sat down with the Governors and 
said, ``If we can come out with 16.5 plus a $2 billion 
contingency fund, plus a supplemental fund, that we should take 
it and be satisfied with it.'' I can understand where you are 
coming from, but all I can tell you is that, if we can get the 
level funding for the TANF program, I think most of the 
Governors--not all, but most Governors will be somewhat happy 
with that, because a lot of Governors felt that they were going 
to be cut.
    In regards to S-CHIP, I think that this is something that 
we should work on because if the money is not used it should be 
reallocated to a State like New Jersey that is doing an 
excellent job with their S-CHIP money and be able to use that 
money because it needs to get in to help children. If it is not 
in the budget, we should make the modifications to accomplish 
that.
    Senator Corzine. I think the bite on all of these issues 
though is going to show up in these State budgets, whether it 
is for just supporting the job training programs, the day care 
programs, all of those support programs that have been a 
fundamental part of the successes, if one labels them that, in 
the Welfare to Work, and those programs are extraordinarily 
expensive, and we will not have the ability.
    Secretary Thompson. They are.
    Senator Corzine. I have one other quick question. I think I 
have time. One of the issues which I think you and I are 
probably on the same boat, although we come at it in an 
entirely different way, it is fairly shameful what our infant 
mortality rate is, what maternal mortality rate is, and Senator 
Bingaman and I have proposed Healthy Starts program which 
brings women, pregnant women themselves into the S-CHIP 
program. I am concerned--I will make this a statement as 
opposed to otherwise--that we are tying this up into political 
debates about abortion if this were to be proposed with regard 
to unborn fetuses, when in fact we ought to stay focused on 
making sure that we attack this infant mortality and maternal 
mortality problem, which I think we both agree on, and I think 
ends up saving us a lot of money over a long period of time. 
And I do not really see why we need to get it meshed up in this 
other debate.
    Secretary Thompson. If the legislation can be passed, I 
would agree with you, but right now I do not know if the 
legislation is going to get passed. And I think prenatal care 
for mothers is very important, as you do, and I think it is 
absolutely vital to have healthy children, to give them----
    Senator Corzine. You do support though, expanding S-CHIP 
to----
    Secretary Thompson. I was the first one to apply for a 
waiver when I was a Governor, and set it up so that low-income 
working families could be covered. I think it is absolutely----
    Senator Corzine. I hope we could work together to find a 
proposal that----
    Secretary Thompson. Absolutely.
    I think you and I want to accomplish the same thing, and I 
would love to work with you, Senator.
    Chairman Conrad. Senator Snowe.
    Senator Snowe. Thank you, Mr. Chairman.
    And welcome, Mr. Secretary. And I appreciate your testimony 
here today, and the focus on the President as well as yourself 
on some key domestic issues and priorities, and I am pleased 
that included in the President's budget is prescription drugs 
and Medicare modernization. And that is one of the areas I 
would like to address with you today and explore some of the 
issues. One, of course, is the funding issue.
    Last year we included in our budget a $300 billion reserve 
fund for prescription drugs and Medicare modernization, and I 
noted the President has $190 billion. I am concerned that this 
obviously is not going to be sufficient to provide for a strong 
prescription drug program. I would like to say I think the 
President has $77 billion over 10 years for prescription drugs, 
and the remainder for Medicare modernization. Is that correct?
    Secretary Thompson. No. The $77 million is for immediate 
help. This would allow a State like Maine to set up their own 
prescription drug program and would not have to be on Medicare, 
would not have to be on Medicaid. They could set up a separate 
program any way possible. And then the States would get their 
regular Federal match for drug coverage for individuals up to 
100 of poverty, and then the Federal Government would come in 
with 90 percent FMAP for individuals between 100 and 150 
percent. So the States would only be investing only 10 percent 
on every dollar up to 150 percent.
    We think that we would use--if the Congress passes it, we 
would use about $7.8 billion of the $77 billion because we are 
hopeful that on a bipartisan basis we could modernize Medicare 
and have the prescription drug coverage in there so you would 
not need this special program at the State level. This is for 
years 2003, 2004, 2005, and we are hoping then by 2006, when 
the modernized Medicare with prescription drug would kick in, 
this would fall by the wayside. And during this period of time 
we would use 7.8 billion and the rest of it would go into 
Medicare, not the full 77.
    Senator Snowe. Well, that is interesting. In other words, 
you are saying that this money is initially for the 
transitional program?
    Secretary Thompson. Yes.
    Senator Snowe. So that means that----
    Secretary Thompson. Once you kick in the Medicare, then you 
would not need this program.
    Senator Snowe. Exactly, but you are still going to need 
additional funding for a strong prescription drug benefit 
program over the 10-year period, even if it is initially for 
this program, because this is for low-income seniors. Is that--
--
    Secretary Thompson. That is correct.
    Senator Snowe. And going up to what, 150 percent of 
poverty?
    Secretary Thompson. 150 percent of poverty, right.
    Senator Snowe. So, obviously, we are going to need more 
ultimately in order to have a strong program, even beyond the 
transitional program, to have to make additional funding----
    Secretary Thompson. That is why the President put in the 
$190 billion over 10 years. The President and this 
Administration feels that we can come up with a strengthened 
Medicare program and have prescription drug coverage in there 
starting in 2006 with the $190 billion. We can argue back and 
forth about the $190 billion, but I think the President should 
be complimented in this very trying time to put in a 
placeholder, of $190 billion for prescription drug coverage and 
strengthening Medicare, and that is what we are doing.
    I know that the Congress passed $300 billion last year, and 
I know that you are supportive of that, and I also want to 
compliment you on your leadership on the Medicare reform 
package.
    Senator Snowe. I think we are all in agreement on the 
common goal. The question is in terms of when to start and how 
we work through those issues. The President has multiple 
programs, which is I think significant with respect to the 
prescription drug benefit.
    Could you elaborate on some of these issues?
    Secretary Thompson. Sure.
    Senator Snowe. One, the President has a prescription drug 
discount program; is that correct?
    Secretary Thompson. Yes.
    Senator Snowe. Second, he has a waiver program?
    Secretary Thompson. Yes.
    Senator Snowe. Is that one of the other proposals for a 
State like Maine that is providing a discount prescription drug 
program to Medicaid recipients?
    Secretary Thompson. Yes.
    Senator Snowe. That is another proposal. And then third is 
creating this transitional program?
    Secretary Thompson. Yes, $77 billion.
    Senator Snowe. And then, fourth, obviously, would be 
designing the overall comprehensive program. How do you 
anticipate folding in the transition program to the 
comprehensive program? Are we hoping--is there that goal to--is 
it the Administration's goal to design the comprehensive 
program this year?
    Secretary Thompson. I do. I hope we do it on a bipartisan 
basis. I think it is important for this Congress to do it, and 
this Administration wants to work with you. I think we can get 
a strengthened Medicare with prescription drug coverage passed 
this year if we do it on a bipartisan basis.
    In regards to your question, number 1, the card. The courts 
put us in a temporary restraining order because we did not go 
through promulgating a new rule. We are in the process of 
promulgating the rule. We think that hopefully will satisfy the 
courts.
    Number 2, we are asking this Congress, in the meantime, 
while we are working on Medicare to pass immediate helping hand 
for $77 billion. So that what you would do is you would, if 
Congress passed it, if the State would set up a program on 
prescription drugs like Maine has, Maine. Maine would get the 
regular FMAP up to 100 percent. I do not know what Maine's FMAP 
is. I think it is 60/40.
    Senator Snowe. That is right, just about.
    Secretary Thompson. And so you would get 60 percent, up to 
100 percent, and then from 100 to 150 you would get 90 percent 
coverage from the Federal Government. And this would be for a 
period of time until we got the Medicare up and running, and 
then this would go by the wayside and we would go into the 
Medicare coverage with prescription drugs.
    The waiver program is another program that we are starting 
in the Department of Health and Human Services by giving a 
prescription drug waiver, and we have given one to the State of 
Illinois, and the State of Illinois is capping their Medicaid 
payments up to 200 percent of poverty, and they are on a 
sliding scale. If it goes over that, the State would pay it, 
and so the Federal Government is not going to be out. We are 
giving them a waiver to try this new program.
    The fourth one is the comprehensive Medicare strengthened 
proposal with prescription drug coverage within it.
    Senator Snowe. Now what do you anticipate the cost of this 
drug subsidy program to be out of the $190 billion over, let's 
say, the next 3 years? What would you anticipate the cost to be 
out of that $190 billion?
    Secretary Thompson. Well, we figure at least $7.8 billion 
for the program for up to 100 percent of poverty. We think that 
the model waiver for Pharmacy Plus would be held harmless 
because the States should cap it. We are going to set it up so 
they would be able to get their Medicaid match up to 200 
percent of poverty, and we think that by using this, you would 
hold--people would be doing this and would not be spending down 
their assets and go into the nursing home in order to get 
prescription coverage.
    I think we could actually save money by keeping people out 
of the nursing home if we set up a program like this. That is 
why we set up the model waiver.
    The third one is the prescription drug card discount. We 
think we can save seniors up to a max of 20 to 25 percent of 
their cost if we get this general card out there through 
Medicare.
    Senator Snowe. OK. Well, thank you, Mr. Secretary. I 
applaud you and the President for leadership on these key 
issues. Thank you.
    Secretary Thompson. Thank you very much, Senator Snowe.
    Chairman Conrad. Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Secretary, it is always good to have a chance to work 
with you, and you have been very forthright in dealing with me. 
I think you also know that there is strong interest in working 
with you on a bipartisan way. Senator Snowe and I have had 
bipartisan prescription drug legislation for a number of years. 
Senator Smith has been very involved. We want results. Today, I 
want to ask you some questions about some of the issues 
relating to the tools that we need to put together a bipartisan 
bill.
    Let me start, if I might, with coverage for the uninsured, 
because your proposal this year is slightly different, but it 
is still pretty close to the proposal that you had in the last 
session, the idea of an individual tax credit of $1,000.
    Tell me, if you would, what you think an uninsured person, 
say a woman who is 45 years old with diabetes, what is that 
person going to be able to buy, with the $1,000 tax credit that 
the Administration proposes for the uninsured?
    Secretary Thompson. It depends upon whether or not the 
State would go out there and set up a pooling arrangement, 
Senator Wyden. I know that in our Badger Care plan back in 
Wisconsin, we have got a very good plan for $1,600 that would 
cover an individual. And in this case if the State of Oregon 
would set up a pooling arrangement so that this individual 
could go in and purchase insurance, they would go to their IRS 
regional office, get a number, take that number into the 
pooling arrangement set up by the State, either a company, a 
group, or whatever, and that group would then negotiate with 
the insurance companies to set up a policy that would cover 
that individual.
    That would give her a fairly good policy, I would think, at 
$1,000. She would still have to pay probably the difference 
between $1,000 and $1,600 or $1,500, whatever the case may be. 
But I think if she is in good health, I think with the pool 
arrangement, she can get a fairly decent one.
    Senator Wyden. But that is the whole point, Mr. Secretary. 
A lot of those people are not in good health.
    Secretary Thompson. That is true.
    Senator Wyden. Put me down as very, very skeptical. I want 
to submit for the record--Mr. Chairman, I was sent a letter by 
Ken Abramowitz of the Carlysle Group, certainly a very 
conservative theorist in this field. He points out that full 
health insurance delivered through managed care in a group 
setting costs about $2,500 per individual. He is not talking 
about a person with any special health concerns, the way so 
many of the uninsured have.
    And I will tell you, Mr. Secretary, I am convinced that the 
vast majority of uninsured in this country, certainly people 
with any semblance of health problems, are going to get 
certainly 40 percent, maybe barely that, under this proposal. I 
hope you will work with us, because we are trying to work with 
a number of business groups and low-income advocates to see if 
we can put together a bipartisan package. I just do not think 
that $1,000 individual credit is going to buy anybody a whole 
lot, and we would like to work with you on it.
    The second point that I would like to touch on deals with 
when we are going to get names for the key health positions in 
this country. The fact of the matter is we are about to spend 
billions of dollars in terms of bioterrorism. The 1990's were a 
renaissance in health policy, again, because of bipartisan work 
by people like Arlen Specter and John Porter.
    You have got your key agencies hemorrhaging scientific 
talent right now at NIH, FDA. We are waiting for a Surgeon 
General. When do you anticipate names being sent to the United 
States Senate so again we can work in a bipartisan way and get 
these positions filled?
    Secretary Thompson. Well, first let me back up and tell you 
that I do want to work with you in a bipartisan basis. As you 
know, you and I have worked together on many different issues, 
and I want to continue that opportunity, and I would look very 
much for that possibility.
    In regards to the group policies, we have made some 
improvements by getting the immediate credit so that a person 
can apply for and get it, and the group formation is a giant 
step forward. So I think we can develop a good plan.
    In regards to the FDA director, the President is reviewing 
the names that are over there, and hopefully he will make a 
nomination shortly, and the same way for NIH. The Surgeon 
General has just been opened, and we are vetting a lot of 
candidates. I think we have 200 applications at the present 
time, and the White House is going through them and going to 
make recommendations to me on a number of candidates. I will 
then interview them and get them back.
    I want to tell you that I would like to have this done 
yesterday, and I think it needs to be done, and the President 
feels the same way. And so hopefully we will get those 
nominations to you shortly, sir.
    Senator Wyden. What is holding it up? I mean, this country 
cannot fight a war on bioterrorism if there are not any field 
generals in place. This country is filled with good scientists, 
people with no political axe to grind. What is your sense of 
why this is taking so long?
    Secretary Thompson. We want the best person, sir.
    Senator Wyden. All right. On prescription drugs, on the 
issue that Olympia Snowe talked about, as you know, what the 
seniors are really concerned about is the cost of their 
medicine, and they are saying to themselves, look all over the 
world, and it just seems that you can go to Canada, Mexico, 
just about anywhere and get medicine at a cheaper price.
    We really feel that the key to cost containment is to not 
fracture the market and to keep everybody together so they have 
got some bargaining power. Your proposal doesn't do that. Your 
proposal fractures the market. It is essentially targeted at 
the low-income. We all want to help them, but I am concerned 
about how we are going to get bargaining power for seniors in 
the marketplace to hold down the cost of medicine if you 
fracture the market.
    What is your sense of how you are going to go about 
achieving some real bargaining power out there for the seniors?
    Secretary Thompson. We think the prescription card put out 
by Medicare will be able to have a real stabilizing impact on 
being able to have a big bargaining chip with the 
pharmaceutical companies and be able to develop the necessary 
purchasing power to limit it.
    We think that the prescription drug coverage in Medicare, 
if and when the Congress passes that, is going to have a lot of 
potential to accomplish that. But in the meantime we think it 
is very advisable for the State of Oregon to take a long, hard 
look at the $77 billion that we set aside for coverage of 
individuals between 100 to 150 percent of poverty with, the 
Federal Government paying 90 percent.
    Senator Wyden. Yes, I am willing to work with you on those 
various kinds of areas, but I think if you are talking about an 
itty-bitty discount for at least some seniors, that is not 
enough for cost containment. The way you get cost containment 
is to keep the markets together, and that is why in effect you 
were talking about pooling for the uninsured, and you are 
moving away from that in your prescription drug proposal by 
fracturing the market. I will work with you, but I hope you 
will work with us because what Olympia Snowe and I say in our 
bill is that the key to cost containment is to have exactly 
what you are talking about, pooling, and not fracturing the 
market.
    One last question, if I might.
    Secretary Thompson. I do want to work with you, Senator.
    Senator Wyden. I know that you do, and I appreciate it.
    I would like to know your personal opinion with respect to 
this organ shortage situation we have in this country. As you 
know, it is very serious at this point. There is at present a 
payment ban with respect to paying for organs, essentially 
organs of the various sorts, live donors, cadavers, that sort 
of thing.
    I know that this is being looked at in the Department, but 
I would be interested in your personal opinion with respect to, 
given how serious the organ shortage is in America right now, 
whether you personally think that the payment ban for organs 
ought to be lifted as a way to deal with this.
    Secretary Thompson. Not at this point in time, Senator. I 
think that is something that we should continue to monitor, but 
I do not think we should start paying for organs. This, as you 
know, is a passion of mine. We have 80,000 Americans waiting 
for an organ, and you can imagine the angst that that 
individual or individuals go through with their family waiting 
to get an organ, when only 22,000 to 23,000 Americans are going 
to receive an organ this year. Sixty people receive an organ 
each and every day. Fifteen people die because they don't 
receive an organ. That is not good enough for America. We need 
to do a much better job publicizing, to get people out there to 
talk about it. I just got some TV spots with Chris Kluge, who 
is the skier who is in the Olympics, who got a new liver 18 
months ago. He was not expected to live, and he was able now to 
have a liver transplant 18 months ago from a young child that 
was shot and killed in Denver. He got the liver and now he is 
performing at the Olympics. It is a powerful message that he 
gives out why we need to do this.
    I think if we get more of these powerful messages out there 
and more support in Congress to pass legislation to promote 
organ donors, I think we can do a much better job in America 
and get more people involved, because every time I talk to an 
audience, I can convince people to sign up. I tell people, God 
does not want your organs in heaven, He wants your soul, and I 
think that is true.
    Senator Wyden. I, too, have very serious ethical 
reservations about lifting that payment ban. I think your 
answer is a thoughtful one, Mr. Secretary. I look forward to 
working with you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Grassley.
    Senator Grassley. I know you can do a very good job of 
defending yourself and the Administration, but I want to make a 
comment about three or four accusations about whether or not 
the President has done enough on prescription drugs.
    And I say this maybe in feeling that we are working our way 
to doing more, and also we are saying that we have had the 
White House and your cooperation on helping us do those things.
    But here is what is wrong with the criticism of the $190 
billion at this point. For 2 or 3 years, or maybe 4 or 5 years, 
Congress was working on bills to get some prescription drugs 
for seniors and did not have the money to implement them, and 
all of a sudden we get $300 billion in last year's budget to 
implement them. And we fritter away a whole year trying to 
decide policy.
    So instead of worrying about whether the White House is 
doing enough or how much money you are going to put into it, I 
decided the course of action we have got to take this time is 
to get the policy decided so that when we get the money to do 
it, we can jump right into it and not waste another whole year 
deciding what kind of policy we are going to have.
    I know in your exchange with Senator Snowe you went through 
a lot of detail about how that ought to work out, even 
implementing your plan, and how you would work toward more, and 
how you have been working with her and with others of us to 
accomplish that. So that is where we have been. We should not 
make the mistakes of the past, and instead of worrying about 
whether it is $190 billion or $300 billion or what the Federal 
Health Employees Benefit Plan might cost if we did the same 
thing for seniors, I think we had better settle on policy so 
that when we get this economy turned around and we have got the 
money coming in that we can pay for the prescription drug 
program, we are ready to start on day one. And that is where I 
am going to put my energies this time.
    Beyond that, I thought before I asked questions I would 
take just a second to thank you for the budget reflecting a lot 
of very important things that I think are important: obviously 
protection of our citizens against bioterrorism; doubling the 
budget for the National Institutes of Health; full funding for 
the Safe and Stable Families Act; transitional Medicaid 
assistance; community health centers; National Health Service 
Corps; and reducing medical errors.
    Obviously I feel that the biggest flaw in Medicare today is 
its failure to have prescription drugs, and I believe that we 
need to add drug coverage this year.
    You know that I have been working with a group of Senators 
on the Senate Finance Committee from all political persuasions 
to develop such a comprehensive bill to strengthen and improve 
Medicare, and I would hope that we could roll out a bill to do 
that in the very near future, and then have your reaction to 
that. I will not ask for that reaction now, but I know that you 
have been following that.
    I certainly hope that we can work across party lines to 
accomplish this policy that I have already talked about, even 
though maybe the exact amount of money is not there. I believe 
that it would be helpful to have ideas like the 
Administration's transitional low-income drug benefit on the 
table in case we do not get the full load that I would like to 
get.
    But in the meantime, I am going to be advocating in this 
Committee sufficient funds to pay for a comprehensive approach, 
and I think most members of my political party will follow that 
course of action as well.
    The last thing I would like to mention before I ask any 
questions is just to say that another big item we have got to 
work on in the Senate Finance Committee, and we will have to 
provide for it in this budget of this Committee, is the 
reauthorization and change of welfare, TANF, as it is called 
now, and I look forward to working with you. You were a very 
key factor in that when you were Governor, and you know how to 
bring all the players together, and I hope that we will see you 
in the same fashion in the same cooperative way to find a 
solution as we did with you as Governor.
    As I mentioned, one of my priorities is the prescription 
drug program, and I am working with a group of people to put a 
comprehensive program together. I hope that we will be able to 
have you help us with that as you have in the past.
    Secretary Thompson. Absolutely, Senator. I would just like 
to comment, Senator, that your statement, the first statement 
in regards to Medicare and the $190 billion, spoken like a true 
common-sense farmer from Iowa, and I compliment you.
    Senator Grassley. And I suppose I also ought to remind the 
people of the United States that you have a farm near Eland, 
Wisconsin, is that right?
    Secretary Thompson. Elroy, Wisconsin.
    Senator Grassley. Elroy, OK. And also then I would like to 
talk a little bit about rural health care. The reason I bring 
this up, and I think you have made clear in your statement that 
you are very concerned about that, but the word ``rural'' was 
never mentioned in the budget, and so I think it is important.
    Do we have your commitment that if Congress spends money to 
strengthen and improve Medicare this year that the 
Administration will advocate greater payment equity for rural 
providers as a part of such a package?
    Secretary Thompson. I cannot speak for the Administration, 
but I can certainly speak for myself and say absolutely. It is 
something that needs to be done. The wage question is something 
that causes a great deal of disparity between rural hospitals 
and urban hospitals. It still costs the same amount of money in 
Iowa as it does in North Dakota to purchase equipment in the 
hospital, and we need to do that.
    I would like us to see if we could on a bipartisan basis, 
Senator Grassley, sit down with all of the providers and find 
out how we might be able to solve some of the formulas and do 
something on rural health disparity payments and see if we can 
improve them.
    I think it would be a positive thing, and I know we have 
talked about it, and I know Senator Conrad is passionate about 
this, I know you are, and I am. I think the three of us could 
sit down and see what we could do in this area. I would love to 
work on it with you.
    Senator Grassley. And then maybe just a yes or no, because 
I think you discussed this as thoroughly as it needs to be 
discussed with Senator Snowe, but just the President's 
prescription drug program versus something more comprehensive, 
and I am not talking about just what I might lead a group of us 
putting in here shortly, but if we can develop a very 
comprehensive prescription drug program coupled with the 
improvement of Medicare, that would be the President's first 
choice?
    Secretary Thompson. Absolutely. Yes.
    Senator Grassley. In other words, the $190 billion plan is 
not necessarily the President's ideal program; it is a starting 
point for the President.
    Secretary Thompson. That is correct. We want to work with 
you, Senator.
    Senator Grassley. Thank you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you, Senator Grassley.
    Senator Stabenow.
    Senator Stabenow. Well, thank you very much, Mr. Chairman, 
and welcome. I appreciate your leadership and advocacy on 
important issues like organ transplant and your advocacy for 
our public health system and the other wide variety of issues 
that are on your plate that are very important and touch 
people's lives.
    In the interest of time I want to talk just specifically 
about one issue, and that is the issue of prescription drugs. 
It has been talked about this morning, but let me just start by 
saying that this is, as you know, not just an issue for our 
seniors, although right now we have somebody sitting at home at 
their kitchen table deciding do I eat today or get my medicine, 
pay my utility bills, tough choices that our seniors are having 
to make, and as tough as our choices are, I think that the 
choices they are having to make are even tougher.
    But I am also hearing this as an issue across with everyone 
I talk to, small business people who see their insurance 
premiums going up 25, 27 percent, who call me and tell me they 
are canceling their insurance, they and their five employees no 
longer will be insured because of the cost, and it is the cost 
of prescription drugs. I see it from the biggest businesses in 
the State of Michigan coming to me who are concerned about 
this, university presidents who come to me, hospital CEOs who 
are coming to me. This is by far and away the largest 
underlying reason for the increase in costs of health care.
    And so, on the one hand, while I believe strongly in the 
Medicare prescription drug plan, we need to update Medicare. It 
was written in 1965 and is structures like we provided health 
care in 1965. And I would say as an aside that when we talk 
about priorities for this country and in this budget, I would 
say that the President's first choice is not comprehensive 
prescription drug coverage. The first choice was the tax cut, 
which has taken the majority of the resources off the table, 
geared very much to a few at the top of the income stream, and 
the majority of people, seniors, small businesses, all those 
affected by the issue of prescription drugs, have not been the 
top priority. And I would like them to be, because I think this 
is such a pervasive issue, and the amount of money in the 
budget does not address in a comprehensive manner--although you 
have given it your best efforts, I appreciate the way you have 
attempted to approach this. It does not address in a 
comprehensive long-term manner the costs for our seniors 
through Medicare.
    But having said that, you have within your grasp, you 
yourself as Secretary, the ability to cut costs immediately, 
substantially, and without great cost to the taxpayers of this 
country. And as you know, that is the issue of opening our 
borders to American-made, safe, FDA-approved drugs that are 
sold to other countries, every other country in this world, for 
less than they are sold here. And I know we have talked about 
this before, but from my perspective as we look at this budget, 
the tough choices, the concerns about how to design Medicare 
prescription drug coverage, and the time that that is going to 
take, and the money that that is going to take, we can at least 
in the short run open our borders.
    As you know, the House and the Senate overwhelmingly 2 
years ago passed a provision, and in fairness to you, your 
predecessor did not implement that. And I received a letter 
from you this summer, a letter from Secretary Shalala as well 
as yourself, concerning why you do not want to proceed with 
that. But I feel very strongly that if we can allow our 
American companies to, in fact, create manufacturing plants in 
other countries, if we can send FDA inspectors there to inspect 
them and then allow them to come back to this country, we can 
create a way to satisfy the concerns of the FDA and open our 
borders for prescription drugs. And we could at minimum cut 
costs by 30 percent. In efforts that I have done with Canada, 
it is easily 50 percent. And that would not only address 
seniors, it would address businesses, hospitals, universities, 
everyone who is concerned.
    So I would appreciate your thoughts on that right now. And 
also when we look at your budget, you have indicated that in 
the budget there will be a substantial increase in the number 
of safety inspections for FDA-regulated products that are 
imported into this country. I wonder if that might not be an 
opportunity for us to address the issue of safety inspections 
in prescription drugs.
    Secretary Thompson. First, let me thank you for your 
kindness, Senator. You have been very generous with your 
kindness to me, and I appreciate it and thank you very much.
    Now second, in regards to Medicare, I really, sincerely 
hope that we can sit down on a bipartisan basis and develop a 
strengthened Medicare proposal this year. I am optimistic that 
we can do that and get one that is satisfactory to the 
Democrats and the Republicans and this Administration, and get 
it passed with a very comprehensive drug component. I think 
that we can do that, and I hope that we can do it.
    Number 3, the reason that I have not, and the reason that 
Donna Shalala did not, is that the law requires us to certify 
as Secretary that we know that these drugs are safe. It is 
impossible for us to certify that these drugs are safe.
    I came to this Committee, and I asked Senator Conrad many 
times to help me with food inspections. I consider this a huge 
problem in America, and I have said that in this Committee, in 
Congress, and that is why we requested some additional 
inspectors. We only had 700 inspectors in FDA to inspect 56,000 
places. We only had 125 inspectors to inspect food that was 
coming into America in 151 ports of entry and we were only 
inspecting less than 1 percent of the food that was coming into 
the United States.
    This Congress was very generous and on a bipartisan basis, 
I know you supported that as well, Senator, to give us some 
additional dollars. We are in the process of hiring those 
individuals. We are going to get an additional 400 inspectors, 
coupled with our 700, a little over a 50 percent increase which 
I think is tremendous and it is going to be very helpful.
    Now if you want to pass a law requiring these inspectors to 
get involved in inspecting plants outside of America that are 
in the pharmaceutical industry, I think that is something that 
we should explore and see if we could not work together. But 
the current law in which I would have to certify that drugs 
coming into America are safe, I am not in a position to do 
that. But I think we can change the law so that we could 
satisfy you and satisfy your constituents and come up with 
something that is workable.
    Senator Stabenow. I am very anxious to work with you on 
this because of the immediacy of the concern, both by 
individuals, health care providers, as well as the business 
Community, and the reality is that this is one of the ways to 
most directly and most quickly lower costs.
    But let me ask, have you examined the regulatory system of 
Canada? Have you looked at it? Because we have taken a look at 
it, and feel that the system of oversight is very similar to 
the United States, and if we were to focus, say, just on Canada 
in terms of opening our northern border, I am wondering if you 
have looked at the regulatory and safety system.
    Secretary Thompson. You know, the only way I can ever 
operate is to be candid. I personally have not, but my lawyers 
and people at FDA have, and they have come back with that 
recommendation to me that I would not be able to do that.
    Senator Stabenow. Well, we are happy to change the law. I 
mean, in my mind that language was put in specifically to make 
it difficult to be implemented, unfortunately, as it went 
through the Congress 2 years ago, and we are going to offer 
something that will be much easier for you to implement and 
would want to work with you on that. I think it is a 
challenging situation. On the one hand, you have seniors that, 
in fact, certainly are in great pain, may lose their life as a 
result of inability to receive prescription drug coverage, 
maybe a small business whose employees find themselves in life-
threatening situations because they have to stop their 
coverage, and we will have to weigh that as it relates to any 
perceived or potential risk of opening the borders.
    I would argue there are risks in not opening the borders 
and keeping the costs as high as they are, and I look forward 
to working with you.
    Secretary Thompson. The only rejoinder I would have is I 
compliment you on it, and I want to work with you on it. I only 
hope you bring the same passion to want to work with me in 
strengthening Medicare, and it is a two-way street.
    Senator Stabenow. I absolutely want to strengthen Medicare. 
What I would just urge you, and I am sure that you know this, 
when you look at your numbers of $190 billion in terms of 
prescription drug coverage, it does not provide what our 
seniors are asking for in terms of the amount of coverage, the 
premium that will be unfortunately much higher than they would 
like. We will not be able to have 100 percent coverage. It is 
difficult. You cannot fit that into the box.
    Secretary Thompson. Well, let us start.
    Senator Stabenow. I am happy to start. I am happy to start 
and have been involved and will continue to be involved with 
you, because it is critically important, and probably it is the 
most critical issue on a daily basis for families, as well as, 
I think, in terms of the economy and where the uncontrollable 
costs are right now.
    Secretary Thompson. Thank you very much.
    Chairman Conrad. Thank you, Senator Stabenow.
    I can tell you there is nobody who has been a stronger 
voice for strengthening Medicare than Senator Stabenow, and we 
appreciate her contributions to this Committee.
    I want to thank you again for your appearance here. As you 
know, I have high regard for you. I have high regard for you 
professionally and personally.
    Secretary Thompson. I know that.
    Chairman Conrad. And I would be less than honest if I did 
not say I have got low regard for this budget. I do not think 
it adds up. I think it clearly breaks the promise that has been 
made to protect Social Security and Medicare. I believe that is 
compounded by this budget for HHS, and I know you do not have a 
free hand here, but I know how it works, I know the role of the 
OMB and the White House.
    I believe this understates the cost of Medicare by $300 
billion. I believe it understates the cost of a meaningful 
prescription drug benefit. I believe it understates the need to 
address payments for providers, and that is hundreds of 
billions of dollars of cost. So I fundamentally think it 
misleads Congress and misleads the American people.
    My frustration is with this overall budget--not yours 
specifically. I have said what I see as the shortfalls there, 
but the overall budget circumstance is growing, as I examine 
more closely the overall budget, and I would send a message, if 
I could, through you to the Administration that I think they 
have put us on a fiscal course that is truly reckless. I 
believe that. I can see what is happening here.
    You know, it used to be that budget deficits were a line in 
the sand, and then we were able to stop running budget 
deficits, and then we were able to draw a new line that fenced 
off Social Security funds, and that had tremendous benefits, 
not just to Social Security, but imposing fiscal discipline 
when we are on the brink of an entirely different set of facts 
with the demographic changes coming to this country. I believe 
it is absolutely essential for the fiscal future of the country 
to have those lines, and now the President, in not just his 
budget submission for this year--I could understand that at a 
time of economic slowdown, but he has got deficits here, budget 
deficits on a unified basis for years to come. He has got 
deficits on a non-trust fund basis for the entire next decade, 
and I tell you, once those lines are gone, the floodgates are 
open, and I can see it in the conversations I am having with my 
colleagues, I can see that in terms of the consideration of the 
other body, and it is going to take some dramatic 
reconfiguration.
    It is very clear the tax cut imposed last year, based on an 
assumption of these big surpluses, that that fundamental 
consideration has been just dramatically changed. If we use the 
President's own formula, he said last year he was taking one of 
every four surplus dollars for tax cuts. That is how we got to 
$1.6 trillion out of a $5.6 trillion projected surplus. He 
proposed a $1.6 trillion tax cut, and he said he was taking one 
of every four dollars. That math did not quite work out, but 
that is what he was talking about.
    Well, now we are talking about realistically maybe $200 or 
$300 billion left, really. If we take the President's 
proposals, we take CBO's scoring of those proposals, we have 
got maybe $200, $300 billion dollars left. Two or three hundred 
billion. And every dime of it is Social Security, every dime of 
it.
    One quarter of that would be a $50 billion tax cut instead 
of a $1.6 trillion tax cut.
    But the larger amount has been put into law. And the result 
is under the President's plan we are going to be taking $1.6 
trillion of Social Security money over the next decade, $500 
billion of Medicare money, and using it to pay for tax cuts and 
using it to pay for other spending. I think it is a profound 
mistake with the baby boomers about to start retiring in 6 
years.
    And I mean, it is not just a little mistake. I think it is 
a huge mistake, and the consequences for the Nation are 
enormous because we all know those baby boomers are going to 
retire, and they are going to be eligible for these benefits. 
And it is true the money has been credited to the accounts, but 
there is no money there. There are bonds there that have to be 
redeemed out of the future earnings, future revenue stream of 
the Federal Government. And that is going to compel a future 
Congress and a future President to propose really draconian 
steps, massive cuts in benefits, huge tax increases, gigantic 
increase in debt.
    Now, I see that Senator Murray has arrived. I would 
certainly recognize her for a statement or questions, and be 
happy to have you answer as well.
    Secretary Thompson. I just would like to thank you for your 
consideration and your friendship. I would like to work with 
you on the budget and see if we could make improvements to your 
satisfaction. I just want to pledge to you that cooperation, 
sir.
    Chairman Conrad. We look forward, as we always do, to 
working with you. I think you are a very creative person and a 
creative political leader. You certainly were in your home 
State and you have been here, and under very difficult 
circumstances.
    Senator Murray, I will leave. I have an appointment here, 
and I will leave----
    Senator Murray. Oh, good.
    Chairman Conrad [continuing]. You in charge.
    Senator Murray. [presiding]. Thank you, Mr. Chairman.
    I will not keep you, Mr. Secretary, and I apologize for 
coming late. I was Chairing another hearing, but I did want to 
just come, and I am sure other members have emphasized this 
well. But my State is really hurting. We are going to have to 
cut $1 billion out of a $20 billion budget. You have been a 
Governor. You know what that means at home. And they are very, 
very concerned about the Medicaid funding levels and are 
sending everybody here to talk to me about that. I am concerned 
about the budget and how we are going to address this, but I am 
particularly wanting to just bring to your attention today the 
regional inequities within the Medicaid formula that are 
dramatically impacting States like mine.
    We have a good utilization rate and more efficient delivery 
structure, and we have been penalized for that. We have been 
trying for a number of years to try and correct that situation. 
I know Senator Harkin has a bill, S. 1020, that would ensure 
that no State get less than 95 percent of the national average 
Medicare reimbursement rate, but we have a severe health care 
crisis in the State of Washington. We have doctors and nurses 
who are leaving. We have a budget that is really impacted by 
the costs of health care that our State has had to pick up 
because of that low reimbursement rate.
    My constituents are looking at other States that have high 
reimbursement rates and saying this is not fair, and so I 
wanted to just come and really point that out to you and see if 
this Administration is going to help us get a handle on that 
challenge.
    Secretary Thompson. Senator Murray, I assure you that I 
want to work with you. I assure you that I know the problem 
very well from being a former Governor. I can assure you that a 
day does not go by that I do not receive another telephone call 
from a former fellow Governor of mine asking me about it. All I 
can tell you is that most of them are looking for increases in 
the FMAP, and I do not think that is going to happen, but I 
think the disparities certainly should be looked at.
    I understand full well, you know, that you have got a 
health care system that pays more for utilization, whereas a 
State like Washington, who underutilizes and looks for ways for 
prevention, which I think is the way we have to go in America, 
is something that we should be looking at and possibly 
rewarding much more so than it has in the past.
    All I can tell you is I will work with you and work with 
your Governor and work with other Governors and Congressmen and 
Senators to accomplish a more equitable package. There is no 
question in America that the health care system is strained, 
and we have got to make some improvements, and I have got some 
ideas, I know you do. I would like to sit down and see if we 
cannot work them out.
    Senator Murray. I look forward to it. I am very concerned 
that if we do not make any adjustments to FMAP and deal with 
some of these problems, the number of uninsured is going to 
rise dramatically, and we all know that that has a huge impact 
on our health care system that already cannot take any more.
    Thank you. Again, I apologize for being late.
    Secretary Thompson. Thank you for coming.
    Senator Murray. On behalf of the Chair, I will adjourn the 
committee.
    [Whereupon, at 12:13 p.m., the committee was adjourned.]

              Prepared Statement of Senator Russ Feingold

    Thank you, Mr. Chairman, for holding this hearing today. I would 
also like to thank my friend and former Governor, Secretary Thompson, 
for testifying here today. I want to commend him for the job he has 
done as Secretary. While we may not always agree on every policy, his 
straightforward management of so many vital Federal programs is a 
welcome breath of fresh air in Washington.
    The Department of Health and Human Services' budget contains some 
of the most vital programs to Wisconsinites, from Medicare to our 
health care safety net to research programs that can find cures for 
diseases like Alzheimer's and Diabetes.
    I want to commend the Administration for doubling funding for the 
National Institutes of Health by providing the final installment of 
$3.9 billion over the Fiscal Year 2002 funding level. This research is 
of paramount importance to this and future generations.
    I also strongly support the Administration's proposal to strengthen 
our health care safety net. While I would like to see the safety net 
improved beyond what the President has proposed, I commend him for 
attempting to address the health care work force shortage by increasing 
funding for the national health services corps and the Nursing 
Education Loan Repayment Program.
    I was joined by my colleague from Arkansas, Senator Hutchinson, 
last year in promoting the Nurse Education Loan Repayment Program, and 
I am glad to see that the President also considers this program a 
priority.
    I must express my concern, however, at the lack of emphasis to 
address Medicare modernization, including the addition of a 
prescription drug benefit.
    The additional Medicare funding in the President's budget does not 
take us in the direction of real reform. For example, the President's 
budget has a 6.5 percent increase in the HMO rate for the 
Medicare+Choice Programs, even though this program isn't available to 
Medicare recipients in much of the country.
    Medicare HMOs aren't offered in the vast majority of Wisconsin 
counties, so we would receive little, if any of the benefits from this 
additional funding. Instead of expanding access to this program, this 
funding would subsidize existing Medicare HMOs in other parts of the 
country to offer benefits such as eye glasses and hearing aids. I 
strongly favor offering these benefits under Medicare, but they should 
be provided to all beneficiaries regardless of where they live.
    While the President's proposal to include $190 billion for targeted 
improvements and comprehensive Medicare modernization is a good first 
step, it is not adequate to provide an effective prescription drng 
benefit or other necessary modernizations.
    I am also concerned that across-the-board cuts may jeopardize 
access to health care for Wisconsin Medicare beneficiaries. Just last 
year, due to a glitch in the Medicare payment formula for physician 
services, as of January 1 of this year, a 5.4 percent Medicare cut 
affects all Medicare services provided by physicians and other health 
professionals.
    These cuts in Medicare dollars to providers have devastating 
consequences, particularly for states like Wisconsin where Medicare 
payments are already low. The cut will force providers in my state to 
make difficult choices concerning their ability to accept new Medicare 
patients, opt out of the Medicare program, lay off administrative staff 
or retire early.
    I recognize the budget constraints that we face. And while I 
disagree with the President about how we arrived at this budget 
situation, I strongly agree with him that we must reign in wasteful 
Federal spending to fund important priorities such as Medicare. And 
when we need to evaluate our funding priorities, Medicare should be at 
the top of the list. We need to look within the Federal budget and 
allocate more funds for this important program if we are serious about 
modernizing Medicare.
    Again, I would like to commend the Secretary for all of his efforts 
to reform the Department and make it more effective. Our Federal 
Government is truly fortunate to have such an effective and dedicated 
public servant. I look forward to working with him and the 
Administration during this next budget cycle to make sure the budget 
lives within its means and, at the same time, supports important 
priorities like the Medicare program.

              Prepared Statement of Senator Olympia Snowe

    Good morning. I would like to express my appreciation to the 
Chairman and Ranking Member for holding this hearing on the President's 
budget proposals for programs under the Department of Health and Human 
Services. And, I join with my colleagues in welcoming Secretary Tommy 
Thompson. Mr. Secretary, thank you for being here with us today.
    The President's budget is an ambitious blueprint that proposes to 
enhance our bioterrorism preparedness, reduce the number of uninsured 
Americans, provide prescription drug coverage for seniors, modernize 
Medicare, and speed the approval of lower-cost generic drugs--all while 
we continue to fight the war on terrorism. The President is to be 
commended for maintaining his focus on the domestic front--on important 
issues like Medicare, medical research, and the economy--while our 
country is engaged in efforts to defeat those who would do harm do our 
citizens and our country.
    One of the most important domestic priorities is modernizing 
Medicare and providing a drug benefit for our Nation's seniors. Senator 
Grassley and I worked together last year expand the funding in the 
congressional budget resolution for Medicare and prescription drugs to 
$300 billion. That the President proposed only $190 billion for this 
important priority was a disappointment. This year, I hope we can again 
have at least $300 billion designated to modernize Medicare and provide 
seniors with prescription drug coverage. Since last July, I have been 
working with Senators Grassley, Hatch, Jeffords and Breaux, and 
together we have developed a tripartisan approach to modernizing 
Medicare and creating a drug benefit. We think there is momentum for 
moving forward, and with the President's strong support and appropriate 
funding in the budget resolution, we can get this done this year.
    The President has also renewed the debate over how to help the 
uninsured obtain affordable health care. Last year, Congress set aside 
$28 billion for efforts to lower the number of uninsured in our 
country--a sum that we knew to be inadequate to the task. This year, 
the President has proposed an $89 billion package of tax credits plus 
increased funding for community health centers and the National Health 
Service Corps. Bipartisan action is necessary, and I applaud the 
President for his leadership.
    Another issue that has long been a passion of mine is the unique 
health needs of women. We have come a long way from the days when women 
were excluded entirely from clinical trials. However, there is much 
left to be done. Mr. Secretary, I hope to work with you in the coming 
months to complete a long-term goal of mine to permanently authorize 
Offices of Women's Health within agencies of your Department, including 
the FDA, CDC, the Agency for Health Care Research and Quality and the 
Health Resources and Services Administration, The establishment of 
these offices will go a long way towards ensuring that women's unique 
health needs are identified and met throughout our nation s public 
health system--goals that I believe both you and the President are 
committed to.
    On welfare reform, as you know firsthand from your experience and 
leadership on this issue, the 1996 reform changed welfare from a way of 
life under the old entitlement system, to a temporary assistance 
program, focused on work and self-sufficiency. We have witnessed 
dramatic decreases in welfare caseloads--decreases more dramatic than 
any of us may have dared to hope for.
    However, as with any reauthorization, it is critical that we take a 
close look at the shortcomings, as well as the successes, of the 1996 
effort, before we reauthorize the program. Careful consideration of the 
rules governing work supports like child care subsidies, assignment of 
child support payments, and access to transitional benefits like food 
stamps and Medicaid, will significantly effect whether a family 
succeeds in making a successful transition from welfare to work. 
Overall, I believe that the 1996 effort was a landmark effort, however, 
there are areas in need of improvement that are critical to the future 
well-being of our Nation's most vulnerable families. I look forward to 
working with you, to reauthorize the 1996 welfare reform bill. Your 
experience in this regard will be of tremendous value as the Congress 
begins this endeavor.
    Thank you Secretary Thompson for appearing before us today and I 
look forward to hearing your testimony and working with you in the 
coming months on these issues many of which are priorities for this 
committee, the Senate and the Nation.

 WRITTEN QUESTIONS FROM CHAIRMAN CONRAD TO SECRETARY THOMPSON AND THE 
                               RESPONSES

    Question: As you know, the President's budget would provide 
Medicare+Choice plans $4.1 billion in additional resources over the 
coming years. While it is certainly important to ensure Medicare 
beneficiaries served by Medicare+Choice plans have access to stable and 
quality care, I am concerned that the President's budget does not 
reflect a similar commitment to the more than 86 percent of Medicare 
beneficiaries who are enrolled in traditional Medicare fee-for-service.
    According to recent Medicare Payment Advisory Commission 
recommendations, many health providers who serve fee-for-service 
beneficiaries, including rural hospitals, home health agencies, 
physicians and other providers, are in need of increased Medicare 
reimbursement. However, there are no additional resources allocated in 
the President's budget to meet this need. In addition, we have 
witnessed increasing Medicare+Choice plan withdrawals, which have 
totaled more than 170 over the last few years and have affected more 
than 2.2 million seniors. Finally, in North Dakota any many other 
States with primarily rural populations, there has been minimal 
availability of Medicare+Choice plans, which means that an investment 
in this program will likely have no positive impact for beneficiaries 
living in these communities.
    Given the clear need to provide additional resources to fee-for-
service providers, particularly those serving rural communities, I 
would be interested in hearing your views on how the Administration 
would propose meeting these needs within the President's Fiscal Year 
2003 budget request.
    Answer: The Administration shares your commitment to ensuring that 
all our Nation's elderly and disabled have secure access to modern 
health care whether they live in New York City or Grand Forks, North 
Dakota. The President's fiscal year 2003 budget renews his commitment 
to comprehensive Medicare modernization integrated with prescription 
drug coverage. This proposal is based on the framework for bipartisan 
legislation that he proposed last July. Specifically, the President's 
budget proposes to invest $190 billion in Medicare to modernize the 
program by improving health insurance plan options for all 
beneficiaries that include prescription drug coverage. The President's 
budget did not contemplate any particular provider payment changes; 
however, the Administration is willing to work with Congress to 
consider limited adjustments to payment systems and to work to develop 
a comprehensive package that is budget neutral across providers. As we 
consider changes to payment systems, we must be cautious; our focus 
remains on beneficiaries and how best we can spend Medicare dollars to 
ensure seniors have access to quality care, including the availability 
of reliable private plan options.

   WRITTEN QUESTIONS FROM SENATOR FEINGOLD TO SECRETARY FEINGOLD TO 
                  SECRETARY THOMPSON AND THE RESPONSES

    Question: As you know, I am concerned about many of the 
inequalities in the Medicare program, and that due to the use of 
inaccurate data, reimbursement rates in Wisconsin are some of the 
lowest in the country. One section of the Medicare, Medicaid and SCHIP 
Benefits Improvement and Protection Act of 2000 requires the Secretary 
of Health and Human Services to collect data every three years on the 
occupational mix of hospital employees for the purposes of constructing 
an occupational mix adjustment to the wage index for use beginning in 
Fiscal Year 2005. Given the importance of the wage index in adjusting 
hospital payment levels across geographic areas, any changes to the 
current system should be carefully considered. What is the status of 
this proposal? Do you plan to issue a detailed proposed methodology, 
for comment, illustrating how the occupational mix index will be 
calculated and how it will be used to adjust the overall wage index?
    Answer: I share your desire that the Medicare program treat all 
beneficiaries equitably and am committed to ensuring that Medicare 
payments, and the data used to calculate them, are appropriate. As you 
stated, the Benefits Improvement Protection Act requires the Secretary 
to collect data on hospitals occupational mix by September 30, 2003, 
for use beginning in Fiscal Year 2005. We are currently on track to 
meet this deadline, and we are developing the methodology and the 
process by which the methodology will be implemented.
    Question: One other area of concern is the substantial variation in 
payments to skilled nursing facilities. As you know, payments to 
skilled nursing facilities are currently geographically adjusted using 
the hospital area wage index. Skilled nursing facilities employ a 
significantly different group of health professionals than do 
hospitals. And using this geographic adjustment results in misguided 
geographic variation in payments to skilled nursing facility. My 
understanding is that the Center for Medicare and Medicaid Services is 
already collecting skilled nursing facility wage data, but has not set 
a date for implementation. When can we expect a formal rule on using 
skilled nursing wage data to geographically adjust payment rates to 
skilled nursing facilities?
    Answer: CMS has been collecting data nationally for several years 
on skilled nursing facility wages. On May 10, 2001 (66 FR 23984), we 
published a proposed rule that included the results of CMS' analysis of 
this data. Unfortunately, CMS found there were problems with the data's 
accuracy and reliability. As a result, CMS is continuing to study this 
issue, as well as whether committing the significant resources we 
believe will be required by providers and contractors to improve this 
data, is appropriate and will, in the end, provide some commensurate 
level of improvement in the accuracy of SNF payments. Until this 
decision is made, we continue to believe that the current hospital wage 
index provides the best available measure of geographic variation in 
wages in this sector.
    Question: The Balanced Budget Act of 1997 mandated a balance 
between urban and rural representatives on the Medicare Payment 
Advisory Committee, but there seems to be little progress in ensuring 
adequate rural representation. I understand that five rural candidates 
have been submitted to the General Accounting Office which makes the 
formal recommendations. Do you see any future progress in ensuring 
adequate rural representation?
    Answer: I certainly hope so. As your question clearly recognizes, 
MedPAC is an independent Federal body, and its members are appointed by 
the General Accounting Office, not the Department of Health and Human 
Services. Thus, while I do not have the authority to determine 
appointments to MedPAC, I am doing what I can to ensure that rural 
health issues are at the forefront of this Administration's health care 
agenda. I believe the HHS Department-wide Rural Health Task Force that 
I convened is one example of the sincerity of my commitment to rural 
health issues.
    Question: I would appreciate it if you could address an issue of 
great concern to the providers in my State of Wisconsin, the Medicare 
physician payment update formula. The Medicare Payment Advisory 
Committee (MedPAC) has urged that this formula, which is used in the 
Medicare program to reimburse physicians, nurses, therapists and many 
other providers, does not adequately address the cost of care. On 
January 1st of this year, these providers received the largest cut to 
their reimbursement in the history of the Medicare payment system. 
These cuts in Medicare dollars to providers have devastating 
consequences, particularly in States like Wisconsin, where Medicare 
payments are already some of the lowest in the country. The cut will 
force providers in my State to make difficult choices concerning their 
ability to accept new Medicare patients, opt out of the Medicare 
program, lay off administrative staff or retire early. Having said 
this, it is clear that the current Medicare payment cut will likely 
result in patients having difficulty finding a physician and other 
health care providers. What is the Administration's position on 
creating a new system that appropriately reflects the relevant factors 
in practice costs that MedPAC recommended?
    Answer: The current system for updating Medicare's payment for 
physician services was originally established in law in 1989, and has 
been adjusted a number of times since then, eventually resulting in the 
Sustainable Growth Rate (SGR) system that is used today. The system has 
been working as designed with physician spending increasing from 17.6 
percent to 20.5 percent of total Medicare fee for service spending 
between 1997 and 2001. Last year, a number of factors combined to cause 
the physician payment formula, as set in law, to produce a negative 
update. However, despite the negative update, overall Medicare 
physician spending is not projected to decrease this year.
    We believe that considerations of sustainability and of our other 
urgent priorities in Medicare argue strongly that, if changes in the 
physician payment system are undertaken this year, they should be 
undertaken carefully and implemented in a way that does not 
significantly worsen Medicare's long-term budgetary outlook. The 
Administration supports reforms in physician payment that lessen 
volatility, and further believes that any short-term payment problems 
can be addressed at a much lower cost that the MedPAC recommendation 
implies.

  WRITTEN QUESTIONS FROM SENATOR NELSON TO SECRETARY THOMPSON AND THE 
                               RESPONSES

    Question: Do you know why the Center for Medicare and Medicaid 
Services has not yet approved Florida's Upper Payment Limit (UPL) plan 
amendment? I understand that it has been pending at CMS for quite some 
time?
    Answer: CMS approved Florida's LTPL amendment on February 22nd CMS 
had requested additional information from the State in order to 
complete their review of the amendment. The State provided that 
information in mid February. Once CMS received the information from the 
State the Agency was able to complete its evaluation of the plan and 
approve the amendment.
    Question: Regarding the CMS rule, scheduled to take effect March 
19, to eliminate the Medicaid 150 percent UPL: Why has CMS chosen to 
take an ax to a vital Federal program that is working well in many 
States to provide care to those most in need? If some States have 
abused the program, why not go after the ``bad actors'' rather than 
curtailing the flow of $9 billion in Medicaid funds over 5 years?
    Answer: Some States have used a variety of legal and regulatory 
loopholes to enhance the Federal funds that they receive to help 
provide health care for their citizens. Although States often have 
worthy reasons for using these loopholes, this is not how the Medicaid 
program was designed. CMS believes that it is important to ensure that 
all beneficiaries get the care they are entitled to and that the 
Federal Government pays its appropriate share under the law. However, 
if States are not providing their appropriate share of the 
expenditures, and if these Federal funds are not used to pay for 
Medicaid covered services provided to Medicaid-eligible individuals, 
CMS has a duty to correct the situation.
    Federal statute and regulation restrict Medicaid spending to 
Medicaid eligible services, populations, and providers. While some 
States are using this money to pay for laudable, health care related 
services, if the services or the people receiving them are not covered 
under the Medicaid statute, it is inappropriate for this money to be 
used to pay for the services. Even when States use UPL money to pay for 
Medicaid services for Medicaid eligible citizens, the financing 
arrangements are still a problem. Because the money is recycled through 
State treasuries, there are little or no real State matching dollars. 
The Department's IG and the independent GAO believe these UPL payment 
arrangements violate both the letter and the spirit of the Medicaid 
laws.

  WRITTEN QUESTIONS FROM SENATOR SMITH TO SECRETARY THOMPSON AND THE 
                               RESPONSES

    Question: Yesterday, I sent a letter to President Bush articulating 
this priority, and urging him to work with Congress this year on a 
realistic plan to cover the uninsured. I have also met with Tom Scully 
to discuss ideas for covering the uninsured. And I would like to ask 
you, Secretary Thompson, on this day--Valentine's Day--would this 
Administration be willing to work with the Congress in crafting 
comprehensive uninsured legislation that would provide not only health 
credits and deductions, but appropriately targeted program expansions 
as well?
    Answer: The Secretary looks forward to working with Congress to 
enact legislation that will improve access to affordable health care 
coverage insurance. The legislative package proposed by the President 
would commit over $117 billion and provides a comprehensive vision to 
improve accessibility and affordability of Health care for all 
Americans. Its emphasis is on empowering individuals to make their own 
choices. The plan also acknowledges an important role for public 
programs, which the President wants to improve.
    The President's plan would improve public programs and their 
ability to cover more of the currently uninsured by:

  Continuing Medicaid funding for Americans in transition from 
    welfare to work ($350 million).
  Working with States to develop coverage innovations without 
    increasing spending.
  Making available to States an estimated $3.2 billion in 
    unused S-CHIP funds that would otherwise be lost.

    Since January 2001 there have been 1.8 million new people covered 
under these Medicaid program and beneficiaries are receiving 4.5 
million new benefits. These proposals complement other components of 
the President's plan to expand and improve private sector health care 
coverage by:

  Offering refundable tax credits of up to $3000 for families 
    without employer-sponsored insurance to help them pay for their 
    insurance premiums. The Administration will work with States to 
    expand State-sponsored purchasing pools, which will further ensure 
    that these families have access to affordable insurance options.
  Lifting excessive restrictions on Medical Savings Accounts 
    (MSAs) and Flexible Savings Accounts (FSAs).
  Making it easier for small employers to pool together to 
    offer their employees health insurance comparable to insurance 
    offered by large employers.

    Question: The President's budget suggests that States should be 
given more flexibility to develop innovating approaches to Medicaid and 
S-CHIP without seeking Federal waivers. Could you describe in a bit 
more detail what the Administration has in mind?
    Answer: In August 2001, the Administration announced the Health 
Insurance Flexibility and Accountability (HIFA) Demonstration 
Initiative. The HIFA Initiative:

  Gives States the flexibility to develop comprehensive health 
    insurance approaches that utilize available Medicaid and SCHIP 
    funding to address insurance coverage for individuals with incomes 
    less than twice the official poverty level, who comprise most of 
    the uninsured.
  Gives States the flexibility to increase health insurance 
    coverage through support of private health coverage.
  Simplifies the waiver process by providing clear guidance and 
    data templates.
  Increases accountability within the State and Federal 
    partnership by ensuring that Medicaid and SCHIP funds are being 
    effectively used to increase health insurance coverage.

    The Administration will continue to build on the HIFA Initiative by 
developing proposals to give States the statutory authority to provide 
broader coverage to low-income Americans and the flexibility to design 
innovative programs without seeking waivers. States will be encouraged 
to use current resources to extend coverage to their neediest residents 
and reduce the number of people without health insurance coverage. 
These proposals are currently under development and I look forward to 
working with Congress as we continue to look for innovatice approaches 
ro incease health insurance coverage.
    Question: Mr. Secretary, research seems to indicate that people 
leaving welfare often have difficulty obtaining health insurance. It 
may be that, because they are employed, they are no longer eligible for 
Medicaid, and their employers do not offer heahh insurance. It may also 
be that they are offered employer-based coverage but cannot afford 
their share of the premium. I also understand that people leaving 
welfare may still be eligible for government coverage but do not know 
it. Are you confident that we are doing enough to make sure that people 
leaving welfare have access to health coverage, or is this an issue we 
should address during the upcoming reauthorization of welfare?
    Answer: As a former governor, I can tell you that the Temporary 
Assistance for Needy Families Program--or TANF--has been a truly 
remarkable example of a successful Federal-State partnership. States 
were given tremendous flexibility to reform their welfare programs and 
as a result, millions of families have been able to end their 
dependency on welfare and achieve self-sufficiency. But even with this 
notable progress, much remains to be done, and States still face many 
challenges. You raise an important point about access to health 
coverage after leaving welfare and we need to be sure that we address 
this during the upcoming reauthorization of welfare.
    The law enacting TANF recognized the importance of providing health 
care to encourage and ensure the success of families making the 
transition from welfare to work. That law required States to continue 
transitional Medicaid assistance for up to one year to families who 
would otherwise lose it due to work. Some innovative States provide 
transitional access to Medicaid for even longer periods of time.
    I understand that perhaps not all families eligible for such 
transitional coverage may have received it. However, I can assure you 
that everyone at the Federal and State level recognizes the value of 
health coverage as an incentive to work and further, that both levels 
of government are committed to remedying any administrative 
shortcomings in the program.
    Finally, I would note that the transitional Medicaid assistance is 
scheduled to sunset on September 30, 2002. The President proposes to 
spend $350 million to extend the transitional Medicaid assistance an 
additional year. I have asked my staff to look for ways to further 
improve the long-term effectiveness of Medicaid for families in 
transition to work. I look forward to working with the committee on 
reauthorization of this hallmark program.
    Question: Mr. Secretary, I have been a major proponent of a real 
prescription drug benefit for seniors, working with my colleagues in 
this committee last year to set aside $300 million for prescription 
drug coverage. I was encouraged to see that the President agrees with 
Congress that prescription drug coverage for seniors is a high 
priority. But his budget proposes allocating only $190 billion for 
prescription drug coverage and Medicare reform, while at the same time 
calling for a ``comprehensive reform plan that includes prescription 
drugs for every senior.'' Of the $190 billion proposed by the 
President, $77 billion is to go to the states to expand drug coverage 
for low-income seniors. The Administration anticipates that the States 
may run these programs through Medicaid. I am worried, Mr. Secretary, 
that the proposed $190 billion is far too small to provide a meaningful 
benefit to struggling seniors, and that relying on State Medicaid 
programs will have an adverse impact on the non-elderly uninsured. Mr. 
Secretary, can you describe for me what kind of benefit you 
realistically anticipate being able to provide to our Nation's seniors 
for $190 billion?
    Answer: The Fiscal Year 2003 budget dedicates $190 billion over ten 
years for immediate targeted improvements and comprehensive Medicare 
modernization, including a subsidized prescription drug benefit, better 
insurance protection, and better private options for all beneficiaries. 
The President's proposal for assistance for low-income drug coverage 
reflects the fact that all of the major drug benefit proposals that 
Congress will be debating--all proposals from Republicans and Democrats 
alike--include new Federal support for comprehensive coverage of 
seniors up to 150 percent of poverty. And in all the proposals, the 
Federal Government would work with the States to provide this coverage.
    The Medicare transitional low-income drug assistance program is one 
of the steps that Congress can take now to assist low-income seniors 
while a comprehensive drug benefit for all seniors is developed. The 
President intends that a comprehensive benefit for all seniors would be 
in place by 2006, and would spend $8 billion over the next three years 
for the transitional assistance program. If comprehensive reform, 
including a subsidized drug benefit for all seniors, is not enacted by 
2006, then the Medicare transitional low-income drug assistance program 
would continue until a comprehensive benefit is enacted. If the 
transitional program were to continue for a full 10 years because a 
comprehensive benefit had not been enacted, then the full cost of the 
transitional program would be $77 billion.
    The transitional low-income assistance program will provide States 
with funds to establish drug only programs for seniors up to 100 
percent of poverty at existing Medicaid matching rates and would 
provide a 90 percent Federal match for the costs of these programs for 
seniors between 100 and 150 percent of poverty--about $17,000 for a 
family of two. This policy would eventually expand drug coverage for up 
to 3 million beneficiaries who currently do not have prescription drug 
assistance.
    Last year, the President proposed the creation of a new Medicare-
endorsed prescription drug card program to reduce the cost of 
prescription drugs for seniors. This year, HHS will continue working to 
implement the drug card, which will give beneficiaries immediate access 
to manufacturer discounts on their medicines and other valuable 
pharmacy services. The President is absolutely committed to providing 
immediate assistance to seniors who currently have to pay for 
prescription drugs.
    In addition, I recently announced a model drug waiver program--
Pharmacy Plus--to allow States to reduce drug expenditures for seniors 
and certain individuals with disabilities with family incomes up to 200 
percent of the federal poverty level. This program is being done 
administratively. The first such program was approved in January 2002 
for the State of Illinois. The Illinois initiative illustrates how we 
can expand coverage to Medicare beneficiaries in partnership with the 
Federal Government. The program we approved will give an estimated 
368,000 low-income seniors new drug coverage. The model application I 
have announced is easy to understand and use, and the Centers for 
Medicare and Medicaid Services is working with numerous States--at 
least 12--that have already expressed interest in this program.
    Question: Mr. Secretary, can you tell me, if Oregon were to run a 
prescription drug plan for low-income seniors as envisioned under the 
President's proposal, what kind of expenditures you would expect the 
State to incur? I ask you to keep in mind that our Medicaid Program--
the Oregon Health Plan--is already in financial difficulties as the 
State struggles with more Medicaid-eligible uninsured people, while the 
State is experiencing serious deficits?
    Answer: Unfortunately, CMS is not able to formulate State-specific 
cost estimates for expanded drug coverage. Many States have already 
begun exploring ways to expand drug coverage to low-income seniors 
through State-only funded drug assistance programs and Medicaid 
expansions. The President's new proposal will give States the Federal 
support and flexibility they need to provide prescription drug 
assistance for low-income seniors in conjunction with the 
implementation of a Medicare drug benefit. For seniors with incomes 
between 100 and 150 percent of the Federal poverty level, the Federal 
Government will contribute 90 cents of every dollar spent by States.
    The Administration believes that States understand the benefit of 
providing some drug coverage to low-income Medicare beneficiaries. By 
paying a few dollars up front for drug coverage, States may possibly 
avert impoverishment or long-term disability of seniors that can lead 
to higher Medicaid costs for States in the long run.
    Question: As you may know, current cost trends for some 
Medicare+Choice providers in Oregon are running between 10-15 percent. 
The Administration has proposed a 6.5 percent increase for the 
Medicare+Choice Program. This is a step in the right direction, 
however, how can CMS implement a Medicare+Choice increase that is 
relative to what the jurisdictions are already receiving, so that no 
county receives a greater proportion? Otherwise, under-reimbursed 
counties in States such as Oregon won't benefit. Further, what is the 
Administration's plan in general to address regional disparities in 
Medicare+Choice reimbursements so seniors in Oregon can have greater 
benefits and reduced premiums in line with what seniors in other 
``higher'' reimbursement areas are currently getting?
    Answer: Since the Medicare+Choice payment changes, included in the 
Balanced Budget Act of 1997, went into effect in 1998, the rates of 
increase in Medicare+Choice payments have varied significantly from 
county to county. Many Medicare+Choice enrollees live in counties where 
the rate increases since 1997 are less than 12 percent. Others live in 
counties where the rate of increase has been much higher. For example, 
I understand that rate increases in some Oregon counties with 
substantial Medicare+Choice enrollment have ranged from about 35 
percent to over 70 percent since 1997.
    The immediate issue facing us right now is to address payment rates 
in counties where rate increases have generally been only 2 or 3 
percent a year. We want to work with the Congress to address this 
important payment change for 2003, and we also want to work with 
Congress on broader Medicare Program improvements, including examining 
payment inequities, such as those you describe, and looking at new ways 
to set payment rates under the Medicare+Choice Program as a whole.
    Question: Secretary Thompson, MedPAC and the American Medical 
Association, both agree that the Medicare formula to reimburse 
physicians, nurses, therapists--and just about everyone else who treats 
Medicare patients--is highly flawed. As of January 1, physicians have 
received their largest cut in the history of the Medicare payment 
system. Cuts in Medicare dollars to providers have devastating 
consequences, especially in rural States such as Oregon. Most Medicare 
providers are small businessmen and women--in fact, two-thirds of 
physicians offices in Oregon and throughout the country meet the 
definition of a small business. Cuts in revenue to these small 
businesses inevitably means that physicians and other providers will 
discontinue seeing Medicare patients, retire early, lay off staff, or 
postpone necessary investments in new technology. Clearly this has 
profound implications for access to health care. A recent survey by the 
American Academy of Family Physicians found that nearly 30 percent of 
family physicians are not accepting new Medicare patients. I find this 
very troubling. Oregon physicians alone will lose nearly $15 million 
dollars this year because of the cut. A super-majority of the Senate 
supports funding to alleviate some of the harm from these cuts. (69 
Senators have cosponsored S. 1707, the Medicare Physician Payment 
Fairness Act, which CBO recognizes as an item that will be scored). Mr. 
Secretary, I hope you will also support a budgetary proposal to fix 
this critical health care problem. Secretary Thompson, this issue must 
be addressed. The President, in his budget, referenced the problem, but 
said it must be resolved in a budget-neutral way. If Medicare 
reimbursement payments are taking this major cut, how can fixing the 
formula occur in a budget-neutral manner?
    Answer: The current system for updating Medicare's payment for 
physician services was originally established in law in 1989, and has 
been adjusted a number of times since then, eventually resulting in the 
Sustainable Growth Rate (SGR) System that is used today. The system has 
been working as designed with physician spending increasing from 17.6 
percent to 20.5 percent of total Medicare fee for service spending 
between 1997 and 2001. Last year, a number of factors combined to cause 
the physician payment formula, as set in law, to produce a negative 
update. However, despite the negative update, overall Medicare 
physician spending is not projected to decrease this year.
    While the President's Budget did not contemplate any particular 
provider payment changes, we are willing to consider limited 
adjustments to payment systems and to work with Congress to develop a 
comprehensive package that is budget neutral across providers. We will 
not support any package of provider payment changes unless it is budget 
neutral in the short and long term. To this end, we recognize that some 
provisions in law that, in the past, have restrained growth in payments 
are about to expire, and extension of these provisions is one potential 
way to ensure a budget neutral package or reforms.

 WRITTEN QUESTIONS FROM SENATOR HOLLINGS TO SECRETARY THOMPSON AND THE 
                               RESPONSES

    Question: ``While our Nation is focused on the war in Afghanistan, 
bioterrorism, and homeland security, which I and all of us on the 
Committee fully support, how will we meet the demands of chronic 
disease in our Nation without increased funding for the chronic disease 
prevention and control programs at the CDC?''
    Answer: HHS remains committed to reducing the burden of chronic 
diseases. To that extent, I have directed the Department to begin 
formulating a comprehensive prevention strategy with CDC playing a 
major role. Much of what we know about prevention and management of 
chronic diseases comes from our research, and the budget includes 
substantial funds for prevention research at the National Institutes of 
Health.
    The CDC's Fiscal Year 2003 funding of $697 million reflects program 
increases totaling $14 million and a reduction of $71 million in 
program and management savings. Most activities, including tobacco, 
diabetes and arthritis prevention, are funded at essentially the same 
level as last year. There are nominal reductions targeted at internal 
CDC management improvements.
    The Fiscal Year 2003 funding includes increases of $14 million in 
cancer prevention and health promotion activities for,

  Breast and Cervical Cancer Screening: $203 million, an 
    increase of +$9 million, to provide 29,000 mlore mammographies and 
    pap smears; and
  Healthy Communities: $5 million for a new public education 
    campaign to promote exercise and physical activity, with a focus on 
    families.

    The $71 million in program and administrative savings in the Fiscal 
Year 2003 funding reductions are for discontinuing the Youth Media 
Campaign (a savings of $68 million) and management reforms that reflect 
consolidation of certain job functions and workplace restructuring (a 
savings of $3 million). With regard to the Youth Media Campaign, we 
note that:

  Congress reduced this program in Fiscal Year 2002 from $125 
    million to $68 million;
  The Fiscal Year 2003 budget proposes eliminating the 
    remaining funds;
  Because the initial projects planned for this major media 
    activity have not yet begun, we are hesitant to invest future 
    resources until there is a full assessment of the benefit and 
    effectiveness of this approach; and
  The paid advertising campaign will begin in May 2002; 
    Campaign events in fifteen cities will begin in October 2002.

    Question: ``Mr. Secretary, TANF reauthorization and welfare reform 
is one of the major issues the Senate and your agency will have to 
address this year. I believe your experiences and record in this area 
as Governor will prove a valuable asset during the debate. At the same 
time, I think it is important to note that not every Governor is 
afforded the same opportunities that you were. I still remember what 
you said last year during your confirmation hearing that welfare reform 
``can't be done on the cheap'', yet that is what the current law 
expects many of our States to do--welfare reform on the cheap.
    ``To the point, you received more than three times the TANF funding 
per poor person than my Governor received. I would challenge anyone to 
prove that welfare recipients are three times as poor in Wisconsin as 
they are in South Carolina. Mr. Secretary, do you feel that [sic] is 
fair and just for States like South Carolina to receive a fraction of 
the TANF funding than [sic] States like Wisconsin, New York, 
California, and Connecticut receive?''
    Answer: As Congress enacted the welfare reform legislation, the 
TANF block grant amount for each State was based on the highest Federal 
dollars it received for the AFDC, Emergency Assistance, Job 
Opportunities and Basic Skills (JOBS) and related child care programs 
in FYs 1992-1994 (annual average), FY 1994 (adjusted), or FY 1995 
(estimated). This funding distribution among States closely relates to 
the spending patterns that States 1exercised under the former, matching 
AFDC program, because these benefits largely dwarf other prior program 
funding.
    Under AFDC, in FY1994 State expenditures for benefits were 
Federally matched from 50 to 79 percent, based on the inverse ratio of 
average per capita income of a State. To illustrate, in that year, 
South Carolina had a matching rate of 71.08 percent, Wisconsin's was 
60.47 percent and New York, California and Connecticut were all matched 
at 50 percent. Stated differently, for each dollar of State investment 
in FY 1994, South Carolina received $2.46, Wisconsin received $1.53 and 
the others each received one Federal dollar. By providing a higher 
match rate, the formula attempted to compensate for a reduced ability 
of low per capita income States to raise funds.
    But, as you have noted, the differential matching rate did not 
eliminate the historical disparity in State spending per eligible 
child. Under the funding formula designed by Congress and widely 
supported by Governors, the prior, disparate spending pattern of each 
State determines the amount of the annual block grant.
    Congress made an effort to address these disparities in funding per 
poor child among States through supplemental grants to States that had 
both substantial population growth and low per capita welfare spending. 
$800 million was available for fiscal years 1998 through 2001. But, 
South Carolina failed to qualify for supplemental grant funding.
    In our reauthorization listening sessions with States and in 
response to our request for written comments, there were very few 
comments recommending a change in the current funding formula. Both our 
budget and the President's recently released welfare reform proposal 
retains the existing block grant formula and asks Congress to restore 
and fund supplemental grants at $319 million annually. We want to work 
closely with you and other Members on the reauthorization to promote 
work and strengthen families working toward independence.

 WRITTEN QUESTIONS FROM SENATOR SARBANES TO SECRETARY THOMPSON AND THE 
                               RESPONSES

    Question: What are your views on the importance of the FDA 
consolidation and the Administration's commitment to this project?
    Answer: FDA consolidation at the White Oak, Maryland site remains a 
high priority for the Administration. FDA Headquarters currently 
occupies approximately 39 buildings in more than 16 locations. It is 
important for an Agency, entrusted with protecting the Nation's food 
supply and approving pharmaceuticals, biologic products and medical 
devices, to have modern facilities and be able to work effectively and 
efficiently.
    Assistant Secretary for Administration and Management, Edward 
Sontag, has already attended one of the local community's Labquest 
meetings at White Oak and has seen first hand the local support the FDA 
consolidation project has gained. Hopefully, any further delays to this 
important project can be minimized.
    Question: FDA's Fiscal Year 2003 budget justification includes $159 
million for counter terrorism which would fund almost 900 new 
employees. I am advised that for those assigned to the Washington area, 
one possibility for housing them would be to quickly renovate the 
existing main building at White Oak, which was formerly the Navy 
headquarters building. If funds could be made available for that 
purpose, would HHS support such an initiative?
    Answer: We understand from GSA, that in the revised master plan for 
White Oak, Building One (the existing main building) takes on a more 
prominent role. Building One has been designated as the ``front door'' 
of the FDA campus. This structure would be revitalized and an 
architectural forecourt, consisting of two flanking buildings and a 
circular pedestrian plaza, would be established. Providing funds for 
Building One's renovation would be beneficial to the long-term 
development of the site, and could accommodate increased review staff 
and new counter terrorism personnel being employed by FDA's Center for 
Drug Evaluation and Research. The new FDA counter terrorism employees 
are spread among the headquarters organizations and the Office of 
Regulatory Affairs; therefore co-locating all of these new employees in 
a single building may not be the most efficient deployment of these 
personnel.















THE EFFECTS OF THE PRESIDENT'S FISCAL YEAR 2003 BUDGET PROPOSAL ON THE 
 ARMY CORPS OF ENGINEERS, THE FEDERAL HIGHWAY ADMINISTRATION, AND THE 
                        DEPARTMENT OF EDUCATION

                              ----------                              


                       TUESDAY, FEBRUARY 26, 2002

                              United States Senate,
                                   Committee on the Budget,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:01 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Murray, Domenici, and Bond.
    Staff Present: Mary Ann Naylor, staff director; Bonnie 
Galvin, analyst; Sarah Kuehl, analyst; and Shelley Amdur, 
senior analyst.
    For the minority: G. William Hoagland, staff director; 
Margaret Stewart, senior analyst; James O'Keeffe, senior 
analyst; and Walter Hearne, junior analyst.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The committee will come to order.
    We want to welcome the witnesses who are here with us today 
to share their expertise. Today we are going to look at the 
President's budget and its impact on three major areas of the 
Federal Government: highway and bridge-building programs, the 
construction projects of the Corps of Engineers, and education.
    We have two panels this morning, and, unfortunately, the 
Senate is scheduled to vote at 10 o'clock. That vote is now 
underway, but my intention is to make my opening statement, and 
then recess briefly so we can vote. I apologize to the 
witnesses, but this is part of what has happened in the Senate 
when votes are scheduled at the last moment.
    I would just start with this chart. We have all said what a 
difference a year makes. Last year we were all told that we 
were going to see budget surpluses as far as the eye can see, 
and now we see budget deficits as far as the eye can see, 
certainly trust fund deficits that continue throughout the next 
decade. And there are very large deficits.
    Let's go to the next chart. Last year we were told that 
outside the trust funds we would have some $2.7 trillion of 
surpluses over the next decade. Now we see, instead of 
surpluses outside the trust funds, deficits of $2.2 trillion.
    That means $2.2 trillion will be coming out of the trust 
funds of Social Security and Medicare. Many of us think that is 
unwise given the fact the baby boomers start to retire in just 
6 years. But that is the factual circumstance we face.
    The areas that we are going to examine today include the 
construction programs for highways and bridges. We see in the 
President's budget about a 27 percent cut from last year. Last 
year we provided roughly $32 billion. This budget will be 
roughly $23 billion, so about a $9 billion cut--actually, 
something a little bit less than that. It is a 27 percent 
reduction, and we will go into some of the reasons for that.
    Earlier this month, the OMB Director said that these 
proposed highway cuts were not a policy decision, but the 
results of a simple calculation based on the law. The fact is 
there is nothing in TEA-21 and nothing in the Budget Act that 
prevents the President or the Congress from providing 
additional funding for the highway and bridge program beyond 
the funding levels that are guaranteed in TEA-21.
    We can add, the President could have added, so that we 
would be reducing the level of cut that is before us. I am 
concerned that the President's proposed highway and bridge-
building budgets will force a loss of over 300,000 jobs across 
the country, just as the economy is starting to rebound.
    In addition, the President's budget will significantly 
reduce Federal funding for highway construction and maintenance 
at the same time as nearly 40 States are being forced to scale 
back their State budgets in light of their constitutional 
requirements to run balanced budgets.
    The second area that we will examine is how the President's 
budget would reduce the Army Corps of Engineers' ability to 
carry out and complete crucial water and flood control projects 
across the country. Within the total for the Army Corps, the 
budget provides $1.4 billion for the primary project 
construction account, and this is roughly $300 million less, or 
an 18 percent cut from the 2002 enacted level of $1.7 billion.
    Now, what does that mean? For people in the community of 
Grand Forks, North Dakota, in my home State, it means they will 
have to wait an additional 2 to 3 years to be safe from floods. 
That is not a result any of us wants, and we need to work 
together to see if we can't do better.
    I am afraid that my State's story is not unique. Projects 
from Texas to Missouri to Washington State will also be funded 
substantially below what is needed to get the job done in a 
cost-efficient way. Not only are projects being delayed, but in 
order to stay within the proposed 2003 funding level, the Corps 
may actually have to terminate ongoing construction contracts 
at a cost of up to $190 million to taxpayers.
    So, again, we have got to find a way to work together here 
to address these challenges.
    In education, which is the third area that we will examine 
today, the President's education budget promises to leave no 
child behind. At a time when more is being demanded from our 
schools, more accountability, more testing, better results, I 
was particularly disappointed to find that just one month after 
the President signed into law the landmark education reform 
bill, No Child Left Behind, his budget actually cuts funding 
for these programs by $90 million.
    Again, I want to thank our witnesses for being here to 
testify. I will go to my colleague, Senator Bond, for any 
opening statement that he would like to make.

