[Senate Hearing 108-33]
[From the U.S. Government Publishing Office]




                                                         S. Hrg. 108-33

        CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2004

=======================================================================

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               ----------                              


               January 29, 2003--THE STATE OF THE ECONOMY

           January 30, 2003--THE BUDGET AND ECONOMIC OUTLOOK

       February 4, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET

  February 5, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET PROPOSALS

    February 11, 2003--THE PRESIDENT'S INTERNATIONAL AFFAIRS BUDGET

  February 13, 2003--DEPARTMENT OF TRANSPORTATION'S FISCAL YEAR 2004 
                            BUDGET PROPOSALS

February 26, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET PROPOSAL FOR 
                         MEDICARE AND MEDICAID
      September 3, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET



           Printed for the use of the Committee on the Budget



        CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2004





                                                         S. Hrg. 108-33
 
        CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2004

=======================================================================

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________


               January 29, 2003--THE STATE OF THE ECONOMY

           January 30, 2003--THE BUDGET AND ECONOMIC OUTLOOK

       February 4, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET

  February 5, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET PROPOSALS

    February 11, 2003--THE PRESIDENT'S INTERNATIONAL AFFAIRS BUDGET

  February 13, 2003--DEPARTMENT OF TRANSPORTATION'S FISCAL YEAR 2004 
                            BUDGET PROPOSALS

February 26, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET PROPOSAL FOR 
                         MEDICARE AND MEDICAID
       September 3, 2003--THE PRESIDENT'S FISCAL YEAR 2004 BUDGET

                                _______


                    U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
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           Printed for the use of the Committee on the Budget


                        COMMITTEE ON THE BUDGET

                    DON NICKLES, Oklahoma, Chairman

PETE V. DOMENICI, New Mexico         KENT CONRAD, North Dakota
CHARLES E. GRASSLEY, Iowa            ERNEST F. HOLLINGS, South Carolina
JUDD GREGG, New Hampshire            PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               PATTY MURRAY, Washington
CONRAD BURNS, Montana                RON WYDEN, Oregon
MICHAEL ENZI, Wyoming                RUSSELL D. FEINGOLD, Wisconsin
JEFF SESSIONS, Alabama               TIM JOHNSON, South Dakota
JIM BUNNING, Kentucky                ROBERT C. BYRD, West Virginia
MIKE CRAPO, Idaho                    BILL NELSON, Florida
JOHN ENSIGN, Neveda                  DEBBIE STABENOW, Michigan
JOHN CORNYN, Texas                   JON S. CORZINE, New Jersey


                Hazen Marshall, Majority Staff Director

                    Mary Ann Naylor, Staff Director

                                  (ii)


                            C O N T E N T S

                               __________

                                HEARINGS

                                                                   Page
January 29, 2003--The State of the Economy.......................     1
January 30, 2003--The Budget and Economic Outlook................   205
February 4, 2003--The President's Fiscal Year 2004 Budget........   291
February 5, 2003--The President's Fiscal Year 2004 Budget 
  Proposals......................................................   345
February 11, 2003--The President's International Affairs Budget..   435
February 13, 2003--Department of Transportation's Fiscal Year 
  2004 Budget Proposals..........................................   543
February 26, 2003--The President's Fiscal Year 2004 Budget 
  Proposal for Medicare and Medicaid.............................   615
September 3, 2003--The President's Fiscal Year 2004 Budget.......   671

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman Nickles...................1, 205, 291, 345, 435, 543, 615, 671
Senator Bunning................................................588, 758
Senator Byrd.....................................................   426
Senator Conrad.....................2, 205, 291, 345, 435, 543, 615, 671
Senator Corzine..................................................   593
Senator Enzi...................................................488, 649
Senator Feingold...............................................424, 755

                               WITNESSES

Barry B. Anderson, Acting Director, Congressional Budget Office..   228
Michael E. Baroody, Executive Vice President, National 
  Association of Manufacturers...................................    36
Hon. Mitchell E. Daniels, Jr., Director, Office of Management and 
  Budget.........................................................   354
Douglas Holtz-Eakin, Director, Congressional Budget Office.......   697
Glenn Hubbard, Chairman, Council of Economic Advisers............   304
Michael P. Jackson, Deputy Secretary of Transportation, United 
  States Department of Transportation............................   552
David R. Malpass, Chief Global Economist, Bear Stearns & Company, 
  Inc............................................................    19
Hon. Colin L. Powell, Secretary, United States Department of 
  State..........................................................   447
Gene B. Sperling, Former National Economic Advisor and Director 
  of the National Economic Council...............................    56
Hon. Tommy G. Thompson, Secretary, United States Department of 
  Health and Human Services......................................   626

                         QUESTIONS AND ANSWERS

Questions and Answers...........................276, 405, 427, 492, 604

               ADDITIONAL MATERIALS AND CHARTS SUBMITTED

Testimony, charts, and graphics submitted...93, 259, 397, 486, 594, 719




                        THE STATE OF THE ECONOMY

                              ----------                              


                      WEDNESDAY, JANUARY 29, 2003

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:08 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Don Nickles 
(chairman of the committee) presiding.
    Present: Senators Nickles, Allard, Burns, Enzi, Sessions, 
Bunning, Crapo, Ensign, Conrad, Sarbanes, Nelson, Stabenow, and 
Corzine.
    Staff present: Hazen Marshall, staff director; Dan Brandt, 
economist and Bob Taylor, special counsel.
    For the minority: Mary Ann Naylor, staff director; and Lee 
Price, chief economist.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. I call the Committee to order. I want to 
thank everybody for coming and especially thank my colleague 
and ranking member, Kent Conrad, for his assistance.
    We have a series of hearings set up. Today will be on 
economic growth. We have three very distinguished panelists 
that will provide their expertise and insights on how we might 
be able to better grow the economy, and I appreciate their 
participation as well.
    I would especially like to thank my friend and colleague, 
Senator Conrad, who has served on this committee I believe 16 
years. He has served as chairman and ranking member, and he has 
also served in almost every position in this committee. I 
appreciate his service. The last Congress was a very difficult 
Congress. It is always difficult. This committee is a tough 
committee. I appreciate that, I recognize it, and I recognize 
and appreciate the willingness of our colleagues to serve on 
it. We have several new members on the Committee. I welcome 
them. I see Senator Conrad Burns has just joined the Committee 
as well as Senator Mike Enzi from Wyoming joining us, Senator 
Sessions from Alabama, Senator Bunning joins us as well. So we 
welcome you to the Committee. Senator Crapo has joined us, and 
Senator Ensign will be here as well. So we have some new 
members and some veterans. I believe Senator Hollings has been 
on this committee for 27 or 28 years. I have been on it for--I 
am not sure how long--a long time. It is kind of bad when you 
think, well, maybe 20 years or so.
    I want this committee to be an enjoyable, educational, 
informative opportunity for all of us so we can better learn 
how to manage Government and maybe have a better success in the 
budgeting process.
    We have a $2-trillion-plus budget. That is a big challenge. 
We don't have a $750 billion budget. Our budget is not just the 
discretionary amount. Our budget is the entire Federal budget. 
So we need to keep a lot of things in perspective.
    We have some big challenges. We happen to be presiding now 
at a historic time. We have had a recession, and we have had 
revenue declines. We went from surpluses to deficits. That is 
caused primarily because revenues have fallen. Revenues have 
fallen by 9 percent in the last 2 years, the first time in 
history we actually had a revenue drop 2 years in a row. I 
believe it dropped from 2000 to 2001 1.7 percent and the next 
year almost 7 percent, combined, about a 9-percent drop in 
revenues. That is historic. At the same time, expenditures went 
up, and expenditures went up rather dramatically. Last year, 
they grew by 7.9 percent, and that is 11 percent if you exclude 
falling interest rate costs. So you had revenues declining and 
you had expenditures growing rather dramatically. So we went 
from a surplus of, I believe, $129 billion to a deficit of $159 
billion just between 2001 and 2002.
    Well, we need to reverse that, and hopefully one of the 
ways we can reverse that is by having a growing economy. The 
purpose of our hearing today is to figure out how can we grow 
the economy.
    I compliment President Bush. He challenges us last night in 
the State of the Union Address. He made several recommendations 
to Congress on how we might better grow the economy. I 
compliment him for those proposals. We will have administration 
witnesses before this committee to explain those proposals and 
to hear ideas.
    That is not the purpose of this hearing. The purpose of 
this hearing is to pull in individuals who are recognized as 
experts in their field to hear their insights on how we might 
better grow the economy and to have maybe a little dialog. So 
we will have administration witnesses. I believe we have 
scheduled tomorrow CBO, and they just issues the report, the 
budget and economic analysis. I haven't had a chance to look at 
it. It just came out. I think they are supposed to have a 
hearing in the House Budget Committee today. I believe that was 
canceled, so we will hear from them tomorrow. So we get a 
little more technical from CBO on what their analysis of it is, 
and then the following week we will hear from Mitch Daniels and 
administration officials to explain their budget and give us 
some insights as well.
    So I look forward to working with all members of our 
committee. I look forward to our witnesses. Before I introduce 
our witnesses, I will call on the ranking member and my friend 
Kent Conrad for any opening remarks he might have.

              OPENING STATEMENT OF SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman.
    Thank you, first of all, for holding this hearing because I 
think it is a critically important subject. Thanks, too, for 
the new energy and attitude you have brought to the Committee. 
It is welcome and we look forward very much to working with 
you.
    I want to report to our colleagues that the incoming 
chairman and his staff have been eminently fair in the 
operations of the Committee, and we all appreciate that very 
much. They are professional and it has been a delight to deal 
with them.
    I want to also welcome the new members. We have many new 
members, and we are delighted that they have joined the 
Committee. We look forward to working with you in the days 
ahead as we discuss really critical choices for the country. 
What do we do with the budget of the United States? What do we 
do to promote growth? What do we do to improve the national 
defense and improve education? What do we do to secure the 
long-term fiscal strength of our Nation?
    It won't surprise you, Mr. Chairman, if I just turn briefly 
to a few charts to make the point on what I think I have 
learned from my past service here in terms of what is 
effective.

[GRAPHIC] [TIFF OMITTED] 

    I want to go back to the 1980's when we had a policy of a 
significant tax cut at the same time we were having a 
significant military buildup, and what we saw was the deficits 
increased dramatically. Then in the 1990's, we changed course, 
and we moved back toward balanced budgets. I want to just talk 
about what I learned from those changes.
    During the period of the 1980's, when deficits were growing 
dramatically, I believe Federal Government borrowing was 
squeezing out private investment; that as the Government 
competed for funds, that reduced funds available for 
investment. Investment is critical to economic growth.
    Then we saw a change and, instead of adding to deficits and 
adding to debt, we started growing out of deficits, we got very 
good results in the real world. Real investment in equipment 
and software grew much faster in the 1990's than in the 1980's.

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

    Let's go to the next chart. The unemployment rate fell to 
the lowest level in 30 years at this time that the Federal 
Government was moving toward fiscal balance.

[GRAPHIC] [TIFF OMITTED] 

    Let's go to the next one. Total wage and salary income rose 
rapidly in the 1990's, again, much faster than in the 1980's.

[GRAPHIC] [TIFF OMITTED] 


    Now we face a circumstance in which 2 years ago the 
projections were by the Office of Management and Budget and the 
Congressional Budget Office that we would have $5.6 trillion of 
surpluses over the next decade. Now we see that that 
circumstance has changed dramatically. If we adopt the 
President's policies, the additional tax cuts that he is 
advocating, the spending that he is advocating, we will be $1.5 
trillion in the red.

[GRAPHIC] [TIFF OMITTED] 


    When I look at his specific plan for economic growth, the 
stimulus plan or the growth plan, it strikes me that it will be 
ineffective in the following ways:
    First of all, only a small part of it is effective in this 
fiscal year, some $36 billion this fiscal year, with a 10-year 
cost of over $900 billion when the associated interest cost is 
included.

[GRAPHIC] [TIFF OMITTED] 


    It also strikes me that it will be ineffective because it 
is so heavily weighted to the highest-income people in our 
country. Those earning over $1 million a year will get an 
$88,000 tax reduction, but those in the middle of the income 
stream in this country, those in the middle 20 percent who earn 
between $21,000 and $38,000 a year will get, on average, only 
$265. Yet those are the people that are very most likely to 
spend the money and thereby stimulate the economy.

[GRAPHIC] [TIFF OMITTED] 

    It also strikes me that over the long term it will be 
ineffective because of the deficits and debt that it will add. 
This is to me the key point.
    We are looking ahead with the new CBO numbers. If Social 
Security is not used, is not invaded for other purposes, we see 
deficits throughout the whole rest of the decade of very, very 
large proportion, approaching $4 trillion. It is for that 
reason that on our side we have proposed a different stimulus 
package, one that has much more stimulus now, but much less 
cost over the 10 years. We have just received an evaluation 
from Mark Zandi, the economist that has now been widely quoted 
in the Wall Street Journal and on the various news programs. 
His conclusion is that for 2003 the Democratic plan would give 
us about eight-tenths of 1 percent growth in GDP; the 
Republican plan, about half as much. The same is true for 2004: 
the Democratic plan, about 1 percent of GDP growth, in addition 
to what will otherwise occur; the Republican plan, about four-
tenths.

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

    The bigger message is the long term. In the long term, he 
finds, as have other econometric modelers, that the President's 
plan will actually hurt growth--by a very small amount but, 
nonetheless, negative. The reason is that the growth of 
deficits and debt will provide a drag to the economy that 
overwhelms the increased efficiency one gets from the tax 
changes that are made.
    That tells me, Mr. Chairman, that we do have a real 
challenge. How do we forge a plan that gives lift to the 
economy now, but doesn't endanger long-term growth by adding to 
deficits?
    Chairman Nickles. Senator Conrad, thank you. I am going to 
try and make sure that we don't have this turn into a debate 
between you and me. I could respond, but I won't at this time.
    Do any other colleagues wish to make a comment before I 
introduce our guests? If not, we are delighted to have three 
outstanding panelists, and I seek and welcome your testimony 
today. Your statements will be inserted into the record.
    First, I am going to ask you--I am not going to set a time 
limit, but if you would keep your remarks to 7 or 8 or 9 
minutes, then we will open it up for questions. I am not 
ringing a bell.
    First we have David Malpass. He is the Bear Stearns chief 
global economist. I have had the pleasure of knowing him for 
some time. I respect and admire his work. He has had a series 
of economic appointments during the Reagan and Bush 
administrations, including 6 years with Secretary James Baker 
at Treasury, and also the State Department. Mr. Malpass has 
extensive experience on economic, budget, and international 
issues, including the 1986 tax cut and the Gramm-Rudman budget 
law. So, Mr. Malpass, welcome.

  STATEMENT OF DAVID R. MALPASS, CHIEF GLOBAL ECONOMIST, BEAR 
                    STEARNS & COMPANY, INC.

    Mr. Malpass. Thank you, Senator. Mr. Chairman, Senator 
Conrad, members of the Committee, thank you for the invitation 
to testify.
    What I propose to do, Senators, is go through in detail the 
first page of my prepared testimony, and then explain the 
graphs as a way to summarize the prepared testimony.
    The economy faces an unusual number of near-term problem: 
Iraq, the war on terrorism, artificially expensive oil, sudden 
weakness in the U.S. dollar, a large and growing current 
account deficit, rapid growth in Federal Government spending, 
and a 3-year decline in equity values.
    Arrayed against these problems are the small-business 
character of the U.S. economy, record low interest rates and 
inventory-to-sales ratios. Inventories are at low levels now. 
We have the likelihood, I think, of a pro-growth tax cut. We 
have a strong, flexible labor force, 131 million workers in the 
United States with fast productivity growth.
    The balance, in my view, is favorable for the longer-term 
U.S. outlook. I will be more confident about the near term when 
Iraq disarms, a growth-oriented tax cut passes Congress, and 
oil prices find a lower level based on market forces rather 
than a cartel.
    A growth-oriented tax cut is a critical part of the 
recovery. Our economic health depends on the efficiency of the 
capital and incentive structures rather than on cash in the 
consumer's pocket. I disagree with the view that consumption is 
the weak part of the economy or that a demand-oriented tax cut 
is a necessary step for economic recovery.
    One key to faster economic growth is to shift from the 
present debt-biased capital structure to a more balanced one. 
That is why President Bush's proposal to eliminate the double 
taxation of dividends would, in my view, add to both the near- 
and long-term growth outlook. Remember that double taxation 
causes a heavy bias toward debt in the corporate structure.
    There is an additional urgency for the U.S. to make 
progress on a growth agenda. In most other parts of the world, 
economies are substantially weaker than ours. Unemployment 
rates are higher, government spending and unfunded pension 
liabilities are even greater than our own, health care systems 
are less effective, and currencies even more volatile than the 
dollar.
    As a result, clear U.S. leadership will play a critical 
role in helping improve growth policies elsewhere, including 
promoting tax reform, currency stability, sensible 
environmental policies, and restraint in the size of 
Government.
    What I would like to do now is show you some of the graphs 
in my prepared testimony. On page 2, there is a graph showing 
some budget issues, and the first graph is one showing how well 
economists do in forecasting the growth rate. The graph shows 
you that economists do badly at this task. You can see in the 
1990's, for example, how CBO and OMB both expected certain 
growth rates, roughly 2-3 percent, and the actual economy grew 
much more strongly. Then in 2000-2001, we saw the actual growth 
rate well below the OMB and CBO expectations. CBO just put out 
a new report this morning, and one thing they do is show the 
sensitivity of the budget deficit to growth. They find that the 
change in the Fiscal Year 2002 fiscal deficit was a $471 
billion deterioration; of that, 16 percent was caused by tax 
cuts, another 16 percent by new spending, and fully 68 percent 
by the change in the economic outlook.
    So what they are saying basically is that growth is 
critical to the fiscal deficit much more so than the 
assumptions on the deficit effect of a tax cut.
    Looking out over 10 years, what CBO found was that the 
numbers are more clear against government spending. Of the $5.6 
trillion deterioration in the fiscal outlook, the tax cuts 
caused less than a quarter of that, spending caused a full 
third, 32 percent, and the slower economic growth caused nearly 
half of the deterioration in the longer-term fiscal outlook.
    The graph that I show on the bottom of page 2 illustrates 
this. We fall into a big fiscal deficit 2.5 percent growth. If 
you have a 3.5-percent growth rate, you run into big surpluses 
in the out-years.
    Small changes in the growth outlook, meaning half-percent 
changes in the longer-term growth outlook have a great deal of 
control over the fiscal deficit.
    I would like to show you now page 4. What happened in 2002 
was the aftermath of a recession. We can all regret it and 
regret the loss of jobs. By the numbers, it was a shallower 
recession than what we have seen. The peak to trough was the 
shallowest that we have on record.
    On page 5, I am showing business equipment spending. We 
often hear the idea that there was simply no investment taking 
place in 2002. In reality, the rate of recovery was pretty much 
in line with averages. By the third quarter of 2002, we were 
back at the level of business equipment spending that was the 
average of the boom years, of the 1997-to-2000 period shown on 
the graph.
    At the bottom of 5 and the top of 6, I show a chart about 
the peak to trough job losses. Again, as I emphasize, it is 
unfortunate to lose any jobs, but when you have a recession, 
you do lose jobs. What we saw in the recent recession is that 
the job losses in this last recession peak to trough were 1.7 
million. That was 1.3 percent of the labor force. The U.S. 
economy and the number of workers is just much bigger than what 
we used to have. 1.7 million job losses is unfortunate, but 
relative to GDP was the smallest loss in jobs from peak to 
trough of any of the recessions going back into the 1960's.
    At the bottom of 6, even though the unemployment rate has 
climbed now to 6 percent, it is below what used to be the 
normal unemployment rate or even the trough unemployment rate. 
In the 1970's, the unemployment rate never really got down to 
the current level.
    The gist of this is that while we have to focus on getting 
more jobs into the economy, it was a shallower-than-normal 
recession, and a shallower-than-normal recovery. Fewer jobs 
were lost than in the normal peak to trough recession.
    One of the reasons for that is that personal income growth 
was strong in 2001 and 2002, well above average. The top of 7 
shows you the current path of personal income growth versus 
what the average cycle. One of the reasons for the strength of 
personel income growth was the strength of the economy leading 
into the recession in 2001, but also the tax cuts that occurred 
in 2001.
    We had unusually well-timed fiscal and monetary stimulus 
that allowed a shallower-than-normal recession and better-than-
normal personal income growth.
    On page 7 and 8, I describe the consumer behavior. We often 
hear the idea that the consumers were profligate, spendthrift. 
Certainly we could all save more, and that would be good. As we 
look at the data, there is a huge discrepancy in the government 
data. They exclude capital gains income from income. 52 percent 
of Americans hold equities, either directly or indirectly now. 
As people took capital gains, the Government didn't see that 
income, didn't record it. Capital gains tax was considered an 
expenditure. The higher the stock market went in the 1990's, 
the worse it looked for the personal savings rate. It gave the 
Government justification for taxing money away from people by 
saying, look, the people aren't saving. In reality the low 
savings rate was purely a mistake in the Government personal 
savings data.
    At the bottom of 8, we have tried to adjust the savings 
rate simply to include one of the discrepancies, the realized 
capital gain. People actually were saving at a relatively 
steady rate in the 1990's, and I think that has continued up 
through 2002. So as you think about how to build a tax cut, be 
leery of the idea that you have to have a tax cut to replace 
lost consumption. There really wasn't any lost consumption, and 
there really wasn't as much lost savings. This is particularly 
true at the lower-income levels because their personal wealth 
and net worth is much more tied up in the home than in 
equities. As you go up in the income brackets, people lost more 
from the stock market, but at the lower income levels they 
still may have a home and a job, and that turns out to be the 
critical part of consumption.
    On page 9 of my prepared text, I go through reasons for 
thinking that the capital structure is really what you ought to 
focus on in thinking about a tax cut. We have a heavily skewed 
system in the United States where debt is strongly encouraged 
by the Tax Code. President Bush has proposed a way to somewhat 
level the playing field. I think it would be very stimulative 
in both the short and the long run--
    In the middle of 10, I address municipal bonds. I think 
there is a little bit of confusion going on there. One of the 
criticisms of the tax proposal is that it might disadvantage 
municipal bonds. I disagree on two grounds:
    First, in economic theory and practice, municipal bond 
yields are related to the after-tax return on U.S. treasury 
securities. President Bush's proposal to eliminate double 
taxation of dividends won't affect that calculation.
    Second, municipal bonds are substantially different from 
dividend-paying equities in terms of creditworthiness and 
volatility. The two instruments aren't very good substitutes 
for one another. I don't agree with the idea that eliminating 
double taxation of corporate income would somehow disadvantage 
State and local governments. In fact, I think they would 
benefit immensely from the new jobs that are created in the 
economy by the proposal.
    On page 10 and 11, my testimony goes through foreign 
experience with double taxation of dividends. What we find is 
that the U.S. is one of only three major economies that double 
taxes corporate income. As a result, the U.S. has the second 
highest combined top tax rate on dividends. The only country 
that has a higher tax rate on dividends is Japan. That is an 
aberration in our system.
    Chairman Nickles. Mr. Malpass, do you have a chart that 
shows effective countries' tax rates on dividends?
    Mr. Malpass. The text on page 11 goes through a breakout of 
countries. On page 10, it points out that only three 
countries--the U.S., Switzerland, and Ireland--have double 
taxation.
    Chairman Nickles. I would just be interested, if there is a 
chart, I would be interested in seeing what other countries are 
doing, if you have it. I am not asking you to do----
    Mr. Malpass. I don't have it here, but I will be happy to 
provide it.
    Chairman Nickles. I appreciate that. You kind of need to 
summarize so I can get to the other panelists.
    Mr. Malpass. I will finish it here.
    Deficits and interest rates are connected on page 11. There 
really isn't a correlation between the fiscal deficit and 
interest rates. In the 1980's 10-year bond yields fell 
throughout the decade even as the fiscal deficit was rising. In 
1999 and 2000, as we moved into sizable fiscal surpluses, bond 
yields were rising sharply.
    In summary, the Administration's tax proposal will, in my 
view, provide substantial near-term and long-term stimulus. It 
will reduce the distortion in the U.S. capital structure and 
boost the U.S. growth rate. I think there are obviously many 
other things that should be done at this point to stimulate 
growth because, that is the dominant factor in the fiscal 
deficit.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Malpass follows:]

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    Chairman Nickles. Mr. Malpass, thank you very much.
    Next we will hear from Michael Baroody. He is the executive 
vice president of the National Association of Manufacturers and 
serves as chairman of the Asbestos Alliance Steering Committee. 
The National Association of Manufacturers has 14,000 member 
companies and subsidiaries. In addition to that, Mr. Baroody 
has an impressive background that includes serving as Assistant 
Secretary at the Department of Labor and also as the Deputy 
Assistant to President Reagan.
    Mr. Baroody, welcome to the Committee.

  STATEMENT OF MICHAEL E. BAROODY, EXECUTIVE VICE PRESIDENT, 
             NATIONAL ASSOCIATION OF MANUFACTURERS

    Mr. Baroody. Thank you very much, Chairman Nickles, and 
Senator Conrad and members of the Committee.
    As the Chairman indicated, I am here to testify both for 
manufacturers and the NAM and for the Asbestos Alliance we 
lead. I would like to try to summarize the formal testimony 
that I have submitted and ask that the studies I attached to 
that formal submission be included in the record. Those are 
studies that look at the asbestos litigation crisis. I also 
attached a copy of the NAM's pro-manufacturing, pro-growth 
policy agenda that we would recommend to the 108th Congress.
    I would like to summarize emphasizing three major points.
    First, American manufacturers are on the leading edge of 
the most intense global competition in history, which, put 
simply, makes it impossible to raise prices. That means that if 
costs rise for whatever reasons, including congressional action 
or inaction, while we can't raise prices and costs go up, 
something has got to give. Regrettably, in the past 2 years, 
despite the fact that we have the best workers in the world in 
manufacturing, it was the people who make things in America who 
had to give, and they had to give too much as we lost 2 million 
jobs in American manufacturing.
    Second, the overall economy--and, more specifically, the 
manufacturing economy--is growing currently too slowly to 
reverse this trend, far more slowly than in any comparable 
recovery period in the post-World War II era. In fact, the 
recent recession was unique in that manufacturing led into the 
slowdown and currently lags in the recovery opposite from the 
pattern of previous recessions.
    In December of 2000, as the recession in manufacturing 
became apparent to us, the NAM called for pro-growth policy, 
including pro-growth tax relief. Now that the manufacturing 
slowdown has proven so durable, we repeat the call more 
urgently than ever, in the conviction that manufacturing 
remains central to the strength of the American economy and its 
prospects for future economic growth and as central to our 
national security as to our economic security.
    Third, Mr. Chairman, there is a need to look at obstacles 
to growth. I have in mind among them the well-documented burden 
of excessive regulatory and legal compliance costs which 
together accumulated to an estimated $700 billion last year. On 
the regulatory side alone, these burdens tend to fall 
disproportionately on manufacturers, so much so that the 
regulatory costs per worker in manufacturing is estimated at 
$8,000 per employee, about two-thirds more than the burden on 
it per employee in the general work force. While the costs of 
the legal system are borne broadly throughout the country, 
there is one egregious example: the asbestos litigation 
crisis--it is a scandal, really--that has fallen especially 
hard on manufacturers. I would like to elaborate on this last 
point first and then return briefly to my other two before 
concluding this summary.
    Over its history, asbestos liability has bankrupted more 
than 65 companies, more than 20 of them in the past 2 years. 
Though most of the companies which made asbestos products and 
mined it are in bankruptcy, the list of defendant companies 
continues to grow. A preliminary Rand study last fall offered 
an estimate of 6,000 defendants. Last week, that estimate was 
revised upward by 40 percent. It is now 8,400 defendant 
companies.
    By any common-sense standard, many defendants who were made 
to pay, and sometimes paid to the point of bankruptcy, haven't 
harmed anyone. They are guilty only of being a solvent and 
usually an insured defendant. I have in mind, for one example, 
Mr. Chairman, a small Midwestern manufacturer of industrial air 
compressors. The company employs about 100 workers. Its 
compressors contain no asbestos, and it knows of no way that 
their use could have exposed anyone to asbestos. Yet they have 
been sued in multiple cases in multiple courts. And, worse, as 
for the plaintiffs, by any similar common-sense standard most 
of them aren't sick. Again, Rand estimates that anywhere from 
two-thirds to 90 percent of all claimants are ``functionally 
unimpaired, meaning that their asbestos exposure has not so far 
affected their ability to perform activities of daily life.''
    What we have, Mr. Chairman is a massively dysfunctional 
system that forces many companies in cases where they aren't 
liable to compensate people who aren't sick. That dysfunctional 
system hurts people. It creates many victims and many classes 
of victims, and first among these victims are the people who 
really are sick. Yet often they are forced to wait for years 
for compensation that is inadequate, and it is inadequate 
because the awards going to people who aren't sick are 
depleting the resources that ought to go to compensate people 
who are.
    To illustrate the dysfunction, there is the case of the 
widow of a shipyard worker, widowed because of his fatal 
asbestos illness. Her only recourse was to sue several 
companies. She reports that most of them filed bankruptcy in 
the past 2 years, and she can expect to receive only a fraction 
of the compensation she might have expected pre-bankruptcy, 
perhaps a few thousand dollars. Contrast that with the 
notorious October 2001 Mississippi case where a jury awarded 
$150 million to six plaintiffs, $25 million each, about whom 
their lawyer boasted that ``Most of these guys have never 
missed a day of work in their lives.''
    As for fairness in that, one member of the asbestos trial 
bar who favors reform, as we do--and there are many of them--
testifying last September before both then-Judiciary Committee 
Chairman Leahy and now Chairman Hatch, concluded by urging 
Congress ``to act quickly to fix this broken and abused part of 
our justice system before the real victims of asbestos lose 
everything.''
    If sick people and their families are the first victims of 
the system, they are not the last. There are thousands of 
economic victims, including people whose jobs are lost or 
threatened, whose retirement savings are depleted, and whose 
communities are diminished and economically shaken by the 
effects of massive asbestos liability burdens that hang over 
the companies they work for. One of the defendant companies in 
the Mississippi case I just mentioned is now bankrupt. Its 
total liability added up to more than the company had made in 
profits in its entire 40-year history.
    Another company saw 42 percent of its market value, $3.8 
billion, disappear in a day because of financial market 
concerns about its asbestos liability.
    Thus far, $54 billion has been spent on this, and several 
estimates of the present and future liability if the asbestos 
litigation system isn't reformed exceed $200 billion and range 
as high as $275 billion.
    The Nobel Prize-winning economist Joseph Stiglitz completed 
an excellent study last year of the economic consequences, and 
particularly on workers, of this asbestos crisis. Put briefly, 
he found that 60,000 workers had lost jobs because of 
bankruptcies; that these workers and their families had lost 
$200 million in wages because of this; and that workers at 
bankrupt companies had seen their retirement 401(k) savings 
drop by an average of 25 percent. When the study was released, 
I characterized its findings to mean that what we have seen so 
far was ugly, and we ain't seen nothing yet.
    Rand, for example, says the eventual costs could exceed 
400,000 jobs, and if the system remains unreformed, the number 
of bankruptcies could grow with concomitant loss of jobs and 
wages, market valuation retirement savings, and community 
economic activity and well-being.
    Mr. Chairman, that takes me back to where I began. The 
overhang of asbestos liability is huge, and it adds to costs at 
a time when we can't raise prices. I have called a $250 billion 
anchor of present and future liability that American industry 
has to drag as it strains to participate in this recovery. What 
we need instead of that anchor is the wind at our backs--in 
other words, more growth. Manufacturing remains today at the 
leading edge of productivity, innovation, and technology. Most 
of the R&D done in America, for example, is done in 
manufacturing. We are challenged as never before--by the 
effects of global and domestic economic slowdown and 
geopolitical certainty, the export-depressing effects of an 
overvalued dollar, the return of double-digit health care cost 
inflation, and other substantial changes.
    Mr. Chairman, a concluding thought. The state of the 
economy is our subject, and we are always in danger of assuming 
too much about its capacity to withstand such problems and 
costs as the asbestos crisis represents because--well, because 
it has withstood so many challenges in the past and continued 
to grow despite them and to prevail in global competition. The 
cumulative weight of these problems can overwhelm even a $10 
trillion economy and sorely test even the considerable 
strengths of modern American manufacturing. This Congress could 
make a good start at dealing with them and invigorating 
economic growth by passing tax relief of the sort proposed by 
President Bush, which the NAM strongly supports, by 
constraining Federal spending, by doing no harm when it comes 
to adding regulatory and other costs to the conduct of business 
in America, and at long last, by responding to repeated urgings 
from the Supreme Court and elsewhere with a solution to the 
asbestos litigation nightmare.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Baroody follows:]

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    Chairman Nickles. Mr. Baroody, thank you very much.
    Our next witness we have is Mr. Gene Sperling. I think most 
of us know Mr. Sperling. We had the pleasure of working with 
him during his role advising the Clinton administration. He was 
the White House National Economic Advisor, and he also served 
as Director of the National Economic Council. Currently, Mr. 
Sperling is a senior fellow for economic policy and Director of 
the Center of Universal Education at the Council on Foreign 
Relations.
    Mr. Sperling, welcome.

STATEMENT OF GENE B. SPERLING, FORMER NATIONAL ECONOMIC ADVISOR 
         AND DIRECTOR OF THE NATIONAL ECONOMIC COUNCIL

    Mr. Sperling. Thank you, Mr. Chairman, Senator Conrad, the 
rest of the Committee. I will do my very best to summarize my 
remarks, my testimony; if I read it, I would probably go longer 
than President Bush did last night.
    Chairman Nickles. Thank you.
    Mr. Sperling. I really want to focus in on two things, 
which are: one, what I believe is the short-term economic 
policies we need to stimulate demand and restore growth; and 
then, second, why I believe that the long-term focus on fiscal 
responsibility is an essential component to growth in the 
degree that it increases savings and capital and, I believe, 
leads to the type of sustainable growth and virtuous cycle that 
I think our country benefited from in the 1990's.
    Let me start on the need for economic stimulus. There are 
several things Mr. Malpass said that I agree with. Consumers 
unquestionably were the economic hero in 2001, I think for a 
variety of reasons. I think the significant income gains that 
we have seen in the last half of the 1990's and productivity 
have carried through. I think people saw their housing values 
staying high, and so I think there is no question that the 
consumer response was stronger than anyone expected. I also 
agree with him that outside of construction, aircraft, and 
telecom, there were some industries that certainly moved into 
growth on the investment side.
    The reason why I disagree, though, about the need to have a 
sharp degree of demand stimulus right now is that, one, I 
believe that for us to count on that consumer demand being 
there would be very unwise. Help-wanted index, at a 40-year 
high; we have lost 2.35 million private sector jobs in the last 
2 years. Yesterday the consumer confidence went to its lowest 
level since November 1993. In other words, consumer confidence 
is lower today than it was in September and October of 2001 
after 9/11. In terms of investment growth, some companies 
certainly--industries are picking up, but look at a Business 
Council survey that showed that 78 percent of major companies 
are planning on reducing or maintaining their investment 
levels. Capacity utilization stays at 74 percent, 61.7 percent 
in the high tech. So I think that we do face a far greater risk 
of a negative downturn in which the perception of less demand 
could keep more companies sitting on the fence, and that this 
could lead to a negative cycle. So, in a sense, when one 
supports stimulus, one supports essentially an insurance policy 
against that type of negative cycle downward.
    Now, I believe if you are going to do a stimulus, it should 
really have two fundamental principles. I respect those who 
disagree that you need any kind of stimulus. If we are going to 
talk about that, it should be about how you inject as much 
demand as possible into this period of time when we fear weak 
demand will lead us in this downward cycle. Therefore, you 
fundamentally want to do a ``bang for the buck'' test. How much 
of the stimulus is likely to inject more consumer spending and 
business spending in the time that we are trying to focus on? 
So, therefore, my test has been how strong is the ``bang for 
the buck'' analysis and how much can we do this without having 
long-term costs on our deficit in the long term.
    Now, my opinion is that so far we have not served our 
country well with the forms of stimulus we have done. If you 
look at the consumer demand elements, we did get an advance of 
the 2001 tax cut at the 10-percent level into the fall of 2001. 
We left out the 34 million families at the bottom who would 
have had the highest propensity to spend. While, Chairman 
Nickles, I congratulate you and Senator Clinton for making 
progress on unemployment, the people who get unemployment 
insurance are among those most likely to spend a high 
percentage of their funds and in the communities hardest hit. 
So, again, I don't think we have served the country well with 
the types of stimulus that we have done so far.
    Second, on the business incentives, the goal on the 
business incentives for stimulus, as opposed to our different 
strategies for long-term growth, is to take measures that 
accelerate investment into this time period. Therefore, I 
supported having a very strong, 40-percent depreciation bonus 
last year, but just for that year. What we passed was a 30-
percent depreciation bonus, but it lasts for 3 years. That is a 
little bit like a store saying we have a special deal this 
weekend, 50 percent off; oh, but, by the way, you can get the 
same deal 2 months from now, 2 months after, 2 months after 
that. Nobody would rush to the store to buy in that 
circumstance.
    What we wanted to do was say to those companies who were 
sitting on the fence, we want you to accelerate your investment 
now, and so in doing that you offer temporary incentives that 
makes companies feel that they need to accelerate investment up 
in addition. Again, by doing a 3-year plan, we encouraged 
anybody sitting on the fence to keep sitting on the fence, 
because you could get the same incentive in 2004 that you could 
by accelerating investment right now. Again, I don't think we 
have served our country well because we have not seen, I think, 
the effectiveness of that stimulus.
    Finally, we heard warnings from both Democratic and 
Republican Governors that States were hurting. Now, just from a 
simple point of view, $1 of stimulus at the Federal level will 
be canceled out by $1 of tax increases or spending cuts at the 
State level. So it has not made sense for us to have a plan 
that did not deal with the State contraction that they are 
going under.
    Now, let me stress, I am not for a complete bailout of 
States. I think that would create a moral hazard situation. I 
think you want States to feel that they are not going to be 
fully bailed out when they run through the rainy-day funds. 
Again, I believe we could be doing significantly more without 
coming anywhere near that problem, especially in light of the 
fact that States are facing the additional challenge of 
homeland security.
    So, quite simply, as my testimony says, I think that we 
should focus on consumer demand that is highly targeted to 
getting spending out in 2001. I think we should assist the 
States. I think the business incentives should be temporary. I 
would recommend that the Administration and Democrats 
compromise on a plan that is limited to costs in 2001--excuse 
me, 2003, that doesn't have long-term costs, but you could take 
a mixture of Democratic ideas and things like increasing the 
child tax credit or expensing, as President Bush proposed, but 
limit the cost to 2001. Now--excuse me, 2003.
    Now, I think going to our long-term situation, one of the 
great debates that we are having right now is on what should be 
the importance of long-term fiscal discipline. If I was 
speaking earlier, I don't think I would have to even start with 
this case. In the mid-1990's, we debated how to balance the 
budget, how to have fiscal discipline, not whether it matters 
economically. In the late 1990's, there was a bipartisan 
agreement that the Social Security surpluses should be 
fundamentally saved.
    I want to just kind of mention why I believe the seven 
reasons that fiscal discipline should be very important, and as 
I look at my clock, Mr. Chairman, I realize that I am going to 
have to go briefly.
    No. 1, fiscal discipline was fundamental to the increase in 
national savings in the 1990's. Our private savings rate, 
regardless of whether it is calculated right, certainly moved 
in the wrong direction. The full increase in our net national 
savings came from the improvement in our Federal fiscal 
position. All of our national savings improvement came from 
fiscal discipline.
    Second, the fiscal responsibility promoted a strong long-
term investment climate through low interest rates and 
increased confidence. As Harvard's Martin Feldstein said, ``An 
anticipated future budget deficit means a smaller amount of 
funds at the future date to finance investment in plant and 
equipment. Restricting that investment will require a higher 
rate of interest.'' I think that the point that we have to 
focus on, and which Peter Orszag and Bill Gale have done so, is 
what is the impact of anticipated deficits on interest rates. A 
company that is going bankrupt on asbestos may not see their 
stock value go down dramatically the day somebody walks in to 
file the papers. I guarantee you the moment that markets 
anticipate the expectation that the company may be going into 
bankruptcy, I guarantee you their stock market goes down. 
Therefore, one has to analyze what is the expectations of 
deficits on long-term interest rates, and their study says that 
when you look at that, you find 92 percent of studies do show 
this very strong link.
    Let me mention a couple of final things, as I am running 
out of time, which is, one, the question has been raised: Do 
surpluses create growth or growth create surpluses? That is the 
wrong question. The question is: What is the best fiscal policy 
that encourages a sustainable degree of economic growth in 
which, as the economy heats up and there is a greater demand 
for capital, we do not hit the wall of inflation or capacity, 
but we continue to have an environment that seeks additional 
investment? The magic of the 1990's, the virtuous cycle, was 
that as the economy strengthened, the improvement in the fiscal 
situation created more capital and savings for the private 
sector. Instead of crowding out the private sector, as Senator 
Conrad fears, we actually crowded in more capital by paying 
down the debt. That should be our question: Which are the 
policies that lead to greater fiscal--lead to great sustainable 
growth?
    The last point I want to make is one that I think is missed 
much too often. I heard the OMB Director say yesterday that 
with the stimulus policies the Administration is proposing, the 
deficit may be $300 billion, and that that is OK because that 
is within 3 percent of GDP. I agree that temporary deficits to 
stimulate the economy, and particularly to fight a war, is 
justified. I also agree that if you can keep it at a relatively 
low level of a couple percent of GDP, that is a good place to 
be. The only reason we are in that position is because of the 
policies of savings surpluses from the late 1990's. Had we just 
been in a position of projected balanced budgets in 2001 and 
2002, the deficit for next year would be projected to be $600 
to $700 billion. It would be the largest deficit even as a 
percentage of GDP.
    So our lesson today should be that rainy days do come. You 
do need to stimulate the economy. You do need to face war. That 
is all the more reason why the long-term fiscal discipline, 
once we get out of this period of economic weakness, is 
justified.
    I clearly have much more to say, Mr. Chairman, but I fear I 
am already over the allotted time. So thank you.
    [The prepared statement of Mr. Sperling follows:]