                   OPENING STATEMENT OF SENATOR BOND

    Senator Bond. Well, thank you very much, Mr. Chairman, and 
welcome to our witnesses today.
    Mr. Chairman, I would agree with you on the first part of 
your macroeconomic analysis. It looked a year ago that we were 
going to be running surpluses. But, frankly, we have now found 
that the recession that started back early in the year 2000 has 
continued. Certainly it took an even greater dip with the 
tragedies of September 11th. And it is clear that we are going 
to be running a deficit. But when we are in a recession like 
this, I think that for the long-term health of our trust funds, 
the Social Security fund and everything else, we have got to 
restore economic growth. Economic growth is far more important 
right now than trying to be Herbert Hoover and run a surplus 
when we are in a recession.
    You and I, Mr. Chairman, started out with the Deficit 
Reduction Caucus when we first got here in 1987, a lonely 
little group, and all of a sudden we found that we were getting 
spending under control. We happened to disagree a little bit on 
how we got there. You think it was tax increases; I think it 
was budget cuts. But we got to where we wanted to be.
    Now, with an economic downturn, it is time to put our foot 
back on the accelerator, not the brake. And I share the 
concerns--I know Senator Domenici is going to talk about 
highway funding. I was very proud in TEA-21 to be the author 
with the late Senator John Chafee. We call it the Bond-Chafee 
proposal in Missouri. I guess elsewhere it is called the 
Chafee-Bond proposal in the other 49 States and Washington. It 
said that what we get in ought to be paid out, and we have been 
for many years suffering from deficits in that trust fund.
    Now, because of the wild swings, we potentially suffer 
significant disruption in highway construction. Frankly, I can 
think of nothing more important to helping get our economy to 
grow than to continue with investments in highways and water 
transportation. And that brings me to Secretary Parker. I was 
going to say some really nasty things about this budget, and I 
felt bad about it, until I was told by my staff that Secretary 
Parker in his previous transmogrification had similar and 
stronger things to say when totally ineffective and inadequate 
budgets were proposed for the Corps.
    So I am emboldened by that, Mr. Secretary. I was just going 
to lay out some questions, and you can think about them. I 
don't think you would be permitted to answer them. But knowing 
how injurious the budget requested by OMB is to the Corps of 
Engineers, if Congress actually passed the Administration's 
budget for the Corps--and I guarantee you it will not--would 
you recommend the President veto it? You might think about that 
one.
    And let me ask you to consider some things. I think you 
know, but I don't think the people at OMB know. Am I wrong to 
say the President supports economic growth, the President wants 
to put people back to work, the President supports trade, and 
the President knows that trade will help restore economic 
growth and jobs? The President knows that you can't FedEx or e-
mail grain to overseas customers. The President knows that 
there is a relationship between efficient shipping and 
international competitiveness. The President knows that water 
transportation is the artery of the Midwest to the world 
markets. And he supports the competitive shipping options for 
United States exporters. He knows that water transportation is 
safe and efficient and environmentally friendly and burns less 
fuel and creates less congestion and less pollution, and that 
one medium-sized hull can carry the grain of 900 trucks.
    We know that he went down the Mississippi River corridor 
for a reason in New Orleans, and it wasn't just for Mardi Gras. 
I think he was interested in seeing how we ship grain to the 
overseas markets. And I think he understands that you can't 
support big river navigation without supporting the smaller 
ports and tributaries that feed traffic to the big rivers. If I 
am wrong on that, please advise me.
    Two years ago, the Corps testified that a sloppy budget 
sent up by the previous Administration, if enacted, would 
conservatively result in an estimated $376 million increased 
cost to the Federal Government and $3.9 billion in foregone 
benefits. And I might ask you, in terms of cost inflation, 
delays, and resulting flood damage, if you could tell us how 
much this budget, with their cuts, will cost us.
    As I said, you might think back to some of the comments you 
made when you were on the House Energy and Water Appropriations 
Subcommittee. As a matter of fact, I am going to suggest to 
Chairman Reid, our Energy and Water Appropriations Chairman, 
that he consider bringing up the OMB staff since they wrote the 
budget for the Corps, and maybe they could explain it.
    For the record, Mr. Chairman, I wonder if we can get the 
names of the staff people at OMB who write the Corps budget and 
find out how long they have been in the natural resources 
section at OMB, because I think we need some budget reform to 
reduce waste. And I think we can start by saving the Corps the 
cost and burden of submitting budgets to OMB because it is a 
waste of time. And we can perhaps eliminate the positions at 
OMB who work on the Corps budget because, since Congress 
totally has to rewrite it, the positions are a total waste of 
the taxpayers' money.
    Chairman Conrad. I think you got the attention of people at 
OMB this morning, Senator Bond.
    Senator Bond. I have written them letters. I have talked to 
them. I have sent out letters. I don't know what else to do. 
Maybe I can walk in on stilts. But at least I am going to find 
out who is doing these dumb things and why and what their 
explanation for it is. And I am sure that Secretary Parker has 
been told to say some things, but he is not the one who did it. 
I know General Flowers didn't do it.
    Chairman Conrad. Again, it can't stand. I mean, it 
doesn't--it just doesn't make any sense. It doesn't make any 
economic sense.
    Let me just say in response to Senator Bond that we were 
allies at the time that this country desperately needed deficit 
reduction, and we were a lonely band. But we did help get the 
country back on course, and it wasn't just a matter of tax 
increases. It was spending cuts. And we were advocates of a 
balanced program because the hole was so deep at that time, we 
had to do a little bit of everything to get this country back 
on track, and working together we did.
    I also want to make clear I agree with Senator Bond; it 
would not be wise at a time of economic downturn to cut 
spending or raise taxes. That would be Hoover economics, and I 
don't favor that. But we are not talking about a plan that is 
just a 1-year plan. The President sent up here a 5-year budget 
plan. He is forecasting strong economic recovery, which we all 
hope occurs. But he is also forecasting deficits for the next 
decade, and we are going to have to face up to that. We can't 
do things that counter the cycle now because of our economic 
condition. But, looking ahead, we have got to face up to these 
deficits.
    With that, we are going to go and take a 10-minute break, 
and we will be back to open the hearing and the statements from 
the witnesses. Again, I apologize. Obviously when this hearing 
was scheduled for 10 o'clock, there were not votes scheduled, 
and previously there have been attempts to prevent scheduling 
votes until committees of Congress have completed their morning 
hearings. Because of the press of business, apparently that has 
not been what was done today, but we will return as quickly as 
possible, and we ask for your indulgence. [Recess.]
    Chairman Conrad. The committee will come back to order. 
Again, I apologize to the witnesses.
    Senator Domenici has now joined us, and we will ask him for 
his opening statement and then go to the witnesses for their 
presentations.
    Senator Domenici, it is good to have you back.

             OPENING STATEMENT OF SENATOR DOMENICI

    Senator Domenici. Thank you very much. Good to be here, Mr. 
Chairman.
    Let me say to the witnesses, I am sorry I wasn't here 
earlier. We could have gotten this perhaps behind us. But let 
me abbreviate my remarks and ask that the entire prepared 
statement be made a part of the record.
    Chairman Conrad. Absolutely.
    Senator Domenici. I think it is fair to say, Mr. Chairman 
that the Olympics are over and March Madness begins at the end 
of the week. There is no question about it. We are not talking 
about the NCAA or the Olympics. We are talking about this, the 
madness that will occur now for the next two and a half months 
here in the Congress as we attempt to make some sense out of 
budgeting for our country in the midst of recovering from a 
recession and in a war, very different than usual times that we 
have had here in this committee to put budgets together.
    I want to break my remarks up into the two parts that are 
logical. First, with reference to the Highway Trust Fund, the 
funding there, let me suggest that it is very vivid in my mind, 
and perhaps in yours, Mr. Chairman, when we had this very big 
debate on the floor of the Senate. Senator Byrd and Senator 
Gramm from Texas wanted to change the formula and say that 
every penny that came in from gasoline tax ought to be spent--
that was a very big debate that passed overwhelmingly--that 
every nickel, every penny, every quarter that comes in you 
spend that year. That is the law, and the most interesting 
thing is that when you apply the law that we passed then, the 
trust fund has less money than we expected because we are 
driving less and the prices are lower.
    So what the President's people did is just come along and 
apply the formula. The formula was every penny that comes in 
gets spent. It just happened that the pennies were fewer.
    I want to make it clear and, to the extent that this helps 
you in any way with putting your budget together, this Senator 
doesn't believe--I believe we ought to go ahead and fully fund 
on schedule as prescribed, as expected, rather than reducing it 
by the amount that we did not receive. And the reason is the 
States--yours, mine, and all the others--and the entities under 
them that received this money, they all are on a timetable. 
They have let contracts. This is no way to handle highway 
funding in the United States. There are a lot of reasons that 
we ought to be maximizing the funding, but the real reason here 
is that it is not fair to our States that we would now go back 
on not only the formula but we would go back on the amount that 
they actually expected to get because they were prudently 
anticipating this money under the basic underlying formula. It 
didn't come in through not fault of their own.
    Now, if somebody wants to save some money over the long 
run, then I think they could look out at the next 5 years and 
say maybe that next 5 years we will pay back this $4 or $5 
billion. But from my standpoint, I believe that this unexpected 
disturbance of the highway program is not justified, and 
certainly as we are coming out of this recession, there is even 
more reason for it to be unjustified.
    The Corps of Engineers, I understand that I missed Senator 
Bond's--I don't know what one would call it, but certainly 
``critical analysis,'' perhaps would be the right way to say 
it, of the Administration's Corps budget. I didn't hear it, so 
I can't say that I agree with every word of it. But let me 
suggest we can't live with the Corps of Engineers budget that 
the Administration put forth. I am hopeful that between Mr. 
Parker and General Flowers you will be able today to tell us 
how difficult it will be, what it will cause if we, in fact, 
follow the President's suggested numbers.
    I kind of wonder who helps put this together and whether 
they are serious or whether they expect us to raise the amount. 
I can't tell which one yet. But the argument that we have too 
many projects that are not yet completed, in other words, we 
have an abundance or an overload of projects, we don't need any 
new starts, frankly, maybe that overload is getting bigger 
because we don't have enough money to finish them and we have 
to start new ones without enough money to stay on schedule.
    So I don't know what the right number is, but let me just 
say I don't think the right number is what the Administration 
has proposed with reference to the Corps of Engineers water 
programs and related activities.
    Thank you, Mr. Chairman.
    [The prepared statement of Senator Domenici follows:]

             Opening Statement of Senator Pete V. Domenici

    Mr. Chairman it is good to be back.
    The Olympics are over and March madness begins the end of this 
week. And I am not talking about the NCAA basketball tournament. I am 
talking about the significant amount of work needed to draft and agree 
to a Congressional budget resolution over the next four weeks.
    Once again, Mr. Chairman, I extend to you my offer to work in a 
bipartisan manner to see if we can craft a fiscal blueprint for the 
Congress.
    Today we have two witnesses from the Administration--representing 
two agencies--whose budgets are important in our drafting a budget 
resolution.
    Let me go straight to the Federal Highway Administration. Welcome 
Administrator Peters.
    Back in 1998 we all worked hard to find a solution to highway 
funding so that spending for highways was tied directly to the Federal 
gas tax revenues being deposited in the highway trust fund. Senator 
Byrd and Senator Gramm on this Committee were instrumental in bringing 
about this new law called TEA-21.
    The President's budget follows precisely that law. Up until this 
year, the formula in TEA-21 tying gas tax receipts and spending 
authority provided $9.2 billion more in highway spending authority than 
was assumed at the time the law passed.
    But because of the dramatic lower gas tax receipts associated with 
the slower economy last year, this adjustment is now a negative $4.4 
billion--with states receiving nearly $23.5 billion next year.
    I continue to support the linkage between Federal gas tax receipts 
and Federal spending on highways. But much like the rapid and 
unexpected swing in the surplus estimates last year, this large 
unexpected swing in gas tax revenues has disrupted States' long-term 
transportation construction plans.
    TEA-21 worked the way it was supposed to work--gas tax revenues 
went up and spending authority went up. But the large, unexpected swing 
in revenues this last year needs to be evened out, and I hope that when 
this bill is up for authorization next year we can reexamine the 
formula that caused this dramatic swing, and try to prevent similar 
occurrences in the future.
    In the meantime, I will propose to my members on this side that 
while keeping the linkage of gas taxes and highway spending in the 
future, that at least for the FY 2003 budget, I will recommend that we 
add back $4.4 billion in highway obligations to the President's budget. 
This will fund the program at the level States anticipated originally 
in TEA-21. And this will prevent the large unexpected disturbance in 
State highway programs at this time when States are having to address 
other important budget decisions.
    Finally Secretary Parker, as we understand the President's budget 
request, the Corp will be reduced about $600 million from last year.
    Further, your budget includes no funding for any new construction 
starts next year, with the exception of one on the Colombia River. No 
new construction contributes to about half of the savings in your 
budget.
    The Budget Committee of course does not make these line-item 
decisions. But the Energy and Water Appropriation Subcommittee, on 
which I serve as the Ranking Member, does. So I will have an 
opportunity to visit with you again Mr. Secretary.
    At a minimum, however, I understand the President's argument that 
new construction starts have been significant over the last many years, 
and that this may be contributing to delays in completing those 
projects.
    So to reduce the back-log of these projects already underway, no 
new construction projects are requested next year. Of course, another 
way of addressing the back-log of ongoing projects is to provide more 
funding for them.
    Some balance will be needed between these two approaches if we are 
to try to reduce the backlog. At a minimum I would assume that a freeze 
on the Corp's budget next year, would allow us to reach some 
accommodation between the sure demands for new construction projects 
next year, preventive maintenance on existing projects, and finally 
reducing the time required to complete current projects.
    I look forward to the two witnesses' testimonies. And once again, 
Mr. Chairman, it is good to be back.

    Chairman Conrad. Thank you, Senator Domenici. And, again, I 
want to say how good it is to see you back here at the dais, 
and we missed you very much. And we are glad to see that your 
health has recovered and you are ready to go as we enter budget 
season in earnest.
    We are going to turn now to the witnesses. Mary Peters, the 
Administrator of the Federal Highway Administration, who is 
accompanied by Donna McLean, the Assistant Secretary of 
Transportation for Budget, welcome to you both. We are glad you 
are here. We will go first with you, and then we will go right 
to our second set of witnesses on the first panel: the 
Honorable Michael Parker, the Assistant Secretary of the Army 
for Civil Works, who is accompanied by Lieutenant General 
Robert Flowers, the Chief of Engineers for the Army Corps.
    With that, Ms. Peters, why don't you proceed?

  STATEMENT OF MARY E. PETERS, ADMINISTRATOR, FEDERAL HIGHWAY 
ADMINISTRATION, AND DONNA MCLEAN, ASSISTANT SECRETARY OF BUDGET 
   AND PROGRAMS, AND CHIEF FINANCIAL OFFICER, UNITED STATES 
                  DEPARTMENT OF TRANSPORTATION

    Ms. Peters. Thank you, Mr. Chairman.
    Mr. Chairman and members of the committee, thank you for 
the opportunity to testify today on the effects of the 
President's fiscal year 2003 budget on the Federal Highway 
Administration. It is an honor to be here today with Assistant 
Secretary for Budget and Programs and the Chief Financial 
Officer of the Department of Transportation, Donna McLean. With 
your permission, we will submit a joint written statement for 
the record.
    Our highways are the critical links in our Nation's multi-
modal surface transportation system. Our challenge is to 
maintain our high-quality network while increasing safety, 
improving mobility, and promoting environmentally responsible 
project decisions, and, of course, efficient program delivery. 
Our ability to accomplish these objectives is related to the 
adequacy and the availability of transportation funding.
    TEA-21 provided a mechanism for ensuring that revenues into 
the Highway Trust Fund are spent, and that funding levels for 
the highway program are aligned with trust fund receipts. Over 
the past 3 years, the revenue-aligned budget authority (RABA) 
has provided more than $9 billion of additional highway 
spending, funding that is now working in our economy.
    Due to the recent economic slowdown and current projections 
of future Highway Trust Fund receipts, a downward adjustment of 
the highway program occurred when spending was aligned with 
revenues in the Highway Trust for the 2003 budget year. The 
calculation is not a policy call. It is a calculation that was 
based in law and reflected in the budget.
    The $24.1 billion funding level for highways, as was 
proposed in the President's 2003 budget, reflects the spending 
level enacted in TEA-21, as adjusted for the latest Highway 
Trust Fund revenue figures. As we approach reauthorization, we 
need to look for ways to smooth out the current positive and 
negative swings that result from this adjustment. However, we 
should not abandon the concept. Linking highway spending to 
receipts is a fundamental principle of TEA-21. Even with the 
negative calculation in 2003, over the life of TEA-21 RABA 
adjustments will provide a net gain of almost $4.7 billion in 
highway spending.
    The 2003 reduction can serve, I think, as a wake-up call 
for us. Current trends in fuel use as well as technological 
advances, such as fuel-cell technology, will require us to 
consider new sources of revenue and leveraged funding if we are 
going to have sufficient funds for our highway system in the 
future. Reauthorization gives us the opportunity to consider 
those important factors.
    The Federal Highway Administration budget emphasizes four 
priority areas: safety, mobility, environmental stewardship and 
streamlining, and oversight.
    Safety remains our first priority and our greatest 
challenge. Our core construction programs contribute to both 
safety and mobility by improving roadway design, system 
condition and capacity, and eliminating hazards. We can also 
improve the overall operation of the highway system.
    Significant progress has been made in the deployment of 
intelligent transportation systems, but we need to complete 
that deployment, both in urban and rural areas.
    The 2003 budget provides almost $360 million for research 
and technology funding that will support innovations in safety, 
system preservation, and congestion mitigation, and including 
expanded deployment of ITS.
    Continued progress in streamlining the delivery of 
transportation improvements will also improve safety and 
congestion. We must at the same time, of course, remain 
respectful stewards of our environment. However, meeting our 
Nation's mobility goals and environmental stewardship are not 
mutually exclusive goals.
    I am happy to report that the median time it takes to do an 
environmental impact statement and get to a record of decision 
has been cut by nearly an entire year. While this is an 
excellent start, we are committed to accomplishing much more. 
Our budget proposes $6 million in additional funding for 
streamlining efforts.
    We will also continue to improve Federal oversight and 
accountability to ensure, as Secretary Mineta has said, the 
public gets what it pays for. We do owe the public a good 
return on their investment for public transportation funds, and 
I call this the public value that we return to them in place of 
dividends.
    We must keep our infrastructure secure and strengthen our 
commitment to reducing highway injuries and fatalities, even as 
we obtain additional capacity from the system. Working 
together, we can provide the American people with a safe, 
efficient, affordable, and accessible transportation system.
    Mr. Chairman and members of the committee, I again thank 
you for the opportunity to testify today. The Assistant 
Secretary and I would be pleased to answer any questions you 
may have.
    [The prepared statement of Ms. Peters follows:]

   The Prepared Statement of Mary E. Peters, Administrator, Federal 
 Highway Administration; Donnna McLean, Assistant Secretary for Budget 
                and Programs and Chief Financial Officer

    Mr. Chairman and members of the committee, thank you for the 
opportunity to testify today on the effects of the President's Fiscal 
Year (FY) 2003 Budget proposal on the Federal Highway Administration. 
We are looking forward to working with the Committee and with Congress 
to achieve the goals outlined in the fiscal year 2003 budget request 
and to shape reauthorization proposals. Working together, we can meet 
the transportation challenges flicing our Nation and provide the 
American people with a transportation system that is safe, efficient, 
arid accessible, while remaining respectful stewards of the 
environment.
Overview
    As a whole, the strong but flexible multi-modal system developed 
under the Intenriodal Surface Transportation Efficiency Act of 1991 
(ISTEA) and the Transportation Equity Act for the 21st Century (TEA-21) 
is working well in supporting our Nation's economic growth and 
improving the quality of life for all our citizens. Our Nation's 
highways and intermodal connectors are the critical link in the 
national intermodal transportation system. The challenge is to maintain 
our high-quality network while achieving our goals to increase safety, 
ensure national security, improve mobility and enhance productivity, 
and promote environmentally responsible and efficient project delivery. 
The 524.1 billion funding level proposed by the President for FHWA in 
fiscal year 2003 provides funding that is essential to meet this 
challenge. This funding includes a Federal-aid Highway obligation 
limitation of 523.2 billion. The fiscal year 2003 request reflects the 
funding levels enacted in TEA-21, as adjusted to reflect the latest 
Highway Trust Fund (HTF) revenue figures, and honors the highway 
category guarantees in that Act.
    The key to ensuring that highway-related receipts are spent is that 
the highway funding level is adjusted each year to reflect the latest 
information on HTF receipts. At the time of the enactment of TEA-21, 
highway program funding levels were set based on estimates of HTF 
receipts. Each year, the level is adjusted using a formula specified in 
TEA-21. This adjustment ensures that highway spending remains aligned 
with HTF receipts.
    In fiscal years 2000, 2001, and 2002, our Nation reaped the 
benefits of record]evel funding for surface transportation as 
authorized in TEA-21. The guaranteed funding level, tied to HTF 
receipts, has provided the States with much needed resources to support 
the Nation's highway infrastructure, as Congress intended. In fiscal 
year 2003, however, declining HTF receipts will, for the first time, 
trigger a downward adjustment, in the amount of 54.369 billion, in the 
highway program level, in order to keep highway spending aligned with 
the status of the HTF. Even with this negative calculation, over the 
life of TEA-21, these adjustments will provide a net gain of almost 
$4.7 billion in highway spending.
    The calculation of the adjustment is not a policy call--it is a 
calculation based in law and reflected in the budget, As we discuss the 
reauthorization of the surface transportation program, we need to look 
for ways to smooth out current positive and negative swings that result 
from this adjustment. However, we should not abandon the adjustment 
concept. Linking highway spending to receipts is a fundamental 
principle of TEA-21.
    Our fiscal year 2003 budget proposes to fund most Federal-aid 
highway programs from within the obligation limitation, including our 
major programs: the Surface Transportation Program, the National 
Highway System, Interstate Maintenance, the Highway Bridge Replacement 
and Rehabilitation Program, and the Congestion Mitigation and Air 
Quality Improvement Program. Other TEA-21 programs include the National 
Corridor Planning and Border Infrastructure Improvement programs and 
the Transportation and Community and System Preservation Pilot Program. 
The Emergency Relief program and a portion of the Minimum Guarantee 
program will continue to be exempt from the limitation. The estimated 
obligation level for exempt programs in fiscal year 2003 is $893 
million.
    In the face of declining revenues into the HTF, we continue to 
strongly support creative financing solutions. Consequently, the 2003 
budget includes $99 million to leverage our Federal investment in 
transportation infrastructure under the Transportation Infrastructure 
Finance and Innovation Act Program (TIFIA). This investment will 
translate into over $6 billion in nationally significant surface 
transportation projects.
    As the events of September 11 so graphically demonstrated, a safe 
and secure surface transportation system is vital to all Americans. We 
must keep our infrastructure secure and we must strengthen our 
commitment to reducing highway injuries and fatalities, even as we 
squeeze additional capacity from the system. To meet this challenge, 
the fiscal year 2003 Budget for FHWA emphasizes four priority areas: 
safety, mobility, environmental stewardship and streamlining, and 
oversight.
Safety
    Safety continues to be the Department of Transportation's most 
important priority. While the number of highway fatalities in recent 
years has been held relatively flat, despite significantly rising 
numbers of vehicles on our roads, more than a quarter of a million 
people have been killed on America's roadways in the past six years, 
and 41,821 were killed in 2000. There are also more than 3 million 
police-reported injuries annually. Highway safety improvements are 
critical to improving these numbers. Success will depend on a balanced 
approach that addresses driver behavior, vehicle design, and roadway 
infrastructure and operations challenges. We can, we must, and we will 
strive to do better.
    FHWA works closely with the other Departmental modes, the States, 
and other partners to improve our ability to analyze roadway safety 
challenges and to direct investments to specific projects and programs, 
which will deliver the most value in terms of lives saved and injuries 
minimized. For example, construction programs continue to contribute to 
safety by correcting unsafe roadway design and removing roadway 
hazards. States may--and do--use their Surface Transportation (STP), 
Interstate Maintenance, and National Highway System (NHS) funds for 
safety improvements. Safety can be built into every interchange 
upgrade, intersection redesign, and new facility through safety 
conscious planning and design. Signing and pavement improvements can 
enhance the safety of existing and new facilities for all users of the 
highway system.
    Within the STP, 10 percent of funds are reserved under TEA-21 for 
highway-rail crossing improvements and hazard elimination. The Hazard 
Elimination program supports efforts to resolve safety problems at 
hazardous highway locations. Since the enactment of TEA-21, States have 
obligated $489.3 million in Hazard Elimination funds, and another 
$707.4 million in optional safety funds have been obligated primarily 
for Hazard Elimination purposes. These Hazard Elimination expenditures 
are estimated to have saved 7,200 lives since 1998. The Highway-Rail 
Grade Crossing Safety program is designed to reduce crashes at public 
grade crossings, and $499 million in Highway-Rail Grade Crossing funds 
have been obligated. The grade crossing safety program is estimated to 
have saved 2,000 lives since 1998.
    To meet its highway safety goal, FHWA will focus its safety 
programs on reducing the most frequent types of fatal crashes through 
technical assistance, research, training, data analysis, and public 
information.
    From the $359.8 million requested for research and technology 
programs for fiscal year 2003, significant resources will be invested 
in improving safety. Part of the research funding will support 
innovations to improve safety at or near intersections, where 50 
percent of all crashes occur, such as brighter traffic signal lights 
that are more visible to drivers. Research funding also supports speed 
management techniques, which arc designed to reduce the 30 percent of 
fatal crashes in which speed is a factor. Rumble strips help prevent 
run-off-the-road crashes, which account for 38 percent of all fatal 
crashes. FHWA provides technical assistance to States like Maryland, 
whose 1999 data show a $182 safety benefit for every dollar spent on 
rumble strip installation.
    National deployment of wireless enhanced 9-1-1 (E-9-1-1) will be 
accelerated this year. E-9-1-1 is an emergency cellular telephone 
service that automatically routes calls to the closest public safety 
answering point and informs the dispatcher of the caller's location. It 
will save lives. About 25 percent of 9-1-1 calls come from wireless 
phones. Without automatic location, when callers are unable to describe 
their location, response times dramatically increase. Response time is 
a critical factor in determining the survivability of a crash. Also, 
more timely and accurate information will aid police, fire, and other 
emergency responders in protecting victims and property and in reducing 
traffic congestion surrounding the scene.
    Recent events have focused attention on the need to ensure the 
security of our Nation's transportation system and ITS technologies 
offer many opportunities to significantly improve transportation 
security. The ITS program is developing and deploying technologies to 
help States and localities improve traffic flow and safety on streets 
and highways and address the need for emergency notification and 
response. This budget proposes to focus the fiscal year 2003 ITS 
Deployment Program resources of $93 million on ITS technologies that 
enhance the security of our surface transportation systems.
    A major emphasis in ITS will continue to be in the area of 
intermodal freight. The Department is conducting several ITS 
operational tests that are designed to improve the efficiency and 
security of the intermodal movement of freight. The Chicago O'Hare 
cargo project, which is an operational test, uses a ``smart card'' and 
biometric identifiers to identify the shipment, vehicle, and driver 
during transportation from the shipper to and through the air cargo 
terminal. Another project, Cargo-Mate, has particular applicability to 
port and container security, in addition to enhancing efficiency of 
freight movement. The system is designed to perform real-time 
processing of asset and cargo transactions, provide for the 
surveillance of cargo movement to and from ports, and provide an 
integrated incident and emergency response capability.
    To improve safety of motor carriers operating on our highways, as 
well as national security, a total of $47 million is requested for 
construction of motor carrier safety inspection facilities on the 
Southern Border within the Coordinated Border Infrastructure Program. 
This builds on funding provided in fiscal year 2002 and supports 
infrastructure improvements necessary to accommodate permanent 
facilities.
Mobility
    Congestion is one of the most obvious results of the mismatch 
between the growing demands for transportation and the capacity of our 
systems, particularly in metropolitan areas. Congestion is a complex 
problem involving many factors. This budget works to address the causes 
of frustrating delays that face travelers and shippers and impact the 
Nation's economic efficiency. Funding will support the identification 
and implementation of a mix of locally preferred investments, including 
selective additions of new capacity, to improve traffic flow and system 
reliability. Our progress toward our goal of supporting mobility is 
tracked by measures such as improvement in pavement and bridge 
condition and by reduction in the growth of traffic congestion.
    States may direct 2003 Federal-aid highway funds, according to 
their priority needs and goals, to a variety of system improvement and 
congestion relief purposes. In recent years, approximately 50 percent 
of Federal funds were obligated for system upgrading purposes, 
including reconstruction, widening, restoration and rehabilitation, and 
resurfacing. Consequently, overall highway system conditions, as 
measured by pavement condition, ride quality, alignment adequacy, and 
bridge ratings, have steadily improved. In 2000, 90.9 percent of travel 
on the NHS occurred on pavements rated acceptable or better. In fiscal 
year 2003, the Department's goal is to increase this to 92.5 percent.
    For fiscal year 2002 and beyond, the FHWA has modified its bridge 
performance measures in order to take into account the actual area and 
average daily traffic on the bridge. This measure more accurately 
reflects progress toward meeting our mobility goal. The previous 
measure of reducing the number of deficient bridges considered all 
bridges as equal, therefore large bridges with higher average daily 
traffic were considered the same as smaller bridges with lower average 
daily traffic. Since the enactment of TEA-21, the condition of NHS and 
non-NHS bridges has improved significantly. In 1998, the percentage of 
the Nation s total bridge deck area that was on deficient NHS bridges 
was 32.6 percent and 32.5 percent on non-NHS bridges. In 2001, the 
percentage of deck area on deficient NHS bridges was 30.6 percent and 
32.3 percent on non-NHS bridges. Our goal for fiscal year 2003 is to 
improve the condition of bridges so that the percentage of deck area on 
deficient bridges is reduced to 27.5 percent for the NHS and 29.8 
percent for the non-NHS.
    The development and deployment of longer lasting materials will 
mean that facilities will need repair or improvement less often, 
thereby reducing congestion and safety problems associated with work 
zones. Research and Technology program funds support multi-year 
initiatives in pavements, structures, and asset management.
    Along with improved condition and strategic expansion of 
infrastructure, we must address congestion through improved operation 
of the highway system. Over the last year we developed and tested a 
system reliability index in 10 cities that we call the ``buffer 
index,'' the amount of time you have to add to your trip because of 
system unreliability. It will help cities gauge how well they are doing 
in responding to incidents, managing their work zones, and responding 
to weather. The measure will be applied in 22 cities this year.
    In the area of congestion mitigation, we have a number of other 
initiatives underway that will continue in 2003, including three that 
have great potential for long term impact:
    We will be piloting a national campaign to rethink the way we look 
at work zones. The focus will be on managing the work zone from the 
perspective of the highway user, emphasizing the concept of getting in, 
getting out, and staying out.
    We are sponsoring a national conference on incident and emergency 
management that brings together transportation and public safety 
communities to focus on ways to improve traffic incident response time 
and traffic incident management methods.
    We are working with our State partners to help each make use of the 
roadway operations self assessment diagnostic tool at least once during 
the year. The purpose of this tool is to help the operating agencies to 
identify ways that they can improve the operation and management of 
their roadway networks.
    Other strategies to improve operations include the deployment of 
ITS to provide more information to drivers faster, enabling them to 
take the most efficient travel route. Significant progress has been 
made in ITS deployment since the enactment of TEA-21. We have seen a 37 
percent increase in the number of freeway miles with real-time traffic 
data collection technologies, a 55 percent increase in the coverage of 
freeways by closed circuit television, a 35 percent increase in the 
number of buses equipped with automatic vehicle location systems, and 
an 83 percent increase in traveler information dissemination on our 
freeways. However, only 22 percent of the freeways in major 
metropolitan areas are instrumented for real time monitoring. 
Therefore, ITS deployment must continue to be a high priority for the 
Department. The search for new technological and innovative solutions 
to our mobility challenges will be supported by the 2003 budget request 
for $359.8 million for research and technology.
    We are committed, along with our partners at the State and local 
levels, to maintain, operate, and improve transportation systems to 
reduce congestion and improve mobility, thus allowing our Nation to 
compete globally and Americans to enjoy a higher standard of living.
Environmental Stewardship and Streamlining
    Implementation of environmentally responsible transportation 
improvements, delivered on time and within budget, is an important 
component of the Department's vision for all its programs. TEA-21 gave 
States and communities additional tools and opportunities to enhance 
the environment and quality of life for their residents, while 
directing us to streamline the environmental review process. Within the 
Federal-aid highway program, NHS and STP funds support programs that 
also protect the environment. There is also a mandatory 10 percent set-
aside from each State's STP apportionment for Transportation 
Enhancement projects that support historic preservation, bicycle/
pedestrian travel, scenic easements, and other enhancements. The CMAQ 
program supports projects to reduce emissions that often reduce traffic 
congestion. To minimize the impact of transportation on air quality, 
FHWA will continue to work with the Environmental Protection Agency and 
other partners to continue to reduce on-road mobile source emissions.
    Continued progress in streamlining the delivery of transportation 
improvements will also improve safety and ease congestion, but must be 
balanced against the need to protect communities and the environment. 
Successful environmental streamlining requires fostering good working 
relationships across a number of organizational lines. These 
relationships allow for the development and establishment of reasonable 
and realistic schedules for advancing major projects. It is important 
for the Department to facilitate agreement by Federal agencies on time 
frames for conducting reviews and granting approvals. Working together 
in partnerships, combining a full range of Federal, State, and local 
officials and interest groups, will lead to reasonable ways to meet the 
Nation's transportation needs, while being good stewards of the 
environment.
    The Department's streamlining approach has resulted in:

    Reinvention of the environmental review process, through 
interagency training, development of national programmatic agreements, 
and guidance that encourages flexible mitigation practices.
    Development of a system for dispute resolution that includes draft 
national procedures, guidance for managing conflict during the project 
development process, and assistance by qualified dispute resolution 
specialists to States and project sponsors.
    Research conducted to evaluate project time frames, identify 
reasons for project delays, and assess the effectiveness of 
implementation efforts.
    Assistance, support, and encouragement to develop numerous best 
practices and pilot projects to catalyze change and lead to even better 
streamlining outcomes.
    Since the enactment of TEA-21 in 1998, progress has been made in 
streamlining the planning and approval process for projects throughout 
the country: 34 States have interagency agreements for funding 
additional persoimel necessary for faster, concurrent reviews; 29 
States have adopted a merged process for wetland permits with the Army 
Corps of Engineers; 26 States have adopted context sensitive design 
approaches; and 41 States have some level of delegated authority for 
historic resources. As a result of these actions, between 1999 and 
2001, the mean time to process environmental documents for major 
highway projects has been cut by almost eight months, and the median 
time has been cut by one year. The Department is well positioned for 
significant future progress.
    We have begun the job, but more can be done. FHWA continues to work 
with other agencies to advance the Environmental Streamlining National 
Memorandum of Understanding (MOU). Efforts to cooperatively establish 
realistic project development time frames among the full range of 
transportation and environmental agencies will be advanced by this 
budget. For example, in 2003 we propose to fund $6 million from the 
FHWA administrative takedown for FHWA support of Federal and State 
initiatives to identify new, more efficient business processes that 
will result in more timely project delivery. Working cooperatively to 
adhere to those time frames is resource intensive, but it is critical 
to our success. With the additional proposed funding, we will be able 
to intensify efforts currently underway within DOT that focus on 
solidifying the interagency partnerships, such as pilot efforts and 
process reinvention.
Oversight
    We must continue to improve Federal oversight and accountability 
for the expenditure of public funds. Increased emphasis on FHWA's 
oversight responsibilities must accompany the significant increases 
that have occurred in the Federal-aid Highway program in recent years 
if our Nation is to make the ``best buys'' in safety and congestion 
relief. FHWA oversight policies were updated and clarified in fiscal 
year 2001 and their implementation will continue into the requested 
budget year. Even as legislation has directed FHWA to delegate many 
project-level authorities to the States, the responsibility for program 
oversight to ensure the effective delivery of all programs remains with 
FHWA. Additional resources deployed in this area will enable FHWA to 
work with the States to improve its management of the Federal-aid 
highway program, including cost containment, while allowing States 
maximum delegated authority and flexibility, as appropriate. FHWA will 
continue to advance asset management and system preservation 
initiatives to foster more systematic and strategic thinking and 
investment choices by the State and local governments. Timely 
investments in the size and makeup of the Federal workforce itself are 
also crucial with the aging of both the Interstate Highway System and 
the workforces of our partner agencies in States and localities. We are 
focusing new attention on workforce development issues and will keep 
the subcommittee advised of our efforts. As larger and more complex 
projects are contemplated, a balance must be achieved between 
addressing the needs of major projects and the vast majority of the 
program vested in smaller projects.
    In 1998-1999, FHWA undertook a major restructuring in order to move 
program decision authorities closer to our primary customers, the 
States, and to focus high-level technical expertise in our Resource 
Centers. Through this redeployment of existing resources we have also 
been able to fulfill FHWA's commitment to add an additional position in 
respective Division Offices for the oversight of each major project.
    The fiscal year 2003 budget requests a funding level of $318 
million for the necessary salaries and benefits for our employees and 
for ongoing administrative expenses in support of our Federal-aid 
program. The budget request reflects modest adjustments for mandatory 
salary and benefit increases and other adjustments for current service 
levels.
Status of the Highway Trust Fund
    The cash balance in the HTF at the end of fiscal year 2001 was 
527.740 billion, of which $20.372 billion was located in the Highway 
Account and $7.369 billion in the Mass Transit Account. Based on the 
latest projections of income to the HTF reported by the Department of 
the Treasury, the Department of Transportation estimates that the 
Highway Account of the HTF has sufficient revenues to support the 
levels of funding proposed in the President's budget.
    Balances in the Highway Account of the HTF should riot be 
considered as surplus funds. Current commitments of HTF revenues for 
prior year obligations, as well as unobligated balances of prior year 
apportionments, exceed $67 billion. However, as reimbursing cash is 
made available from the HTF, revenues from excise taxes are coming into 
the HTF. Any consideration of HTF balances must take into account not 
only current levels of revenue, but also commitments made against that 
revenue, and projected levels of future income.
Conclusion
    The funding requested in 2003 will help improve transportation 
safety; enhance national security; maintain and expand our 
transportation infrastructure, as well as increase its capacity; reduce 
environmental degradation; and improve the quality of life for all our 
citizens. On behalf of FHWA, we look forward to working with Congress 
to enact the President's fiscal year 2003 budget in order to provide a 
viable transportation system to support a strong America.
    Once again, thank you for this opportunity to testify today. We 
will be pleased to address any questions that you may have.

    Chairman Conrad. Very well. We are glad you are here. We 
appreciate your testimony.
    We will now go to Assistant Secretary Parker for his 
testimony and then open it up for questions.
    Senator Domenici. Mr. Chairman?
    Chairman Conrad. Yes, Senator Domenici?
    Senator Domenici. Could I have just 30 seconds?
    Chairman Conrad. Absolutely.
    Senator Domenici. I failed to mention in my opening remarks 
the Corps of Engineers' activities in our State when we had the 
big fire at Los Alamos. I would tell you that anybody that 
still harbors the ideas of 15 years ago that the Corps doesn't 
do their job well, they should have been there and watched 
that. That was a tremendously difficult public works project 
and program, and I want to, General, thank you for all the 
things that were done. They are all working. The remnants of 
that fire are not--there is nothing that has to do with the 
water flow and the like. It has all been properly handled, and 
the Mexicans appreciate it.
    Thank you, Mr. Chairman.
    Chairman Conrad. Well, thank you for that. I would echo 
that. You know, in 1997, we had the worst floods in 500 years 
in North Dakota. I might tell you the Corps of Engineers did an 
absolutely superb job, and they won that flood fight up and 
down the valley. We lost it in one place with the circumstance 
which nobody could have foreseen what we were up against. In 
fact, Colonel Kasprisin, who led that fight, was in my office 
yesterday. He is now a top executive with FEMA and one of the 
most outstanding people I know, just the kind of person you 
would want handling any disaster. He helped lead the effort at 
the Olympic Games to provide security out there. He was the 
FEMA lead person on that. I just have a very high regard for 
him.
    With that, Mr. Parker, please proceed.

 STATEMENT OF MICHAEL PARKER, ASSISTANT SECRETARY OF THE ARMY, 
  CIVIL WORKS, DEPARTMENT OF ARMY, ACCOMPANIED BY LIEUTENATE 
 GENERAL ROBERT B. FLOWERS, CHIEF OF ENGINEERS, UNITED STATES 
                    ARMY CORPS OF ENGINEERS

    Mr. Parker. Thank you, Mr. Chairman and members of the 
committee. I first want to thank you for the opportunity to 
testify today on the President's fiscal year 2003 budget for 
the Army Corps. I am accompanied, as you said, by Lieutenant 
General Robert Flowers, who happens to be the 50th Chief of 
Engineers of the Corps.
    I want to summarize my statement due to time constraints, 
but with your permission, I would ask that my complete 
statement be entered into the record.
    The President's overall priorities are national defense, 
protecting the American people from terrorism, and reviving the 
economy. Funds for the civil works portion of the budget in the 
Corps are very tight. The President's budget for civil works 
seeks appropriations of $4.3 billion. After adjusting for 
changes in financing methods, such as retiree costs, this 
represents an increase of about 7 percent from last year's 
President's budget and a decrease of about 7 percent from last 
year's appropriations.
    The Bonneville Power Administration, non-Federal cost-
sharing partners, and other sources would provide another $0.5 
billion, bringing the total civil works program to $4.8 
billion. The budget provides construction funding for the 
principal civil works missions of commercial navigation, flood 
damage reduction, and environmental restoration. The budget 
allocates this funding for ongoing construction projects that 
are known to be consistent with policy, especially 30 projects 
that are nearing completion, three priority projects, and two 
projects to meet environmental requirements in the Missouri and 
Columbia basins.
    Also, there is one new start that is required to comply 
with the Endangered Species Act. There would be no construction 
funding for non-traditional missions, such as environmental 
infrastructure. Construction funds are thinly stretch, and 
there are many construction projects awaiting funds. To reduce 
the number of projects in the construction pipeline, the budget 
cuts back the study and design program from recent funding 
levels.
    In the fiscal year 2003 budget, hurricane protection 
projects are treated comparably with other flood damage 
reduction projects. For the Mississippi River and tributaries 
project, the budget emphasizes the flood damage reduction 
projects on the main stem of the Mississippi River and the 
Atchafalaya River Basin.
    The budget proposes that the Federal Power Marketing 
Administrations directly fund hydropower operation and 
maintenance costs at Corps projects. This more reliable funding 
would lead to more reliable performance at Corps hydropower 
facilities.
    The Corps received $139 million in fiscal year 2001's 
supplemental appropriations for anti-terror facility 
protection. We will use those funds for recurring costs, 
facility assessments and improvements. The fiscal year 2003 
budget provides another $65 million for recurring 
infrastructure protection costs. The budget limits funding for 
shallow draft harbors and for inland waterways that have low 
commercial tonnage. The intent is to direct funding from purely 
recreational harbors and from waterway segments that have high 
costs per commercial ton mile.
    The budget would step up funding for the regulatory program 
to improve permit turnaround times and improve environmental 
protection. The Chief of Engineers and I are working to 
strengthen civil works projects, project planning and review. 
The chief is focusing on improving planning capabilities and 
management processes. I am staffing a project planning and 
review group that will function as part of the Corps' overall 
vertical planning team. These changes are intended to ensure 
that technical and policy questions are addressed early in the 
planning process rather than at the end.
    Mr. Chairman, we are all proud of the way the Army Corps of 
Engineers stepped forward on and after September the 11th, 
demonstrating its emergency response and recovery capabilities 
and the importance of maintaining the civil works capability 
within the Army. The Army Civil Works Program is a wise 
investment in the Nation's economy and way of life, and it is a 
great pleasure for me to be able to advocate its funding.
    Let me just address some of the things that have been 
stated this morning.
    When I was on the Energy and Water Subcommittee of 
Appropriations in the House, I always looked at OMB and never 
had those warm, fuzzy feelings toward them. I have found that 
after being in the Administration and dealing with them, I 
still don't have those warm, fuzzy feelings. [Laughter.]
    Mr. Parker. The fact of the matter is that OMB, in giving 
them credit, they do have a problem. They have a situation that 
they were forced into. Instead of being able to have surpluses 
and dealing in an environment where we were determining 
priorities on spending with surpluses, because of the 9/11 
attack we are now caught in a situation where we have these 
deficits, we have national security as our main goal, and 
homeland security. I think it would be safe to say that I know 
the President understands this, and I am hoping that everybody 
at OMB understands, that this process, we are at the beginning 
of it, knowing full well that Congress plays a vital role in 
making the decisions that have to be made to continue the vital 
work of the Corps.
    If the Corps is limited in what it does for the American 
people, we will see a negative impact on the people of this 
country. Anyone knows that over the next 20 years, we have to 
double trade in order to maintain our standard of living. That 
trade goes over our waterways. And if we don't have the 
infrastructure in place to make that happen, we will not be 
able to maintain that.
    There have been situations in the past where I have felt 
sometimes, when I was a member, that OMB sometimes gave low 
numbers, knowing full well that Congress would plus those 
numbers up. I wouldn't be so brash as to say this was the case 
here, that we have to ask OMB as far as what their opinions 
are.
    The fact of the matter is, as Assistant Secretary of the 
Army for Civil Works, I look forward to working with this 
Committee, being able to put together a package. In the final 
analysis that package will go to the President for signature, 
where we can fulfill our responsibility to the American people 
within the work of the Corps itself.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Mr. Parker follows:]

    The Prepared Statement of the Honorable Mike Parker, Assistant 
                  Secretary of the Army (Civil Works)

    Mr. Chairman and distinguished members of the Committee:

                              Introduction

    Thank you for the opportunity to testify before this Senate Budget 
Committee and to present the President's budget for the Civil Works 
program of the Army Corps of Engineers for Fiscal Year (FY) 2003.
    Accompanying me this morning is Lieutenant General Robert B. 
Flowers, Chief of Engineers.

             Army Civil Works Program for Fiscal Year 2003

    The President's fiscal year 2003 budget confronts a two-front war 
against terrorism while taking steps to restore economic growth. In 
order to finance the war against terrorism it moderates spending in the 
rest of government. This year's budget also takes the significant step 
of assessing performance in government, and begins to tie what works 
and doesn't work to spending decisions. This will help ensure that 
government programs that fail to achieve their purpose can be held 
accountable and, perhaps, be reformed or ended as a consequence.
    The fiscal year 2003 budget for Army Civil Works provides funding 
to continue the development and restoration of the Nation's water and 
related resources, the operation and maintenance of existing 
navigation, flood damage reduction, and multiple-purpose projects, the 
protection of the Nation's regulated waters and wetlands, and the 
cleanup of sites contaminated as a result of the Nation's early efforts 
to develop atomic weapons. The budget includes new appropriations of 
$4.29 billion. The new appropriations are expected to result in fiscal 
year 2003 outlays of approximately $4.47 billion.
    Three legislative initiatives support the fiscal year 2003 Army 
Civil Works budget. First, the Administration is proposing government-
wide legislation under which the full costs for Federal retirees will 
be allocated to agency programs instead of the Office of Personnel 
Management. Under this proposal, $115 million of the $4.29 billion 
represents retiree costs not previously borne by the Army Civil Works 
program.
    Second, the Administration is proposing legislation under which 
three Federal power marketing administrations will finance hydropower 
operation and maintenance costs directly, in a manner similar to the 
mechanism currently used by the Bonneville Power Administration in the 
Pacific Northwest. This proposal is described below in greater detail.
    Third, the Administration is proposing legislation to increase fees 
at Corps of Engineers lakes and recreation areas and to extend the 
existing recreation fee demonstration program. This proposal also is 
described below in greater detail.
    The new appropriations, including new funding for retiree costs, 
will derive an estimated $3.258 billion from the general fund, $764 
million from the Harbor Maintenance Trust Fund, $85 million from the 
Inland Waterways Trust Fund, $34 million from Special Recreation User 
Fees, and $149 million from three Federal power marketing 
administrations for hydropower operation and maintenance costs.
    Other program funding is estimated at $464 million. This total 
includes $118 million transferred from the Bonneville Power 
Administration for operation and maintenance of hydropower facilities 
in the Pacific Northwest and $272 million contributed by non-Federal 
interests.
    The budget represents an increase from the fiscal year 2002 budget 
of 7 percent and a decrease from fiscal year 2002 appropriations of 7 
percent, including adjustments for the new retiree costs and excluding 
emergency supplemental appropriations and inflation adjustments.

                           Program Highlights

Priority Missions
    The budget gives priority to ongoing studies, projects and programs 
that provide substantial benefits under the principal missions of the 
Civil Works program, which are commercial navigation, flood damage 
reduction (including coastal storm and hurricane damage reduction), and 
environmental restoration. No funds are provided for studies and 
projects that carry out non-traditional missions that in the view of 
the Administration should remain the responsibility of non-Federal 
interests or other Federal agencies, such as wastewater treatment, and 
municipal and industrial water supply treatment and distribution. In 
addition, the budget does not fund individual studies and projects that 
are inconsistent with established policies governing the applicable 
missions.
Emphasis on Ongoing, Budgeted Construction Projects
    The Corps estimates that the balance of funding needed to complete 
all active construction projects and authorized and unauthorized 
projects in pre-construction engineering and design is about $44 
billion. Of this, about $21 billion is necessary to complete the flood 
control, navigation and environmental restoration projects funded in 
the budget in the Corps Construction, General program. This represents 
12 years of funding at the level enacted in fiscal year 2002 just to 
finish funding ongoing Construction, General projects supported in the 
budget.
    More projects have been started than can be prosecuted efficiently, 
given the limitations on available funding. The budget directs funding 
to ongoing projects that have been determined to be consistent with 
policy, in order to quickly realize the benefits that those projects 
are designed to provide.
Shore Protection
    The budget treats projects to protect coastal structures from 
hurricane and storm damage on a par with other types of flood damage 
reduction projects. The Administration continues to be concerned about 
the appropriate level of non-Federal cost sharing for shore protection 
projects, and is considering proposing legislation to adjust Federal 
and non-Federal cost shares.
Direct Financing of Hydropower Operation and Maintenance Costs
    Historically, each year the Army Civil Works program has financed 
the operation and maintenance costs of Corps of Engineers hydroelectric 
facilities, and in the next year Federal power marketing agencies have 
repaid the Treasury for these costs from the revenues provided by 
ratepayers. The exception has been in the Pacific Northwest, where 
under section 2406 of the National Energy Policy Act of 1992, Public 
Law 102-486, the Bonneville Power Administration has directly financed 
the costs of operating and maintaining the Corps hydroelectric 
facilities from which it receives power.
    In 1999, the General Accounting Office found that the Corps 
hydropower facilities are twice as likely to experience ``unplanned 
outages'' as private sector facilities, because the Corps does not 
always have funds for maintenance and repairs when needed. Corps 
facilities experience unplanned outages approximately 3.7 percent of 
the time, compared to the industry average of 2.3 percent.
    To address this problem, the budget proposes that the Southeastern 
Power Administration, the Southwestern Power Administration, and the 
Western Area Power Administration finance hydropower directly, in a 
manner similar to the mechanism used by Bonneville. The budget 
contemplates that these power marketing administrations will make those 
hydropower operation and maintenance investments that they believe are 
justified in order to provide economical, reliable hydropower to their 
customers and that, as a consequence, unplanned outages will decline 
over time to levels comparable to the industry average.
Protection of Critical Facilities
    The Administration sought $139 million in emergency supplemental 
appropriations to the Operation and Maintenance, General account for 
the protection of critical Civil Works facilities from terrorist 
attack. Congress provided these funds in Division B of the fiscal year 
2002 Department of Defense appropriations act. The funds will be used 
to pay recurring facility protection costs and one-time costs to assess 
the vulnerability of each facility and to initiate ``hard'' protection 
of critical facilities. The Corps expects to complete its facility 
assessments by the end of April 2002.
    The Administration is continuing its commitment to facility 
protection in fiscal year 2003. The budget includes $65 million for 
recurring security costs ($64 million in Operation and Maintenance, 
General and $1 million in Flood Control, Mississippi River and 
Tributaries), not including new retiree costs). The Administration will 
evaluate the need for additional security measures based on the 
conclusions of the facility assessments.
Fee Increases at Recreation Areas and Lakes
    The Army is undertaking efforts to increase day use fees, camping 
fees, annual pass fees, and special use permit fees under existing 
authority. These efforts are expected to help increase annual 
recreation user fee receipts to $38 million in fiscal year 2002 from 
less than $34 million in fiscal year 2001. In addition, under proposed 
legislation, recreation user fees and shoreline permit fees increases 
would be phased in through fiscal year 2006. The legislation also will 
extend the existing demonstration program under which recreation user 
fee receipts over $34 million per year are automatically available to 
the Corps to spend on operation, maintenance, and improvement of its 
recreation facilities. We project that annual recreation and shoreline 
permit fee receipts will grow by $6 million in fiscal year 2003 to $44 
million, and an additional $5 million per year in fiscal year 2004 
through fiscal year 2006, to a total of $59 million in 2006.

                  Discussion of Appropriation Accounts

General Investigations
    The budget for the Civil Works study program is $108 million, 
including $5 million for new retiree costs. This is a significant 
reduction from funding levels in the budgets and appropriations for 
previous years. The reduced funding level for General Investigations is 
intended to slow the rate at which studies and pre-construction 
engineering and design efforts are carried out and completed and the 
rate at which projects with completed studies are added to the existing 
construction backlog. Cost-sharing sponsors, who are being asked to 
invest in studies and design, expect timely construction once studies 
and design are completed and the projects are authorized. This reduced 
funding level reflects the Administration's priority of completing 
policy-consistent projects that are under construction before 
initiating new work.
    No new study starts are included in the budget. However, to the 
extent allowed within available funding, policy-consistent studies that 
are under way will continue to move seamlessly from the reconnaissance 
phase to the feasibility phase and from the feasibility phase to pre-
construction engineering and design as they receive the necessary 
levels of review and approval within the Corps and the Army. 
Coordination, technical assistance, and research activities also will 
be continued, including continued Army participation in the National 
Estuaries Council.
Construction, General
    The fiscal year 2003 budget for the Civil Works Construction, 
General program is $1.44 billion, including $22 million for new retiree 
costs. Of that total, $85 million will be derived from the Inland 
Waterways Trust Fund to fund the construction and major rehabilitation 
of inland waterway projects and $15 million will be derived from the 
Harbor Maintenance Trust Fund to fund the Federal share of construction 
costs for dredged material disposal facilities at operating harbor 
projects.
    Funding is included in this account for continuing projects for 
which the Administration has completed its review and made a 
determination that the project supports priority missions and is 
consistent with established policies. No funds are included to initiate 
construction of discretionary new projects. Furthermore, no funds are 
included to continue planning, engineering, design, or construction of 
projects added by Congress in fiscal year 2002 for which the 
Administration has not completed its review and established a favorable 
position.
    The budget for the Construction, General account gives priority to 
projects that can be completed in fiscal year 2003. Thirty projects, or 
15 percent of the 194 budgeted projects, will be completed. The budget 
also includes substantial CG funding, net of new retiree costs, for 
three priority projects: $120 million for the New York and New Jersey 
Harbor deepening project; $77 million for the Olmsted Locks and Dam 
project in Illinois and Kentucky; and $148.5 million for restoration of 
the Florida Everglades, including $37 million for the Comprehensive 
Everglades Restoration Plan.
    The budget also ensures that environmental requirements for the 
Columbia River Basin and for the acquisition and development of shallow 
water habitat on the Missouri River will be met. For the Missouri 
River, $17.5 million is allocated to the Missouri River Fish and 
Wildlife Mitigation Project to expedite restoration of aquatic habitat. 
For the Columbia River Basin, the budget includes $98 million for the 
Columbia River Fish Mitigation project and $2 million for a new 
construction start, the estuary habitat restoration program for the 
lower Columbia River, which must be started to meet legal requirements. 
(These figures do not include new retiree costs.) Both the ongoing 
project and the new project on the Columbia River are required in 
fiscal year 2003 to comply with Biological Opinions issued under the 
Endangered Species Act by the National Marine Fisheries Service and the 
United States Fish and Wildlife Service for the recovery of threatened 
and endangered fish species.
    The budget provides, net of new retiree costs, $78 million for 
continuing planning, design, and construction of projects under the 
Continuing Authorities Program. These are small projects for flood 
damage reduction, navigation, shoreline protection, streambank 
protection, navigation project impact mitigation, clearing and 
snagging, aquatic ecosystem restoration, beneficial uses of dredged 
material, and project modifications for improvement of the environment. 
The budget includes no funding to initiate new construction under the 
Continuing Authorities Program.
    The Administration is proposing legislation to require agencies to 
pay the full cost of the Federal Employees Compensation Act (FECA). The 
Department of Labor will add a small surcharge to the amount charged to 
each agency for FECA benefits to ensure full coverage. The CG account 
includes an additional $1 million in the Workmen's Compensation line 
item to cover the surcharge.
Flood Control, Mississippi River and Tributaries
    The budget includes $288 million for the Mississippi River and 
Tributaries program, including $7 million for new retiree costs. The 
budget directs funding to the priority flood damage reduction projects 
on the mainstem of the Mississippi River and in the Atchafalaya River 
Basin, Louisiana, including the completion of the Louisiana State 
Penitentiary Levee, Louisiana, project. No funding is provided for 
studies or projects that represent non-traditional missions or are 
inconsistent with established policies. No funding is provided for new 
studies or projects. $1 million is included for the recurring costs of 
protecting critical Mississippi River and Tributaries facilities from 
attack.
Operation and Maintenance, General
    The budget provides funding for the Army Corps of Engineers to 
carry out its operation and maintenance responsibilities at Corps-
operated projects for the purposes of commercial navigation, flood 
damage reduction, recreation, natural resources management, and 
multiple purposes including hydroelectric power generation.
    The overall budget for the Operation and Maintenance, General, 
account is $1.979 billion, including $65 million for new retiree costs. 
Of this amount, $749 million will be derived from the Harbor 
Maintenance Trust Fund, $34 million will be derived from Special 
Recreation User Fees, and, under proposed legislation described above, 
$149 million will be derived from the direct funding of hydropower 
operation and maintenance costs by three Federal power marketing 
administrations.
    In addition to these funds, operation and maintenance of hydropower 
facilities in the Pacific Northwest will be directly financed by a 
transfer of approximately $118 million from Bonneville Power 
Administration revenues.
    The budget directs funding for navigation projects to those that 
support commercial or subsistence usage. The budget provides: $536 
million for deep draft harbors (harbors with authorized depths of 
greater than 14 feet); $47 million for shallow draft harbors, with 
priority given to those harbors that serve commercial activities or 
provide a means of subsistence; $384 million for inland waterways with 
commercial traffic of more than one billion ton-miles per year; and $57 
million for waterways with less commercial traffic, with priority given 
to those operation and maintenance activities that provide the highest 
return, generally on the waterways and waterway segments with the 
lowest average cost per ton-mile (these figures do not include new 
retiree costs).
    The budget includes $64 million, not including new retiree costs, 
for the recurring costs of protecting critical Civil Works facilities 
from attack.
Regulatory Program
    The budget for the Regulatory Program is $151 million, including $7 
million for new retiree costs. These funds will be used for permit 
evaluation, enforcement, oversight of mitigation efforts, 
administrative appeals, watershed studies, special area management 
plans, and environmental impact statements, in order to provide 
effective regulation of the Nation's waters and wetlands and expedite 
permit decisions.
    The $151 million represents a much-needed increase for the 
Regulatory Program and supports responsive service to the public. This 
funding will enable a reduction in average permit processing times from 
an estimated 160 days in fiscal year 2002 to an estimated 120 days by 
the end of fiscal year 2004. The budget also provides additional 
resources for monitoring of compliance with issued permits and for 
partnerships with States and local communities through watershed 
planning efforts.
Formerly Utilized Sites Remedial Action Program (FUSRAP)
    The Formerly Utilized Sites Remedial Action Program (FUSRAP) is an 
environmental cleanup program for sites contaminated as a result of the 
Nation's early efforts to develop atomic weapons. Congress transferred 
the program from the Department of Energy in fiscal year 1998. We are 
continuing to implement needed cleanups at contaminated sites. This 
year's budget is for $141 million, including $1 million for new retiree 
costs.
Flood Control and Coastal Emergencies
    This program finances preparedness, response, and recovery 
activities for flood, storm, and hurricane events, and preparedness 
activities in support of the Federal Emergency Management Agency 
through the Federal Response Plan. The budget proposes $22 million for 
this program, including $2 million for new retiree costs. This amount 
will be used, together with any funding that may remain available from 
prior year appropriations, to finance programmed and emergency 
activities during fiscal year 2003.
General Expenses
    Funding budgeted for the General Expenses program is $161 million, 
including $6 million for new retiree costs. These funds will be used 
for executive direction and management activities of the Corps of 
Engineers headquarters, the Corps division offices, and related support 
organizations.

                 Government Performance and Results Act

    A performance plan is in preparation for the Army Civil Works 
program, based on the fiscal year 2003 budget. After completion of 
Administration review, the plan will be submitted to the Congress.

              Army Civil Works Planning and Review Process

    Both the Army Corps of Engineers Headquarters and the Office of the 
Assistant Secretary of the Army for Civil Works are taking steps to 
strengthen the project planning and review process. We have undertaken 
these efforts to ensure that the Corps provides this Nation with 
technically sound, environmentally acceptable, and justified projects.
    Improved Planning Capabilities. The Corps is improving the 
competency of its planning cadre through the development of a long-term 
training and development plan. The Corps is developing a web-based 
information system to enable planners to find the information they need 
to do their jobs more efficiently and effectively.
    Process Improvements. To ensure more accountability, the planning 
organization within each district will manage the planning process from 
problem identification to the development of a proposed project. The 
Corps has clarified technical and policy review responsibilities. The 
Corps Headquarters has consolidated the policy and planning functions 
and initiated a new business process under which one individual at 
Corps Headquarters is responsible for solving study and project issues.
    Environmental Advisory Board. The Chief of Engineers has 
reactivated the Environmental Advisory Board (EAB) and redefined its 
role to include advising him on policy and specific projects. This 
participation by the EAB can contribute to improved project formulation 
and thereby reduce the need for mitigation and the potential for 
conflict or litigation.
    Independent Peer Review. The Chief of Engineers has endorsed, in 
concept, the establishment of an independent panel of experts to review 
Corps projects. The proposal is to establish a panel of six members, to 
include three members from outside the Corps, who would review large, 
complex, or controversial projects. Additionally, in response to 
Section 216 of the Water Resources Development Act of 2000, the Corps 
contracted with the National Academy of Sciences (NAS) to study and 
make recommendations on the independent peer review of Corps projects. 
The Administration will formulate its position on this issue in the 
coming months.
    Plan Formulation and Evaluation. The NAS also will evaluate the 
various techniques, models, and processes used to formulate Corps 
projects and will consider modernizing the Federal Principles and 
Guidelines. Consideration will also be given to how the Corps conducts 
multi-purpose formulation and evaluation and trade-off analysis, and 
how it integrates environmental, economic and social considerations. 
Finally, the NAS will review various approaches to ecosystem 
restoration and application of adaptive management to the planning and 
operation of projects. These reports will be completed in the summer of 
2003.
    Army Civil Works Planning and Project Review. Recently, I formed a 
new, four-person group within my office to perform oversight of the 
Corps planning program and to advise the Corps and me on the 
application of laws, regulations, and Army policies to project 
proposals. In particular, this new group will conduct reviews of Corps 
projects and will help me develop my recommendations to the 
Administration and Congress on the authorization or modification of 
projects. To facilitate coordination with the Corps, this group will be 
co-located with the Corps of Engineers Headquarters. My planning group 
will engage with the Corps on planning issues as they arise, rather 
than after reports are completed. My new Deputy for Project Planning 
and Review and administrative staff already are on board, two positions 
have been advertised, and the last position will be advertised shortly.

                               Conclusion

    I believe that the President's fiscal year 2003 budget for the Army 
Civil Works program is a solid one. The budget continues support to 
ongoing work, emphasizes primary missions, and applies resources to 
areas likely to have the greatest national economic benefit. Providing 
the requested funds for the Army Civil Works program is a wise 
investment in the Nation's future.
    Thank you.

    [The prepared statement of General Flowers follows:]

 The Prepared Statement of Lieutenant General Robert B. Flowers, Chief 
                              of Engineers

    Mr. Chairman, and Members of the Committee:

                              introduction

    I am honored to be testifying to your Committee today, along with 
the Assistant Secretary of the Army (Civil Works), the Honorable Mike 
Parker, on the President's Fiscal Year 2003 (fiscal year 2003) Budget 
for the United States Army Corps of Engineers Civil Works Program.
    I am especially honored to have the opportunity to lead the Corps 
through its current challenges to serve this great Nation in meeting 
its many water and related land resources management needs.
    Thanks to this subcommittee's support, the Civil Works Program 
remains strong, balanced, responsive, and highly productive. I look 
forward to working with you in furtherance of our partnership in 
prosecuting this fine program, so broadly beneficial to our Nation.
    In this statement, I will focus on significant challenges for the 
Nation in light of the September 11th terrorist attacks, and will say 
just a few words about the Corps role in assessment of national water 
and related land resources management needs. Accordingly, my statement 
covers just these three topics:

  Summary of Corps of Engineers actions after the terrorist 
    attacks, especially support to the Federal Emergency Management 
    Agency;
  Highlights of the Civil Works program budget;
  Summary of how the Civil Works Program provides support to 
    the Nation's economic security.

                  summary of corps post-attack actions

    Mr. Chairman, and Members of the Subcommittee, last September 11th 
the Nation and the world watched in horror and disbelief as the World 
Trade Center and the Pentagon were attacked by terrorists and the 
passengers and crews of four air liners lost their lives.
    I am proud to say that the Corps of Engineers provided critical 
support to the Federal Emergency Management Agency in the aftermath of 
those terrorist attacks. Corps members provided technical assistance 
for debris removal, electrical power assessment and structural 
assessments during operations in New York City. Corps memibers also 
provided technical assistance for debris removal at the Pentagon. 
Today, the Corps continues to support FEMA, the Department of Defense, 
and the Nation in the disaster recovery mission in New York City and at 
the Pentagon through its execution of the Public Works and Engineering 
mission. These emergency response and recovery actions take place under 
Emergency Support Function number 3 in the National Emergency Response 
Plan, for which FEMA has assigned the lead to the Corps of Engineers.
    I would like to highlight some of the accomplishments the Corps 
achieved in our support:
    In the aftermath of the collapse of the World Trade Center towers, 
it was virtually impossible to exit Manhattan by car or other ground 
transportation. A virtual armada of boats came together, in an 
impromptu fashion, crossing the water to reach Manhattan to ferry 
trapped people out of the area of devastation.
    Among those boats were seven vessels owned by the United States 
Army Corps of Engineers. These craft carried approximately 2,000 
stranded citizens from south Manhattan to Brooklyn, Jersey City, and 
Staten Island. On the return trip, the crews ferried firefighters and 
relief workers into Manhattan, provided fuel, anti-freeze, and oil for 
the New York City fire trucks, and transported 1,000 gallons of potable 
water to the firefighters. Personnel on board the vessels also included 
structural analysts deployed to New York City to assist in the urban 
search and rescue mission. The collapse of the World Trade Center's 
twin towers caused so much destruction and devastation to the buildings 
surrounding them that those buildings were unsafe to enter to conduct a 
safe search and rescue effort. The Corps deployed surveyors to assist 
the city's engineers in evaluating some of the more complicated 
building situations.
    An assessment team from the 249th Engineer Battalion (Prime Power) 
was deployed to the financial district of New York City shortly after 
the attack. The soldiers provided technical assistance to Con Edison, 
the power company that provides electric service to New York City and 
most of Westchester County, in the installation of 56 city-supplied 
1500-kilowatt generators to support emergency electrical power 
requirements. As a result of their efforts, the New York Stock Exchange 
was up, running, and fully operational on Monday September 1 7th, only 
four business days after the attack.
    On September 13, New York City requested a permit to dredge 120,000 
cubic yards of material from around Pier 25 to allow large boats to 
support rescue and recovery operations. Brigadier General Stephen 
Rhoades, North Atlantic Division commander, gave permission in record 
time to dredge and place material in the Newark Bay Confined Disposal 
Facility. The Corps also dredged Pier 6 in Manhattan, which permitted 
greater access for barge transportation of debris from the pier to the 
facility. Prior to this dredging, it was necessary to truck the debris 
uptown through Manhattan, to a pier that could accommodate the large 
barges, and then transport the debris to the facility.
    At one point, more than 160 Corps of Engineers personnel had 
deployed from across the Nation to New York City to join the 750 North 
Atlantic Division employees who work in the city. Those deployed 
included structural engineers skilled in urban search and rescue, 
debris management specialists, logistics and contracting personnel, and 
the soldiers of the 249th Engineer Battalion (Prime Power).
    Since the attack, the Corps of Engineers has continued to support 
and work closely with the Federal Emergency Management Agency in the 
recovery operations, and we will continue to do so until the operation 
is complete.
    We also are working closely with the Office of Homeland Security in 
protecting the Civil Works infrastructure from terrorist attacks. We 
have developed a Civil Works Infrastructure Assessment Program, which 
to date has consisted of training 250 Corps Engineers and Security 
personnel; conducting infrastructure assessments of critical projects 
in each Division; and offering a specialized security training course 
to Corps personnel through our training facility in Huntsville, 
Alabama. The Civil Works program received $139 million in emergency 
supplemental appropriations to fund recurring protection costs at 
critical facilities and some physical security measures identified in 
the critical facility assessments.
    The immediate response of the United States Army Corps of Engineers 
is yet another reason I am so proud to be the 50th Chief of Engineers. 
Corps employees from every division and district called to volunteer to 
do whatever is needed to support the Emergency response and recovery.
    I would like to conclude my comments on the Corps support after 
these tragic events by quoting the Honorable Thomas White, Secretary of 
the Army, in a speech he gave shortly after visiting ground zero in New 
York City. He said, ``To the Corps of Engineers I would say. * * * 
while your history is impressive, given the current situation, your 
finest hour is a chapter yet to be written. The Nation will look to 
your extraordinary capability to protect and sustain our infrastructure 
against a wide variety of threats.'' Mr. Chairman, and Members of the 
Committee, the United States Army Corps of Engineers is ready, able, 
and proud to serve the Nation in its time of need.

    The Fiscal Year 2003 United States Army Corps of Engineers budget 
provides the following:


              HIGHLIGHTS OF THE CIVIL WORKS PROGRAM BUDGET
------------------------------------------------------------------------
------------------------------------------------------------------------
General Investigations.........................              108,000,000
Construction, General..........................            1,440,000,000
Operation and Maintenance, General.............            1,979,000,000
Regulatory Program.............................              151,000,000
Flood Control, Mississippi River & Tributaries.              288,000,000
General Expenses...............................              161,000,000
Flood Control and Coastal Emergencies..........               22,000,000
FUSRAP.........................................              141,000,000
Total..........................................           $4,290,000,000
------------------------------------------------------------------------


                     construction, general backlog

    The Corps estimates that there is a construction backlog of about 
$44 billion, including about $21 billion to complete ongoing flood 
damage reduction, navigation, and environmental restoration projects 
consistent with Administration policy, about $8 billion to complete 
other ongoing construction projects, about $6 billion to complete 
already started Mississippi River and Tributaries construction 
projects, and about $8 billion for authorized and unauthorized projects 
in Pre-construction Engineering and Design.
    Available funding is directed toward construction of the ongoing 
projects that are consistent with Administration policy. One new 
project construction start is proposed for funding to meet the legal 
requirements of a Biological Opinion under the Endangered Species Act. 
No discretionary new project construction starts are budgeted and no 
new study starts are budgeted.

               operation and maintenance, general backlog

    The fiscal year 2003 budget of $1.979 billion is $40 million more 
than the amount enacted in fiscal year 2002, excluding emergency 
supplemental appropriations and including imputed employee pension and 
annuitant health benefit costs. We can sustain customer services in 
fiscal year 2003 with this level of funding. While we join the other 
Federal agencies in coping with severe demands on the Nation's fiscal 
resources, sustaining all of our current customer services becomes 
increasingly difficult in the long term, given the vast and aging 
infrastructure needing care and attention. As stewards of a diverse and 
widespread complex of water resources projects, the Corps of Engineers 
is challenged to ensure the continued flow of benefits that are so 
critical to our Nation's security and economic well being.
    As I reported to this Committee in the fiscal year 2002 
appropriation hearings, we still face a growing maintenance backlog. 
Routine maintenance, major repairs, replacement of outdated or worn 
facilities, management improvement studies, and correction of 
environmental deficiencies could use much more than the budget amount. 
However, to be realistic in our assessment, we normally focus on 
critical maintenance. Critical maintenance is maintenance that should 
be performed in the budget year in order to continue operation at a 
justified level of service and to attain project performance goals.
    The funds provided for fiscal year 2002 left us with a critical 
maintenance backlog estimated at $702 million, and we estimate that our 
critical maintenance backlog in fiscal year 2003 will be about $884 
million. The critrcal maintenance backlog for navigation is $587 
million and consists largely of dredging and repairs to structures such 
as locks, dams, breakwaters, and jetties. The critical maintenance 
backlogs for other business functions are $127 million for flood damage 
reduction, $110 million for recreation, and $60 million for 
environmental management, and consist of work such as spillway repairs, 
seepage control, embankment toe protection, access road and recreation 
facility repairs, and environmental compliance actions. The critical 
maintenance backlog for hydropower will be eliminated in fiscal year 
2003 in conjunction with the Administration's proposal that Federal 
power marketing administrations directly finance hydropower operation 
and maintenance.
    The critical maintenance backlog includes $93 million for 
maintenance of shallow draft harbor projects and $108 million for 
maintenance of low commercial-tonnage inland waterway projects. Most of 
this work is for purely recreational harbors and higher-cost inland 
waterway segments and therefore is low priority work.
    To improve our program execution, my Division Commanders are 
continuing a concerted effort to identify and concentrate available 
resources on the most critical of this work and to do this work at 
least cost. We are analyzing the work in this backlog to ensure that it 
qualifies as critical maintenance. In addition, we will continue to 
assess the justification for the level of service that we are 
providing. These analyses may result in a slight reduction in our 
estimate of the critical maintenance backlog for fiscal year 2003.

 how the civil works program provides support to the nation's economic 
                                security

    The Civil Works program employs nearly 25,000 full time equivalent 
Federal employees and many thousands more private sector contract 
employees. These individuals are employed in a wide array of fields 
including all aspects of engineering; architecture; project management; 
construction management; planning; program management; operation and 
maintenance; economics; and environmental sciences.
    The Civil Works program provides the infrastructure to support 
important economic activity. The components of the program include 
navigation features, which facilitate domestic and foreign commerce, 
flood control features, which reduce flood hazards and damages, water 
supply to millions of citizens as well as industrial firms, businesses, 
and farms, hydroelectric power generation features at 75 Corps operated 
facilities, and recreational features at Corps-constructed lakes and 
shore protection projects.
    I would like to discuss in greater detail the economic impacts 
associated with two of these areas of activity: navigation features; 
and recreational opportunities at Corps-constructed lakes.

    the significance of navigation to the nation's economic activity

    Commercial navigation is one of the Civil Works program's high 
priority missions and a focal point for a substantial amount of the 
Civil Works budget. In the year 2000, over 2.4 billion tons of foreign 
and domestic cargo were transported via our Nation's ports and 
waterways. This figure is composed of 1.4 billion tons of foreign trade 
cargo and 1 billion tons of domestic cargo.
    Of the 1.4 billion tons of foreign cargo, almost 1 billion tons 
were foreign imports to the United States, including over 500 million 
tons of crude petroleum and 130 million tons of chemicals and related 
products. Over 400 million tons of cargo were United States exports to 
other nations, including over 150 million tons of food and farm 
products, 60 million tons of coal, 58 million tons of chemicals, and 56 
million tons of petroleum products.
    Of the 1 billion tons of domestic cargo, almost 630 million tons, 
or 8 percent of the Nation's freight tonnage, moved on the Nation's 
11,000-mile inland waterway system. Of the nearly 630 million tons, 
coal comprised about one quarter of the total with 160 million tons 
moved, petroleum products totaled 121 million tons, food and farm 
products totaled 90 million tons, and sand, gravel and stone made up 
about 80 million tons.
    Over 225 million tons of domestic cargo moves via coastwise 
shipments, including 115 million tons of petroleum products and 48 
million tons of crude petroleum such as Alaskan crude petroleum moving 
to refineries on the West coast of the United States.
    Over 114 million tons of domestic cargo moved via shipments on the 
Great Lakes, including 57 million tons of iron ore and scrap metal, key 
components in the manufacturing of steel, 30 million tons of sand, 
gravel and stone, and 20 million tons of coal.
    In its 1999 report to Congress, ``An Assessment of The United 
States Maritime Transportation System'', the United States Department 
of Transportation reported that waterborne cargo movements created 
employment opportunities for more than 13 million individuals. While 
many jobs created are directly in water transportation and ports, most 
of the 13 million jobs created as a result of waterborne transportation 
are in other sectors of the economy.
    Although there are a number of actors, public and private, that 
contribute to waterborne transportation, the Corps of Engineers plays a 
key role. We create and maintain economically justified navigable 
capacity. We enable the ports and waterways to handle the vessels. 
Without this capacity, the Nation cannot compete for trade, cannot move 
goods efficiently, and cannot sustain those 13 million jobs.

         recreational opportunities at corps constructed lakes

    I will now turn my remarks to the subject of the economic impacts 
associated with the provision of recreational opportunities at Corps 
constructed lakes. The Operation and Maintenance, General budget 
includes $277 million for recreational activities, slightly above the 
fiscal year 2002 enacted level.
    I quote from our recently completed report, ``A National Dialogue 
About America's Water Resources Challenges For the 21st Century: 
National Report on Identified Water Resources Challenges and Water 
Challenge Areas.''
    ``When it is time for outdoor recreation Americans head for the 
water. The Nation's many lakes, rivers, and beaches offer everyone fun, 
fitness, rest and relaxation. Water is the number one recreation 
attraction in America today, making Federal lakes an irreplaceable 
public resource.''
    America's first choice for water-based recreation is the Corps of 
Engineers. One out of every ten Americans will visit a Corps lake this 
year.
    I would now like to provide you with some figures describing the 
Corps recreational features at our lakes. The Corps operates 456 lakes 
in 43 States with a total land area of 12 million acres. At these 
facilities there are 56,000 miles of shoreline, 4,000 recreational 
areas with 101,000 campsites, 3,800 boat launch ramps, and 5,000 miles 
of trails.
    Not only is recreation important to the individuals who visit our 
lakes and other recreational facilities, but also it is important for 
the economic impacts and employment opportunities created within those 
communities located near to these recreational facilities.
    For example, a 1996 study prepared by the Corps Engineering and 
Research Development Center, entitled ``Estimating the Local Economic 
Impacts of Recreation at Corps of Engineers Projects--1996'' concluded 
that visitors to Corps facilities spent approximately $6 billion on 
trip related expenses, which in turn generated over 160,000 jobs in the 
surrounding communities. Significant economic and employment impacts 
associated with our recreational facilities were identified in a number 
of geographic locations, including our Little Rock, Nashville, Mobile, 
Tulsa, Huntington, Louisville, and Fort Worth District offices.

                               conclusion

    We must continue to find ways to reduce our costs and shift some 
costs to direct beneficiaries of our services. Meanwhile, we will do 
our very best to execute the Civil Works Program for maximum benefit to 
the Nation. I have testified today on the positive effects of the Corps 
mission on the Nation's economy. In closing, I would like to restate 
that the Corps of Engineers Civil Works program supports economic 
activity, prosperity, and well being in its high priority mission areas 
by facilitating waterborne transportation and reducing the threat of 
flooding and the extent of flood damages incurred, as well as other 
Civil Works activities.
    Thank you Mr. Chairman and Members of the Committee. This concludes 
my statement.

    Chairman Conrad. Thank you. Thank you for your testimony.
    Let me turn first to Ms. Peters, if I could. You said in 
your testimony, and I quote, ``The calculation of the highway 
funding adjustment is not a policy call. It is a calculation 
based in law and reflected in the budget.''
    Let me just say I do not agree with that. I think it is a 
policy call. Let me ask you this: there is nothing in the law 
or in the Budget Act, that prevents the President from adding 
to highway funding that is called for in TEA-21, is there?
    Ms. Peters. Mr. Chairman, the Assistant Secretary will take 
the question.
    Ms. McLean. Thank you, sir.
    I think that the situation is that the law specifically 
articulates what calculation is to be included in the 
President's budget. It does--
    Chairman Conrad. That is not my question.
    Ms. McLean. It does specify--
    Chairman Conrad. My question is very clear. There is 
nothing in law that prevents the President from adding to the 
funding base in TEA-21, is there? Would it be illegal for the 
President or for this Congress to add money to highway funding?
    Ms. McLean. No. If funding was added to highways, in the 
form of an increase in obligation limitation, as has been 
proposed both in the House and the Senate, the calculation that 
is required in TEA-21 reduces the firewall, the protected 
funding in Highway. Any funding above and beyond what is part 
of the calculation that reduced the obligation limitation would 
be above and beyond the firewall, so those outlays would have 
to either displace funding that is in the budget elsewhere, or 
would add to a deficit situation.
    Chairman Conrad. There are other ways to pay for things, 
right? I mean those are not the only ways to pay for things. 
Now, you have only given two. There is other ways to pay for 
things, is there not?
    Ms. McLean. Yes, sir.
    Chairman Conrad. So those are not the only two ways to pay 
for things.
    Ms. McLean. Yes, sir. I suppose you are implying an 
increase in taxes perhaps or--
    Chairman Conrad. I am just saying there are more than one 
way to bell this cat. There are more than two ways to bell this 
cat. And to suggest that this was not a policy call, to me is 
just not accurate. It is a policy call. The President has said 
to this Congress, ``Cut highway and bridge funding in this 
country by nearly $9 billion.'' That is 27 percent. Now, to 
suggest that is just a matter of law is just not true. The 
President could have determined to supplement the budget to 
make up for these dramatic cuts. We are talking about cutting 
road building and bridge building in this country 27 percent.
    Do you have any idea what the job loss would be associated 
with that, may I ask, Ms. Peters?
    Ms. Peters. Mr. Chairman, yes, I do.
    Chairman Conrad. What would the job loss be associated with 
that?
    Ms. Peters. Well, let me give you some figures. When we 
look at Federal funding, $1 billion in Federal funding equates 
to approximately 38,000 jobs in the market. That is strictly 
Federal funding. However, that funding is spent out over a 
period of time.
    Generally speaking, the capital outlay on Federal aid 
programs occurs on average 27 percent in the first year, 41 in 
the second year, 16 in the third year, 10 percent in the fourth 
year, et cetera. So that money spends out slowly over time.
    If we look at the actual reduction in outlays between 
fiscal year 2002 and fiscal year 2003, we are looking at less 
than a 3 percent reduction in capital outlay because of that 
slower spending over time. That equates, Mr. Chairman, to just 
under 19,000 jobs between 2002 and 2003 using the baseline that 
I spoke to earlier, the 38,000 jobs per billion dollars of 
Federal funding.
    Chairman Conrad. Well, we are talking here about $8.6 
billion less for highways and bridges in fiscal 2003; is that 
correct?
    Ms. Peters. Mr. Chairman, that is correct, but again that 
money does not all get spent in--
    Chairman Conrad. Right. It has a spend out over a number of 
years.
    Ms. Peters. That is correct.
    Chairman Conrad. But if we used your formula, $8.6 billion, 
and we applied for every billion, 38,000 jobs, that would be 
over 350,000 jobs affected over time. Would that not be the 
case?
    Ms. Peters. That is accurate, sir.
    Chairman Conrad. So I mean at the time we got the 
Administration calling for a stimulus package to provide more 
jobs, the President gives a speech saying his focus is jobs, he 
sends up a budget that cuts 350,000 jobs, and at the same time 
damages economic efficiency of the economy because it leads to 
more gridlock.
    Have you seen the calculations of the cost to the economy 
of gridlock on the highways, Ms. Peters?
    Ms. Peters. Yes, sir.
    Chairman Conrad. And what are those calculations?
    Ms. Peters. Sir, I do not have the numbers with me today. I 
do know that gridlock or congestion is detrimental to the 
economy. But I think the point is that the President's budget 
followed the formula that was specified in TEA-21. We certainly 
are mindful of the impacts of congestion and of not putting 
forward transportation projects but, as the Assistant Secretary 
said, these are unusual times. These are difficult decisions 
that have to be made by our country in these times of 
unprecedented issues.
    Chairman Conrad. Well, are you saying, as the Highway 
Administrator, that you do not think this budget should be 
added to? Do you think it would be irresponsible by the 
Congress to add the funding for highways and bridge 
construction in this country?
    Ms. Peters. Mr. Chairman, I would never call the members of 
Congress irresponsible.
    Chairman Conrad. Well, I am asking a specific question. Do 
you think adding to the funding for highway and bridge 
construction in this country would be irresponsible?
    Ms. Peters. No sir, I do not think that would be 
irresponsible.
    Chairman Conrad. Do you think it would be the right thing 
to do?
    Ms. Peters. Mr. Chairman, again, I think we have to weigh 
competing priorities in a variety of areas. If I would look at 
this strictly as the Federal Highway Administrator, certainly I 
see the value in increasing highway funding. But what the 
Administration has to look at are the competing demands for 
funding across a broad range of important--
    Chairman Conrad. Well, that is what Congress has to do too, 
Ms. Peters, and I think you see overwhelmingly Congress is 
saying the Administration's proposal here does not make a whole 
lot of sense. You are talking about cutting highway and bridge 
funding 27 percent, affecting over 300,000 jobs at a time when 
the President is calling for more jobs. I mean this is a 
contradictory policy that makes no earthly sense, does not make 
any sense to the governors, does not make any sense to the 
people of Congress, to come in here and talk about a 27 percent 
cut, and say, ``Well, it is not our fault. It is immaculate 
conception.'' This just came out of a formula. Budget is not 
immaculate conception. It is choices. And the President has 
chosen to cut highway and bridge funding 27 percent.
    I cannot find much of anybody who agrees with it, not on an 
economic basis, not on terms of strengthening the economy, not 
in terms of keeping the commitment that the States thought had 
been made to them under TEA-21. I tell you, I find very little 
support for what the President has sent us.
    Let me, if I could, go to you, Mr. Parker. How much was the 
budget authority for last year that was enacted by Congress for 
the Corps; do you recall?
    Mr. Parker. 4.6 billion.
    Chairman Conrad. That is my number as well. $4.6 billion. 
What has the President proposed?
    Mr. Parker. Well, when you look at the basic number, it is 
4.3. However, when you do put the adjustments in for 
retirement, security, you come back down close to the $4 
billion that was proposed last year.
    Let me just point out the way that--this is the way--you 
know I just came on board in October. And what I did is I got 
with my staff, and I said, ``You tell me. I want you to put 
together what could we do in all the projects that we have 
going on in this country, in a utopia, taking out the 
discussion of September the 11th, just in a utopia, what could 
we do to maximize our total program?''
    That figure we came up with was around $6.4 billion. That 
would be the most that we could do. We could prioritize, we 
could do all kind of things as far as the construction backlog 
and everything. That is what we went to OMB with.
    Chairman Conrad. That is what you requested?
    Mr. Parker. Yes.
    Chairman Conrad. $6.4 billion?
    Mr. Parker. Right.
    Chairman Conrad. And you got, on a comparison basis, 4.
    Mr. Parker. But we knew full well that that was as much as 
we could ever get. I mean that was the most we could ever 
utilize. We also knew that that amount would come down, and it 
should come down. I mean if we knew that--especially in this 
day and time things would--
    Chairman Conrad. Well, did you think 4 billion was the 
right number to come to?
    Mr. Parker. No. I would have offered that number if I 
thought it was the right number.
    Chairman Conrad. Okay. Let me ask you this. How big is the 
backlog?
    Mr. Parker. Well, it depends on what you are talking about. 
The backlog on maintenance has now increased to around, it will 
be around 900 million, and the longer we put it off, the more 
that it will increase.
    Chairman Conrad. Yes. I have got the maintenance backlog as 
884 million?
    Mr. Parker. Right.
    Chairman Conrad. Is that correct?
    Mr. Parker. Right, $900 million.
    Chairman Conrad. And if we were to look at all the projects 
that are under way around the country, how big a backlog would 
that represent?
    Mr. Parker. If you looked at all the projects in total, you 
would be talking about $44 billion.
    Chairman Conrad. $44 billion. Let me ask you this. You have 
had, last year there was $4.6 billion. The President cut that 
by 600 million on a fair comparison basis to $4 billion. What 
are the implications of those reductions? What would it mean? I 
am told that it could require the agency to terminate ongoing 
project contracts prematurely, resulting in an estimated $190 
million loss. Is that correct?
    Mr. Parker. Let me, if I could, let General Flowers answer 
that question.
    General Flowers. Yes, sir. With the budget as it stands, we 
would in fact have to terminate projects.
    Chairman Conrad. What would that mean?
    General Flowers. Would be about $190 million is what it 
would cost us, roughly, to terminate those projects. And the 
resulting job loss could be in the neighborhood of 45,000 jobs.
    Chairman Conrad. Why would you have to terminate ongoing 
projects? Why would you have to terminate contracts that are 
already in place?
    General Flowers. Sir, based on the contracts that we have 
in force and the amount of money which has been budgeted for 
our construction general account, there is not enough to keep 
all projects going. And what we would find ourselves doing is 
keeping in force contracts, and operating them at about below 
50 percent efficiency, and having to terminate those other 
contracts for the cost that I mentioned earlier.
    Chairman Conrad. So you would have no choice but to 
terminate contracts?
    General Flowers. Yes, sir, that is correct.
    Chairman Conrad. And then you would have to pay termination 
fees, I take it?
    General Flowers. Yes, sir. The costs that I mentioned are 
in fact the termination fees, an estimate of termination fees.
    Chairman Conrad. So we would be spending several hundred 
million dollars and not getting anything for it?
    General Flowers. That is correct, sir.
    Chairman Conrad. It does not sound like it would make much 
sense to me. Does it make much sense to you, General Flowers? 
Knowing what those projects are, would it make any sense to you 
to terminate these projects?
    General Flowers. Sir, it does not. I think one has to look 
at the President's stated objectives and what the Corps I think 
can bring to help fulfill those objectives. And I would submit 
that in combatting the war on terrorism and providing homeland 
security, the work that we do in maintaining strategic ports is 
very vital to the military effort as well as to the economy, 
because about 98 percent of our foreign commerce is seaborne.
    Chairman Conrad. How much? Can you repeat that?
    General Flowers. About 98 percent of our international 
commerce is seaborne.
    Chairman Conrad. So this has a security issue attached to 
it.
    General Flowers. Sir, I believe it does. We have 
traditionally, in the United States Army Corps of Engineers, I 
think contributed to the national defense.
    And if I could, I would just like to cite a quote from 
President Eisenhower, when he was testifying on the civil works 
functions of the Army, because we quite often get asked why are 
civil works in the Army. And his quote was that operations in 
New Guinea were conducted in wild virgin territory. He talked 
about a number of facilities that had to be built in places 
where nothing existed, and the war in the South Pacific being 
an engineer war.
    And his quote was: ``I am firmly convinced that but for the 
existence of the Corps of Engineers peacetime organization and 
its resources of men, methods, training and supply, its close 
association with the military through the years, the history of 
the Pacific area in World War II would have been written more 
in blood than in achievement.''
    And so we pride ourselves on helping our national security, 
and at the same time being able, through the application of our 
projects, in having a positive effect on the economy, not just 
in the jobs created by the construction themselves, but in 
benefits that are returned to the treasury that come from our 
projects.
    Chairman Conrad. Let me go to a specific example if I could 
that is in my State--Grand Forks, North Dakota, the place that 
suffered these disastrous floods in 1997. There is a project 
under way there that is a partnership between the State, the 
local community and the Federal Government to build protection 
for the community so that it would never suffer that disastrous 
impact again, when we had 98 percent of the community 
evacuated, the biggest mass evacuation since the Civil War. 
This is a town of about 50,000 people. The Federal Government, 
to fix up the mess, spent $700 million in that town, $700 
million. Now, none of us ever want to see that happen again. 
And so a dike is being constructed. What is in the budget for 
that dike? Do you recall?
    General Flowers. Yes, sir. We have $30 million in the 
fiscal year 2003 budget for the flood protection at Grand 
Forks.
    Chairman Conrad. And what could you realistically use to 
improve the flood protection? In other words, how much money do 
you need to make maximum progress on providing flood protection 
for that community?
    General Flowers. Sir, full capability would be $75 million.
    Chairman Conrad. $75 million. So this is one example of 
many of where you have insufficient resources to do something 
that everybody who has been involved in the challenge agrees 
needs to be done.
    General Flowers. Yes, sir.
    Chairman Conrad. I do not know of anybody that says do not 
provide flood protection to that community. Certainly the 
Governor of our State believes it is a priority. The local 
community, I was just with the mayor of that town, they believe 
it is a priority, and they have put their money where their 
mouth is. The State has put up money. The local community has 
put up money, and a lot of money for a community like that, and 
a lot of money for a small State like mine. And yet we are not 
making the progress that we could make to provide flood 
protection. Let us just all hope, keep our fingers crossed, 
there is no flood there in the meantime while we are waiting to 
get this job done.
    Let me turn to my colleague, Senator Murray, for questions 
that she might have.
    Senator Murray. Well, thank you very much, Mr. Chairman, 
for having this hearing on two issues that really are important 
to the economic success of our country and the renewal of our 
economy that we need, both education and transportation. And 
unfortunately, I cannot stay for the second panel and third 
panel on education.
    So I just wanted to make a comment that last year Congress 
passed and the President signed the ESEA reauthorization, and 
that bill had two parts. On one hand it called for higher 
standards and accountability. On the other hand it promised 
more investments so our schools could make progress.
    Well, here it is just a few months later, and already the 
President's budget has pulled rug out from under our students 
by reneging on that promised investment. This budget that has 
been presented to us cuts funds for teacher quality. It cuts 
class size reduction activities. It freezes funding for after-
school programs and safe and drug-free schools. And it does not 
fully fund our share of special education costs, failing yet 
again to fulfill that commitment to our communities, our 
schools, and our disabled students.
    Mr. Chairman, we know the needs are out there. We know what 
works to help our children succeed, and we know that this 
budget does not do enough to help. So I just wanted to make 
that statement since I cannot be here, and I am extremely 
concerned about what the President's budget does in terms of 
education after all the rhetoric that we heard on the 
Elementary and Secondary Education Act that just passed.
    But the other area that I am deeply concerned about as well 
is the transportation issue. Mr. Chairman, in my home State we 
just found out that we are at over 8 percent unemployment. We 
also have the second worst traffic in the entire country. 
Transportation is a crisis in the State of Washington, and 
investment in transportation is a crisis across the country.
    Now, we all know that when we invest in infrastructure, it 
pays dividends for our communities. Better roads and highways 
mean less time in traffic. It means greater productivity and 
greater quality of life. But, Mr. Chairman, as you pointed out, 
it creates jobs. At a time when our economy is floundering, it 
is especially important that we invest in these infrastructure 
jobs and not pull the rug out from under all of these projects 
across the country. This $8-1/2 billion cut will mean, as you 
pointed out, 350,000 jobs lost across this country. That is 
going to have an incredible economic impact.
    Now, Mr. Chairman, I would like to insert into the record a 
list of what this cut means to every single State. I think you 
will find it especially interesting, but I will summarize it 
with just one statistic for this Committee. If we just look at 
the States that are represented on this Budget Committee, the 
communities represented right here will lose more than $3 
billion in infrastructure investments.
    Now, Mr. Chairman, when the President's budget director was 
here, Mitch Daniels, he told us that the Administration was 
only following the requirements of the TEA-21 law, and I think 
I heard that again this morning. But what Mr. Daniels really 
failed to tell us is throughout his budget proposal, there are 
hundreds of examples where the Administration is asking us to 
ignore existing law or to change the law. Just within the 
transportation budget we are asked to ignore current law and to 
adopt measures to throw out several communities out of the 
essential air service program. And we are asked to ignore the 
TEA-21 law and divert transit formula funds to the President's 
new freedom initiative. We are also asked to ignore current law 
and impose new user fees on railroads, shipping communities and 
transportation of hazardous materials. Mr. Chairman, we are 
also asked, in the President's budget, to ignore TEA-21 law and 
lower the Federal cost share for major transit projects.
    So to me, what the Administration wants to do is to change 
the law dramatically in many areas, but uses the law as an 
excuse for cutting highway funds.
    So, Ms. Peters, I would just like to ask you why the 
Administration supports current law when it required billion 
dollar cuts in infrastructure, but it ignores current law in so 
many other places?
    Ms. Peters. Mr. Chairman, Senator Murray, I am going to 
defer to the Assistant Secretary in terms of the compilation of 
the President's budget, but let me say this first. I have been 
a State transportation director. I spent the last 17 years of 
my life as director of the State Department of Transportation 
in Arizona, and I do understand the difficulties that are faced 
by this Nation and by States such as yours that are 
experiencing high growth and have significant transportation 
demands. And we are certainly willing to work with you and 
members of Congress on this issue.
    But the point is, and I think the important point is, there 
were many, many difficult choices to make in this budget, 
difficult choices that you face as well, and again, let me 
defer to the Assistant Secretary for a direct answer.
    Ms. McLean. I think you are absolutely right, that the 
proposed budget includes some suggestions and changes in law. 
In this case we felt like we should not abandon the adjustment 
that was in TEA-21. The concept of linking highway spending to 
receipts is a sound one. It is a fundamental principle of TEA-
21, and on the eve of reauthorization we did not believe that 
moving away from this principle was the right approach.
    However, as Administrator Peters mentioned and Assistant 
Secretary Parker mentioned, the formulation of the President's 
budget this year is extremely difficult. You have a situation 
where you need to fund, obviously, the Defense Department in 
the situation that we are in a war. Plus defending terrorism, 
we have a significant increase in the Transportation Security 
Administration (TSA) funding for transportation security 
issues. And in this case, we followed the TEA-21 formula for 
this adjustment.
    Senator Murray. Well, I appreciate the choices that are 
made, but I do not think it is fair to say that the $8-1/2 
billion cut is a policy call, when in fact many other places in 
the budget, the President does ignore, or asks us to ignore 
existing law. So using the existing law as an excuse for the 
$8-1/2 billion cut does not carry with me.
    What is the Federal Highway Administration going to do to 
lessen the impact this cut will have on States? I especially 
want to know about 2004 and beyond.
    Ms. Peters. Thank you. Senator Murray, there are several 
things that we can do to work with the States. As I mentioned, 
overall we are seeing a spending outlay difference between 2002 
and 2003 of about $500 million. Methods that we stand ready to 
work with the States on, in terms of addressing those issues, 
are using features such as advance construction, moving 
projects forward, and then repaying that--
    Senator Murray. What do you mean by advance construction? 
You are going to ask States to pick up the cost till we come 
back around and pay for them?
    Ms. Peters. Senator Murray, that is accurate. State or 
other funds would be used, or perhaps--
    Senator Murray. I would just point out, Ms. Peters, that 
sounds really good, but my State has to cut a billion and a 
half dollars out of a $20 billion budget that they currently 
have because of the economic conditions in my State right now. 
I cannot tell them, ``You pick up the money right now. Trust 
us. Kent and I will be back here in a couple years, and we will 
come through with the money for you.'' That does not work.
    Ms. Peters. Mr. Chairman, and Senator Murray, I do 
understand that States are undergoing very difficult issues 
right now. There are other tools that we can use to move 
projects out over time--though clearly that does delay the 
completion of the projects. But that is an option.
    Senator Murray. And costs more.
    Ms. Peters. There is also the ability to use unobligated 
balances on other projects that we might be able to move 
forward in a shorter term. Again, as I said earlier, I do 
understand these issues. I have worked with the director of 
transportation in Washington State, and do understand your 
issues. We will work with you, both in terms of what Congress 
chooses to do with this, and working with the States to help 
mitigate the effect of this over time.
    Senator Murray. Well, Mr. Chairman, I would just say that 
we have been handed a really difficult situation, where we have 
been given an $8-1/2 billion cut that is going to have an 
extreme impact on our economy which cannot take it. It will 
have an impact on our future ability. Our States cannot make up 
these or future any of this, and I hope we do not see finger 
pointing at the end of the time here where the President says, 
``See that, Congress goes and spends money,'' because the 
choice came in his budget when he cut $8-1/2 billion, and I do 
not want us to be holding the bag at the end of the day, but it 
looks like that is what he has given us.
    Chairman Conrad. All right. I think it is very clear, this 
is budget rope-a-dope. We all know what is going on here. They 
know exactly down at the other end of Pennsylvania Avenue, that 
Congress is not going to cut highway and road-building projects 
across the country by 27 percent. It would not be the 
responsible thing to do.
    Frankly, we have had little talk about responsibility. I 
think this budget submission on highway and road building is 
irresponsible, irresponsible with respect to the jobs that it 
would kill, over 350,000 jobs over the life of these projects 
that would be lost makes absolutely no sense at a time of 
economic weakness, makes absolutely no sense in terms of the 
gridlock that we see in the transportation systems of the 
country.
    Recently I was out to visit Admiral Owens, a former vice 
chairman of the Joint Chiefs of Staff that now lives in 
Seattle. And I saw there firsthand the gridlock. Trying to go 
to the airport, I mean that road is stopped dead, and it is not 
stopped dead the 5 o'clock, it is stopped dead at 4 o'clock in 
the afternoon. And it happened to me three times out there on 
that road.
    I just think we all know what is going on here. They know 
full well this funding is going to, at least in some measure 
going to be restored, and then they are going to turn around 
and say, ``There go those spenders down in Congress.'' I just 
think it is kind of a tired old game that is being played here.
    And the same with the Corps. Cutting the Corps below the 
amount of money they had last year, so as to actually require 
terminations of projects that are currently contracted for, 
does not make any sense. General Flowers does not think it 
makes any sense. I do not think it makes any sense. But this is 
more rope-a-dope. And, you know, it is kind of a clever game, 
but it is tedious and it is silly.
    And if there is anything that is clear, Congress is not 
going to be terminating contracts that are under way. That is 
irresponsible. Congress is not going to cut 27 percent from 
highway building and bridge building and cut 350,000 jobs at 
the same time the Administration's asking us for a stimulus 
package to generate jobs. Does anybody connect the dots down 
there on these kinds of questions? I do not know. Apparently 
not.
    But I would again thank the witnesses. We appreciate your 
being here. We have a second panel, and we will go to them 
next, but first let me just say this to you. Mr. Parker, we 
want to work with you and General Flowers to create a budget 
here that does make sense. We do not want you terminating 
contracts. We do not want you to be in that position. We want 
to help you work off this backlog, the maintenance backlog as 
well as the construction backlog. Obviously, we are under very 
severe constraints, but we are not going to have less money 
this year than last, when last year was insufficient to whittle 
down that backlog. That would just be penny wise and pound 
foolish. It would mean more cost. I know that with these 
construction projects, designed for flood control, waiting, 
stretching it out means it costs more money. We are not going 
to do that.
    And we do not have the luxury of doing all that could be 
done or should be done. We understand that. We are going to 
have to be very tough on the bottom line, but I do pledge to 
you this Committee is going to work closely with you, and I ask 
you to work with us. Will you do that, Mr. Parker, help us 
identify how we can construct a budget number here that does 
meet the needs and will avoid contract terminations?
    Mr. Parker. The Administration will work with you on that, 
totally.
    Chairman Conrad. I look forward to that.
    And I say the same thing to Ms. Peters. We are not going to 
be cutting $8.6 billion around here. There is no support for 
that. I have not talked to a single member on the House or the 
Senate side that thinks that that is a responsible thing to do. 
So I would ask you as well, will the Administration work with 
us to try to come together around a fiscally-responsible plan 
that does not have a 27 percent cut in highway and bridge 
building?
    Ms. Peters. Mr. Chairman, the Administration is always 
pleased to work with Congress, and we will work with you on 
these issues.
    Chairman Conrad. All right. We look forward to that, and I 
again thank the witnesses for being here.
    Now we will go to our second panel.
    On our second panel, we are going to be talking about 
education. We have Bob Chase, the president of the National 
Education Association; Larry King, the secretary of the 
American Association of State Highway and Transportation 
Officials; and Thomas Till of the Amtrak Reform Council.
    Welcome to all of you, and why don't we start with you, Mr. 
Chase, on the subject of education.

   STATEMENT OF ROBERT CHASE, PRESIDENT, NATIONAL EDUCATION, 
                          ASSOCIATION

    Mr. Chase. Thank you very much, Senator. On behalf of the 
NEA and our 2.7 million members, I want to thank you for the 
opportunity to testify today on the fiscal year 2003 education 
budget and would like to request that my full statement, along 
with the attachments, be made part of the record.
    Chairman Conrad. Without objection.
    Mr. Chase. Thank you.
    NEA members represent the full diverse spectrum of public 
education. We are elementary and secondary teachers, para-
professionals, vocational educators, as well as post-secondary 
education faculty. We are deeply committed to strengthening our 
education system to guarantee a quality public education for 
every student. The NEA believes that an effective, successful 
public school system must include, among other things, a highly 
qualified teacher in every classroom, rigorous academic 
standards for all students, strong accountability measures, 
small class sizes, and modern, safe school facilities with 
access to new technologies for all students. We also believe 
that all qualified students should have access to post-
secondary education and have access to the financial resources 
and academic supports they need to succeed.
    However, ensuring the highest quality education for all 
students is not possible without significant Federal 
investment. Simply put, reform without resources will not work. 
A strong Federal commitment to education funding is made even 
more critical today by current State budget pressures and new 
Federal mandates. These crises, coupled with rising school 
enrollments and the increased numbers of students with special 
needs, have already led to many State's cutting critical 
education programs.
    At the same time, States face new testing and 
accountability mandates under the newly enacted No Child Left 
Behind Act, or ESEA, most of which will become more challenging 
each year. Without a substantial increase in resources from the 
Federal level, many of the important goals of the new law, 
including yearly improvements in student achievement and in 
teacher quality, will simply be impossible to reach.
    NEA applauds the bipartisan commitment to education 
investment over the last 6 years. Increases have averaged 
approximately 13 percent a year. Now we urge Congress to 
continue on this path by providing immediate investments for 
key programs such as Title I and IDEA, but not at the expense 
of other important education programs.
    While the Administration's proposed fiscal year 2003 budget 
includes some important programmatic increases, overall it 
offers the smallest percentage of dollar increases in education 
funding since 1996. At the Administration's proposed fiscal 
year 2003 level, many important programs will be unable to 
serve eligible students, and successful implementation of new 
reforms and mandates will be very difficult to achieve. 
Therefore, we urge Congress to use the budget request as a 
base--as a base--on which to build toward needed investments.
    First, NEA opposes the Administration's proposal to pay for 
needed Pell Grant supplemental appropriations by eliminating 
current funding for 29 elementary and secondary education 
programs. We completely agree that a supplemental Pell Grant 
appropriation is necessary and important. However, we strongly 
oppose pitting higher education against elementary and 
secondary education or pitting any one education program 
against another.
    In terms of the coming fiscal year, we commend the 
Administration for proposing increases in Title I and in IDEA 
and also providing an important $1 billion for Reading First. 
But we are deeply concerned that the budget would essentially 
pay for most of these increases by eliminating 40 other 
programs, freezing funding for 66 programs, and cutting funds 
for an additional 16 programs.
    Overall, the Administration would cut funding for ESEA 
programs, reauthorized less than 2 months ago, by $90 million. 
These cuts will undermine efforts to implement the 6 years of 
new reforms and requirements in the No Child Left Behind Act, 
thereby setting children, schools, and States up for failure.
    Instead of cutting funds, Congress should commit to yearly 
increases to help States and schools successfully implement 
reforms. For fiscal year 2003, NEA recommends that Congress 
provide at least a $12 billion increase above the 
Administration's budget for education programs. Specifically, 
NEA's priority includes:
    Title I, where we believe that the Administration's 
proposed $1 billion increase offers a good starting point, but 
still falls far short of what is needed. The Administration's 
proposal falls $4.65 billion below the fiscal year 2003 level 
authorized in the new law, a level that was adopted on a 
bipartisan basis through the efforts of Senators Dodd and 
Collins. Keeping Title I on track toward full funding is 
particularly important given the new accountability and 
adequate yearly progress provisions in the new law. As these 
new requirements tighten each year, the number of schools 
deemed in need of improvement will likely increase. All of 
these schools will need assistance. Simply placing them on a 
list and labeling them will not magically produce results. 
Therefore, NEA urges Congress to fully fund the authorized 
level of $16 billion for Title I in Fiscal Year 2003 and to 
provide $500 million for the school improvement fund to help 
turn around low-performing schools.
    Secondly, IDEA. The Administration has also proposed a $1 
billion increase for IDEA, or special education. Again, while 
we certainly applaud this proposal as a good starting point, we 
believe it falls short of what is needed. Providing a quality 
education for all students, including those with disabilities, 
requires a Federal-State-local partnership. Today's States and 
localities simply cannot provide students with disabilities the 
quality of services they need, and often must cut other 
critical programs or raise taxes in order to provide mandated 
services.
    Students with disabilities and their families deserve more 
than an empty promise. Therefore, NEA urges Congress to provide 
a fiscal year 2003 increase of $2.45 billion for IDEA and to 
guarantee similar increases for each of the next 6 years, as in 
the bipartisan Harkin-Hagel amendment passed by the Senate last 
year.
    The third area, teacher quality. Research clearly--
    Chairman Conrad. Could I just stop you on the last point?
    Mr. Chase. Yes, sir.
    Chairman Conrad. Just more broadly, I should say we are not 
going to be able to do a $12 billion increase. We have been 
going over this budget. I think what you are asking for is 
completely understandable, given the need. I can tell you in 
terms of the enormous pressure we are under, because of the 
downturn and the attack on September 11th, and because of the 
tax cut passed last year, which is the biggest reason for the 
disappearance of surpluses, that we are not going to be able to 
accommodate an increase of that magnitude.
    But I am very interested in what your recommendation is on 
IDEA specifically. As I heard you say, you are proposing a 
$2.45 billion increase for IDEA.
    Mr. Chase. That is correct.
    Chairman Conrad. And with a commitment for that amount for 
the next 6 years?
    Mr. Chase. Over the next 6 years. That was the bill that 
was passed last year, the Harkin-Hagel amendment passed by the 
Senate last year, to fully fund IDEA over a 6-year period. I am 
sure you recall that 27 years ago, when IDEA was first enacted, 
there was a promise made by Congress at that time that the 
Federal Government would fund 40 percent of the costs of 
mandated special education programs. As of now, it has funded, 
at the highest point, somewhere between 16 and 17 percent. 
Certainly an additional 24 percent of that funding being 
provided to State and local governments would free up those 
dollars at the State and local level to be spent on other very 
needed education programs.
    Chairman Conrad. I do think there is a clear Federal 
obligation. I believe the commitment was to 40 percent funding. 
We have not kept it. That has put enormous pressure on school 
districts all across the country.
    Would you think that the single most important thing we 
could to help school districts across the country would be to 
keep the Federal promise on IDEA?
    Mr. Chase. I am not sure, Senator, if I would say it is the 
single most important, but it certainly is a critical one. I 
think Title I funding is also critically important. But if, in 
fact, the commitment made to fully fund IDEA was met, it would 
make an enormous difference to State and local efforts as far 
as public education is concerned.
    Chairman Conrad. If Congress were to start down the path of 
meeting the obligation--and you added that roughly $2.5 billion 
a year for 6 years--at the end of that time do your 
calculations show we would meet the 40 percent promise that was 
made?
    Mr. Chase. Yes, sir.
    Chairman Conrad. So it would be at the end of that period--
    Mr. Chase. At the end of 6 years.
    Chairman Conrad [continuing]. That we would then be at the 
40--
    Mr. Chase. That is correct.
    Chairman Conrad. Okay. I appreciate that, and I am sorry 
for the interruption. But I wanted to make certain that we got 
that on the record.
    Mr. Chase. Thank you.
    On the teacher quality issue, research clearly demonstrates 
that the presence of a highly qualified teacher in a classroom 
is the most critical element in raising student achievement. 
The new ESEA law creates new teacher quality requirements, 
mandating that all teachers be highly qualified within 4 years. 
At the same time, States are facing teacher shortages caused by 
record enrollments and the projected retirements of thousands 
of veteran teachers.
    The combination of new teacher quality requirements and a 
teacher shortage necessitates an increased investment in 
teacher recruitment and in professional development programs. 
Although the President in his State of the Union speech 
recognized the need to recruit more highly qualified teachers 
in the coming years, the Administration's fiscal year 2003 
budget freezes funding for teacher quality and eliminates 
funding for the National Board for Professional Teaching 
Standards and teacher technology training. Clearly, this 
proposal is at odds with the goal of improving teacher quality 
and ensuring every student has a highly qualified teacher.
    We recommend a $1 billion increase for Title II, teacher 
quality. The math-science partnership program should be funded 
at its authorized level of $450 million. We also strongly 
recommend retaining funding for the National Board.
    I would also like to briefly mention school modernization. 
Another critical component of raising student achievement is 
ensuring every student a safe and modern learning environment. 
America frankly does not expect corporate executives and 
employees to work in overcrowded buildings with leaky roofs, 
crumbling ceilings, faulty heating systems, and go down the 
list. Yet these unacceptable conditions exist in far too many 
of the Nation's schools. The fiscal year 2002 appropriations 
bill eliminated the $1.2 billion urgent school repair program, 
and the Administration's fiscal year 2003 budget provides no 
funding for school repair and renovations. We urge Congress to 
provide $1.75 billion over 5 years to subsidize the interest on 
school modernization bonds and to provide a $1 billion 
appropriation for urgent school repairs.
    NEA strongly supports the Administration's proposal to 
provide an above-the-line tax deduction to offset educators' 
out-of-pocket classroom supply and professional development 
expenses. We recommend it be expanded to cover such expenses 
starting with this tax year. In 1996, NEA found that an average 
K-12 educator spent over $400 a year out-of-pocket for 
classroom materials, and many spent much more than this. For 
educators earning modest salaries, such purchases require 
considerable expenses.
    We also support increased investment for rural education, 
higher education, early childhood education, and a range of 
other critical programs. These recommendations are detailed in 
the appendix in my written statement.
    Finally, I would like to express our opposition to the 
Administration's proposal for subsidized tuition tax breaks for 
private and religious school expenses, a proposal that NEA 
strongly opposes. The proposal is essentially a voucher 
proposal, providing direct payment of Federal funds to parents 
for private and religious school tuitions. It will siphon off 
$3.7 billion over 5 years from public schools. This funding 
could be much better spent to help the 90 percent of students 
attending public schools. Therefore, NEA urges Congress to 
reject this dangerous voucher proposal and instead to focus on 
the real reforms that help all students succeed.
    Mr. Chairman, thank you very much for giving us the 
opportunity to share our thoughts with you this morning.
    [The prepared statement of Mr. Chase follows:]

  The Prepared Statement of Bob Chase, President, National Education 
                              Association

    On behalf of the National Education Association's (NEA) 2.7 million 
members, thank you for the opportunity to testify today about the 
importance of an increased Federal commitment of resources in building 
the world-class educational system our children deserve.
    NEA members represent the full, diverse spectrum of public 
education. We are elementary and secondary school teachers, para-
professionals, vocational educators, and Post-secondary education 
faculty. We are deeply committed to strengthening our educational 
system to guarantee a quality public education for every student.
    NEA's vision for quality public education focuses on improving 
student achievement and elevating teacher quality. NEA believes that an 
effective, successful public education system must include: a highly 
qualified teacher in every classroom; rigorous academic standards for 
all students; strong accountability measures; small class sizes; and 
modern, safe school facilities with access to new technologies for all 
students. We also believe that all qualified students should have 
access to Post-secondary education, and to the financial resources and 
academic supports they need to succeed.
    However, ensuring the highest quality education for all students is 
not possible without a significant Federal investment. Simply put 
reform without resources will not work. My testimony today will focus 
on those Federal investments necessary to ensure successful, meaningful 
education reform.

                  The Context: State Budget Pressures

    The need for a strong Federal commitment to education funding is 
made even more critical by current State budget pressures and new 
Federal mandates. A new report prepared for the National Governors 
Association The Outlook for State Tax Revenues found that ``At least 
forty States are now experiencing budget shortfalls during the current 
2002 fiscal year, which ends in June for most States. The miss between 
actual budget results and that expected when budgets were drafted a 
year ago is approaching a stunning $40 billion.'' The report goes on to 
note, ``Longer term, State governments have the daunting task of 
meeting the rising funding needs of such things as education, public 
welfare and homeland safety in the face of an increasingly inflexible 
tax system.'' In addition, according to a January 2002 survey conducted 
by the National Conference of State Legislatures (NCSL), Forty-five 
States and the District of Columbia report that revenues have failed to 
meet budgeted levels * * * At least 30 States have implemented budget 
cuts or holdbacks to address fiscal problems in fiscal year 2002. 
Another nine report that cuts are possible before the fiscal year ends. 
Most State programs have been affected by budget cuts * * * The 
magnitude of budget gaps has been significant enough that even programs 
that often are spared from cuts, such as K-12 education, have been 
reduced in some States.
    These crises, coupled with rising school enrollments and increased 
numbers of students with special needs, have already led many States to 
cut critical education programs.
    At the same time, States face new testing and accountability 
mandates under the newly-enacted No Child Left Behind Act, most of 
which will become more challenging each year. Without a substantial 
increase in resources from the Federal level, many of the important 
goals of the new law including yearly improvements in student 
achievement and teacher quality will be simply impossible to reach.

                           The Public's Views

    The general public strongly supports increased Federal investments 
in education. A recent poll commissioned by the Committee for Education 
Funding of which NEA is an active member found that two-thirds of the 
American public would accept a larger deficit in order to provide 
improved education for students from kindergarten through college. 
Similarly, a recent Zogby poll found the public favoring by a 69 to 29 
percent margin ``rolling back the tax cut if it means the Federal 
Government has more money available for education.''

                NEA's Education Funding Recommendations

    NEA believes that significant, targeted Federal investments are 
necessary to help all students reach the highest standards. To this 
end, we applaud the bipartisan commitment to education investments over 
the last six years increases that have averaged 13 percent a year. Now, 
we urge Congress to continue on this path by providing needed 
investments for key programs such as Title I and IDEA, but not at the 
expense of other important education programs.
    While the Administration's proposed fiscal year 2003 budget 
includes some important programmatic increases, overall it offers the 
smallest percentage and dollar increase in education funding since 
1996. In addition, even with the yearly increases in Federal funding 
for education over the last six years, the Federal share of total 
education spending is still less than it was in 1980, when the Federal 
Government provided almost 12 percent of all funds for elementary and 
secondary education. Last year, the Federal share was down to 8.5 
percent. Similarly, the Federal share of higher education funding 
declined from 15.4 percent in fiscal year 80 to 10.9 percent in fiscal 
year 2001.
    At the Administration's proposed fiscal year 2003 level, many 
important programs will be unable to serve eligible students, and 
successful implementation of new reforms and mandates will be very 
difficult.\1\  Therefore, we urge Congress to use the Administration's 
budget proposal as a base on which to build toward needed investments.
---------------------------------------------------------------------------
    \1\ To illustrate the unmet needs across the country, NEA has 
compiled a set of State-specific charts contrasting current funding 
levels for Title I, IDEA, Head Start, and school modernization with the 
President's proposal and remaining unmet State needs. These State-
specific charts are available on the NEA website at http://
www.nea.orgllac/fyO3ed$/. The charts are intended to highlight the need 
for increased resources, and to set the stage for work over the next 
few years to address these unmet needs.
---------------------------------------------------------------------------
    In addition, we urge Congress to reject proposals to freeze funding 
or eliminate important Federal programs. And, we strongly oppose 
proposals to divert limited funds away from public schools through 
voucher-like tuition tax credits.
    I would now like to focus my testimony on NEA's general reactions 
to the Administration's proposal, and our overall recommendations for 
fiscal year 2003 funding priorities. More detailed proposals for fiscal 
year 2003 education funding are included in an appendix to this 
testimony.

               Opposition to Fiscal Year 2002 Rescissions

    NEA opposes the Administration's proposal to pay for a needed 
fiscal year 2002 $1.3 billion Pell Grant supplemental appropriation by 
eliminating 29 elementary and secondary education programs. We 
completely agree that a supplemental Pell Grant appropriation is 
necessary and important in order to maintain the $4000 maximum award 
set by Congress. However, NEA strongly opposes pitting higher education 
against elementary and secondary education, or pitting any one 
education program against another. Last year, Congress carefully 
considered and approved funding on a bipartisan basis for each of the 
programs marked for elimination. First, Congress explicitly decided to 
retain authorization for each of these programs as part of the No Child 
Left Behind Act. Later, Congress again decided to maintain and fund 
these programs as part of the fiscal year 2002 Labor-HHS-Education 
Appropriations bill. In fact, many, if not all of these programs 
enjoyed broad bipartisan support, with Republican Senators acting as 
the programs main champions in many cases.
    Therefore, NEA recommends that Congress enact the Pell supplemental 
but reject proposed rescissions of fiscal year 2002 funding for 
elementary and secondary education programs.

                      Fiscal Year 2003 Priorities

    The Administration has proposed a $1.37 billion increase for 
education funding for fiscal year 2003. While, as noted in more detail 
below, this proposal includes increases for Title I and IDEA, and also 
provides an important $1 billion for Reading First, the Administration 
would essentially pay for most of these increases by eliminating 40 
programs, freezing funding for 66 programs, and cutting funds for an 
additional 16 programs.
    Overall, the Administration would cut funding for ESEA programs 
reauthorized less than two months ago by $90 million. These cuts will 
undermine efforts to implement the six years of new reforms and 
requirements in the No Child Left Behind Act, thereby setting children, 
schools, and States up for failure.
    Instead of cutting funds, Congress should commit to yearly 
increases to help States and schools successfully implement reforms.
    For Fiscal Year 2003, NEA recommends that Congress provide at least 
a $12 billion increase above the Administration's budget for education 
programs. Specifically, NEA priorities include:

  Title I: The Administration has proposed a $1 billion (+9.7%) 
    increase in Title I funding for Fiscal Year 2003. This 9.7 percent 
    increase would bring Title I to its highest funding level ever. NEA 
    believes the Administration proposal offers a good starting point, 
    but still falls short of what is needed. We are pleased that the 
    Department of Education has recognized the value of Title I in its 
    fiscal year 2003 Justifications of Appropriations Estimates, which 
    states ``* * *there is evidence that Title I, as reauthorized in 
    1994, helped put in place the infrastructure needed to improve 
    student achievement. This, coupled with the reforms in the NCLB 
    Act, is expected to have a positive impact on the Nation's schools 
    that warrants further investment in the program.''
    The current Title I authorization levels were adopted last year on 
a bipartisan basis through the efforts of Senators Dodd and Collins. 
The Dodd-Collins amendment to the No Child Left Behind Act was intended 
to put Title I on a ten-year path toward full funding. Unfortunately, 
the Administration's proposal falls $4.65 billion below the fiscal year 
2003 level authorized in the new law.
    Keeping Title I on track toward full funding is particularly 
important given the new accountability and Adequate Yearly Progress 
provisions in the new law. As these new requirements tighten each year, 
the number of schools deemed ``in need of improvement'' will likely 
increase. Estimates indicate that as many as 10,000 schools will start 
the 2002-03 school year categorized as ``low-performing,'' based on 
standards under prior law, All of these schools need assistance; simply 
placing them on a list and labeling them will not magically produce 
results. Tragically, approximately one-half of schools identified as 
needing improvement a year ago received no additional resources or 
assistance. If our goal is to turn these schools into successful, high-
performing institutions, we must provide the necessary funding.
    Unfortunately, less money will be available for school improvement 
in fiscal year 2002 than in the previous year. In fiscal year 2001, 
Congress earmarked $225 million for school improvement, in addition to 
a 0.5 percent State set-aside. Thus, a total of $268 million is 
available this school year. However, while Congress increased the 
fiscal year 2002 State set-aside to 2 percent, it failed to earmark 
additional funds for school improvement. Therefore, only $207 million 
will be available for the 2002-03 school year. In addition, while the 
new ESEA law authorizes $500 million for school improvement activities 
in low-performing schools, Congress did not fund this program for 
fiscal year 2002 and the Administration did not include it in the 
fiscal year 2003 budget request. A significant increase in Title I is 
also necessary as, under current law, as much as 40 percent of Title I 
funds will not be available for classroom instruction. Under the No 
Child Left Behind Act, portions of Title I funding are earmarked for 
other purposes including transportation for public school choice, 
supplemental services, and professional development. While important, 
these earmarks reduce the funds available for direct instruction.
    Therefore, NEA urges Congress to both fully fund the authorized 
level of $16 billion for Title I in Fiscal Year 2003 and provide $500 
million for the School Improvement Fund.
    IDEA: The Administration has also proposed a $1 billion increase (+ 
13.3 percent) for IDEA special education. Again, while NEA applauds 
this proposal as a good starting point, we believe it falls short of 
what is needed. In fact, the proposed budget would provide only 18 
percent of the Average Per Pupil Expenditure, less than half of the 40 
percent full funding share.
    Providing a quality education for all students, including those 
with disabilities, requires a Federal-State-local partnership. Today, 
however, Federal IDEA appropriations fall far short of the Federal 
Government's commitment. As a result, States and localities simply 
cannot provide students with disabilities the quality of service they 
need, and often must cut other critical programs or raise taxes in 
order to provide mandated services. The Department of Education in its 
fiscal year 2003 Justifications of Appropriations Estimates notes, 
``Historically, local educational agencies have struggled with meeting 
the minimal education needs of children with disabilities.'' In the 
Fiscal Year 2002 alone, the unpaid Federal contribution shortchanged 
local schools by $10.5 billion funds that could have made a real 
difference in modernizing school facilities, training teachers, 
upgrading technology, or improving curricula.
    At the rate of increase under the Administration's proposal, it 
will take 33 years to reach full funding of IDEA. In contrast, the 
bipartisan Harkin-Hagel proposal included in the Senate version of the 
ESEA reauthorization bill last year would phase in full IDEA funding 
over six years. The Harkin-Hagel plan would also move IDEA to the 
mandatory spending side, thereby removing it from the arbitrary and 
unpredictable annual appropriations process, and freeing up 
discretionary funds for other priorities. Students with disabilities 
and their families deserve more than an empty promise. Therefore, NEA 
urges Congress to provide a Fiscal Year 2003 increase of $2.45 billion 
for IDEA, and to guarantee similar increases for each of the next six 
years.
    Teacher Quality. Research clearly demonstrates that the presence of 
a highly qualified teacher in a classroom is the most critical element 
in raising student achievement. The new ESEA law creates new 
requirements mandating that all teachers be highly qualified within 
four years. At the same time, States are facing teacher shortages 
caused by record enrollments and the projected retirements of thousands 
of veteran teachers. According to the Department of Education, 22 
percent of all new teachers leave teaching in their first three years 
of service, 12 percent of teachers in high-poverty secondary schools 
hold emergency certification, and 18 percent of teachers are teaching 
out of their field of expertise. In addition, estimates for the number 
of new teachers needed range from 2.2 to 2.7 million by 2009. The 
combination of new teacher quality requirements and teacher shortages 
necessitates an increased investment in teacher recruitment and 
professional development programs.
    Although the President in his State of the Union speech recognized 
the need to recruit more highly qualified teachers in the coming years, 
the Administration's fiscal year 2003 budget freezes funding for 
Teacher Quality and eliminates funding for the National Board for 
Professional Teaching Standards and Teacher Technology Training. 
Clearly, this proposal is at odds with the goal of improving teacher 
quality and ensuring every student a highly qualified teacher.
    NEA recommends an increase of $1 billion for Title II Teacher 
Quality for a total of $4 billion. The Math-Science Partnership program 
should be funded at its authorized level of $450 million. We also 
strongly recommend retaining funding for the National Board. In 
addition, we recommend restoring funding for Preparing Tomorrow's 
Teachers For Technology to the fiscal year 2001 level of $125 million 
and providing $300 million for Higher Education Act Teacher Quality 
Enhancement Grants to improve teacher preparation programs.
    School Modernization: Another critical component in raising student 
achievement is ensuring every student a safe, modern learning 
environment. America would not expect corporate executives and 
employees to work in overcrowded buildings with leaky roofs, crumbling 
ceilings, and faulty heating systems. Yet, these unacceptable 
conditions exist in far too many of the schools educating tomorrow's 
workforce.
    The research on this issue is clear overcrowded classrooms and 
structurally unfit school buildings impair student achievement, 
diminish student discipline, and compromise student safety. In 
contrast, safe, modern, well-equipped schools send a message to our 
children that we as a nation are willing to invest in their future.
    The need for Federal school modernization assistance is also well 
documented. The National Center for Education Statistics has projected 
an unmet need of $127 billion just for repairs to existing facilities. 
NEA's own recent study estimated a $268 billion cost for school repair 
and modernization. In addition, the Treasury Department's own General 
Explanations of the Administration's Fiscal Year 2003 Revenue Proposals 
stated, ``Aging school buildings and new educational technologies 
create a need to renovate older school buildings * * * Many school 
systems have insufficient fiscal capacity to finance needed renovation 
* * *''
    Yet, despite this documented need, the fiscal year 2002 education 
appropriations bill eliminated the $1.2 billion urgent school repair 
program, and the Administration's fiscal year 2003 budget provides no 
funding for school repair and renovation. The budget does include a 
two-year extension of Qualified Zone Academy Bonds (QZAB), which have 
been used successfully by schools across the country. While expansion 
of QZABs is a good first step, we support the proposal by Senators 
Harkin and Kerry to create $25 billion of zero-interest bonds, at a 
five-year cost of only $1.75 billion. A similar proposal offered by 
Representatives Rangel and Johnson in the House currently has 225 
cosponsors a bipartisan majority.
    We urge Congress to provide $1.75 billion over five years to 
subsidize the interest on school modernization bonds, and to provide a 
$1 billion appropriation for urgent school repairs.
    Educator Tax Benefits: NEA supports the Administration's proposal 
to provide an above the-line tax deduction to offset educators out-of-
pocket classroom supply and professional development expenses. Senators 
Collins, Warner, and Landrieu have also proposed such a tax deduction, 
and a similar proposal passed the Senate last year by a 98-2 vote.
    A 1996 NEA study found that the average K-12 educator spent over 
$400 a year on classroom supplies. For educators earning modest 
salaries, such purchases represent considerable expense. Therefore, NEA 
urges Congress to include the Administration's educator tax deduction 
in the fiscal year 2003 Budget Resolution. However, we urge making it 
effective with the 2002 tax year, as opposed to delaying it to 2004 as 
in the budget request.
    NEA also supports increased investments for rural education, higher 
education, early childhood education, and other critical programs. Our 
recommendations are detailed in the attached appendix.

                   Opposition to Tuition Tax Credits

    NEA strongly opposes the Administration's proposed taxpayer-
subsidized tuition tax breaks for private and religious school 
expenses. The proposal is essentially a voucher providing direct 
Federal funds to parents for private and religious school tuition. 
Similar proposals were resoundingly rejected by strong bipartisan 
margins during consideration of ESEA reauthorization.
    The tuition tax credit proposal will siphon off $3.7 billion over 
five years from public schools. In fact, the plan would provide more 
than 2.5 times as much money per child to attend private and religious 
schools than is currently provided per child to improve achievement of 
low-income public school students. This funding could be better spent 
to help the 90 percent of students attending public schools. For 
example, $3.7 billion could pay for:
    Math and reading help for an additional 3.7 million low-income 
children;
    Interest to subsidize $25 billion of zero-interest school 
construction bonds, plus an additional $2 billion in grants for urgent 
school repairs for high-poverty schools, or
    Salaries of 20,000 highly qualified teachers to reduce class size 
for the next five years.
    The Administration's proposal would also undermine important 
accountability measures put in place under the new ESEA law. Funds 
could subsidize private, religious, and home schools that are not held 
to the same teacher quality and student achievement standards as public 
schools. Federal funds could also be used to subsidize discrimination, 
as private, religious, and home schools are not all fully covered by 
civil rights laws.
    Therefore, NEA urges Congress to reject these dangerous voucher 
proposals and instead to focus on real reform that helps all students 
succeed.
    Thank you.

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    Chairman Conrad. Thank you. We appreciate that testimony 
very much and all the effort that went into it.
    Mr. King, welcome.

  Statement of Larry King, Secretary, American Association of 
           State Highway and Transportation Officials

    Mr. King. Thank you, Mr. Chairman, and good morning. I am 
Larry King. I am deputy secretary for the Pennsylvania 
Department of Transportation, and I also serve as secretary of 
the American Association of State Highway and Transportation 
Officials, AASHTO. Thank you again for the opportunity to be 
here this morning to add to the very useful discussion that has 
already taken place on highway spending levels for the upcoming 
fiscal year.
    Mr. Chairman, also thank you for your affirming statements 
on the importance of a strong highway program to safety and 
mobility in the economy. We appreciate that. We believe much 
good has been accomplished over the years from this very 
successful Federal-State partnership, and certainly believe 
that it is worth keeping at a very strong level.
    Mr. Chairman, frankly we in the States are stunned by the 
fiscal year 2003 budget proposal to slash this $8.6 billion 
from current highway funding levels. This, in the midst of a 
recovery from recession, would cut the Federal aid highway 
program, as you have so accurately stated, by 27 percent 
because of an apparent slowdown in revenues to the Highway 
Trust Fund, invoking this revenue-aligned budget authority 
provision, RABA.
    Now, losses of this magnitude, Mr. Chairman, could wipe out 
much of what we have collectively accomplished over the past 4 
years to reduce the enormous backlog of needed highway 
improvements. It would return us indeed to levels of the decade 
of the 1990s, as you can see from the chart to my right.
    Now, AASHTO has recently completed a survey of its member 
departments on the impacts on State transportation programs 
that would occur if this reduction would indeed take place.
    Now, it is not just the $8.6 billion in Federal cuts that 
would be impacted, but also the matching funds that go with 
those Federal funds, and the damage, therefore, would actually 
exceed significantly the $8.6 billion Federal cut. But, more 
importantly, it will delay important projects at the State 
level. It will impact projects at the city level, county level, 
and transit agencies also, and would reduce, we fear, the 
prospects for future transportation funding next year when TEA-
21 is up for reauthorization.
    Let me cite just a couple of examples from the State 
survey.
    First, in my State of Pennsylvania, this year, 2002, we 
expect a record-breaking year in highway and bridge 
construction contracting, more than $1.5 billion worth of work 
in Pennsylvania this year. However, beyond 2002, in the face of 
a proposed reduction in Federal funding of $346 million, we in 
Pennsylvania would be forced to delay up to $500 million worth 
of contract construction lettings and also an additional impact 
of $100 million in design costs, right-of-way acquisition, 
utility relocation, and other pre-construction activities.
    In North Dakota, the survey says that the proposed $44 
million reduction in Federal funding would trigger some $54 
million in program cuts in your home State of North Dakota, 
increasing the backlog of needed projects and enlarging the 
gap, which all of us have, between affordable program levels 
and what is needed, increasing that gap by about 50 percent.
    Importantly, also, for North Dakota and for many other 
States, a reduction of this magnitude would also limit our 
ability to supplement the high-priority project funding that 
was specified in the original TEA-21 legislation.
    Another example, South Carolina, a reduction of $112 
million in Federal funding would have a $140 million impact on 
their program, and on and on.
    We have provided to the committee copies of our survey 
report, hot off the press, which identifies the direct impact 
of this proposed funding reduction on each State's 
transportation program.
    In the longer term, we are very concerned that the proposed 
fiscal year 2003 cut from $32 billion down to $23 billion will 
be used as a baseline for reauthorization of TEA-21, making it 
extremely, extremely difficult to enact legislation to address 
the Nation's highway investment needs.
    We strongly support the bill introduced by Senator Jim 
Jeffords to restore highway funding to not less than $27.7 
billion for fiscal year 2003. We commend the Senator and the 27 
co-sponsors of the bill for their appreciation of how important 
sustained highway investment is to our country.
    However, we would ask that you look once step farther. It 
is our emphatic view, and that of the Nation's Governors, that 
it is vital to sustain Federal highway investment in fiscal 
year 2003 at no less than the $31.8 billion level provided in 
fiscal year 2002. With upwards of 40 State Governors and 
legislatures already contending with severe budget shortfalls 
and the Nation struggling to recover from recession, it makes 
no sense, no sense, as you have said, Mr. Chairman, to cut the 
highway program.
    Now, there has been some concern expressed that the Highway 
Trust Fund can't support full funding at the $31.8 billion 
level in fiscal year 2003. We believe that this question needs 
and deserves a credible answer. Therefore, we would 
respectfully suggest and urge that the Budget Committee obtain 
calculations from the Congressional Budget Office to determine 
the maximum sustainable level for highway funding in fiscal 
year 2003. With that information in hand, it seems to us, as 
you draft the fiscal year 2003 budget resolution, you could 
make room to permit the maximum level of Federal highway 
spending that can be sustained.
    Now, as Congress looks to the reauthorization of Federal 
highway and transit programs next year, this RABA forecasting 
method we believe needs some refinement to avoid such wild and 
harmful funding swings in the future, and particularly in times 
of economic downturn. But clearly, at least to us, the firewall 
and guaranteed spending principle must be preserved. After all, 
the intent of the RABA provision is simply to ensure that the 
revenue collected in highway user fees from all of us is fully 
spent on transportation improvements. We believe that 
preserving a mechanism to enable year-to-year adjustments is 
critically important.
    Mr. Chairman, in the final analysis, though, this issue is 
more than calculations and revenue projections and bricks and 
mortar. As has been so aptly stated before, it is about people; 
it is about jobs; it is about people's lives, their safety and 
their mobility; and it is about economic growth and vitality. 
Construction contractors throughout the Nation will soon begin 
to cut back on equipment purchases and lay off tens of 
thousands of well-paid construction workers. Likewise, 
engineering consulting firms will almost immediately have to 
start laying off engineers and technicians, as design work for 
anticipated projects for next year is delayed or cancelled.
    We understand, Mr. Chairman, that there are multiple 
national priorities competing for limited budget resources, but 
would submit that investment in better infrastructure makes for 
a better America.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. King follows:]

The Prepared Statement of Larry M. King, Deputy Secretary for Planning 
               Pennsylvania Department of Transportation

    Mr. Chairman and Members of the Committee, my name is Larry King. I 
am the Deputy Secretary of the Pennsylvania Department of 
Transportation, and I serve as Secretary/Treasurer to the Board of 
Directors of the American Association of State Highway and 
Transportation Officials (AASHTO), and I lead AASHTO's Financial Issues 
Work Team for Reauthorization. I also am here today to testify on 
behalf of AASHTO.
    I want to thank you for your leadership in scheduling a hearing to 
specifically address the impacts of the President's proposed Fiscal 
Year 2003 budget on the Nation's highway infrastructure. I am also 
honored that you invited me to testify before your Committee. I believe 
that I can offer a real world picture of the significance of the 
Federal-aid highway program to the States highway infrastructure 
programs.
    Mr. Chairman, I would like to start by giving your colleagues a 
brief picture of the Commonwealth of Pennsylvania. Although the 
Keystone State is not large in geographic size, we are fifth in 
population with more than 12 million people. One-third of our 
population lives in rural areas, giving us the largest non-urban 
population in the country. By 2025 our population is expected to grow 
by 20 percent to 14.3 million, and most significantly, the number of 
residents aged 65 and older is expected to grow by 80 percent during 
the same time period. Pennsylvania also ranks fifth among the States in 
the size of the highway system under its jurisdiction. The Commonwealth 
owns, maintains and operates 40,500 miles of highways 34 percent of the 
total system and 25,000 bridges, which are spread out across many rural 
miles as well as in the metro areas. This 34 percent percent of the 
system carries 76 percent of the total vehicle miles of travel. The 
remaining travel is on systems maintained by municipalities or other 
governmental agencies.
    Pennsylvania also serves as a highway freight land-bridge for the 
Northeastern States, carrying a higher percentage of trucks on its 
interstates roughly 35 percent than any other northeastern State. 
Pennsylvania is called the Keystone State for a good reason. It is the 
connection between New York, New Jersey, New England and the rest of 
the country. With more cars, trucks, and increasing vehicle miles of 
travel, we must focus on preservation of our highways and bridges. At 
the same time, our highest priority will continue to be ensuring the 
safety and security of the transportation system while preserving and 
enhancing the environment. The unique demographics of our State present 
challenges in developing, maintaining and operating a multi-modal 
transportation infrastructure that balances the diverse needs across 
the State increasing congestion in growing urban areas, access and 
economic development in rural regions, and an aging population with 
special needs.
    To address these challenges, we are working with our local 
officials and the private sector to try to keep pace with the competing 
demands on our transportation infrastructure. We have been able to make 
progress in our safety and highway and bridge preservation and capacity 
needs across all regions of the State. For example, in just one year 
beginning in 2000, we reduced the number of closed bridges by 29 
percent while the number of miles of Interstate highways with poor 
pavements declined by 26 percent and the number of miles of National 
Highway System road with poor pavements declined by 41 percent. This 
progress would not have been possible without the 40 percent growth in 
the Federal aid highway and transit programs provided by the 
Transportation Equity Act for the 21st Century enacted in 1998. The 
additional resources from TEA-21 have enabled us to leverage our State 
and local resources to complete such projects as:
    United States 22/322, Dauphin Bypass, Dauphin County, $85.4 
million, a crucial four-lane limited access connection north of the 
State capital at Harrisburg.
    United States 11/15, widening, Perry County, $58.8 million, another 
important connection north out of Harrisburg to the Williamsport area.
    Kittanning Bypass, Armstrong County, $39 million, and United States 
6, Tunhannock Bypass west, nearly $21 million--two projects which stood 
in line for decades awaiting funding. Both are taking heavy truck 
traffic off the Main Street of two towns, making them much more 
livable.
    Mr. Chairman and Members of the Committee, we in the States are 
stunned by the fiscal year 2003 budget proposal which, in the midst of 
trying to climb our way of a recession, would cut the Federal aid 
highway program by $8.6 billion. While we recognize this reduction is 
the product of an apparent reduction in estimated revenues to the 
Highway Trust Fund, which triggered a reduction in the calculation of 
Revenue Aligned Budgetary Authority (RABA), the results are not 
mechanical. This reduction would mean a disastrous cutback in highway 
improvements, reducing our ability to meet basic highway needs, and the 
loss of thousands of jobs.
    We support S. 1917, the Highway Funding Restoration Act recently 
introduced by Senate Environment and Public Works Committee Chairman 
James Jeffords, which would restore highway assistance to no less that 
the $27.7 billion level for fiscal year 2003 authorized in TEA-21. We 
believe that this is a good first step.
    However, we want to share with you our emphatic view that it is 
vital to sustain Federal highway investment in fiscal year 2003, at no 
less than the $31.8 billion level provided in fiscal year 2002. With 37 
State governors and legislatures already contending with severe budget 
shortfalls, with revenue projections down in 45 States, and the Nation 
in an economic downturn, cutting the highway program by $8.6 billion 
just makes no sense. This is especially so when there are more than 
sufficient reserves in the Highway Trust Fund to provide funding for 
fiscal year 2003.
    Let me outline what we believe the consequences would be unless 
current levels of funding are sustained.
    As early as next month, State and local officials will begin the 
task of cutting billions of dollars in highway projects from their 
fiscal year 2003 Transportation Improvement Programs. Final decisions 
will be made public in September affecting nearly every community in 
the Nation.
    Construction contractors throughout the country will start making 
business plans on how to cut back their equipment purchases and lay off 
tens of thousands of well-paid construction workers. The stock prices 
of several heavy equipment manufacturers and construction companies 
have already dropped. Engineering consulting firms, already hard hit by 
the recession, will almost immediately have to start laying off 
engineers and technicians as design work for next year's projects is 
delayed or canceled.
    Numerous projects will be delayed in every State. These are 
projects that the public has long awaited and expect to be completed as 
promised.
    This cut is proposed at a time when we continue to have increased 
needs for highway safety and preservation projects, and for new 
capacity projects in the more rapidly growing western, southwestern and 
southeastern regions of the country. In addition, since the tragic 
events of September 11th the capital and operating needs associated 
with hardened transportation facilities and dealing with emergency 
response, including communication infrastructure needs, are greater 
than ever.
    At the same time, traffic volumes are up all over the country. The 
most recent data from the Federal Highway Administration shows an 
increase in annual traffic growth of nearly 3 percent.

                             State Impacts

    AASHTO recently completed a survey of State departments of 
transportation to assess the direct and indirect dollar and project 
impacts across all 50 States. I have attached a copy of the results of 
that survey, but want to share some of the highlights of the 
consequences of a $8.6 billion cut in the Federal aid highway program:
    The reduction will result in substantial project delays and in 
creased costs, even if Federal funding is eventually restored. In North 
Dakota, the reduction would increase the size of the existing backlog 
of needed projects, and increase the gap between the program and 
program needs by about 50 percent. In Iowa, this result would be a 
delay of approximately $50 to $60 million in State highway/bridge 
construction projects in fiscal year 2003. Cities and counties would be 
forced to delay approximately $25 to $30 million in local road and 
bridge projects. South Carolina would be forced to delay $25 million in 
pavement and reconstruction contracts, $22 million in Interstate 
upgrades, $35 million in Interstate maintenance, $15 million in Safety 
upgrades, $11 million in Bridget Replacement, and a total of $31 
million in other areas including Enhancements, Planning, and Advance 
Construction for fiscal year 2003. Texas reports that the long term 
effects of their anticipated $532 million reduction include significant 
project scheduling impacts with less funding available in fiscal year 
2003 to acquire right-of-way and fund preliminary engineering. In 
Oklahoma a total of $120 million in construction and right-of-way 
projects would be delayed or cancelled.
    The reduction in Federal funding will put a great strain on State 
resources during a time when the economy is and State tax revenues are 
declining. Washington State reported that it is in the midst of a 
transportation funding crisis and the $125 million reduction could not 
come at a worse time. Wisconsin is facing a $1.1 billion general fund 
deficit. While the State's transportation fund is currently in balance, 
it has been used to help offset the general fund deficit. Current 
proposals include transfers of $25 million or more from the 
transportation fund, $5 million of which has already been transferred. 
The combination of the Federal funding reduction, State budget 
overestimate, and State transportation fund transfer for the general 
fund deficit could reduce transportation funding in the State by $175 
million or more.
    The reduction in Federal funding would result in unacceptable job 
losses. Estimates show that an $8.6 billion reduction could result in 
over 150,000 jobs lost in the peak year. In Montana the reduction would 
mean a loss of 2,805 jobs--roughly equal to 25 percent of the new jobs 
created in Montana in 2001.
    The reduction would result in less funding for local projects and 
transit. For fiscal year 2003 New Jersey plans to transfer two-thirds 
of its Congestion Mitigation and Air Quality (CMAQ) funding ($65 
million out of $97 million) to transit. These funds would have to be 
proportionally constrained. Nebraska would have to delay approximately 
$45 million of State Highway System projects and about $15 million of 
Local System projects in fiscal year 2003.
    Mr. Chairman, these are but a few examples of the very real 
consequences of the cut in Federal aid highway funding resulting from 
the most recent RABA calculation. The mechanism itself was created as a 
tool to ensure that the highway user revenues going into the Highway 
Trust Fund would be fully used for the Federal aid highway and transit 
programs. Like any new mechanism a new car design, the latest office 
technology or kitchen gadget--sometimes defects and imperfections show 
up and must be fixed. We believe that Congress could not have foreseen 
and certainly never intended such an abrupt cutback in the highway 
program and its resulting devastating job losses at precisely the time 
of an economic downturn.
    Mr. Chairman, we respectfully recommend that given the current 
economic conditions, the negative impacts to States, and the documented 
need for infrastructure investment, the Federal aid highway program be 
sustained at the fiscal year 2002 level of $31.8 billion. We further 
suggest that the current $19.3 billion cash balance in the Highway 
Trust Fund is more than sufficient to cover the $2.4 billion in 
additional outlays that would be required to sustain current highway 
program levels in fiscal year 2003.

                               A Response

    The public policy questions Congress needs to address are these. 
First, to assist in the Nation's economic recovery does it not make 
sense to sustain highway funding at $3 1.8 billion? Second, are there 
reserves and cash flow in the Highway Trust Fund to make this possible 
in fiscal year 2003? We believe that the answers are emphatically 
``Yes'' and ``Yes!''

         Funds Are Available to Sustain fiscal year 2002 Levels

    Four years ago Congress agreed to the fundamental principle that 
all the receipts going into the Highway Account would be fully used for 
transportation purposes, and not be used to hide the deficit or offset 
other government expenditures. But today there is a $19.3 billion cash 
balance in the Highway Trust Fund. We seek to provide $8.6 billion in 
obligations to restore the highway funding to the fiscal year 2002 
level. The budget impact of this increase will only require $2.4 
billion in outlays for fiscal year 2003 this will allow us to continue 
the momentum we have achieved in fiscal year 2002.
    The table displayed below shows receipts and expenditures for the 
Highway Account of the Highway Trust Fund for Fiscal Year 1998 thorough 
Fiscal Year 2003. Even accounting for unpaid obligations, it is clear 
that there is a substantial balance in the Highway Account with 
receipts exceeding outlays over the six-year period. Mr. Chairman, we 
respectfully urge the Congress and the Administration to honor their 
commitment to spend all the receipts going into the Trust Fund, unlock 
the balances that have built up and make a positive contribution to the 
current economic recession.
    We recommend that the Budget Committee take two immediate steps in 
support of reaffirming Congress commitment to the principle of spending 
all receipts to the Trust Fund. First, we urge you to request that the 
Congressional Budget Office develop independent estimates of the level 
of highway funding that the Highway Trust Fund can sustain while 
maintaining a sufficient balance to avoid a cash deficit. Second, as 
you craft your budget resolution for Fiscal Year 2003, we urge you to 
include sufficient funding to maintain highway funding at the fiscal 
year 2002 level.


                  Highway Account Receipts and Outlays
           Fiscal year               Receipts     Outlays     Difference
1998.............................         24.3         20.3          4.0
1999.............................         33.8         23.1         10.7
2000.............................         30.3         27.0          3.3
2001.............................         26.9         29.1         -2.2
*2002............................         27.7         30.2         -2.5
*2003............................         28.6         30.6         -2.0
Subtotal.........................        171.6        160.3         11.3
Balance from ISTEA...............          8.0
Total............................        179.6        160.3         19.3
 
Estimated
Note: The Highway account balance was $8 billion at the beginning of TEA-
  21. Therefore, the cash balance at the close of FY 2001 is $20.3
  billion.
Source: Federal Highway Administration.


             Firewalls and Revenue Aligned Budget Authority

    As we look to reauthorization of TEA-21 and the future of the 
Federal-aid highway program, we believe that it is essential to 
preserve and reaffirm the principle of a user-based transportation 
financing system in which all receipts are guaranteed to be used for 
the purposes for which they were intended.
    To accomplish this, TEA-21 set highway obligations at levels based 
on then-current estimates of gasoline and related tax receipts, and 
established two mechanisms to guarantee spending. First, separate 
budgetary spending caps or ``firewalls'' were established in the Budget 
Enforcement Act for highway and transit spending. Second, TEA-21 
included an adjustment mechanism, Revenue Aligned Budget Authority 
(RABA), to annually adjust the spending caps or ``firewalls'' based on 
updated revenue estimates, increasing or decreasing highway spending 
each year so that it would align itself with Highway Trust Fund 
receipts.
    These tools RABA and the ``firewall'' provisions--were designed to 
provide the long-term fiscal stability needed for State and local 
highway and transit agencies to finance, design and execute multi-year 
multi-million dollar construction programs.
    Mr. Chairman, we urge you and the Members of your Committee to 
maintain the ``firewall'' provision for highway and transit spending.

                    Refinement of the RABA Mechanism

    Recent experience has demonstrated that there are unintended flaws 
in the RABA mechanism. Changes in economic conditions that result in 
minor adjustments to estimated receipts cause wide swings in highway 
funding levels. As with any new mechanism, it is appropriate that we 
carefully examine and refine the RABA mechanism, including its 
calculation methods and revenue estimating procedures. We recommend 
that Congress consider replacing the current calculation method with 
one that simply compares actual previous year receipts to the 
assumptions made at the time the bill passed, with the difference 
becoming the RABA adjustment.

                    Accuracy of the RABA Calculation

    One serious concern that must be addressed is the accuracy of the 
process used by the Department of the Treasury to determine the revenue 
estimates used in calculating RABA. The correction of a $600 million 
error by the Department of Treasury has already reduced the proposed 
highway cutback to $8.6 billion. Recent information on fiscal year 2001 
truck sales and fuel tax revenues at the State level call into question 
the Treasury forecasts. For example, the American Trucking Associations 
indicates that its data shows truck sales down by 23 percent for 1991 
as compared to the Treasury estimate of 50 percent. This leads us to 
believe that other adjustments in RABA could occur.
    We recommend that you consider instituting reforms to the 
Department of Treasury's process for estimating tax receipts to the 
Highway Account. This is not the first time that the Department of 
Treasury has made costly errors. In 1994, a $1.3 billion error 
eventually cost $3.6 billion to correct. This most recent $600 million 
error leaves us with absolutely no confidence in their accounting 
methods. We are not alone in our concerns. In June 2000, the United 
States General Accounting Office released a report in which they 
indicated that ``Treasury's process for allocating tax receipts to the 
Highway Account of the Highway Trust Fund is complex and error prone.'' 
At the request of House Transportation and Infrastructure Chairman Don 
Young and Ranking Member James Oberstar, GAO is now engaged in a new 
review of Treasury's methods for estimating receipts to the Highway 
Account. We urge you carefully consider the results of GAO's review, 
and consider appropriate reforms during reauthorization.

                            Long-term Issues

    In addition to the immediate impacts of reducing highway spending 
by more than a quarter, the RABA downward adjustment has longer-term 
consequences for the Federal-aid highway program. If the obligation 
level for Fiscal Year 2003 is adjusted downward from $31.7 to $23.2 
billion, then the $23 billion level will become the baseline for 
reauthorization of TEA-21. That would leave us at a starting point $8.6 
billion below where we are today, and considerably lower that the $27.8 
billion obligation level for fiscal year 2003 contained in TEA-2l. 
Starting in such a deep hole, would make it much more difficult to 
maintain the Federal-aid highway program at current levels, and perhaps 
impossible to expand it.