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    Chairman Nickles. Mr. Sperling, thank you very much, and to 
all three of our panelists, thank you, and I appreciate your 
respect for the Committee's time. We have several members that 
wish to ask a few questions, and I think all of you will have a 
chance to add additional comments during the question and 
answer session.
    I might want to mention, I should have mentioned it before 
Mr. Baroody made his speech or comments. One of the reasons why 
I requested--I still wear a manufacturer's hat on occasion. I 
came from the private sector. I look at the economy as a great 
engine that is able to overcome and has overcome a lot of 
obstacles in the past. There are a lot of things that can 
impede economic growth. I used to hire a lot of people in the 
private sector. Excessive taxation can impede your ability or 
willingness to grow, but also can excessive regulation and also 
excessive litigation. One of the reasons why I requested Mr. 
Baroody is because I am very concerned, maybe even--you know, 
we are going to have a significant discussion and debate in 
this committee, in the Finance Committee, and on the floor of 
the Senate about what the size, scope, duration of the growth 
package should be. How much of it should be up front? Very 
legitimate question. Those are all good questions. Good, frank 
discussion. Then how do we put it together?
    I think the President has a very good package. If I was 
drafting it, I probably would have put something a little 
different. Being a manufacturer, I like expensing. I want to 
recoup that investment as rapidly as possible. I would like to 
depreciate things in the year that you write the check or 
shorten the depreciation cycle as much as possible. Or maybe if 
you are going to do--and, Mr. Malpass, you don't need to get 
me--I have a list. My staff has done my work. I have the list, 
and the United States is the second highest to Japan on taxing 
corporate dividends, second highest in the world, if you add 
corporate tax and the tax on consumers, the effective rate of 
70 percent, only Japan is higher. Now, that is not good, not if 
you want to encourage investment and have earnings distributed 
to owners. It is just bad tax policy.
    There are different ways of fixing that. One way of fixing 
it would be to allow the corporation to deduct the dividends. 
That would be my preference. It is probably more expensive. 
Those are things that are probably more efficient. So those are 
things that we will have to weigh not only in this committee 
but also in the Finance Committee.
    One of the things I wanted to do, I want this committee to 
think broad. When we are talking about growing the economy, it 
is not just how we make a few little changes in tax policy, but 
also are there some things on the regulatory side or the 
litigation front? I am very concerned from a manufacturing 
standpoint they are probably more concerned about asbestos' 
potential liability than they are tax cuts or taxation of 
dividends, probably much more concerned, because one can be a 
fatal blow.
    Mr. Baroody, I think you mentioned that there were 60,000 
jobs lost and a potential to lose another 300,000 or 400,000. 
Is that correct?
    Mr. Baroody. That is correct, sir.
    Chairman Nickles. Well, that is staggering, because we are 
talking about jobs. You are talking about in most cases, I 
would think, jobs that pay pretty well. I am concerned about 
the loss of manufacturing jobs in this country. We have had 
growth in a lot of sectors. Manufacturing is not one of them. 
So I mention that.
    I am going to ask all of our colleagues, myself included, 
to adhere to a 5-minute time limit if they would so we can make 
sure that colleagues don't have to wait too long, and we will 
do it by order of appearance. First I will call on my colleague 
Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman, and thanks for the 
comments. Thanks to this panel of witnesses. I thought they 
were excellent and very interesting.
    Mr. Malpass, in your testimony that appears on page 11, 
there appears to me to be a contradiction, and maybe you can 
help me understand why you don't see it that way. You say 
there, ``I expect long-term U.S. interest rates to rise during 
2003, but not because of increased government borrowing. 
Rather, the private demand for credit should rise as the 
expansion gains traction, putting upward pressure on interest 
rates.''
    It would seem to me that you are saying increased demand 
for private credit puts upward pressure on interest rates. Why 
not increased demand from the governmental sector for credit? 
Why doesn't that put upward pressure on interest rates as well?
    Mr. Malpass. Part of that is the magnitude. The total debt 
in the U.S. is $20.4 trillion of which the Government portion 
is only $3.7 trillion. So as private demand goes up for credit, 
that is simply a bigger chunk.
    Another way to look at this is U.S. Government debt versus 
the $8.3 trillion issued by the other six major issuers of 
Government debt. Even though we do have a big national debt, it 
is small relative to what other countries are issuing.
    The U.S. is at a debt-to-GDP ratio of 34 percent now. The 
contemplated fiscal deficits, are simply not large compared to 
the other demands. There is a statistic----
    Senator Conrad. Let me ask you----
    Mr. Malpass. Yes?
    Senator Conrad. Let me ask you, if I could, I understand 
the point that you are making, but it would seem to me that you 
are making the point that increased demand for private credit 
puts upward pressure on interest rates even though the 
governmental sector is smaller in terms of outstanding debt. 
Nonetheless, an increasing demand from the public sector would 
also have the effect of putting upward pressure on interest 
rates, would it not?
    Mr. Malpass. Actually, no, sir, and I am not sure if I gave 
a complete answer before. There is a concept in economics 
called real interest rates or the real return on capital. 
Excluding inflation, it is the return on capital hurdle that 
you have to meet. As the economy begins to grow, then people 
want to put their money in faster-growing investments. That 
raises the real interest rate within the economy. As the 
private sector begins to gain traction, what you are going to 
see is real interest rates going up, meaning people have other 
alternatives for where they can put their funds. That is simply 
not the same effect as what you would get from a fiscal 
deficit.
    Senator Conrad. Mr. Sperling, maybe I could turn to you. I 
must say that logic eludes me. It seems to me that to whatever 
extent either the private sector is going and increasing its 
demand for credit or the governmental sector increases its 
demand for credit, both of those put upward pressure on 
interest rates. Mr. Sperling, I would ask your evaluation of 
that question.
    Mr. Sperling. Senator, I guess I would share more your 
perspective. Nothing about capital repeals either the law of 
supply and demand or the law of fungibility. The question is--
and I think this is the right way to think about it--that when 
the private sector goes into our capital savings, when the 
private sector looks for capital to borrow, to invest for 
productive growth, is there a greater supply of capital 
available to them because the Government is paying down debt, 
or is there less capital available to them because the 
Government is crowding out?
    If the Government is essentially borrowing, we are reducing 
the supply of capital for a given amount of demand. Basic 
economics would suggest that in that situation the cost of 
capital, which is measured in terms of interest rates, would go 
up. There is nothing to suggest otherwise.
    One of the things that I try to say in my testimony is that 
this perception, this argument that the amount of deficits 
increase interest rates is not one I learned on the Democratic 
side. I learned it from listening to Republican CEOs in the 
1980's. That is where I learned the phrase ``crowding out.'' 
What I list in my testimony is the past language of Michael 
Boskin, of Martin Feldstein. So that really supports this basic 
supply and demand.
    There is even another element, which is, to the degree that 
you fear that there will be increased deficits in the future, 
you have a degree of uncertainty that would make a borrower ask 
for a greater risk premium and could also raise deficits 
higher. So, you know, I think that the sentence that you 
referred to there is exactly the point, which is that as the 
private sector asks for more funds, as the economy strengthens, 
interest rates will go up because there will be less capital. I 
do point you to an analysis from Goldman Sachs on April 14, 
2000, that I mentioned here, where they suggest that the swing 
in the deficit during that period of growth kept interest rates 
200 basis points lower. So according to Goldman Sachs, because 
the Federal Government, as opposed to borrowing $200 billion, 
was paying down $200 billion in debt, that $400 billion swing 
was responsible for up to 200 basis in lower long-term interest 
rates, and that is the type of--therefore, leads to the type of 
sustainable long-term investment climate that I think we all 
would like to promote.
    Senator Conrad. My time has expired.
    Chairman Nickles. Senator Conrad, thank you very much.
    Next I will call upon Mr. Enzi. I am going to step out for 
a moment, but after Senator Enzi is finished, I believe Senator 
Corzine would be next. Senator Enzi, if you would please chair 
in my absence, I would appreciate it.
    Senator Enzi. Thank you, Mr. Chairman. I want to express my 
appreciation for having the opportunity to serve on this Budget 
Committee. As a long-time accountant and small businessman, 
this is really the first opportunity I have had in the Senate 
to deal with numbers. I find it very exciting. I understand the 
critical role the budget plays in today's economy, and I 
welcome the challenge of creating a budget that is fiscally 
responsible.
    I note this committee has a tremendous amount of power. It 
develops the foundation for the work of the Senate, and I 
appreciate your being the Chairman. Further, I appreciate the 
conversations and meetings we have already had and I believe we 
are moving in the right direction.
    Chairman Nickles. Well, we welcome you to the Committee.
    Senator Enzi. Thank you. I earned an accounting degree at 
George Washington University here in the District, and as a 
result, there was a tremendous immersion in governmental 
accounting. Given that knowledge and valuable experience I have 
to say that, while we are tromping on corporations for bad 
accounting, we really ought to be embarrassed about the 
Government. This isn't working at all like the textbooks. 
[Laughter.]
    Senator Enzi. Of course, I am not saying the textbooks were 
flawless either. I think there is a lot of room for 
improvement.
    I had the opportunity over New Year's to go down to Brazil 
to witness the inauguration of the new President. To meet with 
him and several members of his cabinet. I was shocked to find 
out they consider their government a leftist government. They 
don't define politics as conservative or liberal, that sort of 
thing down there. Of course, when I had an opportunity to ask 
the President what the main goals of their government is, he 
said the number-one goal was balancing the budget. The number-
two goal was to try and get government to the lowest level 
possible, to that closest to the people. Finally, the third was 
to reduce bureaucracy. That sounds pretty conservative to me.
    They have a whole different understanding, a more 
comprehensive understanding than we do of the importance of 
balancing a budget down there. They can see how it affects 
their economy, and we ought to be able to see that, too.
    When I came 6 years ago, we talked about balancing the 
budget, and we did a balanced budget constitutional amendment 
debate. We didn't pass that, but the American people held our 
feet to the fire and said balance the budget. We got the 
message, even though we didn't get the constitutional 
amendment. We balanced the budget and we did that for quite a 
while.
    However, in recent years, we have started spending more. I 
think the worst word in the American dictionary is probably 
``surplus,'' surplus when you have a huge debt. Apparently, 
surplus means you can spend a lot. We did began spending. We 
avoided that balanced budget, and the economy went down. I do 
think there is a relationship there.
    Now, to get to my questions, Mr. Baroody, you mentioned a 
lot about asbestos. What are you suggesting as a solution to 
the asbestos problem?
    Mr. Baroody. Senator Enzi, the Asbestos Alliance, which the 
NAM leads and is comprised of now more than 150 organizations, 
most of them companies but some other associations, has for 
some time been urging on the Congress consideration of 
legislation that in its essence would establish in law medical 
criteria that would encourage if not require that the courts 
make the vital distinction they are not now making, namely, 
between people who are sick and deserving of compensation and 
people who are not sick.
    The corollary to that would be to take the latter group, 
the people who are not currently sick, even if they can propose 
evidence of exposure to asbestos, which a lot of us can do, and 
suggest that the statute of limitations be tolled, so that if 
they should subsequently become sick, they haven't forfeited by 
artificial deadline in the law the opportunity to seek 
compensation subsequently.
    There are other aspects to the legislative ideas we have 
urged on the Congress, but the essence is that medical criteria 
approach.
    Senator Enzi. Thank you.
    For each of you, again, referring back to my comment about 
a balanced budget and the inability of Government to spend a 
country into wealth, a proposal that keeps coming up is for 
giving $150 or $300 to everybody in the country. Isn't that a 
rather small level even for those at or below the poverty wage? 
So how much of an impact will that have? Is that the best way 
for us to go? Let's start with Mr. Malpass.
    Mr. Malpass. For a lot of people, $100 or $300 is 
significant, and so I don't want to dismiss that as a 
generosity by the Federal Government. I guess the issue is 
whether you create more jobs and long-term growth by having the 
Government take money from the people and then give it back to 
certain people. That is a redistribution of income. You tax 
from one group and then you give back. In fact, we have huge 
transfer programs which have that effect. It is part of the 
progressivity of our system.
    One of the debates that is going on right now is simply 
what will be the first quarter or the second quarter growth 
rate if we gave $300 to everybody in the country. I think that 
we just wouldn't see that much impact because a lot of the 
people that get that money would figure out that in the end the 
Government was going to get it back from them. So they might 
spend a little of it and save some other part of it, and we 
wouldn't have accomplished anything in terms of changing the 
growth incentives for companies to be created, to hire workers 
and make long-term growth.
    Senator Enzi. Mr. Sperling?
    Mr. Sperling. Thank you, Senator. As to your direct 
question, I think that the idea is and the relation to growth 
is that if you get too many companies sitting on the fence, 
essentially they are looking out and not seeing many people 
spend. Then it is understandable that they don't want to invest 
or hire more people now. The more they do that, the weaker 
consumer confidence gets, the less people spend, and you get a 
more negative cycle. So that is why I think as an insurance 
policy injecting money into people who are likely to go to the 
store, spend it, so that it might at least convince some 
companies to not do further layoffs and hopefully get people 
expanding again makes sense.
    In terms of the question of the impact and the balanced 
budget, this is how I would look at it. When you are trying to 
stimulate the economy, I think you could make a good case for 
doing more, Senator, than that amount. So, for example, I think 
one could go higher in your tax cut for families to help 
stimulate the economy now. I would not make--but I think when 
you extend that, then you have to deal with the benefits of 
that versus the negative costs that you mention of moving away 
from balancing the budget, because tax cuts or spending will 
both likely have a negative impact on the long term, which is 
why, if I could be bold enough to say where I would be, I think 
a good compromise for this Congress would be to take some of 
President Bush's ideas to give people closer to--families 
closer to $1,000 this year to help inject more spending into 
the economy right now when we need it, but just make it a 1-
year plan. Let's get that done quickly when we need it now. 
Then we all have these major debates on dividends, long-term 
tax cuts. Some of us would like to freeze some of those things. 
Let's have that debate later. Let's not have those debates 
about the long term hold us from injecting something into the 
economy right now that could help stimulate demand and make 
sure we don't fall into a negative cycle.
    Senator Enzi. Again, I have to apologize to Mr. Baroody, 
but I have used up my time.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Enzi. I truly appreciate 
this discussion. I think this is the heart of the issues that 
need to be debated with regard to how our Government interfaces 
on economic policy. I am a big believer that national savings 
actually ends up driving investment and we ought to do those 
things that improve that. I come down on the side of thinking 
managing our Federal deficit over a cycle toward balance is the 
best way to improve particularly private sector investment, and 
we need to address that. I appreciate the discussion we had 
about the interaction of particularly Mr. Sperling's 
interaction of growth and our economic situation, the Federal 
and State budgets. I think to talk about $90 billion worth of 
deficits at the State level and talking about growth programs 
or stimulus programs that ignore that I think are very weak.
    What I would--since the heart of the proposal on the table 
for growth--I guess we are not using the word ``stimulus''--is 
the dividend exclusion. I would like to poke around a little 
bit on that.
    Am I not correct, David, or any of the witnesses, isn't 
valuation of most companies driven by net free cash-flow? Isn't 
that the basic theory of how we get to----
    Mr. Malpass. I will go along with that.
    Senator Corzine. I would like to understand how it is that 
when we take cash off the balance sheet of corporate America at 
a period in time when we are not seeing strong investment, that 
we think that is somehow or another is going to encourage 
growth or stimulus. One might argue, no matter how you felt 
about double taxation on dividends, that potentially you would 
want to have the dividend potentially deducted at the corporate 
level to deal with the interest issue, but you wouldn't want to 
take cash off a balance sheet if you are trying to grow 
companies. When you go to a bank, you have to put down a 
margin. When you hire people, you have to pay them. You have to 
have cash to be able to do that. It seems to me that when we 
see these economic models show a slow to limited growth even by 
the President's projections, I think what we are actually 
seeing is a robbing of cash off the balance sheets of 
companies. This is a pretty dangerous thing to do in a period 
of slack growth.
    Mr. Malpass. I don't think I agree with that way of 
thinking about it. Let me see if I can state my view on it.
    Right now, if a company has retained earnings or, over its 
life, is going to earn money and create retained earnings, 
there is a wedge between that company and the shareholders. 
There is a toll gate. If you want to give the cash to the 
owners of the company, you have to pay a hefty tax to the 
Government.
    That blocks the turnover of capital within the economy, so 
you have a lot of companies that really don't need the cash. 
The logical thing for them to do is give the cash to the 
shareholders who can then reinvest it somewhere more 
effectively. That can be achieved by lowering the toll on the 
capital.
    As far as free cash-flow, if you lower the double taxation 
of corporate earnings, which I think is an onerous burden right 
now, you get a lower cost of capital and a better distribution 
of capital within the economy. You get companies that don't 
need the cash giving up some of their cash to companies that 
can have a higher return on investment from that new cash.
    Senator Corzine. How does that connection work? I mean, is 
there any kind of certainty that the cash that Microsoft gives 
up on its balance sheet is going to go to someone that is going 
to have a higher rate of return on capital in that? Why is that 
stimulus or growth in any kind of short-term period of time? 
Isn't it really the judgment about what the internal rate of 
return would be available on various investments that that 
company has?
    Mr. Malpass. As we think about the late 1990's, I think one 
of the things that happened was a bubbling in Nasdaq. Part of 
that was because companies had every incentive to keep all the 
cash and go make acquisitions, even at very high prices. If we 
had had a cheaper method of distributing cash to shareholders, 
I think you wouldn't have seen some of those decisions made. 
Some of the acquisitions were simply made because the 
corporation had excess cash. They knew they were not supposed 
to give it to shareholders because that subjects it to extra 
taxation. So they acquired some other company.
    Senator Corzine. I don't think the technology industry or 
the folks that were creating software and all of the 
productivity growth would argue that their choice was holding 
it back for their own purposes or even in mergers. It was 
really to reinvest back into the growth in the economy. 
Objectively, I certainly hear that. I heard certainly here the 
principle of holding cash as the basis of investing.
    Mr. Malpass. Double taxation also causes unwise investments 
by companies. Every day a company is making a decision how much 
to invest in R&D. They have a choice: Should they dividend the 
cash or should they hire another scientist to try to invent 
something new? With the toll gate that we have right now, there 
is really no logical or rational way that the company can make 
that decision accurately. They are inevitably going to pay 
lower dividends. It stagnates the rotation of cash within the 
economy to have this toll gate.
    Senator Corzine. As you know, by the way, just on a factual 
basis, only about 50 percent of reported corporate earnings are 
taxed. The beneficiaries, when you use a divided exclusion, 
even by your own numbers, 50 percent of the American people 
have no participation in dividends. If you then look at IRAs, 
401(k)'s, tax-exempt pension funds, you get the number of 
people actually benefiting from this so-called savings of 
double taxation down to about a quarter of the population of 
supposed dividend beneficiaries.
    Mr. Malpass. I do think it would change the capital 
structure and the distribution of taxation. We will see 
rotation within the equity ownership. I think what you gave 
there was somewhat of a static analysis. I think people who 
ought to own dividend-yielding stocks will rotate from less 
wise investments into wiser investments. I think you will get 
an efficiency gain within the economy simply from the rotation 
of ownership.
    Right now a lot of people make investment decisions--you 
have to--on an after-tax basis. The double taxation of 
corporate earnings right now drastically distorts the decisions 
made on which stocks people own and how much cash a corporation 
holds.
    Senator Enzi. Senator Bunning.
    Senator Bunning. Thank you very much. I have an opening 
statement. I would like to ask unanimous consent that it be put 
into the record.
    Chairman Nickles. Certainly.
    [The prepared statement of Senator Bunning follows:]

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    Senator Bunning. I have a copy of the new CBO baseline 
update, and it shows that by the year 2007, we will be back to 
a balanced Federal budget. Even if the main elements of the 
Bush tax cut were made permanent, and even if the Bush growth 
plan were enacted, it appears that the budget would be balanced 
only 1 or 2 years later, by 2008 or 2009, under the baseline 
scenario. Adding the cost of Medicare expansion, a war, and 
other assumptions, of course, could put this date out farther.
    I would like to ask a related question to the asbestos 
litigation. I understand that approximately $20 billion has 
been paid out by companies for claims and costs relating to 
asbestos litigation and that this number is estimated to reach 
as high as $275 billion. This issue is having an intense impact 
on some of the companies in my home State of Kentucky, with 
companies setting aside vast amounts of reserve cash to deal 
with this litigation. This is cash that could be used to 
improve capacity, grow businesses, and create jobs for 
Kentuckians.
    Could you address the impact that this litigation is having 
on our overall economy? Could you comment on ways that Congress 
can help to mitigate--I know you have commented some--mitigate 
the negative effect of this litigation on the economy as a 
whole?
    Mr. Baroody. Senator Bunning, it is more like $54 billion 
that has already been spent.
    Senator Bunning. $54 billion instead of $20.
    Mr. Baroody. Yes.
    Senator Bunning. Thank you.
    Mr. Baroody. On dealing with the asbestos liability.
    Senator Bunning. What about the estimated reserves?
    Mr. Baroody. The estimated present and future liability 
totals, there are several estimates that exceed $200 billion, 
and $275 billion is a realistic and a reasonable estimate that 
concerns us a lot.
    I have characterized that in my statement as an anchor on 
not just but primarily on the manufacturing economy's ability 
to grow as robustly as we ought to be growing at this stage in 
a recovery. We are doing--the overall economy is doing no 
better than half as well as it ought to be in this stage of a 
recovery, manufacturing even worse.
    The overhang of that liability, the uncertainty that 
attaches to it, the necessity for companies to think about 
establishing the reserves you are addressing, all decrease the 
degree to which companies can be thinking about hiring, 
increasing wages, and making job-creating and productivity-
enhancing investments in both the short and the long term.
    The reason that the National Association of Manufacturers 
is a proponent, as I alluded to in my statement, of the 
President's proposal is that we think it looks both to the 
short and the long term on the tax side. We certainly need--we 
urge the Congress to look at the huge impact in the same terms, 
short and long term, that these inhibitors to growth that I 
have talked about and stressed in asbestos represent. They 
destroy jobs. They dry up the retirement savings of growing 
numbers, thousands and tens of thousands of people around the 
country, and they depress the economic well-being of the 
communities they operate in.
    Senator Bunning. They also put a lot of companies out of 
business.
    Mr. Baroody. That is correct. They throw them into 
bankruptcy.
    Senator Bunning. OK. One other question. The U.S. trade 
deficit is now running close to about $400 billion a year, 
nearly 4 percent of the gross domestic product. One explanation 
for this increase in the trade deficit is the effect of a 
strong dollar--or at least what used to be a strong dollar; it 
is kind of weakening as we go on--on both the price of products 
exported from the U.S. and products imported to the U.S.
    Could you discuss whether the current prices of the U.S. 
dollar are in line with the economic fundamentals? If not, what 
steps should the Government be taking to bring the dollar more 
in line with the global currency markets?
    Mr. Baroody. Senator Bunning, we have spoken out, 
unapologetically, now for a year and a half or more about our 
sense--not that the dollar is strong or weak but that it is, in 
our view, overvalued and that the overvaluation of the dollar 
against all global currencies is having the impact you just 
identified and is contributing to the record balance of 
accounts problems that you identified in significant ways.
    First, the good news is that the dollar has come down in 
its overvaluation against a basket of currencies by about 15 
percent over the last 6 months or so. We are hopeful that that 
will be accompanied--first, that that trend will continue and 
it will be accompanied by growth globally----
    Senator Bunning. Well, but then explain to me why the 
deficits are continuing to accelerate as far as our trade is 
concerned.
    Mr. Baroody. Because that is----
    Senator Bunning. In other words, how much lag time is in 
there?
    Mr. Baroody. Well, we are just beginning to see something 
of a response on exports, and it is not enough yet. That is the 
first answer. There is a lag time. The second is that the 15-
percent recentering of the value of the dollar goes perhaps 
half as far as our sense is that it needs to go. Against some 
of the Asian currencies, there continues to be a mismatch 
between what the market would set as the value of their 
currency relative to ours of 25 or 30 percent. So we have not 
yet seen the effect we call for in terms of revaluing the 
dollar according to market forces. What we have seen, while it 
goes in the right direction, has not been enough, and the lag 
times are just beginning to elapse sufficient that we will see 
some response.
    I would make one other point. You asked what we would have 
done about it. Back in the 1980's, there was intervention on 
the value of the dollar. The National Association of 
Manufacturers is not calling for an overt intervention. We are 
calling for two things: first, that the rhetoric of our 
National Government about a strong dollar make the point that 
what we want--what we view as a strong dollar is one where the 
market sets the value. We have asked for the Administration to 
shift its rhetoric into neutral, is the way I put it. We 
applauded what the President said at the summit last summer, 
speaking about the need for the dollar to be set by market 
values, among other reasons, in the interest of a manufacturing 
recovery and competitiveness.
    We would ask that our Government also encourage other 
foreign governments, including those I pointed to in Asia, to 
cease their own intervention, which tends to keep their 
currencies artificially low and ours artificially high.
    Senator Bunning. Last question for Mr. Sperling and Mr. 
Malpass. I am curious about your views toward capital gain tax 
reform. Do you support lowering or repealing the tax? Would you 
address the impact of capital gains tax cuts or repeal could 
have on the economy in the short term or long term as well? 
Either one.
    Mr. Sperling. Well, I guess the first thing I think we 
would probably all agree on is that whatever the benefits or 
dis-benefits of it, it would not be what you would call a 
stimulus proposal in the sense you are actually trying to 
encourage people to essentially save and invest more.
    There has always been a lot of religion on this issue. To 
me, there is very little to suggest that further lowering of 
the capital gains tax would have any noticeable benefits on our 
economy. As you know, in 1997, we did have a bipartisan 
agreement to lower the capital gains, and we went along with 
that. As you know, President Clinton signed that. I at this 
point would not see a reason to go further.
    My more basic point, sir, is that I think whenever we----
    Senator Bunning. I don't want to interrupt, but I want 
you--what was the spike when capital gains was reduced by 8 
percent in the revenue for the United States Government? There 
was a huge spike. I think it was close to $65 billion.
    Mr. Sperling. Well, Senator, nobody disagrees that there 
was--that the late 1990's were a tremendous economic period in 
terms of revenues coming in and investment. We had the unusual 
situation of the longest expansion in history actually growing 
strong, growth and higher productivity near the end. I myself 
would attribute that more to kind of more sound fundamentals in 
terms of fiscal discipline, I think wise monetary policy, than 
the capital gains reduction per se. The comment I was going to 
make is that I think the important thing when doing tax cuts is 
to calculate in not just whatever marginal incentives they may 
have, but the potential negative impacts that one has from 
raising the deficit, and to make one's calculations in that 
way.
    So, for example, on dividend exclusion, I would think that 
an overall corporate tax reform in which dividends were taken 
care of in a way that did not raise the deficit----
    Senator Bunning. You are not getting to my question. You 
have given----
    Mr. Sperling. I am sorry, Senator.
    Senator Bunning. I asked you about capital gains, and now 
you are on dividend exclusion.
    Mr. Sperling. I am sorry, sir. I do not personally nor do I 
think that many people would attribute the strong increase in 
capital gains or revenues significantly to the cut in capital 
gains we had in 1997.
    Senator Bunning. Thank you.
    Mr. Malpass, do you have an opinion on that? I am finished.
    Mr. Malpass. I think there was a direct effect. As you 
lower the rate of tax on something, you get more of it. If you 
lower the capital gains tax, you are going to get more capital 
gains. That is one of the factors that we saw.
    We saw another example. Congress in its wisdom lowered the 
capital gains taxation on houses in roughly 1997. What we saw 
was the value of houses go up and the number of houses go up. 
The same analogy would apply to equities.
    The value of a given equity is the after-tax value. If you 
lower the capital gains tax wedge that is in there right now, 
the equity market is going to respond favorably to that.
    We are in a situation right now where a lot of people have 
capital gains loss carry-forwards----
    Senator Bunning. I guess we do.
    Mr. Malpass. If you lowered the capital gains tax rate 
right now, the Government wouldn't even lose very much in the 
short run. I think you get even more of a benefit right now 
this year from a capital gains tax cut than you would have, 
say, in the peak period in 1999.
    Senator Bunning. Thank you very much, Mr. Chairman. All I 
can say is that for the first time we have a positive scoring 
estimate on lowering the capital gains tax rate by CBO and OMB.
    Chairman Nickles. Thank you, Senator Bunning. I am just 
looking at the history of capital gains receipts, and it is 
pretty significant increases that happened after the tax 
reduction from 28 to 20 percent. It is also a pretty 
significant reduction in the revenues. Actually, this is 
startling. From 2001 to 2002, revenues on capital gains went 
from 97 to 55. That is a $42 billion decrease and almost a 45-
percent reduction, something like that, very significant.
    Senator Sarbanes. Were the rates increased at that time?
    Chairman Nickles. No.
    Senator Bunning. No. There weren't any profits.
    Senator Sarbanes. The rates stayed the same, so it was the 
economy that did that, I take it.
    Chairman Nickles. Yes, there was a 45-percent reduction in 
Nasdaq in the year 2000 that had something to do with that, and 
I had some of those that crashed as well. [Laughter.]
    Chairman Nickles. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman, and thank you to 
each of you for coming and speaking to the Committee today.
    I wondered, Mr. Baroody, coming from the great 
manufacturing State of Michigan, if we might talk a little bit 
about pressures on manufacturers for a moment. I am proud of 
what we make in Michigan, not just automobiles but 
refrigerators and washing machines and all kinds of things. I 
happen to believe that the economy is based on making things 
and that a manufacturing base is critical to the United States 
economy.
    I would agree with you that asbestos is an issue that has 
to be addressed, and I would encourage the Judiciary Committee 
to do so.
    Where would you rank health care costs to your members 
right now as a pressure on your bottom line?
    Mr. Baroody. It is a huge and durable concern that has sort 
of come back with a vengeance, if I could put it that way, in 
the last 2 or 3 years. Increasingly our members, and especially 
our smaller members--the majority of NAM members are small--are 
reporting double-digit health coverage cost increases again. We 
had hoped in an earlier period that we had seen the end of 
that. Unfortunately, we haven't seen it. It is coming back very 
hard, and it is prompting the squeeze I talked about. If you 
can't raise prices but your costs go up, in this case health 
care costs, something has got to give. The response from a 
growing number of our members is that they have had to require 
of their own workers a greater copay, a greater premium share 
if they have any hope of maintaining coverage.
    Senator Stabenow. I am hearing the same thing, and 
nationally we are seeing the average costs of health insurance 
has risen 12.7 percent just in the last 2 years. In talking 
with manufacturers in Michigan, for instance, Daimler-Chrysler 
shared with me that they are now spending more on health 
insurance than they are on purchasing the raw materials for the 
vehicles.
    What was interesting to me is that about half of that cost 
is the explosion in prescription drug prices, and I wanted to 
note that as, Mr. Chairman, you spoke about having the second 
highest dividend taxes, we pay the highest prescription drug 
prices, our businesses and our individuals, of anywhere in the 
world. I would suggest that we have to tackle that. The average 
brand name product is going up three times the rate of 
inflation.
    So when we look at where we ought to be addressing cost 
issues for manufacturers, for other businesses, as well, as you 
said, for employees--they are paying higher copays or maybe 
taking a pay freeze so their employer can maintain their 
insurance policy--this is a huge squeeze both to workers and 
families as well as businesses. I would hope that as we are 
debating what we are doing in terms of the budget and the 
economy that we would include health care costs as a part of 
that.
    I am wondering, we have been attempting to increase 
competition through greater use of generic drugs and other 
opportunities to lower prices, and I certainly would encourage 
the manufacturers to be involved in that debate. I am sure you 
are.
    Mr. Baroody. Yes, ma'am.
    Senator Stabenow. This is a major issue in terms of a drain 
and a squeeze on the economy right now. I would suggest as well 
in terms of double taxation, you have people paying the payroll 
tax, seniors who have paid it all their lives who now are on 
top of that having to struggle with their prescription drugs 
because it is not a part of Medicare. So there are a lot of 
ways in which people are taxed doubly and pressured doubly and 
triply with that.
    I would like to ask about another kind of proposal. I am a 
proponent of doing something immediately. I put in legislation 
last time to create a major bonus depreciation and believe in 
stimulating the economy immediately in terms of investment. I 
certainly want to support efforts to do that. An effort that 
has been supported by the Business Round Table and others has 
been the idea of a payroll tax cut or refund based on the 
payroll tax. I am wondering if the manufacturers have looked at 
that and taken a position.
    Mr. Baroody. Ms. Stabenow, we have looked at it. We have 
not included it in our priority approaches or recommendations 
to this Congress or to the Administration about stimulus--or, 
we think more accurately, the term ``growth''--provisions.
    If you would indulge me, we put it this way: We are not 
sure at the NAM that we or anyone else really knows how to 
stimulate an economy that is this large and this traumatized. 
The effort to accumulate a number of short-term provisions is, 
we think, bound to be complicated and the payroll tax 
provisions would be complicated particularly, again, for a lot 
of smaller employers like our small manufacturers.
    Also, we think that proposals that can promise some short-
term effect and do so in a way that builds toward a stronger 
and more durably growing long-term effect are the ones we would 
prefer. That is why we are so enthusiastic about marginal rate 
cuts as opposed to temporary provisions to try to put--to 
accelerate demand by putting money immediately in people's 
pockets.
    That is also why we did favor and recommended an end to the 
double taxation of dividends. Frankly, we would have preferred 
it on the corporate side and have done a lot of analysis over 
the years indicating to us that that could have a very big 
growth impact if it were enacted. Certainly on the expensing 
side for small manufacturers, we are very encouraged by the 
proposals that I think both parties are talking about in terms 
of increasing depreciation or expensing for small 
manufacturers.
    When we looked at all the possible proposals, we ended up 
prioritizing first the three provisions I just talked about--
end of double taxation, acceleration of marginal rate cuts, and 
something to spur business investment over a longer period of 
time than just 1 year--rather than looking at the payroll tax 
provisions or ideas that others have talked about, including 
the BRT.
    Senator Stabenow. Mr. Sperling, would you like to respond 
to the proposal I know that has been introduced in the Senate 
relating to payroll tax really both for business and for 
workers?
    Mr. Sperling. As I said, I think that as an insurance 
policy there is adequate justification for a one-time injection 
of funds. It is a stimulus policy. I have in the past hoped 
that such could have been timed in 2001 and 2002 with the 
Christmas shopping season where I think people would be more 
likely to take their check and spend it, and perhaps had we had 
that, it could have prevented us from having the weak Christmas 
shopping season we did.
    I think the level--I think it becomes highly complicated, 
however, to actually try to month by month change withholding. 
So my belief would be that it would be better to do it as a 
single rebate check off last year's payroll. I personally would 
limit it to the employee side so that it would be more focused 
on getting demand going. That is where I believe we have our 
greatest weakness.
    I guess my final comment, which I was trying to make 
before, is that whenever we judge these tax cuts, we do have to 
look at the full--you know, Chairman Nickles talked about you 
have to look at the full picture. The full picture is simply 
that you have to recognize that there are positives, perhaps in 
demand, perhaps longer-term work incentives, but there are also 
negatives when the deficit rises and we crowd out private 
sector savings.
    In 1997, we did things like capital gains and other things 
in the context of a balanced budget plan that actually 
increased fiscal discipline. So on all of these discussions, I 
would just encourage people not just to look at one side of the 
coin but look at the balance. My feeling is if it is one time 
only and it helps stimulate the economy, it will not have a 
long-term impact, it is worth the risk. When things are going 
to have longer-term permanent impacts on our deficits in the 
decade where we need to be saving more to deal with the long-
term entitlement challenge coming, then I think it is incumbent 
upon us to do a more comprehensive analysis of the benefits of 
the tax cut weighed against the disadvantages of hurting our 
national savings.
    Senator Stabenow. Just a closing comment, Mr. Chairman, if 
I might. I find it so interesting, the debates that we have in 
theory in terms of how to stimulate the economy and how to 
create growth when we have, I would reiterate--and I have said 
this before. We have two examples, actually going on three now, 
of differences, one worked, one didn't. The 1980's was very 
much a supply side approach, relieving those at the higher 
incomes, hoping that will trickle down. We saw massive 
increases in national debt, explosion on interest rates. The 
1990's was different. In 1997, I was in the House when we 
balanced the budget for the first time in 30 years, a focus on 
slowing spending, on balancing the budget, paying down the 
national debt, and focusing on education and innovation 
spending.
    Now we are back to policies that look more like the 1980's, 
and if this was just a theoretical discussion, I guess it would 
have more impact on me. We have practical realities of what 
worked and what hasn't worked. I would hope that we would focus 
on what has worked because it was very significant in the 
1990's.
    Chairman Nickles. Senator Stabenow, thank you very much.
    Senator Allard, I apologize. I noticed that you came very 
early and then stepped out and maybe got lost in the queue and 
maybe because I stepped out as well. So I apologize for that, 
but you are next and thank you.
    Senator Allard. Well, Mr. Chairman, no concern on my part, 
and I am just glad to be here on the Committee. I apologize for 
having to step out, and I missed the testimony from Mr. Baroody 
and Mr. Sperling.
    I did appreciate the testimony that Mr. Malpass provided us 
with, and you talked about an increase in personal spending. 
The question that came to my mind: What was happening with 
business spending? I had read reports where business spending 
had come down. I didn't see in your comments or the report that 
you were putting here for the Committee where you talked 
anything about business spending. I would like to have you 
comment on that, if you would, please.
    Mr. Malpass. Business spending in the 1990's grew strongly. 
In fact, in some areas----
    Senator Allard. In the recent time period.
    Mr. Malpass. In 2002, we were in a recovery. People are 
often saying that there was simply no business investment going 
on. That is actually not the case.
    There was a crash in aircraft spending. Taking that out, 
almost all other sectors of business equipment saw growth in 
2002. U.S. equipment investment, was $954 billion in the first 
quarter of 2002. That compared to $452 billion for the whole 
European Community. I think it is important that people put in 
perspective the magnitude of the U.S. economy, even in 2002, 
which we think of as a weak recovery. Every quarter our 
investment was roughly double what Europe was doing. That 
really has a powerful implication for productivity growth into 
the future.
    Senator Allard. So the business spending and the personal 
spending, pretty much the same?
    Mr. Malpass. Consumption, unlike previous recessions, 
didn't dip in 2001. Business spending often takes off in the 
second year of a recovery. It didn't do that this time. Overall 
business spending versus a normal recovery was weaker than the 
normal jump.
    Senator Allard. So your conclusion is that we need to do 
something to stimulate some business spending. Is that your 
conclusion?
    Mr. Malpass. Yes, certainly. I would be happy with stimulus 
or growth measures. If you create a good environment for the 
economy, that is a stimulus in the near term because people 
anticipate the better future.
    What I think would be important is to create a good climate 
long term for investment. That is going to cause people to buy 
equipment today.
    Senator Allard. So you are of the view that if we would 
take away the double taxation on dividends, that would be a 
stimulus for business spending.
    Mr. Malpass. Correct. It's both a near-term and long-term 
stimulus. There really is no difference in my mind between what 
is a stimulus and what is a growth-oriented change in the Tax 
Code. They are both going to operate the same because people 
look ahead.
    Senator Allard. Now, I read over the President's proposal 
on reducing the double taxation on dividends. There is a lot of 
paperwork--I see a considerable amount of paperwork that is 
involved because you take how you are going to carry that over 
to the individual stockholders, and if there is--particularly a 
company has said part of it is going to be subject to double 
taxation and part of it will not be on your dividends, then you 
have percentages that have to be carried over into all your 
allocation distributions to your shareholders.
    Do you view that as a significant disadvantage for business 
that they would not respond to that increased recordkeeping 
requirement?
    Mr. Malpass. As you change the Tax Code, there are always 
consequences.
    Senator Allard. Yes.
    Mr. Malpass. Some of them are a 1-month cost in terms of 
programmers.
    As I have heard it explained, the 1099 form that people now 
get can be changed to show tax-free dividends and also deemed 
dividends. What we are talking about is enough computer 
programming so that when you get that year-end statement, it 
shows some additional information.
    Senator Allard. So with the age of computers, you think it 
is a very workable solution then?
    Mr. Malpass. I can't speak for Bear Stearns on that. We are 
a huge paperwork generator. I don't know our position on that. 
I have heard the Administration talk about the paperwork 
requirement, and it sounds to me like it is quite manageable.
    Senator Allard. Yes, OK. I just want to say, Mr. Baroody, 
it is good to hear you say that you didn't want to see a lot of 
intervention on your question here to Senator Bunning about the 
value of the dollar. I am, I think, of like-minded view. I want 
to see the markets carry that value of the dollar. I would just 
add on top of your comment that when our trade deficit has been 
most favorable has been during the Great Depression, and also 
during the end of the 1970's when we had the misery index, and 
that is when our trade deficits were most favorable. I have 
always felt that trade deficits actually reflected the 
condition of the economy, and if the economy was doing good, we 
bought more goods and services, and so our trade deficit would 
change. Could you comment on that?
    Mr. Baroody. Senator, our concern is not so much with the 
imbalances in the deficits. Obviously that is a symbol of the 
concern, but it is much more hard-edged than that. Companies 
which make heavy equipment find that they are at a 10, 15, 25 
percent cost disadvantage with their global competitors for 
only one reason: the imbalance in the dollar.
    Senator Allard. Yes.
    Mr. Baroody. If the market would be allowed to set the 
value of that dollar, that imbalance and disadvantage would go 
away. Our exports would rise. Our exports-dependent employment, 
which are all very good, highly skill-demanding, but highly 
rewarding jobs, would also rise.
    So, yes, we are not talking about some Machiavellian 
intervention. We are talking about letting the market set the 
value of global currencies, including but not limited to the 
dollar. If we do that, a lot of manufacturing's exports 
problems get ameliorated significantly.
    One point. I mentioned the distinction between this 
recession we are coming out of and all the previous ones. 
Contrast it with the one of 10 years ago, similarly 
characterized as relatively mild, and not with the same adverse 
impact on manufacturing I reported to you today. One of the 
reasons was that even during that 1990-91 recession, export 
growth by the United States held up at about 7-percent rates. 
In this recession, export volume actually declined, and we 
think it declined primarily because of the value of the dollar.
    Senator Allard. One more question, if I might, Mr. 
Chairman. Mr. Malpass, you had a question over here from my 
colleague about a refund or some kind of reduction in the 
payroll taxes. Most of the payroll tax is Social Security. That 
has got to have an impact on the Social Security Trust Fund, 
wouldn't you say? So, in effect, we are taking money right out 
of Social Security with that proposal.
    Mr. Malpass. That has been confusing to me. Right now, as 
people pay Social Security tax and their employer pays it, it 
goes into the trust fund. So if there were a holiday, it seems 
as if it would stop the buildup.
    Senator Allard. Have an adverse impact on Social Security.
    Mr. Malpass. So I guess I haven't understood that. From an 
economic point of view, the question is: Will you get much bang 
for the buck out of a short-term tax cut like that where 
everybody knows that the rates are going to go right back up? 
My view is that you won't.
    Senator Allard. Mr. Chairman, thank you.
    Chairman Nickles. Senator Allard, thank you very much.
    Next we have Senator Sarbanes.
    Senator Sarbanes. Thank you.
    Chairman Nickles. Senator Sarbanes, thank you as well for--
how many years on the Committee?
    Senator Sarbanes. I stopped counting.
    Chairman Nickles. Twenty-some?
    Senator Sarbanes. No, I haven't been on it that long.
    Chairman Nickles. Not that long. Well, anyway, welcome.
    Senator Sarbanes. Mr. Malpass, do you support an amendment 
to the Constitution of the United States to require a balanced 
budget?
    Mr. Malpass. Senator Sarbanes, in 1997, I testified on 
that. In my testimony at that time, I went through quite a few 
of the economic issues that I think are important. I don't know 
where I stand right now. I guess my view of this is that is 
very important that Congress restrain the growth rate in 
spending. That is where my focus is right now.
    Senator Sarbanes. At the moment do you support an amendment 
to the Constitution to balance the budget?
    Consistent with your 1998 position?
    Mr. Malpass. I haven't thought about it.
    Senator Sarbanes. You support President Bush's economic 
program, which would increase the deficit. Is that correct?
    Mr. Malpass. I have thought a lot about that. I support the 
program because I think it would be stimulative to growth.
    Senator Sarbanes. It will increase the deficit.
    Mr. Malpass. Well, in the long run, no. It is going to 
reduce the deficit by creating a better capital structure for 
the U.S. I think our focus has to be on how do we get out of 
this debt----
    Senator Sarbanes. Well, will it create a deficit in the 
short run?
    Mr. Malpass. I think it will increase the deficit depending 
to some extent on the growth response that we get in that first 
year.
    Senator Sarbanes. If we had a constitutional amendment 
requiring a balanced budget, as you advocated only a few years 
ago, we wouldn't be able to do President Bush's economic 
program, would we?
    Mr. Malpass. The proposals that were before Congress at 
that time, it seems to me, had exceptions for war and for other 
things. So I don't know--I think the exceptions may have been 
triggered by our current situation.
    Senator Sarbanes. I don't think so, but we can go back and 
check that.
    Mr. Baroody, do you support a constitutional amendment 
requiring a balanced budget?
    Mr. Baroody. Senator Sarbanes, I believe that the NAM has 
had for some time on its policy books support for such an 
amendment. It is not a current category of our--I alluded to 
our pro-growth, pro-manufacturing policy agenda. We don't 
mention that in it and haven't in recent agendas.
    Senator Sarbanes. You support President Bush's economic 
program?
    Mr. Baroody. We do.
    Senator Sarbanes. How would one do that if there was a 
constitutional amendment requiring a balanced budget? You 
wouldn't be able to do it, would you?
    Mr. Baroody. To be candid, Senator Sarbanes, I think you 
may be right, and we haven't thought about that in terms of the 
two together. What we have thought about is our own sense of 
the need for the manufacturing sector to contribute to--excuse 
me, to participate in this recovery.
    Senator Sarbanes. Well, I have been very sympathetic to the 
manufacturing sector.
    Mr. Baroody. Yes, sir, we know.
    Senator Sarbanes. I think it is important now to draw out 
this obvious inconsistency. The NAM, in reacting to President 
Clinton's speech, says, ``The NAM believes that a 
constitutional amendment requiring a balanced budget will 
ensure fiscal soundness,'' and came out in support of it. Now, 
that seems to have gone by the bye, as you have just said. It 
is not really on your current agenda. I am just trying to get 
at the point that what is sauce for the goose is sauce for the 
gander.
    Mr. Baroody. It is a fair point----
    Senator Sarbanes. Mr. Sperling, do you support a 
constitutional amendment requiring a balanced budget?
    Mr. Sperling. I do not support a constitutional amendment. 
I do, however, support Congress through its own mechanisms 
seeking to have the kind of pay-as-you-go standards that help 
lead to balanced budgets and to helping to save for us to deal 
with the long-term entitlement challenge.
    Senator, I think the main point that you are pointing to is 
the most profound. The swing in what was the mainstream view on 
deficit reduction and balanced budgets over the last 2 or 3 
years is profound. As you will recall, in the late 1990's there 
was almost a complete bipartisan commitment not only to 
balancing budgets, as you recall, but to actually saving the 
surpluses that come from Social Security for debt reduction. 
There was significant notions that new programs, however 
worthy, whether prescription drugs or tax cuts, had to have 
offsets that would be consistent within a balanced budget 
structure. I think it will be to our country's great long-term 
disadvantage that we have moved so far away from what was so 
recently a bipartisan consensus.
    Senator Sarbanes. Yes, but that consensus was not on an 
amendment to the Constitution. That consensus was on taking a 
series of measures that would achieve greater fiscal soundness.
    Mr. Sperling. You can see from right now that the balanced 
budget amendment is in some ways too strict, but then not loose 
enough--I mean, but not good enough in some ways in the sense 
you would not want to be constrained in a temporary moment like 
this where you face war or even economic weakness. The balanced 
budget actually only allowed you an escape clause at, I think, 
1 percent growth, and it would be very difficult to tell when 
that was coming. So our view was that Congress, through 
responsible policies, as we saw when there was split Government 
in the late 1990's, was able to achieve that with that 
commitment, but without a constitutional mandate.
    Senator Sarbanes. Now, Mr. Baroody, Jerry Jasinowski, the 
president of the NAM, testifying before the Senate Banking 
Committee last May, said, and I quote him: ``The overvaluation 
of the dollar is one of the most serious economic problems now 
facing manufacturing in this country. It is decimating U.S. 
manufactured goods, exports, artificially stimulating imports, 
and putting hundreds of thousands of American workers out of 
work.''
    I, in fact, agree with this concern of the NAM, and have 
over quite a period of time. The Treasury Secretary nominee 
yesterday said, ``A strong dollar is in the national 
interest.'' When is the NAM going to be able to find some 
important administration support for its concern? It is very 
clear that some of our competitors are manipulating the 
currency in order to gain a trade advantage--I would put China 
forward as Exhibit Number One, but they are not the only ones. 
How are we going to address this situation?
    Mr. Baroody. Senator, first, we are not for a weak dollar. 
We think that the----
    Senator Sarbanes. No, we are not for anything that is weak. 
We can't be for anything that is weak. That is for sure.
    Mr. Baroody. The appropriate term would be ``a market-
valued dollar,'' and we have found some--and I alluded to it 
earlier in the discussion with Senator Allard. We have found 
someone authoritative in the Administration who has articulated 
the same view. I was going to fumble to see if I had the quote 
directly. Forgive me. President Bush, as I alluded, at a summit 
late last summer or early fall, made exactly the statement that 
you and I would agree on, I think, that the market should set 
the value of the dollar and that we must see to that, among 
other things, in the interest of enhancing manufacturing's 
ability to compete.
    Senator Sarbanes. Well, that is what we keep saying, but 
how do you then deal with the problem where you say the market 
is going to set the value----
    Mr. Baroody. Yes.
    Senator Sarbanes. One of your prime competitors is not 
allowing the market to set the value of the currency but is 
intervening in a lot of very shrewd and skillful ways in order 
to affect the valuation and thereby they gain--I forget the 
percentage figure--20 percent, I think you said.
    Mr. Baroody. Well, it depends on the product and the 
country and currency we are dealing with.
    Senator Sarbanes. Right. Well, now how do you deal with 
that problem?
    Mr. Baroody. Good question.
    Senator Sarbanes. You say, well, we don't intervene in the 
market, we want the market to set it. Fine. I accept that. The 
other fellow is intervening in order to affect the valuation. 
Now, how do you deal with that situation?
    Mr. Baroody. Not easily. I mean, first of all, we have 
asked for the Administration, as I have said, to shift its 
rhetoric into neutral. We have insisted we are not asking for 
intervention, but I think the corollary to that--and the 
Administration understands that this is our view--is that if we 
are not going to seek intervention by our own Government and 
currency exchanges, we do want our Government consistent with 
that to speak out against interventions by other countries when 
they do it.
    You are right, people more versed in the currency markets 
than I would tell you that perhaps you could add up three or 
four Asian countries over the last 3 or 4 years and find that 
they have made purchases exceeding $400, maybe even $500 
billion of dollars for the sake of continuing this imbalance.
    We think that the world trade and international investment 
needs to be governed by rules. The WTO provides some rules. We 
want to see through those mechanisms that companies which are 
intervening in this way are powerfully induced to cease so that 
the market can set these rates.
    Senator Sarbanes. Well, that is nice phrasing, ``powerfully 
induced,'' and I accept that.
    Mr. Chairman, thank you very much. I just ought to close by 
observing it is really fascinating to watch those who were such 
vehement advocates of an amendment to the Constitution to 
require a balanced budget--and it extends quite widely, this 
circle having relegated that to the mists of the past as they 
now support substantive proposals from the Administration that 
will, in fact, contribute to the deficit. My own view is that 
we need to run a deficit, at least in the current fiscal year, 
in order to try to give a boost to the economy. So I accept 
that. I am not in favor of building in the long-term deficit 
over subsequent years because I think we ought to wait and see 
and make those judgments as we move into those years in terms 
of the economy in order to try to maintain some semblance of 
fiscal discipline. There are a lot of people around here who 
were screaming only a few years ago to amend the Constitution 
and have a balanced budget, and that is all simply gone by the 
board.
    I thank the Chairman.
    Chairman Nickles. Senator Sarbanes, thank you very much. To 
our panelists, I want to thank you as well.
    We will have our next committee hearing tomorrow morning at 
10 o'clock. We will have Barry Anderson, who is Deputy Director 
of CBO, also as our principal witness. They just came out with 
their budgetary and economic outlook today, so that will be the 
subject of our hearing.
    To our panelists, thank you very much. I think this has 
been very informative and very helpful to us as we try and put 
together a package that will grow the economy. So thank you all 
very much.
    Mr. Sperling. Thank you, Mr. Chairman.
    Mr. Baroody. Thank you, Mr. Chairman.
    Mr. Malpass. Thank you, Mr. Chairman.
    Chairman Nickles. Thank you.
    [Whereupon, at 12:16 p.m., the committee was adjourned.]

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                    THE BUDGET AND ECONOMIC OUTLOOK

                              ----------                              


                       THURSDAY, JANUARY 30, 2003

                                       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. Don Nickles 
(chairman of the committee) presiding.
    Present: Senators Nickles, Domenici, Allard, Sessions, 
Crapo, Ensign, Conrad, Sarbanes, and Stabenow.
    Staff present: Hazen Marshall, staff director; and Cheri 
Reidy, senior analyst.
    For the minority: Mary Ann Naylor, staff director; Jim 
Horney, deputy staff director and Sue Nelson, deputy staff 
director.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. The committee will come to order.
    I want to thank our members. My guess is we will have a few 
more members shortly. I want to thank Mr. Anderson for joining 
us today. I think most everybody around here has had the 
pleasure of getting to know Barry Anderson. I compliment him 
for his many years of service in the fields of budgeteering. He 
has got about 30 years of budget experience and expertise. He 
has worked at the General Accounting Office; he has worked at 
OMB for many years. Since 1999, he has been at the 
Congressional Budget Office as Deputy Director. So, Mr. 
Anderson, we welcome you to our committee again.
    Before we proceed, I think I will call upon my colleague, 
Senator Conrad, for any opening remarks, if any, that he might 
have.

                OPENING STATEMENT SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman.
    I want to echo what the Chairman has said in commending Dr. 
Anderson for his service. We appreciate it very much. We know 
you could have certainly made more money in the private sector, 
but your dedication to public service is deeply appreciated, 
both in the executive branch of Government and certainly here. 
I am reminded that it was 2 years ago that you were here 
testifying on behalf of Dan Crippen, who was the CBO Director 
and who had been injured in a terrible accident. So you were 
here at that time giving us the view that we were going to be 
in this very advantageous circumstance of having nearly $6 
trillion of budget surpluses over the next decade.
    What a dramatic change from those happy days: $5.6 
trillion, we were told, over the next decade in surpluses; now 
with your new report today, down to $20 billion. That, of 
course, is based on no policy changes, no additional spending, 
no additional tax cuts. We all know that the President has laid 
on the table significant changes: additional tax cuts, making 
the tax cuts permanent, his growth package, which is virtually 
all tax cuts, additional spending on prescription drugs and 
Medicare reform. Obviously there will be additional costs if we 
go to war with Iraq. Those are not expressed in the numbers 
that the Acting Director will give us today.

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

    If we take into account those changes, the changes the 
President has proposed in policy, what we see over the next 
decade is not any surplus, not $5.6 trillion, not $20 billion, 
but no surpluses; but instead we would be $1.6 trillion in the 
red.

[GRAPHIC] [TIFF OMITTED] 

    Let's go to the next chart. Frankly, of greatest concern to 
me is that not only do we see deficits as far as the eye can 
see, but if we also take out Social Security, if we are not 
taking Social Security funds and using those to pay for tax 
cuts and using those for other purposes, what we see is really 
an ocean of red ink out ahead of us for the entire rest of the 
decade, deficits that are what I would call ``operating 
deficits,'' a more accurate reflection of the real deficits of 
the Federal Government, running in the $300 to $400 billion a 
year range throughout the entire rest of the decade.

[GRAPHIC] [TIFF OMITTED] 


    The question becomes: Where did the money go? Where did 
this $7 trillion turn--where did all those dollars go? What we 
see is the biggest reason is the tax cuts, both those that have 
already been enacted and those proposed. The second biggest 
reason is technical changes, largely that the revenue models, 
the revenue being generated is not what was anticipated, given 
the various levels of economic activity, really that revenue 
was being overestimated quite apart from the tax cuts.
    The second biggest reason is spending, 25 percent of the 
reason of the disappearance of the surpluses, spending that has 
already occurred and that is projected to occur under the 
President's plans. Most of that obviously has gone for defense 
and homeland security.
    Then the smallest part is the economic downturn, some 10 
percent of the reason for the disappearance of the surplus.
[GRAPHIC] [TIFF OMITTED] 

    Let's go to the next chart. This leaves us with very 
unfortunate results with respect to the national debt. You will 
recall the President told us in his plan of 2 years ago that he 
was going to have maximum paydown of the debt. That is not what 
we see now. Instead, we see substantial increasing of the debt. 
In fact, the debt by 2008, when the President said his plan 
would allow for virtual elimination of the debt, instead we 
will have a debt of some $4.8 trillion. Again, that is publicly 
held debt.

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

    Why does all this matter so much? Well, Director Crippen 
testified here last year, saying ``as we look ahead, 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.''

[GRAPHIC] [TIFF OMITTED] 

    Then he concluded that is the dilemma that faces us in the 
long run, Mr. Chairman, and these next 10 years will only be 
the beginning.
    Let me just put up a final chart that I want to show this 
morning, and that is, here is what he was talking about. We are 
in the sweet spot of the fiscal cycle now; that is, the trust 
funds of Social Security and Medicare are running surpluses 
now. When we get Social Security out to 2017, the baby-boom 
generation has started to retire, the trust fund goes cash 
negative. When it does, it goes cash negative in a very 
significant way, very dramatic. That is why I have always 
believed during this period we should not be running deficits 
at all, that, in fact, we should either be paying down debt or 
we should be prepaying the liability that is to come. 
Unfortunately, we are doing neither, and the President's plan 
digs the hole deeper, much deeper, a hole that is really 
stunning, approaching $4 trillion over the next decade when one 
safeguards the Social Security funds, which virtually everyone 
in Congress had pledged to do.
[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

    With that, Mr. Chairman, I look forward to the testimony of 
our witness and questions of our colleagues.
    Chairman Nickles. I didn't make any opening comments 
because I was afraid you were going to make some of yours. 
[Laughter.]
    Chairman Nickles. Just for the information of our witness 
and also Senator Burns, we have a Finance Committee vote at 
10:15. They are trying to get that done. I just wonder if we 
should gamble on that.
    I think we will go ahead. Let me make a few remarks, since 
we only have to run downstairs. So we won't go down until they 
tell us they need us, and we just have to go down a couple 
flights, and we can be back in 5 minutes. Let me make----
    Mr. Anderson. I promise not to change the numbers in 
between time.
    Chairman Nickles. I appreciate that, Mr. Anderson. Thank 
you. I just want to make a couple comments.
    One, I don't concur with the analysis of my friend and 
colleague Senator Conrad, and while I do think people are 
entitled to their opinions, they are not entitled to their 
facts. I will just throw out a couple of facts, and I will 
insert these into the record. I think we would agree--one of 
the comments that Senator Conrad mentions--that CBO and OMB, 
and, I might mention, every other analyst, misjudged total 
revenue estimations for 2001 and 2002 and, frankly, for the 
out-years big time, in trillions of dollars. Certainly--well, I 
say in trillions. I would have to extrapolate that, and I will 
ask you a question, but the forecast that Senator Conrad was 
alluding to, the $5.6 trillion surplus that was forecast in 
January 2001 over that 10-year period of time, I would just 
look back to 2002. This is factual. We have 2002 numbers. CBO 
projected in 2002 there would be a surplus of $313 billion. 
Congress enacted a few changes. We cut some taxes, a total of 
$75 billion, and we increased some spending, a total of $75 
billion. The economic and technical re-estimates were $321 
billion. CBO missed it big time. That was 68 percent of the 
difference, not an insignificant amount. It is 68 percent of 
the difference if you want to look at what happened in 2002, 
because the year before we had a $127 billion surplus. In 2002, 
we had a $158 billion deficit. Big swing. Why? Three hundred 
twenty-one of it is economic and technical re-estimates. Most 
of that, where the CBO was off, where OMB was off, where we 
were off, was you had a precipitous drop in income. You had a 
decline of income of 7 percent. That is historic in any 
estimation. It followed, I might mention, a reduction of income 
in 2001 of about 1.7 percent.
    So never, or certainly not in recent decades have we had 
two consecutive years of reduction of income no one estimated 
and a total combined--if you add the 2 years together--of about 
9 percent reduction. A bunch of this nonsense on the charts, 
well, this is caused by tax cuts and so on, just doesn't bear 
out. It is not factual.
    Well, I want to be very factual. I am adamant that we be 
factual.
    Senator Conrad. I agree with that absolutely. Let's be 
factual. I mean, what I put up here, there was nothing here 
that wasn't factual.
    Chairman Nickles. Let me finish. I want to be factual, and 
I am going to insert this into the record. We did go from a 
$127 billion surplus in 2001 to a $150 billion deficit in 2002, 
and according to my chart--and maybe I will ask Mr. Anderson to 
substantiate this, but we got this from him--I believe that 
$321 billion of that change was due to economic and technical 
re-estimates.

                                         Changes in CBO's Baseline Projections of the Surplus Since January 2001          January 2003 Adjusted Baseline
                                                                            [by fiscal year, in billions of dollars]
 
                                                   2001        2002        2003        2004        2005        2006        2007        2008        2009        2010        2011      2002--2011
 
Total Surplus as Projected in January 2001....    281.118     312.934     359.148     396.809     432.940     504.996     572.721     635.089     710.386     795.963     888.707     5,609.693
Changes to Revenue Projection.................
  Legislative.................................
    EGTRRA....................................    (70.208)    (31.338)    (84.003)   (100.697)   (100.318)   (125.606)   (142.120)   (150.709)   (158.152)   (175.921)   (117.284)   (1,186.148)
    Economic Stimulus.........................      0.000     (42.591)    (39.406)    (29.062)     (3.548)     16.101      16.814      16.042      13.666      10.140       7.246       (34.598)
    Other.....................................     (0.999)     (0.630)     (2.900)     (3.125)     (3.351)     (3.440)     (1.637)     (1.345)     (1.352)     (1.527)     (1.516)      (20.823)
        Subtotal, legislative.................    (71.207)    (74.559)   (126.309)   (132.884)   (107.217)   (112.945)   (126.943)   (136.012)   (145.838)   (167.308)   (111.554)   (1,241.569)
  Economic & Technical........................    (72.334)   (307.949)   (295.215)   (265.766)   (237.498)   (205.784)   (184.082)   (171.476)   (162.862)   (154.810)   (115.446)   (2,100.888)
    Total Revenue Changes.....................   (143.541)   (382.508)   (421.524)   (398.650)   (344.715)   (318.729)   (311.025)   (307.488)   (308.700)   (322.118)   (227.000)   (3,342.457)
Changes to Outlay Projections.................
  Legislative.................................
    Discretionary.............................      1.515      50.242      77.431      82.091      84.455      84.629      85.260      86.017      87.231      89.432      91.667       818.455
    Mandatory.................................
      EGTRRA..................................      0.000       6.226       6.600       7.006       7.081       9.597       9.542       9.360       9.668      11.080      12.244        88.404
      Economic Stimulus.......................      0.000       8.278       3.526       0.036       0.023      (0.014)     (0.040)     (0.036)     (0.010)      0.003       0.003        11.769
      Farm Bill...............................      0.000       1.613       8.406       9.854      10.212       9.867       9.253       8.072       8.037       7.519       7.273        80.106
      Debt Services...........................      0.537       4.937      14.779      30.259      45.387      60.078      75.838      93.138     111.895     132.551     153.559       722.421
      Other Mandatory.........................     11.432       4.072      14.942       6.154       5.892       3.045       2.257       4.178       3.172       3.127       3.281        50.120
        Subtotal, mandatory...................     11.969      25.126      48.253      53.309      68.595      82.573      96.850     114.712     132.762     154.280     176.360       952.820
        Subtotal, legislative.................     13.484      75.368     125.684     135.401     153.050     167.202     182.110     200.729     219.993     243.712     268.027     1,771.275
  Economic & Technical........................
    Discretionary.............................      1.340       1.085       4.528       5.205      (0.353)     (2.074)     (0.856)      0.834       3.278       5.436      11.323        28.406
    Mandatory.................................     (4.350)     12.325       6.594       2.532       8.591      37.617      54.326      61.132      75.148      84.286     105.167       447.718
        Subtotal, econ. & tech................     (3.010)     13.410      11.122       7.737       8.238      35.543      53.470      61.966      78.426      89.722     116.490       476.124
      Total Outlay Changes....................     10.474      88.778     136.805     143.138     161.288     202.745     235.580     262.695     298.419     333.434     384.518     2,247.399
Total Impact on Surplus.......................   (154.015)   (471.286)   (558.329)   (541.788)   (506.003)   (521.474)   (546.605)   (570.183)   (607.119)   (655.552)   (611.518)   (5,589.856)
Total Surplus or Deficit (-) as projected in      127.103    (158.352)   (199.181)   (144.979)    (73.063)    (16.478)     26.116      64.906     103.267     140.411     277.189        19.837
 January 2003.................................
Memorandum:...................................
Total legislative changes.....................    (84.691)   (149.927)   (251.993)   (268.285)   (260.267)   (280.147)   (309.053)   (336.741)   (365.831)   (411.020)   (379.581)   (3,012.844)
Total econ & tech changes.....................    (69.324)   (321.359)   (306.337)   (273.503)   (245.736)   (241.327)   (237.552)   (233.442)   (241.288)   (244.532)   (231.936)   (2,577.012)
 

    I happen to think instead of us just pointing fingers back 
and forth, I think it would be wise for us to figure out how we 
can get the growth in our economy again so those estimates can 
be more accurate on the income side.
    I might also mention in 2003, I believe CBO projects that 
we will have a deficit of $199 billion. In 2001, CBO projected 
that we would have a surplus of $359 billion. There is a big 
difference there, a total of $558 billion difference; $126 
billion was due to legislative changes on the Tax Code. We cut 
taxes $126 billion. I might mention bipartisan tax cuts. That 
is both President Bush's tax cut and also the bipartisan 
stimulus act that totaled $126 billion.
    Then we also had spending increases that totaled $126 
billion. It is very interesting how both the spending and the 
taxes equaled changes from the baseline. We also had $306 
billion in technical and economic re-estimates. That is 55 
percent of the difference.
    So, again, there is a big difference between the estimate 
that was made in 2001 for surplus in 2003 of $359 billion when 
we went to a deficit projected to be $199 billion, most of 
which, the majority of which was re-estimates because of the 
reduction in incomr. We didn't meet the targets. Why didn't we 
meet the targets? It wasn't because of the tax cut. The tax cut 
was part of it, but a very small part. Spending increases was 
part of it. The majority of it was re-estimating the economic 
forecast.
    So I just mention that. I think it is important to try and 
look at history, but I also think--and, Mr. Anderson, this kind 
of may be my opening--CBO has missed it a lot. In your 
statement--I read your statement that you are going to present 
to the Committee. I have read it, and you have kind of a window 
of these--I think you have a chart that is called the 
uncertainty of your projections, and it shows the figures.
    Now, you stopped on 1997, but as I mentioned, CBO really 
missed it in 2001 and 2002, and I don't know why you didn't 
show those, because that is where--you know, trying to guess 
what the budget is going to be in 10 years to me is more 
hypothetical than anything else. We missed it big time. In 
2001, we missed it big time for 2002 and 2003. Even last year, 
we missed it big time.
    I am not being critical. You are a professional. You work 
with great people. Everybody missed it. No one projected that 
big of a reduction in revenues.
    Now, part of the problem--could we have that Nasdaq chart? 
Part of the problem happened because of the stock market. The 
market decline precipitously, and it has caused all of us, 
myself included, a significant reduction in our accounts. In 
2000, Nasdaq fell from its peak 45 percent, and that reduced my 
IRA account, and it reduced millions of Americans'. I don't 
think anybody projected how that was going to flow through the 
system.
    So I am not faulting, but I do know that you or OMB--CBO, 
excuse me, and OMB testified before the Committee, and they 
grossly overestimated the amount of money that was going to be 
received. Even when they testified January 2001, we had already 
had a major decline in stock values, unparalleled, but 
estimates were just way off. On January 1, no one was 
projecting that revenues would be declining by 7 percent in 
2002, or even a reduction in 2001.
    Now, granted, in 2001, we didn't know September 11th was 
coming. That had a dramatic impact, no doubt. On January 1 of 
2002, that had already happened, but we still had--in 2002 is 
when we had the biggest reduction of income. September 11th had 
already happened. Again, I am not faulting. These are 
unintended consequences maybe as a result of September 11th. 
Everybody, all the professionals, missed the total estimates 
coming into the Government big time, by hundreds of billions of 
dollars. We had total revenues--correct me if I am wrong--of 
$2.25 trillion in the year 2000, and last year they were $1.85 
trillion. That is a reduction of $175 billion compared to 2 
years before, not to mention from what was projected, which was 
much higher. CBO missed it big time, and so did everybody else.
    So, Mr. Anderson, you are my friend, but we all have to do 
a better job. I take some responsibility now that I am chairing 
this committee. I really want to do a better job. I want to do 
a better job in fiscal management of the Government, all the 
Government. I look forward to working with you to accomplish 
that goal. You are an accomplished professional. You have done 
a fantastic job. You have some great people. CBO, OMB, 
everybody missed the estimates big time in 2002, and I did note 
in your report that you project that we have a deficit this 
year of $199 billion and that deficit declines if we stay with 
present law, declines basically to a balanced budget in 2006. 
We are working on 2004's budget, so in 3 or 4 years, 2007, it 
would be balanced.
    Congress is also looking at some changes--growth package, 
prescription drugs, could have a military conflict that could 
influence that as well.
    So I mention this. I would like an explanation from you, if 
possible, in your comments as to how did CBO miss it so much 
and how can we do a better job in estimating revenues.
    I might mention you have done very well in estimating 
outlays. You are on target on your outlay estimates. Everybody 
missed it on revenues. Maybe if we could figure out modeling or 
something to where we could do a better job on the revenue 
estimates, I think it would be helpful for the future.
    So with that comment, I welcome you to the Committee, and, 
again, I will apologize. In a second I think we are going to 
have to run downstairs. Welcome again before our committee.

STATEMENT OF BARRY B. ANDERSON, ACTING DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Anderson. Thank you, Mr. Chairman. Thank you for your 
kind comments, and yours, Senator Conrad. I had hoped to make 
my career more than that of super sub, but I am glad to be here 
anyway and to talk about the Congressional Budget Office's 
economic and budget projections for the upcoming 10 years.
    Chairman Nickles. Go ahead. Please proceed.
    Mr. Anderson. I have a statement I would like to submit for 
the record, if that is approved by the Committee, but instead 
of reading that statement, I would like to summarize and 
address five points from it.
    Chairman Nickles. Mr. Anderson, can you give us 3 minutes? 
We will be right back. Good. Thank you. I apologize. We will be 
right back. [Recess.]
    Chairman Nickles. Mr. Anderson, I apologize, but now you 
can begin, and we won't be interrupted again.
    Mr. Anderson. Thank you. As I said, I have a statement I 
would like to submit for the record, but I would like to 
summarize it briefly and emphasize five points.
    First, as you have indicated, I have been in budgeting for 
quite some time, and have been doing budget and economic 
forecasts for some time, and am used to the kind of uncertainty 
that you alluded to and that is inherent in any kind of budget 
forecast.
    With respect to the forecast we are making this year, I 
have to say that I do not believe I have ever encountered an 
economic forecast that is more uncertain. The reason for that 
is not the intrinsic uncertainties in the economy that are 
detailed in our report. Rather, it is the--as I call it--
hippopotamus under the living room rug that nobody seems to be 
able to talk about, and that is the geopolitical risks.
    As you may know, Mr. Chairman, we base a lot of our 
economic forecasts taking on what the private sector and our 
panel of economic advisors tell us. We try to listen carefully 
to them and not be significantly different in our forecast from 
the larger economic wisdom of private economic forecasters. We 
pay a lot of attention to the consensus of the Blue Chip 
economic forecasts.
    What they assume with respect to the outcome of the current 
geopolitical situation is unknown. We have not built into our 
economic forecast the potential outcome of the current 
geopolitical situation we are facing, not just in the Middle 
East, not just in Asia, but also the terrorism aspects. The 
reason is that for all the uncertainties and problems you have 
just mentioned, those geopolitical outcomes are virtually 
impossible for us to predict.
    We have looked at what others have said about the impact of 
the geopolitical situation on the economy and have tried to 
make estimates, but those other forecasts vary widely across 
the board. In addition, the possible geopolitical outcomes have 
impacts not just on direct spending for homeland security or 
national defense and not just on the price of oil but 
potentially on a much, much broader range of factors that 
includes the more important aspects of consumer and business 
confidence.
    Therefore, we have a set of economic projections here that 
suffers from the same risks that previous economic projections 
have had to take into account, but on top of that, there is a 
level of geopolitical uncertainty that surronds CBO's forecast 
with more uncertainty, I think, than I have ever seen before.
    My second point is that added to this level of geopolitical 
uncertainty, we also do not have--as you have correctly 
indicated, certain policy actions that the Congress and the 
President are actively debating as we speak. Those policy 
actions are very big and very important. They include not only 
defense spending, not only antiterrorism spending, but also 
increased spending on education, on health, on drug benefits, 
and various kinds of proposals on the tax side. As you have 
correctly pointed out, our projections do not take into account 
any potential new legislation. The impact of that new 
legislation could be large.
    Having made those two points, I would like to just spend a 
few minutes on our baseline itself. Again, our baseline is not 
a forecast. It is a projection of what--under our assumptions 
about the economy and our pricing out of current law--the 
budget deficits and surpluses would be over the next 10 years. 
As the chart indicates, you can see that we have a projection 
of a $199 billion deficit in fiscal year 2003, dropping to $145 
billion in fiscal year 2004, gradually declining after that, 
and then going to surpluses by 2007 (See Table 1). Those 
surpluses would increase into the out-years.
    The point I would like to highlight from this, in addition 
to the uncertainties, is that as a percentage of Gross Domestic 
Product (GDP), virtually all of those numbers are quite small. 
To know the specific year in which we cross from deficit to 
surplus is much less important than to look at what the 
baseline says, under our economic assumptions, about how much 
of a deficit or surplus as a percentage of GDP we will have for 
the upcoming future. It is not the situation that I saw so much 
of in the 1990's and the 1980's, when we had significant 
deficits--significant not only in nominal amounts but as a 
percentage of GDP.
    Instead, the numbers here--again, with no new legislation 
included--are very close to balance whichever year you take. 
About the only exception to that occurs way out in the out-
years, in 2011, 2012, and 2013, when under current law the 2001 
tax cut is scheduled to expire, and therefore, the amount of 
revenues coming in are projected to be significantly greater.
    With those introductory comments, I have two other comments 
I would like to make before I end my short presentation. The 
comments revolve around the uncertainty of our budget 
projections.
    Not only do we have significant uncertainty in the CBO 
baseline by design--that is, we explicitly do not make 
forecasts of what is going to happen in legislation--but we 
also have it in part because of the impossibility of accurately 
forecasting geopolitical outcomes. In addition, much 
uncertainty has to do with the fact that the U.S. economy and 
the Federal budget are highly complex and are affected by many 
economic and technical factors.
    That uncertainty can be best illustrated by a fan of 
probabilities surrounding CBO's year-by-year point estimates, 
as indicated in this chart (See Figure 2). Not surprisingly, 
the range of those possible outcomes widens as the projection 
period extends farther out. The fan chart makes clear that 
outcomes quite different from the ones we have projected have a 
significant likelihood of occurring.
    We can also use the fan chart methodology to examine 
whether CBO's projections are consistently biased in one 
direction or another. As the next chart indicates, CBO's missed 
estimates of the budget's bottom line do not appear to be 
systematically biased (See Figure 3). Sometimes the projections 
were too high and at other times, too low. For example, the 5-
year budget calculations made between 1993 and 1997 tended to 
be too pessimistic, while most of the estimates made earlier 
tended to be too optimistic.
    By the way, this chart presents only estimates through 1997 
because we did not have actuals for the full 5-year period 
beginning in 1998. We also do not have a figure in here for 
1982, because CBO did not produce a full 5-year projection at 
that time.
    The same chart can also be looked at not only to see if 
there is some systematic bias but also to see if we can achieve 
greater estimating accuracy in our forecast.
    In looking at recent criticisms of our methods, we 
undertook to do some calculations to see whether our baseline 
economic projections sufficiently accounted for the supply-side 
effects of changes to tax laws. The small fan charts show that 
increasing the assumed response of labor supply and 
investment--the feedback effects--would generally not have 
improved budget estimates made during periods in which there 
had been major changes to the tax system (See Figure 3).
    For example, adding revenues to the baseline projections of 
the primary surplus--that is, the surplus excluding interest 
costs--for the mid-1980's to reflect larger supply-side effects 
from the Economic Recovery and Tax Act of 1981 would have 
increased rather than reduced the forecasting inaccuracies. 
Similarly, incorporating larger supply-side effects from the 
Omnibus Budget and Reconciliation Act of 1993 than those 
incorporated into subsequent baselines would have reduced the 
level of revenues and magnified the inaccuracies.
    I am not saying, Mr. Chairman, that there are no supply-
side effects. There are. CBO has regularly--does now and, in 
this document, continues to--estimate the supply side effects 
of fiscal changes in general and tax changes in particular. To 
do more than what we have done in the past according to this 
analysis, would not apparently have increased our accuracy.
    The last point in my testimony is that given the 
uncertainty surrounding CBO's outlook and the current pressures 
on the budget, I thought it might be useful to say something 
about how our projections might be used in considering fiscal 
policy.
    First, several factors argue for focusing on the long term. 
Just past the 10-year budget baseline loom significant long-
term strains on the budget as the baby-boom generation ages. 
The number of people reaching retirement age will surge by 
about 80 percent in the next 30 years while the number of 
workers to pay for those benefits will increase only by 15 
percent.
    In addition, we know given the demographic situation, that 
the costs per enrollee for Federal health benefits are likely 
to grow much faster than inflation. As a result, the amount 
that the Government spends for major health and retirement 
programs 30 years from now is projected to consume a 
substantial portion of what the Federal Government currently 
spends for all its programs. Although the current baseline that 
I have just talked about leads to a brighter situation for the 
next few years, that picture is bound to change; and policy 
choices now would serve the Nation's fiscal health best if they 
could avoid making the long-term situation worse.
    Today, with security and economic concerns paramount, the 
long-term perspective may seem elusive. The current debate 
seems to focus on desirable levels of taxes and spending and, 
correspondingly, the appropriate size of Government. This chart 
is a good way to keep in mind what that longer-term situation 
is, particularly over the next 10 years (See Figure 1).
    It also helps present what I see as two contrasting 
viewpoints about how questions about future policies ought to 
be answered. One viewpoint advocates a more limited size of 
Government. Proponents of that viewpoint seek lower levels of 
taxation and lower levels of spending. CBO's estimates indicate 
that total revenues as a percentage pf GDP are now close to 
their historical level. As you can see, at our current levels 
of taxation, we are close to the average revenues we have had 
for the past 40 years--that is, about 18 percent or so. 
However, revenues as a share of GDP are projected to creep up 
to more than 19 percent by 2010 under current policies. If the 
tax cuts enacted in 2001 are allowed to expire in 2010, as is 
called for under current law, then by 2013, revenues as a 
percentage of GDP will climb to 20.6 percent--a level never 
reached before except during World War II and in 2000, and more 
than 2 percentage points above the 1962-to-2002 average.
    Another viewpoint is to see a larger, more expensive role 
for Government. This viewpoint says that there are important 
and legitimate unmet needs that cannot be offset elsewhere by 
spending cuts and that require a higher level of taxation. 
CBO's baseline does not include the funding for those needs. If 
it did, spending as a percentage of GDP would move toward 
higher levels than those depicted in the figure--levels closer 
to the historical average shown there.
    Boosting spending further to pay for education, homeland 
security, precription drug benefits for the elderly, and other 
needs, including, possibly, a war with Iraq, will require a 
level of revenues much above the historical average; and 
without the willingness or ability to cut other spending in 
order for deficits not to grow, taxes must go up.
    So the outstanding question for the Congress seems to me to 
be, as it creates a budget for 2004 and future years, not the 
way this chart looks now but rather how it should look in the 
future. While some people feel that there may be some obvious, 
clear path to a higher standard of living for all Americans, I 
do not see the public policy choices that must be made as quite 
so clear.
    Whatever the decisions that are made, it is critical, I 
think, to avoid a prolonged and unsustainable mismatch between 
taxes and spending. Cutting taxes and limiting spending growth 
is one alternative. Boosting spending and increasing taxes in 
order to support that spending is another.
    In this context, I hope, Mr. Chairman, that CBO's baseline 
projections can be used to gauge the degree of latitude that 
the Congress has to adjust its priorities while preserving a 
budget that balances long-term economic growth and fiscal 
responsibility with unmet needs.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Barry Anderson follows:]