                              Conclusions

    In conclusion, I would like to State that the Federal-aid highway 
program has been one of the most successful Federal-State partnerships 
ever created. It has contributed to the Nation's mobility safety, and 
to the unprecedented economic growth that the nation has experienced 
since the 1950's.
    TEA-21 is a major step forward in providing much-needed funding to 
the Nation's highway and transit program, It is essential that the RABA 
principle of fully spending Highway Trust Fund receipts and 
guaranteeing that spending be maintained. However, it is also essential 
that in a time of recession, the consequences of the RABA mechanism not 
be permitted to eliminate hundreds of thousands of jobs while setting 
back much-needed transportation projects nationwide.
    We emphatically believe that there are sufficient receipts in the 
Highway Trust Fund to sustain a higher program level. Authorizing a 
higher level is consistent with TEA-21, which provided additional 
contract authority to the States to assure that the Congress could 
elect to increase the program above the guarantee. We urge the Congress 
to make this investment in America. We urge the Congress to deliver on 
the promise of TEA-21 to fully use all the revenues in the Highway 
Trust Fund.

    Chairman Conrad. Thank you.
    Might I just inquire, Mr. King, have you looked at this 
question of job loss associated with the cut that has been 
proposed in the President's budget?
    Mr. King. Yes, we have, Mr. Chairman. There are several 
algorithms around for estimating job impacts. Administrator 
Peters earlier referred to a 38,000-job-per-billion impact. 
There are higher estimates around. I have seen 42,000 also as 
an estimate. But, clearly, the job impact potential here is 
enormous, and the 350,000-job impact number that you used we 
believe is in the ball park, certainly.
    Chairman Conrad. So you believe that that estimate has 
credibility? That is an estimate that was given to me in a 
hearing that we conducted in North Dakota during the break on 
the question of the impact of the President's proposal, not 
only in terms of projects underway but what the impact would be 
on jobs. And the number that we were given was actually in 
excess of 350,000. So you think that would be in the ball park?
    Mr. King. Yes. And to be clear, the job impact estimates 
not only include people who are actually working in the 
projects themselves, but also people working in the supply 
industries and other attendant industries that support--
    Chairman Conrad. Engineering firms?
    Mr. King. Absolutely.
    Chairman Conrad. Yes. We understand that. I thought what 
Ms. Peters said here was not credible. She talked about 18,000 
jobs lost. That I don't think has any serious credibility 
attached to it as a number. Did you hear her testimony with 
respect to that?
    Mr. King. I certainly did, yes, and frankly I didn't follow 
the logic of that particular number.
    Chairman Conrad. I don't think there is any logic to it. It 
is kind of make-believe.
    Let me ask you this: I don't know if we are going to be 
able to fully restore this cut, $8.6 billion. That is a very 
serious problem. We know we can't live with the magnitude of 
the cut the President has proposed. It would not be good for 
the economy given the attendant job losses. It would not be 
good for the overall efficiency of the economy given the cost 
of gridlock that is occurring all across America.
    I know that AASHTO and the Governors are asking us to fully 
restore the cut. Have there been any other calculations done by 
your organization with respect to other levels of funding that 
you would consider?
    Mr. King. Well, certainly, Mr. Chairman, we would always 
want the maximum level of funding, to state the obvious. We 
believe, again, that the crux of this question lies with the 
level of funding that can be supported by the Highway Trust 
Fund. And as we know, there are a number of different versions 
of what that number might be.
    Chairman Conrad. Yes, that is correct, and there is a very 
important point that you made in your testimony, and I want to 
tell you that we will absolutely follow the request that you 
have made to ask the Congressional Budget Office to do a 
calculation of what will the trust fund sustain.
    I am sorry to have interrupted.
    Mr. King. That is quite all right, Mr. Chairman. Beyond 
that, though, the GAO is presently examining the numbers that 
have been forthcoming from the Treasury Department relative to 
the Highway Trust Fund revenue picture. You may recall that 
when all of this began a few months ago, the anticipated cut 
was $9.2 billion. Then suddenly there was a $600 million error 
in the revenue statistics that was discovered, which now 
results in the $8.6 billion number.
    Frankly, that leaves us little confidence in the Treasury 
Department's numbers, and there is an ongoing study right now 
by GAO looking at the process, if you will, for generating 
those numbers by the Treasury Department.
    Chairman Conrad. Let me just ask a final question here. I 
have been told by some that an informal calculation has 
concluded that if we were to have the entire $8.6 billion 
restored, it would then require a gas tax increase for TEA-21 
authorization to stay even. Are you familiar with assessments 
that have reached that conclusion?
    Mr. King. I am not, Mr. Chairman. As a matter of fact, I 
seem to recall that there are some assessments, again, perhaps 
informal, that would show that the existing tax structure can 
support a program level in the range that we are speaking of 
here for the foreseeable future.
    Chairman Conrad. Well, that is obviously the question we 
have got to get answered here. We do not want to trigger any 
requirement for a gas tax increase. That is not the purpose of 
this undertaking. So it is very important that we get what, in 
fact, the trust fund will sustain. I thank you very much for 
your testimony.
    Mr. King. Thank you, Mr. Chairman.
    Chairman Conrad. Mr. Till, welcome. Thank you very much for 
being here, and thank you for your patience as well. I 
appreciate that. If you would proceed?

STATEMENT OF THOMAS A. TILL, EXECUTIVE DIRECTOR, AMTRAK REFORM 
                            COUNCIL

    Mr. Till. Good morning. Thank you very much, Mr. Chairman. 
I am just happy to have an invitation to present the council's 
views today, on the President's budget and its effect on 
funding infrastructure investments and other expenses related 
to intercity rail passenger service.
    Also here today, Mr. Chairman, is one of the council's 
members, Mr. James Coston of Chicago.
    I am going to speak to the council's views in the context 
of the council's Action Plan for Restructuring and 
Rationalization of the National Intercity Rail Passenger 
System, a report that was submitted to the Congress on February 
the 7th, and with your permission, Mr. Chairman, I will 
summarize my statement and submit the full statement for the 
record.
    Chairman Conrad. I appreciate that very much, Mr. Till.
    Mr. Till. The council has submitted its recommendations to 
the Congress for reform, and we are sure that other reasonable 
reforms will be proposed for Amtrak. Indeed, Senator McCain has 
introduced I think an 86-page piece of legislation with that 
objective in mind.
    I think the most important thing is that the council 
believes that reform of Amtrak is no longer an option, Mr. 
Chairman. Reform is an imperative. It is an imperative both for 
effective operation of the passenger program and passenger 
service, and it is also an imperative, as I hope you will 
conclude after my testimony, if we are to fund rail passenger 
service effectively.
    Over its lifetime, Amtrak's ridership growth has barely 
kept pace with the growth of the United States population. And 
contrary to popular belief, the period between September 11th 
of last year and the end of last year, in that period Amtrak 
carried fewer passengers than it did in the comparable period 
of the year before, 2000. Amtrak is burdened with debt and debt 
service, and its assets are in poor condition. And the 
continuing deterioration of Amtrak's performance since the 
council was established led the council to its finding last 
November that Amtrak would not be operationally self-sufficient 
by December 2, 2002, as the Amtrak Reform and Accountability 
Act of 1997 requires.
    Indeed, Amtrak is no closer to self-sufficient today than 
it was in 1997, despite the appropriation to Amtrak, over 5 
years, of more than $5 billion, including $2.2 billion in 
capital funding under the Taxpayer Relief Act. Amtrak's 
announcement on the 1st of February of this year that it needs 
$1.2 billion for 2003 or it will shutdown the network of 18 
long-haul trains is likely to be business as usual for Amtrak: 
lower revenues than projected, higher costs than projected, 
greater losses than projected.
    Sadly, Amtrak has proven that it cannot in its current 
structure concentrate on its core mission of running trains. It 
has too much to do, and it does little of it well. As it is 
chartered and organized today, no agency of the Government has 
effective oversight of Amtrak's business plans, its funding 
requests, or its financial and operational performance. A 
program cannot be effective without effective oversight, and 
Amtrak has none.
    The action plan the council sent to Congress on the 7th of 
February thus recommends a fundamental restructuring of the way 
we organize, fund, and operate rail passenger service under a 
new program that provides a structure for operating passenger, 
mail, and express service, and also separately for developing 
the infrastructure to support those operations throughout the 
country. If we are to have an effective rail passenger service, 
Mr. Chairman, the council believes we have to organize and fund 
passenger trains and the infrastructure that supports them 
separately.
    The council proposes that the new program be administered 
by a small Federal agency, which is a restructured National 
Railroad Passenger Corporation, an institution which already 
exists in the current Rail Passenger Service Act. The council 
recommends that the NRPC be modeled after the United States 
Railway Association, which was created by Congress in 1973 to 
restructure Penn Central and six other bankrupt Northeast 
railroads.
    USRA enforced strict accountability on Conrail, it shielded 
Conrail from political interference, and by working closely 
with Conrail management, contributed to Conrail's success. The 
council believes that the national passenger rail program needs 
and would benefit from a similar oversight organization.
    In this framework, a new train operating company could 
concentrate on running trains, with the resources to do so, 
under contract, with no unfunded mandates, and without 
political pressure on its management decisions.
    To ensure that there are adequate incentives for 
efficiency, the council proposed a national passenger train 
operating company. The council also recommends introducing the 
possibility of competition into the provision of passenger 
train services. In many countries around the world, reforms in 
the provision of both passenger and freight rail service have 
involved competitive bidding for contracts to provide those 
public services.
    Our recommendations also deal strongly with the parts of 
the Northeast Corridor and other infrastructure that Amtrak 
owns. Today Amtrak is a minority user of the Northeast 
Corridor--running only about 150 of the corridor's 1,200 
trains--and its finances and management cannot bear the burden 
of maintaining and improving what is largely a commuter 
facility. The main evidence of the infrastructure's physical 
deterioration is the increase in minutes of delay under 
Amtrak's stewardship--from 134,000 minutes in 1998 to 234,000 
minutes in 2001, or more than 160 days of train delay. The 
system is literally slowing down, and this is reported in the 
January 2002 report of the DOT Inspector General.
    The council's final major recommendation for a passenger 
program is that the Congress enact measures to provide stable 
and adequate sources of funding--separate sources for train 
operations and for infrastructure--under a restructured rail 
passenger program. There are those who say that putting more 
money into the existing Amtrak is all we need to do. The 
council strongly rejects that notion. What we have today, Mr. 
Chairman, is an institution that through more than 30 years of 
existence has never had the full confidence of either the 
Congress or the Executive regarding its ability to spend money 
properly. And this is without regard to which party controlled 
either of those branches. Effective structural reforms will 
correct that lack of confidence.
    Even then, the reality of Government funding today poses 
important challenges, as you know, to effective funding of 
passenger rail infrastructure and other needs. Guaranteed 
spending programs have been very beneficial for highways, 
transit, and aviation, but other modes of transportation are 
having a tougher time getting funds appropriated. Today 
guaranteed spending programs predetermine the appropriation of 
75 percent of all transportation funds. As a result, there is 
no room in the appropriations bill to fund major facilities 
such as the Northeast Corridor infrastructure, which needs all 
by itself about $1 billion a year. Clearly, the Northeast 
Corridor infrastructure has to be shifted to an owner that has 
better access to Federal, State, and local guaranteed funding 
than Amtrak has.
    Most important for the infrastructure needs of an improved 
passenger rail program are several bond bills that have been 
introduced. One is the High Speed Rail Investment Act [S. 250], 
co-sponsored by Senators Daschle and Lott. A bill sponsored by 
House Transportation and Infrastructure Committee Don Young, 
so-called RIDE-21 [H.R. 2950], would provide $36 million in 
tax-exempt bonding authority--and $35 billion additional in 
loan guarantees--for railroad investments.
    Under appropriate safeguards, as another potential source 
of funding, the council also recommends that States should have 
the flexibility to use highway and aviation funds for 
investments to improve the intermodal connectivity of the 
passenger network or to fund rail investments that would 
relieve highway or aviation congestion in short-haul corridors.
    The Federal fuel tax revenue shortfall of approximately $8 
billion, which has been spoken about much here today, is not 
only bad for highway infrastructure; it will have a devastating 
impact on the flexible provisions of TEA-21.
    Pending House and Senate bills would restore funding above 
the Administration's request. If the funding is restored, the 
likelihood that the flexibility provisions will be exercised is 
greater because the highway program would be funded to the 
level projected in TEA-21.
    When such a program--and I am talking about a rail 
infrastructure program--is enacted--and I say ``when,'' not 
``if''--such funds will be the engine for an effective Federal-
State rail infrastructure program, in cooperation with the 
freight railroads, to support improved passenger service. The 
systematic and continuing improvement of railroad 
infrastructure that this program would support is the essential 
foundation for the sound national passenger program that 
America needs, both across the country as well as in the 
Northeast Corridor.
    The issue of funding for operating subsidies and other 
capital needs of long-haul trains or of corridor trains is more 
difficult. The council's action plan recommends the Government 
provide funding on the basis of a formula that would promote 
efficient use, not simply fund inefficient, deficit-ridden 
operations. Funding under such a structure might be provided 
through appropriations or through some dedicated source of 
funding. Some have suggested that a new penny might be added to 
the Federal motor fuel tax that could go to rail uses if 
matched by a new penny from a State's motor fuel tax. Under the 
program structure that the council recommends, in which train 
operations would be provided under contract, much of the 
funding for passenger equipment investment needs of the 
operating company, in the council's view, should be able to be 
secured from private capital markets.
    Let me now address the Northeast Corridor infrastructure.
    Chairman Conrad. If I could just interrupt before you do 
that, I would just say, Mr. Chase and Mr. King, we would be 
happy to excuse you at this point. We had indicated we would 
try to be done at noon, and perhaps you have made plans on that 
basis. So I would want to at this moment excuse the two of you 
so that we keep our commitment. I thank you both very much for 
being here.
    I apologize, Mr. Till, for interrupting, but we had reached 
the appointed hour.
    Mr. Till. No need to apologize.
    Chairman Conrad. Because of the vote earlier we have been 
delayed, and I didn't want them to miss something. Please 
proceed.
    Mr. Till. Thank you, sir.
    Let me address the Northeast Corridor infrastructure. 
Separating the Northeast Corridor infrastructure--both 
organizationally and financially--from Amtrak's nationwide 
train operations--and that includes their train operations in 
the Northeast Corridor--is another way of narrowing the gap 
between the subsidy needs of Amtrak's train operations and the 
uncommitted funds available in the budget. There is little or 
no chance that Amtrak will be able to get the capital it needs 
if it is to maintain and improve the Northeast Corridor rail 
infrastructure out of appropriated funds. It has not been able 
to do so. Why?
    Amtrak has demonstrated that it will try to use whatever 
capital is available to offset the operating losses of its 
trains. To fund operations, Amtrak raised $300 million for 
operating expenses last year by mortgaging 16 years of future 
income from two concourses in Penn Station, New York. It 
regularly charges portions of its large management overhead to 
capital projects, and it has deferred maintenance on the 
Northeast Corridor infrastructure below levels needed for 
minimum operational reliability, according to the DOT inspector 
general. And despite the $3.8 billion backlog of capital 
projects on the Northeast Corridor, Amtrak did not request the 
full amount of appropriations authorized by the Congress under 
the Amtrak Reform Act.
    And we were quite surprised, Mr. Chairman, that, in their 
February 1st press conference; that they indicated that the 
Congress had not provided that money. The fact is Amtrak did 
not ask for it.
    Our view is that Amtrak, as is presently structured, cannot 
be an effective public steward for the vital infrastructure 
known as the Northeast Corridor.
    The council's action plan describes a variety of funding 
sources for the corridor, which, while not directly available 
to Amtrak, may be much more accessible to State governments to 
assist in providing the investments to support their large NEC 
commuter operations.
    Indeed, there is no single source, no silver bullet, that 
could provide all the necessary capital for the Northeast 
Corridor. Thus, the Congress should look at a variety of 
sources, which may include:
    Bond bills that are pending before the Congress, as I 
mentioned before;
    A Federal appropriation, perhaps through a reauthorized 
Northeast Corridor improvement program, to address some of the 
life/safety projects that must be addressed soon, particularly 
in Penn Station, New York, and several bridges and tunnels;
    The Congress might also consider providing part of the 
funding needed to establish a trust fund to pay off bonds for 
Northeast Corridor life/safety improvements;
    TIFIA and RRIF, railroad loan guarantee and loan programs, 
may be employed in various ways. One way would be to work with 
regional transmission organizations in the Northeast, in 
partnership with a restructured National Railroad Passenger 
Corporation and the States, to undertake one of the major 
projects south of New York, which would be the funding of the 
replacement of the electric traction system, which is keeping 
Acela Express at a speed or 135 miles an hour, rather than its 
designed speed of 150, south of New York;
    As mentioned above, the Congress should consider expanding 
the flexibility provisions in current transportation trust 
funds to include the Northeast Corridor projects that would 
reduce highway and air traffic congestion;
    And--I am sorry General Flowers and Mr. Parker have left--
civil works projects under the Army Corps of Engineers are 
often undertaken with Federal transportation funds, and there 
is some precedent for the Corps to undertake bridge projects 
that are over navigable waters. And I am sure that throughout 
the Amtrak network and certainly in the Northeast Corridor, 
there are a number of bridges that are in critical condition;
    The Congress could also expand the role of the NEC States 
through special-purpose mechanisms for ownership and control. 
Assets such as the Penn Station Complex, whose needs have been 
neglected for decades, might be effectively handled under some 
kind of appropriate regional umbrella;
    And, finally, Federal and/or State tax incentives might be 
developed to encourage the private sector to make investments 
in the corridor. The Association of American Railroads has 
suggested a similar funding mechanism for railroad investments 
nationwide.
    Mr. Chairman, the council believes its recommendations are 
strong and that they are sound. The chronic difficulty that 
Amtrak experiences--year in and year out--are not principally 
due to lack of funding. They spring primarily from an 
organization that is obsolete and that desperately needs to be 
redesigned.
    Effective reform will beget funding, at least better 
funding than we have today. Funding alone will not beget 
reform.
    Mr. Chairman, thank you for the opportunity to testify, and 
I am pleased to answer any questions.

 Testimony of Thomas A. Till, Executive Director, Amtrak Reform Council

    Mr. Chairman, members of the committee, thank you for the 
opportunity to appear before you today to discuss the Council's views 
on funding for infrastructure and other needs to support intercity rail 
passenger service.
    My name is Tom Till, and I am the Executive Director of the Amtrak 
Reform Council. I am here together with one member of the Council, 
James Coston, and several members of the staff, in response to your 
invitation to present the Council's views on the effect of the 
President's FY 2003 Budget Proposal on the prospects for financing 
needed improvements in rail infrastructure to support passenger rail 
operations. At first glance, it might appear that this has little to do 
with the other issues before the Budget Committee today, but I can 
assure you that there is a real link between the funding of road 
infrastructure and even infrastructure provided by the Corps of 
Engineers. The views I present today will be consistent with the 
Council's Action Plan for the Restructuring and Rationalization of the 
National Intercity Rail Passenger System, which was submitted to the 
Congress on February 7, 2002. With your permission, Mr. Chairman, I 
will summarize my statement and submit the full statement for the 
record.
    The Council's Action Plan clearly states the spirit of the 
Council's recommendations:

    ``The Council's view is that there should be a bright future for 
passenger rail service in America. But the Council believes that 
passenger rail service will never achieve its potential as provided and 
managed by Amtrak. A new and different program is needed to move 
forward.''

    In its three years of operation, the Council found strong and 
growing support for a modern, improved national program of intercity 
rail passenger service. The Council's dialogue with the States, Amtrak, 
and others, together with its own analyses and deliberations, have led 
us to support major improvements in our national passenger program 
based on a sound vision.
    Amtrak's performance is at odds with this vision. Over its 
lifetime, the increase in Amtrak's ridership has barely kept pace with 
the growth rate of the U.S. population. Despite popular belief to the 
contrary, Amtrak's ridership did not increase between September 11, 
2001, and the end of last year compared to the same period in 2000. 
Amtrak is burdened with debt and debt service, and its assets are in 
poor condition. And Amtrak's organizational structure and its 
management and financial systems are not those of a modern corporation.
    For these reasons, the Council strongly recommends that the 
Congress first adopt badly needed institutional reforms before 
providing major new funding for passenger rail service.
    The Council has submitted its recommendations to the Congress. We 
are sure that other reasonable reforms will be proposed. The most 
important thing is that reform is no longer an option, Mr. Chairman. 
Reform is an imperative.

                    I. The Failure of Today's Amtrak

    On November 9, 2001, the Amtrak Reform Council found that Amtrak 
will not achieve operational self-sufficiency by December 2, 2002, as 
required by the Amtrak Reform and Accountability Act of 1997. Amtrak 
finished FY 2001 with a loss of $341 million for purposes of self-
sufficiency, as the test is defined by Amtrak, and a record operating 
loss of $1.1 billion under Generally Accepted Accounting Principles.\1\ 
 Amtrak is no closer to self-sufficiency today than it was in 1997, a 
conclusion recently affirmed by the Inspector General of the US 
Department of Transportation, and Amtrak's announcement on February 1, 
2002, that unless it receives $1.2 billion of Federal funding in FY 
2003, it will eliminate all long-haul routes on October 1, 2002. 
Amtrak's actions to raise needed cash by mortgaging a portion of Penn 
Station and increasing its debt have weakened the company's financial 
condition.
---------------------------------------------------------------------------
    \1\ Based on Amtrak's unaudited financial statements. As of 
February 25, 2002, Amtrak had not released audited financial statements 
for the fiscal year.
---------------------------------------------------------------------------
    Sadly, Amtrak has proven that it cannot concentrate on its core 
mission of running trains and running them well. Under current law, 
there is no one who can hold the railroad accountable. It has too much 
to do, and does little of it well. As it is chartered and organized 
today, Amtrak does not have any effective oversight of its business 
plans, its funding requests, or its financial and operational 
performance. Nor are its many business operations flexible, innovative, 
or responsive to customer needs. One knowledgeable commentator called 
Amtrak ``a self-regulating monopoly"; it tries to set passenger rail 
policy, build and maintain the 366 miles that it owns of the 460-mile 
Northeast Corridor infrastructure\2\ , raise money, and run some 300 
trains a day nationwide both in the Northeast Corridor and over 20,000 
miles of private railroad tracks.
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    \2\ See Appendix for a diagram of the Ownership of the Northeast 
Corridor Infrastructure.
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                  A. Problems of a Flawed Institution
    The vision of improved passenger rail operations bears no 
resemblance to the performance of Amtrak over its 30-year history. The 
Council previously determined, as reported in its Second Annual Report, 
that the roots of Amtrak's flaws lie in its institutional structure. 
While one may criticize the management, the board of directors, and 
even the employees or the unions, the institutional structure is the 
root cause of Amtrak's problems. Effective reform will ensure that 
these same flaws do not undermine a new passenger rail program.
    Some outstanding examples of Amtrak's problems under its existing 
organizational structure include:

 Failure to develop and execute sound business plans has 
    prevented Amtrak from meeting its goals for revenue growth and cost 
    containment. 
    [GRAPHIC] [TIFF OMITTED] 80544.077
    

    Amtrak's original Strategic Business Plan for FY1999 FY2002 
projected that Amtrak would achieve self-sufficiency in fiscal year 
2002. With the delays in the introduction of Acela Express service and 
rising costs, Amtrak had to revise its Business Plan, pushing back the 
date for achieving operational self-sufficiency a full year to fiscal 
year 2003. Amtrak finished fiscal year 2000 $100 million behind its 
revised Plan. Amtrak finished fiscal year 2001 more than $150 million 
behind its revised Plan and about $280 million behind its original 
plan. Its operating loss for purposes of operational self-sufficiency--
as that test is defined by Amtrak--increased in FY2001 to $341 
million\3\ , up from $292 million in FY2000.
---------------------------------------------------------------------------
    \3\ Based on Amtrak's unaudited financial statements for fiscal 
year 2001. Amtrak concurs with the Amtrak Reform Council's calculations 
for purposes of the self-sufficiency test.
---------------------------------------------------------------------------
-  Amtrak's costs continue to grow faster than its revenues. Amtrak has 
    projected significant overall cost reductions in its strategic 
    business plans since 1999, but Amtrak did not define specific cost 
    reduction initiatives until FY2001, and those proposals total only 
    $75 million annually, exclusive of any savings from Amtrak's 
    planned reduction in force. These cost reductions are clearly 
    inadequate to meet Amtrak's strategic business plan projections.
     In five years, Amtrak has made no progress toward 
achieving self-sufficiency and is in aweaker financial condition today 
than in 1997. While Amtrak made modest improvements towards self-
sufficiency in FY1998 and FY2000, its FY2001 loss was its highest ever.
    On January 25, 2002, the US Department of Transportation's Office 
of the Inspector General (DOT/IG) released its report on Amtrak's 
FY2001 performance. The Inspector General reached the same conclusions 
as the Amtrak Reform Council about Amtrak's performance, stating 
``Amtrak's cash losses have not decreased and Amtrak is no closer to 
operating self-sufficiency now than it was in 1997. With less than a 
year remaining in its mandate, there is not sufficient time for Amtrak 
to implement the kinds of sustainable improvements necessary to meet 
its deadline for self-sufficiency.
    At this point in time, Amtrak will face a formidable challenge in 
2002 just managing its cash resources be they from operating revenues 
or Federal subsidies to make ends meet without further borrowing.''
[GRAPHIC] [TIFF OMITTED] 80544.078


 Amtrak's contentions to the contrary, simply meeting an annual 
    target for reduced Federal operating funding does not mean Amtrak 
    is making meaningful strides toward self-sufficiency. Amtrak has 
    been able to continue operations with more limited Federal 
    operating funds only by using Taxpayer Relief Act (TRA) capital 
    funds for operating purposes and by engaging in counterproductive 
    practices and transactions that have weakened the overall financial 
    and physical condition of the company.\4\  Federal operating grants 
    for Amtrak may be declining, but Amtrak's losses for purposes of 
    operational self-sufficiency are increasing. The statutory deadline 
    of December 2, 2002, for operational self-sufficiency is not a 
    finish line. It is instead the starting point from which Amtrak 
    must sustain operations over the long run without Federal operating 
    assistance.
---------------------------------------------------------------------------
    \4\  The sale leaseback of equipment in FY2000 raised approximately 
$124 million, and the $300 million Penn Station loan in FY2000 provided 
additional funds that were not in Amtrak's strategic business plans, 
but which helped fund cash shortfalls from business plan projections. 
Such additional debt and asset liens will limit future years options 
and sources of cash flow.
---------------------------------------------------------------------------
 Despite receiving appropriated Federal funds and TRA funds 
    totaling approximately $5 billion for Fiscal Years 1998 through 
    2002, Amtrak's assets are in worse physical condition now than when 
    the ARAA was passed.
 Amtrak's inability to follow its business plans have led to 
    imprudent borrowing, most notably the mortgaging of a portion of 
    Penn Station New York to obtain a $300 million loan that was used 
    to avoid running out of cash in the last quarter of FY2001. In 
    FY2000, Amtrak also engaged in the sale-leaseback of substantially 
    all unencumbered Amtrak equipment, which raised $124 million that 
    had not been projected as a cash source in its strategic business 
    plan for that year. The Penn Station loan and other borrowings, 
    including sale-leaseback transactions, have tripled\5\  Amtrak's 
    debt since 1995, increasing its costs for debt service to about 
    $200 million annually.
---------------------------------------------------------------------------
    \5\ Amtrak notes that its debt only doubled since 1995 if cash 
escrow deposits of approximately $1 billion set aside to defease (i.e., 
repay outstanding debt from a dedicated escrow fund) the sale-leaseback 
obligations are deducted from the approximately $3 billion of Amtrak 
debt outstanding at September 30, 2000.
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 Amtrak lacks a transparent accounting system for its 
    operations and infrastructure, an effective reservations system 
    that will identify seats available on Amtrak trains on a real-time 
    basis (including reservation no-shows), and a system to measure the 
    productivity of its use of capital, labor, energy, and materials.
 Amtrak has not made any use of the reforms enacted under the 
    Reform Act. Amtrak has not used its Reform Act authority to 
    restructure or eliminate unprofitable routes. It has not used its 
    Reform Act authority to contract out elements of its operations to 
    achieve cost savings.\6\ 
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    \6\ The Reform Act eliminated previous statutory prohibitions 
concerning contracting out work where the loss of a job would result, 
and made contracting out a collective bargaining issue. Amtrak and its 
unions have been in collective bargaining on the issue of contracting 
out since June 2000.
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 Until February 7, 2002, the day the Council submitted its 
    restructuring plan to Congress, Amtrak resisted all requests that 
    it separate the financial statements for the Northeast Corridor 
    Rail infrastructure that it owns and maintains from the financial 
    statements of its train operations. The preliminary information 
    provided by Amtrak to the Council raises important issues that need 
    to be resolved before the information can be used for analysis.
 Amtrak lacks a strong policy to improve the intermodal 
    connections of its system. A case in point is that Greyhound, which 
    serves about 3,500 cities, has secured access to only 55 of 
    Amtrak's 500 stations in the 30 years that Amtrak has been in 
    business, and at only 35 of those 55 stations do all Greyhound 
    buses serving that city come to the train station.

    These flaws make it clear that Amtrak will not achieve operational 
self-sufficiency because, as an institution, it has not been able to 
use the past four years to get its house in order by better managing 
revenues, costs, and productivity. The events of September 11 are 
simply irrelevant to the reasons why Amtrak's financial situation has 
not improved over this period, and why Amtrak will fail to pass the 
operational self-sufficiency test.
                    B. Root Causes of these Problems
    Amtrak's poor performance is the result of institutional flaws:

    Direct susceptibility to political pressures on major and minor 
management decisions, which provides strong incentives to make 
decisions that are politically expedient in the short run, but 
financially crippling in the long run.

 A monopoly structure, that exhibits inherent resistance to 
    innovation and lacks motivation to improve efficiency.
 Lack of transparency and accountability in Amtrak's management 
    structure, accounting system, and financial reporting
 Lack of effective program administration and oversight.
 A business model based on the faulty premises of large-scale 
    cross-subsidization and the availability of Federal funding as 
    needed.
    Lack of Congressional confidence in Amtrak as an institution, 
making it virtually impossible for Amtrak to secure stable and adequate 
funding.

    Both historically and currently, the administration and oversight 
of the passenger rail program are ineffective. Without reform, there 
will be continued reliance on deficit financing with no incentives for 
efficiency in the conduct of operations or the use of capital. These 
practices will continue to fuel the debate about the efficacy of the 
institution, making it difficult if not impossible to secure adequate 
funding. Inadequate funding will continue the cycle of deterioration of 
assets, both equipment and infrastructure. This particularly will be 
true for the passenger equipment on the long-haul trains and for the 
NEC infrastructure. The operational reliability of the NEC will 
continue to degrade, introducing further train delays that will if 
unchecked act as a drag on the competitiveness of the regional economy 
of the Northeastern US (New England and Middle Atlantic). Impediments 
to the ability of states outside the NEC to develop their emerging 
high-speed rail corridors will continue.
    Improvement will not come without institutional reform.

              II. REFORM CONCEPTS ENDORSED BY THE COUNCIL

    The Amtrak Reform Council's action plan is based on three principal 
concepts for reform.
    a) A New Business Model for Amtrak. Amtrak's primary mission is the 
transportation of people. Today's Amtrak also establishes and 
administers governmental policy on rail passenger issues and is 
effectively the sole Federal oversight body responsible for monitoring 
its own business plans and operations. Amtrak also owns and maintains 
much of the Northeast Corridor (NEC) rail infrastructure, an asset 
shared with commuter authorities and freight carriers and having an 
economic significance that transcends Amtrak's operations. To correct 
these institutional failings, the Council recommends:

 Restructuring the National Railroad Passenger Corporation 
    (NRPC) as a small Federal program agency to administer and oversee 
    the intercity passenger rail program. In the absence of 
    competition, a monopoly operator such as Amtrak needs government 
    oversight. While audits of Amtrak's financial performance are 
    regularly performed by at least three agencies, analysis and 
    reporting functions are not a substitute for effective, hands-on 
    oversight. Amtrak's current train operating and infrastructure 
    functions, under the Council's plan, would be strong companies with 
    independent boards. The NRPC would actively oversee the new train 
    operating and infrastructure companies with respect to budget 
    matters and approval of business plans. The NRPC would also be 
    responsible for administering the Federal program for development 
    of high-speed rail corridors and would have the authority, at its 
    discretion, to introduce competition for some or all Amtrak 
    markets.
 Organizing Amtrak's responsibilities for train operations and 
    infrastructure as separate companies. This would allow Amtrak to 
    focus on its mission of running trains and free it from the burden 
    of ownership for the portions of the NEC that it owns. A separate 
    infrastructure company would ensure that funds earmarked for 
    infrastructure improvements will be used for the intended purpose, 
    and will better represent and balance the needs of all Corridor 
    users and stakeholders. The NRPC would insulate both new companies 
    from political interference. Separation also would highlight the 
    NEC's 20-year capital needs, estimated by Amtrak to be nearly $28 
    billion.

    b) The Option of Introducing Competition. The Council's plan 
permits, after a transition period, the introduction of competition 
through the franchising of train service and NEC maintenance through a 
competitive bidding process. The Council believes that, as is the case 
throughout our free-market economy, competition would drive down costs 
and improve service quality and customer satisfaction.
    Competition would help minimize losses, but in all likelihood would 
not eliminate the need for operating subsidies. Some Amtrak services--
specifically Amtrak's long-distance trains would need to be offered on 
a negative bid basis, i.e., the bidder requiring the least subsidy 
would be awarded the franchise.
    The Council has taken a strong position in favor of protecting the 
rights of rail labor in any franchise arrangement. Congress, of course, 
would be the ultimate arbiter of the specific labor-protective 
conditions that would be imposed by law.
    c) Adequate and Secure Sources of Funding. The Council believes 
that adequate and secure long-term sources of funding are needed to 
meet the needs of the intercity passenger rail program.

               III. The Councils's Restructuring Proposal

    At its first working session to consider reform options, there was 
a consensus among the Council members that train operations and the 
Northeast Corridor infrastructure should be organized as separate 
companies and that any reform plan should include more effective 
government policy and program oversight. The Council then evaluated 
four distinct approaches for train operations: (1) national or regional 
operating monopolies; (2) competition for long-haul markets only; (3) 
competition for all markets; and (4) a regionally-managed, 
operationally self-sufficient rail passenger network.
    The Council considers all of the options meritorious, but 
specifically endorses option 3, with respect to train operations. The 
most significant amendment makes the introduction of competition 
permissive rather than mandatory.\7\ 
---------------------------------------------------------------------------
    \7\ A matrix summarizing the major elements of each of the 
proposals may be found at the end of Chapter IV.
---------------------------------------------------------------------------

            The Council's proposal thus has three elements:

    1. Federal Program Management and Oversight. The Council recommends 
that the administration and oversight of the national passenger rail 
program be conducted by the National Rail Passenger Corporation 
(NRPC),\8\  which would be restructured as a small government 
corporation. The NRPC would operate at arm's length from Amtrak's 
current train operations and infrastructure, which would be organized 
as companies with independent boards of directors. While it may be more 
appropriate for these companies initially to be subsidiaries of the 
NRPC, over the long term they would function more appropriately as 
separate companies. The NRPC's board of directors would comprise 
representatives from congressionally-defined regions covering the 
entire US (the governors of each of the regions would propose 
candidates to the President, for nomination to the Senate), the Federal 
Government, the railroad industry, and railroad labor. NRPC would hold 
the statutory franchise to operate over the rights-of-way of the 
freight railroads at incremental cost with operating priority, and 
would authorize the train operating company or other service providers 
to operate under the franchise on its behalf.
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    \8\  The name National Rail Passenger Corporation is retained to 
make clear that it is intended to be the legal successor to the 
existing NRPC. Under existing law, the NRPC holds Amtrak's statutory 
right to operate over the lines of the freight railroads at incremental 
cost and with operating priority, and such rights would be retained by 
the restructured NRPC.
---------------------------------------------------------------------------
    The Council recommends that the NRPC be modeled after the United 
States Railway Association (USRA), and be charged to administer and 
oversee the intercity passenger rail program. USRA was formed by the 
Congress in 1973 to plan Conrail and monitor its performance. USRA 
reviewed Conrail's business plans, monitored its progress in executing 
its plans, disbursed Federal funds, and had the authority to withhold 
funds if Conrail did not take actions to improve its performance. USRA 
enforced discipline, shielded Conrail from political interference, and, 
by working closely with Conrail management, contributed to Conrail's 
success. The Council believes the passenger rail program would benefit 
from a similar oversight organization.
    The NRPC would also:

 Administer Federal funds made available for intercity 
    passenger service;
  Administer the development of high-speed rail corridors, 
    including evaluating project proposals and prioritizing projects 
    for design and construction;
 Oversee the business plans of the train operating and 
    infrastructure companies;
  Divest non-NEC physical assets (e.g., stations and track) to 
    states and localities;
 Determine whether to franchise train services and/or 
    maintenance of the Northeast Corridor, design franchises to be 
    offered, administer the competitive bidding process, and administer 
    contracts with franchisees; and
 In cooperation with Congress, the States, passenger and 
    freight railroads and the public, manage public policy issues with 
    respect to rail passenger service.

    2. Train Operations. There should be a separate company 
(``Amtrak'') organized to provide train-operating services. Amtrak's 
train-operating services, including passenger and mail/express 
operations, equipment repairs, and commuter operations, should be 
provided by contractual arrangement with Federal or State authorities. 
NRPC would appoint its board, which would be comparable to the board of 
a major transportation operating company, such as an airline.
    Amtrak operates a number of services today under contract with 
State departments of transportation and commuter authorities and these 
contracts to operate services franchises are a model of how franchising 
can work. Amtrak's responsibilities are clear and none of these 
services involve unfunded mandates to operate particular routes without 
adequate compensation. The Council recommends that contracts for train-
related services require continuous improvement in specified 
performance measures such as cost recovery, customer satisfaction, and 
ridership. And train operations, mail and express, the equipment repair 
shops, and commuter services should each have transparent accounting. 
Amtrak must become more efficient either by meeting the terms of a 
contract or through the eventual introduction of competition.
    The Council's plan would permit a pilot project to be implemented 
immediately by the NRPC to gain experience with franchising. Otherwise, 
Amtrak would be given two to five years to ``get its house in order'' 
before competition could be introduced. During this transition period, 
the NRPC would design appropriate franchise units, seeking input from 
State authorities, the freight railroads, Amtrak and others.\9\  Terms 
and conditions for franchising would be developed during this period 
and decisions made about how to manage the bidding process. Any 
exercise of franchise authority by the NRPC would be specific in its 
terms, would be based on consultation with all concerned parties, and 
would require that adequate capacity exist for both passenger and 
freight requirements before any expansion of services would be 
implemented.
---------------------------------------------------------------------------
    \9\  The Council envisions a relatively small number of franchises 
to avoid cherrypicking of Amtrak's routes.
---------------------------------------------------------------------------
    After the initial transition period, the NRPC would have the 
authority, at its discretion, to franchise some or all Amtrak train 
operations, including mail/express. Franchises would be offered through 
a competitive bidding process and would provide exclusive rights to 
operate passenger and mail/express service. Franchisees would operate 
under the NRPC statutory franchise and would be afforded the same 
liability protection and access to insurance currently available to 
Amtrak. Ultimately, Amtrak, as the train operating company, could be 
privatized.
    All franchisees would be subject to the Railway Labor Act, 
FELA,\10\  and railroad retirement. Current Amtrak employees would be 
granted hiring preference with new franchisees to the extent that 
hiring is necessary. The Council recommends to Congress that in any 
restructuring, employees follow their work in seniority order with 
their collective bargaining agreements intact. Agreements would be 
subject to collective bargaining under the normal provisions of the 
Railway Labor Act. Labor protection would be provided by the NRPC under 
the terms of the then-existing collective bargaining agreements.
---------------------------------------------------------------------------
    \10\ Federal Employer's Liability Act.
---------------------------------------------------------------------------
    After transition, the Amtrak shops could be sold, leased to private 
entities, or operated or disposed of by the NRPC. Alternatively, train 
operators might bid to operate equipment repair shops as part of a 
franchise or contract with the shops for equipment maintenance. The 
equipment itself could be either owned by or leased to franchisees.
    Federal operating subsidies to support train operations after the 
transition period would be available only for the long-distance trains 
that are Amtrak's most unprofitable operations. Shortfalls on non-
national system routes, including new high-speed corridor services, 
would be the responsibility of the States after a transition period. 
The Council believes equipment capital should be funded through private 
financing, if possible.
    3. Infrastructure. The Council recommends that Amtrak's Northeast 
Corridor infrastructure assets be organized as a government corporation 
that would control corridor operations, perform maintenance, and 
implement capital improvements. The company's board of directors would 
comprise representatives from the States along the Corridor, the US 
Department of Transportation, freight railroads operating on the 
Corridor, and the intercity passenger service provider. The Corridor 
would be managed as a shared regional and national asset.
    As with Amtrak's train operations, the infrastructure company would 
operate under a contractual agreement with the Federal Government. 
Performance standards would require continuous improvement in specified 
performance measures. After a two- to five-year transition period, the 
NRPC could authorize the NEC company to franchise its functions through 
competitive bidding.
    Track use fees would continue to be based on incremental costs for 
passenger operators with other users paying negotiated rates. 
Incremental cost is the standard that applies to intercity passenger 
services off the Corridor and for that reason is retained as the 
standard on the Corridor.
    Significant capital funding is needed for the NEC infrastructure. 
While the Northeast Corridor is operationally self-sufficient under the 
standards of the Reform Act, the infrastructure company will not be 
able to fund its own capital needs. The Council's plan endorses Federal 
funding but also expects the States to fund a portion of the need in 
recognition of the Corridor's importance to regional and commuter rail 
operations.

    IV. Issues and Options for Improvement of Rail Passenger Funding

    I would like to offer some comments about the funding issue, 
regarding both the entire passenger program and the NEC infrastructure.
    There are no easy answers to funding rail passenger service. But it 
is clear that given the size of the needed investment, reform of Amtrak 
is essential to minimizing costs and protecting the taxpayers 
investment. It is also clear that all of the stakeholders in intercity 
passenger rail service the Federal Government, the States, Amtrak and 
its employees, the commuter authorities on the Northeast Corridor, the 
freight railroads, and the public will need to make a contribution for 
the program to move ahead. A number of proposals have been advanced to 
fund capital needs. The Council has taken no position on these 
proposals but supports adequate and secure sources of funding for 
intercity passenger rail service.
    As the Council began to carry out its mandate, it became 
increasingly clear that the environment in which Amtrak was functioning 
had begun to change around the time the Amtrak Reform and 
Accountability Act of 1997 was signed into law. Without making any 
judgment, I think it is fair to say that the advent of guaranteed 
spending programs in transportation has limited the ability of the 
Appropriations Committee to address other worthy transportation 
projects. For the most part, Amtrak depends upon on the availability of 
Federal funds as authorized by this committee and appropriated in the 
annual Transportation Appropriation bill. However, in recent years, 
appropriators have had less discretion to find resources to fund 
transportation programs not included in guaranteed spending programs. 
That has left Amtrak to compete with the Coast Guard, DOT, safety 
programs and a variety of independent agencies for whatever funding is 
left over.
    Several years ago, the Congress addressed serious program and 
funding issues affecting Amtrak when it drafted the Amtrak Reform and 
Accountability Act of 1997. Remember, it was the enactment of the ARAA 
that allowed Amtrak to access the $2.2 billion in the Taxpayers Relief 
Act for a ``tax refund'' for capital improvements. In addition to the 
reforms, this legislation also provided Amtrak with an authorization of 
approximately $1 billion per year, on average, for five years.
    For whatever reason, Amtrak chose not to ask for an appropriation 
equivalent to what had been authorized in the first or any succeeding 
year until now. We all know the value of hindsight but it is now clear 
that if Amtrak had succeeded in establishing a benchmark appropriation 
nearer to what had been authorized, it may have been able to establish 
a foothold in the appropriations process that would have allowed it to 
address much of its infrastructure needs in that first year and 
subsequent years.
    As a result, the pattern for Amtrak appropriations was set in 1998 
and after four years the total average appropriation received by Amtrak 
is actually closer to about half of that amount included in the 
authorization legislation enacted. While no one will ever know if that 
additional appropriation would have forestalled the bleak financial 
condition we find Amtrak in today, it certainly would have helped 
address some of the important capital projects that could have reduced 
costs or minimized the estimated $3 billion backlog of ``state of good 
repair'' needs in the Northeast Corridor. Frankly, Mr. Chairman, I was 
a little surprised to hear Amtrak, in its press conference on February 
1st, blame Congress for not providing enough funding.
       A. Amtrak's Request for $1.2 billion for Fiscal Year 2003
    Amtrak's ``Fiscal Year 2002-2003 Business Plan, Fiscal Year 2003 
Legislative & Grant Request'' once again assumes significant operating 
improvements so that all but $200 million of its $1.2 billion Fiscal 
Year 2003 Grant Request is for ``Capital'' (including maintenance of 
equipment and maintenance of way) purposes rather than for operating 
losses. Amtrak states that, ``Leading up to the current fiscal year, it 
was clear that in the absence of aggressive management action, these 
challenges would combine to create an operating gap of $550 million--
even after factoring in previous cost management efforts and faster 
growth in the new Acela service.'' To address this gap, Amtrak 
indicates that it developed a program to further reduce expenditures, 
including $195 million in cost management initiatives. It also 
identified $356 million in revenue enhancement, financing transactions 
and commercial project initiatives. Amtrak claims that its $550 million 
of ``baseline challenges were therefore addressed in full, with an 
aggressive business plan that was put in place on October 1, 2001.''
    Following the September 11 attacks, there were additional risks 
that resulted (according to Amtrak) in further immediate cuts in 
operating costs in Fiscal Yeaer 2002 of approximately $111 million and 
deferrals in capital investments of approximately $175 million.
    Historically, Amtrak's business plan projections of operating 
improvements have been optimistic, with operating losses frequently 
higher than projected. Amtrak has funded those losses by deferring 
capital expenditures or by entering into asset financing transactions 
to make up the shortfalls.
    One likely source of additional operating losses is the 18 long 
distance trains that Amtrak anticipates will require a $200 million 
subsidy in Fiscal Year 2003. Amtrak states, ``The projected operating 
loss from the 18 routes is about $360 million (after cost reductions) 
[emphasis added] of which $160 million is covered by internally-
generated cross-subsidies and the remaining $200 million represents a 
net funding need. . . .'' In Fiscal Year 2001, Amtrak's 18 long 
distance trains (excluding the Auto Train) had an operating loss of 
approximately $700 million including depreciation and their allocated 
share of excess Railroad Retirement Taxes. If depreciation and their 
share of excess Railroad Retirement Taxes are excluded, they had a loss 
of approximately $470 million. Giving Amtrak every benefit of the 
doubt, implicit in Amtrak's Fiscal Year 2002-2003 Business Plan and 
Fiscal Year 2003 Grant Request is a $110 million improvement in the 
profitability of the 18 long distance trains coupled with the 
availability of another $160 million of ``internally-generated cross-
subsidies.'' Based on prior experience, Amtrak once again is requesting 
capital funds, but risks having to use a significant portion of those 
capital funds to cover cash losses that are likely if the 18 long 
distance trains continue in operation during Fiscal Year 2003.
    The chart below, which summarizes Amtrak's Fiscal Year 2003 Funding 
Request and Other Capital Investments, assumes significant improvements 
in operating performance from actual performance in Fiscal Year 2001. 
The $1.2 billion funding request, including mandatory debt principal 
repayments and allocated shares of excess Railroad Retirement Taxes, is 
anticipated to be used as shown: $544 million for the Northeast 
Corridor infrastucture and train operations; $251 million for other 
corridor trains; and $405 million for long distance trains.
[GRAPHIC] [TIFF OMITTED] 80544.079


                  B. Funding for the Operating Company
    The cost to fund intercity rail service will be considerable. Based 
on its Fiscal Year 2001 cash loss, Amtrak's Federal operating subsidy 
could approach $600 million annually (with Amtrak currently receiving 
another $125 million in operating subsidies from States). Additional 
operating subsidies could be needed for high-speed corridors if 
ridership and revenue targets are overly optimistic. The Council's plan 
would minimize operating subsidies by creating incentives for cost 
containment and efficiency either through operating contracts with 
Amtrak or franchising. The plan also recommends that, after a 
transition period, Federal operating subsidies be limited to long-
distance ``national'' trains; States would bear the cost of operating 
subsidies for corridor services, including new high-speed services.
    The Council believes that, if train operations are separated from 
infrastructure and trains are operated under contract (which will occur 
even if franschising is not initiated), private capital markets are 
likely to play a much larger role in financing passenger equipment.
                   C. Funding for the Infrastructure
    Infrastructure investment needs are even greater. The Northeast 
Corridor infrastructure is in need of about $1 billion annually in 
capital funds. According to Amtrak's estimates\11\ , the cost to 
develop all of the high-speed corridor projects that have been advanced 
by the States amounts to $70 billion, or $3.5 billion per year over 
twenty years. These spending levels may be unrealistic in today's 
budget environment.
---------------------------------------------------------------------------
    \11\  In the Fiscal Year 2003 Legislative Report that Amtrak issued 
earlier this month, it indicates a level of corridor spending of $50 
billion over 20 years, including $9 billion for improvements to the 
NEC, but excluding $3.8 billion of deferred NEC infrastructure 
investments.
---------------------------------------------------------------------------
    As you now know, the Administration's budget for fiscal year 2003 
proposes $521 million for Amtrak, the same level provided in this 
fiscal year and continuing the pattern established in 1998.
    Now the Federal Government is facing deficits and there is intense 
pressure on the transportation budget to deal with aviation security, 
increases in Coast Guard funding and significant shortfalls in Federal 
fuel tax revenues that fund highway programs. This is not an 
environment in which Amtrak will be able to reverse the appropriations 
trend and obtain the resources it needs to fund critical infrastructure 
projects in the Northeast Corridor. It was this fact, among others, 
that led many on the ARC to conclude that Amtrak, as the owner of the 
Northeast Corridor, is simply not in the best position to access the 
capital the NEC requires for critical improvements.
    Clearly, I do not need to demonstrate to this committee how 
difficult it is for the Federal Government to address important 
transportation funding decisions when the bulk of these funding 
decisions are now set by statute. This environment dictates that we 
must begin to consider other alternatives to finding the capital 
requirements for the Northeast Corridor.
    If Amtrak were relieved of its obligation, as the owner of the 
corridor, to provide the capital and human resources necessary to keep 
it in a state of good repair, it would have an immediate and positive 
impact on Amtrak's bottom line. We believe, as the Administration 
stated in its recent budget submission, that a ``Federal, State and 
private partnership'' would be best suited to address the staggering 
capital needs now required in the corridor.
    Two additional factors need to be considered when weighing the 
policy decision on Amtrak ownership of the Northeast Corridor. First, 
any company faced with the level of operating losses and debt that 
Amtrak has experienced will frequently feel a sense of desperation 
about minimizing its losses. In the past (according to the DOT/IG in 
its January, 2002 report), when Amtrak had a large base of capital 
funds (like TRA), it allocated indirect and overhead costs that were 
initially recorded to the company's operating expenses to capital 
projects through the application of an overhead rate for capital 
project-related labor and material expenses. While this may be a 
legitimate accounting mechanism, it masks one of the difficulties of 
having an operating company that is experiencing operating losses also 
being responsible for making capital improvements to its 
infrastructure. It may be too difficult to avoid the temptation to 
shift operating expenses to capital projects. The result is that 
Federal capital dollars lose their full impact when the opportunity 
exists for this type of accounting to be employed. The other concern is 
also related to an operating company that is experiencing losses. A 
case in point is that its ownership of the NEC infrastructure led 
Amtrak to make the poor financial decision to mortgage portions of 
Pennsylvania Station in New York over a 16-year period in return for 
three months of operating expenses. This example could be a case study 
for any business school in the country on how not to conduct business. 
These examples alone would be enough to consider separation.
    So, Mr. Chairman, looking at these facts we have concluded that the 
current structure of Amtrak as a rail passenger operator and owner of 
the Northeast Corridor has not worked in the past and is a formula for 
disaster if it is allowed to continue without restructuring. With 
Amtrak being unable to obtain the funding necessary for corridor 
improvements, the corridor will continue to deteriorate and ultimately 
will become a safety threat to the hundreds of thousands of people that 
use it every day. If the status quo continues, it is only a matter of 
time before we reach a crisis point and the infrastructure requirements 
will require a heavy toll on the Federal Government. At a time when the 
Federal Government is preparing to make major investments in homeland 
security, it should not walk away from confronting the safety issues in 
one of its critical transportation assets.
    There are no easy solutions to restructuring Amtrak and our goal 
should be to take a step back and look at the system as a whole and 
make a determination on what works best for the various components of 
the system. That is what we have tried to do. No matter what the 
Congress decides to do about Amtrak one thing is very clear the 
Northeast Corridor will continue to exist, with or without Amtrak, and 
the first objective of the Federal Government must be to take steps to 
assure that a proper level of investment is achieved through Federal 
and State Governments and, possibly, through public-private 
partnerships. It is in everyone s best interest to place the 
responsibility of the corridor in a position where it has the best 
chance to access funds, and where it will have the least impact on the 
financial performance and financing requirements for both operating and 
capital of the new train operating company. Based on historical funding 
patterns, particularly in recent years, having Amtrak as the owner of 
the NEC may be the worst outcome.

         V. Potential Source for Funding the NEC Infrastructure

    Separating the Northeast Corridor infrastructure both 
organizationally and financially from Amtrak's nationwide train 
operations is another way of closing the gap between the subsidy needs 
of Amtrak's train operations and the uncommitted funds available in the 
budget. The other side of this coin is that leaving most of the 
Northeast Corridor under the ownership and funding of Amtrak will 
continue the inadequate funding and perpetuate the deterioration of 
this vital NEC infrastructure. There is little or no chance that Amtrak 
will be able to get the capital it needs to maintain and improve the 
NEC out of appropriated funds.
    The Council's February 7, 2002, Action Plan included a detailed 
list of funding options for the NEC rail infrastructure. These options 
were from a preliminary report on NEC funding options that BGL Rail 
Associates provided to the Council.\12\  The final BGL recommendations 
identified three major advantages in securing capital funding that 
would accrue to the NEC infrastructure if it is separated from Amtrak's 
train operations, as the Council proposes.
---------------------------------------------------------------------------
    \12\  The BGL report to the Council is available, as is the 
Council's Action Plan and its other major reports, on the Council's 
website at .
---------------------------------------------------------------------------
    First, a separate NEC could apply to the management, operation, 
maintenance, and improvement of the NEC infrastructure about $500 
million in annual funding generated by the NEC infrastructure (not by 
fare-box revenues from Amtrak's train operations). That's a number that 
you might not have heard before, This $500 million comprises several 
categories of income: (1) about $215 million in annual non-train-
operating income generated by the NEC; (2) about $90 million in track 
use fees from commuter and freight railroads; (3) an estimated $160 
million in track use fees that Amtrak's trains would have to pay for 
using the NEC tracks on an incremental cost basis; and (4) capital 
contributions from commuter railroads of about $30 million.
    Second, a separate NEC would, through the states on its board, have 
some access to the flexible provisions of the transportation trust 
funds. Those trust funds, also called guaranteed spending programs, 
currently control 75 percent--let me repeat that: 75 percent--of all 
Federal transportation funds, and they are funds that Amtrak can not 
access.
    Third, a separate NEC could access other sources of incremental 
funding for infrastructure that Amtrak cannot access. There is no 
single ``silver bullet'' source of government financing that can meet 
the Corridor's annual needs for investment. To quote the BGL report:

``Even if more funds were authorized for the NEC, the chances of more 
    funds being appropriated are not good. Our analysis of capital 
    needs and the likely sources of funding indicates that only through 
    a coordinated program of new ownership with broad participation of 
    users can the NEC users expect to achieve the operating level the 
    NEC requires and that the region's transportation needs justify. A 
    change in ownership is essential because Amtrak has demonstrated 
    that it cannot obtain the level of funding necessary out of Federal 
    appropriations. Participation of all owners and users in the 
    identification of logical funding sources can result in a concerted 
    effort to achieve a multi-year capital improvement program using 
    multiple sources of funding.''

    Some of the sources of incremental funding that could be considered 
to support the multi-year NEC improvement program for a NECRIC are:

 Bond authority in legislation currently pending before 
    Congress appears to have bipartisan support and is a logical source 
    for addressing some of the critical Northeast Corridor 
    infrastructure projects. H.R. 2950 and S. 1991 would be effective 
    if States used their discretion to exercise those programs.
 Tax incentives for public interest rail projects like those 
    being proposed by the Association of American Railroads could 
    generate private sector investments in the NEC and take some 
    pressure off the appropriations process to find all the funding 
    required.
 Creative partnerships with private sector entities such as 
    ``design and build'' agreements with engineering construction firms 
    and Regional Transmission Organizations could be a means to build 
    much needed electric transmission lines in the Northeast. Such 
    partnerships could implement the $800 million catenary replacement 
    program on the south end of the corridor.
 Turning over portions of the corridor that are used primarily 
    by commuter services (like the Penn Station New York Complex) to 
    local commuter authorities would shift many of the associated 
    maintenance costs and capital expenditure requirements that are now 
    dependent on Federal appropriations to other sources.
 Reauthorize the Northeast Corridor Improvement Project (NECIP) 
    to provide Federal funding for life safety/security concerns on the 
    corridor.

    Other sources of funding might be added to this list. Such 
additions are possible during next year's reauthorization of both the 
Transportation Equity Act for the 21st Century (TEA-21) and the 
Aviation Improvement Act for the 21st Century (AIR-21).
    It would make sense for Congress to expand the flexibility 
provisions in TEA-21 and similar flexible provisions in the Aviation 
Trust Fund where NEC improvements would relieve capacity and congestion 
restraints of major highways and airports. The NEC serves cities with 
four of the seven most congested airports in the US, and it parallels 
Interstate 95 for much of its length. Today, the NEC's intercity 
passenger, commuter, and freight rail operations help reduce regional 
highway and airport congestion, thus justifying flexibility so that 
these programs can assure the availability and value of an alternative 
mode of freight and passenger transportation.

                             VI. Conclusion

    Mr. Chairman, the Council believes its recommendations are strong 
and sound. The chronic difficulties that Amtrak experiences year in and 
year out are not due principally to lack of funding. They spring 
primarily from an organization that is obsolete, that cannot do all the 
things that it is charged to do, that will not consider recommendations 
for change, and that desperately needs to be redesigned.
    For these reasons, the Council strongly recommends that the 
Congress first adopt badly needed institutional reforms before 
providing major new funding for passenger rail service.
    Once such reforms are adopted, the Council is convinced that the 
new structure will make the investment needs of rail passenger service 
much easier to understand. The new structure will also be much more 
conducive to effective financing by Federal, State, and local 
governments and by private capital markets.
    I stand ready to answer questions and address issues that the 
Congress might want to pursue. The Council thanks you, Mr. Chairman, 
for the opportunity to address the committee.
[GRAPHIC] [TIFF OMITTED] 80544.080

    Chairman Conrad. Thank you, Mr. Till, for that testimony.
    Can you tell me a little about the Amtrak Reform Council? 
How did that come together? And what is the genesis of the 
Reform Council?
    Mr. Till. A series of events in the mid-1990s led to the 
enactment of a law called the Amtrak Reform and Accountability 
Act, which provided about $5 billion in authorized funding for 
Amtrak and which also had the effect of releasing about $2.2 
billion of a so-called tax refund that Amtrak was authorized to 
get under the Taxpayer Relief Act of 1997.
    As part of that law, the Congress mandated that Amtrak 
should achieve operational self-sufficiency, and that means 
that if you look at the normal income statement of a 
corporation, in Amtrak's case you could take out about $600 or 
$700 million worth of expenses and they wouldn't count against 
being ``self-sufficient'' on an operational basis.
    To oversee Amtrak's progress towards self-sufficiency, to 
advise the Congress of that process, to monitor Amtrak's 
financial and operational performance, and, finally, to suggest 
recommendations for Amtrak to improve so that it might make 
better progress towards self-sufficiency, the Amtrak Reform 
Council was authorized and created under that act.
    It took about a year and a half for it to get into 
effective operations, until the early spring of 1999, and that 
was after a period when Governor Christie Todd Whitman of New 
Jersey had been appointed to the council and had become its 
chairman. Difficulties in receiving funding for the council led 
her to resign, and the council's current chairman, Mr. Gilbert 
Carmichael, was elected by the other members of the council. He 
has been the chairman ever since, and the council's basic 
approach has been very simple, to take a two-track approach: 
one is to monitor Amtrak's performance and identify its 
problems and what recommendations can we make [for improving 
its performance] and the other is to look at more fundamental 
problems and identify the things that the Congress should be 
advised of. Another one of the mandates that the council has, 
is to advise the Congress of changes that should be made in the 
laws pertaining to Amtrak.
    Chairman Conrad. And what is your position there, Mr. Till?
    Mr. Till. I am the executive director. I am the chief of 
the staff that the council has selected.
    Chairman Conrad. And how long have you been there?
    Mr. Till. I have been there about almost 3 years.
    Chairman Conrad. OK. Let me ask you this: Do you think it 
is a realistic goal that the passenger rail system be self-
sufficient?
    Mr. Till. I think parts of the passenger rail system can be 
self-sufficient, but I think it is very difficult to take a 
nationwide train operation and a monopoly construct without any 
oversight, without any transparency or accountability, and to 
tie to it an enormous piece of infrastructure on which that 
company is a minority operator and expect that the company is 
going to be able to manage itself or that people will be able 
to understand effectively what is happening in that company.
    I can tell you that in late 1999 the council requested that 
Amtrak provide a simple set of financial statements. Tell us 
what your income statement is for the Northeast Corridor 
infrastructure, and tell us what all your train operations look 
like. We got that statement, in a form that could not be used, 
on the day we submitted our restructuring plan to the Congress, 
on February 7th of this month. And that gives you an idea about 
Amtrak's responsiveness to any notion of oversight.
    Let me just very quickly answer exactly, yes, parts of it 
can be self-sufficient. Most of it can be much more efficient 
than it is right now. And the key to doing that is to organize 
it the way that the council recommends. You don't have to 
follow our exact recommendations. There are a number of people 
who are going to make proposals that will be consistent with 
this because we have got to get the States into the business of 
making transportation decisions.
    You will find that the surge in transportation ridership on 
rail has been driven in the 1990s by States and groups of 
States, in the Pacific Northwest, in California, in New York, 
in the Midwest, and in Florida and in North Carolina. These are 
the States that are leading the way, and these are the people 
who are driving Amtrak's most effective operations, with the 
best customer service, and with the highest satisfaction rate.
    Chairman Conrad. Mr. Till, can you tell me, I have always--
I have often wondered--I am not expert in this, so you are 
educating me and I appreciate that. It has always struck me 
that, in terms of nationwide passenger rail system, it seemed 
an unrealistic goal that that be something that could be self-
sustaining. And I don't doubt for a minute that the efficiency 
could be improved with perhaps some of the changes that you 
have recommended here.
    As I understand it, you are talking about splitting this 
into three different operational entities. Is that correct?
    Mr. Till. What we have today is a single National Railroad 
Passenger Corporation, which under the Amtrak Reform Act is now 
technically a private corporation. When the National Railroad 
Passenger Corporation was originally created under the Rail 
Passenger Service Act of 1970, it was so-called mixed 
enterprise/government corporation.
    The council believes that the actual Government functions 
that this corporation performs--and it has a number of major 
governmental-type functions--should be placed in a restructured 
National Railroad Passenger Corporation, which would be a 
Government corporation, and that corportation would spin off 
the train operations and the infrastructure.
    Chairman Conrad. OK. Let me stop you right there. I am 
sorry to be taking this time. I have another appointment I am 
going to put off here because, while we have got you here, I 
would like to get the benefit of your experience.
    Mr. Till. I appreciate it very much, Mr. Chairman.
    Chairman Conrad. You have talked here about a governmental 
function. Can you describe that further?
    Mr. Till. The main purpose of the Rail Passenger Service 
Act of 1970 was to take about $500 million in operating losses 
for passenger services off the backs of America's private 
railroad industry. They were already reeling from the highway 
program, from the development of aviation, from the growth of 
the trucking industry, and as a result, they started losing 
more and more money. So they came to the Government and said, 
Please take this passenger load off of our backs, and that is 
indeed why Amtrak was created. So you end up with a company 
that was created for a negative reason, not for a positive 
reason.
    To make sure that it could operate, the Government 
extracted from the freight railroad industry a power for this 
National Railroad Passenger Corporation that it would have the 
authority to operate trains over their network at incremental 
cost and with priority over freight operations. So that is a 
Government franchise right that is very important.
    Chairman Conrad. I see, yes.
    Mr. Till. Also, the direct access to the Congress for 
purposes of seeking funding, which Amtrak has under statute, is 
a governmental prerogative. And the notion that both the 
company or the entity that does that and the entity that runs 
trains should be tied directly to the Congress may give you 
some insight into why it has been so difficult to manage it 
effectively over 30 years.
    Chairman Conrad. OK. So you would split off that part. Now, 
you made a reference to infrastructure that I didn't fully 
understand, and I want to make sure we have got that understood 
in the record.
    Mr. Till. Yes, sir.
    Chairman Conrad. You made a reference to splitting off this 
governmental--in effect, governmental responsibilities, 
passenger rail infrastructure, and earlier you had made a 
reference to infrastructure that I didn't quite--I didn't fully 
understand. Do you recall your earlier reference to 
infrastructure?
    Mr. Till. When we talk about infrastructure, we are talking 
about--primarily we are talking about in terms of what is the 
so-called 800-pound gorilla in Amtrak's infrastructure zoo--the 
Northeast Corridor infrastructure, which is in a terrible state 
of repair and is absolutely vital in the Northeast. They also 
own substantial infrastructure in little bits and pieces around 
the country. Now--
    Chairman Conrad. The infrastructure--let me make sure--and 
the Northeast infrastructure, they own that but others use it?
    Mr. Till. They own part of it. They own about 366 miles out 
of 460. Massachusetts owns the part that is in Massachusetts. 
Connecticut owns 46 miles of the Northeast Corridor that is in 
Connecticut [from New York to New Haven]. And New York owns 
about 12 miles between a place called New Rochelle interlocking 
and the Connecticut border. And those happen to be, Mr. 
Chairman, the portions of the corridor that are actually in the 
best condition. But there is another reference to 
infrastructure I made, and that is that, if the Congress is to 
move forward, as is proposed under, I would think, the Young 
bill [H.R. 2950] and certainly under the High Speed Rail 
Investment Act [S. 250] proposed by Senators Daschle and Lott, 
and from the development of infrastructure improvements--track 
and signals and other improvements that are necessary to 
improve the speed and capacity of tracks that are owned by the 
freight railroads so that you can have better and more 
extensive passenger service, you know, throughout the country--
in these so-called emerging high-speed rail corridors--then 
that is also another element of infrastructure that is involved 
in this. And eventually the infrastructure funding for rail, I 
think the council believes, ought to be all put on the same 
footing. But right now, with the Government having $4 billion 
in liens on the Northeast Corridor and Amtrak being $3.3 
billion in debt, it is hard for the Government to get 
disentangled from that Northeast Corridor infrastructure. 
Amtrak has had that infrastructure--it didn't start with that 
infrastructure--it got that about 5 years after Amtrak was 
created. It got it when Conrail was created, when Conrail, or 
USRA on behalf of Conrail, said, that is too big a burden and 
Conrail doesn't need that expense and you need to give that to 
somebody else, Mr. Federal Government. So--yes, sir?
    Chairman Conrad. I want to make sure I understand this. So 
one of your recommendations is that the infrastructure piece of 
that be under a separate umbrella. Is that correct?
    Mr. Till. Yes. And, in fact, there is some talk--and in the 
Amtrak Reform Act, there is a provision that provides prior 
Federal approval of interstate compacts for rail facilities. We 
looked at the possibility of having the States of the Northeast 
Corridor form an interstate compact to own and operate the 
Northeast Corridor. In the process of doing that, we talked to 
a woman by the name of Anne Stubbs, who is the executive 
director of the Conference of Northeastern Governors, which has 
offices right over here on North Capitol Street. She has 
indicated that they had worked for 18 years, or something like 
that, well over 10 years, to try to put together a northeastern 
energy compact that would have the same status as an interstate 
compact for this rail facility. And she said they hadn't been 
able to do it.
    So our proposal is that to put this infrastructure into a 
separate Government corporation and put on its board the 
Northeast Corridor States, who would probably appoint their 
commuter operators to it or their secretaries of 
transportation, put on it a representative of the freight 
railroads, put on it a passenger train operating company 
representative--
    Chairman Conrad. Who would be opposed to that?
    Mr. Till. I think that a good deal of fear and 
trepidation--of the sort that you are hearing at this table 
today from people who are worried about highway funding and 
other things--would also attend to the notion of splitting this 
off and putting it primarily under the responsibility of the 
States. There will have to be some Federal funding. But right 
now, as I indicated in the testimony, if only 25 percent of the 
funds are available for non-guaranteed spending, then having 
this piece of infrastructure get all of its funding needs out 
of that 25 percent, it is not going to happen.
    And so the fact of the matter is that as we move into TEA-
21 and Air-21 reauthorization next year, these are the kinds of 
issues that are going to have to be raised, and not just for 
the rail passenger program, for a whole lot of issues having to 
do with urban transit and other infrastructure.
    So this is all part of an evolving situation in which we 
need a better institutional structure for rail passenger 
service so that it can more effectively participate in terms of 
infrastructure development by the Federal Government, by States 
and localities, and in terms of any operational funding that is 
going to be necessary to operate train service that, quite 
frankly, the Congress may require as part of its vision for a 
reformed rail passenger program.
    Chairman Conrad. You know, a lot of what you say makes a 
great deal of sense to me. Again, I am not an expert in this 
area. I don't pretend to be. I have got an obligation to try to 
understand it better, and that is the reason we wanted this as 
part of the hearing today. And, again, I appreciate your being 
here.
    You know, as you describe this, I wonder what would be the 
effect on a State like mine, where we have Amtrak service, I 
would presume, that is subsidized, because I don't know how you 
could run these long-haul passenger rail systems. If that were 
split off and put out as part of a rail passenger system, what 
do you think would happen to these long-haul--
    Mr. Till. Well, let me give you the scholarly answer to 
that question based upon looking at what has happened for 
similar operations around the world let me also. And give you a 
very practical example of what happened when a company came in 
and said to us, Here is the map of a restructured long-haul 
network that we would propose to run, we will get private 
financing for it, enough to cover operating losses for about 5 
years. And we think under this construct that we could actually 
make money, with the combination of luxury service, coach 
service, and passenger rail express service, but to do it in a 
way were you are actually moving where people move and where 
freight moves, the kind of premium freight that Amtrak has 
actually led the way in identifying the market for. They do 
provide very important premium freight services out there, but 
just as the council had indicated, you have seen the ears perk 
up on the freight railroads, and they are saying, Hey, if 
Amtrak can make that much money, then maybe we can make that 
much money, too. And so they are going after the same sort of 
traffic where they can compete effectively.
    So you do have people out there who think they could make a 
go of it. An experience in Australia where they restructured 
that kind of operation actually has proven that out. There are 
trains in Australia that operate long-haul services, probably 
not on a scheduled basis but on a periodic basis, that are 
private--profitable in the private sector.
    Now, if you wanted to blend those two kinds of operations, 
maybe someone could come together and say I will put together a 
package in which, maybe the train company--the Burlington 
Northern or the Union Pacific--would say, well, we will operate 
the trains and we will organize the mail and express traffic 
and hire some cruise line to organize the luxury service and 
let the national train operating company, Amtrak or somebody 
else, provide the coach service.
    So there are lots of different opportunities. In fact, 
Amtrak itself even participated in bidding on one of the 
franchises that was let for long-haul passenger operations in 
Australia. So people are out there who want to do it, and it 
has been successful, and I think in the best case you can cut 
your operating losses by about 50 percent, and in a more 
conservative way, I think you could say we would be looking at 
something between 20 and 30 percent in terms of improved 
efficiency and loss reduction with a properly managed long-haul 
system. So that kind of long-haul passenger train would be less 
difficult to fund if the Congress decides it wants to move 
ahead.
    Chairman Conrad. Let me just say I have got to bring this 
to an end. I wish I didn't have to, but scheduling requirements 
compel me to do that. I have found this discussion very 
interesting, and I want to thank you very much for coming. I 
thank you for your patience here today.
    You had a whole series of ideas on funding that I also 
found interesting because I agree with you, this is not going 
to happen just on Federal appropriations. I mean, if we 
reality-test here, it is not going to happen. We don't have the 
money. And I can't foresee any time now in the near future 
where we are going to have the money to do all that is 
required. And the needs out there are enormous. I don't know 
what the correct number is with respect to the Northeast 
Corridor. You used a number of some $3.4 billion of 
infrastructure backlog. Was that--
    Mr. Till. It is 3.8. That is pretty vital stuff. It 
includes life/safety problems, tunnel problems in Penn Station, 
New York, and--
    Chairman Conrad. What period of time would that be?
    Mr. Till. I think the backlog has grown up gradually over 
the whole 25 years. It has probably built up--
    Chairman Conrad. That $3.8 billion, that is immediate 
needs? Those are--
    Mr. Till. If you had a program that could put that into--
you know, begin to implement that immediately, you could spend 
it all. But, you know, obviously there is--
    Chairman Conrad. Yes. Well, I think I kind of like this 
list. In fact, I made notes of things that you mentioned in 
terms of a combination of ways of addressing this, because I 
think it is going to take a combination.
    Mr. Till. Well, Senator, I think, you know, we didn't have 
a lot of lead time to prepare this, and I will get a revised 
version of this that is cleaned up and a little bit more 
succinct. I will provide that to the committee.
    Chairman Conrad. That would be very useful to us.
    Mr. Till. And if you have further questions you would like 
to pose to the council, I would be happy to take them back and 
we will get you an answer.
    Chairman Conrad. Thank you very much.
    Mr. Till. You are welcome, sir.
    Chairman Conrad. With that, we will close the hearing.
    [Whereupon, at 12:27 p.m., the committee was adjourned.]

                Opening Statement of Senator Tim Johnson

    Mr. Chairman, I am pleased that we are holding this hearing today 
to discuss the ramifications of the President's budget proposals on 
highway fuinding, education programs, and the Army Corps of Engineers.
    I have strong concerns about the level of highway funding in the 
President's budget for fiscal year 2003. As we all know, TEA-21 was 
enacted to provide a guaranteed funding stream for highway projects 
throughout the Nation. Highway construction and improvements are funded 
through an excise tax on gasoline that goes directly into the highway 
fund. This arrangement guarantees that revenues raised are used only 
for road projects.
    South Dakota and the Nation have greatly benefitted from this 
funding, which has resulted in new roads and improvements throughout my 
State. Because of the great distances in South Dakota, we are extremely 
dependent on surface transportation for economic development and 
travel. Without adequate roads and infrastructure, the economy of South 
Dakota and the State will suffer.
    However, the President's budget for fiscal year 2003 contains an 
unexpected huge reduction on highway funding of $8.6 billion-a cut of 
over 25 percent. This will result in a loss of $53 million for South 
Dakota and potential disruptions in existing road projects. 7,500 
people are employed in my State on road projects that are funded 
through the Highway Trust. The proposed reductions means 2000 jobs will 
be lost in the State this year alone. For a small-population State like 
South Dakota, this is a major job loss.
    Moreover, there are 200 projects in South Dakota that are funded 
through the Highway Trust Fund. In addition, there is a $700 million 
backlog in projects in my State that will only get worse with severe 
reductions in resources.
    This is unacceptable. The reduction is due to largely to technical 
corrections and overestimations of revenues in prior years. But it is 
under the amount that was guaranteed for this year under the 1998 Act. 
Technicalities should not result in I have co-sponsored a bill that 
would raise the amount allocated by $4.4 billion this year, about half 
of the proposed cut. While this is a good start, as a member of the 
Senate Budget and Appropriations Committees, I will work to see that 
the funding: is further raised to an amount comparable to last year's 
figures. We must ensure that our infrastructure is adequate for future 
needs and growth.
    In addition, I am disappointed by the Administration's decision to 
not fund the Missouri River Restoration Act in the Army Corps budget. 
Although it is listed in the United States Army Corps of Engineers 
fiscal year 2003 budget at $750,000, it is my understanding a decision 
has been made to eliminate that funding. The Missouri River Restoration 
Act is designed to provide needed funds for improved conservation in 
the river's watershed, reduce sediment loads in the river, and extend 
the life of South Dakota's reservoirs. Under the Act, $50 million has 
been authorized over 5 years and it is my hope that the Administration 
will take an active role in helping fund this critically important 
measure. As a member of the Apporopriations Committee, I will to see 
that this the program is adequately funded this year.
    I am concerned with funding level the Administration has provided 
for the Pierre/Ft. Pierre buyout in South Dakota. This is an ongoing 
project to relocate homeowners who have been displaced because of 
flooding on the Missouri River. $10 million is needed this year to 
continue that process. Unfortunately, only $1.426 million is included 
in the budget and because of this very low figure, it will be much 
harder for Senator Daschle and I to bring that funding level up to 
where it needs to be. Last year, $6 million was appropriated and I will 
work to see that the funding is increased this year.
    With respect to education, the passage of the recently-enacted. No 
Child Left Behind Act means States and local education agencies will 
now be equipped with new resources and guidelines for improving our 
education system and continuing our efforts to provide every child with 
the best education in the world. The new education bill also provides 
for new testing and accountability measures to be implemented by States 
and public schools. Therefore, it is critical that we provide 
sufficient education funding from the Federal level to allow our States 
and schools to meet these new testing and accountability mandates. 
Without adequate funding, we are simply setting up our schools for 
failure.
    Along those lines, we must also preserve funding in the Fiscal Year 
2003 budget for rural education initiatives. I am deeply concerned with 
the Administration's education budget which includes an elimination of 
funding for critically important rural education programs. 
Specifically, the Administration's budget eliminates funding for Rural 
Education Achievement Program (REAP) initiatives which were funded at 
$162.5 million for Fiscal Year 2002. Designed to help rural districts 
that lack the personnel and resources to compete effectively for 
Federal competitive grants and that receive grant allocations in 
amounts that are too small to be effective in meeting their intended 
purposes, these flexibility programs are vastly needed in rural school 
districts throughout States like South Dakota.
    I am hopeful that the Chairman will share my concern on these 
issues and I look forward to working with the Committee to adequately 
these programs in the Fiscal Year 2003 Budget Resolution.
    [The prepared statement of Senator Murray follows:]

             The Prepared Statement of Senator Patty Murray

    Mr. Chairman, thank you for calling this hearing on two issues 
vital to the ongoing success of our Nation and the renewal of our 
economy--education and transportation. Last year the Congress passed 
and the President signed ESEA reauthorization.
    The bill had two parts. On one hand, it called for higher standards 
and accountability. On the other hand, it promised more investments so 
schools could make progress. Just a few months later and already the 
President's budget has pulled the rug out from under our students by 
reneging on the promised investment. It cuts funds for teacher quality 
and class size reduction activities. It freezes funding for after 
school programs and Safe and Drug Free Schools. And it does not fully 
fund our share of special education costs, failing yet again to fulfill 
that commitment to our communities, our schools and our disabled 
students. We know what the needs are out there. We know what works to 
help our children succeed. Unfortunately, this budget does not do 
enough to help.
    Education is not the only area where this budget falls short of 
meeting our country's needs. Mr. Chairman, our communities are working 
to strengthen their economy during the current recession. 
Unfortunately, many regions are being held back by outdated and 
inadequate infrastructure.
    In my own State of Washington, we are experiencing a transportation 
crisis. We know that investing in our critical infrastructure will pay 
real dividends for our communities. Better roads and highways mean less 
time wasted in traffic, greater productivity, and a better quality of 
life. In addition, transportation projects create jobs and lay the 
foundation for our future economic growth. That's why I'm so 
disappointed that the President's budget cuts billions of dollars in 
infrastructure investments.
    In fact, this $8.5 billion cut in 2003 is the single largest 
proposed cut across the entire government. Not only will it prevent us 
from improving our productivity, business climate and economic growth, 
it also threatens to eliminate over 350,000 jobs across the country.
    Mr. Chairman, I want to insert into the record a list of what this 
cut means to the people of every State. Let me just summarize this 
chart with one statistic. Looking just at the States represented on 
this committee, our communities will lose more than 3 billion dollars 
in infrastructure investments.
    When I asked the President's Budget Director about the cuts, Mitch 
Daniels said that the Administration was only following the 
requirements of the TEA-21 law. What Mr. Daniels failed to say is 
that--throughout his budget proposal--there are hundreds of examples 
where the Administration is asking us to ignore existing law or to 
change the law.
    Just within the Transportation Budget, we are asked to ignore 
current law and to adopt measures to throw several communities out of 
the Essential Air Service program. We are asked to ignore the TEA-21 
law and divert transit formula funds to the President's ``New Freedom 
Initiative.'' We are asked to ignore current law and impose new user 
fees on railroads, shipping companies, and transporters of hazardous 
materials. We are also asked to ignore the TEA-2l law and lower the 
Federal cost share for major transit projects.
    Simply put, the Administration wants to change the law dramatically 
in many areas, but uses the law as an excuse for cutting highway 
funding.
