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    Chairman Nickles. Mr. Anderson, thank you very much. We 
appreciate your presentation before the Committee and welcome 
your input, and we will ask you a few questions.
    Before I do that, I notice my colleague and former chairman 
of the Committee arrived, and I wished to mention this 
yesterday but we missed each other in the Committee. I wanted 
to compliment him for his many years of service on this 
committee--I believe going back to 1975?
    Senator Domenici. Right.
    Chairman Nickles. That is remarkable. You also chaired it 
or was ranking member, I believe, for about----
    Senator Domenici. Seventeen years.
    Chairman Nickles. Seventeen of those years. Senator Conrad 
and I would say that that is not an easy challenge, and you 
handled yourself very well, both as chairman and as ranking 
member.
    Senator Domenici. Thank you.
    Chairman Nickles. Passed a resolution every year, and I 
compliment you for your service. I am delighted that you are 
still on this committee and would welcome any opening comments 
that you wish to make.
    Senator Domenici. Well, thank you very much, Mr. Chairman. 
It is good to be here. I heard a little bit but not enough to 
be totally familiar with the words of wisdom you have given us, 
but I would like to say before I make a few observations, Mr. 
Chairman, that, one, I compliment you based on what I have seen 
about your attitude about the Committee. I think it is 
marvelous that you are enthusiastic and that you want to 
broaden the scope of the hearings and activities of the 
Committee. I think that will be welcome. The committee has 
broad jurisdiction in that regard, and if the Committee members 
want to join you, that would be a very exciting approach for 
the Committee.
    In addition, as I have told Senator Nickles heretofore, for 
better or for worse, the Committee has a legacy from those 17 
years of expanded power beyond which those who wrote the Budget 
Act envisioned. Clearly, the scope and capacity to mandate 
change through reconciliation is a rather fantastic power, and 
it has been used so often that I believe it is now without 
challenge. Of course, the challenge can be made as to what to 
use it for, but not to its use. In addition, the concept of 
reserve funds that are released at the Chairman's call, if the 
Senate complies with what the Committee said, it is indeed a 
very vital tool which you will find exciting as you attempt to 
use the Committee for more than just a resolution that perhaps 
in some instances would not even be complied with.
    So I think that is a good result. I am very hopeful that 
sometime we will be able to document the impact of that on the 
Senate. I would think a small textbook about the impact of the 
Budget Act in 25 years on the procedures and processes of the 
U.S. Senate might indeed be a welcome document. It will show 
that Senator Robert Byrd, the beloved spokesman for open debate 
and filibusters, helped write a bill that clearly whacked 
filibusters to the bone. They are not available in anything 
that has to do with the budget, neither reconciliation, neither 
budget resolution, neither amendments. I am sure that if it we 
reconsidered, that is, the Budget Act, people would wonder 
whether it would pass in that way, Mr. Chairman, again.
    I have had a chance to review as much as I usually do, even 
when I was chairman, the economic outlook, and I understand it 
is very uncertain. I do understand that the world is uncertain. 
It is not just the policies of the Federal Government in 
budgetary matters that are uncertain. I am a bit concerned. I 
see the deficit as being manageable, and I see your projections 
for the next 10 years of the deficit as being manageable. 
However, you have not put into your projections what we might 
do. Your projections, so everybody understands, are what we 
have already done. You don't have in these projections what 
Senator Nickles and this committee might say we are going to do 
in taxes. It doesn't have what we are going to do in 
expenditures in excess of this baseline or less than, or in new 
entitlement programs that are not in your baseline.
    Hopefully, when they finish their work, they will ask 
somebody to adjust the baseline, but you start with yours. That 
is a good working arrangement, Mr. Chairman.
    Also, it would appear to me that 10 years out of 10 years 
of debt, accumulation of deficit is workable. I would be 
interested what the debt-to-GDP ratio might be at 20 years or 
30 years or 40 years, with just a few things put in it, 
assuming Medicare and assuming Social Security and perhaps a 
few other benefits of significance are put into it. It would be 
interesting to see the debt--debt, not deficit-to-GDP ratio. 
Could you tell us just in summary what is the debt-to-GDP ratio 
now and what will it be in 10 years?
    Mr. Anderson. It is about 35 percent now. Under our 
baseline, I believe it declines to 14 percent. Two years ago, 
we did a study of the debt-to-GDP ratio under a variety of 
different long-term scenarios. The operative word from that is 
``explosive''; that is, with the growth that one can see of the 
baby boomers retiring for Social Security, Medicare, and 
Medicaid, one can see an explosive result in debt to GDP.
    Senator Domenici. Thank you very much, Mr. Anderson.
    Thank you, Mr. Chairman. It is good to be with you.
    Chairman Nickles. Well, it is good to have you back, 
Senator Domenici, and, again, I thank you for your service and 
look forward to working with you continually on this committee 
and on the Energy Committee, of which you are now chairman. I 
think you will do a fantastic job in that capacity as well.
    I am going to call upon our colleagues in order of 
appearance. I would like to recognize the ranking member, but 
before I do, I want to just say I always want these meetings to 
be congenial, as I stated earlier, you are entitled to your 
opinion, not your facts. I say that all the time. We might have 
a little difference of opinion on some things, and one of the 
questions I think I would ask you, Mr. Anderson, is: Where did 
the $5.6 trillion surplus go? Or where did the $313 billion 
surplus that you projected in 2002 or the $350 billion surplus 
that you projected in 2003--how that differed? If you would, 
just give us a little piece of paper. You don't have to do it 
today. You can do it today if you so desire. How much of your 
revenue estimates were missed? How much of it was technical and 
economic? How much of it because of the tax changes we made? 
How much because the spending exceeded estimates? If you have 
that, you can submit it for the record. If not, I just wanted 
to mention to my colleagues, we are going to have a lot of 
hearings, but I will try to always stick to the facts and never 
impugn anybody's motives in any way, shape, or form.
    If you have that information, you can give it to us, or----
    Mr. Anderson. Let me just answer very briefly. As was 
mentioned, I was here 2 years ago and was at that time the 
official representative of CBO's forecast of the $5.6 trillion 
surplus. I hope that the forecast I am presenting now turns out 
to be much more accurate than the one that we presented then.
    Let me also point out that that $5.6 trillion projection 
covered the years 2002 through 2011. We are in 2003 now. We 
still have quite a few years to go on that. Yes, our 
projections have changed dramatically. I personally hope--and I 
am sure you all do too--that they will change dramatically 
again but in the opposite direction; that we will see a much 
greater increase in economic growth than the growth we have 
seen in the past 2 years.
    Looking at what has happened in 2002 and then looking at 
the revision for the projections for 2003 through 2011 relative 
to the $5.6 trillion, we have seen, as was indicated 
previously, that $5.6 trillion surplus now go to a cumulative 
baseline surplus of $20 billion for the 2002-2011 period.
    Where did that $5.6 trillion go? Well, first of all, 
economic and technical changes accounted for well over $2.5 
trillion of the reduction, or about 46 percent. Let me 
emphasize that I said economic and technical. The line between 
those two isn't nearly as distinct as it appears in our 
documents, with specific numbers for each kind of change. It is 
very much a subjective process to decide how much of a change 
is economic and how much is technical and how much interaction 
there is between the two. Therefore, I like to lump them 
together when looking at it.
    We missed for sure. We missed on the economy. We missed the 
technical interactions of the economy with the budget, and that 
constituted about 46 percent of the decline in the projected 
surplus.
    The remaining 54 percent is from legislation, and I think 
it is important to break that legislation into three 
components. The first is the Economic Growth and Tax Relief 
Reconciliation Act of 2001, which accounted for about 23 
percent. The second is increased discretionary spending, which 
was about 18 percent. The remainder reflectsis a few smaller 
bills and debt service on the rest.
    My point is, it wasn't the tax cut and it wasn't spending. 
It was, first, the economy and, then, a combination of the tax 
cut and spending. That took us from $5.6 trillion down to $20 
billion.
    Chairman Nickles. Can I just ask you a question?
    Mr. Anderson. Sure.
    Chairman Nickles. This is on my time now. I will turn it 
over to my colleague, but you are answering some of the 
questions. I happen to concur. The figures I have showed that, 
yes, the technical re-estimates, 46 percent. I show tax cuts of 
21 percent on the bipartisan but also the bipartisan economic 
stimulus being another 1 percent, so tax cuts being 22. On 
spending, I show discretionary at 15 percent and mandatory at 
17 percent for a combined spending increase of 32 percent.
    Mr. Anderson. The figures you have I believe are accurate, 
but the mandatory total includes debt service.
    Chairman Nickles. I think that is correct.
    Mr. Anderson. Then I think everything balances out.
    Chairman Nickles. I appreciate that. I would also like the 
breakdown for 2002 and 2003, and you don't have to give that to 
us today, but I would just like it. I think it would be good 
for the record.
    You missed big time and everybody else did, so I want to 
continue repeating that. I am not throwing stones. I am just 
trying to maybe help us get to where we are more accurate. It 
was a very difficult time to estimate. I did show the chart on 
Nasdaq collapsing in 2000, and I don't think it was plugged in 
correctly on those losses and how they would go through, 
whether that is reduction in capital gains, which I remember 
yesterday we pulled out a chart that showed capital gains 
income went from $119 billion to 50-some, maybe 70 and then 50-
some.
    Anyway, I think we are pretty close, and basically if you 
could give us year by year, but I think it shows that economic 
and technicals were $308 billion of the difference in 2002. 
That is way off. That is way off. I told my friend and 
colleague, I said--and we are debating whether to do a 5-year 
or 10-year budget. We missed it so badly in the first 2 years. 
You know, we all need to do better, and maybe if we don't have 
an unpredictable event, we will be much closer.
    On the revenue side, like I mentioned before, you were very 
close to being right on the money on outlays. You have been for 
years. Outlays, the estimates are very close. The revenues, 
because there was unprecedented decline or reduction in 
revenues of 7 percent last year, we all missed it big time. So 
I just mention that.
    It is a pleasure to call upon my colleague and friend, 
Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Let me just revisit this question of where the money went.
    Mr. Anderson. Sure.
    Senator Conrad. Because the calculations you have just done 
leave out significant items that are included in the chart that 
I showed. The chart that I showed, let me just put that back 
up. It showed that the disappearance of the surplus from 2002 
to 2011, we included the President's proposals; that is, we are 
not talking about your baseline, which you are precluded from 
taking into account what the President has proposed going 
forward. You have to do just what has happened so far. So, of 
course, that leaves out the President's proposed making the tax 
cuts permanent, does it not?
    Mr. Anderson. Our projection clearly does. It is based on 
current law.
    Senator Conrad. Yes. You don't have that included, and that 
is because you are presenting what is in current law. You don't 
have the President's growth package included in your 
calculation; isn't that correct?
    Mr. Anderson. Correct.
    Senator Conrad. In addition, you show the associated 
interest costs with the loss of that revenue on the spending 
side.
    Mr. Anderson. I tried to differentiate debt service when 
separating out three categories: taxes, spending, and 
additional costs.
    Senator Conrad. Right. I would attribute it to the tax cut. 
You are losing--you have additional interest costs because of 
the tax cut. When you do that calculation and you look at the 
$5.6 trillion, we adopt the President's policies, we are $1.6 
trillion in the hole. That is over a $7 trillion swing. Where 
did it go? Thirty-nine percent of it is the tax cuts, both that 
have been made and that the President proposes, and the 
associated interest costs. Twenty-six percent are the technical 
changes. Much of it is the revenue not coming in as 
anticipated, quite apart from the tax cut. Spending, 25 
percent, most of that defense and homeland security; 10 percent 
economic downturn.
    So, Senator Nickles, I am not trying to have my own set of 
facts here. I am trying to do an honest determination of where 
the money went and where it is going. What accounts for this 
dramatic turnabout? I honestly believe the presentation that I 
have made is an accurate assessment of that. It takes into 
account not only what has happened but what the President 
proposes. It includes the associated interest costs.
    Now, let me go to--you put up a fan chart, Mr. Anderson, 
which I commend you for showing because I think it is very 
important to understand how wide the swing can be here. Let's 
look back at what CBO showed in a fan chart back in 2001 and 
where we have actually come out. This is the range of estimates 
in the fan chart from low to high 2 years ago, and now we put 
in where we actually are. We are below the low end.
    I can remember so well people telling me when I raised 
doubts about the size of the tax cut, that that was going to 
put us in jeopardy of going back into deficits and debt, so 
many people told me, Kent, you are being overly cautious. There 
is going to be more money than the top end of the projection 
because of the dynamic effect of the tax cut. We will have even 
more revenue. The head of the Office of Management and Budget 
of the President of the United States said there was going to 
be more revenue. He said that in testimony before this 
committee. He said maybe much more.
    Well, he was wrong. He was wrong. Those of us who warned 
repeatedly that we were headed into a risky circumstance when 
we are betting on a 10-year forecast unfortunately have been 
proven all too right. I think, you know, past is prologue. Now 
we have a question of what we do going forward.
    I think the Chairman is right to say we have to focus on 
what is going to improve economic growth, what is going to help 
us with this long-term circumstance. In addition to that, I 
believe we have to be very mindful of where this is all headed.
    Mr. Anderson, you talked about explosive growth of debt as 
we head into the time of the baby boomers. Let me just put up 
the chart that I ended with before that shows what is happening 
to the trust funds. Let's put up that. Medicare Trust Fund, we 
are in the sweet spot of the cycle, and when this thing turns, 
it turns big time. Yet the President is proposing at that time 
a tax cut package now that will cost $4 trillion then. It 
doesn't add up. It doesn't add up. It is going to be a very 
deep hole for this country.
    When you say explosive growth of debt, you are referring 
to, I take it, the effect primarily of the retirement of the 
baby-boom generation.
    Mr. Anderson. Right.
    The Chairman. Senator Conrad, are you--do you have a 
response?
    Mr. Anderson. A couple of things. First of all, with 
respect to the numbers you mentioned, we will provide for the 
record the numbers you need for comparing the projections of 2 
years ago with what actually happened and what the impact has 
been for 2002, 2003, and for the current 10-year projection 
period.
    Chairman Nickles. I appreciate that. We thank you.
    Mr. Anderson. Second, my long career has been in budgeting. 
I am not an economist, and I am not an economic forecaster. In 
working with economists and economic forecasters, I believe 
that they have their most difficult time making forecasts when 
there is a change--a fundamental change. That is one of the 
things that was so pronounced in the past 2 years--that is, 
that we had a change from a fundamental rate of powerful 
economic growth to a rate that led us into a recession. As was 
pointed out, we didn't catch it. The Office of Management and 
Budget (OMB) didn't see it. Neither did anybody else.
    The last thing I would point out is that we have also 
looked at the fan chart and at where we came out with respect 
to those projections. We do that without having policy changes 
in there--which I think your chart has--because we don't 
project policy changes in the baseline. Nevertheless, I also 
don't wish to dispute the point that, even taking out the 
policy changes, we are barely at the bottom line of the fan 
anyway.
    Senator Conrad. If I could just make a point on that? I 
don't want to leave the impression that I was being critical of 
CBO.
    Chairman Nickles. No, I know you weren't.
    Senator Conrad. I wasn't being critical of you showing the 
fan chart. I was trying to show where we are in the real world 
compared to the estimates of where we might be. You know, it is 
pretty stunning, and I think it has got to sober us all with 
respect to what we do going forward.
    Chairman Nickles. Senator Conrad, I echo that. I think I 
said the same thing. Nothing critical, Dr. Anderson, of you or 
even your cohorts. We just all missed the numbers big time, 
particularly 2 years ago. We didn't know about the terrorists, 
and we didn't know what happened in the market. I think there 
was a lot of negatives there that have flowed up, and the 
reason why revenues were down $175 billion from 2 years ago, 
that has hurt us big time.
    Next we will call on Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Anderson, I just have a question at the outset with 
regard to the first chart you showed called the budget outlook 
where you projected potential surplus and deficit over the next 
10 years. As I understood your testimony and that chart, we see 
a significant increase in revenues in the out-years, primarily 
as a result of the expiration of the Tax Act of 2001; is that 
correct?
    Mr. Anderson. Starting in 2011, that is correct.
    Senator Crapo. I realize it is not what you do in terms of 
you have to focus on current law, and currently that law is 
projected to expire. Have you done any projections as to what 
chart would look like if we assume that the Tax Act is 
continued and not allowed to expire?
    Mr. Anderson. Yes.
    Senator Crapo. Well, first of all, I would like to ask if 
you would make those charts available. Second, what does that 
tell us if we make the assumption that the tax cuts are made 
permanent?
    Mr. Anderson. If the tax cuts are made permanent, the 
surpluses in the out-years are not eliminated, but they are 
greatly reduced.
    Senator Crapo. There are still surpluses?
    Mr. Anderson. There are still surpluses, small surpluses, 
in the out-years. One of the points I made is that in this time 
period, from 2004 to 2013, as a percentage of GDP, deficits or 
surpluses are relatively small. They don't really climb to a 
significant level until one reaches 2011, 2012, and 2013.
    If one extended the tax cuts in 2011, 2012, and 2013, you 
would still have surpluses, but as a percentage of GDP, they 
would be very, very small.
    Senator Crapo. All right. Thank you. I want to focus now on 
the spending side of the equation for the next budget year, and 
as I understand your testimony--well, actually, let's look back 
at the current year for a moment. If I understand your 
testimony correctly, outlays grew by about 8 percent in 2003; 
is that correct?
    Mr. Anderson. Correct.
    Senator Crapo. Do you know how that is broken out among 
mandatory spending versus discretionary?
    Mr. Anderson. It is in our document here; The Budget and 
Economic Outlook: Fiscal Years 2004-2013. I will tell you what 
it is in just a second.
    Senator Crapo. All right. Well, the question I have is--
and, again, looking at your testimony, it appears that you are 
projecting a 5.5 percent increase in outlays for this coming 
budget year. Do I read that correctly?
    Mr. Anderson. That is correct. I believe that is correct.
    Senator Crapo. Well, again, I will kind of read from some 
of the statistics I get here, and you can correct me if I am 
reading them wrong. I understand that you are taking into 
consideration net interest costs falling during that period, 
but if you take out the interest factor, the actual increase in 
outlays is about 6.7 percent for the coming year.
    Mr. Anderson. I believe that is correct.
    Senator Crapo. The growth in the economy, do you know what 
we expect the economy's growth to be?
    Mr. Anderson. For calendar year 2003, 2.5 percent.
    Senator Crapo. So what you are projecting is that Congress 
is going to be outspending the growth in the economy by more 
than double in the coming budget year.
    Mr. Anderson. I think it is 2.5 for 2003, and I think the 
figures you are quoting were between 2003 and 2004.
    Senator Crapo. Oh, OK.
    Mr. Anderson. It is 3.6 for 2004.
    Senator Crapo. OK. So somewhere----
    Mr. Anderson. Yes, right.
    Senator Crapo [continuing]. In the neighborhood of about a 
double of the economy.
    Mr. Anderson. Right.
    Senator Crapo. Can you tell me what is fueling the rise in 
spending there in your projections?
    Mr. Anderson. It is entirely in the entitlement area; that 
is, discretionary spending is growing at about or a little bit 
lower than the rate of the economy. In the entitlement area, 
particularly in the health area, Medicare and Medicaid and 
other Federal health benefits are increasing at rates 
significantly greater than the size of the economy.
    Senator Crapo. So if we are concerned about the rate of 
growth of spending on the spending side of the budget, it is 
the entitlement area, and particularly the health care area of 
entitlements, that we must focus on.
    Mr. Anderson. It is; however, our baseline for 
discretionary spending assumes current law, which is right now 
at about a $750 billion budget authority level for 2003 and 
then just inflation. As we have talked about before, we don't 
have estimates in there for a war or additional anti-terrorism 
expenditures or whatever new discretionary expenditures may 
come out. Under that scenario you are exactly right.
    Senator Crapo. So what you are telling me is that under the 
Budget Act, you are required to assume that discretionary 
spending remains stable?
    Mr. Anderson. At inflation, that is correct.
    Senator Crapo. At inflation.
    Mr. Anderson. Right.
    Senator Crapo. Regardless of what you would see with regard 
to congressional actions, and I understand that.
    If I could just ask one more question, I know that you have 
previously been asked about the potential cost of a war and 
that you have provided that information to the Budget Committee 
before. Could you briefly tell us whether you have any 
evaluations as to what the potential cost of a war with Iraq 
would entail?
    Mr. Anderson. In late September, we did some estimates and 
broke them out in several different categories. The categories 
we broke them out into was the cost to get the men and 
materials and troops and ships over to the Middle East, so the 
deployment costs. Then we had a cost per month for combat, 
particularly the cost for the first month and for subsequent 
months. Then we had a cost for redeployment to take our 
materials and men back. Then we broke all that down by whether 
one looks at what we call the heavy air where we had much more 
concentration on an air conflict versus a heavy ground 
conflict. What we didn't do was say how many months the 
conflict was going to last.
    Senator Crapo. So you have broken it out on a monthly cost 
basis?
    Mr. Anderson. On a monthly basis. After we did all that, 
then we also took a look at some historical occupation costs 
and gave figures on a monthly cost there. So I have these 
figures here, but the purpose of them was to take a look at 
past figures and our current knowledge and provide you with the 
information so that if you make a judgment of how long you 
think the war is going to last and how long the occupation was 
going to last, then you would have some broad senses of what 
the cost would be.
    Senator Crapo. I know we have those numbers, but if you 
could submit those again, I would appreciate that.
    I believe my time has expired.
    Chairman Nickles. Senator Crapo, thank you very much.
    Next we will call on Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    Just to follow-up with Senator Crapo's comments regarding 
the costs of war and Department of Defense, Homeland Security, 
and so on, you had indicated that economic change, slowdown, 
coupled with the tax cut passed last time and spending amount 
for these swings or changes and the loss of the surplus and so 
on, and I would just to my colleagues urge us to take a look at 
history when we are in time of war. We saw in the 1960's and 
early 1970's a buildup in military spending because of Vietnam 
and large deficits accumulate. In the 1980's, we saw large 
supply side tax cuts and, again, a large military buildup in 
the 1980's. The result was a tripling of the national debt and 
an explosion in interest rates.
    I now see--and we are all talking about being at the brink 
of war, major war, possibly, with Iraq and homeland security, 
coupled with other costs that we have that relate to the 
ongoing war on terrorism. I would just first indicate that I 
would hope we would look to history and what has happened in 
the past when those items collide. We know, in fact, that on 
the discretionary side the largest increases are in defense and 
homeland security, and we all support those efforts to make 
sure that we are providing safety and security. Those are the 
kinds of spending increases that we are seeing, and we are 
going to see increased pressure in those areas. Wouldn't you 
agree--
    Mr. Anderson. I agree, and the history aspects, 
particularly for military history and the costs involved, I 
think are important for whenever we consider a future military 
action.
    Senator Stabenow. Concerning your comments regarding the 
uncertainties--and we certainly are in a time of credible 
uncertainty, geopolitical as well as economic, and I wouldn't 
want to be in your shoes or those of CBO trying to figure this 
out in the time of great uncertainty that we have.
    In looking at your comments, I noted that your comments on 
economic uncertainty and where that comes from are different 
from what we heard yesterday, in part, from economists saying 
it wasn't about demand. You are putting forth another view that 
the growth of consumer spending is uncertain in the near term; 
however, because demand is weak--we have heard this certainly 
in many places. Demand is weak in many sectors of the economy; 
spending by the business sector remains weak as low corporate 
profits and excess capacity from overinvestment during the 
bubble years of the 1990's have inhibited investment. So we 
have an excess capacity problem which would say we need to 
increase demand. It is not a question of increasing supply. It 
is a question of increasing demand so we can bring down that 
overcapacity. At least that is how I would read it from what 
you are saying.
    Then you go on, moreover, uncertainty about the strength of 
demand the risks of terrorism and war and so on have caused 
businesses to be cautious.
    Mr. Anderson. Right.
    Senator Stabenow. Could you speak to that? Because I think 
that is very important as we debate how we stimulate the 
economic, how we do things in a way that will strengthen and 
hit the right points. It seems to me you are saying very 
clearly that demand and bringing down that excess capacity is 
important in terms of stimulating the economy.
    Mr. Anderson. Well, you have hit on the highlights of what 
our major concern here is, and particularly your reference to 
the uncertainties aspect. We feel that much of the lack of 
demand, both on consumers and on the part of businesses, and 
much of the low level of capacity is very, very much related to 
the uncertainties involved. Again, it is not just the business 
uncertainties. We highlight those. We talk about those. The 
world gets smaller every day. We have much more competition 
with people outside the country here, the foreigners. It is the 
geopolitical.
    The resolution of that kind of geopolitical we feel is 
perhaps much more important, and perhaps much important than we 
can give credit for here, because it is so difficult for 
economists or forecasters or businessmen to really tie those 
larger issues together with the impact that it has on consumer 
confidence, business confidence.
    Now, after having said that, are we in the conditions for a 
jump-start, if you will? Are we in the conditions for stimulus? 
Yes. You mentioned history, and I do like history, not just 
military but also financial and economic. Our estimates, our 
success at doing stimulus proposals in the past has not been 
uniformly good. Frequently, we have get the timing exactly 
wrong. That is, by the time we take the actions to do 
particularly a fiscal policy impact on jump-starting the 
economy, the economy will have changed in and of itself. 
Monetary policy is perhaps another thing. Monetary policy 
generally can be done much quicker than fiscal policy.
    So my comment to you is that I agree, we are in the 
conditions now--and it certainly has been discussed actively by 
not only the political environment but by the economic 
environment--that we might be ripe for, could be very ripe for 
a jump-start stimulus. Timing is paramount, though.
    Senator Stabenow. I agree. You are saying exactly what many 
of us have said in terms of having whatever happens happen 
immediately. From what you are saying, this needs to be focused 
on consumer confidence and demand and all of those efforts that 
are different than some, certainly than what we have heard in 
terms of many of the tax proposals that are more long term as 
opposed to immediate and focusing on demand.
    I would just say, in conclusion, one other comment. I found 
it interesting and very important to note for the record that 
when we look at the next 10 years and the focus on whether we 
will be in surplus and when, it is important to note that of 
the $1.3 trillion that is projected in a cumulative surplus 
over the next 10 years, as you indicate, the last 3 years are 
almost entirely responsible for that total and that that 
accounts for 93 percent of the 10-year sum. That is because you 
assume that at the end of 10 years the tax cuts are not extend. 
Isn't that correct?
    Mr. Anderson. That is correct.
    Senator Stabenow. So that we only have surplus, 93 percent 
of what you are projecting occurs only if those tax cuts are 
not extended. If they are extended, do you have numbers at this 
point as to what we are talking about in terms of debt?
    Mr. Anderson. I have them. I don't know exactly--I was 
asked before, and I will provide them for the record. The 
surpluses do not evaporate, but they remain very small. So 
basically, just as the numbers we have for the initial years 
would indicate, if we were to get rid of the--if we were to 
retain the tax cuts, we would have surpluses of very small 
levels, not only nominal amounts but as a percent of GDP, from 
basically the next 2 or 3 years throughout the 10-year period.
    Senator Stabenow. Thank you.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Stabenow, thank you very much.
    Next we call upon Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    I want to go back to a line of questioning regarding the 
10-year numbers. Tax cuts wipe out the surplus, or at least 
greatly decrease it. Second, you don't project any increases in 
discretionary above inflation because you are not allowed to. 
Is that correct?
    Mr. Anderson. Correct.
    Senator Ensign. If you project those out, what happens to 
the surplus?
    Mr. Anderson. It is gone.
    Senator Ensign. OK. I just wanted to make sure. I don't 
want to get partisan about this, but we have heard a lot about 
the tax cuts. Last week we had on the floor of the House the 
omnibus bill. There were $500 billion in new spending increases 
voted on in that bill--$500 billion over the 10-year period of 
time.
    Senator Conrad. Would the Senator yield?
    Senator Ensign. In just a second. The President's proposal 
on tax cuts is about $670 billion over 10 years. I haven't seen 
too much economic modeling that state that the spending 
increases are going to actually grow the economy, where tax 
cuts--that is the whole point. The purpose for tax cuts is a 
supply side effect. During the 1980's, we saw a tripling of the 
debt.
    Three factors. One, we had going into the 1980's--
tremendously high interest rates. Second, we had a dramatic 
decrease in the size of the Defense Department that had to be 
rebuilt. Third, the tax cuts actually increased revenues to the 
Government. We outpaced those increases in revenues to the 
Government by spending, both mandatory and discretionary 
spending. Is that correct?
    Mr. Anderson. We believe at CBO, consistent with most other 
economists, that there is a dynamic or supply side effect to 
tax cuts, although I want to be very careful, it depends upon 
the tax cut.
    Senator Ensign. The kind of tax cut.
    Mr. Anderson. Absolutely.
    Senator Ensign. I totally agree with that.
    Mr. Anderson. How permanent in nature, and there are very 
different kinds. In addition, we believe that the effect is 
very much influenced about how the tax cut is financed. In 
fact, we are seeing that today. Where we have a tax cut that 
goes through 2010 and then, if you will, expires. Well, the 
economic impact of a tax cut that goes out for 6 or 7 years and 
then goes away is much, much, different, I think, than an 
economic impact of one that goes out permanently and is also 
financed by spending cuts.
    Senator Ensign. I think it is fine to look out 10 years, 
but at the same time, we are so off on 1- and 2-year numbers, I 
have little faith in 10-year numbers. I think we should have 
fiscal discipline. I don't want to add to the voices that say 
there is not a problem with running deficit, as long as you 
keep the deficit at a certain percentage of the GDP. I believe 
that we should look to not only balancing the budget but also 
paying down the debt. I am a strong believer in that. Lastly, I 
also believe that certain types of tax cuts can stimulate the 
economy. The one thing I have learned in Washington, D.C., is 
we don't cut spending. There just is not a lot of appetite here 
to cut spending. I am one of the few that actually will vote to 
cut spending, and the best we can hope to accomplish is to slow 
the rate of growth of government spending down. We continue to 
increase and increase and increase spending up here. I would 
like to see the rate of growth slow down and have some tax 
cuts. That seems to me the only way that you are going to take 
care of the deficit. I believe a combination of slowing down 
spending with the right kind of tax cuts is the only way for us 
to get to where we all want to be, and that is where we are not 
leaving our children and our grandchildren, with a country that 
is debt-laden.
    I apologize to Senator Conrad, I took so long to yield.
    Senator Conrad. No, I appreciate it very much, Senator.
    The Senator mentioned that we voted on $500 billion of 
spending increases.
    Senator Ensign. Correct.
    Senator Conrad. I would just say to the Senator, that is 
just not correct. We voted on $27.7 billion of spending 
increases. Those were 1-year appropriations--1-year 
appropriations. The only way you get to $500 billion is you 
accumulate it over 10 years. There is no requirement--there is 
no requirement that you have additional expenditures for 
follow-on years.
    Senator Ensign. We have all seen up here, when we do 1-year 
expenditures they get added into the baseline. We don't just do 
1-year expenditures on education or on anything else, and then 
the next year cut it back. We never do that. It gets added into 
the baseline. That is why that $500 billion number, I believe, 
is real. Senator Stabenow said let's look at the past. I 
haven't been around this place for too long, but it doesn't 
take long to realize that things don't get taken away.
    I think back to Ronald Reagan's famous statement, the best 
way to eternal life is to become a Federal agency or a Federal 
expenditure. It never goes away.
    I think that we should be consistent. Let's look for the 
right kind of tax cuts to stimulate the economy and have some 
restraint on Federal spending and that is how we will get out 
of these deficits.
    I thank the Chairman for the time.
    Chairman Nickles. I thank the Senator.
    Senator Allard.
    Senator Allard. Mr. Chairman, thank you. I just want to go 
into the debt limit just briefly here, if I may. Right now, 
when we talk about our debt limit, we are talking about the 
total debt. We are not talking about the public debt. That is 
correct?
    Mr. Anderson. Correct.
    Senator Allard. Just share with us some of the--maybe 
historically why it is that when we set the debt limit--this is 
actually money going outside the Government for money to be put 
in. There is an obligation out there. Why is it that we don't 
use the public debt as the limit as opposed to the total debt?
    Mr. Anderson. I am not exactly aware of exactly why the 
decision was made many years ago to use what we call in the 
budgeting community the gross debt, that is, the debt not only 
that goes outside the Government, the debt to the public, but 
also that portion of securities that are given to Government 
agencies, such as those that operate trust funds. So I am not 
sure exactly of the limit, but the irony of that is that if one 
looks at the two changes that we have had, the last two changes 
we have had in the debt limit, the one from 1997 to just 
recently, the changes in that were almost exclusively--I 
believe exclusively because of an increase in the amount of 
debt for inside the Government. Over that period of time, we 
have actually reduced the debt that went to the public, the 
outside.
    Senator Allard. You know, the only thing I could think of 
is that perhaps maybe they were just looking at the obligations 
on the general fund, in which case these trust funds--like 
Social Security is a future obligation on the general fund if 
we are going to honor those notes which automatically go out on 
Social Security, for example, or any of the other funds. I 
think that is an automatic obligation on the general fund.
    Mr. Anderson. It may well have been. There have been 
proposals recently also to decrease the amounts of moneys 
coming into trust funds and make up for those losses by 
transfers from the general fund. Well, that----
    Senator Allard. That is a future obligation, exactly.
    Mr. Anderson. Yes, that would have debt limit concerns then 
under the current definition that we have. It is an odd and 
confusing thing to explain to the public.
    Senator Allard. Now, we just raised the debt limit last 
year, the first part of last year, I think, didn't we? We are 
at $6.4 trillion.
    Mr. Anderson. Yes.
    Senator Allard. The Administration at the end of this last 
year--or somebody in the Administration has suggested that 
maybe we need to raise that a trillion or so. Can you share 
with us some of the thoughts--or has the Administration shared 
some of the thoughts of why they think that might be necessary?
    Mr. Anderson. I believe just before Christmas the Treasury 
Department came to the Congress and said that they needed an 
increase--I don't recall the exact amount--of the debt limit 
and that they would need it by about a month from now. The 
cash-flows of Treasury are such that April, as you might 
imagine, is our big cash intake month. Because so many people 
resolve--both individuals and corporations, but particular 
individuals resolve their tax liabilities about the middle of 
April, because of that, Treasury does need or run short of 
income in February and March, and I believe what Treasury said, 
that under current projections--and we looked at them carefully 
and we believe that we are consistent with them--they are going 
to bump up against the current debt limit of $6.4 trillion 
sometime around a month from now, that is, at the end of 
February.
    Senator Allard. At the end of February. I mean, if we would 
deal with the debt limit in this particular piece of 
legislation, our resolution, I guess we wouldn't. We need--that 
is a statutory change, isn't it?
    Mr. Anderson. I believe so, yes.
    Senator Allard. This is a resolution. So we will have to 
probably deal in the Congress, if we are going to raise that 
debt limit, we are going to have to deal with that within--
before this resolution actually gets even reported out of the 
Senate.
    Mr. Anderson. I believe so, yes.
    Senator Allard. OK.
    Mr. Anderson. Again, Senator, though just as we talked 
about from 1997 to 2002, a good portion of that is the increase 
in debt to trust funds.
    Senator Allard. Yes. Now, there is also--I mean, our budget 
has been pretty impacted by the cost of the war. We have had an 
impact there. I think there has been a cost to the war there. 
How have you figured in--and I am sorry I missed your 
presentation. I had another committee meeting. Did you talk 
anything about the future potential costs of this war? We could 
be right in the middle of this resolution, and we could 
potentially--I am not saying we are going to be, but 
potentially be at war with Iraq. We are amassing our troops on 
the borders now, and so there is some extra cost there. Have 
you given that any thought?
    Mr. Anderson. We have given it a lot of thought, and I did 
talk about it a bit, but it is easy to summarize.
    First of all, in our baseline projections where we do not 
make, explicitly do not make forecasts of congressional action, 
we do not have any forecast of what additional appropriations 
the Congress may provide to the Department of Defense for 
conducting the war.
    Second of all, the major impact of the war could be its 
impact on the economy. By its impact on the economy, I mean not 
just oil but in a much broader sense, particularly on consumer 
and business confidence.
    We at the Congressional Budget Office try to take into 
account what the private sector forecasters of the economy do. 
We have an extensive panel of economic advisors that meets 
twice a year. We regularly communicate with them, and we do an 
awful lot with what is known as the blue chip, taking a look at 
the consensus and various different estimates there. We are not 
sure exactly what they have done with an expectation of the war 
or not. Our estimates are such that we feel that these larger 
geopolitical risks are not really something one can estimate on 
the economy.
    So our economic projections and the baseline that we 
presented here this morning is basically not taking into 
account what war might do to the economy. It could be positive. 
A quick resolution of the war could take away a lot of the 
uncertainty and could get--just to pick oil, for example, lower 
the price of oil considerably. There are many, many other 
scenarios that go well into the opposite direction and would 
cost not only the Federal budget but also the economy billions 
and billions of dollars.
    Senator Allard. I am going to change completely away now 
from that and go into the tax cut area. When we put in place 
the temporary tax cuts a year and a half ago, the Congress 
here, I noted in an editorial by the Washington Post--and they 
have never been any friend particularly of those of us who want 
to cut taxes, but they had to admit in one of their editorials, 
very short in that editorial, that the temporary tax cuts that 
were put in place a year and a half ago that extended out only 
over 10 years actually did help buoy up the economy.
    Do you have any evidence to indicate from what you have put 
in that those tax cuts did actually help buoy up the economy so 
that it kept us out of going any further than what we have gone 
if they hadn't been in place?
    Mr. Anderson. We have looked at the impact of the tax cuts, 
temporary, yes, but temporary through 2010, and also the 
increased spending. I have been in budgeting for many years and 
looked at many different efforts to provide a jump-start or a 
stimulus. As you may have heard me say just a few moments ago, 
I think one of the problems of using fiscal policy in that 
sense is getting the timing right. There have been so many 
times in the past when, because of the delays of passing the 
legislation and then actually implementing the various 
different types of tax or spending for stimulus purposes, that 
frequently we have missed the timing; that is, we provided the 
stimulus tax cuts or spending at the wrong time after the 
economy has picked up.
    Last year, I think we hit it right. We may have been lucky. 
I am not sure it was the immense wisdom of those of us here in 
Washington. Nevertheless, from an economic perspective, I think 
we hit it right. By that I think we mitigated the depth of the 
downturn by the combination of the fiscal policies that we 
made.
    Senator Allard. So your bottom line is that we did help 
buoy up the economy from your point of view.
    Mr. Anderson. Yes, we did. We have some estimates of 
exactly how much that was. I will be happy to provide them for 
you for the record.
    Senator Allard. I would appreciate that if you would 
provide it.
    Mr. Anderson. Certainly.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Nickles. Senator Allard, thank you very much.
    We are delighted to also have Senator Sessions join us, a 
new member of the Committee. Welcome, Senator Sessions.
    Senator Sessions. Thank you. I won't--I had an important 
Judiciary Committee meeting. I just had to be there, and I am 
sorry I couldn't be here earlier.
    After the last Gulf War, the price of oil did plummet 
significantly, didn't it?
    Mr. Anderson. It really did, yes.
    Senator Sessions. Was that a factor in the general economic 
growth that we sustained after the Gulf War?
    Mr. Anderson. I think it was definitely a factor, and not 
just the price but also certainty, as we have been talking 
about here, the levels of uncertainty on the economy were 
diminished after the last war. We hope they will be diminished 
shortly here, too.
    Senator Sessions. Well, I know that a lot of people are 
nervous about the economy and they would like to see it bounce 
back. There are things that indicate that it is healthy enough 
that the market should reflect that, and it hasn't shown that. 
I suspect some of it is nervousness over the war, and the 
sooner we can get that over, I think we can have every 
prospect--and I am glad you agree--that some stability in the 
region, we could show a reduction in oil prices, which could be 
key to long-term growth. Certainly that can be our hope.
    That is all I have, Mr. Chairman.
    Chairman Nickles. Senator Sessions, thank you very much.
    I would make just a couple quick comments. I was kind of 
fumbling around for the record. Its total amount of money that 
we pay for Social Security and Medicare approximately equal to 
the total taxes that we receive in Social Security and 
Medicare?
    Mr. Anderson. The total amount of money we pay for Social 
Security and Medicare now is less than the amount of taxes that 
we pay because of the general fund transfers that we make, 
particularly to Medicare Part B.
    Chairman Nickles. OK. That wasn't my question.
    Mr. Anderson. I am sorry.
    Chairman Nickles. My question was: Is total amount of money 
that we pay in Social Security and Medicare equal to the total 
taxes we take in Social Security and Medicare? I know there is 
presently some general revenue fund that supplements Part B, 
but I think if you take that out, they are roughly equivalent, 
I think the income and the outlays are roughly equivalent, and 
I want you to substantiate that or correct me if I am wrong.
    Mr. Anderson. I believe that it is largely true. That is 
right. Yes, it is.
    Chairman Nickles. There are a lot of misconceptions about 
trust funds, period.
    Mr. Anderson. Yes, there is.
    Chairman Nickles. A lot of misconceptions that maybe at 
some point we need to try to figure out or better explain. I 
believe the total payroll taxes, the 15.3 percent, which 
includes Social Security and Medicare, the total money that is 
received on payroll taxes for those two accounts are roughly 
equivalent to the outlays that we make every year on those two 
programs.
    Now, granted, Medicare has--we say we supplement--we 
transfer general revenue funds and so on, but, anyway, 
revenues, I believe, and outlays are roughly equivalent for 
those two programs.
    Mr. Anderson. I believe you are correct.
    Chairman Nickles. You could correct me if I am wrong, or 
you could give me something for the record if that is 
incorrect. I think Senator Conrad and I are both concerned 
about long-term viability of both programs. We will have 
hearings that will deal with those at a later point. I am 
planning on having a Medicare hearing and we may do a Social 
Security hearing as well. I am really concerned. Those are two 
programs that have a lot of attention and I think some 
confusion on trust funds that I wrestle with.
    One other question is in regards to what Senator Allard was 
talking about on debt limit. The publicly held debt is what, 
$3.7 trillion?
    Mr. Anderson. 3.2 or 3.3 trillion? I should have that on my 
fingertips.
    Chairman Nickles. $3.5 trillion at the end of 2002.
    Mr. Anderson. Right.
    Chairman Nickles. Does it really make sense or is it 
necessary--I know you mentioned that you thought we would be up 
against the statutory debt limit by the end of next month or 
close to that time.
    Mr. Anderson. Right. That is correct.
    Chairman Nickles. The statutory debt limit also includes 
debt owed the trust funds or debt owed the Government; is that 
correct?
    Mr. Anderson. That is correct.
    Chairman Nickles. We are not going to be bouncing checks on 
those. Those are basically governmental entries. Does it make 
sense to have the debt limit exceed what is in excess of the 
publicly held debt?
    Mr. Anderson. First of all, I think it is very, very 
confusing for the public, that is, to try to talk about a debt 
limit that has a limit on debt that the public doesn't actually 
incur, the intergovernmental transfers.
    What the purpose was when it was originally instituted many 
decades ago, I don't know. I am just not aware of that. I do 
not find it from a budgetary perspective particularly helpful 
to have the liabilities of intergovernmental accounts reflected 
as part of the debt limit.
    Chairman Nickles. I appreciate that. I may even do a 
hearing one of these days, Senator Conrad, on some of the trust 
funds and misconceptions and so on.
    Let me ask you one addition question. If we did make the 
President's tax cut that passed in 2001 permanent, would we 
continue under your projections under the baseline to have 
surpluses for all those years?
    Mr. Anderson. Yes. Deficits would decline, as we indicated, 
in the near term, get to surpluses, small surpluses, and then 
remain there through 2013.
    Chairman Nickles. I appreciate that. I look forward to 
working with you.
    Mr. Anderson, I have several questions that I think I will 
submit to you for the record and would appreciate your response 
to those as well.
    Chairman Nickles. Senator Conrad, do you have any final 
comments?
    Senator Conrad. I do. Thank you, Mr. Chairman.
    On the last point that was made, I think we have to be very 
careful about the message we send the American public about 
surpluses. There are no surpluses here anywhere, anywhere in 
sight, under any scenario. Your baseline doesn't include, does 
it, any provision for making the tax cuts permanent?
    Mr. Anderson. It does not.
    Senator Conrad. There is no provision in your baseline for 
the President's growth package and the revenue loss from that, 
is there?
    Mr. Anderson. That is correct, no provision.
    Senator Conrad. There is no provision in your baseline for 
the President's proposal on reforming Medicare or providing a 
prescription drug benefit.
    Mr. Anderson. That is correct.
    Senator Conrad. There is no provision in your baseline for 
growth in spending for homeland security above inflation.
    Mr. Anderson. Correct.
    Senator Conrad. There is no provision in the baseline for 
potential costs of the war.
    Mr. Anderson. Correct.
    Senator Conrad. You have indicated potential costs of the 
war, if there were a 5-year occupation, relatively short 
conflict, I think those estimates were in the hundreds of 
billions of dollars, were they not?
    Mr. Anderson. I believe for a 5-year occupation that would 
get up into that level.
    Senator Conrad. The other thing that is important to 
understand is in the baseline, you are jackpotting, you are 
including Social Security Trust Fund surpluses over the next 
decade; is that not correct?
    Mr. Anderson. I presented them on a unified basis.
    Senator Conrad. Unified basis.
    Mr. Anderson. Right.
    Senator Conrad. Which means all the funds are jackpotted, 
which means there is no special treatment for Social Security 
surpluses or for other trust funds. They are really not treated 
as trust funds. All the money is jackpotted.
    The problem with that is, I believe, that it misleads the 
American people as to our true financial condition. No company 
in America could jackpot its retirement funds or its health 
care funds for employees and pay operating expenses out of 
that, could they? Could any company do that?
    Mr. Anderson. We certainly have a different way of treating 
our trust funds than anybody else, and I think I agree with 
what you are saying with respect to the confusion that it 
causes the American public. Even the mere phrase ``trust fund'' 
we treat differently than what you or I or the American public 
or businesses treat as trust fund.
    Senator Conrad. You know, the thing that has always struck 
me, I came from a financial background to the Congress, and I 
started out in this committee way at the end of the table 
there. I will never forget when I had my first briefing on how 
the Federal Government does its accounting. To me, it is 
totally misleading. I had a long talk with Chairman Greenspan 
about this 2 weeks ago, and I personally believe we ought to go 
to an accrual system, because that would demonstrate to people 
there are no surpluses here, under any scenario, under any 
presentation. Even if you leave out the President's proposals 
for additional spending and additional tax cuts, all that 
aside, there are no surpluses. Because in an accrual system, 
what would show is that we have these incredible liabilities 
that are hanging over us, for Social Security, for Medicare.
    The reason they don't appear on the balance sheets of the 
Federal Government is because the notion is Congress could 
change those programs on 30 days' notice. That is the reason we 
don't show them as contingent liabilities. Does anybody believe 
these are not truly liabilities? I don't think there is a 
member around this dais that wouldn't say those are real 
liabilities.
    Chairman Nickles. Just to echo some of the things Senator 
Conrad is saying, I am happy to get into some of our unfunded 
liabilities that we are looking at in some of our programs--
Social Security, Medicare. Both--well, Medicare certainly, and 
Social Security for the most part, a PAYGO system. It is so far 
from being a funded system. I think the unfunded vested 
liability in Social Security is more like $10 or $11 trillion. 
So one could put that figure down if you want to say actual 
debt, you could add that. It is a liability. We basically 
agreed to pay for it on a PAYGO basis, right or wrong. Some 
people would like to change the system, and I think maybe with 
some merit, to provide for a vested capitalized system, but 
that would take some transition and some political cooperation 
to make that happen.
    Senator Conrad. I go back to any private company, there is 
no company in America today that could take the retirement 
funds of its employees, the health care funds of its employees, 
and use them to pay operating expenses. If they did that, they 
would be on their way to a Federal facility, but it wouldn't be 
the Congress of the United States.,
    Chairman Nickles. They would also be on their way to a 
Federal facility if they used PAYGO. Every company in America 
has actuarial standards that they must meet that the Federal 
Government does not.
    Senator Conrad. Absolutely. This may be an area where the 
Chairman and I are on the same page. I think we would do the 
country a tremendous service if we would have hearings that 
would focus on these unfunded liabilities and where we are 
headed, the demographic time bomb we face, and what the 
implications are for future policy. Perhaps that will be 
another day.
    Chairman Nickles. I look forward to working with you.
    Mr. Anderson, thank you very much.
    Chairman Nickles. For the members of our committee, our 
next hearing will be on Tuesday. We will have Mr. Glenn 
Hubbard, who is the President's Council on Economic Advisers, 
present to us at 2:30 on Tuesday.
    The committee is adjourned.
    [Whereupon, at 11:48 a.m., the committee was adjourned.]
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                THE PRESIDENT'S FISCAL YEAR 2004 BUDGET

                              ----------                              


                       TUESDAY, FEBRUARY 4, 2003

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:04 p.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Don Nickles 
(chairman of the committee) presiding.
    Present: Senators Nickles, Enzi, Sessions, Conrad, and 
Corzine.
    Staff present: Hazen Marshall, staff director; and Cheri 
Reidy, senior analyst.
    For the minority: Mary Ann Naylor, staff director; and Lee 
Price, chief economist.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. We will convene the hearing. Dr. Hubbard, 
welcome. We are delighted to have you before our committee. We 
are delighted, as well, that Senator Enzi is with us.
    I will apologize and mention that because of the recent 
tragedy, there are several of our members that are attending 
the memorial services, and our hearts, and prayers, and 
sympathies are certainly with the victims and their families of 
this recent disaster. I observed the memorial service, the 
President and others, we have several of our colleagues that 
are present, and we decided to go ahead and conduct the hearing 
today.
    Dr. Hubbard, we welcome you to our committee. We are 
pleased that you would join us and pleased as well that my 
friend and colleague, Ranking Member Senator Conrad is with us 
as well.
    Senator Conrad, do you have any opening comments?

              OPENING STATEMENT OF SENATOR CONRAD

    Senator Conrad. First of all, Mr. Chairman, I want to join 
you in saying that our minds are very much with the family 
members, and we are thinking very much about those who lost 
their lives. It is an incredible tragedy, and I think the 
Chairman was right to go ahead with the business of the 
Committee because, after all, this deals with issues that 
affected those who gave their lives. So I think the Chairman 
was quite right in proceeding, and we certainly welcome Dr. 
Hubbard here.
    Mr. Chairman, I would start with just a brief review of 
where we are from my perspective, and where we are headed, and 
why this all matters a lot.
    The President said in 2001 that he was using conservative 
economic assumptions. He said, ``Tax relief is central to my 
plan to encourage economic growth, and we can proceed with tax 
relief without fear of budget deficits. Even if the economy 
softens, projections for the surplus in my budget are cautious 
and conservative. They already assume an economic slowdown in 
the year 2001.''
    Well, we now know, with the President's release of the 
budget, that those statements really missed the mark. We were 
told that we were going to have nearly $6 trillion over the 
next decade in surpluses. In the President's most recent 
information, that has turned to $2.1 trillion in deficits, a 
truly dramatic turn, approaching $7.8 billion over the next 
decade.

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    Let us go to the next. Last year, the President said our 
budget will run a deficit that will be small and short term. 
Well, again, he missed the mark, and the reality of our 
situation is much more stark. This, again, is from the 
President's own documents that show that we are actually, even 
though we are running record deficits now, those deficits on 
the left-hand side of the chart are record. They are the 
biggest in dollar terms we have ever had. The President's own 
information shows that if we pursue this budget policy, we 
never get out of deficit, and in fact they become much larger 
over time, as the baby boom generation retires.

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    The President, as part of his package, has proposed a 
stimulus or a growth package, but we see that very little of 
it, very little of the cost of it is effective in this first 
year, the first fiscal year. Less than 5 percent of the 
stimulus plan or the growth plan is effective this year.

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    The one thing that is growing is the debt, and the debt is 
growing dramatically. Gross Federal debt will go from $6.2 
trillion last year to $9.4 trillion by 2008, a time at which 
the President had previously indicated we would virtually 
retire the publicly held debt.

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    Now, we go to the question of what works in terms of 
economic growth. The Chairman has been very correct, I think, 
to point out what we have got to do is get back on an economic 
growth path. This is from the Macroeconomic Advisers, who I am 
told provide macroeconomic analysis to the White House, as well 
as to the Congressional Budget Office. What their estimates 
show is that the President's policy does provide a spike up in 
the near term, but past 2005 provides lower economic growth 
than if we did not do anything at all. It actually hurts 
economic growth for the long term.
    That view is buttressed by Mark Zandi, the chief economist 
for Economy.com. He says, in 2003, the Democrats plan that 
provides more short-term stimulus will provide about twice as 
much economic growth in 2003, little more than twice as much in 
2004, but interestingly enough will not provide the long-term 
harm that the President's plan will have.

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    Again, he finds, just like the other econometric firm has 
found, that the President's plan actually hurts long-term 
growth.
    Let me just conclude with a statement from you, Dr. 
Hubbard, in your textbook. You say, and I quote, ``We can 
represent the large increases in the Federal budget deficit in 
the early 1980's, creating short-run pressures for higher 
output and interest rates. By the late 1990's, an emerging 
Federal budget surplus put downward pressure on interest 
rates.'' I would agree with that, and I would suggest that 
increasing deficits, increasing debt will serve as a drag on 
the economy. That is what other economists have found; that the 
dead weight of deficits and debt actually hurt long-term 
economic growth. That is really what this discussion is about, 
this debate is about.

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    We have got to, together, find the strategy that will best 
help our country return to economic growth, and I thank you, 
Mr. Chairman, for the hearing.
    Chairman Nickles. Senator Conrad, I will agree with that 
last statement. I hope that we will work together and find the 
policies that will help best grow the economy.
    I would like to show one chart. I am going to try and avoid 
chart wars with you. The guy makes charts like they are 
popcorn. They keep popping up every where I go, Senator 
Conrad's charts.

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    I am going to show this chart because this chart kind of 
shows what happened a little bit, and maybe I will ask Dr. 
Hubbard to help maybe explain, but the blue is revenues, and 
you can see revenues in the year 2000 were over $2 trillion--
$2.25 trillion. The next year they declined by about 1.7 
percent, went down to $1.99 trillion, and then in 2002, 
declined to $1.853 trillion, a reduction of almost 7 percent 
from 2001 to 2002, a combined reduction of about 8.5 percent.
    Conversely, expenditures climbed dramatically, total 
outlays of the Federal Government. There was, let me see if I 
have the percentages, the spending increased between 2000 and 
2001 about 4.2 percent and then between 2001 and 2002 by 7.9 
percent. Actually, if you took away the reduction in interest 
costs, spending grew by, well, actually, in the appropriated 
accounts by over 12 percent.
    So you had spending growing dramatically, revenues 
declining substantially, and, Dr. Hubbard, OMB missed the guess 
on revenues and so did CBO. You both guessed about the same. I 
mean, your mistakes were about even. You both misjudged 
revenues, but I will tell you history has never shown this kind 
of reduction in revenues. Two consecutive years, we have never 
had reduction in revenues, and we have certainly never had a 
reduction in revenues of 7 percent like we saw between 2001 and 
2002.
    I might note from my colleagues, since the President has 
proposed a budget of $2.2 trillion, if revenues would have 
maintained any type of growth for 2001, 2002, 2003, 2004, a 
growth of 2 percent, and we would still be in balance, but we 
had a rather dramatic departure in growth and a decline in 
revenues. At the same time, we also had a big increase in 
spending.
    So, Dr. Hubbard, one of the questions I will ask you--I am 
going to ask Senator Enzi if he has any opening remarks--but 
one of the questions I will be asking you is what caused this 
dramatic reduction of income? There was a stock-market 
collapse, but how did that flow through? How has that impacted? 
Why did everybody misjudge the estimates, even in 2001, on 
total revenues by hundreds of billions of dollars?
    We all goofed. OMB goofed, CBO goofed; i.e., Congress, so 
the Administration and the Congressional Branch both misjudged 
total revenues by a lot, and so as a result, we are a couple 
hundred billion dollars behind, and then how do we get out of 
this mess?
    I do not think you can get out unless you grow the economy. 
You have some proposals. I would like to hear from you today on 
how you think the Administration's proposals would grow the 
economy, how they will create equity, how they will increase 
market values. I think a large part of this reduction in 
revenues was a result of the stock market decline, and will the 
proposals that you are advocating, will that increase stock 
market values?
    Before I finish that, I would like to call upon Senator 
Enzi if he had any opening remarks.
    Senator Enzi. I will stay with the new tradition.
    Chairman Nickles. Thank you. I appreciate that.
    So, Dr. Hubbard, to introduce you, I will say that you were 
confirmed by this body on May 10th of 2001, so I guess I should 
not give you full credit for the estimates that were made in 
January of 2001, but we are delighted that you are here. You 
were appointed by the President to be chairman of the Council 
of Economic Advisers. You also received your Ph.D. in economics 
from Harvard University in 1983, and you are currently on leave 
of absence from Columbia University.
    You also served as deputy assistant secretary for Tax 
Analysis at the Treasury Department, which also makes it very 
important for you to be here, I think, to further explain some 
of the growth proposals that you have made. So, Dr. Hubbard, we 
welcome you to our committee. We are delighted to have you 
here, and we are happy to hear your opening remarks.

   STATEMENT OF GLENN HUBBARD, CHAIRMAN, COUNCIL OF ECONOMIC 
                            ADVISERS

    Mr. Hubbard. Thank you very much, Mr. Chairman, and Senator 
Conrad, Senator Enzi.
    In my oral remarks, I really just wanted to do three things 
with you: one, to try to sketch first a sense of long-term 
prospects for the economy and why I still believe they are 
very, very bright; second, to talk about the problem that the 
President was trying to fix in his growth package; and then, 
third, to talk about benefits of the plan and then come back to 
some of the budget issues that you and Senator Conrad had 
raised.
    In a sense, we start out with a very complicated time, not 
just for budgeting forecasting, but for thinking about the 
economy. The recession we went through and the recovery that we 
are now in are very atypical. We had not only an investment 
collapse leading this business cycle, which is very unusual, 
but of course we had the terrible events of September 11th, and 
corporate governance scandals as well.
    That is not just a challenge for forecasters. I think it is 
a challenge for all of us in Government, in the executive 
branch and the legislative branch, in thinking about policies.
    It is important, I think, to start out with the long term. 
One thing that is very clear about the American economy is that 
productivity growth is not only good for us absolutely; that 
is, we have had an increase in structural productivity growth 
in the United States, but it is good relative to our trading 
partners, and most of that is not because of what we do here in 
Washington, it is because of the strength and resiliency of the 
private sector in the United States and institutions that 
promote that flexibility, and part of our role is to try to 
think of policies that bolster that flexibility.
    In the short term, as I said, we experienced a recession 
that is atypical by post-war standards, in particular, because 
of the key role played by business investment. As we have 
argued in the Administration, and I think the President has 
said very persuasively, a key downside risk in the economy at 
the moment also comes from investment. Public policy, as you 
know, has been quite active. The Federal Reserve has worked 
very, very hard for an accommodative monetary policy. In the 
Executive and legislative branches, of course, fiscal policy 
has been quite appropriately propping up the economy's near-
term prospects.
    In terms of risks to the outlook, the key risk that we see 
in the Administration is a delayed investment recovery. Built 
into most of the forecasts in the private sector is a very 
timely and vigorous investment recovery. As I talk with 
business executives around the country, as I am sure all of you 
do, one gets a sense of delay, a sense of very high hurdle 
rates or a bar over which new investments must jump. Part of 
this reflects general uncertainty in the environment, partly it 
reflects concerns over corporate governance.
    At the same time, in the consumer sector, there is a 
possibility, given the significant loss of wealth in the 
household sector, that consumers might engage in a bit of what 
economists call some precautionary saving in response to 
changes in uncertainty.
    The President, as you know, put out a very bold jobs and 
growth initiative. You know, of course, what is in it. What I 
would like to do is explain why we think the President's 
initiative is aimed four-square at the problem.
    First of all, the most immediate effect I think from the 
President's plan in addressing the investment issue comes from 
the reduction of cost of capital for many small businesses who 
are, one, paying taxes at individual rates, and of course the 
rate cuts are accelerated, and from a dramatic increase in 
small business expensing.
    In addition, eliminating the double tax of corporate 
income, both on the dividend side and retained earnings side, 
is a significant pro-investment change in the tax code. We have 
estimated at the Council that the cost of capital for 
investment would fall by between 10 and 25 percent, depending 
on the assumptions you use about the life of a piece of 
equipment or how that equipment is financed.
    To those who say there is no short-term effect, let me 
translate that into something that is more familiar in our 
policy discussions, which is an investment tax credit. What the 
President proposed in eliminating the double tax would be the 
equivalent of between a 4- to 7-percent investment tax credit. 
Put that way, I think you can see this is a very large change 
in investment policy, not simply aimed at long-term growth.
    We believe that eliminating the double tax also has very 
important effects on corporate governance by making debt and 
equity on a more neutral footing, taking a lot of the wind from 
the sails of financial engineering and increasing the premium 
on cash and transparency and decreasing the premium on the 
management of earnings.
    The President's proposals would also help, we believe, 
shore up the problem that is identified on the consumption 
side. This comes from the acceleration of the tax relief 
already in place. That is, of course, principally accelerating 
marginal rates, but also the child tax credit and marriage 
penalty relief.
    The cash out the door, if you will, from the Treasury, is 
estimated by our Treasury to be about $52 billion in calendar 
year 2003. That could be bigger, depending on the timing of 
changes. This is, of course, the down payment on a long-term 
tax cut, and economists have long believed the responses of 
consumers and businesses to long-term tax changes substantially 
exceeds that through short-term changes. So not only is the 
cash out the door, in terms of what the President is proposing, 
as large or larger than many of the alternative plans that have 
been surfaced, but also, by being long term, is likely to have 
a much bigger effect. To be concrete, for a family, a typical 
family of four, with the two earners making ($39,000) would get 
$1,100 in relief in the President's plan.
    We believe also the plan has very important effects on the 
employment market in the United States, most directly by 
raising GDP growth, but also through the proposal for 
reemployment accounts, which is a very bold and new way of 
trying to get people back to work, instead of simply 
languishing on unemployment insurance.
    I think it is important, as I mentioned at the beginning, 
to note how the proposals will help the economy in the long 
run, and here there is a lot of confusion as to who actually 
bears the burden of a tax. Sometimes we think who bears the 
burden of a tax is who writes the check to the IRS. So, for 
example, if we are thinking about the proposal to eliminate the 
double tax on corporate income, is this about people who get 
dividends and retained earnings capital gains? Of course, in 
part, it is.
    Economists argue that most of the burden of the double tax 
is not borne by those people, it is borne by all of us. To see 
why, we know intuitively when we double tax something, we get 
less of it, and here the something we are getting less of is 
capital formation. As we get lower capital formation, we get a 
lower level of productivity and lower wages. Who bears this tax 
in a dynamic economy like ours is all of us, in terms of our 
wages, not the recipients of dividends for capital gains.
    A very important question, of course, for the short term 
and the long term, is the effect of the policy on the fiscal 
position of the Government. We, in the Administration, like all 
of you, are very concerned about the country's fiscal outlook. 
We do not believe that tax relief of the kind and size that the 
President proposes worsens substantially the Government's 
fiscal position.
    The way I think of this, as an economist, is to look for a 
fiscal anchor, and the most logical fiscal anchor is thinking 
about our debt-to-GDP ratio, which does not rise in response to 
the President's proposals. The comment on deficits and interest 
rates that is often mentioned is one where, as a profession, we 
believe we know the sign, and I am delighted to note that the 
Senator purchased my textbook. I hope he purchased it, so I can 
get some royalties for my kids. [Laughter.]
    Mr. Hubbard. I think we know the sign. The magnitude 
depends a lot on the types of deficits and what they are used 
for. Just as a household or a business, it matters what you do 
with the money, so it does for Government. We believe that pro-
growth tax policies are very much in our country's interest and 
very much have a high internal rate of return.
    Is the notion of deficit welcome? No. Is it understandable? 
Yes, for much of the reasons that Senator Nickles made in his 
opening presentation. We, in the Administration, the 
Congressional Budget Office and many in the private sector 
missed the mark on forecasts of surpluses in recent years. 
There is no doubt about it. Much of that has to come with 
complex changes in our economy that I look forward to 
discussing with you, if you like.
    Let me end by closing on the economics of the President's 
plan. We believe that this plan adds substantially to GDP 
growth. If you look at the changes in the cumulative level of 
GDP going forward, about nine-tenths of a percentage point in 
the end of the first calendar year, and about 1.8 percent by 
the end of 2005. These level effects of GDP are persistent. 
They are largely permanent, which means two things; one, a 
larger economy and, second, a larger feedback for Federal 
revenue.
    Thank you very much, Mr. Chairman.
    [The prepared statement of R. Glenn Hubbard follows.]

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    Chairman Nickles. Dr. Hubbard, thank you very much.
    I am glad that Senator Corzine joined us as well, so thank 
you for coming.
    Let me just ask you a couple of questions. You mentioned, 
under your proposal, your effort to eliminate double taxation 
of dividends, and a little birdie tells me that you were very 
instrumental in getting that included in the President's 
proposal, so I will compliment you on it.
    I think many people, and almost all economists, I would 
believe, would think that double taxation is not good tax 
policy. It needs to be fixed. Some might argue maybe not now or 
maybe it should be done in the form of more comprehensive tax 
reform, but it is not good tax policy to tax such a large 
percentage of distribution of corporate earnings. The tax rate 
I believe I saw in the handout last week is 60 or 70 percent; 
is that correct?
    Mr. Hubbard. That is correct.
    Chairman Nickles. A corporation pays 35 percent, an 
individual, whatever their collective rate is. It might be 28, 
it might be higher, it might be lower. Is there an effective 
rate that you count or can estimate that corporate dividends 
are taxed at in the United States compared to other countries? 
I saw one chart that had us listed as the second-highest tax 
rate on dividends of all industrialized countries; is that 
correct?
    Mr. Hubbard. That is correct. For new equity finances, 
money just going into the corporate sector, only Japan, among 
major countries, would have a higher tax rate. This is because 
I think most of the industrial world has some kind of dividend 
relief, not always complete, but some sort of dividend relief. 
We really are the outlier in that respect.
    Chairman Nickles. I have often thought it was wrong, and I 
may have some bias because I used to run a corporation, but I 
thought the best way to fix it would be to allow the 
corporations to deduct dividends, just like they deduct 
interest. They write a check for dividends, why can they not 
expense that with before-tax dollars instead of--or just get an 
expense for dividends, just like they get an expense for 
interest. Is that not another way of doing it?
    Mr. Hubbard. Well, if everybody in the economy faced the 
same tax rates or the corporate rate is the same as individual 
rates, there is no tax-exempt entities, from a purely economic 
perspective, you could give relief at the individual level or 
the corporate level. It would be the same effect on the cost of 
capital.
    What the President was trying to do, and has said many 
times, is make sure that income is taxed once, and only once, 
and he means the ``once'' part, as well as the ``only once'' 
part. If you do relief at the corporate level, given the 
importance of exempt shareholders and foreign shareholders, it 
is quite possible much of the income is not taxed at all.
    A second reason we had was, in terms of thinking about 
corporate governance, relief at the individual level puts a 
great deal of pressure on management to meet the judgment of 
the capital markets. If they have good projects, of course, 
they can retain earnings, but there is the constant pressure 
from the capital market.
    So you are right, relieving double tax on either margin is 
in the economy's interest. Those are the principal reasons the 
President used in his decision.
    Chairman Nickles. I was assuming one of the reasons was 
that it might cost a lot more because you do have a lot of 
dividends that are in tax-exempt status, 401(k)'s, retirement 
accounts and so on.
    Mr. Hubbard. It clearly costs more, but I think his concern 
was principally with the argument that we want to tax it once, 
and only once.
    Chairman Nickles. Let me ask you a question. There is also 
a very significant retirement savings or both savings and 
retirement savings proposals by the Administration. I do not 
believe you alluded to those too much, but those would have the 
impact of basically creating what I would call a Roth IRA, but 
basically after-tax dollars going into an account that would 
have tax benefits of not paying taxes on accumulated earnings; 
is that correct?
    Mr. Hubbard. That is correct, Senator.
    Chairman Nickles. Do you want to further explain how that 
would also help the economy.
    Mr. Hubbard. Sure. First of all, one big reason for the 
Lifetime Saving Account and Retirement Saving Account proposal, 
to which you are alluding, is simplification. Under current 
laws, you know many families have access to a bewildering array 
of savings incentives with different phase-outs and different 
rules, and it seems quite silly to tell people you should save 
for this, that and the other purpose, as opposed to giving them 
choice and control.
    What the President's proposal would do is create one 
nonretirement and one retirement vehicle. By expanding 
contribution limits, this would significantly increase savings. 
There is a large body of work in economics. I confess I have 
contributed to it, so I have a bias in my statement, but I 
believe these plans have significant chances to increase 
saving.
    A counterargument that you often hear is, well, this is 
just reshuffling, and to that, I would ask you the question how 
many American families do you think, on a year-to-year basis, 
can reshuffle $7,500 in cash for every member of their family? 
Not many.
    Quite quickly, this is marginal saving, new saving for the 
economy.
    Chairman Nickles. So the proposal on the lifetime savings, 
I thought was $7,500 per person, and so I was assuming that 
would be $15,000 per couple.
    Mr. Hubbard. That is correct. That is my point, that if 
your argument is you are not getting any new saving for people 
who are really saving at those rates, that is largely going to 
be new saving. Not very many families could reshuffle at those 
rates for very, very long.
    Chairman Nickles. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Let me first talk about something the Chairman has 
mentioned several times about the tax rate on capital, and, Dr. 
Hubbard, you just mentioned it.
    CBO did an analysis of this question, and it is in their 
latest budget book on Page 26: ``Effective marginal income tax 
rates 2001 to 2013.'' They are not 60-percent effective rates, 
they are not 50-percent, they are not 30-percent.
    Effective tax rates on capital 2003, 15.5; 2004, 15.4. 
Those are, according to CBO, effective tax rates on capital, 
including individual income taxes and corporate income taxes.
    Let us turn to the question of economic growth because that 
really is the key, I think, Mr. Chairman, as you quite rightly 
have said before.
    Are you familiar with Macroeconomic Advisers, Dr. Hubbard?
    Mr. Hubbard. Yes, of course.
    Senator Conrad. I take it you have respect for them.
    Mr. Hubbard. They are a certainly very well-known 
econometric consulting firm.
    Senator Conrad. This is what they wrote about the 
President's plan: ``Initially, the plan would stimulate 
aggregate demand by raising disposable income, boosting equity 
values and reducing the cost of capital. However, the tax cut 
also reduces national savings directly, while offering little 
new permanent incentive for either private saving or labor 
supply. Therefore, unless it is paid for with a reduction in 
Federal outlays--'' which the President does not propose ``--
the plan will raise equilibrium real interest rates, crowd out 
private-sector investment, and eventually undermine potential 
GDP.''
    Let us just put up graphically what they are talking about 
here. What this chart shows is the black line is the 
President's policy, and it does show a spike up in 2004, but 
then it plunges and is below the rate of growth that we would 
get if we did nothing for 2005 and beyond.\1\ 
---------------------------------------------------------------------------
    \1\ Table not available at press time.