                    THE LONG-TERM BUDGETARY OUTLOOK

                              ----------                              


                      WEDNESDAY, FEBRUARY 27, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:05 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Stabenow, Corzine, Domenici, and 
Snowe.
    Staff present: Mary Ann Naylor, staff director; and Sue 
Nelson, deputy staff director.
    For the minority: G. William Hoagland, staff director.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. I will bring the committee to order.
    There has been a vote scheduled for 10 or somewhat after 
that time, but we can anticipate a vote soon. But I wanted to 
begin with my statement and then defer to Senator Domenici, if 
he arrives. He may well be at the floor anticipating the vote 
right at 10 o'clock. If that occurs, Bill, will you just have 
him go ahead and reconvene us and assume the Chairmanship until 
I return. I would appreciate that.
    First of all, I want to welcome Comptroller Walker to the 
panel. He has appeared here before. He is somebody that enjoys, 
I think on both sides of the aisle, strong credibility. I know 
I never fail to benefit from your thoughtful analysis, and we 
very much appreciate the thinking and the energy that you have 
put into helping us evaluate the long-term challenges that this 
country faces as we look to the future, understanding that what 
we are facing now is unlike anything we have ever seen before.
    I think one of the problems Washington is having with this 
new fiscal environment is that it is substantially different 
than anything we have ever faced before. Always before, the 
following generation has been bigger than the one that was 
retiring, and that is about to change in a dramatic way. And it 
is very hard to fully understand how dramatic these changes 
are, and that is the reason we wanted to have this hearing 
today.
    When you met with us last year, you advised that no one--
and this is a quote--``No one should design tax or spending 
policy pegged to the precise numbers in any 10-year forecast.'' 
How I wish more people would have listened to your wise counsel 
then. We could have avoided perhaps some of the very serious 
fiscal problems we now confront.
    They say bad news comes in threes, and I am afraid that may 
be the case when it comes to the budget outlook this year.
    First we learned from CBO in January that the surpluses we 
worked so hard to achieve have all but disappeared. Last year, 
CBO projected there would be some $5.6 trillion in surpluses 
over the next 10 years. Twelve months later, CBO reported to us 
that the surplus for that same period had dropped by $4 
trillion, and that projection does not count the President's 
defense buildup, his request for homeland security or an 
economic stimulus package. It also presumes that the tax cut 
sunsets in 2010 as required under current law.
    The second piece of bad news came in the form of the 2003 
budget submittal from the President, which reduced the $1.6 
trillion remaining surplus even further, reducing it by another 
approximately $1 trillion. And I suspect that when CBO does 
their re-estimates of the President's budget that they will 
tell us the circumstance is even worse than that.
    Under the plan proposed by the President, we return to non-
trust fund deficits for as far as the eye can see. These are 
CBO's numbers, and they show non-trust fund deficits for the 
entire next decade.
    And I don't expect your news to be particularly good 
either, although we certainly can't blame the messenger. Since 
you did your level best to warn us about overcommitting the 
surplus last year, I expect to hear from you that the tax cut, 
the recession, and the attack of September 11th have taken 
their toll on the long-term budget outlook as well as on the 
short-term projections, making the task of addressing our long-
term needs even more difficult.
    The hard reality is that last year we were told that the 
non-trust fund surpluses over the next decade would be $2.7 
trillion. And now we are told the non-trust funds can 
anticipate a $2.2 trillion deficit. Of course, where does that 
money come from? It comes out of the trust funds of Medicare 
and Social Security. There is no alternative but for that to be 
the case.
    The decisions that were made last year and the current 
state of the budget have enormous implications for our long-
term fiscal future. Really, that is the message of this 
hearing.
    In your testimony last year, you advocated growing the 
economy through increased national savings and principally 
through running surpluses to pay down debt. Reducing deficits 
and running surpluses has propped up a steady decline in 
personal savings which stood in the year 2000 at seven-tenths 
of 1 percent.
    In the United States, net national savings has risen 
substantially over the past 7 years, from 3.3 percent of GDP in 
1993 to 5.5 percent in 2000. But the improvement in Federal 
savings more than explains the entire improvement in national 
savings. In other words, it is because the Federal Government 
has been running surpluses that our rate of national savings 
has increased.
    Personal savings has been going down. National savings we 
got going up, and we got it going up by the Federal Government 
running budget surpluses.
    Why is national savings important? National savings is 
important because that is the pool of money that is available 
for investment. And it is investment which makes us able to 
grow the economy. It is these connections that are critically 
important.
    You know, I think sometimes that when those of us who have 
talked for a long time about the need to be fiscally 
responsible and the need to run budget surpluses, especially in 
light of the baby boomers about to retire, I think some people 
in the public say, well, that a bunch of green-eyeshade guys 
who are worried about accounting and they are worried about 
things adding up.
    Well, that is important, but that is not the real 
importance of the exercise. The real importance of the exercise 
is having economic growth in the future so that America can 
meet its long-term obligations.
    Some say, well, you don't have to worry about it. The money 
is being credited to the Social Security Trust Funds. And that 
is true. The money is credited to the trust funds when it comes 
in in the payroll taxes. And then we have a special 
certificate, a treasury bond, if you will, that is in the trust 
funds. But there is no money there and those obligations are 
going to have to be redeemed in the future out of the revenue 
stream of the Federal Government.
    Of course, we know the Federal Government has never reneged 
on its obligations. But that doesn't reduce the hard reality 
that a future Congress and a future President are going to face 
very difficult choices.
    I am also very concerned that the dramatic decline in 
surplus resources leaves us little room to address the solvency 
of the Social Security Trust Funds. The President has put forth 
a budget that spends the Social Security surpluses in each year 
over the next decade. Further, his budget fails to account for 
the substantial implementation resources, some $1 trillion, 
according to Social Security actuaries, required for his Reform 
Commission Social Security private accounts plans. Each of the 
recommendations of his commission will cause significantly 
higher deficits than the President's budget currently 
acknowledges.
    You know, a number of weeks ago I said this reminded me of 
Enron accounting. And I did it because on the way in that 
morning I heard a description of what got Enron in trouble, and 
what caused the problem for Enron was that it was hiding its 
debt--hiding its debt from its creditors, hiding its debt from 
its investors, perhaps even hiding its debt from themselves.
    I am very concerned that the Federal Government is on that 
same path, that we are understating our long-term obligations, 
that we are, in effect, fooling the American people, I think 
even fooling ourselves.
    This talk of surpluses to me is totally misleading. There 
are no surpluses. All the money is fully committed--in fact, it 
is overcommitted. And unless we face up to that reality, I am 
very concerned about what a future Congress and a future 
President will find when they go to the cupboard and the 
cupboard is bare.
    All of this has been made more complicated by the tax cut 
passed last year, by the economic recession, and by the attack 
of September 11th. But we are going to have to face up to this 
as a society. Putting our heads in the sand, making believe 
that it is not there, making believe that these debts are not 
going to come true is not going to solve the problem.
    So I hope very much that today, General Walker, you will 
give us the longer-term outlook, where we are headed as a 
country, and help us to understand how that fits in with our 
current budget deliberations.
    The vote is now occurring on the Senate floor. There are 
about 5 minutes left. So I will recess the Committee and 
return. Again, I would ask that if Senator Domenici gets here 
before I return that he reopen the Committee and make his 
statement, and then we have an opportunity to hear from General 
Walker. I would ask that we wait until I return for Mr. Walker 
to begin his statement, if we could. [Recess.]
    Senator Domenici. I ran into the Chairman en route. He 
suggested that I open the meeting and proceed with my opening 
remarks. He said he would be back soon, perhaps about the time 
I am finished. I had planned to yield to you, Senator, if you 
had some opening remarks, as soon as I am finished here.
    Senator Corzine. Thank you.

         OPENING STATEMENT OF SENATOR PETE V. DOMENICI

    Senator Domenici. First of all, I want to say thank you to 
you again for joining us. I note that the title of this hearing 
is long-term budgetary issues, and I appreciate hearing GAO's 
assessment of the long term.
    I do, however, want to be honest and say I suspect that it 
is not very different from what we have known for a decade, and 
you have presented the evidence that you are going to present 
in a slightly different way to us heretofore, indicating the 
demographics that confront this country with reference to the 
future.
    When we look out 20, 30, even 40 years from now, the 
pressure from the demographic changes, especially of the baby-
boom generation, will strain this Government if nothing is done 
to reform Social Security or Medicare. And I understand you 
told us that the last time you were here, and we had a little 
discussion about what it meant to reform them. Of course, in 
your position you were not talking about detailed reform within 
the programs but, rather, generally giving us some of your 
thoughts, which were very helpful.
    But the story isn't new. There have been three commissions 
over the past decade whose missions have been to address long-
term fiscal issues, and I assume that you and your people, as 
good as they are, have looked at all those and that the 
conclusions and the good thoughts have been incorporated in 
your discussion here today.
    There was one commission on Entitlement Reform. I think we 
all remember it. It was led by Kerrey and Danforth. They were 
put on that to chair that with people having great enthusiasm 
that there would be major changes. Then there was the 
commission on the Future of Medicare, led by Senator Breaux and 
Representative Thomas, and then President Bush's commission to 
Strengthen Social Security. I see that all these reports 
contained information that is being summarized by you, Mr. 
Walker, and in a sense, given kind of a unity of understanding.
    This Senator has always approached fiscal policy from a 
balanced viewpoint. Do what is best for the economy and the 
American people, both in the short term and the long term. That 
is getting more and more difficult to do. There is no question 
about it.
    I believe the action we took last year to reduce the tax 
burden on Americans was best in the short and in the long term. 
A large majority of my colleagues agreed, as did Chairman 
Greenspan and other students of fiscal policy.
    Tomorrow, I believe that we are going to receive yet more 
evidence that the recession was shallow, perhaps the shallowest 
in history. I don't know whether you, Mr. Walker, have 
commented on it in your remarks. I did not get a chance to read 
them. But it seems pretty obvious that the recession is going 
to be rather shallow.
    In fact, many economists expect that we grew at about a 
positive 1 percent rate in the fourth quarter. This means that 
we only had one quarter of negative growth and the overall 
growth rate during the recession was about zero rather than 
being negative. That is good. That is good news for future 
Social Security recipients, too.
    In my view, one of the key reasons the recession was as 
shallow as it was was because the tax cut came in just at the 
right time. We were out there saying we needed to reduce taxes, 
which was an important issue, and at the same time it seems 
like the first cut came in right when the recession might have 
bottomed, along with Alan Greenspan's and his Federal Reserve 
reduction in interest rates I think kept this economy from 
going into deeper recession.
    Last year, I was concerned that we were on track, reducing 
our debts very rapidly, and then the rapidity with which we 
began to reduce our national debt caused me some concern. I 
don't have to repeat that concern now because obviously we 
don't have staring us in the face the huge surplus that 
concerned this Senator and others with reference to what would 
that money be used for.
    I agree with the Director of the Congressional Budget 
Office who is fond of saying, and I quote, ``It is not the size 
of the trust fund that matters, but the size of the economy.'' 
I would like to repeat that: ``It is not the size of the trust 
fund that matters, but the size of the economy.''
    Finally, Mr. Walker, at this time last year, GAO issued an 
extensive series of reports on the high-risk areas of the 
Federal Government. Those reports as well as the work that 
Director Daniels and the OMB staff are doing will be extremely 
helpful in terms of the short-run focus of policymakers. I 
commend you for those reports. I think they are very good.
    There is inefficiency in this Government that must be 
addressed, and we can never let up. We have to take a shot at 
that regularly as policymakers, or inefficiency will grow and 
will be much bigger than anybody assumes. Maybe you can help us 
determine where the American people are not receiving their 
money's worth. I think you are uniquely equipped to do that.
    Now I wonder if the Chairman wants to proceed or does he 
want to wait. Does anyone know? [Pause.]
    Senator Domenici. OK, Senator, you are in charge.
    Senator Corzine. Not with you around, Senator Domenici, I 
assure you.
    I didn't prepare a formal statement, but let me just say 
for the record that I think nothing is more important than 
sorting out this balance between those short-term realities 
that we must face as public officials and the needs of the 
economy and our long-term fiscal stability, which will be upon 
us soon. The topic of this demographic bubble and its 
implications for medical care for Americans, not only the 
seniors but for all of Americans, along with the Social 
Security program is one that I think is as close to an honest 
dilemma that we face in our political life. And so resolving 
that and solutions to that, Mr. Walker, are ones that I am 
anxious to hear your thoughts about because we need to truly 
acknowledge that we are running into a Box Canyon on our fiscal 
affairs in this Nation. And I think we have a structure that 
doesn't provide solution for those.
    I appreciate your commentary on it. It will be interesting 
to see how we can both finance Medicare, Medicaid, and our 
Social Security obligations and still perform the other 
functions of Government. And my fear is that we have prescribed 
a fiscal situation that reduces the role that Government plays 
to a level that is not acceptable to the American people on a 
whole host of other areas, including education and 
transportation infrastructure, et cetera.
    I will stop here. The Chairman will be returning, but I 
look forward to your comments. I appreciate your 
straightforwardness and integrity on a whole host of issues in 
the reports that you have published in history.
    Thank you.
    Mr. Walker. Thank you, Senator. [Pause.]
    Senator Corzine. Being a freshman Senator, I am learning 
how this works. Go ahead, Mr. Walker, and start your testimony. 
I think the Chairman should be here in a very few minutes.

 STATEMENT OF DAVID M. WALKER, COMPTROLLER GENERAL OF THE UNITED STATES

    Mr. Walker. Thank you, Senator. I am pleased to return this 
year to present GAO's perspective on the long-range fiscal 
policy challenges facing the Congress and our Nation.
    Thank you, Mr. Chairman. I am just on the second sentence, 
so your timing is impeccable.
    We meet today in a situation that seems very different from 
that of last February. Today the challenges of combating 
terrorism and ensuring our homeland security have come to the 
fore as urgent claims on our attention and on the Federal 
budget. While there are indications that the economic recovery 
is underway, the recession that began last spring, according to 
the National Bureau of Economic Research, has had real 
consequences for the budget.
    These are important changes in the past year. At the same 
time, the known fiscal pressures created by the retirement of 
the baby-boom generation and rising health care costs remain 
the same this year as they have been for a number of years.
    Absent substantive reform of entitlement programs, the 
rapid escalation of Federal spending for Social Security, 
Medicare, and Medicaid beginning less than 10 years from now is 
virtually certain to overwhelm the rest of the Federal budget. 
Indeed, the slowing economy and tax and spending decisions that 
were made during the past year, including increased spending 
levels necessary to respond to the new security challenges that 
we face, have increased these pressures on the budget. 
Correspondingly, the ultimate task of addressing these needs 
without unduly exacerbating the long-range fiscal challenge has 
become more difficult.
    In summary, I would like to make the following points, and 
I have a few charts to illustrate a few of these points.
    The surpluses that this committee and many others worked to 
achieve, with the help of the economy, not only strengthened 
the economy for the longer term and helped us in our fiscal 
posture for the longer term, but also put us in a stronger 
position to respond to the events of September 11th and to the 
economic slowdown than otherwise would have been the case.
    Going forward, the Nation's commitment to surpluses will be 
severely tested. A return to surplus will require sustained 
discipline and very difficult choices.
    Because the longer-term outlook is driven in large part by 
known demographic trends, in some ways we can be surer about 
the outlook 20 years from now than about the forecast for the 
next few years.
    The message of GAO's updated simulations remains the same 
as last year: absent structural changes in entitlement programs 
for the elderly, in the long term persistent deficits and 
escalating debt will overwhelm the Federal budget.
    Both longer-term pressures and new commitments undertaken 
after September 11th sharpen the need to look at competing 
claims and new priorities. A fundamental review, reassessment, 
and reprioritization of existing programs and activities is 
necessary both to increase fiscal flexibility and to make 
today's Federal Government fit the modern world. Stated 
differently, there is a need to engage in a fundamental 
reassessment of what is the proper role for the Federal 
Government in the 21st century and how should the Government do 
business in the 21st century.
    This committee in the past--in particular, I know, Senator 
Domenici among others--has been very interested in trying to 
understand what works and what doesn't work within the base of 
Government. It is critically important that we get back to 
that. The fact of the matter is the numbers do not add up. We 
are not going to be able to sustain all the programs abd 
activities that we have now under current tax levels and 
projected tax levels; we would not be able to do it with huge 
increases in taxation--which I don't think would be acceptable 
or desirable--unless we end up dealing with some of these 
structural problems. That means we need to look at what exists 
today and ask whether or not it is still relevant in the 21st 
century; and if it is relevant in the 21st century, at what 
level of priority? Because there are new claims and competing 
needs before us. Look just at the health care area, where we 
already have a huge imbalance. There is increasing interest in 
having a prescription drug benefit, but at the same time we 
already have trillions of unfunded promises associated just 
Part A of Medicare alone, and prescription drugs represents the 
fastest-growing cost in health care.
    The fiscal benchmarks and rules that moved us from deficit 
to surplus expire this year. Any successor system should 
facilitate both a debate about reprioritization of today's 
programs and spending and a better understanding of the long-
term implications of current actions. Simply stated, there are 
many things that we may be able to afford to do today but we 
may not be able to sustain in the future.
    If I may, let me show you three charts that illustrate 
this. Now, these are simulations. These are not projections. It 
is difficult enough to go out 10 years, Mr. Chairman, as you 
noted. You can't have a great degree of precision.
    On the other hand, there is a higher degree of certainty 
with regard to demographic trends, because most of those 
persons are alive today. We can't be as certain about economic 
growth, but about demographics there is less doubt.
    We show three different fiscal scenarios here. First, we 
show ``the baseline extended'', and you and others have 
articulated what the limitations of that scenario are. Second, 
we show the path where the Social Security surplus is saved 
after we come back to where we are not using part of that for 
other spending, which starts in about 2010. Finally, we show a 
path in which increasing discretionary spending increases at 
the rate of the economy, which is historically what has 
happened in recent years, and the tax cut is extended. That is 
both growing spending at about the rate that it has been 
growing for a number of years and extending the tax cuts beyond 
the scheduled sunset dates.
    We do not endorse any of these. We are is not intending to 
take a position one way or another. These are three separate 
fiscal simulations. The bottom line is it is bad under any one 
of the three.
    There is a difference as to the timing. There is a 
difference as to the magnitude of the challenge. But the 
challenge exists, and the challenge is worse today than it was 
a year ago when I was here.
    The next chart----
    Chairman Conrad. Could I just stop you?
    Mr. Walker. Yes, sir.
    Chairman Conrad. Just before you take that down, let's, if 
we can, quantify how bad this gets, because under any of these 
scenarios, you are approaching deficits of 20 percent of GDP. 
Is that correct?
    Mr. Walker. That is correct. It is just a matter of when--
--
    Chairman Conrad. Twenty percent of gross domestic product 
as deficit. That would be--if we were to apply that today, try 
to put it in today's terms, that would mean $2 trillion of 
deficits. Is that correct?
    Mr. Walker. That is about right, roughly correct.
    Chairman Conrad. Yes.
    Mr. Walker. Today's dollars.
    Chairman Conrad. I hope people just stop and think about 
that. The whole budget today is $2 trillion. If we were to fast 
forward what your simulations are showing, we would be running 
$2 trillion deficits.
    Mr. Walker. At some point in time in the future.
    Chairman Conrad. At some point in time in the future, but 
that is applying the size of the economy today to the level of 
deficit you have in the future applied to the size of the 
economy today.
    Mr. Walker. Correct. Now, obviously the economy will be 
bigger in the future, so it will be 20 percent of the future--
--
    Chairman Conrad. Of an even bigger number.
    Mr. Walker. Correct.
    Chairman Conrad. But if you were to apply this 20 percent 
to today's economy, you would have a $2 trillion deficit today. 
We have a $10 trillion economy, 20 percent of GDP, you would 
have a $2 trillion deficit. I hope people are getting this. 
This isn't just a little bitty problem. This is a huge problem.
    Mr. Walker. And it has existed, as Senator Domenici said 
earlier, for a number of years. My concern is it may not be new 
news, but we have got to figure out how we are going to get on 
dealing with this, because it is not going away. Another 
concern that I have is that there are many activities or 
programs people want in theory today on Congress may need to 
act, and which may be affordable today. The question is will we 
be able to afford and sustain these actuaries in the future?
    I agree with Director Crippen, and I have said similar 
things, that in the end it is not the size of the trust fund, 
it is the size of the economy.
    All of these simulations are based upon CBO assumptions. We 
are not going to compete with our sister agency on that. We use 
their economic growth path. Obviously, if economic growth, is 
greater it will make it better. The scenario won't be as bad. 
But I would respectfully suggest the situation is so serious 
that you are not going to grow your way out of this problem. As 
a result, the Congress needs to figure out--we need to figure 
out--as a Nation--how best to go about addressing this 
challenge.
    If I can show the next one, Mr. Chairman, I think it 
illustrates this even better. Again, we take current law as a 
starting point--not a policy or position but a basis for the 
simulation.
    The line shows taxes as a percentage of GDP. The scenario 
uses CBO assumptions, and the Social Security and Medicare 
trustees' best estimate assumption of what is likely to happen 
on spending for those programs in the future. Finally, this 
scenario assumes that discretionary spending grows at the rate 
of the economy, and the provisions in the 2001 tax bill don't 
sunset----
    Between 2000 and 2030 you get to the point where you either 
have to cut all other spending by a little more than two-
thirds, or you have to increase taxes by about 35 percent, or 
some combination of the two. Neither one of these is desirable.
    Chairman Conrad. Why don't you just repeat that so that 
this sinks in.
    Mr. Walker. Under this scenario, it would say that by the 
year 2030--and, of course, you would have to do it before that. 
This is a point in time. Overall tax levels at the Federal 
level would either have to increase by about 35 percent, or all 
other spending would have to be cut by a little more than two-
thirds.
    Now, as you know, Senators, discretionary spending includes 
things like national defense, homeland security, the judicial 
system of the Nation, education programs, infrastructure 
spending. Some of these are in the Constitution of the United 
States and obviously cannot be compromised in any way. This is 
just to illustrate the magnitude of the problem.
    By the time you get to 2050, there is only enough money to 
pay interest on what will be a massive Federal debt that will 
have been reaccumulated and Social Security, basically. The 
alternative would be to double Federal taxes.
    Chairman Conrad. Let's rivet on that point: 2050, the only 
things you could pay for would be the interest on the debt and 
Social Security. You wouldn't be able to pay--you wouldn't have 
any money for Medicare. You wouldn't have any money for any 
other discretionary spending.
    Mr. Walker. That is correct, under this simulation.
    Now, let's face it. If you go out 50 years, God only knows 
what is going to happen 50 years from now. But point is this: 
Not to be as precise, but to show the magnitude of the gap, the 
gap is huge. And as I said before, yes, we can ease the 
pressure if we can grow the economy at a faster rate. But I 
would respectfully suggest you are not going to grow your way 
out of this problem.
    And I would also respectfully suggest the Congress is 
probably not going to want to increase taxes to this level, nor 
is it going to want to decrease all other spending by this 
much. This is all the more reason why we have got to figure out 
how can we go about establishing, metrics and processes to 
begin to address these situations while we have more 
flexibility and while people have time to be able to adjust to 
whatever changes might be made.
    Chairman Conrad. Let me just stop you on that point. In 
2050, you would have to eliminate all domestic spending, all 
spending for defense, all Medicare spending, all spending on 
law enforcement, judiciary, every Government agency, because 
the only money you would have is money to pay for Social 
Security and interest on the debt, or an 100 percent increase 
in taxes.
    Mr. Walker. Federal taxes.
    Chairman Conrad. Yes, Federal taxes. A 100 percent increase 
in taxes. Now, let me ask you one other question. People will 
say, 2050, what are they talking about? But let's understand 
what the assumptions are. The assumptions are just current law. 
You are not up here making up new law.
    Mr. Walker. It is not current law, in fairness. There are 
two adjustments to current law here.
    Chairman Conrad. And what are those?
    Mr. Walker. The two adjustments to current law are: No. 1, 
you are growing discretionary spending at the rate of the 
economy, which historically over the last----
    Chairman Conrad. So you are taking current law as the base.
    Mr. Walker. Right.
    Chairman Conrad. And then you are adding an inflationary 
adjustment.
    Mr. Walker. More the inflation. It is growing at the rate 
of the economy rather than inflation.
    Chairman Conrad. The economy.
    Mr. Walker. Which is generally----
    Chairman Conrad. Which is basically what has been 
happening.
    Mr. Walker. Which is basically what has been happening up 
through last year, and----
    Chairman Conrad. And the tax cuts do not sunset.
    Mr. Walker. Right, correct. It assumes that Congress--and I 
am not saying that is good, bad, or indifferent, either one. It 
is a scenario. We have two other scenarios. You know, we have 
two other scenarios that have somewhat more favorable outcomes 
than this, but I would respectfully suggest nonetheless 
unacceptable outcomes, even though they are somewhat more 
favorable than this.
    As Senator Domenici said before, this is really not new. I 
mean, we have faced this scenario, as you know, Mr. Chairman, 
we have faced this scenario to differing degrees ever since GAO 
started doing the simulations 10 years ago. And if I could----
    Chairman Conrad. Has it gotten better or worse?
    Mr. Walker. It depends on which year you are talking about. 
Some years it got better, some years it got worse, the bottom 
line is we have always had a big problem.
    Senator Corzine. Mr. Chairman, may I ask, in the last year 
has it gotten better or worse?
    Mr. Walker. Well, it has gotten worse, but it has gotten 
worse for a number of different reasons. You know, some of it 
had to do with the economy. Some of it had to do with increased 
spending. Some of it had to do with changes on the revenue 
side. So it has been a lot of different reasons why it has 
gotten worse. No one single reason.
    Senator Stabenow. Mr. Chairman, if I might also just ask a 
question as well, did you look at what would happen if, in 
fact, the tax cuts were accelerated so that they would be fully 
in effect in the next couple of years?
    Mr. Walker. Senator, we did not. I have a difficult 
position here, and that is, what I am trying to do is I am 
trying to provide meaningful information that is policy 
neutral, because I don't think it is GAO's job nor my job as 
Comptroller General to say it is a good idea or a bad idea to 
do X or Y on taxes or on spending. I do think, however, it is 
my responsibility as the chief accountability officer to be 
able to show you what the future might look like and to try to 
help people understand that we need to be thinking about some 
of these things when the Congress is making decisions today, 
whether it be on the tax side or the spending side or whatever.
    Chairman Conrad. I think your statement earlier was about 
as clear as it can be. This whole thing doesn't add up.
    Mr. Walker. The numbers don't add up.
    Chairman Conrad. They don't add up. All right.
    Mr. Walker. Let me wrap it, Mr. Chairman. The next one just 
illustrates something that I think, again, hasn't changed much 
from last year, but we just need to get on with dealing with 
it, quite frankly. That is, these are the negative cash-flows 
that start in 2016 for Social Security and Medicare, and you 
see how rapidly they escalate.
    I was a trustee of Social Security and Medicare for 5 
years, from 1990 to 1995. Trust fund solvency matters, but it 
can be misleading. What is more important is how big are these 
programs as a percentage of the economy, how big are they as a 
percentage of the budget, and are they sustainable. In 
addition, cash-flow is important, and we turn negative cash-
flow in 2016. This is just a subset of the problem, if you 
will.
    So, in summary, Congress and the President stand at a point 
where current needs and wants need to be balanced against known 
long-term pressures. As stewards of our Nation's future, we 
need to begin to prepare for tomorrow. In this regard, we need 
to start focusing on how best to go about addressing these 
structural challenges in a reasonably timely manner in order to 
identify specific actions that need to be taken in order to 
avoid this train wreck in the future.
    This will not be easy. But it is not going to get any 
easier the more we wait. And obviously GAO stands ready, 
whether it is through our high-risk work or whatever else that 
we have done, to try to help the Congress in answering those 
two key questions that I mentioned before which are critically 
important. What is the proper role for the Federal Government 
in the 21st century? And how should the Federal Government do 
business? Reviewing, reassessing, reprioritizing existing 
Federal programs and policies.
    Mr. Chairman, I would respectfully suggest that this 
committee combined with the Governmental Affairs Committee are 
in a perfect position to be able to take a leadership role in 
trying to address those two fundamental questions. What is the 
proper role? And how should the Government do business? And we 
stand ready to assist you.
    [The prepared statement of Mr. Walker follows:]

 The Prepared Statement of David M. Walker, Comptroller General of the 
                             United States

    Chairman Conrad, Ranking Member Domenici, and Members of the 
Committee:

    I am pleased to return this year to present GAO's perspective on 
the long-range fiscal policy challenges facing this Congress and our 
Nation. We meet today in a situation that seems very different from 
that of last February. Today the challenges of combating terrorism and 
ensuring our homeland security have come to the fore as urgent claims 
on our attention and on the Federal budget. While there are indications 
that an economic recovery is underway, the recession that began last 
spring has had real consequences for the budget. These are important 
changes in the last year. At the same time, the known fiscal pressures 
created by the retirement of the baby boom generation and rising health 
care costs remain the same. Absent substantive reform of the 
entitlement programs, a rapid escalation of Federal spending for Social 
Security, Medicare, and Medicaid beginning less than 10 years from now 
is virtually certain to overwhelm the rest of the Federal budget. 
Indeed, the slowing economy and tax and spending decisions, including 
the increased spending levels necessary to respond to new security 
challenges, have increased pressures on the budget. Correspondingly, 
the ultimate task of addressing these needs without unduly exacerbating 
the long-range fiscal challenge has become much more difficult.
In my testimony today I make the following points:

  The surpluses that many worked hard to achieve--with help 
    from the economy--not only strengthened the economy for the longer 
    term but also put us in a stronger position to respond to the 
    events of September 11 and to the economic slowdown than would 
    otherwise have been the case.
  Going forward, the Nation's commitment to surpluses will be 
    tested: a return to surplus will require sustained discipline and 
    difficult choices.
  Because the longer-term outlook is driven in large part by 
    known demographic trends, in some ways we can be surer about the 
    outlook 20 years from now than the forecast for the next few years.
  The message of GAO's updated simulations remains the same as 
    last year: absent structural changes in entitlement programs for 
    the elderly, in the long term persistent deficits and escalating 
    debt will overwhelm the budget.
  Both longer-term pressures and the new commitments undertaken 
    after September 11 sharpen the need to look at competing claims and 
    new priorities. A fundamental review of existing programs and 
    activities is necessary both to increase fiscal flexibility and to 
    make government fit the modern world. Stated differently, there is 
    a need to consider what is the proper role of the Federal 
    Government in the 21st century and how should the government do 
    business in the future.
  The fiscal benchmarks and rules that moved us from deficit to 
    surplus expire this fiscal year. Any successor system should 
    facilitate both a debate about reprioritization today and a better 
    understanding of the long-term implications of different policy 
    choices. Simply stated, there are many things that we may be able 
    to afford to do today but we may not be able to sustain in the 
    future.
The Fiscal Backdrop for Today's Choices
    Today it is evident that recent surpluses were the result not only 
of hard choices made earlier in the 1990's, but also of fortuitous 
economic, demographic, and policy trends that are no longer working for 
us as we enter the 21st century. In retrospect, the Nation emerged from 
deficits of nearly three decades only to find itself in what has been 
called ``the eye of the storm.'' The passage to surpluses was aided by 
a tailwind consisting of (1) extraordinarily strong economic growth, 
(2) a slowing of health care cost growth, (3) a demographic holiday 
stemming from low birth rates during the Depression and World War II 
paired with a large workforce resulting from the post-war baby boom--
which together gave rise to a stable worker-to-beneficiary ratio in 
Social Security, and (4) the fall of the Soviet Union permitting a 
decline in defense spending as a share of the economy.
    The fiscal winds have now shifted--many of these fortunate trends 
have now reversed course and are making the choices harder. Although it 
appears the economy may have turned the corner, forecasters are not 
showing a return to the extremely rapid growth the Nation enjoyed 
during the last half of the nineties. Health care costs have once again 
resumed growing at double-digit rates. Reductions in defense spending 
can no longer be used as a means to help fund other claims on the 
budget; indeed, spending on defense and homeland security will grow as 
we seek to defeat terrorism worldwide. Finally--and I know this is one 
of the reasons you invited me here today--the Nation's demographic 
holiday is ending. In 2008--only 6 years from now--demographic storm 
clouds will begin to shadow the baseline as the first wave of baby 
boomers become eligible to claim Social Security.
    However one allocates credit across the events and decisions that 
led to years of surpluses, we benefited from that achievement. These 
large surpluses not only helped in the short term by reducing debt and 
interest costs but also strengthened the budget and the economy for the 
longer term. The budgetary surpluses of recent years put us in a 
stronger position to respond both to the events of September 11 and to 
the economic slowdown than would otherwise have been the case.
    However, going forward, the Nation's commitment to surpluses will 
truly be tested. For the last few years surpluses were built in to the 
baseline so that given a lack of policy action, there would be a 
surplus. Last year, the Congressional Budget Office (CBO) baseline not 
only projected unified surpluses for at least the 10-year window but 
also substantial surpluses in the non-Social Security portion of the 
budget. Saving the Social Security surplus became an achievable and 
compelling fiscal policy goal for the Nation in this context. This is 
no longer true. At least for the next several years the baseline does 
not turn to unified surplus. A surplus in the non-Social Security 
portion of the budget is not projected under the baseline to emerge 
until 2010. As a result, explicit policy actions on spending and/or 
revenue will be necessary to return to and maintain surpluses over the 
next 10 years.
The Known Demographic Challenge
    Although in important ways you begin the task of crafting a budget 
this year in a very different place than you did last year, in other 
ways the responsibilities remain the same. We still have a stewardship 
obligation to future generations. By stewardship obligation I mean that 
in making budget decisions today, it is important to be mindful of 
their impact on the future. This means that in responding to the 
legitimate needs of today, we should take into account the longer-term 
fiscal pressures we face. The message of GAO's long-term simulations, 
updated using CBO's new budget estimates, is consistent with previous 
simulations: absent change, spending for Federal health and retirement 
programs eventually overwhelms all other Federal spending.
    As we look ahead we face an unprecedented demographic challenge. A 
Nation that has prided itself on its youth will become older. Between 
now and 2035, the number of people who are 65 or over will double. As 
the share of the population over 65 climbs, Federal spending on the 
elderly will absorb larger and ultimately unsustainable shares of the 
Federal budget. Federal health and retirement spending are expected to 
surge as people live longer and spend more time in retirement. In 
addition, advances in medical technology are likely to keep pushing up 
the cost of providing health care. Moreover, the baby boomers will have 
left behind fewer workers to support them in retirement, prompting a 
slower rate of economic growth from which to finance these higher 
costs. Absent substantive change in related entitlement programs, large 
deficits return, requiring a combination of unprecedented spending cuts 
in other areas, and/or unprecedented tax increases, and/or 
substantially increased borrowing from the public (or correspondingly 
less debt reduction than would otherwise have been the case). These 
trends have widespread implications for our society, our culture, our 
economy, and--of most relevance here--our budget.
    Ultimately, as this Committee and its counterpart in the House 
recommended on October 4,\1\ 1 the Federal Government should attempt to 
return to a position of surplus as the economy returns to a higher 
growth path. Returning to surpluses will take place against the 
backdrop of greater competition of claims within the budget. Although 
budget balance may have been the desired fiscal position in the past 
decade, surpluses would promote the level of savings and investment 
necessary to help future generations better afford the commitments of 
an aging society.
---------------------------------------------------------------------------
    \1\ House and Senate Budget Committees, The Revised Budgetary 
Outlook and Principles for Economic Stimulus (Oct. 4, 2001).
---------------------------------------------------------------------------
    Early action is important. We all recognize that we have urgent 
matters to address as a Nation and our history shows we have been 
willing to run deficits during wars and recessions. However, it remains 
important that to get on with the task of addressing the long-term 
pressures sooner rather than later. Some will suggest that early action 
may not be necessary--for example, that faster economic growth may 
enable a smaller pool of workers to more easily finance the baby boom 
retirement. While this might happen, the best estimates of the 
actuaries suggest it is unlikely. CBO has also said that the Nation's 
long-term fiscal outlook will largely be determined by Federal spending 
for retirees, especially for health.
    Although long-term projections are inherently more uncertain than 
short-term forecasts, in some ways we can be surer about the outlook 20 
years from now since it is driven by known demographics. The swing in 
1-, 5-, and 10-year projections over the last 12 months has served to 
emphasize the extent to which short-term projections are subject to 
uncertainty. And CBO notes that this year the near-term projections are 
subject to unusual uncertainties as the Nation wages war on terrorism 
and recovers from a recession. CBO pointed out that it is considered 
more difficult to forecast the economy when it is entering or exiting a 
recession. This year there are additional uncertainties in the near-
term budget outlook. CBO's reference case--the baseline--from which you 
begin your deliberations (and which in the first 10 years is the 
underpinning for our long-term model) is a representation of current 
laws and policies. Thus, by definition it does not account for the 
effects of future legislation, including likely increases in spending 
for defense and homeland security to which both parties have agreed in 
principle. Nor, as CBO noted, does it make assumptions about a number 
of issues, e.g., the extension of agriculture programs, Medicare 
prescription drug coverage, changes in the Alternative Minimum Tax, or 
the extension of various expiring tax provisions.
    Given this extreme uncertainty around the next 1 to 5 years, why 
look out 20 or 30 years? Absent some draconian or unexpected dramatic 
event, the long-term budget outlook is driven by factors already in 
motion--most notably the aging of the population. In previous 
testimonies before you, I have talked about a demographic tidal wave, 
Beginning about 2010, the share of the population that is age 65 or 
older will begin to climb, surpassing 20 percent by 2035. (See fig. 1.)
[GRAPHIC] [TIFF OMITTED] 80544.081



    Note: Projections based on intermediate assumptions of the 2001 
Trustees' reports.
    Source: The 2001 Annual Report of the Board of Trustees of the 
Federal Old-Age and Survivors Insurance and Disability Insurance Trust 
Funds.

GAO's Model Simulations Illustrate Long-term Budget Challenges
    Because of the coming demographic shift, the message from our 
simulations remains the same as last year, indeed as since we first 
published results from our long-term model in 1992: Absent policy 
change, in the long term, persistent deficits and escalating debt 
driven by entitlement spending will overwhelm the budget. This year we 
ran three different policy paths to illustrate the implications of a 
range of budgetary choices. I'd like to emphasize again that these 
simulations are not intended to endorse a particular policy but rather 
to illustrate the long-term implications of different scenarios.
    All three scenarios begin with CBO's baseline estimates. The first 
starts with the baseline where for the first 10 years tax and 
entitlement laws are unchanged--including sunset provisions--and 
discretionary spending grows with inflation. After the first 10 years, 
we hold discretionary spending and revenues constant as a share of 
gross domestic product (GDP) and allow Social Security and Medicare to 
grow based on the actuaries' intermediate estimates.\2\  In this path, 
the unified surpluses that emerge in 2004 are saved. Nevertheless, 
deficits return in 2036. At the other end is an alternative policy path 
in which discretionary spending grows with the economy in the first 10 
years and in which last year's tax cuts are extended. This yields a 
smaller period of surpluses with deficits returning in 2011. In both of 
these paths taxes remain constant as a share of GDP after 2012; this 
is, of course, a policy decision. To illustrate something in between 
these two paths, we simulated a third that tracks the CBO baseline 
until 2010. After 2010 we assume that the full Social Security surplus 
is saved through 2024\3\ --this requires some combination of tax and 
spending policy actions. In this simulation deficits reemerge in 2025. 
(See fig. 2.)
---------------------------------------------------------------------------
    \2\ We also assume that all current-law benefits in entitlement 
programs are paid in full (i.e., we assume that all promised Social 
Security and Medicare benefits are paid including after the projected 
exhaustion of the respective trust funds).
    \3\ The last year of projected Social Security surpluses (including 
interest income) under the 2001 trustees' intermediate estimates. As 
discussed later in this testimony, program expenses exceed non-interest 
income beginning in 2016.
[GRAPHIC] [TIFF OMITTED] 80544.082



    Source: GAO's January 2002 analysis.
    In all three paths, surpluses eventually give way to large and 
persistent deficits. These simulations show that there is a benefit to 
fiscal discipline--it delays the return to deficits--but that even the 
most demanding path we simulated--a path that does not provide for 
funding Presidential or many Congressional initiatives--is structurally 
imbalanced over the long term. Although savings from higher surpluses 
are important, they must be coupled with action to slow the long-term 
drivers of projected deficits, i.e. Social Security and health 
programs. Surpluses can help--they could, for example, facilitate the 
needed reforms by providing resources to ease transition costs--but, by 
themselves, surpluses will not be sufficient.
    In the long term, under all three paths Federal budgetary 
flexibility becomes increasingly constrained and eventually disappears. 
To move into the future with no changes in Federal health and 
retirement programs is to envision a very different role for the 
Federal Government. Assuming, for example, that last year's tax 
reductions are made permanent and discretionary spending keeps pace 
with the economy, spending for net interest, Social Security, Medicare, 
and Medicaid consumes nearly three-quarters of Federal revenue by 2030, 
leaving little room for other Federal priorities including defense and 
education. By 2050, total Federal revenue is insufficient to fund 
entitlement spending and interest payments--and deficits are escalating 
out of control.\4\  (See fig. 3.)
---------------------------------------------------------------------------
    \4\ Due to recent changes in methodology as well as updates to 
underlying assumptions, simulations presented in this testimony are not 
comparable to previously published simulations.
[GRAPHIC] [TIFF OMITTED] 80544.083



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    0

    0
    Source: GAO's January 2002 analysis.

    Reducing the relative future burdens of Social Security and Federal 
health programs is critical to promoting a sustainable budget policy 
for the longer term. Absent reform, the impact of Federal health and 
retirement programs on budget choices will be felt as the baby boom 
generation begins to retire. While much of the public debate concerning 
the Social Security and Medicare programs focuses on trust fund 
balances--that is on the programs' solvency--the larger issue concerns 
sustainability.
    The 2001 Trustees Reports estimate that the Old-Age Survivors 
Insurance and Disability Insurance (OASDI) Trust Funds will remain 
solvent through 2038 and the Hospital Insurance (HI) Trust Fund through 
2029.\5\  Furthermore, because of the nature of Federal Trust Funds, HI 
and OASDI Trust Fund balances do not provide meaningful information 
about program sustainability--that is, the government's fiscal capacity 
to pay benefits when the program's cash income falls below benefit 
expenses. From this perspective, the net cash impact of the trust funds 
on the government as a whole--not trust fund solvency--is the important 
measure. Under the trustees' intermediate assumptions, the OASDI Trust 
Funds are projected to have a cash deficit beginning in 2016 and the HI 
Trust Fund a deficit also beginning in 2016. (See fig. 4.) At that 
point, the programs become net claimants on the Treasury. In addition, 
as we have noted in other testimony,\6\  a focus on HI solvency 
presents an incomplete picture of the Medicare program's expected 
future fiscal claims. The Supplementary Medical Insurance (SMI) portion 
of Medicare, which is not reflected in the HI solvency measure, is 
projected to grow even faster than HI in the near future. According to 
the best estimates of the Medicare trustees, Medicare HI and SMI 
together will double as a share of GDP between 2000 and 2030 (from 2.2 
percent to 4.5 percent) and reach 8.5 percent of GDP in 2075. Under the 
trustees' best estimates, Social Security spending will grow as a share 
of GDP from 4.2 to 6.5 percent between 2000 and 2030, reaching 6.7 
percent in 2075.
---------------------------------------------------------------------------
    \5\ In the Fiscal Year 2000 Financial Report of the United States 
Government, issued in March 2001, the net present value of the 
estimated expenditures in excess of income as of January 1, 2000, was 
$3.8 trillion for Social Security and $2.7 trillion for Medicare Part 
A. The 2001 figures will be available at the end of next month.
    \6\  Medicare: New Spending Estimates Underscore Need for Reform 
(GAO-01-1O1OT, July 25, 2001).
[GRAPHIC] [TIFF OMITTED] 80544.084



    Note: Projections based on intermediate assumptions of the 2001 
OASDI and HI reports.
    Source: GAO analysis of data from the Office of the Chief Actuary, 
Social Security Administration and the Office of the Actuary, Health 
Care Financing Administration.
    To finance these cash deficits, Social Security and the Hospital 
Insurance portion of Medicare will need to draw on their special issue 
Treasury securities acquired during the years when these programs 
generated cash surpluses. This negative cash flow will placed increased 
pressure on the Federal budget to raise the resources necessary to meet 
the program's ongoing costs. In essence, for OASDI or HI to ``redeem'' 
their securities, the government will need to obtain cash through 
increased taxes, and/or spending cuts, and/or increased borrowing from 
the public (or correspondingly less debt reduction than would have been 
the case had cash flow remained positive).
    Our long-term simulations illustrate the magnitude of the fiscal 
challenges associated with an aging society and the significance of the 
related challenges the government will be called upon to address. As we 
have stated elsewhere,\7\  early action to change these programs would 
yield the highest fiscal dividends for the Federal budget and would 
provide a longer period for prospective beneficiaries to make 
adjustments in their own planning. Waiting to build economic resources 
and reform future claims entails risks. First, we lose an important 
window where today's relatively large workforce can increase saving and 
enhance productivity, two elements critical to growing the future 
economy. We lose the opportunity to reduce the burden of interest in 
the Federal budget, thereby creating a legacy of higher debt as well as 
elderly entitlement spending for the relatively smaller workforce of 
the future. Most critically, we risk losing the opportunity to phase in 
changes gradually so that all can make the adjustments needed in 
private and public plans to accommodate this historic shift. 
Unfortunately, the long-range challenge has become more difficult, and 
the window of opportunity to address the entitlement challenge is 
narrowing. It remains more important than ever to return to these 
issues over the next several years. Ultimately, the critical question 
is not how much a trust fund has in assets, but whether the government 
as a whole can afford the promised benefits now and in the future and 
at what cost to other claims on scarce resources.
---------------------------------------------------------------------------
    \7\ Major Management Challenges and Program Risks: A Governmentwide 
Perspective (GAO-01-241, January 2001), p. 45.
---------------------------------------------------------------------------
The Need To Reexamine Government Activities and Programs
    One of the reasons to address these longer-term pressures is their 
potential to crowd out the capacity to support other important 
priorities throughout the rest of the budget. The tragedy of September 
11 made us all realize the benefits fiscal flexibility provides to our 
Nation's capacity to respond to urgent and newly emergent needs. 
Obviously we will allocate whatever resources are necessary to protect 
the Nation. However, these new commitments will compete with and 
increase the pressure on other priorities within the budget. Financing 
these compelling new claims within an overall fiscal framework that 
eventually returns the budget to surplus is a tall order indeed.
    The budget process is the one place where we as a Nation can 
conduct a healthy debate about competing claims and new priorities. 
However, such a debate will be needlessly constrained if only new 
proposals and activities are on the table. A fundamental review of 
existing programs and operations can create much-needed fiscal 
flexibility to address emerging needs by weeding out programs that have 
proven to be outdated, poorly targeted, or inefficient in their design 
and management. It is always easier to subject proposals for new 
activities or programs to greater scrutiny than that given to existing 
ones. It is easy to treat existing activities as ``given'' and force 
new proposals to compete only with each other. Such an approach would 
move us further, rather than nearer, to budgetary surpluses.
    Moreover, it is healthy for the Nation periodically to review and 
update its programs, activities and priorities. As we have discussed 
previously,\8\  many programs were designed years ago to respond to 
earlier challenges. In the early years of a new century, we have been 
reminded how much things have changed. For perspective, students who 
started college this past fall were 9 years old when the Soviet Union 
broke apart and have no memory of the Cold War; their lifetimes have 
always known microcomputers and AIDS. In previous testimony,\9\  both 
before this Committee and elsewhere, I noted that it should be the norm 
to reconsider the relevance or ``fit'' of any Federal program or 
activity in today's world and for the future. Such a review might weed 
out programs that have proven to be outdated or persistently 
ineffective, or alternatively could prompt us to update and modernize 
activities through such actions as improving program targeting and 
efficiency, consolidation, or reengineering of processes and 
operations. Ultimately, we should strive to hand to the next 
generations the legacy of a government that is effective and relevant 
to a changing society--a government that is as free as possible of 
outmoded commitments and operations that can inappropriately encumber 
the future. We need to think about what government should do in the 
21st century and how it should do business.
---------------------------------------------------------------------------
    \8\ Budget Issues: Effective Oversight and Budget Discipline are 
Essential--Even in a Time of Surplus (GAO/TAIMD-00-73, Feb. 1, 2000).
    \9\ Homeland Security: Challenges and Strategies in Addressing 
Short- and Long-Term National Needs (GAO-02-160T, Nov. 7,2001) and 
Budget Issues: Effective Oversight and Budget Discipline are 
Essential--Even in a Time of Surplus (GAO/T-AIMD-00-73, Feb. 1, 2000).
---------------------------------------------------------------------------
    The events of last fall have provided an impetus for some agencies 
to rethink approaches to long-standing problems and concerns. In 
particular, agencies will need to reassess their strategic goals and 
priorities to enable them to better target available resources to 
address urgent national preparedness needs. For instance, the threat to 
air travel has already prompted attention to chronic problems with 
airport security that we and others have been pointing to for years. 
Moreover, the crisis might prompt a healthy reassessment of the broader 
transportation policy framework with an eye to improving the 
integration of air, rail, and highway systems to better move people and 
goods.
    Other long-standing problems also take on increased relevance in 
today's world. Take, for example, food safety. Problems such as 
overlapping and duplicative inspections across many Federal agencies, 
poor coordination, and inefficient allocations of resources are not new 
and have hampered productivity and safety for years. However, they take 
on new meaning and urgency given the potential threat from 
bioterrorism. We have argued for a consolidated food safety initiative 
merging the separate programs of the multiple Federal agencies 
involved. Such a consolidated approach can facilitate a concerted and 
effective response to the new threats.
    The Federal role in law enforcement is another area that is ripe 
for reexamination following the events of September 11. In the past 20 
years, the Federal Government has taken on a larger role in financing 
criminal justice activities that have traditionally been viewed as the 
province of the State and local sector. This is reflected in the growth 
of the Federal share of financing--from 12 percent in 1982 to nearly 20 
percent in 1999.
    Given the new daunting new law enforcement responsibilities in the 
wake of September 11 and limited budgetary resources at all levels, the 
question is whether these additional responsibilities should prompt us 
to rethink the priorities and roles of Federal, State, and local levels 
of government in the criminal justice area and ultimately whether some 
activities are affordable in this new setting. The Federal Bureau of 
Investigation has already begun thinking about reprioritization and how 
its investigative resources will shift, given the new challenges posed 
by the terrorism threat.
    With the Coast Guard's focus on homeland security, it has de-
emphasized some of its other critical missions in the short term, most 
notably fisheries enforcement and drug and migrant interdiction. The 
Coast Guard is currently developing a longer-term mission strategy, 
although it has no plans at present to revise the schedule or asset mix 
for its Deepwater Project (which will be awarded mid-2002).
    In rethinking Federal missions and strategies, it is important to 
examine not only spending programs but the wide range of other more 
indirect tools of governance the Federal Government uses to address 
national objectives. These tools include loans and loan guarantees, tax 
expenditures, and regulations. For instance, in fiscal year 2000, the 
Federal health care and Medicare budget functions include $37 billion 
in discretionary budget authority, $319 billion in entitlement outlays, 
$5 million in loan guarantees, and $91 billion in tax expenditures.
    The outcomes achieved by these various tools are in a very real 
sense highly interdependent and are predicated on the response by a 
wide range of third parties, such as States and localities and private 
employers, whose involvement has become more critical to the 
implementation of these Federal initiatives. The choice and design of 
these tools is critical in determining whether and how Federal 
objectives will be addressed by these third parties. Any review of the 
base of existing policy should address this broader picture of Federal 
involvement.
    GAO has also identified a number of areas warranting 
reconsideration based on program performance, targeting, and costs. 
Every year, we issue a report identifying specific options, many scored 
by CBO, for congressional consideration stemming from our audit and 
evaluation work.\10\  This report provides opportunities for (1) 
reassessing objectives of specific Federal programs, (2) improved 
targeting of benefits, and (3) improving the efficiency and management 
of Federal initiatives.
---------------------------------------------------------------------------
    \10\ Supporting Congressional Oversight. Framework for Considering 
Budgetary Implications of Selected GAO Work (GAO-0l-447, March 9, 
2001).
---------------------------------------------------------------------------
    Just as long-standing areas of Federal involvement need re-
examination, so proposed new initiatives designed to address the new 
terrorism threat need appropriate review. With the focus on counter-
terrorism, you will undoubtedly face many proposals redefined as 
counter-terrorism activities. The Congress will need to watch for the 
redefinition of many claims into counter-terrorism activities. It will 
be especially important to seek to distinguish among these claims.
    In sorting through these proposals, we might apply investment 
criteria in making choices. Well-chosen enhancements to the Nation's 
infrastructure are an important part of our national preparedness 
strategy. Investments in human capital for certain areas such as public 
health or airport security will also be necessary as well to foster and 
maintain the skill sets needed to respond to the threats facing us. A 
variety of governmental tools will be proposed to address these 
challenges--grants, loans, tax expenditures, and/or direct Federal 
administration. The involvement of a wide range of third parties State 
and local governments, nonprofits, private corporations, and even other 
Nations--will be a vital part of the national response as well.
    In the short term, we will do whatever is necessary to get this 
Nation back on its feet and compassionately deal with the human 
tragedies left in its wake. However, as we think about our longer-term 
preparedness and develop a comprehensive homeland security strategy, we 
can and should select those programs and tools that promise to provide 
the most cost-effective approaches to achieve our goals.
Budget Process Should Facilitate Discipline and Awareness of Long-term 
        Implications of Decisions
    Today the Congress faces the challenge of sorting out these many 
claims on the Federal budget without the fiscal benchmarks and rules 
that served as guides through the years of deficit reduction. Going 
forward, new rules and goals will be important both to ensure fiscal 
discipline as we sort through these new and compelling claims and to 
prompt policymakers to focus on the longer-term implications of current 
policies and programs. For more than a decade, budget process 
adaptations have been designed to reach a zero deficit. With the advent 
of surpluses, a new framework was needed--one that would permit 
accommodating pent-up demands but not eliminate all controls. A broad 
consensus seemed to develop to use saving the Social Security surplus 
or maintaining on-budget balance as a kind of benchmark. However, the 
combination of the economic slowdown and the need to respond to the 
events of September 11 has overtaken that measure.
    Once again, Congress faces the challenge of designing a budget 
control mechanism. Last October, Mr. Chairman, you and your colleague 
Senator Domenici and your House counterparts called for a return to 
budget surplus as a fiscal goal. This remains an important fiscal goal, 
but achieving it will not be easy. In the near term, limits on 
discretionary spending may be necessary to prompt the kind of re-
examination of the base I discussed above. There are no easy choices. 
There will be disagreements about the merits of a given activity--
reasonable people can disagree about Federal priorities. There may also 
be disagreements about the appropriate response to program failure: 
Should the program be modified or terminated? Would the program work 
better with more money or should funding be cut? Spending limits can be 
used to force choices; they are more likely to do so, however, if they 
are set at levels viewed as reasonable by those who must comply with 
them.
    Spending limits alone cannot force a re-examination of existing 
programs and activities. However, the recognition that for most 
agencies the new responsibilities acquired since September 11 cannot 
merely be added to existing duties requires that decisions be made 
about priorities. In the last decade Congress and the Administration 
put in place a set of laws designed to improve information about cost 
and performance. This information can help inform the debate about what 
the Federal Government should do. In addition, the budget debate can 
benefit from the kind of framework I discussed above. In previous 
testimony before this committee, I suggested that Congress might equip 
itself to engage in this debate by developing a congressional 
performance resolution to target its oversight on certain 
governmentwide performance issues cutting across agencies and 
programs.\11\  Along with caps, this and other measures might help 
ensure that Congress becomes part of the debate over reprioritization 
and government performance.
---------------------------------------------------------------------------
    \11\  Budget Issues: Effective Oversight and Budget Discipline Are 
Essential Even in a Time of Surplus (GAO/TAIMD-00-73, Feb. 1, 2000).
---------------------------------------------------------------------------
    The dramatic shift in budget projections since last year has 
prompted discussion of shortening the budget window. This may well be a 
sensible approach to reducing uncertainty. However, such a change 
should be coupled with steps to provide a broader and longer-term 
fiscal horizon: goals and metrics to address the longer-term 
implications of today's choices. This does not mean that we should 
budget for a 20- or 30-year period. It does mean considering 
establishing indicators and targets that bring a long-term perspective 
to budget deliberations and a process that prompts attention to the 
long-term implications of today's decisions. Periodic simulations along 
the lines we and CBO have developed can and should become a regular 
feature of budget debate. We would be the first to say that the 
simulations are not predictions of the future or point estimates, 
rather they serve as indicators--or warning lights--about the magnitude 
and direction of different policy profiles. These scenarios are 
particularly helpful in comparing long-term consequences of different 
fiscal paths or major reforms of entitlements using the same 
assumptions. As I said earlier, the demographic tidal wave that drives 
the long-term budget challenge is a known element with predictable 
consequences.
    Some kind of fiscal targets may be helpful. As a way to frame the 
debate, targets can remind us that today's decisions are not only about 
current needs but also about how fiscal policy affects the choices over 
the longer term. Other Nations have found it useful to embrace broader 
targets such as debt-to-GDP ratios, or surpluses equal to a percent of 
GDP over the business cycle. To work over time targets should not be 
rigid--it is in the nature of things that they will sometimes be 
missed. It should be possible to make some sort of compelling argument 
for the target--and it should be relatively simple to explain. Reaching 
a target is not a straight line but an iterative process. The other 
Nations we have studied have found that targets prompted them to take 
advantage of windows of opportunity to save for the future and that 
decisionmakers must have flexibility each year to weigh pressing short-
term needs and adjust the fiscal path without abandoning the longer-
term framework.
    In re-examining what I have called the ``drivers'' of the long-term 
budget, we need to think about new metrics. We have been locked into 
the artifacts of the trust funds, which do not serve as appropriate 
signals for timely action to address the growth in these programs. As I 
mentioned earlier, trust fund solvency does not answer the question of 
whether a program is sustainable.
    Although aggregate simulations are driven by these programs, the 
need for a longer-term focus is about more than Social Security and 
Medicare. In recent years there has been an increased recognition of 
the long-term costs of Social Security and Medicare. While these are 
the largest and most important long-term commitments--and the ones that 
drive the long-term outlook--they are not the only ones in the budget 
that affect future fiscal flexibility. For Congress, the President, and 
the public to make informed decisions about these other programs, it is 
important to understand their long-term cost implications. A longer 
time horizon is useful not only at the macro level but also at the 
micro-policy level. I am not suggesting that detailed budget estimates 
could be made for all programs with long-term cost implications. 
However, better information on the long-term costs of commitments like 
employee pension and health benefits and environmental cleanup could be 
made available. Here again, new concepts and metrics may be useful. We 
have been developing the concept of ``fiscal exposures'' to represent a 
range of Federal commitments--from explicit liabilities to implicit 
commitments. Exactly how such information would be incorporated into 
the budget debate would need to be worked out--but it is worth serious 
examination.
Conclusion
    In one sense much has changed in the budget world since last 
February. There are even more compelling needs and demands on the 
Federal budget than a year ago--and policymakers must deal with them 
absent the surpluses that were projected then. However, the demographic 
trends that drive the long-term outlook have not changed. The baby boom 
generation is still getting older and closer to retirement. Because of 
the coming demographic shift, the message from our simulations remains 
the same as last year, indeed as since we first published results from 
our long-term model in 1992: Absent changes in Social Security and 
health programs, in the long term, persistent deficits and escalating 
debt driven by entitlement spending will overwhelm the budget.
    The events of September 11 highlighted the benefits of fiscal 
flexibility. Addressing the long-term drivers in the budget is 
essential to preserving any flexibility in the long term. In the nearer 
term a fundamental review of existing programs and operations can 
create much-needed fiscal flexibility to address emerging needs by 
weeding out programs that have proven to be outdated, poorly targeted, 
or inefficient in their design and management.
    Congress and the President stand at a point where current needs and 
wants must be balanced against known long-term pressures. And you face 
the challenge of sorting out these many claims on the Federal budget 
without the fiscal benchmarks and rules that guided us through the 
years of deficit reduction into surplus. Going forward, new rules and 
goals will be important both to ensure fiscal discipline and to prompt 
a focus on the longer-term implications of decisions. It is still the 
case that the Federal Government needs a decision-making framework that 
permits it to evaluate choices against both today's needs and the 
longer-term fiscal future that will be handed to future generations. As 
stewards of our Nation's future, we must begin to prepare for tomorrow. 
In this regard, we must determine how best to address these structural 
challenges in a reasonably timely manner in order to identify specific 
actions that need to be taken.
    None of this is easy. We at GAO stand ready to assist you.