    This same group--and then I will ask you to comment, Dr. 
Hubbard. On the cost of corporate capital, Dr. Hubbard, you 
have testified that the President's plan will lower it 10 to 25 
percent. That is what I heard you say. If I have got it wrong, 
please correct me. Their analysis shows something quite 
different. They show on the cost of corporate capital a 
reduction of 2-1/2 percent, not 25 percent, 2-1/2 percent in 
2003, but then rising dramatically so that in 2006 the cost of 
corporate capital under the President's plan is increased by 
approaching 7 percent. The cost of corporate capital, because 
of the President's plan, is increased from, actually toward the 
end of 2004, right through 2017, cost of corporate capital is 
increased.
    Dr. Hubbard, obviously you have a different take. You say 
that this is going to reduce the cost of corporate capital. 
They say it is going to increase it. I guess that goes to the 
heart of the debate. What is your response to what these 
respected economic consultants are saying?
    Mr. Hubbard. Sure. If I could take the two parts of your 
question, Senator. Going back to the issue of effective tax 
rates, I will look at the CBO table. That is at variance with 
work going back to Feldstein, Poterba and Dicks Mireaux in the 
early 1980's. In any event, what matters for securities markets 
is the tax treatment of the marginal investor, not average 
effective tax rates.
    On the issue of the models, I think you are learning a lot 
about model assumptions as much as you are about model output. 
Let me connect the point you made about GDP and the point you 
made about cost of capital. You are alluding to a model in 
which the principal channel for tax policy is changing 
disposable income, and a model in which interest rates are very 
responsive to changes in saving.
    On the point of the structure of the model, I think most 
economists would view that there are channels for tax policy to 
affect the economy far greater than disposable income. For 
example, in such a model writing checks to everyone has 
identical effects to changing marginal tax rates. We do not 
believe that as a profession. That is to say there are very few 
supply side channels in such models.
    Second, I just do not buy the interest rate sensitivities, 
and rather than getting into an economic discussion, let me 
just try to shape some intuition. We just had a major swing 
over the past couple of years in CBO forecasts about the long-
term surplus. That is what we started out our discussion with. 
We have the lowest nominal and real interest rates in quite 
some time in the United States, which is to say there is lots 
going on in a world capital market, and the notion that fairly 
small changes in U.S. Fiscal policy have dramatic effects on 
the world real interest rate, I do not buy. So what is giving 
you both the GDP effect and the cost of capital effect are 
exactly that.
    The work we have done at ECA, the work Allen Sinai has done 
at Decision Economics, the study the Business Round Table put 
out, both have very large and persistent effects on GDP and 
reductions in the cost of capital. I am afraid you are just 
rediscovering the old problem that economists just do not 
always agree.
    Senator Conrad. I will grant you that. I will tell you one 
other thing, if I could say this, Mr. Chairman, is you have an 
assumption on page 8 of your testimony. ``Another important 
assumption is that the estimates discussed above assume no 
changes in the stance of monetary policy.'' That is what I have 
a hard time believing. We have Chairman Greenspan saying to us 
deficits do matter, that if you run up significant deficits, 
that that inhibits their ability at the Fed to have a more 
accommodative monetary policy, and that is his testimony before 
Congress as well as personal statement to me.
    So the bottom line is we have got a very significant 
disagreement between economic experts. You are asserting you 
are going to get stronger economic growth. Others, respected 
economists, say that you will actually hurt long-term economic 
growth with this plan because of the dramatic increase in 
deficits and debt, the upward pressure that puts on interest 
rates, the additional cost of capital that results, and 
therefore, what we wind up with is less investment and lower 
economic growth.
    Mr. Hubbard. If I might, Senator, on those points--of 
course I do not comment on monetary policy, but I will say that 
if you put familiar monetary policy reaction functions like a 
Taylor Rule into what we did, you get much the same effect 
early on. Where these models are generally unreliable is in the 
out years. We are also very conservative because the 
calculations we did assumed a zero stock market effect, so we 
have deliberately tied our hands behind our back.
    Chairman Nickles. Thank you very much, Senator Conrad.
    Senator Enzi.
    Senator Enzi. Thank you, Mr. Chairman.
    I thank you, Dr. Hubbard, for joining us today. The 
comments, and I read the expanded comments that you did as 
well, are extremely helpful in understanding some of the 
different relationships. Any time that we talk about taxes we 
are talking about probably the most complex thing in the United 
States, and I think you did a good job of explaining some of 
those things. We just got the budget materials yesterday. I 
have been trying to wander my way through there. There are some 
2,700 pages involved in the information that we have got, and I 
found it all to be, everything that I have been able to go 
through to be extremely helpful, but not enough time. Of course 
when we do the budget process, I have already found in my short 
time on this committee that everybody in America thinks that we 
are actually doing appropriations, and I am having a little 
trouble conveying the difference between budget and 
authorization and appropriation, and trying to get them to 
understand that we do not look at every program and every line 
item, that that is the job of the appropriators, that we are 
trying to come up with a blueprint that is much more general 
and a little bit more focused on the policies, although I am 
kind of fascinated with some of the policies that we kind of 
tie our hands with at the same time.
    As an accountant it seems a bit cumbersome and in some 
cases counterproductive. It is not a simple math problem where 
we are just adding and subtracting numbers. It is a complex 
issue that requires policy decisions. This is the policy, the 
group, as we make these financial analyses, and I am hoping 
that we have enough help on staff to be able to grasp, and 
through people like you that are testifying, to grasp some of 
the complexities of these things.
    Then it gets a little bit more complex because each of us 
that are here each has our own opinions based on past 
experience and desires on what could happen.
    I was very pleased to find in the budget that there is a 
performance review. I knew that there was a Government 
Performance and Results Act. I have done some auditing of 
agencies using that myself. It is a very good way for a person 
to learn about the different agencies, and I was glad to see 
that incorporated in the budget, and noted that a lot of the 
programs, while they are not suggested to be eliminated, are 
noted as being ineffective. I guess that would be a note for us 
to perhaps make some policy that there either be some changes 
in the program or elimination of the program. At any rate, I am 
glad to see that performance review.
    I like the idea of the employment bonus that is in there 
too. I think that can have some pretty good effects for States 
and employment, which really kind of brings me to the heart of 
the matter and my love, which is small business. If we are 
going to employ people faster and we are going to have growth, 
we really ought to be relying on that sector of the economy 
that provides the most growth and absorbs the most employees 
and provides them with employment, which is small business.
    So the question that I am getting to here is to find out 
why there would not be more of an emphasis on dividends for 
small business. The reason that I bring this up is even before 
the President made that proposal as I was traveling around 
Wyoming, I have had a number of small corporations, they did 
not go the Subchapter S route, they went a full corporation. 
Under that mechanism we are able to accumulate more capital for 
their business more quickly. As the business matures, then they 
wind up with these dividends that they really ought to get out, 
but they are somewhat irritated that they have to pay taxes on 
them twice. They know they already paid on them when they were 
growing the business. Now they have to pay on them when it is 
released to them as individuals. So it is not a new problem 
that just came up as a result of the President mentioning this. 
It was something that small businessmen with regular 
corporations have been mentioning to me for a long time.
    Capital is always a problem when we are starting a new 
business, and I noted Senator Conrad's comment that the tax on 
capital was 15.5 and then 15.4 percent. I think that chart 
probably refers to capital gains as opposed to overall capital. 
I would be interested in seeing that chart in some more depth 
because there is a big difference between what you get charged 
on the dividends that you receive and the capital that you get 
from selling your stock. Most of these small businessmen that I 
know are not interested in selling their stock. They want to 
continue to do that business, but they have some other 
investments they would make if they could get their dividends 
out a little bit faster without having to give quite as much to 
the Government a second time.
    So my question is: should there be more of a concentration 
on what can be done with small business? The proposal would 
apply to all businesses I assume.
    Mr. Hubbard. Well, I think there is two very important 
small business channels. First for the small businesses who are 
paying taxes on the individual system, the rate cuts are not 
only increasing after-tax income, but a real cut in the cost of 
capital and cost of hiring workers for small businesses. For 
the C-corporations that you mentioned, there are two effects. 
One is by eliminating the dividend tax on excludable dividends, 
but also the buildup of retained earnings. What the President 
is proposing is not just eliminating the dividend tax, but if I 
am a small business owner and I am growing the company and 
plowing money back in, I get continuous basis adjustments. So 
if I do wind up selling out, then I do not have to pay capital 
gains tax on those accumulated retained earnings. So we think 
this is very small-business friendly, and the same tax policy 
that is very good for large business is in this case good for 
small business.
    In addition for small businesses, the expensing changes the 
President has proposed are very much pro investment.
    Senator Enzi. Thank you.
    Chairman Nickles. Senator Enzi, thank you very much.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Chairman Hubbard, welcome. I have questions about the 
dividend exclusion issue with regard to corporate governance. I 
have many of the same questions that Senator Conrad asked with 
regard to return on capital because I have a hard time 
understanding where payment of dividends, where 50 percent of 
them roughly are going to non-taxpaying entities is going to 
dramatically change the return on capital. I can see at the 
margin it has some improvement, but just back of the envelope 
kinds of calculations. I do not see how it gets in the 10 to 25 
percent range, and I frankly would love to see how that 
mechanism works. It does not jive with any of the economic 
discussions that I am hearing.
    The corporate governance issue, I question why dividends 
are going to change the investor community's review of what the 
return on capital is, after-tax return on capital is, of a 
business any more than where they are today when they look at 
the use of capital. Then I put that in conjunction with, which 
I think is explaining what Senator Conrad was talking about, at 
least with the model that reduces rates of return over the long 
run, is you take cash off a balance sheet, encourage that and 
put incentives on that as opposed to retaining it, and I think 
what you do is have a lessened ability to actually form 
capital. You certainly cannot retain or hire employees if cash 
is flowing off the balance sheet. You cannot go to the bank and 
place a margin down. You cannot go to the rating agencies and 
suggest that you are going to be in a solid position on how you 
approach it.
    Now, I do not particularly like double taxation on 
dividends either, but I believe that if you wanted to have, as 
the Administration has stated, and you wanted to encourage 
capital formation, but you also wanted dividends not to be 
prejudiced relative to interest, you would do it against 
taxable income on a company's balance sheet because it is no 
difference than interest not being taxable. So I would love to 
hear your comments on that. If we have a second round, I have a 
series of questions I would ask about State and local budget 
crises that also impact tax rates. Property taxes in this 
country are rising very, very sharply because of the budget 
problems that we have in our State and local Governments. Was 
that taken into consideration when the package that was put 
together to so-called stimulate the economy or create a growth 
package, did we take into consideration the estimated 70 to $90 
billion budget deficits that are occurring that are causing an 
aggregate tax increase at the State and local level that is 
really quite substantial?
    I could go into other undermining tax bases, dividend 
exclusion, and tie it to the Federal Tax Code, or the 
competition that excluded dividends have with a very select 
group of investors who might be a buyer of municipal bonds.
    Mr. Hubbard. Four very good questions. Let me try to go 
over each of them, first the question about whether there is 
any marginal effect. First, I would be happy to give you the 
paper that has all of our calculations and how we did it if you 
like, but let me get to the core of your question, which was 
the importance of non-taxpaying entities. What counts is the 
marginal investor, and most of the work we have by empirical 
researchers in finance is that the marginal investor is 
probably a high tax individual from our home town, and so 
basically the high tax individuals are more likely the marginal 
investors setting securities prices. So even if the vast 
majority of dividends were received outside of that investor, 
as long as he or she is at the margin----
    Senator Corzine. I might just ask a what-if question since 
we are running a current account deficit of, I do not know, 450 
billion, 485 billion. You know the number better than I do. It 
strikes me that the marginal investor is not even a U.S. 
investor.
    Mr. Hubbard. Well, the marginal investor may also be other 
taxable investors, that is true. These policies are actually--
--
    Senator Corzine. That is exempt in the context of----
    Mr. Hubbard. Well, again, that is not the evidence that we 
have from the empirical work people have done on securities 
prices. For corporate governance, I guess there are really two 
effects that get at your question. One, much of the wind in the 
sails, as you know very well, in financial engineering 
transactions, comes from the asymmetric treatment of debt and 
equity and from timing differences. That is the wind in the 
sails from many tax planning transactions. Most, though not all 
of those, would be eliminated by the President's proposal. The 
idea here is not to bias toward paying dividends. It is not to 
force money out of corporation solution. It is to make sure 
that business people are making decisions as business people 
under business judgment and not the tax code.
    We both know there are causes in which retained earnings 
may not have been used to the highest value of shareholders, 
and were there to be neutral treatment, the pressure from 
institutional shareholders, from capital markets generally, is 
probably very healthy. So we are not arguing for biasing for 
dividends, simply not being biased against dividends. The 
President's proposal would have them neutral.
    On the issue of corporate versus individual, the key 
principle the President was after was taxing income once, and 
to do that in the context of share holdings in the United 
States, it is really easiest to do the relief at the individual 
level. I might note that the Treasury Department and the 
American Law Institute studies have also focused principally on 
individual relief, so it is not simply something the 
Administration had done.
    On the issue of State and local, we have----
    Senator Corzine. There is a big debate in the economic 
literature I think over time about where you bring in the most 
efficient way. I think I even read a paper that you wrote in 
the 1980's with regard to the subject where you presented both 
sides of the case.
    Mr. Hubbard. It was certainly both sides, the issues. The 
bang for the buck is much smaller doing it at the corporate 
level because you are incurring a great deal of extra cost, and 
the marginal effect is the same, so the bang for the buck is 
smaller. So again, in terms of the use of scarce resources, 
that was our thinking.
    On State and local, two issues that you raised. One is the 
scale of State problems, and they are significant, no doubt 
about it. The view the President had was that this is not the 
time for a one off aid to the States. Most of the State issues 
are structural. There are elements in the President's budget, 
as you are aware, in Medicaid, education and other areas that 
are additional funding for the States. We believe the 
President's proposal not only does not make the State situation 
worse, it makes it better.
    Your question alluded to effect on the tax base of say 
removing dividends. So if I am a State that piggybacks off the 
1040 structure, am I not worse off? Well, no. We have estimated 
State-by-State income responses to higher growth, and find that 
State revenues in total would be $6 billion higher. The loss of 
dividends from the base is 4 billion, and we would be happy to 
get you those State-by-State.
    Senator Corzine. Thank you.
    Chairman Nickles. Senator Corzine, thank you very much.
    Next, Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman. I thank you for 
this hearing.
    Dr. Hubbard, one thing I have thought about some recently, 
and I will just ask your view of it. Generally our economy does 
better when our major world trading partners are healthy. How 
are the major world economies doing compared to the United 
States at this time?
    Mr. Hubbard. You raise a very important point, also getting 
back to Senator Corzine's question about the current account 
position in the U.S. We have a situation which it is hard to 
have applause with one hand clapping, and the one hand is our 
economy. As rocky as things have been, we have been more of an 
engine. The Japanese economy, as you know, is in quite 
significant distress and unlikely to grow over the next couple 
of years. The Euro zone not only has large structural problems, 
it has issues relating to monetary policy constraints on its 
growth. In the short term emerging markets are not likely to be 
high sources of growth, so we have a situation in which for the 
near future the U.S. economy is the engine of growth. A key 
part of the President's agenda is the promotion of growth 
around the world. I know that our newly confirmed Treasury 
Secretary will be carrying that message to industrial countries 
and to emerging markets alike. So we agree that is important. 
We want to encourage better, more pro-growth economic policies 
in Japan and in Europe and in emerging markets as well.
    In the forthcoming economic report of the President, if I 
can tout one of our home products, will have a chapter 
detailing the President's agenda there.
    Senator Sessions. I think that is important for us to 
remember, and many of these economies have great potential I 
think, but the have more taxes, more regulation and less 
committed to the free market. I am convinced that that is a 
factor in their being less competitive than we are. Do you have 
any thoughts on that?
    Mr. Hubbard. Absolutely. If you go back to the first remark 
I made about the long term for the U.S., there has been a lot 
of introspection about why productivity growth in the U.S. is 
higher than it once was. More interesting I think to me as an 
economist is why it is so high relative to our trading 
partners. We are not smarter than the Europeans and Japanese. 
We do not have better technology. We all know cell phones here 
are worse than they are in Europe. It cannot be that. What it 
is, is our policies, our institutions that promote flexibility 
in allocating capital and labor, and that is something we 
should never take for granted. I think that is something we can 
export in the sense of having a pro-growth mission for the 
world.
    Senator Sessions. Well, I would agree with that, and I hope 
that the world could see that as the State takes a larger and 
larger percentage of the net wealth of the economy, I think it 
depresses the private sector. I think what the American 
experience has been is that the private sector is what drives 
our growth, creates jobs, makes us productive, allows us to be 
able to spend $15 billion in Africa for AIDS or lead in many 
other areas of the world that other nations are not able to do 
because their economy is not as healthy.
    Let me ask this. One thing that you mentioned in your 
written remarks on page 13, I think is important. These numbers 
that you have come up with are consistent with what I have seen 
others say, that this package that the President has proposed 
would produce a growth of almost 1 percent in GDP next year, by 
the end of 2003, and that by the end of 2004 it would be 1.7 
percent increased GDP, more than if the growth package were not 
passed. Then you talk about the number of jobs which would be 
created from just that much increase in growth. Would you talk 
about that, please?
    Mr. Hubbard. Absolutely. The President called this the Jobs 
and Growth Initiative for a reason. We can go back to that 
long-term story again. Productivity growth being high is a 
great blessing for our economy, but it means something else. It 
means as an economy we have to grow more rapidly than we might 
once have had to grow to increase employment. That is very much 
of the President's mind. The GDP effects of this proposal, we 
believe, would lead to about a half a million extra jobs in 
2003. These are new jobs that----
    Senator Sessions. That is this year.
    Mr. Hubbard. This year, that would not have existed, and 
close to 900,000 in the next year. Over the long term the 
structure of the President's proposals raise all of our incomes 
through their effect on capital formation and economic growth. 
So this is very much a jobs initiative. As your question 
suggests, we get jobs in the American economy by promoting 
growth in the private sector and that is what the President is 
trying to do.
    Senator Sessions. One more. Well, Mr. Chairman, I will turn 
it back over to you, and would just say to me, our challenge is 
to continue to strengthen and unleash the engine of the private 
sector that has made America the envy of the world. If we keep 
working on that and do that, I think we will work our way out 
of the financial difficulties we are in today. If we burden 
down the private sector with more and more taxes, we take a 
larger and larger percentage of GDP in the form of Government 
which inevitably is less efficient than the private sector, 
then I think we have the danger of a permanent slowdown as 
Germany has seen, as Japan has seen, and to me that is the big 
challenge. In this crisis and difficulty that we are in, we 
want to create jobs and vitality in the private sector, and not 
create a large and dominant bureaucracy in the central 
Government.
    Thank you.
    Chairman Nickles. Senator Sessions, thank you very much.
    Dr. Hubbard, a couple of quick comments. I have yet to hear 
of an economist--I am going to download this economic group 
that Senator Conrad alluded to, and maybe see if they are 
defending double taxation of dividends. Let me just ask you a 
couple of questions because I am interested. I do not know why 
anybody or how anybody can really defend it, but you correct me 
if I am wrong. I used to run a corporation. I want to 
distribute, let's say hypothetically, $100,000. We have 
retained earnings and we are willing to give it out to our 
shareholders. That is what we would like to do. We would like 
to give it out to the owners. If you do so in the corporate 
world today, a corporation has to pay tax on it. Maybe some 
people are able to escape that, and if they know something I do 
not, that is interesting. A corporation that is a taxpaying 
corporation that would distribute that $100,000, they have to 
pay corporate tax on it. Today that tax rate is 35 percent. So 
they want to distribute $100,000, but OK, after taxes they are 
left with $65,000. They distribute the $65,000 to the owners, 
and the owners have to pay taxes on it, and let's just assume 
it is a 30 percent tax bracket, and so $22,000 of that would go 
to the government in taxes, so the net result would be the 
Government would get $57,000 and the individual that you are 
trying to distribute the earnings to, would get $43,000. Is 
that correct, the Government would actually get more of that 
distribution than the owners?
    Mr. Hubbard. That is correct.
    Chairman Nickles. Now, conversely--and I would like for 
Senator Corzine to catch this--conversely the present tax code 
says, all right, well, bonuses are fine. You can deduct 
bonuses. There is no limit on bonuses, and so we will grant the 
$100,000 bonus, the corporation gets to write off that, and so 
the net cost to the corporation is not $100,000, assuming they 
are profitable--if they are not profitable this does not make 
sense--but if they are profitable, the net cost to the 
corporation of paying the $100,000 bonus is $65,000. The 
individual gets the $100,000. The individual pays the taxes on 
the $100,000, let's assume $30,000, and so the Government loses 
money from the corporation taking the deduction. The individual 
pays the taxes, so basically you have a distribution on the 
bonus where the Government just about comes out even, and maybe 
lose a little bit because 35 percent is higher than 30 in this 
hypothetical, but it could be the same. So the bonus 
transaction works out really well. But dividend distribution to 
the owners is a really crummy deal. So certainly in a closed 
corporation or one where managers can say, well, we will 
distribute cash payments through a bonus type system, it makes 
eminent good sense, and it makes very little sense to 
distribute dividends to the owners. So shareholders really come 
out on the short end of the stick. Maybe people that might be 
recipients of some type of bonus plan would come out very well.
    I just think the present tax code is really skewed against 
shareholders and it is very biased toward debt. If you are 
making a debt vs. equity decision, if you need new capital, you 
are going to issue equity or you are going to go to debt, the 
present tax code screams at you to go debt, and you have a lot 
of corporations now that are struggling with that. So I just 
mention those. If my examples or hypotheticals are not 
accurate, you could please correct me.
    Mr. Hubbard. No. I think they are very accurate, Mr. 
Chairman, and they point out the basic problem, that we have 
created a situation in which we want business people thinking 
as much about tax planning techniques as they are about real 
business. That is not only a waste of their time, it is a waste 
of resources for our country.
    You asked whether people could not support eliminating the 
double tax in dividends, the principal disagreement on the 
other side would be if you thought neither investment nor 
saving is responsive to changes in the rate of return, then 
doing this is not a good thing. I am aware of very few 
economists who believe that, but that would be a principal 
argument.
    I think your questions also raise the sense in which this 
is an important short-term concern for the economy, too. I know 
there is a tendency to think of this aspect of the President's 
proposal as being simply about the long-term--interesting tax 
policy but a long-term question. Again, particularly in light 
of the corporate governance scandals and particularly in light 
of high hurdle rates on investment, we believe it is important 
for the short term as well.
    Chairman Nickles. Thank you. I want to touch on one other 
issue that hasn't come up. Senator Conrad had a chart that 
showed enormous red at the bottom of it and showed deficits 
just climbing out of sight. I am guessing that assumes a lot of 
things. I want to look at maybe the long-term debt projections 
that you and your office have, and I haven't really looked at 
those that closely.
    I will touch on one program that I think Senator Conrad and 
I are concerned about long term, and that would be Medicare. 
The Administration is working on a proposal that not only would 
provide enhanced benefits, i.e., prescription drugs, 
catastrophic, preventive care, lower deductibles, but it also 
is talking about trying to reformulate the program to make it 
competitive and affordable and successful, that would help 
salvage the program and save the program for the long term.
    Would you care to explain that? Many people characterize 
it, well, yes, what the Administration is trying to do is make 
you join an HMO if you are going to get prescription drugs. 
Would you care to comment on that?
    Mr. Hubbard. Sure. Well, I don't want to go through the 
details of the plan because it is in progress. To get at your 
question, I think what the President is trying to say is, look, 
of course, we should have a prescription drug program in 
Medicare. It is crazy that we don't. The question is: Do we 
want a Medicare system that is modernized, that improves 
quality and choices for seniors?
    In terms of your principal concerns here on the budget, I 
would say two things about Medicare: one, our economy's ability 
to make good on our promises that we have rightly made in 
Medicare and Social Security and other programs is to have the 
economy growing as rapidly as possible. As the budget points 
out, the real fiscal issues for our country are not the short-
term wiggles in our budget deficit, because with the proposals 
we have, with the very conservative assumptions we have in the 
budget, the debt in the hands of the public relative to GDP is 
still stabilizing in the out-years. That is not an issue.
    The issue is the entitlements programs. When we take a look 
at Medicare, we have to make sure that we start with the 
medical maxim of doing no harm. Yes, we should add a benefit, 
but we don't want to do so in such a way that actually 
jeopardizes the program. That is what the President will try 
very hard to do.
    Chairman Nickles. Thank you very much.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Dr. Hubbard, would you say that the new Secretary of the 
Treasury, Mr. Snow, is somebody that has a good understanding 
of how the economy functions?
    Mr. Hubbard. Absolutely.
    Senator Conrad. I am glad you said that. Let me just put up 
his evaluation back in 1995 dealing with these questions we 
have been talking about. He said then, ``A credible, sustained 
reduction in Federal deficits leading to a balanced budget will 
bring major economic benefits. As the Government spends less 
and borrows less from investors to cover declining deficits, 
more capital will be available for investment in the private 
sector of the economy. Inflationary pressure will ease and 
interest rates will respond by declining as much as 2 
percentage points.''
    Now, I quote from him because I believe he has got these 
relationships right. Now, the President comes before us and has 
a proposal that explodes deficits. This is from the document, 
``Analytical Perspectives Contained in the President's Budget 
for Fiscal Year 2004,'' and it shows deficits as a percentage 
of GDP, it shows these are the good times because we all know 
what is coming--the baby-boom generation, and then the deficits 
and debt explodes. This is according to the President's 
analysis.
    So if Secretary Snow was right that reducing deficits has 
major economic benefits, I can only conclude increasing 
deficits hurts the economy. We are talking about huge, massive 
deficits going up approaching 15 percent of GDP in the out-
years here.
    You know, it is what takes me back to what other economists 
are saying, that the plan that the President has sent us does 
not give us much boost in the short term. The Democrats' plan 
has much more stimulus short term. That gives us more economic 
growth this year when the economy is weak. Because it doesn't 
have these out-year additional costs, as does the President's 
plan, it doesn't do damage by raising deficits, raising debt, 
that reduces societal savings, that reduces the pool of money 
available for investment, that retards economic growth.
    So, you know, I have looked at all of these analyses that 
we have available to us from respected economists, and there is 
such a divide, those who say that your plan will actually hurt 
long-term economic growth.
    I must say, I look back to the 1980's and the 1990's. In 
the 1990's, we reduced deficits and we had the longest economic 
expansion in our Nation's history. I don't quarrel with 
providing stimulus at a time of economic slowdown. It does 
strike me that adding to deficits and debt in the coming years, 
when the baby-boom generation is about to retire, is going to 
explode the debt and hurt the economy.
    That is the nature of this debate and this disagreement, 
and, again, I will certainly give you a chance, if you want, to 
respond to any of that.
    Mr. Hubbard. Sure. You actually raise several questions. 
Let me start near the end of your questions and remarks with 
the notion that we reduce deficits. Let me go back to the story 
of the economy's boom and downturn.
    We got very good news in the 1990's about our economy's 
expected ability to grow. That raised surplus projections. It 
raised our current incomes. It also raised real interest rates. 
In other words, if the sign goes the other way, theory would 
tell you that good news about the future raises both surpluses 
and real interest rates. When we got a sense that we may have 
been overly optimistic, we see surpluses declining, current 
income declining, and interest rates declining.
    On the notion of John Snow's comments, let me not put words 
in John's mouth. You can ask him. Having had this conversation 
with him many times, I think his view, very similar to my own, 
is that what is very important is to stabilize spending, 
precisely the priority that he mentioned in the statement you 
attributed to him. The reason for that is principally because 
the ultimate claim on the resources of society from Government 
is from the size of Government. It is our taxes today or our 
taxes tomorrow. There is a significant body of work in 
economics, most notably by Robert Barrow, who is a Harvard 
professor, suggesting that countries with very large 
governments have lower rates of growth. This isn't a question 
about whether they are deficit-financed but a question of the 
size of government, and limiting spending was and is a very 
important issue.
    On the issue of balancing the budget, you know, we could 
have a balanced budget in the United States relatively quickly. 
It is a question of our priorities. If you wanted a budget that 
did not have improvements in homeland security and defense, did 
not have Medicare modernization, and did not have a growth 
package, it would be possible to have a balanced budget very 
fast. We all know that fiscal responsibility is very important 
and a balanced budget is important. So are other things. The 
question is priority.
    The President puts the priority on growth and spending 
restraint as being the issue, and I think that is where we may 
just have a difference of opinion.
    Senator Conrad. I would just conclude by saying that is 
correct. I don't see that the President has put any priority on 
balancing the budget or reducing deficits. Just the opposite, 
his plan is to mushroom deficits and mushroom debt at the most 
inopportune time--right before the baby-boom generation starts 
to retire. He is going to present a future Congress, a future 
administration, and future generations with a chasm, a fiscal 
chasm, and then we are going to see really tough choices. That 
is to me a profound mistake.
    Mr. Hubbard. We obviously, of course, don't share that in 
the Administration, Senator. The view is that the effects of 
the President's proposals on economic growth are very much in 
the country's fiscal interest just as much as they are in GDP.
    I neglected to mention--since you showed the chart 
comparing the Democrat and Republican plans, let me, without 
commenting on any model, just make a fairly general statement. 
I know of very few economists--and I will say very few 
economists--who would suggest to you that the kinds of 
temporary tax changes that have been in most of the Democratic 
proposals will have a very big effect on the economy. We have a 
widespread research on this in economics, from Democratic 
economists and Republican economists. This one just isn't that 
controversial.
    Senator Conrad. Well, I would say to you that none of these 
stimulus plans have much effect. Truth be told, the plan the 
President has advanced does not, according to a wide spectrum 
of economists, including the Administration's own claims.
    The one thing we know is it explodes deficits and debt. 
Another thing we know is the baby boomers are getting ready to 
retire. Then the huge surpluses that are being thrown out by 
the trust funds are going to turn to massive deficits. That is 
going to present this country with truly difficult choices.
    As the head of CBO said last year in testimony before this 
committee, it is going to present this country with choices of 
unsustainable debt, unprecedented tax increases, and/or the 
elimination of the rest of the Government as we know it. That 
is pretty draconian.
    Mr. Hubbard. If I may, Senator, that is, of course, a 
statement about the entitlement programs.
    Senator Conrad. Correct.
    Mr. Hubbard. As a statement, that is correct. The 
President's proposal does not lead to mushrooming either 
deficits or debt-to-GDP ratio, and I would invite you to look 
at the budget and the pictures in the budget which plot debt-
to-GDP ratios. We believe those are actually conservative, that 
the revenue feedbacks from the President's proposals are 
actually quite substantial, although those are not portrayed in 
the budget.
    Senator Conrad. I would just draw your attention to page 43 
of the President's ``Analytical Perspectives.'' This is what it 
says: ``2004 budget policy extended, debt-to-GDP explodes.'' 
That is not my chart. That is from the President's ``Analytical 
Perspectives.''

[GRAPHIC] [TIFF OMITTED] 


    Look, I don't know how it can be otherwise. I mean, if we 
look at--look at the Social Security chart, where we are 
headed. We know that the trust funds are running big surpluses 
now. The President is taking all that money and using it to 
fund tax cuts. You have got over $2 trillion out of Social 
Security surpluses in the next decade to pay for tax cuts and 
other expenses of Government. That is when the trust funds are 
running surpluses. Here is what is going to happen. We are in 
the sweet spot now. We are up there in the green. This is where 
we are headed. The baby-boom generation is coming. We have 
never seen this before. That is what is going to mean these 
extraordinarily awkward choices, and I think it is just a 
terrible mistake.

[GRAPHIC] [TIFF OMITTED] 


    Chairman Nickles. Senator Enzi.
    Senator Enzi. Thank you, Mr. Chairman. I didn't realize we 
were going to have such strong support on balancing budgets, 
and we may be able to go further that way than I ever thought 
that we could, because I have always had some concern about 
trying to spend ourselves into prosperity. There is a great 
opportunity any year that we look at the budget. Everybody kind 
of drools over the possibilities of new programs that we could 
do and new spending that we could do, and I understand how we 
can't just take a couple of trillion dollars, although that is 
an awful lot of money, and add a few billion to that and think 
that we can change the world.
    What I am curious about is: Should we be putting our money 
into programs or into investing in ourselves? My Grampy used to 
always say that you even had to be careful investing. He said, 
``Never own anything that can eat while you sleep.'' 
[Laughter.]
    Senator Enzi. That has been pretty good advice to me, but 
that is because the expenses keep going and the investment 
isn't there to back it up.
    Are you saying that with the President's proposal what we 
are talking about with the tax cut is actually getting 
increased investment?
    Mr. Hubbard. Yes, Senator. First, in the sense of business 
investment, capital investment, we believe it is very pro-
investment, the rate cuts, the expensing provisions, 
elimination of the double tax, but also for human capital 
investment. As your question was hinting, a big kind of 
investment we do is investment in ourselves, and there is a 
large and growing body of work in economics suggesting that 
high marginal tax rates can also discourage that investment and 
discourage risk-taking and entrepreneurship. So the President's 
plan is very much centered on all these margins.
    Senator Enzi. I think you were also getting at the 
difference between some tax cuts that would last over a period 
of time versus giving cash. Would you expand a little bit on 
your comments between expanding this 10-percent tax bracket and 
giving a one-time cash benefit to everybody?
    Mr. Hubbard. Well, certainly we--if you are a consumer, you 
are going to respond very differently to somebody giving you an 
amount of money, say $300 once in a check, and somebody telling 
you I am going to give you $300 a year forever, as if it were 
an annuity. That is intuitive to us as individuals. It also 
happens to be borne out statistically. People respond only 
between a third or half as much to temporary changes.
    So if the notion is you would like to shore up the 
consumer, if that is the goal, you want changes that are 
enduring, the President's policies have that advantage. They 
are accelerating rate cuts you already passed. They are already 
in the law, and so they are not just one-off changes. One-off 
changes have an odd fine-tuning feel about them. Going back to 
the beginning of your question, in Government, you know, we 
can't fine-tune the U.S. economy. We shouldn't kid ourselves 
that we can. What we can do is help the private sector have an 
environment for growth.
    Senator Enzi. Thank you.
    Chairman Nickles. Senator Enzi, thank you very much.
    Senator Corzine.
    Senator Corzine. Yes, thank you, Mr. Chairman.
    I hear the argument repeated a number of times about high 
marginal tax rates stifling the economy and what we need to do 
to grow the economy is to adjust those marginal rates in lots 
of different forms.
    For the life of me, I am having a hard time understanding 
how in the 1990's we created 22 million new jobs; we probably 
had the highest rate of entrepreneurship that we ever had in 
the history of the country, created more millionaires, worked 
on reducing poverty levels, and at least since we started 
cutting marginal rates, I actually believe that marginal rates 
were 80 percent. You would be right, when they are moving from 
38.5 or 39.5 to 35, one wonders why we think we--and you talked 
about fine-tuning--why we thought that the tax structure that 
produced such grand expansion, basically the best expansion we 
had in the 20th century, created the kind of growth that 
actually allowed for paydown of deficits, needed to be tinkered 
with, fine-tuned so much that we ended up losing 2.5 million or 
2.4 million private sector jobs certainly over the last 2 
years. I am troubled by--I read on the White House's press 
release that we were going to produce 190,000 jobs in 2003, and 
I heard 500,000 today.
    You know, I have the big question of what did we think was 
wrong with what was creating the kind of economic growth that 
we had with the tax structure we had. You know, I see some 
reform. I personally don't believe in double taxation of 
dividends. Again, we can argue about where that ought to be 
addressed. Why when we just came through one of those periods 
in history where we saw the most significant investment boom, 
the rise in productivity, 22 million new jobs, that we thought 
we needed to fine-tune the Tax Code from 39.5 down to 35 to 
accomplish some growth projections that there is among 
reasonable people, as we have heard today, significantly 
different views on what its impact on growth is going to be or 
certainly long-run national savings.
    Mr. Hubbard. Economists have a kind of annoying phrase they 
use a lot, which is, ``All else equal,'' which is our way of 
saying we don't want the world----
    Senator Corzine. It is kind of like holding the money 
supply----
    Mr. Hubbard. We don't want the world to move while we are 
talking. One reason it is annoying when economists talk to 
people is because the world does move. There are very few clean 
experiments.
    Now, I raise this because when you talked about the 1990's, 
it is, of course, not the tax structure of the American economy 
that led to the boom of the 1990's. We know that we got lots of 
good news about the productivity potential of the American 
economy. That was very good news, even though we had rising 
marginal tax rates in 1993. The good news for our economy was 
such that net-net we did very well. When you asked would we 
like to have that kind of growth forever, of course, we would.
    There is a large body of work in economics, in labor 
economics, in the study of investment and the study of finance, 
to suggest that marginal tax rates not only discourage labor 
supply but entrepreneurship and risk-taking, small business 
formation. This is a vast literature covering data from the 
1980's and data from the 1990's. You simply can't hold all else 
equal in the two experiments that you did. I wish economists 
had more natural experiments. We don't.
    On the issue of jobs, I think if you look on the website, 
what you will see is two sets of numbers. They are often 
calculations presented on a year-to-year basis, that is, 
comparing annual averages. Fourth quarter to fourth quarter is 
another presentation. The 190 that you mention I think is 
roughly the year over year for the first year gain in jobs. The 
510,000 is quarter 4 to quarter 4. That is over the course of a 
calendar year.
    Senator Corzine. You are talking about the rate of growth 
that you are expecting in----
    Mr. Hubbard. Over the course of the calendar year. I used 
that today because, frankly, I think it is more intuitive. I 
think it is easier to talk about growth over a period than 
comparisons of annual averages. You will find both numbers 
because I know people have fascinations with one or the other 
approach.
    Senator Corzine. Was there business investment in the 
1990's? Was there entrepreneurial activity with the tax 
structure that we had? That increase was a part of the increase 
in productivity growth that we experienced in the 1990's, and 
also has continued on into the current environment?
    Mr. Hubbard. Well, let me give you the classic yes and no 
answer from an economist. Obviously rate of investment was very 
high in the 1990's. It is obvious we had good news. It was also 
obvious that we had too much investment in the 1990's. We had 
been working through a period of excessive investment. Part of 
that was because we were overly optimistic. We can miss things. 
Frankly speaking, the very biases in the Tax Code that Senator 
Nickles was referring to also created opportunities for some 
unwise risk-taking, some financial engineering, some lack of 
transparency in earnings and investment.
    So while, yes, the 1990's had many very positive things 
about them, none of those positive things would suggest, to me 
at least, that it is not worth the candle to improve the tax 
structure.
    Chairman Nickles. Dr. Hubbard, thank you very much. I might 
mention, maybe if you would provide for the Committee--I 
mentioned to you this big reduction of revenue between 2001 and 
2002, trying to figure out where did that go, because I know 
there was some irrational exuberance, as Alan Greenspan would 
say, when the market was going up, and I think that caused a 
lot of things--big bonuses, big payments, a lot of transactions 
that were happening that generated a lot of tax payments. When 
the market collapsed, a lot of that collapsed, and maybe that 
had really inflated the ride up and pulled out.
    You have projected that we have bottomed, and you have 
projected an increase in revenues, I believe, between 2003 and 
2004 of 5 percent, something like that. If you could give us--I 
am really interested in how that declined so dramatically and 
where was that reduction, if you have any analysis.
    Mr. Hubbard. I would be happy to give you all the details, 
Senator, but I can give you the Cliffs Notes version in short 
order. If you were to draw a trend line in Federal receipts 
relative to GDP, the story of the late 1990's is borrowing 
forward. We had a tremendous increase in revenue growth, partly 
because we have a very progressive tax system and incomes had 
grown very rapidly among the very well off, and a big increase 
in capital gains. We know that as the bubble burst, that went 
away.
    I will get you all the details, but the largest answer is 
that is the key point.
    Chairman Nickles. I appreciate that.
    For the information of colleagues, we have provided the 
disk for the President's budget so you won't be carrying those 
five or six volumes around with you all week. You will have 
that.
    Dr. Hubbard, thank you very much for testifying.
    Mr. Hubbard. Thank you, Mr. Chairman.
    Chairman Nickles. I appreciate your response to our 
questions as well.
    Mr. Hubbard. Thank you.
    Chairman Nickles. For the information of members and 
others, tomorrow morning we will have the Director of the 
Office of Management and Budget, Mitch Daniels, to testify at 
10 o'clock.
    The committee is adjourned.
    [Whereupon, at 4 p.m, the committee was adjourned.]


           THE PRESIDENT'S FISCAL YEAR 2004 BUDGET PROPOSALS

                              ----------                              


                      WEDNESDAY, FEBRUARY 5, 2003

                                       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. Don Nickles 
(chairman of the committee) presiding.
    Present: Senators Nickles, Domenici, Allard, Burns, 
Sessions, Crapo, Ensign, Cornyn, Conrad, Hollings, Murray, 
Wyden, Nelson, and Stabenow.
    Staff present: Hazen Marshall, staff director; Jim Hearn, 
senior analyst and Cheri Reidy, senior analyst.
    For the minority: Mary Ann Naylor, staff director; and Jim 
Horney, deputy staff director.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. The committee will come to order.
    Today the Budget Committee will hear testimony on the 
President's fiscal year 2004 proposals. We are very pleased to 
welcome Mitch Daniels, the Director of the Office of Management 
and Budget.
    Mr. Daniels has one of the toughest jobs in Government. I 
compliment him for the work that he has done. I have had the 
pleasure of knowing him. Prior to joining the Administration, 
he worked as senior vice president for Eli Lily, and he also 
spent 11 years working for our colleague Senator Dick Lugar. 
Director Daniels, we are delighted to have you with us as well.
    First I will call upon my colleague Senator Conrad, if he 
has any opening remarks.

                OPENING STATEMENT SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman. Thank you for 
holding this hearing. Thank you to Director Daniels for being 
here.
    Director Daniels, this is a budget proposal that we have 
strong disagreements about. We think it is going in the wrong 
direction, that it will build deficits and debt in a way that 
hurts our long-term economic strength.
    Before I go into that, I think perhaps just a review of 
where we have been would be useful. I hate to bring you back to 
words that you have used before, but let me just go back to 
what you told us back in 2001. You said then that ``the budget 
was built on extremely conservative assumptions; the Government 
has been underestimating its revenue repeatedly, and we may 
well be doing that again.
    When you look at these numbers, you will find that chances 
are probably better that we have greater, not smaller, 
surpluses over these years.''

[GRAPHIC] [TIFF OMITTED] 


[GRAPHIC] [TIFF OMITTED] 


    Let's go to the next chart and just look at the reality of 
what has happened. You will recall CBO had done this fan chart 
on likely outcomes, and the midpoint was based on the notion we 
would have almost $6 trillion of surpluses. In 2001, you were 
telling us that there was going to be even more money, in your 
judgment, than that.
    Now if we go back and look at what has actually happened, 
we are below the bottom line of outcomes. Let's go to the next 
chart. So the result is that instead of $5.6 trillion of 
surpluses over the next decade, if we adopt the President's 
policies, we are $2.1 trillion in the hole. That is just over 
the next 10 years.
[GRAPHIC] [TIFF OMITTED] 


    Let's go to the next chart. Last year, the President told 
us that the budget will run a deficit that will be small and 
short term. Again, we can now reflect on that and look at what 
is happening. This is what the President's budget is now 
telling us. We look at his document; it is the ``Analytical 
Perspectives.'' This is a chart from the President's own budget 
book. We never escape from deficit, and the deficits mushroom 
geometrically if we extend the 2004 policies. That is what is 
in the President's budget book.

[GRAPHIC] [TIFF OMITTED] 


[GRAPHIC] [TIFF OMITTED] 


    Let's go to the next one. The President told us back in 
2001 the importance of paying down debt. He said, ``My budget 
pays down a record amount of debt. We will pay off $2 trillion 
of debt over the next decade. That will be the largest debt 
reduction of any country ever. Future generations shouldn't be 
forced to pay back money that we have borrowed. We owe this 
kind of responsibility to our children and grandchildren.''

[GRAPHIC] [TIFF OMITTED] 


    Well, that is another statement, I guess, that is by the 
boards. Let's go to the next that shows what is happening to 
the gross Federal debt. It is not going down. It is going up, 
and going up dramatically. The same picture would emerge if we 
looked at publicly held debt. The President told us in 2001 we 
would pay off virtually all publicly held debt. Now we see by 
2008 we will have $5 trillion of publicly held debt.

[GRAPHIC] [TIFF OMITTED] 


    I guess the point of all this is that this game plan hasn't 
worked. It hasn't come close to working. What the President is 
proposing is more of the same--more tax cuts that are not paid 
for, that add to the deficit, that add to the debt, that put us 
in a circumstance where we never emerge from deficit as far as 
the eye can see. In fact, the deficits become so large that 
they are clearly unsustainable.
    So that is my reading of the President's proposal. I think 
it is one we cannot adopt. We must find a way to move in a 
different direction.
    I thank the Chairman.
    Chairman Nickles. Senator Conrad, thank you very much. I 
will put you down as undecided on the President's budget. 
[Laughter.]
    Chairman Nickles. Still some possibility, but slightly 
undecided.
    I welcome before the Committee--I haven't had the chance to 
welcome--Senator Murray and Senator Wyden. Especially I want to 
say to Senator Hollings, whom I have had the pleasure of 
serving on this committee with for many, many years, and I 
think this is the first time you have joined us since I have 
been chairman, I am delighted to have you continue on the 
Committee. I appreciate your service on the Committee. On 
occasion we have worked together, and I hope that we can in the 
future. I say that to all of our members. I would love to see 
us do a bipartisan budget. It hasn't happened in many years. It 
will be a challenge. This committee is a committee that is a 
big challenge. We have lots of work to do, needless to say.
    I want to avoid extended debate amongst members, but I do 
want to make just a couple comments since a couple of you have 
missed a couple of our previous meetings. Yesterday we had a 
meeting with Dr. Glenn Hubbard, the President's Council of 
Economic Advisers Chairman, and he did a good presentation. I 
had a chart that showed that revenues have declined 9 percent--
8.5 percent over the last 2 years. We went from a little over 
$2 trillion, $2.025 trillion to $1.85 trillion, a reduction in 
revenues received. Because of that, we have enormous deficits.
    Now, that was misjudged by CBO and OMB both, and it was 
caused by a lot of things. Maybe Director Daniels will touch on 
that. Part of it was caused by the stock market bubble 
bursting, and it was also caused by a terrorist attack, and it 
was caused by a recession.
    So revenues have declined precipitously. We have never had 
in our history basically a 9-percent reduction in revenues. 
Because of that, we are behind and we have some deficits. So, 
in my opinion, to get out of this deficit situation we have to 
show fiscal discipline, but we also have to figure out ways to 
grow the economy. The Administration has put forth a proposal; 
they have put forth a budget. It is very important for us to 
pass a budget. So, Director Daniels, I welcome you. I am not 
going to ask other colleagues--if other colleagues are just 
dying to say something, I will recognize them. If not, I will 
recognize Director Daniels.
    With nobody objecting, Director Daniels, welcome back to 
the Committee. I would appreciate your comments before the 
Committee. Please proceed.

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

    Mr. Daniels. Thanks to the Committee for the privilege of 
being here. I have submitted written testimony, and in the 
interest of time, let me just extemporize for a minute or two 
and just pick out a couple of key points.
    The President has sent what we call a budget. Obviously it 
is a program that comprises his sense of the Nation's needs and 
priorities. I think they are pretty plainly set forth. They 
begin with the defense of the physical safety of Americans, 
which now includes carrying not only a stronger and transformed 
Defense Department, but also carrying a war on terror to those 
who would harm us where they live. I will probably point out 
more than once today that the best homeland security money, to 
use our new term, that we can spend is that which we spend 
stopping terror before it ever gets to our shores.
    Behind this, the new category we call homeland security, 
defending Americans against hateful people who might leak 
through. Behind that, action to invigorate the economy, an 
economy which has grown for five straight quarters but not at a 
rate the President finds adequate. Therefore, he made a 
considered judgment to act for the third time in his Presidency 
to try to stimulate greater growth and more jobs.
    Yes, we forecast a deficit. There are two or three things 
that are important to note about this. One is that although its 
origins are sometimes misunderstood or misrepresented, they are 
really no mystery. They are: The recession that was on in the 
first quarter of 2001 wasn't known at the time that we all got 
together around those forecasts we inherited, just as we 
inherited the recession. Second, the attack of September 11th 
and the war and extraordinary costs, now over $100 billion, 
that nobody saw coming, or could have. The third phenomenon in 
a triple witching hour was the collapse of the stock market 
bubble. Now, that did start in March of 2000, but as far as I 
know, no one saw how far and how fast that would continue. If 
anybody did, they are a very wealthy person today, I presume.
    Those three phenomena together put us into deficit, and 
just, as I say, to dispel one fiction, I have been reminding 
people that if the President's 2001 tax plan had never passed, 
if no tax plan had passed--and even those who opposed it at the 
time tended to favor some sort of tax relief. Let's pretend 
that none had ever passed. We would have had triple-digit 
deficits last year and this year and next year.
    So people ought not be casual about the facts and trying to 
assign blame for something that really must be blamed on three 
circumstances that were not within the control of anyone here 
and, as far as I know, no one had a crystal ball so clear they 
could see them coming.
    The most important objective for returning to balance, of 
course, is economic growth. It was economic growth and a strong 
stock market which brought about the last surplus. I would 
offer or try to offer a word of encouragement to Senator Conrad 
and others that they ought not give up so easily, because 
surpluses are the consequence of strong economies, not the 
other way around. They could return just as surprisingly as the 
last time. No one saw the last surplus coming, not 5 years, not 
3 years, not 1 year ahead of time. Those forecasts were all for 
big deficits running on without end.
    In fact, in the year the surplus arrived, 4 months in, both 
CBO and OMB and others were still forecasting a deficit. So 
just as we have learned how surprisingly quickly things can 
change in a negative direction, we ought to maintain the hope 
and the kind of policies that will make a very strong economy 
and, therefore, a return to balanced budgets much more likely.
    I will end on one other point. Part of the proposal that 
the President has made is to reinstate the regime of budgetary 
controls that expired last year under the Budget Enforcement 
Act. We hope that this committee, which has taken so much 
leadership in the past in maintaining fiscal discipline in the 
Congress, will take the lead here, too, and help us to get back 
caps. We suggest them for 2 years, which we think is a 
realistic timeframe--2 years at the level of spending 
restraint, 4 percent, that matches the expected growth in 
family income that the President has proposed.
    We thank you for the opportunity to be here, and I am happy 
to answer any questions.
    [The prepared statement of Mitchell Daniels follows:]

    [GRAPHIC] [TIFF OMITTED] 
    

    [GRAPHIC] [TIFF OMITTED] 
    

    [GRAPHIC] [TIFF OMITTED] 
    

    Chairman Nickles. Director Daniels, thank you very much.
    A quick question. I notice your baseline without any 
changes has a deficit in 2003 of $264 billion. The 
Congressional Budget Office had a deficit projected, I believe, 
of $199 billion, so that you were significantly more 
pessimistic. You even put a $25 billion assumption that 
revenues would be lower than what your computers were telling 
you.
    Would you care to explain to us that $60 billion difference 
and why you put the $25 billion plug in for reduction a in 
revenue? It looks to me that you are just making it worse, and 
P.R.-wise it might have been better if you took out your $25 
billion reduction in 2003 estimate and $15 billion in 2004, you 
would be less than $300 billion in both years. You wouldn't be 
at record nominal deficits. I don't know why that was done. 
Would you care to explain that?
    Mr. Daniels. Well, we were trying for accuracy, Mr. 
Chairman. I don't doubt that optically it would have looked 
better. We are actually $55 billion below our friends at CBO in 
our revenue estimate. I hope we are wrong. I really do. I think 
we would all feel better if we saw revenues recovering, if we 
saw deficits substantially smaller than we are forecasting. We 
have been trying to learn as we go, and there has been a 
completely ahistorical phenomenon going on with revenue. The 
economy has been growing and revenues have fallen. This is not 
what we have seen before.
    Typically, as the Committee knows, in the year after a 
recession--a recession pulls down receipts, and that is to be 
expected. Typically in the year after, there is a very sharp 
snapback. That did not happen, and we are still learning why. A 
lot of it clearly was in the capital gains area and other forms 
of income related to, I believe, the stock market bubble. That 
is the reason we made the adjustment. We have just been 
watching as the best models of the brightest people missed on 
the high side. So we have calculated the likely extent of that 
miss, if it continues, and made that adjustment.
    I sure hope we are wrong. It is the most pessimistic report 
in the field. Until we----
    Chairman Nickles. It is or is not?
    Mr. Daniels. It is. Ours is, as far as I know. Until we see 
revenues coming back, as you might have expected from history, 
we are going to continue to be careful.
    Chairman Nickles. Well, I guess I better appreciate or 
understand it, but just for the information of our colleagues, 
estimates have been fairly on target--correct me if I am 
wrong--on outlays, both by OMB and by CBO, while the estimates 
by everybody, private sector, OMB, and CBO, have missed it on 
revenues. They have missed it for years, and missed it big time 
between 2001 and 2002. We had a 7-percent reduction in 
revenues, and that is a big part of our problem. You have taken 
a more pessimistic estimate of what revenues might be, and 
maybe it is more realistic. No one is going to accuse you of a 
rosy scenario.
    Still, revenues are hard to guesstimate. There were 
trillions of dollars lost in the market over the last 2 or 3 
years, beginning in March of 2000, and that flushes through the 
system, maybe affecting corporations' behaviors and so on, 
which impacts revenues, total receipts. I notice personal 
income tax was down $150 billion from the high; corporate 
income tax was down about--oh, a significant sum, I can't 
remember, $40-some billion.
    Mr. Daniels. Could I just show one thing, Mr. Chairman, to 
pursue that point a little bit?
    Chairman Nickles. Sure.
    Mr. Daniels. We also missed revenues wildly in the earlier 
years. As I said, no one saw the surplus coming. Now with the 
benefit of a few years of experience in looking back, we can 
see a pattern that, I think, points us to a common-sense 
answer.
    On the green line--I asked our folks: What is the long-term 
trend of Federal revenue? Obviously it moves up and down with 
events, but it is surprisingly stable, and it is about 3.3 
percent. We looked back 10 years, 20 years, I think 40 years, 
and that is the average, and that is what the green line 
reflects.
    Well, we hit an incredible hot streak in the late 1990's, 
and revenues surged far above that historical trend line. Where 
I think all predictors were misled was to imagine that that 
rate might slow down, but that we would move on from that top 
plateau. So the predictions that Senator Conrad was talking 
about assumed that we might grow at a modest rate but not drop, 
as we did.
    What has happened, as you can see, is we sort of had a 
bulge of revenue, and now we have given it all back. In fact, 
we are just going to back to that long-term trend line, we 
think, in another year or two.
    So it was a unique phenomenon, both on the way up and the 
way down, and I think now we can see the reason for the extent 
of the misses of both the surplus and its disappearance.
    Chairman Nickles. I appreciate your comments.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Director Daniels, as I listen to you, tax cuts seem to have 
played no role in the disappearance of the surplus. Our 
analysis would indicate it played the biggest role. When you 
look at what has already occurred, what the President has 
proposed going forward, the tax cuts are the biggest reason.
    I want to go back to this question of estimating because, 
you know, I must have showed this fan chart that CBO was 
warning us at the time of the uncertainty of the forecast. I 
must have shown it a dozen times in this committee, I must have 
shown it dozens of times on the floor, warning people that the 
tax cut was unaffordable because there was a risk the 10-year 
forecast would never come true.
    You told us not to worry, there is going to be more money 
than the forecast.
    Well, as we can see now, there is not only less money than 
the--this is the mid-range of the forecast. That is what people 
adopted. As it has turned out in the real world, we are below 
the bottom range of possible outcomes.
    I just have to say, in terms of holding people accountable, 
you all took what Senator Baker talked about in the 1981 tax 
cut as a riverboat gamble. You took a riverboat gamble. You 
said there was going to be more money or at least as much. It 
was wrong. It was wrong. It was a mistake. It was a huge 
mistake. There are enormous consequences associated.
    Now what you are telling us is let's have some more tax 
cuts. Even though none of this adds up now, let's have some 
more tax cuts. This black line is the CBO baseline. The blue 
line shows what happens if you add the President's additional 
tax cuts. The red line is if you add the President's additional 
policies. We never get out of deficit.
    Let's go to the final, which is from the President's own 
document. It shows we never get out of deficit and that in many 
ways we are in the best of the circumstances right now. We are 
in the sweet spot because the trust funds are throwing off 
hundreds of billions of dollars of surpluses.
    My question to you is: Do you ever see us escaping from 
deficit if the President's plan is adopted? When would it be?
    Mr. Daniels. Well, quite possibly, sir. Let me take apart 
things you said piece by piece.
    First of all, those fan charts are important. I showed 
them, too. In the 2001 submission, in fact, you and I agreed 
that it was a very difficult business trying to pretend we 
could peer out as far as 6 and 8 and 10 years when we made such 
enormous--had such enormous surprises just in the previous few 
years. We reserved 15 percent of the theoretical surplus at 
that time as a buffer against surprise. It wasn't near enough, 
as it turns out.
    Second, it simply is not true that any policy, let alone 
the tax cuts, is responsible. As I just showed you----
    Senator Conrad. The tax cuts have no part of the deficits 
going forward?
    Mr. Daniels. That is not what you said, and that is not 
what I said. The deficit we see today would be a triple-digit 
deficit, would be $170 billion this year if----
    Senator Conrad. I am not talking about just this year, sir. 
I mean, let's be fair. I am talking about the 10 years of this 
budget window; the tax cuts and burgeoning debt. That is 
undeniable. That is a fact.
    Mr. Daniels. Well, sir, your comment moves me to use a 
four-letter word: bunk.
    Senator Conrad. The tax cuts have no part in the increase 
of deficits over the 10 years of this budget window?
    Mr. Daniels. The only deficit we know about is the deficit 
we are experiencing right now, perhaps the deficit for next 
year. Let's be a little humble about what we can and cannot see 
going forward. That same fan chart, which we don't prepare--our 
friends at CBO do--if you look at it now shows a range--I don't 
know, did we bring it?--shows a range from deficits larger than 
we proposed, but also including surpluses once again. The point 
is we----
    Senator Conrad. In fairness, that is without--that is 
without, as you know, any policy changes. That is without the 
President's proposed additional tax cuts. That is without the 
President's additional spending proposals. That is without any 
cost of war. That is without any policy changes.
    The document from your own budget document shows we don't 
ever get out of deficit here.
    Mr. Daniels. Well, fortunately for me, my eyes are good 
enough to see that that chart goes to 2050. Now, having--I 
would think----
    Senator Conrad. It is your document, sir.
    Mr. Daniels. I know, but I am certainly not citing it as 
gospel the way you are. I would think having learned how much 
we can be surprised in either direction over the space of 2 or 
3 years, you would be a little bit humble about telling us what 
is going to happen in 50.
    Now, the point I am making is it is sometimes loosely said 
that we are in deficit because of the President's tax relief. 
That is not true, not close. As you know, and as some observed 
at the time, the President's 2001 tax relief bill has most of 
its effects over time. So if it is such a bad idea, you know, 
please stop complaining about it and propose its repeal.
    Now, when you do, you will have a little trouble because 
you will have to explain to America what you want to repeal. 
Most of the money is in the lower bracket, from 15 percent to 
10, that reduction, and in the child credit and in the marriage 
penalty. The pieces that, again, get loosely thrown around in 
rhetoric about the rates don't move the needle detectably.
    It is an honest argument we can have that as to the future 
has nothing to do with the fact that recession, war, and a 
disappearing bubble put us in the red as we are today.
    Senator Conrad. I would just say to you it is absurd to sit 
there and suggest the tax cuts already enacted and the 
additional $1.8 trillion of tax reduction the President 
proposes plays no role in a return to massive deficits and 
dramatically escalating debt. That doesn't pass the laugh test.
    Chairman Nickles. Senator Conrad, thank you very much.
    For the information of all of our colleagues, we are trying 
to stay on 5 minutes, 5 or 6. I am not going to ring somebody 
down unless it is necessary, but hopefully we will stay pretty 
close to that.
    Senator Allard.
    Senator Allard. Mr. Chairman, thank you.
    I just feel like I want to respond a little bit to some of 
my colleague's criticism here and kind of put this in the 
proper perspective. Some of the comments that we saw put on the 
chart I noted were comments that were made before 9/11. Nobody 
would have predicted that. The stock market, nobody would have 
predicted that. I think that the Chairman of this committee hit 
it right on the nose about the real flexibility, the real 
problem we have had is on revenue.
    So I think the question that is facing the Congress and 
facing this committee is how is it that we can best grow the 
economy. I look at what the tax burden is today to individual 
taxpayers as a percent of gross domestic product. If we look at 
the time between World War II and now, it is among the highest 
it has ever been. It is not the highest year, but it is among 
the highest years that it has ever been, and the most highest 
years have been in the last 3 or 4 years.
    If we look at spending, like I think Phil Gramm said last 
year during budgeting, you know, we have been spending around 
here like a drunken sailor, and spending has gone up, and there 
has been tremendous increases in spending. We look at the 
corporate tax burden which in some cases may get us up to 60 
percent, which is the second highest in the world of all 
countries when you do a comparison of all the countries. So I 
try and sit here as a policymaker and say how is it that we can 
stimulate this economy. You know, if it was increased spending, 
we should have been seeing it happen. The only area that I see 
where we may be able to help this economy is to reduce the 
burden of taxes.
    If we look historically, the tax cut that we had a year and 
a half ago was passed by this Congress--almost 2 years now--
that did help the economy. Even the Washington Post said in one 
of the editorials back in September, you know, we have to admit 
that if that tax cut had not occurred, we would have been in 
worse shape today, and so that it did help sustain the economy.
    So I just want to emphasize that I for one think that if we 
are going to get this economy to grow, we are going to have to 
drop taxes to do it. It is the only alternative. Nothing else 
is working. We have got to do it, and I want to commend the 
President for doing it.
    I would like to have you maybe share with me, Mr. Daniels, 
some of the thought about how the tax cuts that are being 
proposed now by the President are going to act to stimulate the 
economy and why you selected those various aspects of our Tax 
Code to stimulate economic growth.
    Mr. Daniels. Sure, Senator. I think this really points us 
to maybe the single most important issue that we all ought to 
try to join together and wrestle with. I think by far the 
most--the one the President spent the most time on in the time 
leading up to the submission of the program this week, in other 
words, his determination and the course of defense rebuilding 
and fighting the war on terror and homeland security was pretty 
much clear and understood. The big question was whether or not 
to act, try to act further to strengthen the economy. Senator 
Conrad, I think his questions really mean to go to this point. 
We know why we have fallen out of balance. The question is how 
best to get back in and at what pace. How urgent is that 
compared to some other priorities?
    As we have been saying all week, a balanced budget is a 
very high priority for this President. There are a couple 
things that he has placed ahead of it. There honest people can 
differ.
    So there was some considerable counsel during the last 
quarter of the year that says, look, the economy is growing, it 
won't be necessary to try to act further, and trust to luck. 
The President, after taking all that in, decided to act and in 
a way that most people found pretty bold.
    He was not prepared to trust to luck that the economy would 
grow or grow more quickly or generate more jobs than it is 
generating. As I say, honest people can differ.
    The deficit for 2004 would be well over a third smaller if 
you made that decision, and perhaps some Senators would prefer 
that, to opt for a much smaller deficit, hoping that the 
economy will perform adequately. The President came out in a 
different place. There we can have, and should have, really, a 
good discussion.
    In terms of the pieces of the program, I think it is a 
balanced program for the near term. The acceleration of the 
rates, which in particular would have benefit along with the 
other provision on expensing for small business, I believe--I 
personally believe would have the most jobs effect in the short 
term. Behind that, the acceleration particularly of the child 
credit, which would put cash in the hands of families, 
principally low- and middle-income families, might have a near-
term effect also.
    The much debated dividend exclusion, the ending of double 
taxation of dividends, I would say is more of an intermediate 
and longer-term effect, but also very important. We don't need 
growth just next year to move back toward balance. We need 
sustained growth over a period of years, and a balanced program 
would try to encourage that.
    Chairman Nickles. Senator Allard, thank you very much.
    Senator Hollings.
    Senator Hollings. Director Daniels, the budget deficit for 
2004 is projected to be, what, 307 is what you project it to 
be?
    Mr. Daniels. Yes, sir.
    Senator Hollings. Well, now, you told Chairman Nickles a 
minute ago that you were trying for accuracy, and you and I 
have corresponded about this. If you turn to page 312, you will 
see without Social Security it is 482. Isn't that more accurate 
than 307?
    Mr. Daniels. Both are accurate numbers, sir. It is two 
different ways of looking at the question.
    Senator Hollings. Well, the law is Section 13-301 that was 
passed in this Budget Committee by a vote of 20-1 and passed on 
the floor of the Senate by a vote of 98-2 and signed by George 
Herbert Walker Bush on November 5, 1990, that you are forbidden 
to set a budget using Social Security Trust Funds. Isn't that 
correct?
    Mr. Daniels. Well, we report the so-called on-budget number 
faithfully for that reason.
    Senator Hollings. I know what you do. The law is there, and 
you are not supposed to do it. Yet you tell Chairman Nickles 
you are trying for accuracy.
    Now, let's get really accurate and turn to page 332, and 
you will see that the debt goes up from 2003 $6.7 trillion to 
$7.3 trillion in 2004 for a deficit of $569 billion, not 307. 
That is the actual deficit. That is how much money comes in and 
how much money goes out. You've got less coming in, more going 
out. Just like any housewife keeps her budget. You're spending 
in the next fiscal year, according to your budget, the next 
fiscal year, $560 billion more than you take in. Is that 
correct?
    Mr. Daniels. Well, not in a cash sense.
    Senator Hollings. What is that?
    Mr. Daniels. No, not in a cash sense. The unified budget 
would actually be the right measure of that, the----
    Senator Hollings. I am looking at the arithmetic. Don't 
give me the unified and the fancy talk and dance now. Let's get 
to the truth. You said you were trying to be accurate. Where is 
my question inaccurate?
    Mr. Daniels. It is an accurate measure of the so-called on-
budget deficit, and as you know----
    Senator Hollings. No, don't give me on-budget deficit. What 
is the debt? Doesn't the debt go up, which is the deficit, in 
my opinion, the gross--you have got it cited here, gross 
Federal debt.
    Mr. Daniels. Yes.
    Senator Hollings. That is what I am asking about, not the 
on-budget deficit.
    Mr. Daniels. Debt by either measure goes up, that is 
correct.
    Senator Hollings. We finally got that.
    Now, you said the 307 is 2.7 percent of the GDP, but 
actually it is $569 billion, that is 5 percent of the gross 
domestic product. Isn't that correct?
    Mr. Daniels. That would be about right.
    Senator Hollings. Now, that would be about right.
    Now let's turn to page 1 of this budget here, and I will 
read you a sentence here. It says, ``Compared to the overall 
Federal budget and the $10.5 trillion national economy, our 
budget gap or deficit is small by historical standards.'' Do 
you remember writing that?
    Mr. Daniels. I do.
    Senator Hollings. So that is exactly what Kenneth Lay was 
doing with Enron, making his budget appear to be more favorable 
to the stockholders. Here what we are trying to do is make our 
budget look better for the taxpayers, because you read this 
here on page 1, ``Compared to the overall Federal budget,'' and 
everything else, ``the deficit is small by historical 
standards.'' Whereas, the truth is--you finally acknowledge it 
on page 332--that it is $569 billion.
    Do you know, Director Daniels, that if you took all the 
deficits from Harry Truman in 1945 to Gerald Ford in 1975, 30 
years, the cost of World War II, the Korean War, the Vietnam 
War, and you added up all of those deficits for six Presidents 
in 30 years, it would only come up to $358 billion. Here you 
are submitting a budget with a deficit of $569 billion and 
calling it historically small?
    The truth of it is, look at your page--go to this other 
book, historical tables, talking about the history, and you 
will see on page 117 that the debt as a percent of GDP goes to 
64.8 percent.
    Now, in the Maastricht Treaty in the European Union, you 
can't even become a member unless your debt is 60 percent or 
less of your GDP. Here you and I, the United States of America, 
which is mouthing around about Germany and France being 
cowardly, they could come back and say you and I are 
cheapskates. We won't pay the bill. That is why all the 
economists in all the countries believe paying the debt and 
paying the bills and not having excessive borrowing. That is 
why they have got it in their treaty. Here you have got 64.8 
percent, and you would have to go back to 1955, almost 50 
years, historically, to find that level.
    Director Daniels, I just can't understand why we don't get 
the truth about this budget and start paying for the war. While 
you are testifying, I can tell you now we are not going to be 
on TV because everybody wants to hear Colin Powell. They don't 
want to hear you and me right now. [Laughter.]
    Senator Hollings. That is fortunate for both of us. What 
happens is that he is trying to sell the United Nations on 
going to war, and we as the Budget Committee ought to be trying 
to sell the country on paying for the war. We paid for the war 
in every war. Even in the Civil War, President Lincoln raised 
taxes. Tax dividends rather than cut taxes. Raise the income 
tax rather than cut taxes. You can go right on down. We had a 
90 percent personal level in World War II, in Korea, and you 
come historically the corporate level, Mr. Chairman, at 50 
percent, and what we are telling those poor GIs, we want you to 
go into Iraq--we are waving the flag. We are loyal. We are 
supporting you. We hope you don't get killed. Hurry back 
because we want to give you the bill, we are not going to pay 
for it. Me and my crowd, Strom and I are home free, and we are 
going to give it to the poor GI going into Iraq.
    Now, this is the first sad Congress that ought to be 
ashamed of themselves and a Budget Committee that dances around 
the fire about charts and everything else. Do you believe we 
ought to pay for the war?
    Mr. Daniels. Well, Senator, I believe you have framed this 
question in the right way this morning, as you often do. I 
would like to respond, I would like to start responding by 
saying that I think you are presenting the right question. You 
said there is a risk in excessive borrowing, and I think 
everyone would agree. The question is: What is excessive? Let 
me present the issues as the President faced them.
    Senator Hollings. While they are looking for that, he said 
we have enough stimulus. You say you have got--this year you 
project on that same page, the last page, that we will have a 
$554 billion deficit, Mr. Chairman, $554 billion at the end of 
September this year, without the cost of Iraq, because we 
haven't gone in yet, 554, and next year 569. That is a trillion 
stimulus, gentlemen, ladies. That is a trillion stimulus. 
Senator Daschle's is 146 and the President is 133, $12 billion 
more a month does not stimulate. I mean, we have got enough 
stimulus. In the 2-year period, we have got a trillion dollar 
stimulus going on, and running around here trying to buy the 
election is really what it is, not the needs of the country but 
the needs of the campaign.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Hollings, I am going to have to 
put you in the undecided category as well. [Laughter.]
    Chairman Nickles. I am counting votes around the table.
    Director Daniels, do you want to make a comment?
    Mr. Daniels. I don't feel I gave a complete answer to the 
Senator's question, and let's do talk common sense and not 
numbers that would be hard for folks to follow.
    You cautioned against--and the President would agree--
excessive borrowing. The problem with governing is you have to 
make choices based on the situation as you find it. We find 
ourselves, of course, in a situation no one could have imagined 
for two or three different reasons just 2 years ago. This is 
the way it looks to the President, and I know it may well look 
different to you. You recognize what a baseline is, and our 
baseline--and CBO's actually says just the same thing--tells us 
that if the central goal, if our No. 1 priority should be to 
get back to balance, it is not hard to do. We could hold the 
Government at exactly the position it is today. We could grow 
it with inflation, and you would be back in balance in a couple 
of years.
    The question is: What would you not do? What would you have 
the President not do? Would you not try to grow the economy? 
Most members of both parties--there are a lot of differences 
about how best to do it, but most folks with whom I have 
visited believe we ought to act, not trust to luck.
    Would you not further strengthen our defenses and our 
homeland defenses and prosecute the war on terror? Would you 
not begin the drive to improve and modernize Medicare? Would 
you not continue doing something more--the President will be 
criticized for not doing enough more, I am sure--about 
education of disadvantaged children, about veterans, about 
global AIDS and so forth? That is the debate we ought to have.
    If, in fact, the wisest thing we can do as a country above 
and beyond those other objectives is to get back to balance, we 
can do that. It is not impossible. I urged your colleague a 
minute ago not to give up so easily.
    These are the President's choices. Apples to apples, the 
deficit we will face is about average for the last 25 years, 
counting the surplus years. It is not extraordinary. We ought 
to try to move it back toward balance, and the budget forecasts 
that happening. You can make it much closer to balance right 
away if you are prepared to forego some of these initiatives, 
and that is what the budget resolution is all about.
    Chairman Nickles. Thank you very much.
    Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Daniels, if you could leave that chart up for just a 
minute, I would like to talk with you a little bit more about 
that.\2\ 
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    \2\ No chart provided at press time.