    Chairman Conrad. I thank you very much for that testimony.
    Let me just say that the importance of this hearing today 
to me is to share with our colleagues how really big the 
problem is that we have. And you are quite right to indicate 
this is a problem that has gotten worse in the last year, but 
it was very big before then. It is why last year I advocated a 
budget that saved all the Social Security and Medicare Trust 
Fund surpluses for the purposes intended. It also set aside 
$900 billion of general fund money to prepay liability. That is 
what other countries are doing that face this same kind of 
demographic wave--at least some of them. And I also believe 
that that would foster economic growth because you would pay 
down debt with that money, and that would mean theoretically 
lower interest rates, more money in national savings, more 
money available for investment, which should lead to greater 
economic growth.
    That course was not chosen, and I don't ask you to pass 
judgment on that. You are in a position of not recommending 
policy. Your job is to tell us where we are headed and how 
serious and how deep the hole is. And you have done that, and 
you have done it in a clear way.
    Let me ask you this: Is it your judgment that we ought to 
attempt to restore surpluses and build surpluses as the economy 
recovers? I take it from your testimony that that is part of 
your advice to us.
    Mr. Walker. That is consistent with what we have said in 
prior years. And in my testimony I said that--and I think it is 
also consistent with what the Congress has stated that it wants 
to do, that it wants to be able to return to surplus. What I am 
telling you is that it has become more difficult, and it is 
going to be progressively more difficult because of the factors 
that I have articulated before.
    Chairman Conrad. How important a role, in your judgment, 
does increasing the rate of national savings play in our 
ability to cope with these future challenges?
    Mr. Walker. National saving is critically important. As you 
noted before, national saving will fuel investment. Investment 
help to fuel productivity increases. Productivity increases 
help to increase our economy, and they also help to improve the 
standard of living for all Americans.
    You were right before that most of the increase in net 
national saving over the past decade have been a result of the 
Congress' effort to create surpluses. That is true. Individual 
saving, personal saving, as currently measured, continues to be 
abysmally low, and it is something that we are going to have to 
figure out how best to address, but we have not been successful 
to date.
    Chairman Conrad. Would somebody listening to you be 
incorrect to conclude, from what you have said here today, that 
we have got to restrain both our appetite for spending and our 
appetite for additional tax cuts? Would that be an appropriate 
conclusion?
    Mr. Walker. We need to do two things, without getting that 
specific, Mr. Chairman. We need to, I believe, consider the 
fiscal risk associated with a range of policy choices.
    Last year, I would commend to you and other members of the 
Committee, one of the things that I presented in my testimony 
was a chart that talked about different types of actions that 
the Congress could take and the different degrees of fiscal 
risk that each of those actions would represent. I suggested 
that the Congress might want to look at what it is doing in the 
budget area, and otherwise, as part of portfolio management, 
which I know, Senator Corzine, you are very familiar with. As 
part of portfolio management, to consider not only the short-
term flexibility, but the long-term implications as policy 
relates to its overall impact on future fiscal risk for the 
country.
    I noted in there that, obviously, to the extent that you 
end up taking certain types of actions, whether it be on the 
spending side or the tax side, they represent higher risk. I 
noted, also, that I felt that the highest risk was permanent 
increases in entitlement spending, where we already have 
trillions of unfunded obligations associated with those 
programs.
    Chairman Conrad. Let us talk a little bit about those 
unfunded obligations. Chairman Greenspan, in a meeting with me 
before he testified here, told me one of his concerns as we go 
forward are the so-called contingent liabilities of the Federal 
Government, contingent liabilities of major entitlement 
programs, Social Security and Medicare, that are not carried on 
the books of the Federal Government on the theory that Congress 
could end those programs on short notice. Therefore, they were 
considered contingent liabilities.
    He said to me he views the vast majority of those 
commitments as not contingent at all. Would you agree with his 
assessment?
    Mr. Walker. Well, let me tell you, first, what the current 
treatment is, and then I will address that.
    One of the first things that I did when I came to GAO, 
given my background and concerns about some of these issues, 
was to work with the Financial Accounting Standards Advisory 
Board, which is the body that promulgates general accepted 
accounting principles for the Federal Government, to increase 
the transparency and to enhance the visibility of our long-
range, unfunded commitments associated with Social Security and 
Medicare.
    Now, today, we have separate statements in the consolidated 
financial statements of the United States Government dedicated 
to these programs and, for the first time, we not only 
demonstrate information that is in the trustees' reports that 
come out every year, but we show the discounted present value 
of the unfunded promises associated with these programs, where 
there has been a----
    Chairman Conrad. How big are those unfunded liabilities? 
This is my last question, and then we will go to Senator Snowe.
    Mr. Walker. Those numbers are noted in a footnote in my 
statement. This is based on last year's report. In the fiscal 
2000 financial report of the United States Government, on Page 
7, footnote 5, $3.8 trillion, in current dollars, for Social 
Security; $2.7 trillion for Part A alone. The problem with 
Medicare is much greater than Social Security. And Medicare, 
while that by itself is much greater than Social Security, that 
does not count Medicaid. So, in reality, our problem in health 
care is multiple times our problem in Social Security.
    Chairman Conrad. Could you just repeat that. How much of 
the $3.8 trillion is attributable--this is unfunded liability--
how much of it is attributable to Social Security and how much 
to Medicare?
    Mr. Walker. Well, right now, $3.8 trillion, discounted 
present value, the difference between projected revenues, 
projected costs, $3.8 trillion, as of last year for OASDI, 
which is the Old Age Survivors and Disability Insurance. So it 
is both the retirement income and the disability program.
    For Part A, which is hospital insurance, HI, which, as you 
know, is funded by a payroll tax similar to Social Security, it 
is $2.7 trillion. But that does not count Part B, which is 
supplemental medical insurance which is, as you know, funded 
primarily by general revenues, and it does not count Medicaid. 
And so, when you look at it as a percentage of the economy, as 
a percentage of the budget, which I also provide in my 
statement, the health care problem is much greater than the 
Social Security problem.
    Chairman Conrad. I think that is too little understood. You 
have presented that before to this Committee. I wish the word 
would go out that these are the realities of what we confront 
as a Nation. There is a train wreck coming, folks. There is a 
train wreck coming, and it is of enormous proportion, and we 
better wake up before it is too late.
    I have attributed or likened this to Enron in the sense 
that Enron got in trouble, I believe, because they were hiding 
debt. They were running all of these off-balance sheet 
operations, and fundamentally hiding debt from the investment 
community, hiding it from their creditors, perhaps even hiding 
it from themselves.
    I worry very much that that is going on in this Government, 
that we are not facing up to the true debt that the country 
faces. We keep talking about surpluses. In my judgment, there 
are no surpluses. The surpluses are all gone. This money that 
is called surplus is committed. It is overcommitted, and yet we 
use the word ``surplus.'' It misleads people.
    People conclude from that we have got extra money here, so 
we can spend more, we can have more tax cuts, and I think the 
reality of what you are telling us here today is the numbers do 
not add up. I use your words. The numbers do not add up, and we 
have got to face up to this as a country, as a Congress, and as 
a Budget Committee. We have got an obligation, an affirmative 
obligation, to tell our colleagues where this is all headed. 
Because I can tell you the appetite for more spending, for more 
tax cuts is totally out of the box. The gate is wide open.
    I will tell you I have a parade of people coming to me, and 
they want more tax cuts, more spending, and the whole thing 
does not add up now.
    Senator Snowe.
    Senator Snowe. Thank you, Mr. Chairman.
    Mr. Walker, continuing on the Medicare issue for a moment, 
how much worse is the Medicare program with respect to so-
called surpluses? The fact is, as you know, a few years ago we 
shifted home health care services from Part A to Part B, so I 
think it camouflages, essentially, the real condition of the 
Medicare program with respect to the Part A fund.
    Mr. Walker. Senator, your point is outstanding. I mean, the 
fact of the matter is it reinforces the fact that we cannot 
focus solely on the trust fund issue, and we cannot focus just 
on Part A versus Part B. We need to look at Medicare on a 
consolidated basis. We need to look at it as a percentage of 
the budget. We need to look at it as a percentage of the 
economy.
    These are metrics that are more meaningful than the trust 
fund. The trust fund just deals with solvency. It does not deal 
at all with sustainability or, stated differently, 
affordability.
    Senator Snowe. What would be the timeframe necessary to 
affect the position of both Social Security and Medicare in the 
years when it begins to have a negative revenue effect, in the 
year 2016, as you mentioned? So how many years in advance would 
we have to effect that date, in terms of a change of policy, 
that would begin to have a more positive outflow?
    Mr. Walker. Obviously, it is the old story; the sooner the 
better. As you know, Senator, is it is difficult to make 
changes to these programs. Historically, what has happened is 
there has had to be some type of a compelling event or 
condition that existed where Congress was forced to act. That 
is what happened in 1983 with the Greenspan commission. The 
checks were not going to go out. Well, needless to say, that is 
not an acceptable outcome for a variety of reasons, and so 
therefore that commission was formed to try to deal with an 
impending solvency problem. The checks were not going to go 
out.
    We face a different problem today, and that is we do not 
have an immediate problem, but we have a major long-range 
problem, and we are much better off to try to start dealing 
with it earlier.
    My personal view is, Senator, having been a trustee of 
Social Security and Medicare, having been involved in this for 
years, we can actually exceed the expectation of all 
generations of Americans for Social Security. The way you can 
do that is because, for current retirees and near-term 
retirees, if the Congress decided you were going to give them 
everything they have been promised, because, that is arguably 
the right thing to do since they do not have time to make 
adjustments, and from a practical standpoint, politically, it 
would probably be difficult to do anything else, and if you 
decided to restructure the Social Security program 
progressively, more changes for baby boomers, more changes for 
Generation Xers, then you will be able to exceed the 
expectations of all generations of Americans because baby 
boomers and Generation Xers are discounting what they think 
they are going to get under this program.
    Now, in many cases, they are discounting it more than they 
should be discounting it. So there is a window of opportunity 
to restructure that program to make it not only solvent, but 
sustainable, and affordable, and exceed the expectations of all 
generations of Americans. We just have to get on with doing it.
    On health care, that scenario does not exist. The gap 
between promises, and affordability and the expectation gaps, 
unfortunately, go in the other direction.
    Senator Snowe. On the issue of economic growth because, 
obviously, that had a significant effect on projected surpluses 
over the next 10 years, and, frankly, I think it was rather 
startling what we saw. I mean, with the reduction of economic 
growth in years 2002 and 2003, that led to a reduction in 
surpluses of $1.6 trillion over the next 10 years. So, even a 
minuscule adjustment in economic growth could work for us or 
against us.
    I guess, what are your projections for economic growth over 
the next 10 years in the long run?
    Mr. Walker. We use CBO's.
    Senator Snowe. You use CBO's.
    Mr. Walker. We do not compete with CBO. They are the agency 
that Congress has chosen to make those types of assumptions, 
and we basically build upon what they do.
    Senator Snowe. Well, I think that in looking at this entire 
issue, and I do not know how we can do it differently, but I 
think it really does magnify the problems that we face with the 
tenuous nature of these projections in predicating, you know, a 
number of programs and expenditures on illusory projections 
because these revenues have not materialized. Just the spending 
that we have agreed to over the last few years has had an 
impact of more than $1.2 trillion in surpluses over the next 10 
years.
    So it may be that we do this, but having some sort of 
impact on the surplus on some of these programs that we pass, 
so that we have a clear idea of what we are doing each and 
every time in reducing the surpluses. The aggregate impact, I 
mean, was astonishing for the spending that we agreed to over 
the last few years.
    Mr. Walker. Senator, we need some new metrics because the 
current ones are expiring this year, and we in GAO have done 
work, to look at what other countries have done, and we have 
made it available to Congress, and I am happy to make it 
available again as to how to do that.
    Let me give you an analogy that I talked to Senator Corzine 
about just a few minutes before the hearing started, and that 
is our budget situation is very similar to what Christopher 
Columbus faced in his day. That was there was great debate 
about whether the Earth was flat or whether the Earth was 
round. Christopher Columbus thought it was round. Many others 
bet that it was flat, and he was going to go off the end of the 
Earth.
    We have to recognize that, while there is inherent 
difficulties in even projecting 10 years, clearly, that is 
difficult enough, and while there is even greater uncertainty 
when you go further out, the fact of the matter is the Earth is 
round, and there is a tidal wave beyond the 10-year horizon. 
That tidal wave is called the baby boom generation, and that is 
not going away, and we have got to start dealing with it.
    Senator Snowe. Thank you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    Senator Stabenow.
    Senator Stabenow. Well, thank you, Mr. Chairman, as usual, 
for holding these hearings and giving us an opportunity to hear 
what is facing us. I appreciate, Mr. Walker, your public 
service and willingness to come forward and talk exactly about 
the facts of the situation.
    Senator Snowe was talking about spending and how we have 
projected spending increases and impacts on the budget from 
decisions that have been made. I was sitting here doing some 
numbers, and when we look at the impact of the tax cut that was 
passed last year, and we look at what you are projecting in 
terms of unfunded liability, I find it interesting, at this 
point, we not only have choices about spending, we have choices 
about tax policy.
    In the next 10 years--or between now and the end of this 
decade--we are looking at $1.7 trillion coming out of the 
Federal budget as a result of the tax cut, and in the next 10 
years, $4 trillion. You indicated to us there is a $3.8-
trillion unfunded liability; is that what I understand?
    Mr. Walker. As of today. That is just for Social Security.
    Senator Stabenow. So we are looking at $3.8-, in terms of 
Social Security unfunded liability, $4 trillion on the other 
side. I do not see how we can escape having a discussion about 
all of the decisions that have been made, not just part of the 
decisions that have been made, and the impact of that when we 
look at the fact that you were projecting a $2-trillion gap out 
into the future, and when you look at $4 trillion in lost 
revenue in the second 10 years of the tax cut. That is part of 
our challenge.
    I know, Mr. Chairman, that you know that and have spoken 
eloquently, on many occasions, but there is a direct impact 
between what was done last year, not only spending, but I would 
argue even more so on the tax policy side and what you are 
talking about.
    Given that, you have mentioned in your testimony that 
fiscal targets may be helpful as a new kind of budget 
mechanism, and I am wondering what you hand in mind. I am 
surprised that Senator Snowe did not mention what we usually 
talk about here, in terms of our working together on some kind 
of a budget trigger mechanism. But I am wondering, when you 
mention in your written testimony about fiscal targets, what 
you had in mind and if you feel there is a way to craft some 
kind of mechanism that would slow down the phase-in on either 
spending or tax cuts if we do not generate growth in the 
economy to be able to pay for that without going into debt.
    Mr. Walker. Thank you, Senator. Two things. On your first 
point, we advocated last year, and continue to advocate, the 
total portfolio management approach. You need to look at the 
tax side, the spending side, you need to look at it all and 
consider the fiscal risk.
    Second, in my statement and also some other reports we do 
talk about some possible metrics or measures that the Congress 
could consider once the current ones expire; certain things as, 
for example, the percentage of debt to GDP. I know, Mr. 
Chairman, you expressed concerns about where they are going if 
we do not do something. So there are several ones that we have 
specifically laid out. There are other ones that we would be 
happy to talk with you and the Committee about.
    I think it is important that we have something. I think the 
other thing that is important is also to make sure that we do 
not just use those measures with regard to where we stand 
today.
    We need to consider what are the longer term implications 
of current policy choices; in other words, not just where you 
stand on these metrics today, but if these were to become law, 
where is that going to take us in trying to deal with our 
longer range challenges because that is really the problem. 
There are a lot of things we can afford to do today, but in all 
likelihood we are not going to be able to sustain and afford 
them tomorrow.
    Senator Snowe. Thank you. I would just comment, in 
conclusion, for the record, because I always feel compelled, 
when we are talking about the tax cuts, to reiterate the fact 
that I support tax cuts. I think we all support tax cuts. The 
question is to whom and what impact they have on the economy, 
how they fit in the overall discussion on priorities.
    My biggest concern right now, as it relates to what is 
unfolding with the tax cut, is that too many people, too many 
of my constituents, in fact, members of my own family now that 
are doing their taxes are finding out that the $300 they were 
given in the tax cut last spring or summer were actually 
advances on their tax liability. They are not very happy about 
that. And then when I explain to them that most of the rest of 
the tax cut, they will not be receiving, they are not very 
happy about that either.
    When we put that in context, when we look at who is going 
to receive those tax cuts versus who benefits by Social 
Security, and Medicare, and the other funds that are going to 
be paying for that tax cut, I think it is very disturbing. I 
know you cannot comment on that, but I would just indicate that 
I think we have some very important choices to debate.
    Mr. Walker. Thank you, Senator.
    Chairman Conrad. Senator Corzine?
    Senator Corzine. Thank you, Mr. Chairman.
    Mr. Walker, I am going to just take a step along the line 
that Senator Stabenow was talking about. She talked about in 
the next 20 years the 1.7 in the first 10 years and 4 trillion 
in the next 10 years, of the cost of the tax cut. If our people 
are doing this right, and actually I would love to have GAO do 
one of those lines breaking out discretionary spending and tax 
cut issues on that chart that you talked about, if you had it, 
if you did not have it, because I think those actually would 
give us some of the tradeoff judgments that we have to make, 
not a perfect tradeoff, but it allows us to see the policy 
implications of the tax cuts' costs to revenues and the 
discretionary spending's cost to revenues and implications for 
the economy.
    But if we are doing it right, over the next 75 years, the 
timeframe that this footnote is addressing with regard to 
Social Security and Medicare, the tax cut is going to cost $7.7 
trillion, and the addition here of the two pieces that you 
talked about on Social Security and Medicare are 6.5 trillion. 
I know that does not allow for Medicare, Medicaid and Part B, 
but we did make a choice that we have pulled away revenues. We 
made choices when we spend money too, I understand, but we 
ought to understand what the implications of what that 
foundation is. It is very clear if we had not made that choice, 
we had the ability at least to cover the discounted values of 
the obligations that we had coming forward. And it is a matter 
of policy choice. Could have done that with spending as well, 
but----
    Chairman Conrad. Although, of course, as you know, Senator 
Corzine, those would not have been dedicated revenues to Social 
Security and Medicare, and so whether or not the Congress would 
have spent that money for those programs is----
    Senator Corzine. There is no question of that, but we did 
have the resources to meet these unfunded liabilities at our 
discretion, subject to self help, if we looked at those 
obligations and said that we wanted to at least dedicate those. 
And I think that is what the debate about the Social Security 
Trust Fund is about, is that there are those, as the Chairman 
has repeatedly stressed, that setting that aside leads to the 
kinds of implications that we might potentially have had the 
ability to meet those unfunded liabilities over a period of 
time. We clearly do not have that ability with the $7.7 
trillion cut in taxes.
    We have got, as you suggest, a portfolio of choices that we 
have to deal with here. One of the things I would love to see 
in that portfolio of choices is that same chart that you had, 
the very first one. You talked about both discretionary 
spending, how that chart would look if that was held the same, 
and then without those tax cuts, I think you would see a 
substantially--you would see a clear breakout of the choices.
    Let me talk about something that is less controversial, 
about the value of tax cuts or not. Do we, anywhere in 
Government actually provide the transparency of what we are 
paying or what we are charging ourselves with regard to tax 
expenditures as opposed to cash expenditures? It seems to me 
that as we sit and debate policy choices in the Congress, it is 
very easy to identify what our expenditures are on programmatic 
issues where dollars go out the door. But when it comes to tax 
expenditures, whether it is for an individual tax break for a 
company or whether it is for 401(k) programs and pension 
retirements, it is very difficult to understand the 
discretionary choices we have made because those things are 
enacted into a tax code.
    Is there a place where we could get a perspective on what 
we are actually doing with regard to tax expenditures, so that 
we could make the choice of whether tax expenditures were 
sensible relative to cash expenditures, which we are making on 
spending?
    Mr. Walker. Senator, that is an excellent question. My 
understanding is the Joint Committee on Taxation does 
periodically come up with the estimates of the amounts 
associated with current tax preferences. They call them 
expenditures. I would argue in certain circumstances that might 
be a fair term; in other circumstances it would not be.
    For example, some of those tax preferences are timing 
differences, as you know. The tax preferences that are provided 
to pension plans represent a timing difference. The employer 
gets the deduction today. The trust gets income exclusion--
pardon me--does not pay taxes. But ultimately taxes are paid by 
the individuals when the benefits are paid out. Health care is 
very different.
    Senator Corzine. The value of money is real.
    Mr. Walker. Correct, absolutely.
    Senator Corzine. And not a--I mean we have been talking 
about discounted values here.
    Mr. Walker. Absolutely. But I think the important point 
that you touch on is when you look at portfolio management. I 
would argue another thing that we need to be looking at that we 
have not been looking at adequately is all the tools of 
Government. The Government has many tools available to it to 
achieve policy outcomes that only elected officials can decide 
what those desired outcomes are. It has spending. It has 
guarantees. It has regulatory policy, and it has tax policy 
among other things.
    And I think one of the things that we do not have adequate 
transparency enough on are the tax aspect. And in addition, one 
of the things that we have not done as good a job on, which we 
believe there is a need to do it, is take an area and look at 
the totality of support. Take, for example, health care. Do not 
just look at Medicare, Medicaid, spending on Federal health 
care, et cetera for Federal employees, also look at tax 
preferences accorded to health care. What about the regulatory 
policies in the area? When you look at it that way, you get a 
very different perspective and the numbers are even larger by 
order of magnitude.
    So I think we need to figure out a way that we can look at 
all the tools of Government and analyze the impact of all the 
tools of Government in an area. Are they achieving the intended 
purpose? What is the cost versus the benefit, if you will, of 
these different options?
    Senator Corzine. Mr. Chairman, one of the hopes that I 
would have is that we would do as much scrubbing of tax 
preferences and tax incentives, which are expenditures or a 
like judgment on public policy as we do with regard to 
discretionary spending issues. And it never was more clearly 
illustrated, at least in my view, than in the tax cut that we 
have when you put the $7.7 trillion against the 6.5 that is 
itemized here. But that permeates a whole series of judgments 
that we make on health care as the Comptroller General said. I 
thank you very much.
    Mr. Walker. Senator, let me add one thing. It was just 
brought it to my attention. On page 11 we have one example, and 
I will just read it for the record. ``For instance, in fiscal 
2000 Federal health care and Medicare budget functions include 
$37 billion in discretionary budget authority, $319 billion in 
entitlement outlays, $5 million in loan guarantees, and $91 
billion in tax expenditure.''
    So that is part of total portfolio management.
    Senator Corzine. Thank you.
    Chairman Conrad. Thanks, Senator Corzine.
    Let me if I could, ask you, Director Walker. If we were 
to--you had in one of your charts if the tax cuts do not 
sunset.
    Mr. Walker. Right.
    Chairman Conrad. Do you know what the cost is in the second 
10 years if the tax cuts are made permanent? I think the cost 
in this 10-year period if 400 billion. Do you now what it is in 
the second 10 years?
    Mr. Walker. I do not, but I can provide it for the record, 
Mr. Chairman.
    Chairman Conrad. Would it surprise you if Joint Tax is 
telling us it would be $4 trillion?
    Mr. Walker. We have not had a chance to review it. We have 
heard that assertion, but we have not had a chance to review 
it.
    Chairman Conrad. That is what they are telling us, $4 
trillion. You have indicated that one of the great challenges 
we face is the entitlement programs. I agree with you. It is 
very clear, just as clear as it can be from the analysis that 
you have provided. Unfunded liability and Social Security $3.8 
trillion, unfunded liability in just Medicare Part A, $2.7 
trillion. So that is $6.5 trillion of unfunded liability. You 
know, I think these numbers are so big that it does not sink in 
to people what it means. What it means is that a future 
Congress and future President are going to be faced with the 
most agonizing of decisions. They are going to be faced with 
either deep benefit cuts and/or massive tax increases, and 
tremendous increases in indebtedness. Is that not so?
    Mr. Walker. Unless we do something different. I think part 
of the problem, Mr. Chairman, is how can we go about trying to 
address this sooner rather than later. And what I found over 
the years is that when you have a big problem like this, where 
the tendency is more to focus on the here and now for a variety 
of reasons, you need to be able to put a face on it in order to 
help people. And I think the faces are there. They are our 
children and our grandchildren. Those are the faces we need to 
put on it.
    Chairman Conrad. No, I am struggling with this----
    Mr. Walker. They are the ones that are going to have the--
--
    Chairman Conrad. I am struggling with this right now, 
struggling with how I communicate to my colleagues and how we 
communicate to a broader audience the message that you have 
delivered here today. We have got big, big challenges facing 
this Nation in the future, and they are unlike what we have 
faced in the past because of the demographic changes. That is a 
big word, demographic changes. That is just that the retiring 
generation, the baby-boom generation is much larger in numbers 
than previous retiring generations, and the ratio between those 
who are retiring and those who are still working, is shrinking 
dramatically. Is that not the case?
    Mr. Walker. That is correct. Let me give you a number that 
I think has helped me over the years. In 1950 there were 16 
persons paying into Social Security for every person drawing 
retirement benefits. Today there are about 3.4 persons paying 
in for everybody drawing retirement benefits. By the year 2030, 
and I will verify this for the record, there will be about two 
persons working for every person drawing retirement benefits. 
That has dramatic implications in a variety of ways, including 
fiscal implications.
    Chairman Conrad. And on the Medicare side, obviously, 
Medicare is begin affected by two significant trends. One is 
the increase in the number of people who will be eligible for 
Medicare, just as we seen an increase in the number of people 
eligible for Social Security. The other major trend is medical 
inflation being higher than other components in society, the 
things that we pay for. Is that not the case?
    Mr. Walker. Well, there are several, Mr. Chairman. Those 
are two. You have the increase in the size population, as you 
point out. You have the increase in health care inflation above 
CPI. You have increasing life expectancies. You know, people 
are going to be eligible for the benefits longer. You have 
increasing utilization. By that I mean increase in the 
utilization of different medical procedures that are used, and 
you have increasing intensity, meaning the sophistication of 
the type of medical procedures are increasing. Like we did not 
have MRIs 10 year, and they are fantastic, but they are very 
expensive. And individuals want to be able to have access to 
those in some cases where there is a need, in some cases where 
there is a want. And so there are a variety of factors fueling 
these costs.
    I think one of the biggest problems we have in health care 
is we have inadequate incentives to control cost and 
utilization; inadequate transparency to try to provide 
reasonable assurance that we can do that, and inadequate 
accountability over these costs. It is not just the design and 
the regulations associated with these programs; I think it is 
also arguably the tax policies associated with these programs.
    Chairman Conrad. Say that again. What are you referring to 
with respect to tax policies?
    Mr. Walker. Well, if you look at the tax side--and again, 
this is something that Congress would have to consider--unlike 
pensions where it is a timing difference as to when you are 
going to pay taxes. Under the current situation, employers get 
a deduction for the value of health care, which arguably makes 
good sense because if they are not going to get a deduction for 
the value of health care, then they will end up paying 
employees cash and drop their health plan, and that is not 
obviously in anybody's interest to do that.
    Individuals get an exclusion. They do not pay any taxes 
whatsoever on the value of health insurance no matter how 
lucrative that health insurance is. And I am not talking about 
health cost. I am talking about the value of health insurance. 
So therefore they do not have much association with a direct 
cost to health care. They do not see it that much when these 
costs are going up. 85 percent of all health care costs are 
paid for by a third party. In many cases the individuals who 
got the services do not even see what the bill is before the 
amount is paid by the third party, so it is no wonder the costs 
are up.
    Chairman Conrad. And when they do see the bill, they cannot 
figure it out.
    Mr. Walker. It is difficult to figure out, but normally it 
is shocking, no matter--the bottom line, it is normally 
shocking.
    Chairman Conrad. I have just been through this circumstance 
with my own wife who had surgery, and we get these bills in the 
mail, and trying to decipher them is no small matter.
    Let us go through these effects, because I think they are 
very, very important to have on the record. We have medical 
inflation. That is, inflation for medical services is running 
above inflation for other goods. The number of people eligible 
for the program is going to dramatically increase, just as the 
case with Social Security. That is the baby-boom generation. A 
third you mentioned, life expectancy. Obviously, people are 
living longer. That means they are going to be eligible for the 
benefits of Medicare for a longer period. You made the point of 
utilization. People are utilizing more health services. You 
mentioned intensity. How would you describe intensity; how 
would you define it?
    Mr. Walker. More advanced technologies, I mean, if you 
will, the nature of the services that they are receiving, not 
just the number but the nature.
    Chairman Conrad. OK. What have we left out? Any other 
trends or----
    Mr. Walker. Well, I am sure there are others, but those are 
the big ones.
    Chairman Conrad. Those are the big five we will call it, 
medical inflation, number of people eligible, life expectancy, 
utilization and intensity. Would those be the big five trends?
    Mr. Walker. The big five sounds good to me.
    Chairman Conrad. Well, I want to thank you again for coming 
before us. This message, I believe, cannot be repeated too 
often, and I encourage you to take every opportunity to share 
with our colleagues these long-term trends. I know that you 
will be appearing before the Finance Committee this afternoon.
    Mr. Walker. Correct.
    Chairman Conrad. I hope that you will be discussing this at 
some level with them this afternoon. I do not know what----
    Mr. Walker. Maybe somebody will ask me a question. 
Actually, my testimony this afternoon, Mr. Chairman, deals with 
pension challenges in light of the recent Enron situation, 
possible reforms that are needed in our pension system as a 
result of that.
    Chairman Conrad. So that is obviously an important subject 
as well. I just hope that members of the Finance Committee--I 
serve on the Finance Committee as well--are exposed to these 
long-term trends at some point and that they have a chance to 
really let this settle in, because there is nothing more 
difficult than focusing on the future. All of the incentives in 
the political system are to focus on this year. That is where 
all of the incentive is, and it is extraordinarily difficult to 
lift up out of that and look over the horizon and see where we 
are headed, and understand it does not add up, and that history 
is going to hold us to account. History is going to look back 
and say, ``What were those people thinking of? Are they just 
fiddling while Rome burns there? Nobody cared about what they 
were doing to future generations,'' as you said, not putting a 
face on the challenge of the future.
    And our kids, I think, are going to look back and really 
wonder, ``What were you thinking of? You were there in a 
position of responsibility, and you did not alert people as to 
where we were headed?'' I hope that cannot be said of this 
Committee, and I hope that cannot be said of the Congress.
    Right now I would hate to have to pass judgment.
    But again, you will be recorded favorably in history 
because you have repeatedly warned the Congress, warned the 
Administration, warned the country of where this is all headed. 
And for that I thank you, and I thank you very much.
    Mr. Walker. Thank you, Mr. Chairman.
    [Whereupon, at 11:39 a.m., the committee was adjourned.]














  THE PRESIDENT'S FISCAL YEAR 2003 DEFENSE REQUEST: WINNING THE WAR, 
                   TRANSFORMATION, AND REFORM ISSUES

                              ----------                              


                      THURSDAY, FEBRUARY 28, 2002

                              United States Senate,
                                   Committee on the Budget,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10:02 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Stabenow, Corzine, and Domenici.
    Staff Present: Mary Ann Naylor, staff director and Dakota 
Rudesill, analyst.
    For the minority: G. William Hoagland, staff director and 
Winslow Wheeler, senior analyst for defense.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    I first want to thank our witnesses very much for being 
here this morning. We appreciate them very much, especially in 
the case of Dr. O'Hanlon--whose wife is due any day now--for 
being here. We certainly appreciate that. I appreciate all of 
the witnesses' being here: Mr. Weston, who is the honorary 
chairman and former CEO of Automatic Data Processing and vice 
chairman of the Business Executives for National Security, and 
co-chairman of the Tail to Tooth Commission, which did really 
very important work helping us understand the defense needs of 
the country going forward; Michael O'Hanlon, a senior fellow at 
Brookings Institution, who is a recognized expert on the 
resources for defense; and Loren Thompson, the chief operating 
officer of the Lexington Institute. Welcome. It is good to have 
all of you here. We certainly appreciate your taking the time, 
and I can say that we look forward to your testimony.
    As we all know, the President indicated in the State of the 
Union that we will spend what it takes to win the war on 
terrorism, and let the message go forth from this hearing room 
that Congress is standing shoulder to shoulder with the 
President in that regard. No adversary should doubt that we are 
going to provide the resources necessary to defend this Nation 
and to win this war on terrorism. No adversary should take any 
comfort in the debate that we will have about what that level 
of necessity is. That is the strength of America, to have a 
debate, to have a discussion, so that we can do the things 
necessary to make certain that America is strong.
    Unfortunately, we do face a budget situation that requires 
us to examine every part of Federal spending. We can't provide 
a blank check to any part of the Federal Government because, as 
the chart shows, we are facing trust fund deficits as far as 
the eye can see. If we look ahead, we can see red ink for the 
entire next decade.
    Understanding the long-term budget outlook requires focus 
on each of its major elements, including defense, which 
represents roughly half of all discretionary spending. For 
several years, I have been pushing for increases for spending 
in national defense. In the budget I presented last year, I had 
a larger increase for defense over 10 years than did the 
President's initial budget because I could see we needed to put 
more money into defense over the next decade.
    And there is no question that a further defense increase is 
needed in 2003. However, serious questions deserve to be asked 
about the President's request, and I will discuss those in 
detail in the question and answer, but let me first turn to a 
couple of charts to frame the debate on defense spending.
    Defense is clearly a major priority in the President's 
budget. Relative to baseline, national defense receives a $36 
billion increase in 2003. Let me just indicate, as you can see, 
homeland security gets an increase over the baseline, and, 
remember, baseline is last year's spending plus inflation. That 
is roughly what constitutes the baseline. The President's 
increase above the baseline for homeland security is $5 
billion; national defense is increased $36 billion. This will 
throw some people because they are familiar with a $48 billion 
increase, but part of that is in the baseline. International 
Affairs, a $400 million increase; All Other Domestic spending, 
a $23 billion reduction.
    Let's go to that next chart.
    In terms of trying to kind of put in perspective how large 
our defense expenditure is, I think this chart is useful. It 
shows that under the President's plan we will be spending as 
much as the next 18 nations combined. Mr. Wolfowitz, when he 
was here, the Deputy Secretary, indicated we don't fight budget 
to budget. We fight adversaries. And he is exactly right.
    But I do think it is important in terms of assessing and 
putting in context what this level of expenditure is that we 
understand where we fit in with the rest of the world.
    And, of course, the increases that are being proposed don't 
just have an effect on 2003. They have an effect for the next 
decade. And we see the President's budget proposal over the 
decade is $656 billion over the baseline. That is an enormous 
amount of money. And we have to ask the tough questions with 
respect to that dedication of resources.
    During this hearing, we hope to better understand the 
President's defense request. In particular, we will focus on 
the following questions:
    One, does the budget make the right assumptions about the 
war on terrorism?
    Two, does the budget take the right approach to military 
transformation?
    And, three, is additional funding becoming the priority at 
the expense of real reform? This is a concern which was 
expressed by the former Vice Chairman of the Joint Chiefs of 
Staff, Admiral Owens, when the President's budget was released 
on February 4th. He said at that time, ``A return to the 
defense spending heights of the mid-1980s is not necessary to 
win the war on terrorism or to transform our armed forces. In 
fact, it could be quite counterproductive. Availability of such 
large sums of money will reduce incentives to eliminate costly 
redundancies in our force structure `tooth,' but particularly 
in the `tail' of defense bureaucracy and support organizations. 
The truth is,'' continuing to quote Admiral Owens, ``that we 
already have all the money for defense we need, so long as we 
undertake real reform and spent it better.''
    Let me just say I think we also need more money for 
defense. I don't think it is going to work if we try to use 
just the existing resources dedicated to defense. I think it is 
going to take more money.
    But Admiral Owens does raise very serious questions about 
whether if we give this amount of money, do we, in effect, stop 
the process of reform and eliminating the duplication that we 
all know exists in the military. I have had top military 
leaders say to me, look, you do have to provide some skepticism 
here. It is important because we have very significant 
duplication because of the various branches of the military. 
And if we were any business, if we were any business in 
America, we would look at those places where we have 
redundancies and duplication. So much of it is in the 
administrative area, not in the warfighting capability but in 
the so-called tail, the administrative support. And I think we 
all know that is true.
    With that, I am very pleased that our ranking member is 
here, and I would recognize him for any statement that he would 
like to make. Then we will go to the witnesses, and we would 
ask each of you to testify, and then we will open it up, as is 
our usual practice, for questions.
    Welcome, Senator Domenici.

         OPENING STATEMENT OF SENATOR PETE V. DOMENICI

    Senator Domenici. Thank you, Mr. Chairman. I will be very 
brief. If you will put my remarks in the record?
    Chairman Conrad. Sure.
    Senator Domenici. I look forward to your testimony. I have 
been listening to budgets now for defense for 25 years, 26, as 
a member of this committee. For many of those I have been 
sitting in that chair or this chair. This is a very unique one 
because we have right in front of us we have a situation where 
the United States military presented us a budget for war. They 
were doing some transition work, and all of a sudden had a 
brand-new war that was unexpected, one that we are not used to, 
one that we didn't plan for.
    Now this year we have the reality of this particular war on 
terrorism, which we can't quite grasp in terms of how long will 
it go on and how big will it get.
    But I would assume it is realistic for all of us to 
anticipate that there might be some other engagement that we 
don't even contemplate during the next 12 months, 24 months, or 
36 months. I would hope that we are not just preparing spending 
all this money for war on terrorists. I would assume we are 
preparing for other kinds of protection to the American people 
internationally.
    Then we have added to it a brand-new set of defense 
criteria that are going to have to be applied to the Defense 
Department for homeland defense. Just as we prepared for the 
defense in an international sense away from our borders, 
clearly there are going to have to be some new use of the 
military here in the United States, preparing the United States 
for terrorism here, some of which could only be handled by 
defense people and some aspects that could only be handled with 
defense equipment.
    So I look forward to your testimony. I say to the chairman, 
whatever numbers we choose, it is pretty obvious to this 
Senator that what is going to happen, defense is going to be 
getting an awful big increase as compared with many domestic 
programs. And one of the difficult things we are going to run 
into is how do we make sure the money is spent for defense and 
not something else. I think that is a very serious problem. I 
am willing to raise it early. There are a lot of people that 
don't think it is a problem. I think it is. When you give 
defense as big an increase as this and you are trying to hold 
many of the other departments to much lesser numbers, there 
have got to be some way that you can be assured that most of 
the defense money will go to defense. And I will share that 
with you in more detail as we progress.
    Thank you for the time, and thank you for your time.
    Chairman Conrad. Thank you, Senator Domenici.
    With that, let's turn to our witnesses, and we will start 
with Mr. Weston, again, a very distinguished business leader in 
our country, the former chief executive officer of Automatic 
Data Processing, a remarkable success story in our country, and 
vice chairman of the Business Executives for National Security, 
and co-chairman, as I indicated before, of the Tail to Tooth 
Commission. And, by the way, I have the document--one of the 
documents, really a package that the Tail to Tooth Commission 
produced. And this really is--I commend it to anybody 
listening. I certainly commend it to our colleagues--a lot of 
very thoughtful work went into the Tail to Tooth Commission--
``Arming the Pentagon to Change Its Business Practices.'' I 
don't think there is a single member of this committee that 
doesn't know we have got to improve management of our defense 
establishment. Senator Grassley has been a leading advocate of 
this for many years. I think every member of this committee 
understands the need for reform.
    With that, welcome, Mr. Weston, and please proceed.

STATEMENT OF JOSH H. WESTON, HONORARY CHAIRMAN, AUTOMATIC DATA 
   PROCESSING, INC., VICE CHAIRMAN, BUSINESS EXECUTIVES FOR 
  NATIONAL SECURITY AND CO-CHAIRMAN, BUSINESS EXECUTIVES FOR 
           NATIONAL SECURITY TAIL-TO-TOOTH COMMISSION

    Mr. Weston. Thank you, Mr. Chairman, and I thank the 
committee for this opportunity. I also thank you for that 
unpaid commercial about the Tail to Tooth Commission.
    I am here today in a couple of capacities, which you have 
already cited.
    I might also add that my predecessor as CEO of ADP was one 
of your former colleagues, Frank Lautenberg. When he got 
elected to the Senate in 1982, that gave me the chance to 
become what I was.
    First, as you cited, I am a vice chair of the Business 
Executives for National Security. We call it BENS for short, B-
E-N-S. It is 20 years old. There are some 300 business 
executives with significant experience in our organization. We 
are absolutely nonpartisan, and our primary mission is to use 
our relevant experience to help the Pentagon improve its 
business practices and its management practices, which today 
govern over half of all the expenditures in the Pentagon.
    BENS is not for more dollars. We are not for fewer defense 
dollars. We want to spend them better. We take no positions on 
strategies or weapons systems, and we are for effective 
planning and efficient implementation to provide appropriate 
national security. We must spend whatever it takes to defend 
our Nation, but I will add to that no likely amount will be 
adequate if we cannot spend our military dollars efficiently.
    BENS has been well-received by senior Pentagon civilian and 
military leaders over the last four administrations, and 
although we haven't agreed on every issue, we think that 
relationship has been helpful. We have also had many useful 
exchanges with relevant congressional committees and their 
leaders.
    In addition, BENS has been very deeply involved in 
promoting public-private partnerships to enhance homeland 
security. We did that well before September 11th, but that is 
not part of today's proceedings.
    My second relevant hat, which the chairman has cited, was 
as co-chair, together with Warren Rudman, of the BENS Tail to 
Tooth Commission. And the Commission members in their various 
capacities included Sam Nunn, Bill Perry, Frank Carlucci, and 
many other well-known civilians and retired military. ``Tail,'' 
as I am sure you deduced, stands in the military for overhead; 
``Tooth'' means fighting forces. Almost 70 percent of DOD 
dollars are now spent on overhead and support functions. Any 
large organization does need logistics support. It does need 
infrastructure. But no well-run organization should be 
allocating up to 70 percent of its resources into overhead 
support. And to put it on a local basis, no local community 
would tolerate seven out of every ten police officers sitting 
behind desks while only three of them are out on the streets.
    DOD is saddled with 20 to 25 percent excess capacity on our 
military bases. These are buildings that must be maintained, 
facilities that have to be guarded. That means using soldiers, 
sailors, and airmen who could be fighting a war on terrorism, 
instead supporting that excess capacity.
    Nine hundred fifty thousand military and civilian workers 
perform activities that are commercial in nature at DOD--
950,000--activities for which efficient providers can usually 
be found in what we call the Yellow Pages of the phone book.
    The DOD logistics system currently spends over $80 billion 
a year, logistics, that is, employs over 1 million people on 
logistics, and still only achieves an average response time to 
fill a repair part requisition of 18 days. In the private 
sector you would look for 1 to 3 days.
    And, finally, DOD over the next decade will have to try to 
keep track of about $4 trillion in spending, with a broken 
finance and accounting system that can't begin to produce an 
auditable financial statement.
    In early 2001, Warren Rudman and I delivered and discussed 
our Tail to Tooth Call to Action with each of the incoming new 
service Secretaries and with their Deputies. Starting with 
Donald Rumsfeld and Pete Aldridge, every one of them 
enthusiastically endorsed our blueprints for action. Secretary 
Rumsfeld indicated so as recently as last September 10th. We 
need sharper teeth, and the tail is consuming grossly excessive 
resources, to the detriment of sharp teeth.
    Our recommendations in that document that the Chairman held 
up were not called reports, because we don't need more reports. 
There have been 18 prior DOD commission or task force reports 
on this subject since the well-known Packard Commission in 
1986. Their cumulative prior findings support our 11 blueprints 
for action that were in that packet. This Nation doesn't need 
reports. What we need is action. I will not recite the details 
in that packet, but I will be happy to answer any questions 
about it.
    Prior to the September 11th tragedy, Secretary Rumsfeld and 
his senior colleagues were on a very aggressive course to use 
many of those BENS blueprints to redirect unnecessary and 
wasteful overhead resources into our fighting forces, where the 
teeth had many cavities.
    Moving tail into tooth is culturally challenging. It 
intersects with entrenched bureaucracies, parochialism, 
politics, and vested interests. BENS believes that the 
determination and skills of the senior Pentagon leadership plus 
the prior discipline of a balanced Federal budget would have 
produced very salutary outcomes in strengthening our fighting 
forces. However, September 11th changed the military and the 
political climate. An easy-money approach and a sense of 
patriotism have very much distracted and loosened the financial 
and management discipline in national security, in both 
branches of Government. We rightfully shifted our primary focus 
to winning a war.
    That war in Afghanistan recently proved that we can gain 
and maintain a huge new competitive edge by radically 
transforming our fighting forces with new technology, mobility, 
adaptability, and rapid, long-distance support. This requires 
big investments in new equipment and processes. This requires a 
much more agile logistics and support structure.
    In the private sector, efficiencies, effectiveness, and 
organization improvements are continually mandated in a very 
compelling way by competition and by shareholder economic 
interests, neither of which operate in the Government.
    There is a good way for Congress to restore and invigorate 
an appropriate continuing high-level pressure at the Pentagon 
to reduce overhead and redundancies. We recommend that the 
Congress determine and authorize appropriate increases in 
expenditures for the teeth of our fighting forces. The Nation 
needs and can afford the necessary expenditures to sharpen 
those teeth and sharpen our fighting capacity.
    At the same time, we recommend to Congress that, in the 
upcoming budgeting process, you mandate a significant reduction 
in the Department of Defense's huge tail and mandate it for 
next year. The originally submitted budget leaves the bloated 
tail virtually intact and requests a relatively modest amount 
for good, new teeth. BENS thinks we probably will need even 
more allocation for tomorrow's competitive advantage in 
technology and agility.
    We urge you to use your budgeting clout to force the 
Pentagon to shed some tail and even some obsolete teeth. You 
might authorize our very capable Secretary of Defense to 
implement changes in that bloated overhead in whichever ways he 
deems most effective and report back to you in that regard in 
the near future. If 70 percent of the DOD budget is tail, a 
mere 5 percent reduction in that tail could quickly save over 
$10 billion per year for better purposes. The future annual 
savings could be much greater. The Defense Science Board has 
estimated that $15 to $30 billion in savings is possible.
    These cuts in overhead are possible even while we wage a 
war against terrorism. In that regard, to use a cliche, the 
Pentagon leadership can walk and chew gum at the same time.
    I shift now to financial management. The Pentagon will 
spend on the order of $4 trillion in the next 10 years in 
thousands of programs for which there is really no effective 
financial oversight or control. There were 670 poorly connected 
major data systems that were required to produce the 2003 
budget--670 poorly connected data systems. The current 
financial system does not permit effective decision-making or 
tracking or outcomes accountability. It makes good sense for 
Congress to mandate a 21st century activity-based accounting 
system under qualified civilian leadership, with funding to 
achieve that objective. Even if it takes several billion 
dollars up front to install a good financial system, the 
payback in financial management over the next $4 trillion of 
expenditure would be huge. Today, we are flying almost blind in 
this area of financial accountability.
    Although your committee does not set the what's and the 
how's of how the Pentagon executes its much needed reformation 
in business and management, you can set the right tone with 
your budget mandate and with the message that you attach to 
your budget.
    A democracy is not designed to primarily be an efficient 
engine. You leave that to the private sector. There is a 
certain unavoidable degree of managerial sloppiness in 
democracy. But our terrific Nation, with its many proven 
leaders, needn't permit the spirit and the skills of our 
fighting forces to be continually diluted and distracted by a 
most clumsy tail.
    I conclude by observing that no matter how much money is 
spent on our defense, our Nation will not have the agile, 
innovative fighting forces it needs to prevent and/or win 
future wars without major changes in the way the Pentagon does 
business. Your budget message can be an important stimulus in 
that direction.
    I thank you for this opportunity and would be pleased later 
on to answer your questions.
    [The prepared statement of Mr. Weston follows:]

The Prepared Statement of Josh S. Weston, Honorary Chairman, Automatic 
Data Processing, Inc., Vice Chairman, Business Executives for National 
  Security and Co-Chairman, Business Executives for National Security 
                        Tail-to-Tooth Commission

    Thank you for giving me this opportunity to share some timely and 
important views with you on next year's DoD budget and its underlying 
processes. I am the former, long-time CEO of Automatic Data Processing, 
a very large computer services company. Frank Lautenberg was my 
predecessor until he was elected to the Senate in 1982.
    I'm here today in a dual capacity.
    First, I am a vice chair of Business Executives for National 
Security (BENS). BENS is 20 years old. We are some 300 business 
executives. We are non-partisan, with a primary mission of using our 
relevant experience to help the Pentagon improve its business and 
management practices, which today govern over half of our military 
expenditures.
    BENS is not for more or fewer defense dollars. We want to spend 
them better. We take no positions on strategy or weapons decisions. We 
are for effective planning and efficient implementation to provide 
appropriate national security. We must spend whatever it takes to 
defend our Nation, but no likely amount will be adequate if we cannot 
spend our military dollars efficiently.
    BENS has been well-received by senior Pentagon civilian and 
military leaders of the last four administrations, although we haven't 
always agreed on every issue. We have also had useful exchanges with 
relevant congressional committees and their leaders.
    In addition, BENS has been deeply involved in promoting public-
private partnerships to enhance homeland security since well before 9/
11, but that is not part of today's agenda.
    My second relevant hat today is as co-chair, together with Warren 
Rudman, of the BENS Tail-to-Tooth Commission. The Commission's members, 
in various capacities, included Sam Nunn, Bill Perry, Frank Carlucci, 
and many other well-known civilians and retired military. Tail in the 
military means overhead and Tooth means fighting forces. Almost 70 
percent of DoD dollars are spent on overhead and support functions. Any 
large organization needs logistics support and infrastructure, but no 
well-run organization should be allocating up to 70 percent of its 
resources to overhead support. No community would tolerate 7 out of 
every 10 police officers having desk jobs or logistics jobs.

  DoD is saddled with 20 to 25 percent excess capacity on our 
    military bases--buildings that must be maintained and facilities 
    that must be guarded by soldiers and sailors, airmen and Marines 
    who could be fighting the war on terrorism.
  950,000 military and civilian workers perform activities that 
    are commercial in nature or not inherently governmental--activities 
    for which efficient providers can usually be easily found in the 
    yellow pages.
  The DoD logistics system spends over $80 billion per year, 
    employs over one million people, and still only achieves an average 
    response time to fill a repair part requisition of about 18 days, 
    vs. 1-3 days in the private sector.
  And, finally, DoD will have to try to keep track of about $4 
    trillion in spending over the next 10 years with a broken finance 
    and accounting system that cant begin to produce an auditable 
    financial statement.

    In early 2001, Warren Rudman and I delivered and discussed our 
Tail-Tooth Call to Action with each of the incoming new service 
secretaries and their deputies. Starting with Donald Rumsfeld and Pete 
Aldridge, each of them enthusiastically endorsed our blueprints for 
action. Secretary Rumsfeld indicated so as recently as last September 
10th. We need sharper teeth, and the tail has consumed grossly 
excessive resources, to the detriment of sharp teeth.
    Our recommendations were not called reports, because there have 
been 18 prior DoD commission or task force reports on this subject, 
since the well-known Packard Commission in 1986. Their cumulative prior 
findings support our eleven blueprints for action. The Nation does not 
need more reports. BENS has made available to your staff copies of the 
Tail-to-Tooth Commission action blueprints. I will not recite their 
details here.
    Prior to the September 11th tragedy, Secretary Rumsfeld and his 
senior colleagues were on an aggressive course to use many of those 
BENS blueprints to redirect unnecessary and wasteful overhead resources 
into our fighting forces, where the teeth had many cavities.
    Moving tail into tooth is culturally challenging as it intersects 
with entrenched bureaucracies, parochialism, politics, and vested 
interests. BENS believes that the determination and skills of the 
senior Pentagon leadership, plus the prior discipline of a balanced 
Federal budget would have produced very salutary outcomes in 
strengthening our fighting forces. September 11th changed the military 
and political climate. An easy money approach and a sense of patriotism 
have very much distracted and loosened financial and management 
discipline in national security, in both branches of government. We 
rightfully shifted our primary focus to winning a war.
    The war in Afghanistan recently proved that we can gain and 
maintain a huge new competitive advantage by radically transforming our 
fighting forces with new technology, mobility, adaptability and rapid, 
long-distance support. This requires big investments in new equipment 
and processes. This requires a much more agile logistics and support 
structure.
    In the private sector, efficiencies, effectiveness, and 
organization improvements are continually mandated in a very compelling 
way by competition and direct shareholder economic interests, neither 
of which operate in government.
    There is a good way for Congress to restore and invigorate an 
appropriate continuing high-level pressure at the Pentagon to reduce 
overhead and redundancies. We recommend that Congress determine and 
authorize appropriate increases in expenditures for the teeth of our 
fighting forces. The Nation needs and can afford the necessary 
expenditures to sharpen our teeth and fighting capacities.
    At the same time, we recommend to Congress that, in the upcoming 
budgeting process, you mandate a significant reduction in the DoD's 
huge tail next year. The originally submitted budget leaves the bloated 
tail virtually intact and requests a relatively modest amount for good, 
new teeth. BENS thinks we probably will need even more allocation for 
tomorrow's competitive advantage in technology and agility.
    We urge you to use your budgeting clout to force the Pentagon to 
shed some tail and even some obsolete teeth. You might authorize our 
very capable Secretary of Defense to implement changes in our bloated 
overhead in whichever ways he deems most effective, and report back to 
you in that regard in the near future, If 70 percent of the DoD budget 
is in ``tail,'' a mere 5 percent reduction in that tail could quickly 
save over $10 billion per year for better purposes. The future annual 
savings could be much greater the Defense Science Board said $15 to $30 
billion in savings were possible.
    These cuts are possible even while we wage a war against terrorism. 
In that regard, to use a cliche, the Pentagon leadership, can walk and 
chew gum at the same time.
    I shift now to financial management. The Pentagon will spend on the 
order of $4 trillion in the next ten years in thousands of programs for 
which there is no really effective financial oversight and control. 
There were 670 poorly connected major data systems that were required 
to produce the 2003 budget. The current financial system does not 
permit effective decision-making, tracking, or outcomes accountability. 
It makes good sense for Congress to mandate a 21st century activity-
based accounting system under qualified civilian leadership, with 
funding to achieve this objective. Even if it takes several billion 
dollars up-front to install a good financial system, the payback in 
financial management of the next $4 trillion would be huge. Today, we 
are often flying blind in this area.
    Although your committee does not set the what's and the how's of 
the Pentagon's much needed reformation in business and management 
practices, you can set the right tone with your budget mandate and the 
message that you can attach to your budget.
    A democracy is not designed to primarily be an efficient engine. 
There is a certain unavoidable degree of managerial sloppiness in any 
democracy. But our terrific nation, with its many proven leaders, 
needn't permit the spirit and skills of our fighting forces to be 
continually diluted and distracted by a most clumsy tail.
    I conclude by observinq that no matter how much money is spent on 
our defense, our Nation will not have the agile, innovative fighting 
forces it needs to prevent and/or win future wars without major changes 
in the way the Pentagon does business. Your budget message can be an 
important stimulus in that direction.
    I thank you again for this opportunity to comment. I would be 
pleased to answer your questions and/or to give examples of why BENS 
and many four-star officers agree that there's huge waste to be saved 
in the Pentagon's tail.

    Chairman Conrad. Thank you very much, Mr. Weston. We 
appreciate the effort that went into this testimony. It is 
really excellent. We appreciate it.
    Dr. O'Hanlon, welcome. Please proceed with your testimony.
    Let me just say once again that Dr. O'Hanlon's wife is 
expecting their first child, perhaps today. And so, Dr. 
O'Hanlon, if you have to rush off on very short notice, we will 
understand. Thank you so much for being here.

  STATEMENT OF MICHAEL E. O'HANLON, SENIOR FELLOW, BROOKINGS 
                           INSTITUTE

    Dr. O'Hanlon. My wife cares enough about the future fiscal 
health and security of our country that she has decided to slow 
things down for the day. I appreciate very much the opportunity 
to be here. [Laughter.]
    It is also a great honor, as a former CBO employee who 
worked for Senator Domenici and others in various capacities 10 
years ago, to be before this committee. So I really appreciate 
the opportunity. I worked for Bob Reischauer in those early 
1990 years.
    I had a couple of broad thoughts before I try to construct 
sort of a brief alternative defense budget plan, and that is 
what I want to try to do in just 5 or 6 minutes with my 
testimony. But the broad thoughts, what I want to propose is 
that we do need additional defense spending increases, but I 
think roughly half as large as what is now in the 
administration's budget, and I will try to give a couple of 
details as to why I think that is about the right size, both 
for next year and then over the 5-year plan. I think the 
planned increases are roughly twice what is called for.
    Before I get into those specifics, I think it is worth 
beginning with a sense of where we are. Two years ago, at 
Brookings, we did a fairly exhaustive study of the hot issue of 
military readiness because that establishes the baseline in 
terms of where the military is today, and I think gives context 
as to how much we need to add to improved readiness. We have 
heard a lot of criticism about the state of the military, and 
there certainly are a number of problems. But the broad point I 
would want to make to start with is that if you look at the 
overall state of the United States military in the late 1990s, 
it was actually what I would say was overall a B-plus. If the 
military readiness of the early 1990s was an A under President 
Bush 41, I think military readiness did decline a bit in the 
1990s as we tried to downsize the force and handle a whole set 
of new missions. But I think overall the decline was 
exaggerated. There were a number of specific problems. Many of 
them were addressed by the Congress and by the administration 
in the late 1990s, and overall we were at a state of readiness 
that was roughly comparable to the typical levels in the Reagan 
years.
    Now, I know that sounds a little surprising perhaps to 
some, and I would acknowledge that the morale of military 
personnel was not as good in the late 1990s as it was in the 
Reagan period. But the overall typical quality of equipment, 
the readiness of equipment, the number of spare parts 
available, the level of training, most of these quantitative 
metrics were comparable to mid-1980s levels. So I think we have 
to recognize the military had not been hollowed out in the late 
1990s. There were a lot of strains. There still are strains, 
and they need to be addressed. There are some needs for plus-
ups, but I think that important point needs to be put on the 
table.
    Let me turn quickly to the 2003 budget, and here I have a 
couple of thoughts on sort of process more than on substance, 
before I get into my alternative long-term plan.
    It seems to me in the 2003 budget, of the $46 or $48 
billion increase that you were discussing earlier, Mr. 
Chairman, about $20 billion of that, of course, is for war-
related costs. And I would propose those costs be pulled out of 
the budget and addressed separately as supplemental 
appropriations bills. I would have two main reasons for arguing 
that. One, of course, Congress' role in the process needs to be 
protected, and I don't believe that Congress should give a 
blank check, even in these times of national emergency, to the 
administration for possible wartime costs in 2003.
    Secondly, I believe that we need to get the money that the 
troops require to them as soon as possible, and part of that 
$20 billion war-related cost request has to do with costs that 
have already been occurred or are being incurred right now. Why 
not consider that piece as part of the 2002 supplemental 
appropriations bill? This would have the added benefit of not 
inflating the 2003 defense baseline any more than necessary. I 
don't want to see that number artificially inflated myself 
because then every future year budget debate begins from a 
higher baseline. And it seems to me if we have war costs that 
are specific to this time of national crisis, we should 
identify them as such and put them into supplemental bills 
instead of implying that becomes the new baseline for future 
debate. So, therefore, I hope that that $20 billion of the 48 
increase is pulled out and treated separately, perhaps some of 
it in the short term as part of the 2002 supplemental bill, and 
then the rest, if and when the money is needed for next year's 
military operations.
    That is my broad thought on the 2003 defense bill. Let me 
turn now to more substantive issues and just go through four 
main points for the four main budget areas of military pay, 
military procurement, research and development, and, finally, 
operations and maintenance. I just have a couple of thoughts on 
each one, and I might as well start with the most 
controversial, which may make the other ideas somewhat less 
visible. But, nonetheless, my idea is that military pay is now 
in reasonably good shape in this country. It is a 
counterintuitive thing to say. It is certainly not being 
commonly voiced in this time of national crisis. But because of 
the efforts of the Clinton administration and the Congress--and 
I don't want to sound partisan in implying one was more 
important than the other, but in the 1990s, in the late years, 
we improved military pay and benefits a great deal in this 
country. And the idea we need to continually increase pay above 
and beyond not just the inflation rate but the employment cost 
index I think is incorrect.
    I think CBO and Rand have done very convincing studies that 
the idea of a systematic military-civil pay gap is a myth. 
There is no such pay gap across the force. Most of our forces 
work in a very brave way, not for large financial compensation, 
but nonetheless, if you compare their compensation, broadly 
defined, including all their benefits, to the benefits of and 
compensation of people at comparable age and experience and 
education levels in the private sector, most military people 
are not underpaid today. And that is just the econometric 
truth.
    Now, we may want to say that military people should be paid 
better because they are risking their lives, they are serving 
their country, and there is certainly a reasonable argument to 
be made along those lines. But I think people need to look back 
at the data and recognize that military pay today is in pretty 
good shape.
    Therefore, I would concentrate pay on those specialties--
future pay increases on those specialties where we are having a 
hard time recruiting and retaining, pilots, computer 
specialists, other technical specialists. These are the fields 
we still need more pay to have recruiting and retention be in 
good shape.
    In general, we have solved a lot of the recruiting and 
retention problem in my judgment, and the numbers back me up. 
And I don't think that big across-the-board pay increases are 
necessarily required. So I would limit the pay increase to the 
rate of inflation for the next few years. There are additional 
benefits that are being conferred upon people in housing, in 
health care, so compensation overall is still going up above 
and beyond the rate of inflation. And, therefore, I don't think 
we need to burden the future budget as much as we now are with 
these increases.
    Secondly, let me turn now briefly, Mr. Chairman, to 
operations and maintenance. This, of course, is the huge 
gorilla that we can never quite understand or get our arms 
around. It seems to have a life of its own. It seems very hard 
to limit this. There are a lot of reasons why. Mr. Weston, of 
course, has discussed many of these already. I won't try to add 
to his remarks. He understands this situation much better. But 
I would make a couple of additional comments.
    One is that in the area of military health care we are 
going to add as much money as we have--add as much in the way 
of liabilities to the military health care system as we have. I 
think we have to think hard about reforming it and looking at 
that particular part of the operations and maintenance budget 
in very specific terms. We have four services that largely have 
their own infrastructures for military health care, much of 
their own administrative mechanisms. They don't really operate 
according to private sector principles, and I think we need to 
seriously reform the military health care system. It is 
primarily being sized and structured today for peacetime civil 
needs. And, therefore, we don't need to think in terms of this 
being primarily a deployable, mobile military health care 
system for combat. You need a certain piece of the system to be 
ready to do that. But most of the rest is treating retirees and 
family members and dependents and so forth, and it needs to be 
done more efficiently, according to more private sector 
principles. So this is a good time, as we are adding money to 
that account, it is a good time to look hard at military health 
care. I think the potential savings are $2 to $3 billion a year 
if you go to more market-oriented principles and consider a 
copayment requirement for people as well. That is my main 
comment on operations and maintenance.
    Maybe one more point in the O&M budget. I think we need to 
find ways to give base commanders more incentives to look for 
reforms and look for efficiencies. Right now if they come up 
with an efficiency, it does them no good because they don't get 
the money or even a part of the money for their own local needs 
in general. We need to give them ways to benefit so that if 
they identify savings, they get to share in those savings for 
their local base needs. And I believe you will see a lot of the 
efficiencies being incentivized if you take that approach. But 
if you have an O&M budget that is going up at 2 and 3 and 4 
percent a year in real terms, it allows people the impression 
they can sort of buy their way out of their problems. So I 
think that is a mistake to have such an ambitious projection 
for future O&M spending.
    Research and development. We are all in favor of research 
and development. I think the Bush administration has a lot of 
good initiatives in this area. I support much of what it is 
trying to do with transformation because I think most of what 
you want to do with transformation today is in the research and 
development stage. I think in general there is not a lack of 
effort here. But I think there may actually be a little too 
much effort because the research and development budget wasn't 
cut that much in the 1990s. It was selectively protected as we 
cut procurement, and now it is being increased drastically. Mr. 
Bush already increased the R&D budget in his 2002 amendment or 
adjustment to the President Clinton budget he inherited, and 
now he wants to add $4 or $5 billion a year more. I think that 
is more than is necessary. R&D spending is already pretty 
robust in the 2002 budget, and further large increases of $4 or 
$5 billion a year I don't think are called from. I would 
propose a couple of specific ways in which you might make those 
savings. If you like, we can discuss that subsequently.
    Finally, procurement. Of course, this is the long-term 
driver of the overall Pentagon request. Right now we are at 
about $60 billion a year. The 2003 budget would get us up to 
70. The 2007 budget would get us up to about 100. And that may 
sound exorbitant, but, of course, those of us who read CBO 
studies know that even CBO acknowledges that if you keep the 
current plan, you probably have to spend almost that much money 
on a sustainable basis to buy all the F-22 and joint strike 
fighters and Virginia Class attack submarines and so forth that 
are in that plan. Therefore, I would propose a different plan. 
I would propose a different approach to modernization. Loren 
probably will have a different approach himself, but it may not 
be quite the same as mine, so let me quickly spell out what I 
would advocate.
    I would advocate largely a silver-bullet force where, in 
other words, you buy modest numbers of the best technology. You 
buy modest numbers of F-22s, modest numbers of joint strike 
fighters, maybe 100 or 150 F-22s. Otherwise, you buy the kind 
of technology you already know how to produce. It is already 
the best in the world. It is getting better all the time 
because we can upgrade it, we can put better munitions and 
better sensors on these weapons. We are already in very, very 
good shape against any possible major-power foe. I would buy 
150 F-22s as an insurance policy. I don't think we need them 
against the Iraqi or North Korean air force, maybe against the 
Chinese air force in 2020. But that is why 150 would be enough, 
essentially a one-way capability worth of F-22s. Otherwise, you 
keep buying weapons like F-15s and F-16s that you know how to 
buy.
    Another example, the V22 Osprey. Assuming that the Marine 
Corps can solve the safety problem that tragically claimed some 
23 lives in the last couple of years, if the Marines can solve 
that problem, I would advocate buying a modest number of V22s 
for special-purpose commando raids, for the kinds of things we 
might have wanted to do in Afghanistan if we had ever found 
actionable intelligence on Osama bin Laden, but not for the 
entire Marine Corps amphibious capability. I would otherwise 
continue to buy helicopters. We can buy those. They are better 
than the ones we already have. We can buy them more quickly. We 
can buy them in a way that keeps the Marines safe because we 
can get those helicopters into the Marines' hands quickly 
instead of holding out all of our hope for the V22, which may 
or may not turn out to be safe, may or may not turn out to be 
affordable. And so, again, I would buy a modest number of these 
kinds of capabilities and not imply that we have to do a 
systematic procurement modernization of the best technology 
across the board.
    I would take advantage of the electronics and computer 
revolutions and buy the better munitions like JDAM, the better 
reconnaissance capabilities like the unmanned aerial vehicles 
we have seen in Operation Enduring Freedom and try to focus our 
efforts on these systems. They are not that cheap, but they are 
not as expensive as F-22s and V22s and joint strike fighters.
    So if you put all this together, just to summarize, Mr. 
Chairman, I think you have a procurement budget of perhaps $80 
billion you would have to ultimately reach, and I would 
acknowledge the need for further increases. I think military 
pay has to keep going up with inflation, but not much more than 
that. I think research and development should be sustained at 
its current real level, but it doesn't have to go up much above 
where it is now in the 2002 budget. And the O&M budget is still 
going to keep pushing up no matter how hard we try, but we have 
to find some ways to incentivize people to do what my colleague 
has suggested and try to reform that budget and make it more 
economical.
    Even if you do all that, you still wind up with real 
defense budgets that go up, and I think next year you have to 
spend $370 billion on defense, and in 2007 you will be up to 
$430 billion, even under my plan. But I think that would still 
leave a savings of ultimately about $40 to $50 billion a year 
relative to where the President is now headed.
    Thank you, Mr. Chairman.
    [The prepared statement of Dr. O'Hanlon follows:]

   Prepared Statement of Michael O'Hanlon, Senior Fellow, Brookings 
                              Institution

    In proposing a $48 billion defense budget increase for 2003 
following a large increase in 2002, President George W. Bush has 
followed in the budgetary footsteps of former President Ronald Reagan 
and Reagan's defense secretary, Caspar Weinberger. Adjusted for 
inflation, Bush's 2003 defense budget would be $50 billion higher than 
the 2001 budget. By 2007, the real dollar defense budget would go up 
$30 billion more, approaching the peak levels of the Reagan years.
    Even in these troubled times, such increases are too much. Further 
defense budget growth is needed. But the Pentagon needs to be more 
selective about its weapons modernization plans. In addition, after 
several successive years of increases, military pay is now in fairly 
good shape, as reflected in the improved statistics for recruiting and 
retaining personnel in recent times. America's military men and women 
are of outstanding caliber and deserve proper compensation, but their 
pay is no longer poor compared with private sector employment, and the 
Administration's plans for large increases are excessive. The large 
research and development budgets proposed by the Administration exceed 
the already hefty increases advocated by President Bush during his 
campaign; given that research and development was not severely cut 
during the 1990s, such growth seems unnecessary now. Finally, the 
Pentagon also needs to reform many of the ways it provides basic 
services such as military health care, military housing, and various 
base operations. Unfortunately, if budgets get too big, the Pentagon's 
incentives to look for efficiencies are likely to weaken. On balance, 
the planned increases in defense spending are roughly twice as much as 
would be appropriate in the years ahead. Instead of the 
Administration's plan for a $396 billion defense budget in 2003, which 
would increase to $470 billion by 2007, next year's budget should be 
about $370 billion and the 2007 level should not exceed $430 billion.
The Bush Administration's Proposed Defense Budget
    The Bush administration's fiscal 2003 budget request for the 
Pentagon fleshes out the budgetary details of Secretary of Defense 
Donald Rumsfeld's Quadrennial Defense Review (QDR), released last 
September 30. That QDR was a cautious document on the whole. While it 
unveiled several new initiatives, they were largely conceptual ones. 
The QDR increased the military's emphasis on homeland security. 
Relative to the Clinton defense plan, it also adopted a somewhat less 
demanding type of two-war scenario as the proper standard for sizing 
American armed forces. In addition, and more concretely, it placed 
greater emphasis on missile defense, defense research and development, 
and joint-service training and experimentation.
    But otherwise, the QDR essentially reaffirmed the Clinton 
administration's weapons modernization agenda and force structure 
retaining about 1.4 million active-duty troops, ten active-duty army 
divisions, three active-duty marine divisions, twelve aircraft carrier 
battle groups, about fifty attack submarines, and roughly twenty 
tactical fighter wings, as well as about 250,000 active personnel 
deployed or stationed abroad. After rampant early speculation that 
overseas troop deployments would be reduced, a generation of weapons 
programs would be skipped, and the size of the United States ground 
forces would be curtailed significantly, Rumsfeld's defense plan proved 
far more cautious and far more consistent with that of his 
predecessors.
    The September review was silent, however, on the question of costs. 
Now we have the bill for this defense plan, and that is where the big 
changes arise. The Clinton administration's national security budget 
had grown to about $300 billion a year by 2001 (including about $15 
billion in annual funding for nuclear weapons activities at the 
Department of Energy). Incorporating the effects of September 11 and 
Operation Enduring Freedom in Afghanistan, President Bush's budgets are 
flow as follows: $329 billion in 2001, $351 billion in 2002, and $396 
billion proposed for next year. Breakdowns of the Pentagon's part of 
these budgets are shown in table 1.
[GRAPHIC] [TIFF OMITTED] 80544.086


    Equally striking, however, are the price tags envisioned for the 
years ahead: $405 billion (2004), $426 billion (2005), $447 billion 
(2006), and $470 billion (2007). Congress will not act on those budget 
plans this year, but they show where the Bush administration's budgets 
are headed if they are approved by Congress--toward a period of very 
high defense spending.
    In a sense, the increases are not quite as great as they seem. The 
figures for 2001-2003 include the costs of the anti-terrorism war; all 
the figures include funding for the Department of Defense's heightened 
vigilance and contributions to homeland security after September 11. 
These combined costs are now running about $30 billion a year. 
Moreover, due to the effects of inflation, the $470 billion budget for 
2007 represents about $425 billion when expressed in 2002 dollars. And 
compared to the size of the United States economy, these budgets would 
still reflect a smaller fraction of Gross Domestic Product (GDP)--about 
3.5 percent--than at any time during the cold war.
    Still, despite these factors, the increases are remarkable. The 
Pentagon's budget in 2007 would be a full $100 billion greater than 
what the Clinton administration had envisioned for that year in its own 
long-term plan. And as noted, these figures would approach the peak 
levels of the Reagan years, as well as those of the Vietnam era.
    Why does President Bush wish to restore defense spending to such 
high levels? He does not plan to increase the size of the military, 
which remains one-third smaller than in cold war times. Moreover, with 
the exception of missile defense, Bush administration officials have 
not yet added any major weapons systems to the modernization plan they 
inherited from their predecessors. Instead, the Bush administration 
claims that in general it is only fully funding the force structure and 
weapons procurement agenda that was laid out in Secretary of Defense 
William Cohen's 1997 Quadrennial Defense Review, as well as the 
immediate exigencies of the war on terrorism. This argument can be seen 
explicitly in the Pentagon's breakdown of the proposed increase in the 
2003 defense budget (see table 2).
[GRAPHIC] [TIFF OMITTED] 80544.087


    The main point that the Bush administration wishes to make with 
this table is that most of the $48 billion added between 2002 and 2003 
is effectively beyond the control of a scrupulous bookkeeper, given the 
obligations inherited from the Clinton administration and the Congress 
as well as the demands of war. The Bush administration is essentially 
arguing that $36.6 billion of the increase is automatic, and another 
$10 billion is simply a conservative estimate of what next year s 
military operations will entail. Indeed, were it not for the $9.3 
billion in program cuts, postponements, and accounting changes the Bush 
administration managed to make, virtually no money would be left for 
other purposes such as increased weapons acquisition. Even the $9.8 
billion added for weapons will fund a plan for fighter jets, ships, 
Army transformation, and other advanced systems that was primarily 
inherited from Clinton administration.
    For those who doubt the need for added defense spending, it is 
further true that a military of a given size costs more to maintain 
each year. Whether it is the price of weaponry, the burden of providing 
military health care to active-duty troops and their families as well 
as to retirees, or the price of paying good people enough to retain 
them, most defense costs rise faster than inflation. Moreover, the 
United States military took a ``procurement holiday'' of sorts during 
the 1990s, since money was tight and since it had so much modern 
weaponry on hand after the Reagan buildup. That holiday must now end, 
as systems age and require refurbishing or replacing.
    In addition, the lessons of Operation Enduring Freedom need to be 
built upon. That conflict has demonstrated, more than any other before, 
the importance of unmanned aerial vehicles, real-time information 
networks, certain precision munitions, and good equipment for special 
operations forces. These and most other ``transformation'' initiatives 
proposed by the Bush administration merit support (see table 3).
    Because of these various factors, real defense spending should 
indeed continue to increase, as it has been doing since 1999. It makes 
perfect sense that today's military, though only two-thirds the size of 
the cold war force, might cost nearly as much. What is surprising, 
however, is that the Bush budget would not only reach but easily exceed 
the cold war defense budget average.
[GRAPHIC] [TIFF OMITTED] 80544.088


An Alternative to the Bush Strategy and Budget
    It is true that the 1997 QDR, developed during a period of fiscal 
restraint, did not provide enough funds for its own proposed plan. But 
Congress and the Clinton administration later added more than $20 
billion to the annual real dollar budget, and Secretary Rumsfeld added 
another $20 billion for 2002 without counting added costs due to 
September 11. So the yearly baseline has already grown by $40 billion 
even as the plan for forces and weapons has remained mostly unchanged. 
Secretary Rumsfeld and President Bush now tell us that is still not 
enough. Alleging a decade of neglect, they claim that further spending 
increases are needed for military pay, readiness, infrastructure, 
health care, research and development, and weapons procurement. 
Overall, the Bush administration proposes to add a total of more than 
$400 billion from 2002 to 2007. It is true that each of the main 
Pentagon budget accounts still needs more funding. But the needs are 
not sufficient to require such large increases.
    Before examining each major defense account individually, there is 
the matter of war costs to address. The Bush administration has 
requested almost $20 billion for such costs in the 2003 budget--$10 
billion as its best guess of the cost of military operations that year, 
and $9.4 billion primarily to replenish weaponry and spare parts 
inventories and otherwise recuperate from the effects of the war on 
terrorism to date. However, to ensure transparency and to protect 
Congress's role in the budget process, these costs should be added to 
the supplemental appropriations bill now being prepared by the 
Administration for 2002 rather than added to the overall defense budget 
for 2003. Making them supplemental appropriations will also avoid 
artificially inflating the defense budget for 2003 in a way that would 
make defense increases in future years look smaller than they really 
are.
    Pay. After the largesse of the last few years, military pay has 
never been higher in inflation adjusted dollars. Partly as a result, 
recruiting and retention have improved markedly in recent years.
    Most additional increases should be targeted at those few technical 
specialties where the Pentagon still has trouble attracting and keeping 
people, rather than the entire force. In that regard, the Bush 
administration's plan to add a total of $82 billion to military pay 
over the 2002-2007 period is excessive. Since troops are receiving 
improved housing and health benefits at present, further pay raises 
should be held to no more than the rate of inflation. Over the 2003-
2007 period, this approach would save about $30 billion relative to the 
Bush administration's plan (individuals would still get additional 
raises as they were promoted, of course).
    In addition, another $5 billion could be saved through 2007 by 
modestly reducing the number of individuals in the military. Generally 
speaking, this should not be done by cutting the number of maj or 
combat units below current levels, but rather by making some of them 
slightly smaller in recognition of the enhanced capabilities of modern 
weaponry--as well as the need for a lighter and more deployable force.
    Operations and Maintenance. This part of the budget funds a wide 
array of defense activities related to so-called military readiness, 
including training, equipment repair, fuel, and other necessities for 
overseas deployments, and most spare parts purchases. It also funds the 
salaries and health care of civilian employees of the Department of 
Defense. Even though readiness funding per troop is at its highest real 
dollar level ever, the Bush administration proposes adding $146 billion 
to this budget over the 2002-2007 period.
    But reform in military health care could save $15 billion over that 
period, if ideas proposed in the past by the Congressional Budget 
Office (CBO)--including merging the independent health institutions of 
each military service, employing market-based care wherever possible, 
and considering introduction of a small co-pay for military personnel--
were adopted. At a time when Congress has legislated a huge increase in 
the defense health budget by mandating free lifetime care for retirees, 
reform is all the more important.
    In addition, giving incentives to local base commanders to find 
efficiencies in their operations might help limit real cost growth to 2 
percent rather than 2.5 to 3 percent a year in other parts of the 
budget, saving $10 billion more.
    Research and Development. President Bush has rightly emphasized 
research and development ever since he began running for president, but 
again, the 2002 budget already added large sums to this area. Current 
real spending on research, development, testing, and evaluation already 
exceeds the levels of his father's administration and roughly equals 
those of the peak Reagan years. No more than another $1 billion is 
needed for the 2003 budget and beyond. For example, economies should be 
possible by canceling one or two major weapons, slowing the army s 
future combat system until underlying technologies are more promising, 
and slowing at least one or two missile defense programs out of the 
eight now under way (while modestly increasing research and development 
on a national cruise missile defense). Rather than add $99 billion to 
the pre-existing plan, about $55 billion should suffice for 2002-2007 
(reflecting primarily the increases in the 2002 budget that would be 
sustained thereafter).
    Procurement. The Clinton administration spent an average of about 
$50 billion per year to buy equipment; the figure is now about $60 
billion. According to CBO, however, the expensive modernization plans 
of the military services might imply an annual funding requirement of 
$90 billion or more, Accordingly, the Bush-Rumsfeld budget envisions 
procurement funding of $99 billion in 2007.
    But Operation Enduring Freedom has underscored the potential of 
relatively low-cost systems, such as Global Positioning System (GPS) 
guidance kits added to ``dumb bombs,'' unmanned aerial vehicles (which 
cost a fraction of what manned fighters do), and real-time data links 
between various sensors and weapons platforms.
    To be sure, expensive weapons such as aircraft carriers have been 
used as well. Moreover, not every future foe will be as militarily 
unsophisticated as the Taliban and al Qaeda. That said, the services 
need to prioritize. They should recognize, as former Vice Chairman of 
the Joint Chiefs of Staff Bill Owens has argued, that the electronics 
and computer revolutions often promise major advances in military 
capability without inordinate expenditures of money.
    The current procurement budget of about $60 billion does need to 
rise to the $70 billion level proposed for 2003; in fact, it probably 
needs to reach $75 billion or higher. But the $99 billion level 
envisioned for 2007 is greatly excessive.
    For many critics, the problem with Rumsfeld and Bush's weapons plan 
is that it protects the traditional priorities of the military services 
without seeking a radical transformation of the United States armed 
forces. But this basic criticism is not quite right. Individual 
programs or omissions in the Bush plan can be debated, but it is beyond 
serious doubt that the Bush administration has an aggressive program 
for so-called defense transformation (see table 3). As is appropriate 
for such an effort, most of the emphasis is in the realms of research, 
development, and experimentation, where the Administration envisions 
spending $99 billion more than the Clinton administration would have by 
2007 (even though, as noted, these areas of the defense budget were not 
severely cut in the 1990s). The problem is a more classic one of 
unwillingness to set priorities. Despite the absence of a superpower 
challenger, the Administration proposes replacing most major combat 
systems of the United States military with systems costing twice as 
much--and doing so throughout the force structure.
    A more prudent modernization agenda would begin by canceling at 
least one or two major weapons, such as the Army's Crusader artillery 
system. In addition, rather than replace most major weapons platforms 
with systems often costing twice as much, the Pentagon would only equip 
a modest fraction of the force with the most sophisticated and 
expensive weaponry. That high-end or ``silver bullet'' force, as CBO 
has described it, would be a hedge against possible developments such 
as a rapidly modernizing Chinese military. Otherwise, the rest of the 
force would be equipped primarily with relatively inexpensive upgrades 
of existing weaponry carrying better sensors, munitions, computers, and 
communications systems. For example, rather than purchase some 3,000 
joint strike fighters, the military would buy about 1,000, and 
otherwise purchase planes such as new F-16 Block 60 aircraft (and 
perhaps even some unmanned combat aerial vehicles in a few years) to 
fill out its force structure.
Conclusion
    In times of war, it is often militarily necessary, and politically 
natural, for defense spending to rise. But the nation is presently 
running the risk of spending too much on defense. Many members of 
Congress are fearful of challenging a popular president in a time of 
war over his proposed defense requests.
    This dynamic puts the Nation's fiscal health and domestic agenda at 
risk and may not even be good for national security. Defense budgets 
may decline in the years ahead, especially as the Nation moves farther 
away from September 11. If that happens, the Bush administration may 
then regret that it sacrificed its opportunity to promote the kind of 
defense reform it championed on the campaign trail and during its first 
few months in office. The country could be left with a defense program 
that is too large and expensive for the resources at hand.
    Some defense spending increases, beyond those already put in place 
since 1999, are needed. But most of those proposed by the Bush 
administration have only limited relevance to the war on terrorism. 
They should not be justified on the grounds of fighting al Qaeda, other 
terrorist organizations, or state sponsors of terrorism. And many are 
not needed on other grounds, either. The $48 billion increase requested 
for 2003 should be cut to about $20 billion, mostly because war costs 
should be paid through supplemental appropriations so that they are 
more visible and more easily debated by the Congress. And future 
defense budgets should grow by less than $10 billion a year above the 
inflation rate, winding up at $430 billion in 2007, rather than the 
$470 billion level proposed by the Administration.
    President Bush, Vice President Cheney, and Secretary Rumsfeld all 
have considerable experience in the private sector. Yet they seem to be 
ignoring an important principle of corporate management--institutions 
need incentives to become more efficient. Give an organization all it 
wants and it will fail to prioritize; impose some financial discipline 
and it will innovate and reform.

    Chairman Conrad. Thank you very much. Thank you for that 
thoughtful testimony.
    Dr. Thompson, welcome. Very good to have you here. We 
appreciate your taking the time to join the committee. Please 
proceed with your testimony.

   STATEMENT OF LOREN B. THOMPSON, PhD., CEO, LEXINGTON INSTITUTION; 
                ADJUNCT PROFESSOR, GEORGETOWN UNIVERSITY

    Dr. Thompson. Thank you for inviting me, Mr. Chairman. I 
would like to spend about 5 minutes this morning talking about 
three things: the size of the defense budget, the priorities it 
reflects, and what I think is its principal defect, which is a 
dearth of procurement spending relative to need.
    Concerning size, much has been made of the fact that at 
$379 billion, the proposed budget for 2003 would roughly match 
the combined spending of the 15 next biggest military powers. 
If you then add in the Department of Energy security programs, 
as you did in your chart, then it is the 18 next biggest.
    Just the proposed increase between 2002 and 2003, or $48 
billion, is as much as the entire military budget of Russia or 
China.
    However, as a share of national wealth, the proposed budget 
is much lower than the norm for the last two generations, 
despite the fact that we have launched a global campaign 
against counterterrorism.
    Between 1950 and the year 2000, defense spending averaged 
about 7 percent of gross domestic product annually. If GDP in 
2003 surpasses $11 trillion, as expected, then the 
administration's defense budget would represent about 3.3 
percent of the economy, less than half the average of the last 
50 years.
    Of course, the economy has grown considerably during that 
period. But if we consider the overall scale of the economy 
today, the proposed level of defense spending is actually 
relatively modest.
    For example, it has been estimated by Standard & Poor's 
that Americans spend 6 percent of gross domestic product on 
gambling. If you believe that estimate, then the entire $6 
billion shipbuilding proposal for fiscal year 2003 is about as 
much as we spend in one weekend on gambling.
    Concerning priorities, the Bush administration has added 
substantial funding to several areas of defense activity that 
it considers to be underfunded, most notably military pay and 
benefits, training, equipment maintenance, and scientific 
research.
    However, because the increases it proposes are spread 
across the entire defense budget, the priority assigned to 
major categories of activities has changed quite little since 
the Clinton years.
    In the year 2000, the Clinton administration spent 26 
percent of the defense budget on military personnel. Bush would 
spend 25 percent in 2003, 26 percent in 2005. In 2000, the 
Clinton administration spent 14 percent of the defense budget 
on research and development. Bush would spend the same 
percentage in 2003, 15 percent in 2005.
    There is a similar alignment across time in the shares 
allocated to procurement and to operations and maintenance.
    So while the Bush administration would raise the buying 
power of the defense budget considerably higher in 2003 than 
what prevailed in 2000--by about a third, actually--the 
alignment of priorities within the budget has changed 
relatively little from the Clinton years.
    That is a very different situation from the fiscal year 
1978 budget that Secretary Rumsfeld proposed when he was last 
in charge of the Pentagon. The 1978 budget was designed to 
reverse the post-Vietnam malaise in military spending by 
raising Pentagon funding above $100 billion for the first time 
in history. But back then, Secretary Rumsfeld stressed the 
importance of allocating a disproportionate share of the 
increase to investment accounts, an emphasis that is not at all 
apparent in the 2003 proposal.
    While the Bush administration makes much of its desire to 
transform the military by embracing new technologies that 
enable new concepts of operation, its basic framework of ideas 
and programs for modernizing the military is quite similar to 
that of the Clinton administration.
    Where it is different is in its willingness to allocate 
more money to all facets of military activity, which at least 
in theory accelerates the potential speed with which 
transformation can occur.
    Even with the increases it proposes, though, a combination 
of rising costs, political constraints, and new overseas 
commitments has diminished the latitude Mr. Rumsfeld and his 
team have for radical innovation.
    Finally, concerning defects, I think that the 
administration's defense proposal contains relatively few. It 
has corrected shortfalls in military pay and benefits. It has 
raised funding for readiness accounts. It has covered the 
Pentagon's share of the cost for the war on terrorism. And it 
has increased research and development funding for 
transformational technologies.
    The one area where the budget is deficient is in 
procurement--in the replacement of aging weapons.
    The Joint Chiefs of Staff estimate that $105 billion in 
procurement spending is needed every year in order simply to 
prevent the existing force structure from aging or shrinking.
    The administration's proposed budget for 2003 only funds 
two-thirds of that amount, and thus it assures that an 
increasingly decrepit arsenal is going to grow older or 
smaller.
    The shortfall in procurement is not new. In the Clinton 
years, we saw the only prolonged period in the last half-
century in which procurement spending was consistently below 20 
percent of the defense budget.
    One consequence of that was that the average age of Air 
Force aircraft was 13 years in 1990 and 22 years today. The 
average Navy plane today, for the first time in history, is 
older than the average Navy warship.
    Some Army and Marine helicopters have become so aged that 
they pose a danger both to the readiness and to the safety of 
the people who are flying them.
    I was sitting at dinner last night next to a four-star 
Marine general who told me that they are flying 35-year-old 
helicopters in Afghanistan. I don't think you could even get 
the FAA to certify a 35-year-old helicopter to fly civilians.
    I have attached a chart to my remarks showing that every 
category of Air Force aircraft except bombers has either 
exceeded its maximum acceptable average age or is within months 
of doing so.
    Because air power is essential to every facet of our 
warfighting effectiveness, I believe the defense budget needs 
to reflect a greater sense of urgency about replacing aging 
aircraft.
    Aside from that shortfall in procurement, though, I believe 
the administration has done a fairly good job in its first year 
of balancing the Pentagon's books, fixing inherited problems, 
and addressing new dangers.
    Thank you.
    [The prepared statement of Dr. Thompson follows:]

     Prepared Statement of Loren B. Thompson, Ph.D, CEO, Lexington 
          Institute, Adjunct Professor, Georgetown University

    Mr. Chairman and members of the Committee, thank you for inviting 
me to comment on the Bush administration's proposed defense budget for 
fiscal 2003.
    This morning, I want to briefly discuss three subjects: the size of 
the defense budget, the priorities it reflects, and its principal 
defect--inadequate spending for procurement.
    Concerning size, much has been made of the fact that at $379 
billion, the proposed budget for 2003 would roughly match the combined 
spending of the 15 next-biggest military powers.
    Just the proposed increase between 2002 and 2003--$48 billion--is 
as much as the entire military budget of Russia or China.
    However, as a share of national wealth, the proposed budget is much 
lower than the norm over the last two generations--despite the fact 
that we have embarked on a global campaign to counter terrorism.
    Between 1950 and the year 2000, defense spending averaged about 7 
percent of gross domestic product annually.
    If GDP in 2003 surpasses $11 trillion as expected, then the 
administration's defense budget would represent about 3.3 percent of 
the economy--less than half the average of the last 50 years.
    Of course, the economy has grown considerably during that period.
    But if we consider the overall scale of the economy today, the 
proposed level of defense spending is relatively modest.
    For example, it has been estimated that Americans devote 6 percent 
of GDP to gambling.
    At that rate, the Navy's proposed $6 billion shipbuilding budget 
for 2003 would be about equal to what is spent on gambling each 
weekend.
    Concerning priorities, the Bush administration has added 
substantial funding to several areas of defense activity that it 
considered to be underfunded, most notably military pay and benefits, 
training, equipment maintenance, and scientific research.
    However, because the increases it proposes are spread across the 
entire defense budget, the priority assigned to major categories of 
activity has changed little since the Clinton years.
    In the year 2000, the Clinton administration spent 26 percent of 
the defense budget on military personnel; Bush would spend 25 percent 
in 2003 and 26 percent in 2005.
    In 2000, the Clinton administration spent 14 percent of the defense 
budget on research and development; Bush would spend the same 
percentage in 2003 and 15 percent in 2005.
    There is similar alignment across time in the shares allocated to 
procurement, and to operations and maintenance.
    So while the Bush administration would raise the buying power of 
the defense budget considerably higher in 2003 than what prevailed in 
the year 2000--in fact, by nearly a third--the alignment of priorities 
within the budget has changed little.
    That is a very different situation from the fiscal 1978 defense 
budget that Secretary Rumsfeld proposed when he was last in charge of 
the Pentagon.
    The 1978 budget was designed to reverse the post-Vietnam malaise in 
military spending by raising Pentagon funding above $100 billion for 
the first time in history.
    But back then, Secretary Rumsfeld stressed the importance of 
allocating a disproportionate share of the increase to investment 
accounts, an emphasis that is not apparent in the 2003 budget.
    While the Bush administration has made much of its desire to 
``transform'' the military by embracing technologies that enable new 
concepts of operation, its basic framework of ideas and programs for 
modernizing the military is similar to that of the Clinton 
administration.
    Where it is different is in its willingness to allocate more money 
to all facets of military activity, which potentially accelerates the 
speed at which transformation can occur.
    Even with the increases it proposes, though, a combination of 
rising costs, political constraints, and new overseas commitments has 
diminished the latitude Mr. Rumsfeld and his team have for radical 
innovation.
    Concerning defects, I think the Administration's defense budget 
contains relatively few.
    It has corrected shortfalls in military pay and benefits, raised 
funding for readiness accounts, covered the Pentagon's share of the 
cost for the war on terrorism, and increased research and development 
funding for transformational technologies.
    The one area where the budget is deficient is procurement--the 
replacement of aging weapons.
    The Joint Chiefs of Staff estimate that $105 billion in procurement 
funding is needed each year to prevent the existing force structure 
from shrinking or aging.
    The Administration's proposed budget for 2003 only funds two-thirds 
of that amount, and thus assures that an increasingly decrepit arsenal 
will continue aging.
    The shortfall in procurement is not new: the Clinton years were the 
only period during the last half century when procurement spending was 
consistently less than 20 percent of the defense budget.
    One consequence was that the average age of Air Force aircraft rose 
from 13 years in 1990 to 22 years today.
    The average Navy plane today, for the first time in history, is 
older than the average warship.
    Some Army and Marine helicopters have become so aged that they pose 
a danger to both the readiness and the safety of United States forces.
    I've attached a chart to my remarks showing that every category of 
Air Force aircraft except bombers has either exceeded its maximum 
acceptable average age or is within months of doing so.
[GRAPHIC] [TIFF OMITTED] 80544.085


    Because air power is essential to every facet of our warfighting 
effectiveness, I believe the defense budget needs to reflect a greater 
sense of urgency about replacing aging aircraft.
    Aside from the shortfall in procurement spending, though, I believe 
the Administration has done a good job in its first year of balancing 
the Pentagon's books, fixing inherited problems, and responding to new 
dangers.

    Chairman Conrad. Thank you very much, Dr. Thompson, for 
that testimony, and we appreciate again very much your being 
here, as well as the other witnesses.
    I would like to go back to this fundamental question of 
tooth to tail, how much warfighting capability, how much 
overhead we have. Admiral Owens, who I have high regard for, 
former Vice Chairman of the Joint Chiefs, who happens to be 
from my hometown--we are very close friends--has told me 
repeatedly--he is a former nuclear submarine commander--before 
he worked his way up the chain of command, he was deeply 
involved in the move towards technology and jointness in the 
military, perhaps the foremost advocate for it when he was Vice 
Chairman of the Joint Chiefs of Staff. He has said to me over 
and over, Kent, you have got to look at tooth-to-tail question. 
We are spending too much--we are spending too much in the tail 
and not enough in the tooth.
    Let me go to your analysis, Mr. Weston, in your testimony 
that 70 percent of the spending is in the tail, in 
administration. One of the things that testimony before the 
Budget Committee identified last year was in four areas we have 
tremendous duplication: medical, logistics, intelligence, and 
long-haul communications.
    In your analysis on the work of the commission, can you 
tell us what is the basis for this 70 percent is in 
administrative overhead, in the so-called tail, versus less 
than 30 percent in the tooth?
    Mr. Weston. Yes. Those are not our numbers. We got them 
from Government sources. The GAO has looked at it, and they 
came up with a number that the Department of Defense also 
reviewed. They said 60 percent, but they excluded and 
identified certain things that you would also call tail, and if 
you put those onto their 60, it adds up to 70.
    Just as another totally different index, the Defense 
Science Board took a look at how many combat-coded positions 
there are in the military. At that time they looked at it, only 
16 percent of the total workforce in DOD was combat-coded 
positions. That means one out of six people are in combat-coded 
positions. The rest are one form of infrastructure, overhead, 
et cetera.
    I don't think the issue is splitting hairs over whether it 
is 70 percent. Bill Owens would probably say it is higher than 
70 percent. Someone else might pick a number of 67 percent. Any 
way you look at it, because of the redundancies you cited, the 
multiple silos, the tiering of the structure, so many tiers of 
supervision that have produced this seeming absurdity of one 
fighter backed up by five other people, any way you look at 
it--it doesn't matter whether you pick the number 70 percent--
it is crying out for reform. And although I am not a Senator, I 
think you have two jobs here for the price of one. You have got 
to set a budget for next year. But I think also you have the 
very important opportunity to set a trajectory and a way of 
looking at things for many years into the future.
    We, in my opinion, have a terrific set of very experienced 
civilian Secretaries. Because of the Tail and Tooth Commission 
I met every one of them, and their Deputies. They have the 
experience. They have the ability. I think what they need is 
the directional encouragement to do what they know has to be 
done, tackle that tail and start making changes.
    Just to give you one other frame of reference, during the 
Vietnam period, it was estimated the tail-to-tooth ratio was 
50/50. The difference between 50/50 and 70/30 would make 
available for teeth and other purposeful things $50 to $60 
billion that is being used in overhead. It is just there if the 
determination is set at the senior capable civilian levels in 
the Pentagon to go after it while you are fighting the war 
instead of letting the war become an excuse to let all this 
other stuff stay.
    I think the budget as submitted to you was business as 
usual. I would hope that this committee and the other relevant 
committees in the Senate decide that it is not the right time 
to just go business as usual.
    Chairman Conrad. Dr. Thompson, what part of that analysis 
would you disagree with in terms of this tooth-to-tail concept?
    Mr. Thompson. Mr. Chairman, I think it is not so much what 
I heard that I disagree with as I would like to make a comment 
about what was left out. I spend a lot of time dealing with 
senior military officers, and they will tell you that, yes, 
they are wasting money. But then they will go on to tell you 
most of the reason they are wasting money is because of things 
that have been mandated by Congress.
    A senior Air Force officer told me two days ago that he 
doesn't need 25 percent of his bases, but he doesn't believe he 
can close them going through the congressional process. I 
participated in two Defense Science Board task forces in the 
early 1990s, one of depot maintenance, one on privatization. We 
expressed many of the same ideas that Mr. Weston has expressed. 
For the most part, they have gone nowhere, and the reason why 
is because each one of these activities represents large 
concentrations of votes, in some cases enough votes so that you 
could argue it would affect the outcome of congressional 
elections.
    You need only ask yourself the question, if Eglin Air Force 
Base were not in Florida, who would be in the White House 
today, to see the significance, the electoral significance of 
some of these issues.
    Chairman Conrad. Could I stop you right there and ask you--
I don't want to miss the point. Depot maintenance, you 
referenced that and you apparently--what is your estimate of 
the surplus capacity in depots around the country?
    Mr. Thompson. That is a very complex calculation. The 
Department of Defense spends more money on equipment 
maintenance than the entire NASA budget, the entire space 
program, about $15 billion a year. The most intensive amount of 
that work, the one that is done for the most part by civilian 
Federal workers, is done in a handful of very large logistics 
facilities such as Warner Robbins Air Logistics and Portsmouth 
Naval Ship Base.
    You could close several of those facilities. More 
importantly, you could substantially downsize and outsource the 
work at those facilities, probably saving at least $1 billion a 
year if you adopted best practices. But it is not going to 
happen. It is not going to happen because the congressional 
resistance would be so fierce that in the end you would wish 
you had never tried.
    Chairman Conrad. Okay. Dr. O'Hanlon, what is your 
observation on this tooth-to-tail question?
    Mr. O'Hanlon. It is a tough question, Senator, because, of 
course, most of our tail is very important to the military. And 
if you look at our military compared to many other militaries, 
we have a lot more tail, and we are also a lot better. And if 
you compare it to the Vietnam era, we are lot better today than 
we were when the tail was only 50/50. I am not saying the tail 
is the reason, but I am saying that a lot of what we do in the 
way of deployable logistics that allows us to put hundreds of 
thousands of forces into a foreign country and operate there 
effectively, that can be defined as tail, but it really is 
inherent to combat capability.
    So in the end, even though I agree with my colleagues, I am 
not that comfortable talking about 30/70 and 70/30 ratios. I 
like to focus on the big areas of military O&M spending, like 
Loren just did in the case of maintenance, and say where can we 
save money. And it seems to me the big areas are health, which 
is one enormous area, base operations--you know, take base 
operations. Maybe I will just spend a second there and then 
stop. Base operations, it is amazing to me, you have a person 
who is running a base who is also, let's say, a one-star 
general, and he is a combat expert, but he is also expected to 
run a base and be the chief financial officer for essentially a 
small town and for all of its physical plan. I think sometimes 
we make unrealistic demands on these people, and I am not sure 
if the services are properly set up to, you know, have the same 
person--I am not sure it is realistic to have the same person 
running the wing or running the division and trying to figure 
out how to make that base efficient. And so to give that person 
incentives, you need to tell that person some of this savings 
that you might get from any reforms, you are going to get back 
for your combat activity. Then that person has an incentive to 
hire people to work for him who know how to make the right 
choices about housing, about base repair and so forth.
    So I am concerned not so much about the 30/70 ratio, but 
about certain specific areas, like health care, base 
maintenance, O&M, where I think we already spend a great deal 
of money, and some of these things are really not contributing 
in a great way to combat capability. But much of the logistics 
tail is important: intelligence, logistics, transportation. 
These are things that we do uniquely and uniquely well among 
the world's military. So I don't want to lose that part of the 
70 percent even as we reform the parts that should be reformed.
    Chairman Conrad. Let me just say that I don't think anybody 
who has seriously looked at the financial management systems of 
DOD has concluded anything other than they are way, way, far 
away from business best practices. I don't know how you would 
manage the Pentagon. And I can tell you, the Secretary is very 
frustrated. As a man who came out of the corporate world where 
he insisted on management information that would allow him to 
save money, eliminate duplication and waste, anybody who has 
looked at the financial management data that flows through the 
Department of Defense, it is a huge problem. I think probably 
anyone would acknowledge that.
    Mr. Weston?
    Mr. Weston. Mr. Chairman, if I could piggyback on your last 
comment with, I think, a useful anecdote, during the Tail to 
Tooth Commission's research, we were invited by the United 
Kingdom's military to visit their logistics group. They had 
started out with a very deficient finance and accounting 
system, and I realize as I mention the U.K. that no two 
countries are the same, but I want to share a story with you.
    They concluded it was terrible. They brought in two outside 
consultants. This is not a paid ad. McKenzie was one of them, 
and Coopers & Librand was the other. And they came up with the 
specs for what is an appropriate financial control system. They 
got the specs. They outsourced it. And for $800 million, in 
their lesser environment, they got a turnkey installation of a 
system that us private sector guys, when we saw it over there, 
said was darn good, much better than ours.
    The message I give you is that if, as I think is necessary, 
this committee and your colleagues in the Senate recognize if 
you don't have a reporting system, you can't hold anybody 
accountable for anything. You don't even know what is going on. 
And, therefore, I think it is time to get away from business as 
usual, budgeting as usual, and insist that the Secretary of 
Defense, together with knowledgeable colleagues, come up with a 
plan that will give you a financial control system for the 
future. Otherwise, for the next 20 years, one year at a time, 
you will continue to have an inadequate system. And if it takes 
a few billion dollars up front, that is probably the best 
investment this Nation can make.
    Chairman Conrad. Senator Stabenow.
    Senator Stabenow. Well, thank you, Mr. Chairman, and thank 
you to all the witnesses. Your information is extremely 
helpful. I think we have a special responsibility and duty this 
year to make tough decisions, to ask tough questions. We heard 
yesterday regarding the future obligations and unfunded 
liabilities that we are incurring in the next couple of decades 
as it relates to our budget. And we have some very tough 
decisions to make. So we appreciate the information.
    I was interested in, Dr. O'Hanlon, your suggestion about 
essentially putting the current costs for the war into a 
supplemental. I think there is some merit to that, Mr. 
Chairman. That would make sense to me. And I was also 
interested in light of that, when you said in your conclusion 
that most of the proposed increases have limited relevance to 
the war on terrorism in the current budget. It seems to me it 
would help us be able to debate the issue if we were looking at 
what was needed currently for safety and security and the war 
and then the long-term implications of the rest of the request.
    Mr. Weston, I wondered if you might expand a little more. 
It is very disturbing, even knowing that obviously we need 
those who are not directly in combat to support those who are. 
That makes perfect sense, whether it is intelligence, whether 
it is other individuals that are involved in the logistical end 
of the strategies and combat and so on. But I think it is safe 
to say that the average American would be very disturbed to 
know that seven out of ten people or seven out of ten dollars 
does not go directly into the fighting force to keep us safe 
and secure. And I think about our schools, and what if we were 
to say that only three out of seven--or three out of ten of the 
staff were actually working with the children, or in the health 
care area only three out of ten were actually treating 
patients? So I think this is an area of concern to me, and I 
wondered if you might give us an example to illustrate and 
speak a little bit more about the tail that you would believe 
is, in fact, not directly related, as Dr. O'Hanlon said, to the 
support of our combat readiness, our combat troops, but what 
you would view as excess tail.
    Mr. Weston. Let me give you several examples in no order of 
priority. Generally, the military builds and maintains its own 
housing, knows very little about building housing, knows an 
equally small amount about maintaining housing; and if you 
spoke to the people who occupy that housing, you would hear 
huge dissatisfaction. Our point of view at the Tail-to-Tooth 
Commission was that if ever there were an area where this 
Nation has extremely skilled entrepreneurs, it is in building 
and maintaining housing. We do that all over the country.
    I will not amplify further, but that is just one example.
    Senator Stabenow. Excuse me, Mr. Weston. So you are 
suggesting essentially a privatization of that function, or--
    Mr. Weston. Absolutely. Outsource the building, the 
maintenance, the operations, everything about housing. A house 
is a house is a house. In fact, if you were in the private 
sector, you would never make a row of tenements called military 
housing; you would want to make it feel like a community. Any 
private sector developer knows that. You take a look at 
military housing--it is just a bunch of rowhouses.
    It is not anybody's fault, but the military does not have 
that talent. It does not add to our fighting effectiveness. It 
is absolute ``tail,'' poorly run.
    Let us take something else. There are many functions that 
are business functions in the military that I previously called 
``yellow pages,'' meaning that you can go into the classified 
section of a phone book and find somebody--find a lot of 
somebodies--who does ``x''. What I am going to say now is not a 
commercial. ADP is not interested in doing any payrolls for the 
military. However, the military with its three payrolls--it has 
made some progress lately--viewed them as being so unusual that 
only they could do them in the Defense Finance and Accounting 
Service. Outsourcing those payrolls--and I am not looking for 
them at ADP; I would reject them if they came our way, just so 
that I would not pick up a stigma--it is another example.
    There is another aspect. We heard words about logistics, 
replenishment, acquisition. In the private sector, as every one 
of our very skilled service secretaries knows from their 
private experience, before you get to procurement, you are at a 
pre-acquisition phase, and you look for full life-cycle support 
if you can arrange it, instead of having your own depots and 
your own parts as a military. I would think that the whole area 
of buying and maintaining logistics and repair support on 
complex hardware could benefit a lot if you used the commercial 
practice, worked with the potential vendors pre-acquisition, 
set specs that require full life-cycle maintenance, do not have 
those depots, do not have stacks of obsolete inventory all over 
the place--and you would not have the 18-day average 
replenishment cycle the military has to get a replacement part. 
The private sector would not stand still for 18 days; they get 
it in 3. That whole thing has to be reviewed. There are 
probably 100,000 people involved in the acquisition phase at 
the Pentagon. They are all sincere, well-meaning people. But I 
am positive that Secretary Rumsfeld knows how to do that 
procurement better. I think he needs the encouragement and the 
priority to get on with it. And then, the Secretaries have to 
stay in office longer than the current average of 19 months. 
There is no major job, including Jack Welsh's--in his first 19 
months at GE, he did not produce the results; he was setting 
the stage.
    I have been told that at the Pentagon, the average term in 
office of the senior civilians looking backward has been 19 
months. Now, you cannot mandate a change, but that is a part of 
the circumstance.
    Senator Stabenow. Thank you.
    Would either of our two other guests wish to comment in 
relation to those items, or do you have differences of 
approach?
    Dr. Thompson?
    Mr. Thompson. I would like to comment briefly.
    Since Mr. Perry was Secretary of Defense, we have been 
moving increasingly toward the privatization of housing. If you 
look at the presentation of the defense budget on OMB's website 
for 2003, you will see a fairly extensive amount of housing 
privatization already underway.
    As far as the depots are concerned, I think we have to 
recognize that managing the Pentagon is as much of a political 
process as a management challenge. One of your colleagues on 
the Senate side said to me a little over a year ago, just 
before the Senate changed hands, when I remarked to him that 
Mr. Rumsfeld would actually like to close a major depot in his 
State, said to me: ``Well, you tell them that if they do, they 
have lost their majority in the Senate.''
    I think that explains why we have been recognizing and 
calculating the savings from these kinds of changes for decades 
and yet we have done very little, because the political system 
is stacked against making these sorts of changes, and it is not 
going to respond to the management arguments.
    Senator Stabenow. I very much appreciate what you are 
saying. I would just comment that in light of the overall 
budget situation that we face and the stark numbers that we 
continue to hear, we have to revisit those issues over and over 
again. We are not going to be able to just indicate that it has 
not been done in the past, so we are not going to be able to 
question it in the future, because we have a lot of issues that 
we are having to revisit. And I appreciate that it is very much 
in our court, some of those tough decisions and policies. But 
when we look at all of the numbers--and I am not speaking of 
defense now, but in general--they do not add up, as our 
Chairman has said many, many times, and we are going to have to 
find the best way to make sure that we are safe and secure, but 
using our dollars wisely, and ideally, being able to move 
dollars within the Department, or every department, to get more 
bang for the buck, and I guess in defense, that is a literal as 
well as figurative statement.
    I have one other question to ask--Dr. O'Hanlon, did you 
want to respond to that?
    Mr. O'Hanlon. I was going to make a very brief point. Loren 
is right, of course, that we need to try to make some of these 
reforms. But I also think the Administration owes it to 
Congress in a sense to make some tough choices itself, because 
from my perspective, the Administration is saying, ``You make 
all the tough choices, you close the bases, close the depots; 
we are going to keep all the weapons systems that the services 
want.'' And this is a pattern that has existed now for a while. 
I think that Secretaries of Defense need to be willing to make 
some people unhappy at the Pentagon just as they are asking you 
to make some of your constituents unhappy in closing bases. And 
frankly, I do not see that atmosphere of shared sacrifice from 
the Administration, and I did not see it that much even from 
previous Secretaries of Defense who kept these, in my opinion, 
exorbitant weapons modernization plans and expected Congress to 
make all the reforms.
    So I would say we do need more procurement spending, but it 
has to be more carefully targeted, and some programs need to be 
cut back.
    Mr. Thompson. I would like to take issue with that.
    Senator Stabenow. Yes.
    Mr. Thompson. It is true that there are very few major 
weapons systems that have been terminated. On the other hand, 
if you look at what we are actually buying, the Administration 
is requesting five ships in its shipbuilding plan this year. 
The Clinton administration was planning to buy eight. If you 
look at where this takes us, it takes us to less than a 250-
ship fleet by the mid part of this decade, when in fact we had 
600 ships--not much more than a decade ago.
    If you look at the purchase of aircraft for the Navy, it is 
less than half the number the Navy says it needs in order 
simply to maintain its existing force. And if you look at the 
Air Force, if we buy every single fighter that is in the 
program of record, the average age of Air Force fighters 
between now and 2020 will go from 14 to 18 years.
    So maybe there are some programs that should have been 
terminated, but the notion that we are overspending on 
procurement in general is belied by the age of the systems.
    Mr. O'Hanlon. I did not say that we were overspending. I 
said that the plans are too ambitious. And these aging problems 
could get worse if you try to buy $100 million fighters and you 
do not have enough money to buy them.
    Senator Stabenow. I appreciate that.
    If I might just in conclusion, Mr. Chairman, ask a broader 
question. We are looking at ways to guarantee, and we are 
putting more dollars into the ``tooth,'' as you would say, Mr. 
Weston, to be able to make sure that we are focusing 
specifically on safety and security of our people, that we are 
doing the maximum amount possible, which we all want to do. And 
when we look at the very large requests for additional dollars 
coming in--and again, Dr. O'Hanlon, you have indicated that 
most of those have limited relevance to the war on terrorism--
how would you suggest we proceed?
    My concern is that by granting large increases, most of 
which do not relate to the war on terrorism--and frankly, we 
have other bioterrorism needs where we are not putting the 
dollars in that our experts are telling us we need to in order 
to be protected on bioterrorism--but where do we put the 
pressure on? If we provide the dollars as opposed to saying we 
must look internally to move more of the 70 over to the 30 so 
that the internal pressures is on to be able to make the 
difficult decisions rather than just adding dollars upon 
dollars and not creating a climate where the tough internal 
decisions need to be made, that is a real concern and question 
that I have as to whether we are in the long run doing a 
service to the long-term goals if in fact we do not put some 
internal pressures on to grapple with these efficiency issues 
as quickly as possible rather than just adding more dollars and 
adding more dollars.
    Yes, Mr. Weston?
    Mr. Weston. I think what has happened in the past is that 
if there was pressure emanating from Congress, it was only 
exercised on the Pentagon as regards essentially the total 
dollars. And if you look backward, if the total dollars were 
not adequate to buy enough ``teeth,'' we did not buy enough 
``teeth,'' and we left the overhead in place.
    If all this committee does is recommend a different total 
from what has been submitted to you, it would be my guess, as 
has been the case in the past, that we will create cavities in 
the ``teeth'' because that overhead, even though some housing 
has been outsourced, will continue.
    I think it would be a contribution to this Nation's 
security if this committee and your colleagues in the Senate 
and hopefully ultimately in the House come up with an 
enforceable message on addressing the ``tail''; otherwise, you 
will just address the total, the ``teeth'' will suffer.
    Post-Reagan, as things were brought down, there was far 
more bring-down in fighting forces than there was in the 
overhead, and it will happen again if you only address the 
total and you do not address some kind of mandate for tackling 
this overhead.
    I think it is interesting that none of the panelists--and, 
for that matter, none of the Senators--have disagreed with the 
fact that we are full of excessive overhead, and if that is a 
continuing circumstance for the last 20 years, which it has 
been, there is a message in that observation.
    Mr. O'Hanlon. I would just add one point, Senator. I 
certainly agree, but I would also refer to a very good study 
just written by Bob Hale, my former boss at CBO who was 
Comptroller of the Air Force for a number of years. He wrote 
this report from the CSBA think tank, and it is easily 
available. He said, basically, it is very hard to get savings 
in O and M. You have to keep trying, but you should not have 
unrealistic expectations.
    So I think the Senate Budget Committee needs to say more 
than let us reform the ``tail'' because if you do that, people 
like Hale who have looked at this and tried to do it are going 
to say, yes, that is right, but you are going to get $500 
million in savings here, $200 million in savings there, and if 
you want to get to these grandiose multi-billion-dollar 
numbers, it is going to take you many years to get there. So 
you have to focus on the other issues as well, and we have to 
have this debate about procurement and figure out a plan that 
is sustainable and that does prevent our forces from getting 
too old but may impose some tough choices on the services, and 
have the debate about military pay. It is easy for me to say; 
in 2003, an elected Member of Congress would perhaps have a 
harder time debating that issue. But unless that issue gets 
raised, because we are putting so many benefits into the 
personnel package and into the personnel accounts that that 
account is going up, just as Loren mentioned earlier. All of 
our accounts are going up, including the ``tooth,'' and some of 
those increases in ``tooth'' are needed, others may not be.
    So I think you have to look at all four major accounts--
pay, O and M, R and D, and procurement--and if you do not look 
at all four of those, you are not going to get enough money out 
of just the overhead alone.
    Senator Stabenow. Thank you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Before I go to Senator Corzine, just a 
quick note. We got some good news. The economic growth in the 
fourth quarter of 2001 was 1.4 percent at an annual rate, so 
better than was anticipated, and that is certainly useful news 
to this committee.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman. I appreciate you 
holding the hearing.
    This is really the first opportunity that I have had to 
explore the budgetary elements of the defense procurement and 
management issues in this kind of detail, and I think that we 
are onto an obligation that is absolutely essential if we want 
to be able to have a legitimate budgetary process that has 
accountability to it and the kinds of things that we have been 
talking about here.
    I also want to compliment Josh Weston, who is a New Jersey 
native and has done an extraordinary job of running an 
efficient company for a very long time, both profitably but 
also with the efficacy that I think he is talking about here 
with respect to trying to bring those principles to bear on the 
Pentagon, and I welcome my good friend.
    I want to ask Dr. Thompson whether you agree that there 
might truly be 670 poorly-connected major data systems in the 
Pentagon.
    Mr. Thompson. Well, speaking as somebody who has been 
thinking about buying ADP stock for years, I am inclined to 
defer to the other person on the panel about information 
systems.
    If I could offer you a response by analogy, I participated 
in the Privatization Task Force back in the mid-1990's in the 
Department--
    Chairman Conrad. Dr. Thompson, could you pull the 
microphone in front of you, please?
    Mr. Thompson. [continuing.] Sorry. We proposed that a 
number of these things--data processing, financial accounting, 
and so on--should be outsourced to get the kind of efficiencies 
that are characteristic of ADP. Maybe the Arthur Andersen 
option is not as attractive today as it used to be. But at the 
time, the Department told us they wanted to fix it before they 
outsourced it, and as a consequence, most of these activities 
are still in the Department.
    The point that Josh makes about an average political 
appointee having a tenure of 19 months tells you a lot about 
why there does not seem to be much continuity. There are always 
neat ideas in terms of management reform floating around the 
building, but they last about as long as those appointees do in 
the positions.
    So I find it quite possible that there are hundreds of, if 
not totally disconnected, poorly interconnected, data systems 
in the building and in the system.
    Senator Corzine. If that data point is real, one could 
understand how you would end up with enormous duplication, lack 
of accountability with regard to what the mission is and what 
is accomplished, and as I said, I am new to this process, but 
if that is the case, you are going to get bad results no matter 
what happens if you do not have the kind of integrated approach 
of understanding the financial information.
    I am not challenging you, but if we have the single largest 
part of our budget going in this area, and we do not have the 
ability to actually track it and manage it, we are going to get 
gross overexpenditures relative to where we should be. I find 
it incredibly difficult to understand this kind of management 
structure with regard to such an incredible amount of 
expenditure we have, particularly when we have the tough 
choices about whether we are going to fund the procurement that 
seemingly needs to be in place.
    Mr. Weston?
    Mr. Weston. Since I know and lots of other people know that 
in your prior life, you were at Goldman Sachs, one of your 
predecessors as CEO at Goldman Sachs specifically helped the 
transition group at the Pentagon on the financial reporting 
system. I think members of this committee or perhaps yourself 
or your staff might want to ask Steve Friedman, who chaired 
that group, to share with you what their findings were, which 
they did deliver to Donald Rumsfeld.
    It is absolutely apparent that the financial reporting 
system is utterly broken, and if anybody spends a lot of time 
trying to decide if it is broken, you are rehashing something 
that is a foregone conclusion.
    I think the real issue is what do you do about it. And if 
every year, you say this budget is only a one-year budget, and 
you cannot fix it in a year, so let us not tackle it, then for 
20 years in a row, you will not fix it.
    Senator Corzine. I think we have an identified target of 
opportunity here, at least with regard to the needs for reform 
that I hope would lead to resources being made available for 
the other things that I think everybody finds necessary.
    I would like to pursue a little bit the propositions of Dr. 
O'Hanlon, talking about substituting procurement of equipment 
that may not be the 21st century's latest model as a substitute 
for some of the things--procurement of the F-22s or other high-
cost elements. Is this a viable military strategy?
    Mr. Thompson. I think the hardest thing about budgeting for 
defense is that there is a lot of subjectivity in terms of 
predicting the future. Some people would say that the notion 
that we need to put more of our money into the war on terrorism 
is an optical illusion; that in fact the reason why we are 
fighting this asymmetric threat is because we have done such a 
good job of defending ourselves against the really big threats, 
that now, nobody will even challenge us on that score, and 
therefore, our principal obligation should be to make certain 
that we remain so overpoweringly effective against a future 
peer or regional adversary that only a nut like Osama bin Laden 
would seriously try to challenge us.
    If that is what has actually happened here, it would be 
folly to put a lot of effort into counterterrorism, because 
that is the residual category. It is the least challenging 
threat. It is the big threats that could really harm us in the 
future, and that is where we are beginning to lose ground.
    Let me just tell you a little anecdote in that regard. A 
friend of mine, Major General David Deptula, used to be the 
head, the commander, of Operation Northern Watch, the Iraqi no-
fly zone. About 2 years ago, he was flying his F-15 over 
northern Iraq, and all of a sudden, everything in his cockpit 
stopped working at the same time. He did not know what had 
happened. He managed to limp back to base, and when they tore 
down the aircraft, they discovered that the F-15 that he was 
flying was so old that the insulation had turned to powder, and 
his cockpit was shorting out. On closer examination, it turned 
out he was flying the same F-15 that, as a young pilot, he had 
flown at Kadina Air Force Base in Japan a quarter-century 
earlier.
    Now, this is not one of those random events. On that 
particular mission when his cockpit went out, he was receiving 
refueling from a KC-135, which is 40 years old; it is an old 
Boeing 707. He was getting jamming support from an EA-6B 
Prowler, which traces its origins to the Korean War.
    This is not a revolution in military affairs; this is a 
revolution in museum affairs. This force is falling apart. And 
I do not think the way to maintain our edge in the world is to 
buy more F-15s. They were designed in the 1960's. We need new 
planes.
    Senator Corzine. Well, there is a need, though, to measure 
that or weigh that or balance that against the absolute 
resource constraints that we have, and if there are other 
opportunities for us to look at different mixes as opposed to 
just saying that we need to go from zero to 100, one wonders 
whether that is an effective strategy. I guess that is what I 
am hearing from Dr.--
    Mr. Thompson. I think you may be right, Senator, but I 
would just like to make one other point about that. After 
spending a year looking at these issues, the Rumsfeld team 
really could not come up with much that was new, that the 
Clinton administration was not already planning to do.
    There is in effect a bipartisan consensus within the 
Department as to what needed to be done. That is why they did 
not change the plan very much. I do not think it is driven by 
bureaucracy; I think it is driven by a recognition of what the 
operators need.
    Senator Corzine. The one issue that I have--and maybe you 
talked about it before I got here--is on the missile shield. Is 
that ``tooth'' or ``tail''?
    Mr. Thompson. Are you talking to me?
    Senator Corzine. Yes.
    Mr. Thompson. I guess it is ``tooth'' if we ever deploy it. 
I myself grew up in New Jersey very close to one of the first 
missile defense sites, or at least that is what it was supposed 
to be, and since that time--
    Chairman Conrad. Dr. Thompson, could I just ask you again 
to pull the mike a little closer? These mikes are very 
sensitive, and if they are not right in front of you, we do not 
pick you up as well, and I want to hear what you are saying.
    Mr. Thompson. I understand. Since I grew up in New Jersey 
near that first-generation missile defense site, we have been 
through Sentinel, we have been through Safeguard, we have been 
through SDI, and I do not know what the new thing is called, 
but the one thing they all have in common is that we never 
ended up with a missile defense system. So I guess until they 
actually build something that works, they will have to call it 
``tail.''
    Mr. O'Hanlon. Senator, if I could just continue the 
conversation on procurement very briefly, if you do not mind, 
Loren quoted earlier this Marine Corps officer who is concerned 
about his 35-year-old helicopters, but the Marine Corps is 
contributing to the problem, in my judgment, because they are 
saying the solution is to build the V-22. Well, the V-22 is not 
ready yet, so more delay. Once it is ready, it is going to cost 
twice as much per copy as a modern helicopter we could be 
buying instead; so if budgets are constrained, yet more delay.
    To my mind, the Marine Corps talks as if the only solution 
to the aging equipment problem is the V-22 for troop transport. 
In fact, the V-22 may exacerbate the problem because of the 
delays in the technology development, because of the high cost 
per system.
    So again, I think that a mix of capabilities there would 
give you some of the long-range, high-speed strike you need for 
commando raids or special-purpose missions, but allow you to 
refit your force more quickly with lesser technology, but still 
very good and reliable technology--because Loren is right--you 
cannot fly around things that are 20 and 30 and 40 years old 
and do that indefinitely. The question is not whether you get 
rid of them, it is what do you replace them with. I think that 
that distinction needs to be highlighted.
    Also, if you look at how we have done in Operation Enduring 
Freedom or Operation Allied Force or what have you, we often 
flew the same kind of airplane and put better things on it. So 
the JDAM munition--we did not even have the JDAM in Desert 
Storm, and it turned out to be the star of Operation Enduring 
Freedom even if it was being dropped by B-52s that are a half-
century old, because the munition is so good and the targeting 
from some of these unmanned aerial vehicles is so good that we 
are improving even as the weapon platforms stay the same.
    So I think you want to have a force that is reliable, that 
is young enough that it is safe, and you want to push 
technology, at least for this silver bullet force in case you 
do face a China or someone else in the future, but you do not 
need to replenish the entire force structure with the most 
expensive modern platforms available.
    Chairman Conrad. Could I just intercede on this question, 
and I know Senator Stabenow wanted to follow up, too, and we 
can be more informal at this point with the number of Senators 
here.
    I think just the age of the aircraft can be misleading, and 
let me give you an example. The B-52s that you just mentioned, 
Dr. O'Hanlon, it is often said that they are much older, maybe 
twice as old, as the pilots who fly them, and it is true. A 
number of years ago, I asked General Loh, who was head of Air 
Combat Command and a very good friend, ``Mike, how long are 
these planes good for?'' He said, ``Kent, these planes are good 
until 2035. With all the modernization, all the upgrades that 
have been done and with their low flight times''--he said when 
you compare the flight times on these frames against the flight 
times on commercial aircraft, these planes are good until 2035.
    The Air Force has now updated that analysis. They say the 
planes are good until 2040. Does that mean you are not making 
any improvement in their war-fighting capability? Absolutely 
not, as we have seen with ERCMs, with what is being done with 
respect to JDAMs. They were the stars in Afghanistan. Read the 
quotes of the Taliban leadership; the thing that devastated 
their morale was when the B-52s came over and dropped a big 
stick on them and scared the hell out of them, killed a lot of 
them.
    So I think we have got to be careful. I am certainly 
willing to accept the argument with respect to F-15s that have 
a lot of tough hours on them; our tanker fleet, average age 40 
years--no question. We have got to be putting money into 
procurement there. The helicopter situation--there is no 
question in my mind that we have got to be putting money into 
newer helicopters. In my State, we have 10 helicopters now, and 
generally, one can fly. That makes no sense. We have a 
helicopter fleet that cannot go anywhere.
    But I do think it is very important to keep in mind this 
question of just the pure age does not necessarily reveal a 
need for something else.
    Senator Corzine.
    Mr. Thompson. Could I respond to that?
    Chairman Conrad. Yes, absolutely.
    Mr. Thompson. Senator, it seems to me there are two parts 
to the aging issue. There is the actual decrepitude of some of 
these systems, the corrosion, the metal fatigue, and so on. But 
in addition to that, there is the relative age of the 
technology on the aircraft compared with what adversaries might 
have.
    The B-52 is a good example. The B-52 was conceived in 
Dayton, Ohio in 1948 as a high-altitude penetrating bomber. The 
threat got worse, so then it became a low-altitude penetrator. 
By the mid-1970's, even the North Vietnamese were able to shoot 
them down in large numbers. Today, nobody in his right mind 
would actually penetrate a well-defended country in a B-52. The 
reason we used them over in Afghanistan is because they were 
defenseless; they had no defenses. But it is still a very old 
technology no matter what shape the air frame itself is in.
    Chairman Conrad. Yes, but they are also incredibly 
effective, and every time we have a conflict, the first thing 
we fly off to do something is a B-52; and now they have a 
stand-off capability that is really quite remarkable that they 
did not have. Nobody in 1948 had any clue that you would be 
able to use a B-52 as a stand-off platform and fire cruise 
missiles, and now extended-range cruise missiles that give you 
a capability that is really quite remarkable.
    Senator Corzine.
    Senator Corzine. I was just going to follow up. 
Anecdotally, I visited the 177th in Atlantic City last week, 
which is the fighter wing that is flying caps over Washington 
and New York City. They had two F-16s go down, one for certain 
mechanical breakdowns, and they are targeted to be replaced, 
but with F-22s or joint strike fighters 15 years out.
    We somehow have to get between now and there with the kinds 
of capabilities that we have, and unless we have some 
derivative of the suggestions that Mr. O'Hanlon is talking 
about, I do not know how we can get there. It just does not 
seem logical that we are going to be able to replace all these 
things immediately, and if we are going to be budgeting to 
start building these as a full replacement, we are going to end 
up having this aging problem that we have been talking about 
here on a whole series of things in the intermediate stage. It 
just does not ring that it is going to work--
    Mr. Thompson. I think that assessment is accurate. We are 
living now with the consequences of the Clinton 
administration's procurement holiday. All of a sudden, we have 
a force that is aging across the board, and we are not sure 
what we are going to do between now and when we replace it, 
assuming we stay on track for the modernization plans, which in 
the past we have not done.
    The problem with continuing to fly F-16s is that it is 
either going to be very expensive because older aircraft are 
harder to maintain and keep ready--hence, this rapidly upward-
spiraling operations and maintenance account--or you are going 
to buy new F-16s, and new F-16s, according to the Air Force, 
are not survivable. They are not stealthy. They do not have a 
number of the features that will be incorporated into the F-22 
or into the joint strike fighter. It is not that they are not 
great aircraft. They are great aircraft today. But the Air 
Force is trying to think out 20 to 25 years in terms of what 
the threat is, and they do not believe they can survive much 
less maintain air superiority in F-16s.
    Mr. O'Hanlon. Although I have had individual Air Force 
officers agree with me that an F-16 Block 60, which is the 
latest version and still quite economical, is a very good 
airplane. It has some improvements in its stealth, and it is 
very effective especially with these longer-range munitions. 
You might not want to fight China's elite air force in 2020 
with that part. That is why you do want some modern aircraft--
but you do not have to have all 2,000 of the Air Force's 
fighters be stealthy planes, I do not think.
    Senator Corzine. It seems that we are trying to do all 
things at once, and it is a questionable theory in all walks of 
life that I have ever been involved with, at least in the 
private sector.
    I appreciate it, Mr. Chairman.
    Chairman Conrad. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    To follow up on Senator Corzine's comment about doing all 
things at once, I wanted to go back for a moment to the 
national missile defense, when we look at tough decisions that 
have to be made, and in light of September 11, we came together 
to allocate $40 billion to deal with what happened on September 
11 as well as the need to move forward on the war on terrorism; 
and then, I look at a number of $60 billion that has been 
suggested for national missile defense that we have yet to be 
able to operationalize, and Dr. Thompson, you said at the 
moment that since we have not been able to get it to work, you 
would put it in ``tail'' as opposed to ``tooth.'' We have to 
make some tough decisions that relate to this question--a) what 
is the biggest threat; are we going to need, as we have been 
discussing here in the last few moments, more conventional 
aircraft and conventional forces; are we going to be called 
upon, as I believe we are, to address terrorism and the more 
conventional interchanges that we will be involved in around 
the world, and is it in fact realistic that a rogue country 
will choose to deploy a missile when we will be able to 
identify exactly where they are and respond with incredible 
force back to them, or is it more likely that they will attempt 
to do what they did on September 11. I think common sense and 
the majority of the public in really looking at this would say 
they are much more concerned about bioterrorism or threats of 
terrorist activities right now.
    So I am wondering--Dr. O'Hanlon, you have written a book, 
``Defending America: The Case for Limited National Missile 
Defense,'' and you talk about that there should be a slow and 
deliberate process of coming to some kind of national missile 
defense--I am wondering how long do you think we should be 
putting dollars in, what should be the amount of dollars into 
research, before we say this is it--we have other areas where 
we need to be putting dollars that are right now a much, much 
bigger threat to Americans. Where do we draw the line on this?
    Mr. O'Hanlon. Thank you, Senator.
    I am personally not in any rush to deploy, but I do not 
want to slow things down too much, either. To my mind, the big 
question is why do you need eight or nine separate missile 
defense programs, all of them robustly funded, and why do you 
have to envision a very, very large missile defense, which is 
essentially what the Administration is doing.
    So instead of the $8 billion a year budget, we are now 
being asked to fund, I would be more comfortable at the $5 to 
$6 billion a year level that the Clinton administration left 
with, and that includes money for theater missile defense as 
well as for longer-range or national missile defense. I think 
that level of spending--mostly R and D, of course, right now, 
except for some limited theater missile defense procurements--
that level of spending to me is about right. The Bush 
administration is putting $8 billion into missile defense, and 
it wants to go up to $11 billion by 2007; if it then deploys 
the kind of systems that it might, CBO's recent study suggests 
that the total acquisition cost of that could be over $200 
billion. Now, CBO acknowledges there is no way to be sure what 
the Administration will really ultimately propose--there are no 
specific deployment plans just yet--but we could be looking at 
budgets that go from $8 billion today to $11 billion in 2007 to 
$15 billion a year if you go for an ambitious missile defense, 
and maybe even more. I think the level of threat is sufficient 
to justify a serious program, but I would put it at $5 or $6 
billion a year today, ramping up to possibly $7 or $8 billion 
once we start to deploy.
    Senator Stabenow. I guess my question is before we deploy, 
we have to have a system that can be operationalized, and even 
in theater missile defense, we have seen the Navy cancelling 
contracts, saying we do not believe we are able to move forward 
in a responsible way, getting things to work and so on.
    At what point--how long do we go on R and D before we say 
that maybe there is someplace else we should invest our 
resources that has a better chance of truly making us safe?
    Mr. O'Hanlon. It is a tough question, but I would tend to 
say we should keep trying. Of course, as Loren well knows, 
there are different levels of missile defense, and some of them 
are working pretty well. The Patriot PAC-3, which is also now 
this hit-to-kill capability, has done reasonably well the last 
few years on the test range, but it is just for local defense 
against short-range missiles. I think that program is in pretty 
good shape. I think Congress should fund the procurement 
request of the Administration for at least most of those 
systems.
    Then, you have the theater missile defense system center 
that you mentioned, the somewhat more advanced ones, going up 
to even these Navy theater-wide and THAD capabilities. That is 
the next tier of difficulty, and then you have national missile 
defense, which is the hardest of all because the threat is 
moving in so fast and is so small.
    There are three different capabilities. The first one, we 
are getting close to be able to do, and I think our deployed 
forces do need that kind of protection. The second tier, the 
Navy areawide, and then the Navy theater-wide or THAD, that is 
harder, it is going to take us a few more years, but I would 
keep at it.
    The national missile defense, I also would like a limited 
system, because I agree with your point--it is not the most 
plausible threat, but there are scenarios that I could imagine 
where someone might consider launching a few missiles at us in 
a very worst case. Let us say we are marching on Baghdad to 
overthrow Saddam Hussein. Well, thank God he does not have 
long-range missiles. But let us say the scenario is 10 or 20 
years from now, and it is not Saddam, but it is one of his 
sons, and that he does have a long-range ICBM, and we are 
saying we want to overthrow him, and he says, ``Okay, at this 
point, there is no reason for me to hold back.''
    So there are scenarios that I could imagine where a limited 
defense would make sense, but it is not the most plausible 
scenario, and we do not need a huge capability for that threat.
    Senator Stabenow. I would just comment that I hope we have 
dealt with Saddam Hussein long before that situation occurs.
    Yes, Mr. Weston?
    Mr. Weston. For a very long time, accountants and others 
have used this R and D term. It may be useful to you for me to 
add this comment. ``R'' you know stands for research, ``D'' 
stands for development. Normally, you do a lot of research 
before you satisfy yourself in development, and you are not 
talking about one subject, you are talking about two, and this 
committee or some other committee might want to examine how you 
divide your management and resource allocations between an 
``R'' and a ``D''--and if you lump them together and say that 
is R and D, we will give you ``x'' dollars or two ``x'', you 
might not be dividing the ``R'' from the ``D'' appropriately.
    But having said all that, I think the last 10 minutes have 
been dealing with very important questions. No matter how you 
choose to answer them, I am positive you will run up against 
constraints in money that you wish you did not have to deal 
with. And the only way to deal with that one--I am sort of 
becoming a broken record now--is concurrently tackle the 
``tail'' thing, because if you do not tackle the ``tail'' 
thing, no matter how you resolve the questions you have been 
asking, you will not be able to fund as many ``teeth'' as you 
think is appropriate.
    Senator Stabenow. Thank you.
    Thank you, Mr. Chairman.
    Chairman Conrad. Let me go back to this question, because 
it really is centrally important. I have had top uniformed 
military officers at very high levels tell me privately that 
they are very worried about the amount of money we are spending 
on national missile defense. And let me say that I have long 
been an advocate of national missile defense. Dr. O'Hanlon, I 
am pretty much on your wavelength on national missile defense. 
I do think it makes sense to invest money first in those 
shorter-range systems but also to continue a robust effort on 
national missile defense. But I must say the President's 
proposal leaves me cold, because CBO tells us that for limited-
layer defense, we are talking about $150 billion.
    Where is the money coming from? We are already in deep 
deficit. We are already under the President's plan going to be 
taking $2.2 trillion out of the Social Security and Medicare 
trust funds over the next decade, right at the time the baby 
boomers start to retire.
    We had testimony here from the Comptroller General of the 
United States just yesterday that we have nearly $7 trillion of 
unfunded liabilities. This is getting more and more like Enron. 
Enron got in trouble because they hid their debt. They hid it 
from investors, they hid it from shareholders, and I think in 
some ways they hid it from themselves. I think these guys--I 
think some of them knew what was going on, but I will bet you a 
lot of them really did not appreciate the debt bomb they were 
facing as a company, and it led to catastrophic failure.
    I will tell you that as a country, we are not facing up to 
the debt that we are building. Chairman Greenspan came and met 
with me, and he said, ``I am very concerned about these so-
called contingent liabilities, because they are not contingent 
at all. The vast majority of them are real liabilities, and we 
are not facing up to them.''
    I guess my frustration, the more I know, the more I learn 
in this position, the more frustrated I become that we are just 
in a dream world here in terms of our long-term fiscal 
condition as a country. So it makes these decisions all the 
more critical.
    I do not see $150 billion for national missile defense over 
the next decade, and yet I believe strongly that we have got to 
pursue national missile defense. But I think we have got to do 
it at a level that is more affordable.
    Let me go to another point and really my final question, 
and that is on the fighter aircraft. I should complete the 
thought with respect to what the top uniformed military 
officials have told me. These are non-Air Force, by the way. 
They have said to me, ``We are deathly afraid that this thing 
is going to eat the rest of the procurement budget for things 
that are really needed to defend this Nation in the future.''
    Now, these are private conversations. Obviously, they are 
concerned about being on the team and yet having grave 
reservations. Do any of you share that concern?
    Mr. Thompson. Do you mean the overall size of the three 
aircraft programs together?
    Chairman Conrad. Well, first of all on the question of 
national missile defense, what the Administration is doing 
there in terms of a long-term commitment; and then on the three 
fighter aircraft, I was going to follow up on that. We are 
doing the F-22; we are doing the FA-18E and F; and Joint Strike 
Fighter. Before September 11, there was a lot of talk that we 
have got to consolidate, that we cannot do all three. So I 
guess I have a two-tier question. On national missile defense, 
do any of you share the concern that top military officials--
and I mean very high-level uniformed military leaders--have 
talked to me about, that it is going to eat the long-term 
budget of their services?
    Mr. Thompson. I can certainly confirm that they are saying 
that. We may be talking to the same 4-stars, but I have heard 
them say exactly the same thing.
    My own personal prejudice--I think you and Michael are 
correct, that the right way to go is with a limited 
deliberative system rather than with any kind of more ambitious 
system.
    The threat is uncertain, but it is sufficiently serious 
that we need some sort of defense against an accident or a 
rogue attack, but beyond that, a very comprehensive crash 
program--I do not know--we have done it several times before, 
and it does not seem to go anywhere. I am kind of inclined to 
think that there is a message there.
    Chairman Conrad. Let me just say that Safeguard was 
operational for one day. I was up there the day it was 
operational.
    Mr. Thompson. Well, operational is not the same as 
effective; right?
    On the subject of the fighter aircraft, the basic problem 
that we face is that all the fighter aircraft are getting old 
simultaneously, and unlike the tankers or the bombers, these 
things do maneuvers that wear them out very quickly.
    There is a difference of opinion in each one of the three 
services that are receiving the Joint Strike Fighter as to 
precisely what role it is going to play and precisely how 
important it is. But in each one of the services, you find that 
at least one of those three systems is considered to be 
absolutely critical. As far as the Marines are concerned, the 
Joint Strike Fighter is absolutely critical to their future. 
That is the way the Navy feels about the SuperHornet, and that 
is the way the Air Force feels about the F-22. The case the Air 
Force makes on the F-22, since it seems to have the most 
controversy around it, is ``Look, we asked for 740; then Bush 
cut it to 648; then Clinton cut it to 438, then to 339; and now 
another Bush has cut it to 295. We still believe that without 
this aircraft, we cannot maintain future air superiority 
against a truly capable adversary. So now is the time to stop 
cutting since we have already spend over a third of the cost of 
the program anyway.''
    Chairman Conrad. Can you just go through those numbers 
again, quickly? We started at 750.
    Mr. Thompson. At 750; and then the Bush administration, if 
I recall correctly, in the major aircraft review, cut to 648; 
and then the Clinton administration cut to 438, subsequently to 
339; and then most recently, last year, the Bush administration 
cut to 295.
    Chairman Conrad. Just looking in this budget, the 
procurement for the F-22 has gone up from 13 to 23; the F-18 
SuperHornets have actually been reduced from 48 to 44; and of 
course, Joint Strike Fighter is still in R and D.
    I agree with you--the Marines have told me exactly what 
they have told you, that they see the Joint Strike Fighter as 
absolutely essential to their operations.
    So what I hear you saying is we ought to go forward with 
all three.
    Mr. Thompson. Yes.
    Chairman Conrad. Dr. O'Hanlon?
    Mr. O'Hanlon. I do not think I would cancel any one, 
Senator, but I would severely curtail the size of the F-22 and 
the JSF in particular. For example, on the JSF, I might go from 
a total buy of close to 3,000 among the three services to 
closer to 1,000 and then buy things like F-16 Block 60 for the 
rest of the force structure.
    Chairman Conrad. What is wrong with that idea, Dr. 
Thompson?
    Mr. Thompson. Well, the F-16 was designed to be a low-cost 
fighter a quarter-century ago. Today, it may be a low-
probability victory fighter.
    Just to take one simple example, if you look at the tail of 
an F-16, the vertical stabilizer and horizontal stabilizer are 
at right angles to each other. That is a guaranteed strong 
radar return on any radar. People do not build fighter aircraft 
like that anymore because you get shot down.
    We had aircraft like B-1s that even the Serbs were shooting 
the trailing decoys off of in Operation Allied Force. We were 
scared to put things like F-16s over Serbia. Serbia is a 
country that spends as much on defense in a year as NATO does 
in a day, so what happens if we face a real enemy?
    Chairman Conrad. Okay. That is a very good point.
    Are there any further questions, Senator Corzine?
    Senator Corzine. No.
    Chairman Conrad. Can I just again thank this panel. You 
have really been a terrific panel, all three of you, excellent 
witnesses and very helpful to the committee. We very much 
appreciate the time and energy that went into preparing the 
testimony and the very thoughtful contributions you have made 
here today. We appreciate it--and best of luck to your wife, 
Dr. O'Hanlon.
    Mr. O'Hanlon. I appreciate it, Mr. Chairman.
    Chairman Conrad. The committee is adjourned.
    [Whereupon, at 11:55 a.m., the committee was adjourned.]












THE CONGRESSIONAL BUDGET OFFICE'S ANALYSIS OF THE PRESIDENT'S PROPOSALS 
                          FOR FISCAL YEAR 2003

                              ----------                              


                        WEDNESDAY, MARCH 6, 2002

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Kent Conrad 
(chairman of the committee) presiding.
    Present: Senators Conrad, Feingold, Stabenow, Corzine, 
Domenici, Frist, and Hagel.
    Staff present: Mary Ann Naylor, staff director; and Jim 
Horney, deputy staff director.
    For the minority: G. William Hoagland, staff director; and 
Cheri Reidy, senior analyst.

              OPENING STATEMENT OF CHAIRMAN CONRAD

    Chairman Conrad. The hearing will come to order.
    Welcome, Dr. Crippen.
    Mr. Crippen. Good morning.
    Chairman Conrad. It is good to have you here. We appreciate 
your coming to tell us about your revised baseline and CBO's 
estimates of the effects of the proposals in the President's 
budget for fiscal year 2003 and beyond.
    I first want to commend you and your staff for the very 
hard work that you have done to produce this analysis in such a 
short time. We are deeply appreciative of the fact that you 
have worked overtime and your staff has worked overtime to 
produce this analysis in order to move ahead with the budget 
resolution on the compressed schedule that we face this year. 
We have a somewhat different circumstance because of when the 
work breaks for Congress fall and the effect of that on the 
budget process. It has put enormous pressure on all of us to 
step up the schedule, and you have responded and we appreciate 
it very much.
    Just 6 weeks ago, you testified how much had changed in the 
last year. You told us that we had gone from projected 
surpluses of $5.6 trillion over the next decade to $1.6 
trillion. The news is a little bit better today, but not much. 
Instead of a $4 trillion disappearance of projected surpluses, 
it is $3.9 trillion, still a very dramatic change. And when we 
look at where the money has gone, we see that most of it has 
gone to the tax cut over the 10 years. The next biggest reason 
is the economic slowdown. The next biggest reason is the 
additional spending that has come about largely as a result of 
the attack on this country. And, of course, then there are some 
technical changes, what had been previously underestimates of 
costs of programs such as Medicare and Medicaid.
[GRAPHIC] [TIFF OMITTED] 80544.089


[GRAPHIC] [TIFF OMITTED] 80544.090


    Now we have got the President's budget as well, and when 
the President's budget came out, he showed that about $5 
trillion was gone. Actually, things are somewhat worse under 
your analysis than what he had told us. We have gone from $5.6 
trillion over the 10-year period to $400 billion. And I must 
say that I think the use in Washington of the word ``surplus'' 
misleads the American people because I think they conclude from 
that there is extra money here, that there is more money than 
we need, and that is not the case. The truth is all of these 
dollars have been fully committed. In fact, I would argue they 
are overcommitted. There truly are no surpluses.
[GRAPHIC] [TIFF OMITTED] 80544.091


    Let me go to the next chart. What we see over the next 
decade, when you take out the trust funds of Medicare and 
Social Security, we see continuing red ink. If the money from 
Social Security and Medicare, those surpluses, are not counted, 
the so-called non-trust funds accounts, we see deficits each 
and every year for the next decade.
[GRAPHIC] [TIFF OMITTED] 80544.092

    Let's go to the next chart. With the President's budget, we 
see that of his priorities, those amounts over the so-called 
baseline, the biggest priority is additional tax cuts; second 
is national defense, which is a priority we all share; the next 
biggest is homeland security, of course, which we all know has 
to be strengthened; and, finally, Medicare reform and 
prescription drugs. So those are the priorities the President 
has set going forward.
[GRAPHIC] [TIFF OMITTED] 80544.093


    The very serious problem that we see with respect to the 
trust funds is we are going back to the bad old days when we 
were taking all of the trust fund surpluses of Social Security 
and using it to pay for other purposes. We largely stopped that 
in 1998. We completely stopped it in 1999 and 2000, started 
slipping backward in 2001, but now we are back on path for the 
next 3 years to be taking every dime and using those funds to 
pay for other expenses of Government, including the tax cuts.
    Let's go to the next chart. The other very notable change 
as we look forward is last year we were told we could expect 
outside of the trust funds some $2.7 trillion of surpluses, and 
now we see instead $2.3 trillion of deficits over the 10-year 
period. And, of course, all of that is coming from the Social 
Security and Medicare Trust Funds.
[GRAPHIC] [TIFF OMITTED] 80544.094


    Let me just conclude with a statement that you made when 
you were before the committee previously. When you were before 
us, you said, ``Put more starkly, Mr. Chairman, the extremes of 
what will be required to address our retirement are these: we 
will have to increase borrowing by very large, likely 
unsustainable amounts, raise taxes to 30 percent of GDP, 
obviously unprecedented in our history, or eliminate most of 
the rest of Government as we know it. That is the dilemma that 
faces us in the long run, Mr. Chairman, and these next 10 years 
will only be the beginning.''
[GRAPHIC] [TIFF OMITTED] 80544.048


    I think you sounded a warning that has been repeated before 
this committee by the Comptroller General of the United States 
that is critically important for this committee to hear, for 
our colleagues in both Houses of Congress to hear, and for the 
administration to hear, and certainly for the American people 
to hear, because we are headed on a long-term course that is 
simply unsustainable.
    As the Comptroller General indicated, the numbers do not 
add up. This has got to discipline what we do on both the tax-
cutting side and the spending side.
    Let me re-emphasize that. I hope the message that is 
delivered is very clear. We have got to discipline ourselves on 
the spending side and on the tax-cutting side if we are to 
begin to cope with these long-term challenges. That to me is 
the simple reality. And it has got to inform our actions here 
and in the larger Congress and in the administration as well.
    Let me just conclude by saying there is a little bit of 
good news in your remarks: that on a unified basis--that is, 
when the trust funds are included--you see before the 
President's budget, before his policy changes, you see slight 
unified surpluses in 2002 and 2003, which is somewhat of a 
change from before. But, again, that is before the President's 
budget proposal.
    When you then put in the policies the President is 
proposing, we are right back to substantial deficits, according 
to your analysis, some $90 billion of deficit in 2002, some 
$121 billion of deficit on a unified basis in 2003. Obviously, 
those are concerns to all of us, and with that I will turn to 
my very able colleague, Senator Domenici, the Senator from New 
Mexico, for his comments, and then we will go to your 
testimony.

             Opening Statement of Senator Pete V. Domenici

    Senator Domenici. Thank you very much, Mr. Chairman.
    I have a prepared statement that I would like to be made 
part of the record, and I just have a few observations.
    Chairman Conrad. Without objection.
    Senator Domenici. Thank you very much.
    First, Mr. Crippen, I want to commend you and your staff 
for the work they have done in helping us and helping the 
American people better understand our budget and have a more 
objective picture of what the fiscal and tax policy of our 
country is.
    Specifically, I want to say thank you to you and them for 
the extra hours that must have been spent to get the work out 
as promptly and as early as you have, and obviously we couldn't 
have proceeded unless you did that. So thank you very much.
    First, I believe what I see in fiscal policy for the next 
10, 12, 15 years is very positive, not negative. I see a fiscal 
policy, depending upon how we proceed beyond the President's 
budget, I see 10 years when things are very good. As a matter 
of fact, I would like to comment on the Social Security Trust 
Fund and the unified budget because I believe you served up 
here when Ronald Reagan was President; you helped Howard Baker 
during the early days of the budget resolution. And, clearly, 
we were on cloud nine when we could talk about a balanced 
budget. The balanced budget was a unified balanced budget. 
Clearly, that was a goal that was deemed to be great fiscal 
policy, and we hardly ever achieved it.
    I asked this morning about the history of the Social 
Security program versus the budget, and I think I am correct 
that since Social Security was initiated, we have only had an 
on-budget surplus eight times. Now, I don't know how many years 
Social Security has been--how long has it been since it 
started? Since 1965.
    Now, the reason I make the point is because everybody got 
their checks; seniors did not have to come up here and lobby 
for us to give them their checks. So there was no surplus of 
the type we are talking about that we in the last 2 or 3 years 
have come up with, that is the off-budget surplus that includes 
Social Security and Medicare.
    So while we have a problem to overcome, one of education, 
one of understanding, one of building confidence with the 
American people, it would appear to this Senator that you bring 
us rather good news with reference to the next few years and 
good news over the long run because of what I have just 
indicated. And I would say that there are three pages that are 
very important in your CBO testimony, three tables. Table No. 
1, everybody should know that the on-budget surplus for the 
current services baseline, meaning before the President's 
requests are added, CBO's baseline shows us in surplus under 
the unified budget all the way across, including this year. 
That is a change from your previous testimony, upward, which is 
very helpful. It moved from what to what for the year 2003? It 
is now $6 billion, a small amount. What was it in your previous 
estimate?
    Mr. Crippen. I think it was--$14 billion, Senator.
    Senator Domenici. All right. And the other one that I think 
everybody should take a look at is the last table, the second 
page of Table No. 11. The reason I think that is an important 
one, Mr. Chairman, I think it is very important to you as you 
attempt to mark up this budget, because this shows what happens 
if we don't have the President's stimulus in the package. And 
that is very interesting. If you don't, you will be in balance 
as far as the President's programs without the stimulus. If 
that is the goal, to be in balance, because we can't get enough 
votes to vote for one that is not in balance either here on the 
floor, I will vote for one that is not in balance if it has the 
other things that are right.
    Then the third one that I think is very important for 
everyone is the first page of Table No. 11. That is the CBO's 
estimate of the President's budgetary proposals. So this says 
where we will be if we adopt the President's plan. And clearly 
we go from balance to non-balance, but it would seem to this 
Senator that with a war, just coming out of a recession, so 
long as we have reason to think we will come out of the 
recession soon--and I think we will. We might already be out of 
it. And so long as we are not going to be in a war for a number 
of years but, rather, a realistic number of months and maybe no 
more than a couple years, clearly spending what must be spent 
leaves the United States with rather good fiscal policy 
nonetheless, and that is compared to what we have had in 
previous history.
    So I am very optimistic as far as the fiscal policy. We 
will not get these $200 and $300 billion surpluses, off-budget 
surpluses for quite some time, but that doesn't mean Social 
Security will be in trouble. It hasn't been in trouble the last 
35 years, and we did not have those kinds of surpluses. In 
fact, we didn't seek them. We talked about tax cuts as soon as 
we had an on-budget surplus that we could look at in order to 
revitalize with tax cuts. So thank you for that, and thank you 
very much, Mr. Chairman.
    [The prepared statement of Senator Domenici follows:]

             OPENING STATEMENT OF SENATOR PETE V. DOMENICI

    Welcome Director Crippen back before the committee this morning.
    Mr. Chairman, this will probably be the last Senate Budget 
Committee hearing before we proceed with out responisibilities to craft 
a budget resolution for the coming year, and Mr. Chairman, I think I 
have a good sense as to just how difficult this will be, having been in 
your shoes a few times over the history of this committee, but that job 
is not made any easier on all of us--by what seems to me to be an 
unusually high level of uncertainty today.
    There is uncertainty about the economy both in the near term and 
over the longer horizon. Is the recession over? Was there ever a 
recession? For some maybe it never was, but for others looking for work 
today--it has never ended. Or maybe the recovery will be weak--or maybe 
events in the world will cause recent growth to falter.
    We are at war against terrorism not just in Afganistan but 
increasing around the world. We continue to experience weakness and 
uncertainties in the largest world economies--in Japan and in Germany.
    No words can adequately describe the torment, uncertainty and 
stress that permeates the Middle East today, and the mood in Latin 
America is down right depressing.
    Then, what must seem so trivial in light of these more global 
concerns, here in this committee we have the complicating uncertainties 
created by an expiring Budget Enforcement Act at the end of this year 
and what that might mean for the future of the budget process and this 
committee.
    Is it any wonder then Dr. Crippen, that the business you are in of 
making projections about the future course of the economy is loaded 
with challenges, trap doors, adn distraught Congressional clients.
    I know that some members in the other chamber have recently 
questioned your position--ignore them--it comes with the turf, but 
before I hear once again how far-off your projections or the 
``Republicans' projections'' were from a year ago, I need to remind 
everyone that unless they somehow are blessed with perfect foresight--
nobody knows today if they were right or wrong. Who knows? The economy 
may surprise all of us, as it did in the 1990's, and your projections 
of a year ago have an equally likely chance of still being right.
    None of us will know until we actually get to 2010 and look back, 
even then we may not know. This is risky business a CBO Director or for 
that matter being the Chairman of a Budget Committee, but even with all 
the risks and uncertainties involved, I still beleive it is necessary 
and essential that the process goes forth. Some anchor, some basis is 
needed to compare and contrast the policy decisions we make here for 
the American public, and that starts for this committee's work this 
year with your testimony this morning.
    I look forward to you pre-policy estimates and your analysis of the 
President's budget Dr. Crippen.

    Chairman Conrad. Thank you. I would just say one thing. In 
my reading of the CBO report on the question of the budget 
excluding the economic stimulus for 2003, we still would have 
deficits, some $43 billion, as I read it, for 2003. So even 
without the stimulus package, according to CBO, with the 
President's spending and tax proposals, we would still have a 
deficit in 2003.
    Senator Domenici. You are right.
    Chairman Conrad. That gives us a challenge here obviously.
    Senator Domenici. Next year.
    Chairman Conrad. Yes.
    Senator Domenici. And thereafter, we are in balance with a 
surplus, which I think is pretty good news.
    He is correct. I change my remarks as to what year it is. 
We are not in balance the year we are writing a budget for 
under the President's, but the next year we are in balance.
    Chairman Conrad. And, you know, this committee has a very 
serious challenge. Let me say one other things about this whole 
question of Social Security. I don't think the past is a good 
indicator for the future because we face this demographic time 
bomb called the baby-boom generation. And what was done before 
doesn't work going forward. It is why I counsel the committee 
and counsel our colleagues, we have got to restrain spending 
and tax cuts if we are to prepare for what is to come.
    It is a very sobering change. You know, in 1950, there were 
16 workers for every retiree. Today, there are 3.3 workers for 
every retiree. We are headed in a circumstance in which there 
will only be two workers for every retiree. That is a dramatic 
and fundamental change, and it means we have got to change. It 
means we have got to do things differently.
    With that, Director Crippen, again, I want to thank you and 
your staff for an extraordinary effort to get these estimates 
to us in a way that is timely for the work of the committee.

   STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET OFFICE

    Mr. Crippen. Mr. Chairman, Senator Domenici, thank you for 
your accolades. As usual, the credit goes to those of my 
colleagues who are sitting behind me and those who were left 
behind. They are the ones who put in the extraordinary hours 
and were able to produce the analysis before you today. I only 
represent them on most occasions, as I do today, but thank you 
very much for your accolades. They have worked very hard to get 
this to you in a timely way.
    Mr. Chairman, Senator Domenici, members of the committee, I 
am pleased to be here today to discuss the President's budget 
for 2003. As it does each year, CBO, with assistance from the 
Joint Committee on Taxation, has estimated the effects of the 
President's budgetary proposals using our own economic and 
technical estimating assumptions.
    In conjunction with this analysis of the President's 
budget, we have updated the baseline projections that we 
published in January. That update incorporates new technical 
assumptions and a slight revision of our economic forecast as 
well. CBO currently projects, as you said, Mr. Chairman, that 
the Federal Government will run a small surplus, $5 billion, 
this year and a surplus of $6 billion next year. Those 
surpluses would total $490 billion over the first 5-year period 
and roughly $2.4 trillion over the 10-year period. That 10-year 
total is $117 billion higher than the figure we published in 
January, as your chart showed earlier.
    The first chart I would like to show today, Mr. Chairman, 
is roughly what the two paths would look like under OMB's 
numbers and ours. We estimate that under the administration's 
proposals, the budget would record a deficit of $121 billion in 
2003 and $51 billion in 2004 but revert to surpluses 
thereafter. Over the first 5-year period, the budget would run 
a cumulative deficit of $33 billion, and over 10 years, it 
would show a cumulative surplus of $681 billion.
    On the spending side of the budget, the President proposes 
to raise discretionary outlays by just under $300 billion above 
our baseline, comprising an increase of $480 billion for 
defense, offset by a reduction of $190 billion in non-defense 
discretionary spending.
    Outlays for mandatory programs would exceed our baseline 
levels by another $440 billion over the 10-year period, mainly 
because of proposals to restructure and expand Medicare, to 
assist people who lack health insurance, to change the funding 
mechanism for military retirees under age 65, and to increase 
spending on agriculture, food, and nutrition programs.
    On the revenue side of the budget, the President proposes 
to reduce receipts by $600 billion over the 10-year period, 
according to estimates by the Joint Committee on Taxation and 
CBO. More than 60 percent of those reductions would occur in 
the last 2 years of the period, largely as a result of 
extending the tax cuts enacted last year, which are scheduled 
to expire, as you know, in 2010.
    The President's budget would lower revenues in 2003 by $73 
billion; $65 billion of that reduction comes from the stimulus 
package, an unspecified proposal to stimulate the economy 
through tax cuts and additional spending.
    Overall, the administration proposes to spend about $2.1 
trillion next year, 19.5 percent of GDP. Total spending would 
rise to $3.1 trillion, or by an additional $1 trillion, by 
2012. But since the economy is expected to grow, the share of 
Federal spending would drop to 17.8 percent. Revenues, on the 
other hand, would continue to grow relative to the economy: 
from 18.4 percent in 2003 to 19.1 percent in 2012.
    With two exceptions, CBO and OMB have remarkably similar 
outlooks and estimates in our baselines. Those two exceptions 
are revenues, particularly in the early years, most notably in 
2003, and Medicare spending over the decade. You will see 
graphs in the testimony that show you both of those items in a 
little more detail, the differences in revenue baselines and 
Medicare baselines between CBO and OMB.
    First, OMB and the Treasury believe taxes on corporate 
profits will be slightly higher in 2003 and 2004 than we do--
$21 billion and $13 billion higher, respectively, for those 2 
years, or roughly 10 percent of corporate revenue in those 2 
years, but only 1 percent of total revenue.
    Second, CBO projects higher Medicare spending over the 
decade, largely because we expect more cases, more recipients 
of home health care and skilled nursing facilities, and more 
expensive patients. Our difference with the actuaries is small, 
amounting to 7 percent of total Medicare spending over the 
decade, and is mostly due to differing assumptions on how well 
the new payment systems for these services will work in holding 
down future costs.
    Mr. Chairman, in light of the economic data released over 
the past 3 months, CBO has modified slightly its economic 
forecast for calendar year 2003, with faster growth of real and 
nominal GDP and higher corporate profits.
    As we have all seen and been encouraged by, the economy 
seems to be rebounding in what could only be called a 
remarkable fashion. When CBO and the administration prepared 
their forecasts in December, most economists thought that the 
economy was headed downward in the fourth quarter of 2001. 
However, the economy has done much better than any of us 
forecast. It grew at an annual rate of 1.4 percent in the 
fourth quarter. In fact, for the first two quarters of this 
fiscal year, we expected combined growth of negative 0.5 
percent. Instead, it looks like growth will be more than 1 
percent over the last quarter and this.
    The surprises in the recent data are further encouraging 
because they involve both consumer and business spending. 
Consumption has remained extremely strong, as we also reported 
in January, contradicting expectations about the effects of the 
weakness of the stock market, job losses, and consumer concerns 
after September 11th.
    The evidence for a rebound in business spending in the 
first quarter of 2002 is more tentative, but it points in the 
same direction. Orders and shipments of capital goods suggest 
an upturn in this sector. News stories about commercial 
construction have been less positive, but after sharp declines 
since March 2001, the January data show an encouraging 
increase. The largest contribution of the business sector and 
the most uncertain, as always, is inventory accumulation. 
Inventories dropped by $120 billion in 1996 dollars in the 
fourth quarter. The rate at which they will be rebuilt remains 
unclear, but even the end of the inventory decline would add 
several percentage points to GDP growth.
    The outlook for growth in coming months, however, is still 
uncertain, as it usually is around turning points in the 
business cycle. Several factors may be adding to the current 
uncertainty. First, the fact that this winter has been 
unusually warm is probably distorting a number of economic 
indicators.
    Second, forecasters who expect relatively strong growth 
most likely anticipate a relatively rapid return to inventory 
building. But that is among the hardest elements of the economy 
to predict.
    Third, other sectors that usually contribute to growth 
during cyclical recoveries, especially autos and housing, are 
unlikely to play the same role this time. It remains unclear to 
what extent the auto sales of the past few months have simply 
borrowed from future sales, and investment in housing has 
remained strong throughout the recession and probably cannot 
contribute much more to growth than it is already doing.
    Finally, Mr. Chairman, I want to highlight the changes in 
the long run that have occurred, as you indicated in your 
chart, between January 2001 and today. The question my chart 
attempts to address is: Can we regain those rosy surpluses or 
large surpluses simply through the change of the economy we 
have seen in the last few weeks? And the answer, certainly, is 
not entirely. What has happened, of course, as we reported in 
January, is that since last December the BEA has reduced its 
estimates of business fixed investment in the national product 
accounts, for several recent years. In addition, plus the 
current, albeit mild, recession has reduced the base of the 
economy upon which we can grow. This chart shows you nominal 
GDP, hich drives nominal Federal revenues, and in this case we 
don't believe we can recover entirely what was lost in the 
base, due to both data revisions and the recession.
    So all that is to say, Mr. Chairman, that this quick 
turnaround and shallow recession will not put us back here next 
January again talking about a 10-year surplus equivalent to 
$5.6 trillion. The turnaround is certainly encouraging, and the 
more the economy grows, the better off we will all be, in the 
long run. But it won't produce the same kind of revenue stream 
that we had hoped it would earlier.
    With that, Mr. Chairman, I am open for questions.
    [The prepared statement of Dr. Crippen follows:]

               The Prepared Statement of Dr. Dan Crippen

    Mr. Chairman, Senator Domenici, and Members of the Committee, I am 
pleased to be here today to discuss the President's budget for 2003. As 
it does each year, the Congressional Budget Office (CBO), with 
assistance from the Joint Committee on Taxation (JCT), has estimated 
the effects of the President's budgetary proposals using its own 
economic and technical estimating assumptions. Several main points 
emerge from that analysis.
  CBO estimates that under the Administration's proposals, the 
    budget would record a deficit of $121 billion in 2003 and $51 
    billion in 2004 but revert to annual surpluses thereafter. Over the 
    five-year period from 2003 through 2007, the budget would run a 
    cumulative deficit of $33 billion; over the 10-year period from 
    2003 through 2012, it would record a cumulative surplus of $681 
    billion (see Table 1 on page 17). The on-budget accounts, which 
    exclude the spending and revenues of Social Security and the Postal 
    Service, would remain in deficit throughout the 10-year period.\1\ 
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    \1\ 1. These estimates are preliminary because JCT has not 
completed its analysis of the Administration's tax proposals. Numbers 
in the text and tables may not add up to totals because of rounding.
---------------------------------------------------------------------------
  In conjunction with its analysis of the President's budget, 
    CBO has updated the baseline projections that it published in 
    January. (Those projections estimate the future path of spending 
    and revenues if current laws and policies do not change.) The 
    update incorporates new technical assumptions and a slight revision 
    of CBO's economic forecast. CBO currently projects that under the 
    assumptions of the baseline, the Federal Government would run a 
    surplus of $5 billion this year and $6 billion next year. Surpluses 
    would total $489 billion over the 2003-2007 period and $2.4 
    trillion over the 2003-2012 period. That 10-year total is $0.1 
    trillion higher than the figure CBO published in January.\2\ 
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    \2\ 2. See Congressional Budget Office, The Budget and Economic 
Outlook: Fiscal Years 2003-2012 (January 2002).
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  Relative to that updated baseline, the President's budget 
    would reduce projected surpluses in each year through 2012, CBO 
    estimates. Over 10 years, those reductions would total $1.7 
    trillion; excluding debt service, 55 percent of the reduction would 
    result from increases in spending and 45 percent from decreases in 
    revenues.
  On the spending side of the budget, the President proposes to 
    raise discretionary outlays by $295 billion above baseline levels 
    between 2003 and 2012--comprising an increase of $483 billion in 
    defense spending offset by a reduction of $188 billion in 
    nondefense spending. Outlays for mandatory programs would exceed 
    baseline levels by another $436 billion over the 10-year period, 
    CBO estimates, mainly because of proposals to restructure and 
    expand Medicare; assist people who lack health insurance; change 
    the funding mechanism for the health benefits of military retirees 
    under age 65; and increase spending on agriculture, food, and 
    nutrition programs. (Those figures exclude the Administration's 
    proposal that Federal agencies pay the full cost of benefits for 
    their employees as such benefits accrue.)
  On the revenue side of the budget, the President proposes to 
    reduce receipts by $602 billion between 2003 and 2012, according to 
    estimates by JCT and CBO. More than 60 percent of those reductions, 
    or $379 billion, would occur in the last two years of the period, 
    largely as a result of extending the tax cuts enacted last year 
    that are scheduled to expire at the end of 2010. The President's 
    budget would lower revenues in 2003 by $73 billion; $65 billion of 
    that reduction comes from the Economic Security Plan, an 
    unspecified proposal to stimulate the economy through tax cuts and 
    additional spending.
  Overall, the Administration proposes to spend about $2.1 
    trillion--or 19.5 percent of the Nation's gross domestic product 
    (GDP)--in 2003 (see Table 2). Total outlays would rise to an 
    estimated $3.1 trillion by 2012, but because the economy is 
    expected to grow faster than spending, Federal outlays as a share 
    of GDP would drop to 17.8 percent. Revenues under the President's 
    budget would increase from 18.4 percent of GDP in 2003 to 19.1 
    percent in 2012, despite the anticipated growth in the economy.
CBO'S ECONOMIC PROJECTIONS
    In the light of economic data released over the past three months--
particularly the Bureau of Economic Analysis's (BEA's) preliminary 
estimates for the fourth quarter of 2001--CBO has modified its economic 
outlook for calendar years 2002 and 2003. Compared with the forecast 
that it published in January, CBO's current forecast anticipates faster 
growth of real and nominal GDP during 2002 and larger corporate profits 
in 2001 through 2003 (see Table 3). Levels of GDP and other major 
economic variables in 2004 through 2012 remain unchanged. However, 
because the projected level of GDP in 2003 is slightly higher, growth 
rates of GDP in 2004 through 2012 are a little different than in the 
previous forecast.
Changes to CBO's Economic Forecast
    The economy is currently rebounding in a remarkable fashion. When 
CBO and the Administration prepared their forecasts in December, most 
economists thought that the economy was headed downward in the fourth 
quarter of 2001, reflecting both the need to correct an excess of 
corporate investment in recent years and the trauma of the September 11 
attacks. However, the economy has done much better than forecast. It 
grew at an annual rate of 1.4 percent in the fourth quarter, according 
to the BEA's recent estimates, and more than made up its losses from 
the brief downturn of the previous quarter. Moreover, although CBO 
(like many forecasters) anticipated a mild upturn in the first or 
second quarter of 2002, recent data suggest that the economy is surging 
ahead. Some forecasters are projecting that growth in the first quarter 
will be as high as 4 percent at an annual rate.
    The surprises in recent data involve both consumer and business 
spending. Consumption has remained extremely strong throughout the past 
six months, contradicting expectations about the effects of weakness in 
the stock market, job losses, and consumers concerns about security 
after September 11. Some of the strength in the fourth quarter was 
attributable to sales incentives for cars, although other consumption 
remained strong. More surprising, consumption spending has been much 
higher than anticipated in the first two months of 2002.
    Evidence of a rebound in business spending in the first quarter of 
2002 is more tentative, but it points in the same direction. Orders and 
shipments of capital goods suggest some upturn in that sector. News 
stories about commercial construction have been less positive, but 
after sharp declines since March 2001, the January data for industrial, 
commercial, and other nonresidential construction showed an encouraging 
increase. The largest contribution of the business sector--and the most 
uncertain--is inventory accumulation. Inventories dropped by $120 
billion (in 1996 dollars) in the fourth quarter; the rate at which they 
will be rebuilt remains very unclear, but even the end of the inventory 
decline could add several percentage points to GDP growth (at an annual 
rate) in the first quarter.
    The economy's greater-than-anticipated output in recent months 
appears to reflect unexpected productivity growth, since recent 
measures of hours worked and employment are still broadly in line with 
the previous forecast. The income generated through that higher 
productivity seems likely to accrue to owners of capital. Consequently, 
CBO has raised its projections of corporate profits through the end of 
2003. Although anecdotal evidence suggests that companies are reporting 
weak profits in their financial reports, such evidence is hard to 
interpret, and profit reports may be temporarily distorted by changes 
in accounting practices.
    On the basis of recent data, CBO has raised its estimate of real 
growth in GDP to 1.7 percent for calendar year 2002. Its forecast of 
corporate profits is now 16 percent higher than in January. CBO's 
revised outlook is similar to that in the February Blue Chip survey of 
some 50 economic forecasters (see Table 4). Forecasts are changing 
rapidly, and it is likely that the March Blue Chip survey, which will 
be published in a few days, will reflect an even more robust view of 
the near term.
    The outlook for growth in coming months, however, is extremely 
uncertain, as it usually is around turning points in the business 
cycle. Several factors may be adding to the current uncertainty. First, 
the fact that this winter has been unusually warm is probably 
distorting a number of economic indicators. Second, forecasters who 
expect relatively strong growth most likely anticipate a relatively 
rapid return to inventory building, but that is among the hardest 
elements of the economy to predict. Third, other sectors that usually 
contribute to growth during cyclical recoveries--especially autos and 
housing--are unlikely to play the same role this time. It remains 
unclear to what extent the auto sales of the past few months have 
simply borrowed from future sales. Moreover, investment in housing 
remained strong throughout the recession and probably cannot contribute 
much more to growth than it is already doing.
Comparison with the Administration's Assumptions
    CBO's and the Administration's economic assumptions are fairly 
similar in their implications for budget projections. For 2002, the 
Administration's forecast of GDP growth is lower than CBO's, though the 
difference is made up in 2003 and subsequent years. Beyond 2002, the 
Administration assumes slightly lower inflation, as measured by the GDP 
price index, so its projection of nominal GDP remains below CBO's 
throughout the projection period (see Table 4). However, the 
Administration assumes that the major tax bases--wages and salaries, 
and corporate profits--will constitute a larger share of GDP than CBO 
does, and as a result, its projections of those tax bases are slightly 
above CBO's for much of the projection period. In addition to lower 
inflation, the Administration expects substantially lower interest 
rates and a lower unemployment rate than CBO does. All of those factors 
contribute to making the Administration's projections of outlays lower 
than CBO's over the 2003-2012 period.
CBO'S AND THE ADMINISTRATION'S BASELINE ESTIMATES
    In general, both CBO's and the Administration's baselines are 
calculated according to statutory rules and guidelines in the 1985 
Balanced Budget and Emergency Deficit Control Act and the 1974 
Congressional Budget and Impoundment Control Act. The baseline serves 
as a policy-neutral benchmark that lawmakers can use to gauge the 
effects of new spending or revenue proposals, such as those in the 
President's 2003 budget.
Revisions to CBO's Baseline
    In preparing its annual analysis of the President's budgetary 
proposals, CBO typically updates its baseline projections to take into 
account new information from the budget and other sources. CBO's 
current outlook for the budget is slightly more favorable than the one 
it published in January. In the absence of additional tax or spending 
legislation, the budget would show small surpluses in 2002 and 2003 ($5 
billion and $6 billion, respectively) instead of the modest deficits 
projected previously (see Table 5). Under that assumption, the surplus 
would total $489 billion over five years, CBO estimates, and $2.4 
trillion over 10 years, up from the previous projections of $437 
billion and $2.3 trillion, respectively.
    CBO has increased its baseline projections of revenues by $23 
billion for 2002 and $15 billion for 2003 because of its upward 
reestimates for GDP and corporate profits in the near term (see Table 
6). For years after 2003, increases to baseline revenue projections are 
relatively small, averaging just over a billion dollars per year. Most 
of the increases stem from receipts of the Universal Service Fund, 
which would be offset by added spending of similar amounts.
    Among the few pieces of legislation enacted since the January 
baseline is Public Law 107-139, which amends the Higher Education Act 
of 1965 to establish fixed interest rates for student and parent 
borrowers and extends certain special allowances for lenders that would 
have expired for loans issued after June 2003. CBO estimates that the 
extension of the yield guarantee for private lenders and changes in 
interest rates charged for direct loans--as well as an increase in the 
volume of borrowers--will increase outlays by $9.5 billion over the 
2003-2012 period.
    Reductions in projected Medicare spending account for most of the 
changes to CBO's baseline since January. A variety of technical factors 
caused CBO to lower its projections of Medicare outlays over 10 years 
by nearly $80 billion:

  About $30 billion of the reduction stems from an analysis of 
    newly published information on the rates to be paid to 
    Medicare+Choice plans (health maintenance organization plans under 
    Medicare) in 2003 and later years.
  About $35 billion of the decrease reflects the 
    Administration's announcement of an effective date for a final rule 
    concerning ``pass-through'' payments for hospital outpatient 
    services and an analysis of new data on the cost of ``buying down'' 
    (contributing more to) coinsurance paid by beneficiaries for 
    hospital outpatient services.
  Another $15 billion of the reduction reflects an updated 
    analysis of the effect on spending of the changing age distribution 
    of the Medicare population, an improved method of constructing 
    price indexes for projecting updates to Medicare's payment rates, 
    and the effects of revised projections of outlays on premiums paid 
    by beneficiaries.

    Conversely, CBO increased its baseline projections of Medicaid 
spending for the 2003-2012 period by $21 billion. Much of that increase 
resulted from higher projections of enrollment and new waivers 
permitting Medicaid programs to offer prescription drug benefits to 
low-income Medicare beneficiaries. CBO also incorporated the savings 
generated by a recent regulation that limits the amount by which 
Medicaid's payments to hospitals may exceed payments based on 
Medicare's rules (the so-called upper payment limit).
Differences from the Administration's Current-Services Baseline
    Both CBO and the Administration estimate that the budget will 
essentially be in
    balance this year under current laws and policies (see Table 7). 
CBO now projects a small surplus ($5 billion), and the Administration 
anticipates a small deficit ($9 billion). The difference between those 
figures mainly arises because CBO is forecasting lower short-term 
interest rates and projecting lower payments for Social Security 
benefits and the refundable portions of the earned income and child tax 
credits. Furthermore, CBO's estimate includes recoveries of 
overpayments in the Supplemental Security Income (SSI) program to 
reflect greater participation by SSI beneficiaries in Social Security's 
Disability Insurance (DI) program.\3\ 
---------------------------------------------------------------------------
    \3\ 3. The Social Security Administration has determined that 
roughly 200,000 disabled SSJ recipients should have
---------------------------------------------------------------------------
    been receiving DI benefits. Those individuals gained insured status 
for DI as a result of wages earned after becoming entitled to SSI 
benefits. Consequently, the Social Security Administration will pay 
those beneficiaries retroactive benefits under DI, but a large portion 
of the payments will be recaptured by the government as recoveries of 
overpayments in the SSI program. The President's budget does not 
include those recoveries, which CBO estimates would total about $2.4 
billion in 2002 and $1.3 billion in 2003.
    In both baselines, surpluses grow after this year, albeit at a 
slower pace in CBO's projections. For 2003, CBO's projects a baseline 
surplus of $6 billion--about the same level as it estimates for this 
year--whereas the Administration, anticipating higher revenues, 
projects a baseline surplus of $41 billion. For the next five years, 
CBO's cumulative baseline surplus ($489 billion) is $180 billion 
smaller than the Administration's ($669 billion). That gap widens for 
the 2003-2012 period: CBO's projected cumulative surplus (nearly $2.4 
trillion) is $305 billion less than the Administration's (almost $2.7 
trillion).
    Revenue Differences. CBO's baseline projection of revenues over the 
next 10 years is nearly identical to that of the Administration--lower 
by only $15 billion, or less than 0.1 percent. In some years, however, 
the projections differ noticeably. For 2003, CBO's revenue projection 
is $35 billion lower than the Administration's, and for both 2004 and 
2005, it is about $25 billion lower.
    Different expectations for corporate income tax receipts account 
for the lion's share of those differences. CBO projects a lower average 
tax rate on corporate profits, especially in 2003 and 2004. The 
Administration assumes that certain factors pushed down corporate tax 
liabilities in tax year 2001 and that those factors will continue to 
affect receipts to some degree in 2002 because of lags in payments and 
the difference between the tax year and the fiscal year. However, the 
Administration does not expect those factors to persist in their 
effects on receipts beyond 2002. The assumption that those factors will 
be temporary pushes up the Administration's projected average tax rate 
on corporate profits beyond 2002. CBO does not feel it has sufficient 
information to identify any temporary factors (except those related to 
the economic forecast) that affect the projected average tax rate on 
profits.
    For 2006 through 2010, CBO's and the Administration's projections 
of revenues are similar. After that, the picture changes. CBO projects 
larger receipts in 2011 and 2012 than the Administration does, partly 
because it makes different assumptions about what will happen when last 
June's tax cuts expire at the end of 2010 and partly because its 
projection of income is higher than the Administration's for those 
years.
    Outlay Differences. On the spending side, CBO's baseline estimate 
of outlays over 10 years exceeds the Administration's by $291 billion, 
or about 1 percent. That difference reflects higher projections of 
mandatory outlays (by $138 billion), discretionary outlays (by $90 
billion), and net interest costs (by $62 billion).
    The main difference between CBO and the Administration in 
projecting mandatory outlays involves Medicare spending. For 2003 
through 2007, CBO's baseline projections for Medicare exceed the 
Administration's by $55 billion (about 4 percent). Over the 2003-2012 
period, that difference broadens to about $226 billion (7 percent).
    CBO's higher Medicare estimates stem from its different economic 
projections and technical assumptions. About $40 billion of the 10-year 
difference is attributable to economic projections and arises because 
CBO projects that updates to Medicare payment rates, which reflect 
changes in prices, will be 0.1 or 0.2 percentage points higher than the 
Administration projects. Another $10 billion to $20 billion of the 10-
year difference stems from possible administrative actions that the 
Administration's baseline assumes but that CBO's does not. The 
remaining difference, $175 billion over 10 years, reflects different 
technical assumptions about participation in Medicare+Choice plans and 
about spending for services provided in the fee-for-service sector.\4\ 
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    \4\ 4. See statement of Dan L. Crippen, Director, Congressional 
Budget Office, Projections of Medicare Spending Under Current Law, 
before the House Committee on the Budget, February 28, 2002.
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    The biggest discrepancies between CBO's and the Administration's 
estimates of increases in spending in the fee-for-service sector 
involve skilled nursing services, hospital outpatient services, and 
home health services. The payment systems for all three types of 
services have been altered substantially in the past few years, and the 
extent to which the volume and mix of services will change under the 
new systems is uncertain. Both CBO and the Administration assume that 
increases in the volume and mix of those services will contribute less 
to growth in spending under current law than they did under the payment 
systems that existed before the Balanced Budget Act of 1997. In 
general, however, CBO assumes less of a reduction from those earlier 
rates of growth than the Administration does. For home health services, 
however, the Administration seems to assume more rapid increases in the 
volume and mix of services through 2005 or 2006 and a more rapid 
decline in the rate of growth of those factors in later years.
    CBO's baseline projections for some other mandatory spending 
programs are lower than the Administration's. For example, Medicaid 
spending in CBO' s baseline is about $42 billion lower over the 2003-
2012 period than the Administration estimates, mainly because CBO 
anticipates lower enrollment rates for the program. CBO's 10-year 
projections are also lower for Civil Service retirement benefits (by 
about $25 billion) and for the refundable portions of the earned income 
tax credit (by $41 billion) and the child care tax credit (by $21 
billion).
    For discretionary outlays, CBO's baseline exceeds the 
Administration's for two principal reasons. First, the inflation rate 
that CBO uses to project discretionary budget authority in future years 
is slightly higher the Administration's. Second, the spending rates 
that CBO assumes for defense appropriation accounts are also generally 
higher than those used by the Administration. However, for fiscal years 
2002 through 2004, CBO estimates that nondefense discretionary outlays 
will be slightly lower than the Administration expects because CBO 
anticipates that many nondefense agencies will spend balances of prior-
year obligations more slowly than the Administration assumes.
    CBO's estimates of net interest are lower than the Administration's 
for 2002 and 2003 and higher thereafter. CBO's lower estimates in the 
near term are largely driven by technical factors, such as differences 
in assumptions about the mix of securities issued by the Treasury. 
Starting in 2004, however, those technical factors are offset by 
economic factors, as CBO's projections of interest rates rise 
significantly above the Administration's, resulting in higher net 
interest estimates for the remainder of the projection period.
THE PRESIDENT'S BUDGETARY POLICIES
    Overall, CBO's and the Administration's estimates of the 
President's budget are similar. Under both sets of estimates, deficits 
end after 2004 and give way to growing surpluses (see Table 8). 
However, within that broadly similar pattern, some differences exist. 
For most years after 2002, CBO estimates that deficits will be larger, 
and surpluses smaller, than the Administration does by $30 billion to 
$40 billion.
    CBO estimates that deficits under the President's budget would peak 
in 2003 (at $121 billion) before beginning to fall. The Administration 
estimates that deficits would reach their high this year (at $106 
billion) and begin declining in 2003. For the 2003-2007 period, CBO 
projects a total deficit of $33 billion under the President's budget; 
the Administration estimates a total surplus of $157 billion. For the 
2003-2012 period, both CBO and the Administration estimate that the 
President's budgetary policies would produce cumulative surpluses--$681 
billion in CBO's estimates and $1,002 billion in the Administration's. 
In both sets of estimates, the bulk of those surpluses accumulates in 
the later years of the projection period.
Policy Proposals Affecting Discretionary Spending
    The President's budget would boost new discretionary budget 
authority for 2003 to $759 billion, CBO estimates, 6.9 percent more 
than the $710 billion enacted thus far for 2002 (see Tables 9 and 
10).\5\  That increase would be similar to the 7.2 percent jump in 
discretionary budget authority that occurred between 2001 and 2002.
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    \5\ 5. All amounts discussed in this section exclude the 
Administration's proposal that Federal agencies pay the full share of 
accruing civilian employees' pensions and annuitants' health benefits. 
That proposal is discussed below.
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    The increase in discretionary budget authority proposed for 2003 
would also approach the annual rate of growth experienced during the 
1998-2002 period, which averaged 7.6 percent. However, it would be 
significantly higher than the average growth rate from 1994 through 
1998: 0.8 percent. For the 2003-2012 period, the President proposes to 
hold the growth rate of discretionary budget authority to 2.8 percent. 
In CBO's baseline, which assumes that discretionary spending grows at 
the rate of inflation, budget authority rises at an average annual rate 
of 2.6 percent.
    Discretionary outlays will total $731 billion this year, CBO 
anticipates, if no further legislation is enacted that affects 2002. 
Under the President's budget, discretionary outlays would rise to $784 
billion next year.
    National Defense. The largest proposed increase for 2003 is for 
defense. The President's budget would add $45 billion in discretionary 
budget authority for defense programs, or 13 percent--the fastest 
growth since the defense buildup of the early 1980s. It would bring 
defense outlays up to 3.5 percent of GDP in 2003, the highest level 
since 1995. (During the 1980s, defense spending averaged close to 6 
percent of GDP.) Included in that request is $10 billion designated as 
a ``wartime contingency'' for combating terrorism in Afghanistan or 
other, as-yet-unspecified, locations; that amount is not requested for 
later years. After 2003, the President's budget envisions much slower 
growth of budget authority for defense--an average annual rate of 3.2 
percent through 2012.
    Nondefense Programs. The President is proposing a much smaller 
increase--about 1 percent--in appropriations for nondefense activities 
in 2003. Excluding funds for homeland security (as classified by the 
Administration), such spending would decline by approximately 1 percent 
under the President's budget. To accomplish that, the President 
proposes reductions in programs related to community and regional 
development, the administration of justice, natural resources and the 
environment, agriculture, and commerce. Appropriations for other budget 
functions, such as energy and general government, would not keep pace 
with inflation.
    The President recommends increasing discretionary spending for some 
budget functions in 2003. For example, budget authority for veterans 
benefits and services would grow by about 7 percent, with most of that 
going for medical care. Budget authority for transportation programs 
would rise by about 8 percent, primarily for the Coast Guard and the 
new Transportation Security Administration.
    The total budgetary resources available for transportation 
programs, however, would decline under the President's budget. 
Obligation limitations, which are not counted as budget authority, 
control the majority of transportation spending. Consistent with the 
current authorizing law, those limitations would decline by 21 percent 
in 2003 in the President's budget (the first decrease since the mid-
1990s).\6\  The President proposes to curb transportation spending to 
the point that by 2012, obligation limitations would be lower, in 
nominal terms, than the level enacted for 2002.
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    \6\ 6. The current surface transportation authorizing law, known as 
TEA-21, specifies that adjustments to obligation limitations for 
highway spending should be made to reflect changes in the estimates of 
highway tax revenues. (The law resulted in a large increase in such 
spending authority for 2002 but calls for a large decrease in 2003.)
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    Homeland Security. Since September 11, the President and the 
Congress have provided additional budgetary resources for homeland 
security. The Administration estimates that nearly $27 billion in 
discretionary budget authority will be devoted to homeland security in 
2002--$18 billion from the 13 regular appropriation acts and another $8 
billion from the Department of Defense and Emergency Supplemental 
Appropriations for Recovery from and Response to Terrorist Attacks on 
the United States Act, 2002 (P.L. 107-117).\7\ 
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    \7\ 7. For 2002, the Administration also estimates mandatory 
spending for homeland security at $1 billion (for total budget 
authority of $28 billion, including discretionary appropriations); in 
the President's budget, such mandatory spending increases to $2 billion 
for 2003 (for a total of $38 billion). Some of the spending for 
homeland security is offset by fees, which amount to $3 billion in 2002 
and $5 billion in 2003.
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    For 2003, the President proposes $36 billion in discretionary 
budget authority for homeland security, $10 billion of which would go 
to defense agencies. Among nondefense departments and agencies, the 
President's budget proposes funding for homeland security of almost $8 
billion for the Department of Transportation, more than $7 billion for 
the Department of Justice, more than $4 billion for the Department of 
Health and Human Services, and $3.5 billion for the Federal Emergency 
Management Agency.
    Funding for homeland security is spread among roughly 40 budget 
subfunctions and at least 100 appropriation accounts. Because most of 
that spending is included within larger accounts, it is difficult to 
reestimate or project the effects of increased homeland security 
funding in the absence of more detailed information from the 
Administration.
    Accrual Accounting for Federal Employees' Benefits. Another request 
in the President's budget that would affect discretionary spending is 
the proposal that Federal agencies pay the full cost of their 
employees' retirement and retiree health benefits as such benefits 
accrue. Currently, the government's costs of retirement benefits for 
military personnel and for civilian employees covered by the Federal 
Employees Retirement System are financed through accrual charges paid 
from the appropriations of the employing agency. However, the costs of 
other retirement programs are covered through a combination of agency 
payments and appropriations. Similarly, although next year the military 
will begin paying the full accrual costs of its health benefits for 
future retirees age 65 or older, civilian annuitants health benefits 
are financed through mandatory spending.
    This proposal would not change the promised benefits to retirees or 
the contributions made by employees and annuitants, so it would not 
have any net effect on the budget. However, it would raise 
discretionary spending by roughly $9 billion in 2003, with an equal 
amount of offsetting receipts recorded on the mandatory side of the 
budget, if agency appropriations are increased to accommodate the new 
accrual charges.
Policy Proposals Affecting Mandatory Spending
    The President's proposals would add $436 billion to mandatory 
spending over the 2003-2012 period, CBO estimates (excluding the 
proposal that Federal agencies pay the full cost of their employees 
benefits as such benefits accrue). Policy initiatives involving 
Medicare, refundable tax credits, and agriculture account for about 69 
percent of that increase (see Table 11).
    Medicare. The President's budget includes several major proposals 
that would increase outlays for Medicare by nearly $170 billion over 10 
years. The bulk of that spending comes from a Medicare modernization 
initiative intended to restructure aspects ofthe program and provide 
coverage of outpatient prescription drugs beginning in 2006. The 
Administration estimates that the initiative would cost a total of $116 
billion through 2012; however, the budget does not provide enough 
details of the proposal for CBO to make its own estimate.
    Another proposal involves allowing states to provide prescription 
drug benefits to qualifying Medicare beneficiaries through their 
Medicaid programs. The Federal portion of Medicaid would reimburse the 
States for the cost of the program, and Medicare would reimburse 
Medicaid. CBO estimates that the benefit would cost $57 billion between 
2003 and 2012.\8\  The Administration has also proposed boosting 
payments to Medicare+Choice plans and encouraging participation by 
alternative managed care arrangements. Those proposals would cost $3 
billion over the 2003-2012 period, CBO estimates.
---------------------------------------------------------------------------
    \8\ 8. Because the budget and other information from the 
Administration provide only the broad outlines of the proposal, CBO's 
estimate is necessarily preliminary and may change depending on how 
important details are clarified.
---------------------------------------------------------------------------
    The President's budget also contains several proposals that would 
reduce Medicare spending during the next 10 years. They include 
creating a nationwide competitive-bidding system that would encourage 
companies to sell durable medical equipment at lower prices than 
Medicare currently pays, adding two high-deductible supplemental 
insurance (medigap) plans to provide a catastrophic coverage option for 
Medicare beneficiaries, and requiring that insurers and group health 
plans periodically report to Medicare those beneficiaries for whom 
Medicare could be the secondary payer. In total, those initiatives 
would save about $7 billion over the 2003-2012 period, CBO estimates.
    Other Health-Related Proposals. Under the President's budget, a new 
refundable tax credit for the purchase of health insurance would be 
available to certain people under age 65 who are not covered by their 
employer or a public program. The credit would subsidize part of their 
health insurance premiums, up to a specified ceiling. The 
Administration estimates that the credit would result in $60 billion in 
outlays (and a reduction of $29 billion in revenues) from 2003 through 
2012. JCT has not completed its analysis of the proposal, so the budget 
projections in this testimony include the Administration's estimate.
    The President has also proposed shifting the costs associated with 
providing health care for uniformed retirees and their dependents under 
age 65 to the same trust fund that covers health care costs for 
retirees 65 and older. Currently, those costs are paid from annual 
appropriations, which are discretionary. The net effect of this 
proposal on total outlays would be minimal.
    Other Initiatives. The Administration's budget would increase 
spending for agriculture, food, and nutrition programs by $72 billion 
over the next decade. However, with the exception of proposals that 
affect the Food Stamp program, the budget offers little detail of the 
proposed changes. As a result, CBO used the Administration's estimates 
for all but the Food Stamp portion of those changes.
    The President's budget also includes an economic stimulus plan that 
the Administration says would boost outlays by $27 billion in 2002 and 
$9.5 billion in the following two years. In addition, the plan would 
decrease revenues through the middle of the decade and produce 
increases thereafter. Again, CBO and JCT did not have enough specific 
information about the plan to produce an independent estimate of its 
effects on outlays and revenues.
    The President has proposed restructuring unemployment compensation 
so that States would be responsible for their administrative costs. 
Currently, the Congress appropriates money from the unemployment 
insurance trust fund to cover those costs, which are recorded on the 
discretionary side of the budget. Under this proposal, States would pay 
those costs directly from their State benefit accounts in the Federal 
unemployment trust fund and would be responsible for generating enough 
revenues from State unemployment taxes to cover those costs. The income 
and outlays related to the proposal would appear in the Federal budget. 
CBO estimates that the change would increase mandatory outlays by $19 
billion over the next 10 years and reduce discretionary spending by a 
corresponding amount below what it otherwise would be. (The policy 
would also reduce revenues.) In addition, the President has proposed 
making it easier for States to extend unemployment benefits during an 
economic downturn, which would cost $0.3 billion over the 2003-2012 
period, CBO estimates.
    A proposal that would not substantially increase outlays above 
baseline levels but is nevertheless significant budgetarily is the 
extension of the Temporary Assistance for Needy Families (TANF) 
program. As it must by law, CBO's baseline assumes that TANF will 
continue when its authorization expires at the end of this year. The 
President's budget explicitly requests reauthorization of the program, 
with funding at $16.5 billion per year. In addition, the budget 
proposes changes to TANF--including reauthorizing two elements of the 
program that expired in 2001--that would add about $350 million in new 
spending each year.
Policy Proposals Affecting Revenues
    The President proposes a number of changes to tax law that would 
reduce revenues. Those changes involve extensions of certain tax cuts 
that are scheduled to expire within the next 10 years as well as new 
revenue-reducing provisions. CBO and JCT estimate that the proposals 
would lower revenues by a total of $602 billion over the 2003-2012 
period and increase outlays by $80 billion (by increasing refundable 
tax credits). Over 60 percent of the reduction in revenues would occur 
in the last two years, 2011 and 2012, largely from the proposed 
extension of the tax cuts enacted last year that are now scheduled to 
expire at the end of 2010.
    The President's proposal to provide economic stimulus through 
unspecified policies would decrease revenues by $62 billion in 2002 and 
$65 billion in 2003, according to the Administration. (As noted 
earlier, CBO and JCT were unable to independently estimate that 
proposal because no detail was provided in the budget.) Over the 10-
year period, the proposal is assumed to lead to a net reduction in 
revenues of $44 billion.
    The President has also proposed providing a refundable tax credit 
for certain health insurance premiums; permanently extending the 
research and experimentation credit, which is set to expire in 2004; 
allowing taxpayers who do not itemize their deductions to deduct a 
certain amount of charitable contributions from their taxable income; 
and providing an enhanced deduction for some long-term care insurance 
(see Table 11). Other proposals that would reduce revenues include 
providing a tax credit for developers of affordable single-family 
housing, altering the way in which the unemployment insurance program 
is financed, and allowing unused amounts in flexible spending 
arrangements for health care to be carried forward in some 
circumstances.
Differences Between CBO's and the Administration's Estimates of Policy 
        Proposals
    For the President's revenue proposals, CBO's and the 
Administration's estimates are quite similar. CBO estimates that those 
proposals would lower revenues by $602 billion over the 2003-2012 
period--only $11 billion more than the Administration projects. The 
difference in estimates does not exceed $2 billion for any year except 
2011. For that year, the estimates differ by $7 billion, an 
insignificant amount given the large changes in tax law and taxpayers 
behavior that are expected to result from extending the tax-cut 
provisions that expire at the end of 2010.
    On the outlay side, there are also few major differences between 
CBO and the Administration. In the case of some of the President's new 
policies for mandatory spending--such as proposals for economic 
stimulus, modernization of Medicare, refundable tax credits for health 
insurance, and farm programs--the budget lacks sufficient information 
for CBO to estimate their costs. In such cases, CBO used the 
Administration's estimates.
    When proposals for savings lacked enough specificity for an 
independent estimate, CBO did not include their potential budgetary 
impact, although it did so for proposals that involve new spending. The 
President's budget includes savings of $18 billion over the 2003-2012 
period from a proposal that would change the measure of drug prices 
used to calculate the rebate that durg manufactures pay under Medicaid. 
However, the proposal is unclear about how it would treat generic drugs 
and how it would change the portion of the rebate program that holds 
the growth of prices for brand-name drugs to the rate of inflation. 
Without such details, CBO had insufficient basis for estimating savings 
from the proposal.
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    Chairman Conrad. Thank you, Director Crippen.
    My first question to you is: You are showing surpluses of 
$5 billion for 2002 and $6 billion for 2003, but that does not 
include the President's budget proposals for those years, does 
it?
    Mr. Crippen. It does not.
    Chairman Conrad. That does not. What would be the result if 
the President's proposals are adopted for 2002 and 2003?
    Mr. Crippen. We estimate, Mr. Chairman, that the combined 
unified budget would show deficits of $90 billion and $121 
billion, respectively, for those 2 years.
    Chairman Conrad. So for 2002, if the President's policies 
are adopted, it would be a $90 billion deficit, and for 2003, 
if the President's policies were adopted, according to your 
best estimates, $121 billion deficit.
    Mr. Crippen. Yes.
    Chairman Conrad. But that includes Social Security in the 
calculation, does it not?
    Mr. Crippen. Yes, that is the combined unified deficit that 
we are talking about.
    Chairman Conrad. What if the Social Security surpluses were 
excluded? What then would be your conclusions for 2002 and 
2003? I believe it is on page 18.
    Mr. Crippen. Is it? OK. Thank you. [Laughter.]
    Mr. Crippen. If I have page 18.
    For 2002 and 2003, if my colleagues can check my arithmetic 
here--you probably have the numbers as well, Mr. Chairman--it 
looks like $248 billion and $297 billion of on-budget deficits, 
respectively, for those 2 years.
    Chairman Conrad. So if we would do what the President--if 
we would follow the course the President has pledged to follow 
and virtually every Member of Congress has pledged to do and 
exclude Social Security from the deficit calculator, the 
deficits, which would be large under the President's plan in 
any case, would even be substantially larger, $248 billion in 
2002, $297 billion in 2003.
    Let me turn just quickly to the Medicare difference, 
because that is where we see, as you have testified, still a 
significant difference between the President's estimates and 
yours with respect to the costs of Medicare over the forecast 
period.
    As I read your analysis, you are telling us that you 
believe Medicare will cost some roughly $200 billion more over 
the period than the President's estimates. Can you tell us the 
reason for that size of difference?
    Mr. Crippen. The difference is $225 billion, as I recall, 
over the 10 years. Much of that is due to how we think non-
hospital ancillary services home health care, skilled nursing 
facilities, and outpatient treatments will be utilized, in 
terms of both the number of people who avail themselves of 
those services and the intensity or case mix. We expect more 
expensive cases, if you will, than the HCFA actuaries believe.
    I should say we have had extensive discussions with the 
actuaries. They are obviously as convinced as we are that they 
are about in the right ballpark--again, not altogether 
different from ours. But I would say that we are likely in many 
areas, but certainly this one, to both be wrong. There are new 
payment systems going into effect for many of these services, 
where you have gone from other kinds of restraints--length of 
stays, numbers of days, all of those things--to more of a 
package payment or a lump-sum payment. And so neither of us is 
all that certain how this is going to work.
    One of the things that the actuaries have assumed that we 
haven't is that there is a fair amount of discretion to the 
Secretary of HHS to make some adjustments in these payments as 
he or she sees fit in the future. They have assumed that that 
authority would be used if our numbers were more like the 
reality that they face come mid-decade, and so there is some 
assumption about secretarial authority being utilized to lower 
payments as well. But largely it is a difference in views of 
how many people will be using the services and at what level of 
intensity.
    Chairman Conrad. OK. I thank you for that. It is very 
important that we understand the differences here.
    On economic growth, can you tell us what economic growth 
you are projecting for the current year and next year?
    Mr. Crippen. I have anticipated all of your questions.
    On a year-over-year basis, we forecast 1.7 percent for 2002 
and 3.4 percent for 2003.
    Chairman Conrad. Could you break down the 2002 number for 
us a little more? The 1.7 percent would be the growth for all 
of 2002. Could you tell us what you anticipate growth to be for 
third and fourth quarter?
    Mr. Crippen. Let's see. I have the projection for the third 
quarter at 3.3 percent on an annual basis and for the fourth 
quarter at 3.3 on an annual basis.
    Chairman Conrad. So fairly health economic growth the 
second half of this year.
    Mr. Crippen. Correct.
    Chairman Conrad. And continuing into next year?
    Mr. Crippen. Yes----
    Chairman Conrad. Strong economic growth.
    Mr. Crippen. Yes, increasing to 3.4 percent in the first 
quarter of the next calendar year and growing to 3.6 percent by 
the fourth quarter.
    Chairman Conrad. Does that include any provision for a 
stimulus package?
    Mr. Crippen. I believe it does not, because these are our 
baseline economics, and so they do not assume any of the 
President's policies.
    Chairman Conrad. So you are forecasting a return by third 
and fourth quarter of this year to strong economic growth 
without any stimulus package?
    Mr. Crippen. That is correct.
    Chairman Conrad. A final question from me. In 2003, what 
are the differences in revenues between you and the 
administration? How big is that difference?
    Mr. Crippen. I am going to rely on my colleagues to give it 
to me. It is about a $50 billion difference.
    Chairman Conrad. Fifty billion?
    Mr. Crippen. In 2003, it is $35 billion; in 2004, $25 
billion.
    Chairman Conrad. So you are projecting in 2002 $35 billion 
less in revenue than the administration?
    Mr. Crippen. In 2002, it is only $5 billon, but in 2003 it 
is $35 billion.
    Chairman Conrad. In 2003, it is $35 billion. Could you tell 
us what accounts for most of that difference?
    Mr. Crippen. The biggest single item is corporate tax 
receipts. Our baseline has taxable profits much lower--close to 
$100 billion lower--than the administration's. CBO's projection 
of corporate book profits for 2003 is $45 billion lower than 
the Adminstration's. Or, to think of it another way, we assume 
a lower effective tax rate on corporate profits than the 
administration to the tune of about $20 billion. So about two-
thirds of it is corporate. The single other largest difference 
is $8 billion or so in individual income tax receipts. There 
the question is roughly how many taxpayers will be in the 
upper-income brackets. We assume fewer such taxpayers in our 
models and our forecasts than the administration does. But, 
again, these numbers, while of course important as you work 
your way around zero of balance or deficit, certainly are very 
small over the 10 years. We are closer to the administration 
than we may have ever been, as you can see from the fourth 
graph that is included in your package in front of you. And 
even these numbers, while unusually large in the end years, are 
still small relative to the $2-plus trillion of revenue we are 
going to be collecting. So it is the equivalent of $35 out of, 
say, $2,000.
    Chairman Conrad. So, in conclusion, your estimates for 
2003, the first year of the budget resolution we would be 
writing, is that there would be a $6 billion surplus without 
the President's budget proposals being adopted; if they are 
adopted, if we would accept the President's spending and 
revenue proposals, we would face a budget deficit of $121 
billion in 2003. Is that correct?
    Mr. Crippen. Correct.
    Chairman Conrad. Senator Domenici?
    Senator Domenici. If one of my Senators on this side 
desired to proceed, I would rather yield to somebody. I will 
come back later. Go ahead. One of you should take it because I 
am not--please.
    Senator Hagel. Dr. Crippen, thank you, as always. As we 
have listened to your testimony and viewed your numbers 
represented on the charts, going back into the last couple of 
years, fiscal year 2000 we had a considerable surplus, as you 
know, and I think that represented about 2.5 percent of the 
GDP. My bigger question is, as you have testified this morning, 
it appears that we are going to come out of fiscal year 2002 
and go into fiscal year 2003 roughly at a balanced budget 
point, and that is at the same time we are fighting a war at 
considerable expense, somewhere coming out of a recession or in 
a recession, and we will know more as the numbers develop.
    Historically, when we have been at times of recession and 
certainly when we have had a war with that combination, has the 
Federal budget been in balance?
    Mr. Crippen. Certainly during and since World War II, 
Korea, and Vietnam, we have had periods where we have increased 
the public debt and the budget has not been in balance. It has 
been in deficit during those times.
    Senator Hagel. Why do you think this situation, as it 
appears is going to be, is different?
    Mr. Crippen. Well, for one thing, of course, we don't know 
yet the costs of conducting of the war we are in. These numbers 
before you don't anticipate any more supplemental spending or 
other things we are told are likely to occur. The 
administration may ask you for some additional defense 
spending, and, of course, we don't know about the future 
conduct of the war. So these estimates are relatively 
conservative (small ``c'' conservative) about the costs of the 
conduct of the war and whatever homeland-defense initiatives 
are necessary, as Dr. Frist and you have both been involved in.
    So, in that sense, we may see some larger deficits in the 
next year or two simply because we haven't anticipated all of 
the necessary expenditures. But in the main, after we get out 
of this dip, revenues will continue to grow over this decade 
and get back up to about 19.5 percent of GDP by the end of the 
decade, we believe, or somewhere in that neighborhood.
    So, in some sense, we will be collecting a significant 
amount of revenue over the course of this 10 years and 
therefore have, I suspect, lower deficits than we did. We 
weren't collecting levels of revenue this high in the run-ups 
to any of the wars.
    Senator Hagel. Are you surprised, in light of September 
11th and the recession dynamic, that, again, it appears that we 
are now on a upward course here, working our way out of 
recession? I suspect a good deal of that is a result of some 
confidence in the economy. Are you surprised by that?
    Mr. Crippen. Yes, we have all been surprised. I say that as 
a member of the economics profession in general, but certainly 
those of us at CBO expected that the weakened economy that 
existed before September 11th would be prolonged, if not kicked 
into a deeper recession, because of the attacks of September 
11th. Consumers backed off from a lot of purchases in the first 
couple of weeks, which is fully understandable, had but they 
came back strong. And as I said in my testimony, auto sales 
took off in part because of zero financing, but they and the 
housing sector continued to be strong throughout this time 
period.
    Consumers have not pulled back. Even the decline in equity 
markets over the last 6 months of last year has not deterred 
them, so far, from continuing to spend. And the really 
encouraging part, I think, of the data we are getting now is 
that businesses are stepping back up to the plate and beginning 
not only to generate some profits but probably to invest again, 
which is where this recession started in the first place.
    Senator Hagel. What do you think is behind the psychology 
of that?
    Mr. Crippen. Well, business, of course, will need to see 
continued positive consumer sentiment, which they are seeing. I 
mean, that is being proved every day. Consumers, as I said back 
in January, have really kept up their end of the deal 
throughout. Last year, even though we had a weak economy, 
consumer spending grew by 2.5 percent. It had been 5 percent 
the year before, so it was a little less, but it was still 
growing. Inventory depletions, of course, have a limit of zero, 
and as people continue to consume, corporations are going to 
have to start using their capacity, and as that happens, there 
will be more capital investments.
    So all of that, plus the apparent reappearance of more 
corporate profits, suggests that businesses certainly should be 
back investing in capital again as they were before.
    Senator Hagel. Is there one factor or element, unknown 
dynamic that concerns you most that is floating around out 
there in this universe of the unknown as to having an effect 
that could take us back the other way?
    Mr. Crippen. I think the single biggest risk the country 
faces is further terrorist attacks and whatever the conduct of 
this war looks like ultimately. That is why these estimates are 
hard to believe but are even more uncertain or more risky than 
one would have assumed before September 11th, because consumer 
confidence (in this case, consumption) is the linchpin of our 
economy. And anything that would deter that, make people stay 
home, would be harmful. That is the biggest single risk, I 
think, in all of our outlooks.
    The economy might not grow quite as quickly in the next 
quarter or two as it would appear at the moment, because there 
are a few downside risks. But probably will not go back into 
recession. No one now is thinking much about a so-called double 
dip. It may be a little weaker than we think, but the only 
thing that I can think of that would dramatically change this 
outlook is further terrorist attacks.
    Senator Hagel. Dr. Crippen, thank you.
    Mr. Chairman, thank you.
    Chairman Conrad. Thank you, Senator.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman. And welcome 
again and thank you to you and your staff for your hard work.
    Following up on the question of unpredictability or 
uncertainty and looking throughout your report, you have 
indicated that the outlook for growth in the coming months is 
extremely uncertain, and you have listed the mild winter and a 
number of other issues that come into play regarding cost.
    Given the fact that you have revised economic projections 
in less than 2 months, which we are pleased at the direction in 
which they are being revised, obviously, but from your 
perspective as we put together this budget resolution and given 
the volatility, given the concern, and hopefully we will not 
see additional terrorist attacks, but certainly there is great 
concern about that, should we put, in fact, some kind of 
corruptive mechanism or a trigger mechanism that would put 
parameters around this budget so that if we are going further 
into debt, it requires some action by the Congress to come back 
and revisit our tax and spending policies?
    Mr. Crippen. I think that in the next year or two, Senator, 
unless there is a major surprise out there somewhere (as we 
hope and pray there is not) we may be off a bit in our 
estimates of both outlays and revenues, as I suspect OMB is as 
well. But, at least in our baseline, before we start adopting 
policies, the bottom line should run roughly at zero. I mean, 
in January we projected small deficits. We have changed our 
outlook a little, and now project small surpluses. But that 
swing is so small that we could say we have a baseline budget 
(if you didn't do anything else about spending and revenues) 
that is roughly in balance. And I don't think that outlook will 
change much in the next year or two. It is certainly the longer 
term that we all are concerned about, and there our forecasts 
are very subject to change, and we have emphasized the 
uncertainty involved. The longer you go, the more uncertainty 
there is.
    In the matter of triggers, that is really a policy question 
for you all to consider. You have the opportunity, of course, 
to change law when you want to, with the concurrence of the 
President, so you have an ongoing trigger mechanism of some 
kind. But I understand that it may be desirable to have things 
happen more quickly or automatically. But that really is a 
policy question. The only thing I would stress is that as 
economic conditions change, desirable fiscal policy may change. 
So whereas last January it may have been a good thing to try 
and pay down debt, in the face of a recession, when we are in 
it, you may not want quite as aggressive a fiscal policy.
    All I am trying to say--and not very articulately--is that 
the outlook for fiscal policy and what you want to do with it 
may change over time, depending upon conditions. A trigger 
mechanism may not be able to anticipate all of those 
circumstances.
    Senator Stabenow. I think the reason for looking at some 
kind of a trigger is that, as you have indicated, it does 
change over time, situations change, and, unfortunately, we 
have locked in policies regarding tax cuts and other spending 
that, unfortunately, is locked in over a longer period of time, 
which, in fact, affects us differently depending on the outcome 
of economic change.
    I am wondering if you have done numbers in here that relate 
to what would happen if, in fact, the tax cut is permanent as 
we move forward in the next decade.
    Mr. Crippen. Yes, we have, Senator, because this 10-year 
horizon includes a few years after the tax cut is currently 
scheduled to expire. I am looking now for the approriate table. 
Maybe Mark has it. We show what happens with expiring tax 
provisions largely because of the tax cut of last year, and the 
effect is several hundred billion each year. We will have an 
exact number here in just a moment.
    It is roughly $130 billion in 2011 and $230 billion in 
2012.
    Senator Stabenow. In deficit?
    Mr. Crippen. That is how much revenue----
    Senator Stabenow. Are you saying the cost?
    Mr. Crippen. That would be the cost of extending the----
    Senator Stabenow. So we would add that essentially to the 
deficit projections.
    Mr. Crippen. Yes.
    Senator Stabenow. OK. A couple of other questions. When you 
are looking at Medicare and you speak about home health, do 
your numbers include the home health care cut of 15 percent 
that is scheduled to take effect? Or does it assume a delay in 
that 15 percent cut?
    Mr. Crippen. We assume that it goes into effect as it is 
currently scheduled.
    Senator Stabenow. So even though we have, in fact, been 
delaying that and choosing not to have that go into effect.
    Mr. Crippen. Right.
    Senator Stabenow. So if the 15 percent cut does not go into 
effect, these numbers would have to change?
    Mr. Crippen. Yes.
    Senator Stabenow. OK.
    Mr. Crippen. The same is true, by the way--and I testified 
last week on the House side--on physician payments. Given what 
you are hearing, I am sure, from your physicians about the 
likely reduction in fee schedules for the next year or two, we 
assume those reductions will take place. So if they don't, 
these numbers will change.
    Senator Stabenow. OK. And as someone who is very concerned 
and would not support that 15 percent cut happening for home 
health care, it is important for us to know that those numbers 
change. And when we look at the overall numbers on Table 11, 
you show the President proposing cutting $188 billion below 
inflation for non-defense appropriations. And so I am assuming 
that if we did not institute the home health cut of 15 percent 
or other reductions in physician services, it would even add 
more to that number and change that number. But I am assuming 
the $188 billion below inflation would affect potentially 
homeland security, border security, education, National 
Institutes of Health, a wide variety of non-defense efforts 
that have been prioritized, and I know of which there is great 
concern that we continue.
    I wonder if you would see in your crystal ball, or you 
would project that this cut would likely happen given the 
recent trends.
    Mr. Crippen. Well, if the recent history is an indicator, 
then domestic discretionary spending would likely go up more at 
the end of the day than this budget shows. In looking through 
briefly what the President has proposed on discretionary--and I 
expect that number, by the way, wouldn't include Medicare--I 
mean, it would make--if we delay home health, it will increase 
the deficit but not discretionary.
    But there are a number of things the President does propose 
to increase in domestic discretionary that I am sure Congress 
will endorse or be in favor of. Some of it is homeland 
security, but NIH and other things you just cited do go up. 
Obviously, in order to come up with a number, there are a 
number of things that don't go up. In fact, there are some cuts 
in here. And I can't tell you whether I think those cuts are 
going to survive or not. Some of them are probably in the 
nature of one-time expenditures, some coming off, FEMA spending 
and other things that you may accept as reductions from last 
year's budget because we had some extraordinary expenditures. 
But I certainly don't know whether the Congress will be of a 
mind to endorse this, and it would be probably a pretty good 
prediction that certainly the President's budget in total won't 
be adopted.
    Senator Stabenow. Thank you.
    Chairman Conrad. Senator Frist.
    Senator Frist. Thank you.
    Senator Domenici. Senator Frist, I wonder if I could ask a 
clarifying question on the last----
    Senator Frist. Sure.
    Senator Domenici. What time do you have to leave?
    Senator Frist. I have got to leave in about 5 minutes, but 
go ahead.
    Senator Domenici. Well, you----
    Senator Frist. I will be quick. I just have one central 
question and that is on the tax cut. For the past several 
years, the good news on revenues and surplus led to the whole 
debate over how Congress could allocate the surplus, a debate 
that we all participated in with varying approaches. Early last 
year, the news that the economy was slowing seemed to have 
generated more interest in tax cuts. The President, working 
with the Congress, was successful in passing tax cuts.
    Your numbers that we have talked about today show that the 
recession has, at least on paper, ended. We still have, I 
think, a lot to accomplish in terms of jobs and in terms of 
employment. But the numbers are increasingly encouraging.
    Do you think last year's tax cut hastened the end of the 
recession?
    Mr. Crippen. It is very hard to sort, Senator, what 
contributed. Certainly in our view, and most economists, some 
of the things that occurred in the tax cut, like the rebates, 
probably added significantly to consumer income. Now, the 
first--well, it did add income. The first month or so after the 
rebate checks went out, we didn't see much in consumption. We 
saw credit card debt being paid down, things like that, which, 
of course, is not harmful either in the long run. But it looks 
like that eventually the rebates and the program did help 
consumption, so it would have helped end the recession or make 
it milder, either one.
    It is hard to sort out, and not only because we don't have 
contemporaneous data, but you have things like the auto program 
with zero financing. We don't know how many of those cars would 
have been sold next week instead of last month had there not 
been the zero financing and had there not been the rebates.
    So it is always a game, if you will, of constructing what 
would have happened if we didn't do something, this 
counterfactual. But our best guess is that it certainly helped 
either make the recession shorter or shallower than it would 
have otherwise been because consumption was higher.
    Senator Frist. You stated earlier that most economists 
believe the latest downturn will take the shape of the typical 
v-shape curve and not a double-dip shape correct?
    Mr. Crippen. Right.
    Senator Frist. Do you think the tax cuts, helped prevent a 
double?
    Mr. Crippen. I think it is hard, but you have through the 
tax cuts, especially the early rebate program and the lower 
bracket, created a situation where consumers have more after-
tax disposable income and, therefore, consumption should be 
reinforced because of it. And we have seen exactly that. I 
mean, consumption has not fallen. Even in the wake of September 
11th, consumers are still out there doing their thing. So one 
has to conclude that it has certainly been very helpful in 
promoting consumption.
    The longer-run effects are equally important, of course, 
for the longer-run problems we are talking about. And as we 
suggested last August in our midyear review, we wrote what the 
macroeconomic effects of the tax cut overall might be. As with 
any tax bill, there are some positives, there are some 
negatives. But in the main, we think there will be a small, 
probably positive effect on economic growth in the long run. 
But that is mostly due to labor supply responses. There will be 
more labor supply because of the tax bill. But that effect 
won't show up in the short run.
    A long way around your question, I guess, but the point is 
we suspect, without a lot of data, that the tax bill, 
especially the short-run rebates, helped shorten and--make the 
recession shorter and shallower. And to the extent that is true 
and consumers keep up their end of this, there won't be a 
second dip, so it probably helped both of those things.
    Senator Frist. If you look at the spending increases we 
made last year, do you think that those were helpful in our 
fiscal and economic outlook?
    Mr. Crippen. Probably. Again, consumption includes what the 
Government does, and the fact that we were consuming more, 
spending more in construction or clean-up or other things 
probably helped as well. That is, of course, the classic sort 
of Keynesian outlook of the world: If you increase Government 
spending, you could increase overall demand. It is not clear 
what the relationship is. It is certainly not dollar for 
dollar, but it probably was helpful.
    Senator Frist. In your first slide, the one that is on the 
floor there, where you show the estimated deficit or surplus 
under the President's budgetary proposals, the increase there, 
how much of that increase--and I know it is difficult to factor 
out, is a product of the increased spending that will go on as 
a product of the war itself?
    Mr. Crippen. Well, some of the deficit, of course, that you 
are seeing there is due to current increases in defense 
spending. But we are going to climb back, out of deficit 
largely because of increases in revenues largely, and that is 
because of the end of the recession and stronger economic 
growth. We show positive surpluses after a couple of years 
because revenues are going to grow, not because spending has 
changed a great deal. Is that responsive?
    Senator Frist. That is actually helpful.
    In looking at the longer term, what do you think we need to 
be doing in terms of fiscal stability? Is there any evidence 
that we should increase taxes?
    Mr. Crippen. I don't know that there is any evidence for 
that, Senator. It is a policy choice you all have to make. Let 
me go back to where I always end, and didn't today, which is 
that when you and I retire, what we need to worry about is how 
much of the economy we are consuming as retirees, demanding 
that our kids give us. And in that kind of outlook, the 
economists would say, there are only two moving parts: how much 
we are transferring to retirees (what the benefit level is, if 
you will, of all the combined programs), and how big the 
economy is.
    So in that view, what you need to be mindful of is 
perpetuating policies and not to the exclusion of other 
objectives, necessarily, but perpetuating policies that help 
economic growth. Most economists would say tax increases 
wouldn't help economic growth most times. So that would suggest 
you wouldn't want to raise taxes.
    But you may have other objectives in addition to economic 
growth. All I am suggesting is you need to keep your eye on 
that one when you are looking at long-term issues, particularly 
the retirement of our generation.
    Senator Frist. Thank you, Mr. Chairman.
    Chairman Conrad. Senator Feingold.
    Senator Feingold. Thank you, Mr. Chairman. And thank you, 
Director Crippen, for appearing before the committee. I look 
forward to reviewing the CBO analysis I more detail, and I, of 
course, having looked at this for a few years, appreciate the 
differences between the OMB estimates and assumptions and those 
of the CBO. And I understand that that might not be terribly 
interesting to a lot of observers. It is not easy to present 
that difference in a compelling way. But to those who would 
dismiss the differences, I remind them that in late 1995, the 
leadership in the other body actually shut down the Government 
over these differences, so they are not inconsequential.
    We have not really had a chance to go over the CBO analysis 
of the President's budget, but though there may be differences 
in some estimates and underlying assumptions, the big picture 
appears to be the same. The President's budget will not be 
balanced this year, nor will it be in balance for the 
foreseeable future without using the Social Security Trust Fund 
reserves. And I find this, as I am sure many people do, 
particularly frustrating given the latest report that CBO's new 
estimates of the baseline actually project a small unified 
surplus for the coming year, as you reported.
    Mr. Chairman, as you have pointed out time and again, we 
are on the brink of a huge challenge. You quoted Dr. Crippen 
with his very clear and strong remarks earlier this year about 
the retirement of the baby-boom generation and with it the very 
significant pressure on Social Security and Medicare.
    A year ago, we were reasonably well positioned to address 
that challenge, even with the economic slowdown that ensue. 
That is no longer the case. Thanks to the tax cut and the 
spending policies enacted last year, now we are actually facing 
what is sort of a steep uphill climb.
    The President's budget makes that climb even harder. The 
load we will carry has been made much heavier with still more 
tax cuts, and then also a record increase in defense spending.
    Mr. Chairman, no one questions the need to provide adequate 
funds to fight the warm on terrorism, but we will not be 
effective in that fight by adopting what one commentator has 
characterized as a ``leave no defense contractor behind'' 
defense budget.
    Fully funding three new tactical fighter programs did not 
make sense a year ago, and it doesn't make sense now. We 
absolutely have to get serious about deficit reduction. Mr. 
Chairman, no one holds this cause more dear to his heart than 
you do. We shouldn't wait. We should start right now. We should 
balance the unified budget this year, and then commit to a 
glide path to balance the budget without using the Social 
Security Trust Fund, balance this by 2007 at the latest.
    With the CBO report today, I think it is clear that it is 
possible. Indeed, apparently the baseline unified budget will 
now be in balance in fiscal year 2003.
    Mr. Chairman, I think we should balance the books using the 
assumptions and the estimates of the Congressional Budget 
Office, not OMB. This may be an obvious point, but I think it 
is necessary to mention it because I have heard now, 
ironically, that there may be a move by the other body to use 
OMB estimates if in doing so it somehow makes it easier to 
craft a budget.
    This would be, to say the least, as I said, ironic, given 
the position that the House took 6 years ago when they shut 
down the Government over this issue. And it may be a moot 
point. It may be that using OMB numbers will not provide a 
significant advantage for budget writers, but if they do, I 
don't think we do the taxpayers any favors by building a budget 
on the very rosiest scenarios we can find.
    I find it troubling that we almost half to resume this 
mantra again. Every politician in the 1990's said it in every 
campaign. We are back to it. We have to start beating the drum 
again, and that is that we won't be doing our children and 
grandchildren any favors by running up deficits now and letting 
them pick up the tab. I thought we were going to have a few 
years here we wouldn't have to be saying that, but it looks 
like we have to say it now with even greater intensity so we 
can get back on a glide path to have a balanced budget.
    Dr. Crippen, the short-term estimates look a little better 
than we thought a few weeks ago, as you have indicated, but it 
appears that the long-term challenges that you have discussed 
before are still facing us. Could you say a little bit more 
about the trend line of the President's budget or the baseline, 
for that matter, as it extends into the next decade when the 
baby-boom generation starts to retire?
    Mr. Crippen. As I have said to the distress of some--and 
repeated to the distress of everyone, I guess--we now have 39 
million Medicare and Social Security recipients, and that will 
be 80 million by the time our generation is through working. 
That alone has to give you pause. But when you look at what 
resources are going to be devoted just to those Federal 
programs for retirees, it more than doubles over this time 
period. That is not to say that you couldn't or wouldn't want 
to raise taxes or increase borrowing at that point to finance 
some of the benefits. But you probably can't do any of those 
things for all of the benefits. It just will be the largest 
single fiscal policy change, I think, this country has ever 
seen to have those kind of changes either in the rest of 
Government as we know it or in the financing of Government as 
we know it.
    It would probably be unsustainable (though no one knows for 
sure) to borrow our way out of it at that point. So the 
question is, do we want to tax our children at those high 
rates, take either 30 percent or 25 percent of what they 
produce at that time to finance those benefits?
    Those are the questions that we all will need to face, and 
this 10 years we are now looking at is not even a proverbial 
tip of the iceberg, because our generation will just begin 
retiring at the end of that period. It is the following 10 or 
20 years in which that development will become overwhelming in 
your budget considerations.
    Senator Feingold. Thank you, Doctor.
    Thank you, Mr. Chairman.
    Chairman Conrad. Senator Domenici.
    Senator Domenici. Thank you very much, Mr. Chairman.
    Let me say, Senator Feingold, I always have appreciated 
your sense of fiscal responsibility, and I listened carefully 
to what you said. I think the interesting point is that each 
one of us can develop a theme and also a proposal that fits our 
desires, but I would challenge you and anyone else on this 
Budget Committee on either side to put together a budget that 
is built on the goals as you have stated here today with 
reference to on-budget and off-budget balances and by what date 
and the like.
    The problem is that all of us look at this fiscal 
situation, and because of Social Security and Medicare in the 
out-years, we would like very much to have the fiscal policy 
you have described. We have dealt some cards that make it 
pretty tough. That is kind of what I am saying. I am not sure 
your chairman can do that in the exact way that you have 
described over multiple years.
    Nonetheless, compared to other times, during my 20-plus 
years serving on this committee, the fiscal policy and what can 
we look forward to, things are hugely better with reference to 
deficits and surpluses than they were for most of the 20-plus 
years that I chaired this committee or was ranking member. As a 
matter of fact, we used to almost open every session with the 
concern that the deficit is out there as far as the eye can 
see, and that----
    Senator Feingold. I even remember some of it.
    Senator Domenici. You were here for some of it. And then we 
had a very, very excellent and rather exciting year. The 
problem is it only lasted a little while. That is when we paid 
down the deficit over a period of 3 years, almost $600 billion, 
which is something rather dramatic. It is more than a down 
payment. It is a very significant event in the fiscal policy of 
this great Nation.
    Then things happened that we couldn't do it, and everyone 
has something to blame for it. I am not now accusing you of 
that. Everybody suggests they know why we are no longer able to 
pay that surplus--to use surpluses to pay down deficits because 
surpluses aren't there.
    I am firmly convinced that it is not the tax cuts that harm 
our situation. I am more concerned than I ever was about 
sustaining the growth in this economy for the next 7, 8, 9, 10 
years. Just imagine if we see another 7 to 8 years like the 
ones we saw just before we were able to start paying down this 
huge deficit. If that happened again in the next decade or 15 
years, that would again be a rather incredible situation. And I 
think that will not occur just because we balance the budget 1 
year versus another or because we don't touch Social Security 
Trust Funds or we do.
    I think what is going to happen is we are going to get a 
huge spate of economic growth because we do things as right as 
we know how for economic growth.
    I think we have latitude, fiscally speaking. The problem is 
the latitude doesn't have with it political plus for each of 
the various proposals that one could come up with, because we 
have convinced ourselves that we cannot write a budget--some 
have--unless, as a matter of fact, it is balanced and unless it 
shows that we are not using any of the surpluses that come from 
Social Security and Medicare.
    That would make it difficult for this chairman, for this 
committee, for all of us. In the meantime, we have a war, 
costing us $1 billion or so a month, and we are just coming out 
of a recession, which we should heed and say we would like to 
come out of it as robust as we can and for as long and as 
strong as we can.
    Based on that, I have just a couple of questions, and they 
will be very brief.
    On your revised economic forecast on Table 4, page 20, you 
state that you now forecast GDP growth of 1.7 in 2002, up from 
January estimate of 0.8. And yet as we look at your testimony 
and report, we see no change in your January estimate for 
inflation measured by CPI. It stays at 1.8. No change in 
unemployment rate forecast from last January. It stays at 6.1. 
And no change in the 10-year Treasury note rate forecast from 
last January. It stays at 5 percent.
    I guess we in reviewing this would have thought that with 
more than doubling your forecast for GDP growth this year from 
January that these other economic variables would have been 
affected, maybe higher inflation, lower unemployment, something 
like that. Could you talk with us about that, please?
    Mr. Crippen. Sure. First, we don't know exactly why the 
fourth quarter was as positive as it was. That is, it looks 
like wages and salaries are about where they were in our 
January forecast, so we can't infer greatly different 
unemployment in that sense. Therefore, it looks like it is 
corporate profits that have gone up, and, that is where we made 
our change.
    But it is not clear what effect this relatively small 
change, would have on all of those other variables.
    Second, even if we had thought there were impacts, we 
didn't have time to make a full change in our economic 
forecast. As you know, Senator, we began this process back in 
November and formalized the forecast in December, and it takes 
a number of weeks to actually incorporate all of that into our 
baseline report that we do in January. So we frankly didn't 
have enough time in the last couple of weeks to do a complete 
reforecast, anyway.
    We see here that it looks like productivity is still 
holding up quite well, over 2 percent maybe in this last 
quarter, higher than we would have expected in a recession. At 
times, in the beginning of a recession, productivity tends to 
drop because employers retain employees in anticipation of 
business picking up later on. That didn't happen here. There 
had been some discussions in the popular press about the role 
of temporary workers and others and how all this adjustment 
takes place.
    That is a long way to say, one, we are not sure exactly 
what has transpired in the fourth quarter . Some of it is 
inference we are making, but clearly, we wanted to at least 
take note of the positive reports for the committee and 
incorporate them to the extent we could. And two, we didn't 
have time to make a complete revision of the forecast.
    Senator Domenici. But it is true that the numbers in the 
out-years would change with lower unemployment and slightly 
lower inflation.
    Mr. Crippen. They could in the next year or two, though in 
the long run it still depends critically upon the long-run 
trend for productivity and growth in the work force. And we 
haven't seen anything yet that would make us change that 
forecast from last January.
    Senator Domenici. I am sure that we are going to hear as a 
result of your testimony today that the President's budget has 
cut non-defense discretionary spending over $188 billion over 
the next decade, and that number appears on the first page of 
your testimony. And let's see if we have this correct. This is 
a reduction from a baseline that the Budget Act mandates you 
produce and that mandates that the total discretionary spending 
be constructed by taking the last appropriation act in 
Congress, including one-time emergency supplementals, and 
taking that number and inflating it all the way into the 
future. So the $20 billion in fiscal year 2002 emergency 
appropriation, following the September 11th attacks, is 
included in your baseline inflated all the way out to 2012. Is 
that correct?
    Mr. Crippen. That is correct, Senator.
    Senator Domenici. And if the staff that has prepared me on 
this are correct, that accounts for over $200 billion in 
discretionary spending in your baseline.
    Mr. Crippen. That is correct.
    Senator Domenici. About $40 billion for defense and $160 
billion for non-defense.
    Mr. Crippen. That would be correct.
    Senator Domenici. So this cut supposedly proposed by the 
President in non-defense discretionary spending is not really 
188, but, in fact, is an increase in non-defense discretionary 
spending in 2003 by about $3 billion, and indeed a cut over the 
decade, but more like $30 billion, not $188 billion. Is that 
correct?
    Mr. Crippen. That would be correct from your numbers, yes.
    Senator Domenici. I thank you very much. Thank you, Mr. 
Chairman.
    Chairman Conrad. Thank you, Senator.
    Director Crippen, I would like to direct your attention 
back to page 18 and the question of how big the deficits are if 
Social Security is not counted.
    Mr. Crippen. Right.
    Chairman Conrad. In 2003, as I read your table, the 
deficit, not counting Social Security, would be $297 billion if 
the President's budget proposals were adopted. Is that correct?
    Mr. Crippen. Right.
    Chairman Conrad. The next year the deficit, not counting 
Social Security, would be $245 billion.
    Mr. Crippen. Right.
    Chairman Conrad. And the next year, $187 billion. And going 
right out through the entire 10-year period, there is never 
less than $100 billion of deficit if Social Security is not 
counted. Is that correct?
    Mr. Crippen. Correct.
    Chairman Conrad. And, in fact, over the entire 10-year 
period, the total deficits, not counting Social Security, are 
$1.8 trillion. Is that correct?
    Mr. Crippen. Correct.
    Chairman Conrad. Let me just repeat that. If Social 
Security surplus funds are not included in the calculation, 
during the entire 10-year period the cumulative deficits are 
$1.8 trillion. That is correct?
    Mr. Crippen. Correct, yes.
    Chairman Conrad. How big was the tax cut over the 10-year 
period that was passed last year?
    Mr. Crippen. I am going to have to rely on my colleagues. 
$1.3 trillion.
    Chairman Conrad. Yes, and how much would the debt service 
cost of that be as well?
    Mr. Crippen. As I recall, over $300 billion, so it rounded 
up to $1.7 trillion for the total impact on the budget.
    Chairman Conrad. Total impact on the budget over the 10 
years of the tax cut is $1.7 trillion, and the cumulative 
deficits, not counting Social Security, are $1.8 trillion. My 
ranking member said he doesn't see any connection between the 
two. I think there is a direct connection. The amount of the 
tax cuts the President pushed, proposed, pushed through 
Congress last year, is almost directly equal to the cumulative 
deficits over the 10-year period if Social Security funds are 
not included in the calculation.
    Now, there has been a lot of talk about whether the tax 
cuts contributed to a shorter deficit. I certainly hope so 
because on both sides here we supported tax cuts last year, 
substantial tax cuts last year, to give lift to the economy. 
Isn't that the case?
    Mr. Crippen. Yes.
    Chairman Conrad. And we did so on the basis that tax cuts 
at a time of economic slowdown would give lift to the economy, 
would increase consumer demand. Isn't that the theory?
    Mr. Crippen. That is the theory.
    Chairman Conrad. And, in addition to that, we increased 
spending in response to the attacks on this country, and 
increased spending would also give lift to the economy at a 
time of economic slowdown. Isn't that the case?
    Mr. Crippen. It is generally thought to be, yes, depending 
on what you spend it on.
    Chairman Conrad. And so the one thing we agreed on last 
year is that we needed to do both those things. We needed to 
give tax cuts in the short term and we needed to have increased 
spending to respond to the sneak attack on this country, and 
that combination would give lift to the economy.
    At the same time, many of us--I certainly argued that the 
magnitude of the tax cuts over the 10 years were too high and 
would threaten the Social Security Trust Funds. Some mocked me 
for that, said, no, these surpluses are so large that we can 
have a tax cut of this magnitude and not endanger the trust 
funds. That argument was made repeatedly. In fact, I had 
members on this committee tell me you are worried 
unnecessarily. These surpluses are too small. I was told that 
repeatedly, that there was even going to be more money than was 
forecast.
    We didn't get more money. We got a lot less money. The 
result is we have got a tax cut that was put in place over the 
10 years--that is the argument I have--over the 10 years that 
is almost equal to the non-trust fund deficits we have over the 
next 10 years.
    That means to me surpluses in the trust fund accounts are 
being used to pay for the tax cut and other spending. It is 
just as clear as it can be. The consequences of that are 
serious because the baby boomers start to retire in 6 years. 
And we know the whole thing doesn't add up.
    And I want to make clear, I don't believe saving Social 
Security and Medicare Trust Funds solves the problem. I don't 
want to mislead anybody on that account. That is why the budget 
proposal I made last year not only saved those funds for the 
purposes intended, but also transferred money from the general 
fund, $900 billion to deal with these long-term liabilities, to 
in effect prepay some of that liability.
    Director Crippen, have you analyzed what other countries 
are doing who face the kind of demographic change we are 
facing? Have you looked at any other countries who have got the 
same demographic profile that we do?
    Mr. Crippen. Not in a thorough way that I would be able to 
report on. I think the truth is that in many countries--and 
Japan, of course, comes to mind first--the outlook at the 
moment is even worse, for two reasons: first, they will have 
more of an elderly overhang, fewer workers supporting elderly, 
in part because they live longer; and second, without economic 
growth, which hopefully they are now just beginning to 
experience again, they won't have the kinds of resources we 
hope our country will have when the time comes.
    But that is an anecdotal, not a complete, look. We have not 
looked at other countries thoroughly.
    Chairman Conrad. I wonder if you would be willing to assign 
some people, if we were to make a formal request to you, that 
is, this committee, to look at a number of other countries that 
have the demographic profile we do and look at how they are 
addressing these long-term fiscal imbalances. You would agree, 
I take it--and I don't want to put words in your mouth, but 
would you agree that we face long-term fiscal imbalances that 
are serious and require our attention?
    Mr. Crippen. Yes, absolutely.
    Chairman Conrad. And how serious would you characterize 
those long-term fiscal imbalances as being?
    Mr. Crippen. Well, I have fairly consistently said that the 
changes, no matter what they are, that we need to make are 
going to be unprecedented, and that they will occur in a very 
short period of time, and that our budget will look different 
and the financing of it very different than it ever has.
    So the changes are going to be quite stark. It is not a 
matter of saying that there is necessarily a pending crisis, 
certainly not to say that anybody currently on Social Security 
and Medicare needs to be concerned in the short run. But 
ultimately we are going to have to change our fiscal policy to 
accommodate the obligations, or at least the promises, we have 
made to our generation.
    Chairman Conrad. Is it true, in your judgment, that 
although all the payroll taxes are credited to the trust funds, 
credited to the Social Security Trust Fund, even though that is 
certainly the case, and there are assets in the Social Security 
Trust Fund, that is, Government bonds that are bearing 
interest, backed by the full faith and credit of the United 
States, that still a future Congress and a future President 
will face very difficult choices because those labilities will 
have to be redeemed out of the income, the future revenue of 
the Federal Government at a time those liabilities come due?
    Mr. Crippen. That is absolutely correct, Mr. Chairman. In 
2011, or thereabouts, when the actuaries think that payroll 
taxes will be insufficient to cover benefits for Social 
Security, at that point the Social Security Administration will 
go to the Treasury with interest demands on the debt that is in 
there, and Treasury will then have to produce cash to pay those 
interest payments in order for the checks to be cashed. And in 
doing so, the government has only the usual three choices: 
raising taxes, increasing borrowing from the public, or cutting 
spending somewhere else.
    And that is true whether or not there are trust funds and 
whether or not there are assets. So come 2011, what is going to 
happen in the fiscal situation of the country is identical with 
or without trust funds at that point. What is important is what 
happens between now and 2011 to make it easier to pay off those 
obligations, whether they are debt held by the trust funds or 
whether they are obligations, moral or otherwise, to sustain 
the elderly in these programs.
    Chairman Conrad. You are saying that the trust fund of 
Social Security goes cash negative in 2011?
    Mr. Crippen. I believe that is the right year.
    No, actually we think it may be 2016.
    Chairman Conrad. 2016 is the year that we have been using, 
and I just wanted to check to make sure we are on the same 
wavelength. They go cash negative in 2016. The thing that is 
important about that, it seems to me--and I would be interested 
in your take on it--right now the trust fund of Social Security 
is throwing off substantial surpluses. Is that not the case?
    Mr. Crippen. Yes.
    Chairman Conrad. That is going to change when we hit 2016.
    Mr. Crippen. Correct.
    Chairman Conrad. What is allowing us as a Nation to foot 
these bills? That is, if you don't count Social Security, we 
have just gone through the numbers. We will be spending over 
the next decade $1.8 trillion more than is coming in. Isn't 
that the case if we are not counting Social Security?
    Mr. Crippen. Without the excess payroll taxes, yes.
    Chairman Conrad. Without the Social Security surpluses, 
they aren't counted and part of the calculation, we will run 
$1.8 trillion of deficits over the next decade. That is the 
run-up to the time that you have indicated the trust fund will 
start going cash negative. Then all of this changes, doesn't 
it?
    Mr. Crippen. Yes, Senator, in the sense that the 
obligations that we have to retirees at that point will not be 
fully funded by the tax system currently in place.
    Chairman Conrad. So what would that mean? In order to keep 
the promises made on benefits, you would have to have a 
dramatic tax increase, wouldn't you?
    Mr. Crippen. Tax increase, borrowing increase, or cut in 
other Government spending.
    Chairman Conrad. And we will be talking by large amounts, 
large tax increases, large increases in borrowing, large cuts 
in other programs. Isn't that the case?
    Mr. Crippen. Yes.
    Chairman Conrad. The Comptroller General testified that as 
they look ahead, under any of their scenarios, we are headed 
for at different time periods--they have three major scenarios. 
As they look ahead, they have different periods at which the 
situation becomes most dire, but under any of the three, the 
Comptroller General indicated we are headed for, with current 
law, with the tax cuts extended, that we are headed for 
deficits as a percentage of gross domestic product of 20 
percent. Twenty percent of gross domestic product as a deficit. 
If we had deficits today of 20 percent of GDP, that would be a 
$2 trillion deficit, would it not?
    Mr. Crippen. Right.
    Chairman Conrad. How big is the total Federal budget?
    Mr. Crippen. $2 trillion.
    Chairman Conrad. $2 trillion.
    Mr. Crippen. Yes.
    Chairman Conrad. So if we had deficits of the magnitude 
that the Comptroller General of the United States is 
forecasting in our future because of these demographic changes, 
we would face deficits this year that are as big as the entire 
Federal budget. Isn't that the case?
    Mr. Crippen. Roughly. Think about it this way (at least, I 
find it a little easier) we are currently spending 18 to 19 
percent of GDP for all Federal programs. The President's budget 
would have spending, I believe, at about 19.5 percent for next 
year. If our projections are anywhere in the ballpark, we will 
be spending 15 or 16 percent of GDP on Federal health 
retirement programs alone. So the----
    Chairman Conrad. When would that be?
    Mr. Crippen. By that point, it would be 2030, but the ramp-
up is pretty significant, of course, between 2010 and 2030. So 
all of that is to say everything the Federal Government does 
today from defense on down spends about 19 percent of the 
economy. That is what it takes to fund it. Sixteen percent will 
be required to fund programs for the elderly in 2030. So the 
difference obviously is roughly 3 percent of GDP for everything 
else.
    Chairman Conrad. And that would only cover, as the 
Comptroller General told us, interest on the debt.
    Mr. Crippen. That could well be. So the point is----
    Chairman Conrad. Right about everyone else, there would be 
no money for Medicare, there would be no money for Medicaid, 
there would be no money for defense.
    Mr. Crippen. Medicare and Medicaid were included in our 15 
to 16 percent number, but everything else--the rest of the 
Government as we know it--will obviously be squeezed into the 3 
percent, if you didn't borrow or you didn't raise taxes.
    Chairman Conrad. His numbers are--he is coming at it a 
somewhat different way. He says at the most difficult point 
when the baby boomers are fully retired, there will only be 
money for Social Security and interest on the debt. There would 
be no money for Medicare, there would be no money for the other 
functions of Government. That is at the depth--that is his 
calculation.
    You are making much the same point in a somewhat different 
way. You would have money for the retirement programs and 
roughly interest on the debt, no money for anything else.
    Mr. Crippen. Right.
    Chairman Conrad. I tell you, I hope that people are 
listening. None of my colleagues are. People are watching on 
television. I have already had colleagues call me and tell me 
they were watching this.
    You know, this is reality, and I think people are having a 
hard time kind of adjusting to where we are headed simply 
because it is unlike anything we have seen before. Would you 
agree with that?
    Mr. Crippen. Absolutely.
    Chairman Conrad. What we are faced with in the future is 
just unlike anything we have seen before. And those who keep 
talking--and I have got discussions going on with colleagues 
all the time in which they say, you know, Senator Conrad, why 
are you so worried about what is to come? We have been getting 
through--we have gotten through the last 200 years without that 
much trouble, and what is the big problem?
    The big problem is what we are about to experience is 
unlike anything we have ever experienced before. Would you 
agree with that characterization?
    Mr. Crippen. Yes. I would say, and probably should have 
sooner as well, that our children, who are going to be faced 
with providing for us in our retirement, no matter how you 
think about it, will also be better off than we are because of 
real economic growth between now and then. But as you said, 
there will only be two of them for each of us. And the 
proportion of total income that goes to the government as taxes 
will be 30 percent, although it may be 30 percent of a bigger 
pie.
    So it is not absolutely true that we will be unable to 
raise taxes or other financing to cover the costs. We don't 
know. But it certainly suggests, as you have said, a very large 
change in our fiscal outlook and fiscal policy and how we 
finance these benefits.
    So it may be--and maybe some of your colleagues think it 
will be--relatively easy to go to 30 percent of GDP for 
taxation. I don't know. That is certainly not the situation the 
country has seen. Revenues have averaged about 18 percent of 
GDP since World War II, and the peaks have been around 20 
percent. In----
    Chairman Conrad. Out of the--I am sorry to interrupt.
    Mr. Crippen. No, that is all right.
    Chairman Conrad. That would be--30 percent of GDP going to 
taxes would be a 50 percent increase over anything we have 
experienced before.
    Mr. Crippen. Yes.
    Chairman Conrad. Well, it strikes me as highly unlikely, 
and I even question whether that would be desirable because 
that would have an impact on economic growth, would it not?
    Mr. Crippen. For our grandchildren, yes, absolutely.
    Chairman Conrad. All right. I thank you, Director Crippen. 
I want to conclude as I began by thanking you and your very 
able staff for making special efforts to get us these re-
estimates on a timely basis for the work of the committee given 
our truncated schedule this year, our compressed schedule, if 
you will. And, again, if you would tell you staff how much we 
appreciate the work that has been done.
    Mr. Crippen. Absolutely. Thank you, Mr. Chairman.
    Chairman Conrad. Thank you.
    [Whereupon, at 11:35 a.m., the committee was adjourned.]

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