    I think that the debate that we are having, that we see 
being framed, misses the point to a certain extent. That is, it 
seems to me that a lot of the discussion, both in the media as 
well as here in the halls of Congress, circles around whether 
we should try to balance the budget now--in other words, to 
reduce the deficit as much as possible--or whether we should 
have tax relief as an effort to try to stimulate the economy. 
The attack that I seem to hear is one that says we can't have 
tax relief now because it would cause us to have too much in 
terms of deficit.
    I am remembering back to when we were debating President 
Clinton's proposals for tax increases, and we had the same kind 
of debate in reverse. We can't have a tax increase now because 
it will--actually it was framed in the context of those of us 
opposed it saying we can't have a tax increase now because it 
will stimulate more spending, not help us reduce the deficit. 
In those days, we were showing figures that for every $1 of tax 
increase that we had had under previous proposals, spending in 
Washington went up by $1.50 or something like that. The 
question we tried to focus on then, which is the question I 
think we should focus on now, is spending and whether that 
spending is justified and whether tax relief, which is a form 
of spending of the Federal revenue, is justified in terms of 
stimulating the economy.
    Here is the point that I wanted to focus on. It seems to me 
that you have hit the nail on the head by the chart that you 
put up here. For those that are criticizing the current 
deficit--and, frankly, I am one of those who thinks that maybe 
we can do a better job at reducing the deficit as we put this 
budget together. For those who are criticizing the deficit that 
the President has proposed in his budget, they have to be ready 
to say what it is that they would do differently.
    Now, some have said let's not do the tax cut, and that is 
where I see most of the focus of the debate today. If you look 
at your chart, and if you look at the statistics that have been 
presented, just focusing this on the tax cut doesn't get to the 
issue.
    We just went through a debate and a series of votes on the 
floor in putting together last year's final appropriations 
budget where we had proposals to spend somewhere between $400 
and $500 billion more than we ended up with ultimately in the 
budget that we put together.
    So you and I both know that there are those who want to 
spend a lot more in every one of these categories and others if 
they have the opportunity.
    Again, that is the debate we ought to be having. Should we 
block all spending now and have a freeze and not do what we 
need to do for national defense, not do what we need to do to 
prosecute the war on terrorism, not do what we need to do in 
order to protect our homeland security, and not do the things 
that have been talked about here, and not have an economic 
stimulus package in the form of tax relief? Or should we have a 
different mixture of the entire package?
    The question I asked you is maybe just to elaborate a 
little bit further on the points that you were just making. We 
all want to reduce the deficit, and I for one don't think that 
it feels totally satisfactory to say that it is small in terms 
of historical circumstances. That is true. Frankly, I would 
like to see the deficit be zero. You would, too.
    What is going to be the impact on the deficit if we don't 
have the tax relief but we do then go back into the spending 
mode that we just fought off in the last few weeks here in the 
Senate?
    Mr. Daniels. Well, Senator, the irony is not lost on me 
that there are people in town I bump into on Monday, Wednesday, 
Friday who are urging a lot more spending, and when I see them 
on Tuesday, Thursday, and Saturday they are yelling at me about 
the deficit. You know, you can't have it both ways.
    Clearly, spending restraint, I would hope there would be 
bipartisan support from those who share the President's 
priorities and from those who believe that a balanced budget 
should come ahead of some of his top priorities, even higher on 
the list. I would hope there would be bipartisan agreement, for 
goodness' sake, let's control spending on the way. The 
President suggested a common-sense measure and a moderate 4-
percent growth, which is a substantial deceleration from what 
we are really forced to propose, more like 9 percent in the 
year just past.
    Senator Crapo. Could I interrupt and just ask you a quick--
I know our time is running out here. Would you agree, then, 
that for those who are saying that we don't do the job properly 
with regard to the deficit in the current President's proposal, 
that first and foremost they need to say what it is that they 
would not do that would help bring that deficit down? If that 
is they would like to stop the tax relief, they need to 
recognize what impact that will and won't have on the deficit, 
and make a commitment that they won't replace that loss of 
proposed tax relief with increased spending. Would you agree 
that those are the--that those who are making this argument 
would have to at least answer those questions?
    Mr. Daniels. Well, I am hoping that will happen. You know, 
the old question ``Where's the beef?'' came to my mind this 
morning because sometimes in these forums beef is all we get--
people beefing about the situation we are in, but not willing 
to step forward and present an alternative plan.
    I want to say a word of appreciation for Senator Hollings, 
as I have often felt moved to do. First of all, he has drawn 
our attention back again to the long-term fiscal problem we 
have, the unfunded liabilities, the true liabilities on the 
books of the Federal Government, which are much bigger than any 
1-year or 2-year or 5-year deficit we are looking at. Second, 
he puts squarely the question: Might it be wiser to raise taxes 
in the situation we are in? I don't mean to put a proposal in 
his mouth, but he at least raised the question. That is an 
honest question.
    Now, the President came out in a different place. He came 
out that, as perhaps your question suggested, believing that 
higher taxes on a weak economy might be very counterproductive, 
might even turn us back in a negative direction in terms of 
economic growth. He would prefer to move in the direction of 
growth and stimulus, even at the cost of a somewhat higher 
deficit temporarily. That is an honest thing we ought to be 
debating, but it is incumbent on those who want to throw rocks 
at his priorities to tell us what theirs are.
    Senator Crapo. Well, it just seems to me that whether the 
proposal is to increase taxes or to not have a tax reduction, 
that those who are weighing in on any of those proposals or 
something in between need to be prepared to also commit, if the 
issue is the deficit, that the increased tax revenue or the 
savings of tax revenue lost through stopping a tax cut would be 
dedicated to the deficit, not to increased spending.
    Chairman Nickles. Senator Crapo, thank you very much.
    Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman.
    Mr. Daniels, I really don't envy you your job of trying to 
sell to the American people the fact that long-term debt and 
deficit spending is a good idea. I came to the Senate in 1992, 
and I clearly remember Ross Perot running around the country 
with charts and graphs and making a very clear case of why 
deficit spending wasn't good, and as a result of that, my 
coming to the Senate, a number of other people, and we put 
together some really tough package back in 1993 that got us out 
of that cycle. I think the American public is pretty cynical 
about deficit spending.
    I come from a State and a region, as Senator Wyden knows, 
where we have been struggling for the last 2 years. I sat on 
this committee 2 years ago when the Administration was 
projecting a $5.6 trillion surplus in 10 years, and I cautioned 
everyone to be careful. Oregon, Washington, other States on the 
west coast were hit with a huge energy crisis. We saw a real 
impact on our employment. The dotcom bubble had burst. I told 
this committee that surplus is going to be gone soon. I, of 
course, wasn't able to predict 9/11. That had a serious impact 
on it, too. I was very concerned about a tax cut at that time 
because we saw on the west coast the unemployment rising. That 
has not left us. Oregon and Washington are still at the top of 
the country in terms of unemployment. We have had 76,000 people 
in my State lose their jobs in the last couple of years. One 
out of nine people don't have health care today because our 
health care system is based on employment. They have lost their 
health care as well.
    We are very concerned about the budget proposal that has 
come forward to us, the tax cut proposal that could put us into 
a worse deficit spending; but even more so, people are saying, 
What does this do to help me get back to work?
    Now, I have two quick questions for you.
    How will this tax proposal put people back to work in my 
State today? I don't see how a dividend tax is going to help 
the unemployment rate on the west coast?
    Second, I would say in response to my colleague from Idaho, 
who I share a lot of concerns with as well, sometimes spending 
is important to get us back on track. When you put money into 
transportation and you build highways, you put those people 
back to work immediately at construction jobs and engineer jobs 
and design jobs, and that helps our unemployment. It helps 
economic development in the long run.
    So is it correct to say that spending is always not helpful 
to our economy? I don't think so, and I would love to hear your 
response to both of those.
    Mr. Daniels. Well, thank you, Senator. Your cautions a 
couple years ago were well placed, and we now see how they were 
well founded. The President shared them, but events overtook us 
all in a way that maybe not even you had foreseen.
    In terms of the growth package, I think I would stand on 
the answer I gave a few minutes ago. I think in terms of 
immediate help to put people back to work, I would sort of rank 
the--I would rank the proposals roughly this way: I think the 
acceleration of the rates, probably first, both for the benefit 
to consumers but also because so many small businesses would 
see a fast improvement in their situation and might be able to 
hire more people. You know that that is where the jobs come 
from, net new jobs in this economy. I think behind that the 
child credit, through which many of your constituents would 
receive an immediate several hundred dollars, depending on 
their family circumstance, from bringing that reform that 
Congress has already voted for forward. I think the small 
business is expensing up there at the top, too.
    One other thing I would mention that I think has gotten too 
little attention is the President's proposal, on top of the 
unemployment insurance compensation that we have now for, $3-
plus billion for new re-employment accounts, in which 1.2 
million Americans, including many of your constituents, could 
access money that they could control to suit their own personal 
family circumstance and to create an incentive, because they 
could keep the balance if they got back to work more quickly. 
It is a new idea that we hope----
    Senator Murray. Well, I would agree with you. You are 
talking about putting cash in people's pockets today. That is 
important if you want them to be purchasing things. I think 
that the other side of that is if this puts us into debt, it is 
going to cost people more, as Ross Perot told us so many times, 
in terms of their interest rates on their mortgage or their 
house or sending their kid to college.
    Mr. Daniels. This is what governing is about, Senator. The 
President believes it is a good idea, it is a good chance to 
take to take an additional step for growth at this time.
    Again, there was a lot of counsel--there is still some out 
there--that says don't take that step, things well enough--
leave well enough alone. That wasn't where he came out.
    With regard to interest rates, interest on mortgage rates, 
we have the lowest rates in 40 years, thank goodness. It has 
been very beneficial to individuals and to the economy. We want 
to keep an eye on that, but for the moment that is a big plus.
    Senator Murray. Well, on the spending side, don't you agree 
that when you spend money, for example, on transportation 
projects that I alluded to, that also helps get our economy 
going again, gets the revenue streams going again, and moves us 
in the right direction?
    Mr. Daniels. Well, the President is proposing, for example, 
greater highway spending in a new reauthorized highway bill, 
and that certainly I think has done well. Better infrastructure 
is very good for the economy. When I think of highways, I think 
first of all of the way they enable businesses and individuals 
to practice more commerce. We need a good infrastructure to do 
that.
    I think we have to be a little cautious about and always 
remember that the dollar we spend on a given project had to be 
taken from somebody first.
    Senator Murray. Let me ask--is my time up? A really fast, 
quick question. Our State legislatures are in extreme--they 
have to balance their budgets. We have a $2.5 billion deficit 
in the State of Washington alone, and I am concerned about the 
Medicaid reform package. If you could just comment quickly, it 
looks like a block grant proposal that has failed several times 
in the past, and I just am curious on whether or not--how this 
is going to help our States when it seems to me that combining 
these programs is not going to help our State legislatures when 
they are dealing with the Medicaid crisis.
    Mr. Daniels. The first thing to note is it is purely 
optional, so any State that believes it would not be of net 
benefit to them can continue on without any effect. It 
involves--if you get a chance to look at it more closely, it 
involves what States, almost all States, I think, have been 
telling Secretary Thompson and telling the President they want, 
much more flexibility and more money to go with it, several 
billion dollars in the first few years, so there would be more 
money per beneficiary, along with more flexibility.
    Again, it is strictly up to the States to choose.
    Senator Murray. I know my time is up, but let me just say 
that if you base it on the formulas from the past that have 
rewarded States who are not as efficient, it is simply going to 
put more of our State legislatures in a bind. I will talk with 
you more about that.
    Chairman Nickles. Senator Murray, thank you very much.
    Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    I want to take a little off of what Senator Crapo and 
Senator Hollings were talking about. I do think it is very 
important for us to look at the long-term debt that we have 
with Social Security. As a matter of fact, Senator Hollings, I 
am one of those people that would love to see Social Security 
money not touched. There are a couple of reasons that I would 
like to protect Social Security one, we would have to reduce 
Federal spending. We would be forced to. The money wouldn't be 
there to spend. If we actually had to take that money and put 
it in an account, we would be forced to reduce Federal 
spending.
    Second, as far as I am concerned, it would give us much 
more flexibility on saving Social Security for future 
generations and would give us the option of possibly creating 
private accounts for future generations, we could turn Social 
Security into a pension system. That is the way that Social 
Security should have been set up a long time ago. It wasn't. It 
was a pay-as-you-go type of system, unfortunately. I would like 
to see it someday transitioned more into a pension system 
similiar to what many companies have. If companies or States, 
borrowed money from their pension funds and spent that money, 
there would be a revolt in this country. So I would certainly 
echo those types of thoughts.
    Taking off of what Senator Crapo said, though, I am 
critical of those in Congress who want to increase spending, 
but I am also critical of the Administration in this regard: I 
don't think enough emphasis has been put on the deficit. It is 
just a priority that I think should be higher on the list of 
the President's priorities. I think it is a legitimate 
discussion to have. There are choices that will have to be 
made. I feel it unfortunate that the President didn't lead a 
little more on saying, you know, we are going to war. We are in 
a war on terrorism already, and we are probably going to war 
with Iraq. I think most of us feel that if we are going to war 
in Iraq that it is going to be a significant cost, so we have 
to make very wise choices on this Budget.
    I have made those kinds of votes in the past, and I would 
be willing to join you in those difficult choices. I think that 
that is up to Presidential leadership, for one, to help control 
spending, because without the President it is difficult to get 
enough votes to control Federal spending.
    On your graph, if you could put that one graph up, I had 
one quick question on there. The Medicare part of the deficit, 
does that include prescription drugs?
    Mr. Daniels. Yes.
    Senator Ensign. How much larger, if the bill that was 
sponsored by Senator Kennedy last year, if that bill would have 
passed, how much larger would those deficits be in the out-
years?
    Mr. Daniels. Well, they would be substantially larger, but 
the real place to see the difference, I suspect, would be in 
capturing the unfunded promise that we already have. The 
unfunded promise of Medicare is about $13 trillion. That is 
more than 3 times the national debt, or 2 times if you measure 
the gross debt, as Senator Hollings does. As we try to improve 
Medicare and, after that, Social Security, we have to be very, 
very careful to watch that number.
    The bill from last year that advanced the farthest in the 
Senate would have added another $6 trillion to the long-term 
unfunded liability of Medicare. So we do have to be very 
careful about that in any reform that we pass.
    Senator Ensign. I agree, and I think that we have got to be 
careful as we go forward. I love the talk from both sides--
especially from the other side of the aisle about deficits. I 
love the fact that they are stressing how important it is to 
control deficit spending. I just hope that when it comes down 
to votes, that we get the votes on some of these things because 
we know that there are going to be votes on spending more money 
on the Medicare prescription drug package.
    Senator Hagel and I, we had the only package that fit 
within the $300 billion number that we had available to spend 
last year. Every other package was outside of that number, and 
some of them were substantially outside.
    Another point that I would like to make is what Senator 
Crapo said, and I made this point last week, that the $500 
billion in extra spending that we tried to tack on to the 
omnibus appropriations bill, that adds to the baseline, which, 
you know, adds tremendously to the deficits, does it not?
    Mr. Daniels. Absolutely.
    Senator Ensign. So if we are going to be concerned about 
the tax cuts, those same people should be willing to not vote 
for more spending, I guess is the point to be made.
    Mr. Daniels. Well, again, it is a matter of where one's 
priorities are, and I will take back to the President your 
reservations. Likewise, I would agree with you that those who 
differ with this set of priorities do have that same 
responsibility to tell us what they are for.
    Senator Ensign. Thank you, Mr. Chairman. Just two quick 
closing comments. That is, I criticized the other side of the 
aisle. Once again, I criticize the Administration. The steel 
imports last year was a terrible decision on the 
Administration's part--I think it hurts the economy, and adds 
to the deficit. Additionally, sigining the farm bill was also a 
terrible decision made by the Administration as it also adds to 
the deficit. So I am trying to be fair in my criticism here. If 
we are concerned about deficits, I would like to see us all 
working together. I personally believe that it is important for 
us to pay down long-term debt and to handle those unfunded 
liabilities that we have in the future with Medicare and Social 
Security.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Ensign, thank you very much.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Welcome to Mr. Daniels, and I think your point about what 
are you for is exactly what this is about. Senator Hatch and I, 
for example, have introduced the Health Care That Works for All 
Americans Act, the first comprehensive, bipartisan health 
proposal in a decade. That is really why I serve on this 
committee, is to try to find some common ground on health care 
issues.
    Let's talk for a moment about the way the Administration is 
approaching this health area. It seems to me there are two 
special problems today. Medical costs are gobbling up 
everything in sight. The number of uninsured has increased 
dramatically, we have a demographic tsunami, millions of baby 
boomers retiring in 2010 and 2011.
    So tell me, if you would, because I want to find common 
ground with the Administration--that is what Senator Hatch and 
I are pursuing with our proposal--how what you are looking at 
moves us in that direction. For example, the tax credits that 
you are offering for health insurance, I look at those and I 
don't see how we get very far down the road with the idea of 
the Administration's tax credit proposals if you can't buy 
decent coverage at an affordable price. So I ask, as somebody 
who wants to work with you, somebody who has got a bipartisan 
proposal in front of the Congress and the Administration, how 
is what you are looking at with tax credits going to sort of 
move us down the road given the seriousness of the problem?
    Mr. Daniels. You are correct that the President has 
proposed--re-proposed--for the third time tax credits to help 
those who are not insured to obtain coverage. It may not be a 
complete answer, but we think it would be of tremendous value 
to those who could take advantage of it.
    I think other areas for early cooperation could be medical 
malpractice reform, clearly a major driver not only of costs 
but driving physicians out of medicine altogether right now in 
States where frivolous lawsuits have run amuck. Medicare reform 
we think is fundamental to overall health care reform.
    I also encourage you to stay in close contact with 
Secretary Thompson, who very quietly but effectively has, 
through work with the States, through a much more flexible 
policy of waivers with the States, has enabled between 1 and 2 
million Americans to secure coverage in the last year or two.
    So you have put your finger on the biggest problems, the 
cost, the uninsured, and the long term, and the President is 
trying to move forward on all fronts.
    Senator Wyden. I am going to move on. I think Secretary 
Thompson's initiatives for demonstration projects is a good 
one. I have met with him. I am going to support his 
demonstration projects, and I say full steam ahead. However we 
have got to start looking at health care as an ecosystem. What 
goes on over here relates to what happens over there. I hope 
that you all, particularly at OMB, will look at this proposal 
that Orrin Hatch and I have. We have gotten a favorable 
reaction from the AFL-CIO and the Chamber of Commerce, two 
groups that don't exactly flock to each other on this health 
issue. We are offering an alternative. We would like your 
support.
    The second area very briefly, Mr. Chairman, involves a 
regional matter that has my part of the country up in arms this 
morning, and that is your proposal with Bonneville Power. The 
proposal there, particularly in the performance assessment 
section, seems to indicate that OMB is looking at trying to 
privatize major functions of the Bonneville Power 
Administration. We just think that would be poison for our 
area, and I would like to give you a chance this morning to 
take that off the table if that is the position of the 
Administration. This is something Democrats and Republicans 
look at in a bipartisan kind of way. Tell us what your position 
is with respect to the Administration's desire to privatize 
functions at Bonneville Power.
    Mr. Daniels. Well, no such interest on our part, if you 
mean by that the privatization of the entire authority out 
there. Questions have been raised for a long time in this 
administration, the last administration, and Presidencies 
before that about the operations there, about the fairness of 
it, really, to taxpayers nationwide. No, it is--improvements 
are in order, but not what you call privatization.
    Senator Wyden. Well, I appreciate that. Just know that just 
yesterday Bonneville Power said this is something the 
Administration believes should be explored. So people out in 
the region are corcerned, particularly, given how hard we have 
been hit economically across the board. There is enormous 
concern in the Northwest about this and when OMB says critical 
things about Bonneville with respect to the private sector, and 
it sure looks--if it looks like a dog and acts like a dog, 
sometimes you think it is a dog. This seems to indicate support 
for privatization. You have told me that you are not interested 
in doing that. Know that our region feels very strongly about 
it, and I thank you.
    Mr. Daniels. Thank you.
    Chairman Nickles. Senator Wyden, thank you very much.
    Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Chairman. I want to thank 
Director Daniels for being here today and tell you that I 
believe the President and OMB deserve a lot of credit for this 
budget that you have laid out. As you pointed out at the 
outset, this isn't about just numbers. This is about 
priorities. This is really about values, and I think you have 
done a good job of laying out what those values are, what those 
priorities should be, and challenging those who would criticize 
this budget to come up with some alternative.
    I think we have heard some of those mentioned today that I 
personally would not support, like tax increases, but that is 
the debate we ought to be having, and I appreciate your work 
and your office's work.
    I am particularly pleased to see that the Administration 
remains committed to restraining the growth of Federal 
spending, and I happen to have a different point of view from 
Senator Conrad, for example, on the effect of the tax cuts and 
believe that really the primary culprit for the situation we 
find ourselves in today is spending increases that range up to 
a 10.8-percent increase in the year 2000, but we have seen 
pretty much lack of any restraint whatsoever on the part of the 
Federal Government when it comes to spending money during good 
times, and now when our income and our revenue is dramatically 
decreased, as it was in 2002 with a 7-percent decrease in 
Federal revenue because of the circumstances you have 
summarized for us, it calls for restraint, I believe. I think 
the President's proposal of 4-percent growth--not a cut. You 
know, nowhere else I have ever been would somebody consider a 
reduction in growth a real cut except in Washington, D.C. The 
President's budget proposes a modest 4-percent growth in the 
Federal budget and spending restraints that would allow us to 
hopefully deal in a responsible fashion with the unfortunate 
set of circumstances we find ourselves confronted with today.
    I really have just two questions I want to ask. I am very 
supportive of the President's plans to improve government 
performance and make it more accountable to the public when it 
comes to how tax dollars are actually spent by the Federal 
Government by reducing waste and inefficiency and making sure 
that taxpayers really get a bang for their buck. Could you 
summarize just briefly for us here what does this year's 
evaluation reveal about the performance of the Federal 
Government when it comes to spending tax dollars in a 
responsible way and being accountable to the public we all 
serve?
    Mr. Daniels. Yes, Senator. There is a new document in the 
budget this year, Performance and Management Assessments, and 
the bulk of that document does report the assessment using a 
standard evaluation tool that was worked out by people 
throughout the Government but with the help of outside experts 
of 234 programs. It is a long step, but it is really just the 
first step toward a goal that many Members of Congress have 
urged on OMB for a long, long time, and that is to get serious 
about identifying what works and what doesn't so that Congress 
can make budget decisions with that in mind. We don't want to 
overclaim for this, but people have worked very, very hard. It 
is the first serious attempt to do this, and I think there are 
some lessons in it.
    There are very few programs that we can identify as clearly 
effective. The test of effectiveness includes things like a 
clear purpose, the accountability to devise measures for 
telling whether that purpose is being approached or not, and 
then hard results using those measures. There aren't very many 
programs that meet that test right now. There are a fair number 
of programs that clearly fail it, and then the top of the bell 
curve there is a large number of programs about which we just 
don't have enough information.
    As we see it, that is not a gentleman's C. That is an F in 
waiting because the burden of proof must finally be on the 
proponent of spending. So a program that goes on year after 
year and can't prove its value at some stage ought to give way 
to something that we think might work better.
    I appreciate your question, and I do hope that people will 
spend some time looking at the evaluations and giving us 
feedback. Undoubtedly, of the 234, some are in error or missing 
some important information. It is a very impartial attempt. 
There is no ideology in it. There is no question in that 
assessment tool about should Government be doing this or not. 
That is a separate, of course, very important question, but 
this is meant to be ideology-free. We are just trying to get at 
the issue of does it work or doesn't it, can it prove it works. 
We would very much value feedback, and we are beginning to get 
some.
    Senator Cornyn. I appreciate the Administration's effort to 
begin to provide that information to the Congress so we can 
then make some decisions based upon the information that you 
are providing us.
    My second and last question has to do with the new 
Department of Homeland Security. I, like a lot of other 
Americans, have wondered that with the consolidation really of 
homeland security functions from 22 different Federal agencies 
into one Federal Department of Homeland Security whether we are 
going to see some savings associated with that, perhaps through 
increased efficiency or just consolidation of duplicative 
functions, or if we have not and do not see any in the short 
term, whether you contemplate that we will in the mid- to long 
term.
    Mr. Daniels. Well, Senator, the motivation for that 
Department was not to save money. In fact, we are going to 
spend more money. On a percentage basis, it is the highest 
priority in the President's budget. This President will do and 
spend what it takes to protect Americans.
    As I said earlier, we don't count it in those numbers, but 
I consider the most important homeland security money we spend 
to be that the military and intelligence services use to go 
after terror before it ever shows its face at an American 
airport or other point of vulnerability.
    In the immediate term, there are enormous responsibilities 
on Governor Ridge, Secretary Ridge, and his people to get 
organized. Thank goodness the Congress passed that legislation. 
We clearly were not organized. It's no one's fault but we never 
needed to be able before to identify and assess and protect 
against this sort of threat. So that was a fundamental first 
step, but the first real job is to get organized and to get 
better at this as fast as we possibly can, ``this'' being 
protection of our most vulnerable places.
    Along the line, of course, we would expect to see some 
savings from consolidation. Shame on all involved if that 
doesn't happen. That is not the first motivator.
    Also, there are some limitations on what the Department can 
do for the first year in terms of personnel and so forth, and 
that will delay the day when I think meaningful efficiencies 
can occur. Keep asking the question because it is an important 
responsibility.
    Senator Cornyn. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Cornyn, thank you very much.
    Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman, and thank you, 
Mr. Daniels. I know you are in a lonely fight sometimes to 
contain spending. I salute you for that. I remember very 
distinctly being elected Attorney General of Alabama in 1994, 
and my predecessor, through colossal mismanagement, had left us 
with a $5 million deficit looming on a $15 million budget. That 
is a big deal. Faced with no alternative, we identified the 
non-career civil servant employees, and we had to let them go, 
one-third of the office. As we reorganized and closed offsites 
and got rid of automobiles and did other things, we made that 
office more productive than it was before I took over. It still 
well below the number.
    So I think you are correct, and I hope you will continue to 
challenge these agencies and departments to reduce their 
overhead, make themselves more productive and efficient. Your 
program--what is it called, PART?--to identify those is a step 
in the right direction. I think you can be a lot more 
aggressive in my view. I don't think most people know that in 
this Government and in this Senate you walk around here and see 
the money we spend and say we can't save on efficiency. That is 
not correct.
    So what do we expect the inflation--I know our spending is 
going up 4.2 percent this year. What do we expect our inflation 
rate to be this year? Do you have that number.
    Mr. Daniels. 2.2.
    Senator Sessions. So this is nearly double, spending is 
going to go up nearly double the inflation rate. I know the 
Chairman asked to try to work together in a bipartisan way, but 
I don't think we can forget that on a virtual party line vote 
just a few weeks ago, amendment after amendment after amendment 
came from the other side on issues all of us cared about to 
spend more, more, more. They totaled up to $500 billion more in 
amendments just to those appropriations bills and didn't 
pretend to deal with every issue. We have people here that want 
more roads and more health care.
    So ultimately we need to understand that this Congress 
can't solve every problem in America. Yes, it sounds good 
politically to say I am going to do more and more and more and 
spend more, but if we don't maintain our discipline, we are 
going to be in trouble. I think Senator Frist deserves a lot of 
credit for saying we are going to have a reasonable increase in 
spending this year, but we are not going to go with another 
$500 billion.
    The testimony we had yesterday from Dr. Hubbard was that we 
would have with the President's growth package a 9.9-percent, 
almost 1-percent increase in GDP this year in growth, and 
another 1.7 next year, and we would create 1 million more jobs. 
So isn't it true that if that were to occur, based on the 
President's growth package, we would begin to see some increase 
in revenue as a result of those new jobs and growth?
    Mr. Daniels. Yes, sir, I think everyone that I know of 
agrees that there would be a recapture, a feedback, an effect 
from any measure that Congress might vote for, any growth 
measure. Economists will differ as to what percent of the money 
left in taxpayers' pockets or spent by the Government would 
come back. Of course, in our accounting we use zero because we 
don't pretend to know how to be precise about that. I guess Dr. 
Hubbard gave you an estimate of about 40 percent, I believe it 
was, of this particular growth package would come back.
    I don't know if that is right or not, but it is on the 
order of the estimates a variety of outside economists gave as 
the President thought about this. So we know that the zero that 
we incorporate is wrong and too pessimistic, but we make no 
attempt to forecast just what that positive effect might be.
    Senator Sessions. So you have no dynamic scoring, but it is 
obvious to me that if all economists agree that we will have 
some increase in growth as a result of this package, it will 
increase tax revenues to some degree. You are providing no--
because of the dispute over dynamic scoring and the fact that 
nobody knows precisely how much, you are not showing any 
numbers for that.
    Mr. Daniels. That is right. As we said in answer to an 
earlier question, for now we have certainly the most 
pessimistic revenue numbers of any forecast I am aware of. We 
sure hope they are wrong, and we hope a growth package will 
make them wrong by a big margin. Unless and until we start to 
see that, we are going to continue to try to be cautious.
    Senator Sessions. With regard to your PART program, this 
program to analyze the agencies of Government and to challenge 
them to be productive to meet the mission for which they were 
created to begin with, I would like to ask a couple of 
questions about it and would just say all of us know that one 
of the great failings of Government in this Congress and many 
times State government is that when agencies and departments 
cease to be productive and efficient and really be worthy of 
the money they get, we never seem to stop them. If anybody 
challenges them, whatever their mission is, they holler and say 
that, you know, we are hurting people unfairly. It is very, 
very, very difficult to stop them.
    Your analysis showed that only 6 percent of the programs in 
Government were rated as effective, 24 percent were rated 
moderately effective, and 50 percent you weren't able to rate.
    On those programs that turned out to be effective, what 
kind of increases in spending did they get? What kind of 
increases or cuts have you proposed for those that are 
ineffective?
    Mr. Daniels. Yes, there is a table in the book, Senator. It 
is not an exact one-to-one correspondence. In other words, 
there are some programs that are ineffective for which the 
right answer might be let's fix what is wrong, it is too 
essential not to do, or there is not an alternative program 
that gets at the same thing. In general, those that we were 
able to reach a clear judgment about, we reinforced with 
greater increases, and vice versa.
    Let me make one other point. There are really two parts to 
that book: one that looks at individual programs, like your 
question pointed to; the rest looks at the departments and the 
way they are doing their day-to-day business. The President has 
made it a part of the responsibility of every Cabinet Secretary 
and Department head and people working for them to leave the 
everyday operations in better shape than we found them. This is 
often an afterthought or no thought at all for busy people who 
are eager to work on new policies and so forth. We have made 
quite a to-do of it, and I do believe a sense of real 
accountability and team spirit has set in around it.
    Last, let me say that it is refreshing to get a question 
about productivity because it is too rarely asked, and in 
American business, business generally, productivity is an 
expectation. I think we all know one great thing happening in 
the economy is productivity continuing to run up above 5 
percent.
    Senator Sessions. Right now, even----
    Mr. Daniels. Right now. That means that a business becoming 
more productive at a 5-percent rate can deliver the same amount 
of work next year with 5 percent fewer dollars. What would it 
be like if the Federal Government was improving its 
productivity even by a percent or two?
    Almost no department seems to think that way. There are 
some that are really working on that. I will cite them: the 
Veterans Administration, Social Security Administration, who 
are actively looking at places in their activities where they 
ought to be able to do more per person or per dollar invested 
and thereby give the taxpayer better service at fewer dollars.
    Senator Sessions. Thank you.
    Senator Sessions. Thank you, Senator Sessions.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman, and, Mr. 
Daniels, thank you for coming. We all want to focus on 
increased productivity and efficiency for the precious dollars 
that are available.
    I would focus on two things. First, in terms of economic 
models, I continue to feel the need to say to colleagues over 
and over again that we don't have to debate economic models. We 
have experience in our lifetime of models that have worked and 
not worked. We have the 1980's and we have the 1990's.
    In the 1980's, there were supply side economic tax cuts 
that were put forward, very much like this administration, and 
with the hope that it would trickle down, with a massive 
buildup in spending, most of which was defense spending at that 
time. I lived through the 1980's as a State legislator in 
Michigan and lived through the highest unemployment, at least 
in my lifetime, and explosion in interest rates as a result of 
a massive buildup in debt. That is one model.
    We come to the 1990's, and I had the opportunity in the 
mid-1990's, 1997, in fact, to be in the Congress in the House 
when, for the first time in 30 years, we balanced the budget. 
We had a different approach. We had a focus on fiscal 
responsibility, paying down the debt, and more focus on demand-
side tax cuts for the middle class, an actual slowing in 
spending, contrary to what is often said, a slowing in 
spending. I was there for the voting on cuts in spending at 
that particular time.
    There was a focus on education innovation, increases in 
dollars there, that helped to increase that productivity that 
you, in fact, are talking about, that we have seen in the 
private sector because of the increase in education focus and 
innovation.
    So now we come back to 2001, 2002, 2003, and we see again, 
like the 1980's, a focus on supply side economics, trickle-down 
economics, a great increase in defense spending, and I have 
voted for that given the current situation, and all of us have 
great concern about safety and security for our citizens. What 
have we seen as a result of this? We are seeing a great 
increase in defense spending, and what do we have now? Over 2 
million private sector jobs lost in the last 2 years. We have 
to go back to the Eisenhower administration to find that kind 
of a number, and a dramatic increase in the national debt.
    So I would just say to my colleagues, we don't have to 
debate economic theory. We have real-life experiences that we 
have all lived through. For many of us, we are scratching our 
heads as to why we would choose a 1980's economic model versus 
a 1990's economic model that worked.
    Before asking you to respond, I would just say to look at 
where the economic uncertainties come from, and the CBO 
comments a week ago we were told that there is excess capacity 
from overinvestment during the bubble years of the late 1990's, 
inhibiting investment, and that the growth of consumer spending 
is uncertain in the near term because demand is weak in many 
sectors of the economy, and that, again, strength of demand is 
the concern that was raised.
    Now, that says to me that we need tax cuts like we have 
suggest that put dollars directly into the pockets immediately 
of middle-income consumers, small businesses, those that will 
move the economy in the short run. I continue to scratch my 
head, Mr. Daniels, as to why we are not using the approach that 
is even backed up by experience in the 1990's of fiscal 
responsibility and keeping an eye on the debt, paying down the 
debt, balancing the budget, and focusing on tax cuts that go 
directly to the middle class.
    Mr. Daniels. Well, thank you, Senator. I see things in part 
the same and in part differently. I take a slightly different 
lesson from the history. Both the 1980's and the 1990's were 
periods of extraordinary economic growth in this country. It is 
astonishing to me that people have a memory blank like some do, 
but I think an honest reading is both were very strong decades. 
We just had a 20-year run from 1982--well, 19 years--to 2001 
with only one small, very short interruption until the 
recession which started in 2001. The lesson I would take is 
that there is no one model that is perfect in all circumstances 
at all times.
    We had good results. One thing we ought to be careful about 
is assuming that it is what Washington does that dictates the 
outcome because there are always many more factors involved. In 
terms of those things that Government can do to create the 
right climate for growth, it may not be the same answer all the 
time.
    I would certainly argue from the results that the tax cuts, 
which began to take effect at the depth of the recession in 
1982, led to or had something to do with the gigantic increase 
in economic growth, 20 million new jobs and, some forget, a lot 
of new revenue to the Government. You quite correctly pointed 
out that there were other things going on. We were facing the 
Soviet Union. There was a lot of spending on defense and also 
on non-defense programs that came along at the same time and 
which consumed all the new revenue and more. Some people think 
too much more, but in terms of economic outcome, it was 
spectacular by any measure. The 1990's were spectacular in 
their own way. Certainly in the situation like that, we were 
able to spend the peace dividend. Most of the cuts, as you 
know, most of the spending moderation was achieved because of 
changes in the defense budget. Certainly at a time like that, 
it was good policy to get to surplus. People in both parties, 
people in this room had a lot to do with it. Get the surplus, 
pay down some debt, exactly the right thing.
    Now the question in a very different sort of environment is 
what is right now, and what you have got here--we talked about 
this. What is the right balance of our priorities? Where do you 
put a balanced budget versus the war on terror, homeland 
defense, economic growth and so forth? Honest people can 
certainly differ about how high on that list it ought to be, 
but that is how I think I would frame it.
    Last, I agree with you that if we are going to have a 
growth package, as the President and others believe, certainly 
at least a substantial piece of it ought to involve the near 
term, ought to involve consumers, and there are elements of his 
package that we believe do that.
    Senator Stabenow. I appreciate your comments. My concern is 
that two-thirds, really, of what you propose has nothing to do 
with the short run and is estimated to continue to increase the 
national debt. Many of us, both sides of the aisle, the 
business community that I talk to in Michigan are extremely 
concerned about where we are going, back into deficit spending.
    Let me shift, though, to one other item, and that is the 
question of health care, to follow-up on Senator Wyden's 
comments and others'--again, talking about to the business 
community. The largest cost, the explosion in costs that they 
are most concerned about relates to health care costs, not just 
seniors but the business community, workers. It is certainly 
the biggest drain right now and the most sense of being 
uncontrolled in terms of the explosion on prices and so on.
    When we talk about Medicare, there are really two pieces on 
the health care front. One is updating Medicare in some 
fashion. I would argue that, in fact, anyone who has paid the 
payroll tax all their life in order to have health care 
available at the time they retired, called Medicare, who then 
turns around and pays the bulk of their health care and 
prescription drugs, which isn't covered, is being double taxed. 
I would argue that is much bigger double taxation than anything 
that the dividend tax would provide for most seniors. That is a 
real issue, out-of-pocket costs and double taxation.
    On the business front, we have been working to create more 
competition as it relates to brand-name prescription drugs to 
lower prices. Strong evidence, major coalitions, we have all 
kinds of business organizations and employer groups and Blue 
Cross/Blue Shield-Michigan is playing a major role, and others, 
to create more competition to lower prices.
    Last summer, we passed on a very strong bipartisan vote, 78 
members voted for a bill that would tighten the generic laws, 
open the border to Canada to change the market pressures to be 
able to lower prices, and create more flexibility for States in 
negotiating lower prices for the uninsured in their States. 
This passed with a very strong bipartisan vote, and I would 
like to know if the Administration, as we introduce it again 
this year, will support that effort to lower prices, which are 
the largest driving factor in the explosion of health care 
costs.
    Mr. Daniels. Well, the President will, I am sure, take a 
look at anything that might help Americans with the cost of 
health care. You mentioned prescription drugs, which, though it 
is something like a dime on the dollar, is growing faster than 
other areas, and that is an area of concern. The President 
acted, as I think you noted, late last year to make sure that 
there wasn't abuse of the patent extension process, something 
that had been, I think, misused on several occasions. He tried 
to move repeatedly to make discounts available to especially 
lower-income senior citizens until we can get to comprehensive 
Medicare reform that includes prescription drugs. Secretary 
Thompson has gone a long way working with individual States 
along the lines you talked about to give them some flexibility 
to wrestle with this cost problem.
    So any reasonable proposal in this area I am sure he will 
look at.
    Chairman Nickles. We need to move on, if you don't mind.
    Senator Stabenow. Yes, absolutely. We look forward to 
working with you. There is certainly much to be done in this 
area.
    Chairman Nickles. Senator Stabenow, thank you very much.
    Senator Nelson?
    Senator Nelson. Mr. Director, I am going to ask you some 
specific questions. Having just returned from the memorial 
service in Houston yesterday where the President spoke quite 
eloquently and spoke not only to a grieving Nation but a 
grieving NASA family as well.
    I have been quite critical in the 2 years that I have been 
Senator not only of your administration but of the previous 
administration in trying to starve NASA of funds when so much 
is demanded of it. Indeed, the funding today for NASA in real 
dollars is the same as it was 12 years ago. So it actually 
spans three administrations, but primarily it spans two 
administrations.
    Now, I notice that you are coming up with beginning to give 
some relief in your proposed budget to the tune of close to 
about $470 million, but most of that is in space science. In 
fact, in the Space Shuttle program in your budget, you are 
actually--overall the space flight part of the budget is 
actually reducing. Where I have been so sharply critical of 
this administration and the previous one is that there are a 
number of safety upgrades that ought to be done, but yet have 
been delayed for funding reasons. We have been saying this for 
some period of time. It is ultimately going to cause a 
catastrophe.
    Now, fortunately, in a very unfortunate world, I don't 
think the delay of those safety upgrades is what caused this 
catastrophe. It looks like this is a failure of the thermal 
protection system perhaps caused as a result of something like 
that debris falling off the external tank. The fact is that 
space flight is risky business, and there is no excuse for us 
not proceeding with the safety upgrades if we are going to keep 
flying the Space Shuttle, and that is our only access for 
humans to space. With a huge investment up there--which I have 
complimented Mr. O'Keefe, publicly and privately, that he is 
getting his arms around the cost overruns on the Space Station. 
I think he is to be commended for that.
    Now, he knows what I have said. I would love to hear what 
you say.
    Mr. Daniels. Well, thank you, Senator, for your leadership 
in this area. I would start by pointing out--and these facts 
are well known to you--that were it not for the last 3 years, 
which were catch-up years, you would be below the level of 12 
years ago, measured as you did it. In other words, it may have 
been inadequate--I know from your viewpoint it probably was, 
but the funding of NASA, I should say, in the first three 
budgets, including the one just delivered for this President 
marked the sharpest increases in that whole time period. That 
is true, and I would be glad to go through the piece parts with 
you, but as we see it, that is true of NASA, it is true of the 
shuttle budget, and it is also true of the shuttle maintenance 
and life extension budget within that. It well may be that more 
should have been done and that more will be necessary, but at 
least it has been moving in the right direction. I would say--
and, again, no news to you--that there have been, as I read the 
record, anyway, and have seen it for 2 years, your views are 
not universally held, and there are a lot of your colleagues 
who have been skeptical and who have preferred to grow other 
programs of Government more than NASA. So they may be 
rethinking that in light of what has occurred.
    Last, I do appreciate your advocacy and your pointing out 
this morning the importance of some improvements in some 
fundamental problems that NASA has had, and I think the Space 
Station is probably the single biggest example. If the Space 
Station had not been overrunning at the rate it was, more 
resources might well have been available for other things in a 
more balanced program. I think you are right that the new 
leadership has begun to really get a handle on that. The better 
job that is done there, I think the more consensus and support 
there will be to strengthen other programs, perhaps starting 
with the shuttle.
    Senator Nelson. Well, in light of this tragedy this 
weekend, let me suggest something that you can do. There is the 
political will here on Capitol Hill, including Senator Stevens, 
in this 2003 appropriations omnibus bill in conference to put 
in some additional money to get some of these safety upgrades 
started. So what I would suggest that you could do is don't 
oppose that and it will happen, because the political will is 
here, particularly in light of what has just happened.
    Mr. Daniels. All right, sir.
    Senator Nelson. Let me ask you, we have got a problem over 
at the Department of Housing and Urban Development. There is 
about a $250 million shortfall for the public housing operation 
fund, and, of course, I am hearing this from housing 
authorities back home that, as a result of this shortfall, they 
have been asked to reduce their operating budgets. This budget 
you have submitted doesn't make up for this shortfall. In fact, 
it even cuts it more by $40 million.
    So can you tell me--give me some level of comfort. Tell me 
why the shortfall, and how about these authorities that are now 
being told because of this shortfall that they have got to cut 
back on their operational expenses.
    Mr. Daniels. Well, I would like to reserve the right to 
write you or visit you with a full report, but I will give you 
a quick answer now. There have been some really very serious 
administrative problems in many of the public housing 
authorities. Many are well run, many are not well run at all. 
The Secretary, in fact, has been compelled to take over at 
least two that I can think of where there is not just failure 
to keep track of money but misuse of funds and things like that 
have been going on for a long time. This is a partial source, I 
believe, of some of the shortfall that some have experienced. 
Some are simply spending money faster than they were supposed 
to be spending it. I would be more than happy to try to give 
you a fuller report.
    Senator Nelson. I think that is increasingly going to be a 
problem, and I would appreciate very much your response.
    Mr. Daniels. Sure.
    Chairman Nickles. Senator Nelson, thank you very much.
    I have to leave, and I am going to ask Senator Allard if he 
would chair the balance of the hearing because I understand 
Senator Conrad and Senator Hollings both have additional 
questions.
    Director Daniels, a couple of quick ones from me. A little 
confusion may come out on on-budget/off-budget. The unified 
deficit that you are projecting is $304 billion or $307 billion 
for 2003 and 2004?
    Mr. Daniels. Presuming the President's entire program 
including his growth package became law.
    Chairman Nickles. OK. The baseline you are projecting, if 
nothing changed, would be $264 billion or something for 2003; 
is that correct?
    Mr. Daniels. For 2003, dropping to, I think it is $158 
billion in 2004.
    Chairman Nickles. That is the cash-flow. I think a lot of 
people, members included, really get kind of confused on-
budget/off-budget, Social Security surpluses and so on.
    A couple of other comments. Just maybe--and I am going to 
present this to our colleagues a little more in-depth, but the 
total tax, the payroll tax, the 15.3 percent Social Security 
and HI tax is on wages up to $87,000 this year. Anyway, back in 
last year, the last year just complete, if my calculations are 
correct, the total amount of money going in, received in 
payroll taxes and the Part B premiums I believe equaled $691 
billion and the expenditures, Social Security and Medicare, 
were $706 billion. I believe your proposal or estimates are 
$711 billion in receipts and $743 billion in outlays, the point 
being if you add the two programs together--and people talk 
about raiding or stealing Social Security funds and so on. 
There is a lot of confusion. If you put the two together, we 
are actually spending more on the programs than we are taking 
in, so I don't quite concur with this claim about raiding of 
the funds because we should include this or not add that to the 
calculation.
    I make those comments, and I will work with my colleagues 
so we can all have maybe a better understanding. It gets kind 
of confusing because you have the Social Security funds and the 
HI funds, and then you have general revenues, subsidies into 
Part B and so on, so it is kind of confusing. The total amount 
of money, payroll going in and outlays coming out for basically 
seniors under the two programs, there is a little more going 
out than going in, so there is not--if you combine the two 
there is not really a current surplus. Is that correct?
    Mr. Daniels. It is correct, and you point to the reason: 
because Medicare viewed in its entirety runs a deficit. That is 
to say, it has to be subsidized heavily by the general fund and 
the taxpayers who pay into that.
    Chairman Nickles. The same beneficiaries on Medicare are 
the ones that are also receiving Social Security.
    Mr. Daniels. More or less.
    Chairman Nickles. OK. Senator Conrad, I will call upon you, 
and then, Senator Allard, if you would be kind enough to 
conclude the hearing.
    For the information of our colleagues and press, we expect 
our next hearing to be on Tuesday with Secretary of State Colin 
Powell, and that will be at 10 o'clock. So, again, I thank my 
colleagues for their indulgence, and thank you, Director 
Daniels. I apologize. I need to run for another meeting. Thank 
you.
    Senator Conrad, I was going to call on you, then him, then 
Fritz.
    Senator Conrad. It seems to me it is unfair not to----
    Senator Allard. I have already asked my questions.
    Senator Conrad. Oh, you did. OK.
    Chairman Nickles. You didn't hear what he said? [Laughter.]
    Senator Conrad. I was obviously not paying very close 
attention. I apologize.
    Director Daniels, again, first of all, I want to say I 
appreciate your public service, and I think you are a straight 
shooter. I have a profound disagreement with you on what is the 
wisest course for the Nation, but that is what democracy is all 
about. I want to make clear, because we have strong differences 
it doesn't mean I have a lack of respect for you. I have 
respect for you. I think you know that.
    Mr. Daniels. You know it is mutual, Senator.
    Senator Conrad. I even enjoy your company from time to 
time. I do have a profound difference.
    Let me first try to correct the record. We have had a 
number of colleagues on the other side say that we voted on a 
package of $540 billion of amendments on the last 
appropriations bill. We did not. We voted on these amendments, 
and they totaled $37 billion, not $540 billion. These were 1-
year appropriations amendments. What were they? Improve 
homeland security, $5 billion; improve education, $6 billion.
    Now, in addition, these amendments were not voted on as a 
package. They were voted on individually. So the first 
amendment failed, $5 billion to improve, strengthen homeland 
security. It failed. So that money was not used.
    So then there was a vote to improve education using that $5 
billion plus another $1 billion. That failed.
    So then there was an amendment to deal with Amtrak because 
Amtrak was going to shut down without it. That was adopted.
    Then there was an amendment on strengthening law 
enforcement. That was for $500 million. That failed.
    So totaling these amendments even for the year is not 
correct. That isn't how we voted. We didn't vote on a package 
of $580 billion or $540 billion or whatever number keeps being 
thrown around. It is just not accurate.
    Let me go to the longer term. Senator Cornyn made a point 
about outlays and receipts, and this is looking at the long 
term. This is from 1980 and going ahead with the President's 
policies to 2008. We can see outlays as a percentage of GDP 
have come down. We have got a reversal last year because of the 
need for additional spending on defense and homeland security. 
That is where the increases have come from.
    On the other hand, the revenue line has dropped 
precipitously, partly as a result of the economic downturn, 
partly as a result of the stock market drop, dramatic drop. You 
are absolutely correct that that is a factor. Also partly 
because of tax reductions, tax cuts. We can see where we are 
headed if we continue on the President's plan, which will add, 
according to the President's own analysis, some $1.8 trillion 
to deficits and debt. The size of tax cuts, including the 
associated interest costs, and that is on top of the $1.3 
trillion passed in 2001.
    So that leaves us with this gap, and the thing that I 
think--let's go to the next chart. The thing that most concerns 
me is what Senator Hollings has been trying to alert us to is 
hard reality. When we talk about these deficits, we talk about 
the gap, as you indicated, and Senator Nickles did, cash-flow 
differences. That is the deficit. What that doesn't own up to 
is the money we owe the trust funds because indeed there are 
separate trust fund. I know Senator Nickles wants to combine 
them, but that is not the way they are set up. They are 
separate trust funds. Both the Medicare and Social Security 
Trust Funds are running surpluses. Part B of Medicare is funded 
in part by general fund money. That was an agreement made here 
long ago as a way of funding Medicare Part B.
    Social Security Trust Funds, Medicare Trust Funds are 
currently running substantial surpluses. Instead of using that 
money to pay down debt or prepay liability, that money is being 
used to pay for other things. Here is what we see. According to 
the Administration's own document, we have just got red ink to 
look forward to in the future.
    Let me just put up an ad that ran, the Concord Coalition, a 
bipartisan group. This is an ad signed by Warren Rudman, former 
prominent Republican United States Senator, signed by Peter 
Peterson, prominent Republican, former Secretary of Commerce, 
signed by Robert Rubin, former Secretary of the Treasury, 
signed by Senator Nunn, prominent Democrats, a former 
Democratic Senator. What they are saying is: Are we really 
cutting taxes or are we just raising them for our kids?
    The point they make in this--I just want to read from this 
and ask the Director. What they say here is: ``Guns and butter 
and tax cuts, can we have it all? To enact permanent new tax 
cuts in the face of large new spending pressures such as the 
prospect of war in Iraq, the inevitable post-war costs, massive 
but indispensable homeland security needs, and a major 
prescription drug add-on for Medicare is to proclaim that 
America can painlessly have it all. Unfortunately, we can't. 
Sooner or later, someone has to pay the bills for guns and 
butter and tax cuts. Many worry about class warfare. Almost no 
one seems concerned about another kind of warfare, generational 
warfare. Yet that is what we risk if we continue to live beyond 
our means and pass the IOUs to our children and 
grandchildren.''
    Their conclusion is that we have got these unfunded 
obligations out here, Social Security, Medicare, civil service 
and military retirement, $25 billion.
    What part of their statement do you disagree with?
    Mr. Daniels. There are many parts of their statement I 
agree very strongly with, and let me start with that, and then 
I will answer your question. I think both your chart and their 
advocacy, the coalition's advocacy over time, and Senator 
Hollings, all point us to the real, the largest problem, not to 
dismiss any of the problems we are wrestling with this year or 
next year, but the largest problem is the unfunded entitlement. 
That is the big swing in your chart, about 2013. It is really 
not the product of the deficits, although we would all like to 
make them smaller and we hope we can. It is all overwhelmed by 
the effect of the mismatch between the promises we have made 
and the revenues coming into those programs the way we have 
them set up now.
    I think the Concord Coalition would agree, although they 
may have a disagreement in this year about the growth package. 
I believe I am right in saying that they would agree with me 
that we cannot tax our way out of that problem. We are going to 
have to have fundamental reform of those programs if we are 
really going to avoid that, that ski slope that you saw there. 
So on all those things I would agree with them, and perhaps we 
here all agree. I think the question immediately before us is 
twofold.
    One is: should we aggravate the deficits that circumstances 
have brought us? Should we undertake some new borrowing in 
order to have a growth package? Some say yes, and I think there 
are some who say no. Then second, if so, what kind of package? 
There are a lot of ideas. The President's put his forward, and 
Senator Stabenow and others have suggested some alternatives to 
that. Those are important debates to have, and we can have a 
very different deficit outcome this year and next, depending 
how we answer them, but you do have to weigh that against the 
perhaps lost opportunity of putting more people back to work.
    Senator Conrad. Let me just conclude by saying this to you. 
I personally support tax cuts this year to give lift to the 
economy. In fact I would support a bigger package than what the 
President has proposed. What I find dangerous and I believe is 
radical and reckless is the President's plan for additional tax 
cuts in future years that explode the deficits, explode the 
debt. Making the tax cuts permanent, which is proposed, costs 
600 billion this decade--I think 600 billion is the estimate--
costs 4 trillion the second decade, right at the time the baby-
boomers retire. So you are making the circumstance that we face 
with Medicare and Social Security where we would agree we face 
massive long-term imbalances. You are making our ability to 
deal with that far more difficult, and presenting the country 
with what I think in the future will be truly draconian 
choices.
    Further, I believe that adding to deficit and debt when we 
are already in deep deficit and debt will not enhance economic 
growth but inhibit it. Because of the dead weight of that 
deficit and debt, will reduce the pool of societal savings, 
will reduce investment, will reduce economic growth, not 
improve it. That is where this debate lies. It is an honest 
difference.
    I am alarmed. I do not want to hide it. I think this is a 
profound mistake for our Nation, not shortcuts in the short 
term to lift the economy, but these deep permanent cuts when we 
already face demands we cannot finance.
    With that, I again want to say to you, I respect your 
public service. It is not easy to be in your position. It is 
certainly not easy at a time like this. Let me thank you for 
your appearance.
    Mr. Daniels. Appreciate it.
    Senator Allard. Thank the Senator from North Dakota, and I 
would just say that I am pleased to see that you would support 
some tax cuts, and I think there is room perhaps for some 
compromise. As one member of this committee, and I think the 
Chairman will agree with me, that that is certainly a step in 
trying to get some kind of bipartisan proposal out of this 
committee, and so I want to compliment you for that outreach I 
think to the other side.
    I would just want to put in my two bits as far as permanent 
versus temporary tax policy. I think that temporary tax policy, 
although it has a positive impact on the economy, that a 
permanent tax policy has more of an impact as far as long-term 
economic growth is concerned, because I can recall my 
experience as a businessman. Your decisions are going to be--
your long-term decisions will not occur, unless there can be 
some assurance that that long-term tax policy is going to be in 
place. When we have temporary short-term tax policy I think 
that there is--you are not going to make those long-term 
decisions, and so you do not have as great an impact to the 
economy.
    I am wondering if you have taken, Mr. Daniels, an 
opportunity to kind of look at the difference in long-term 
economic growth--and you are going to have to use an economic 
model which we do not use around here--but you ar going to have 
to use--if you have looked using a dynamic approach, what might 
be the difference in economic growth between say a package of 
cut packages that only go out for 5 years, as opposed to 10, as 
opposed to permanent?
    Mr. Daniels. Senator, I do not know. I think the President 
would share your common sense view that predictability is worth 
something. That is to say at the margin more businesses and 
individuals will make those decisions you talked about, hire 
that next employee, risk that next dollar when they think they 
know what return they can expect over time.
    I guess my reflection on this whole business of 
permanence--and therefore, the course the President supports 
making the cuts permanent. My reflection on this is there is 
not anything permanent about taxation the way we do it. We jerk 
this system around every so often, and I think it would 
probably be a very good thing to make the tax cuts permanent 
and just step back and leave it alone for the next 8 or 9 
years, but odds are that will not happen. Circumstances change, 
the composition of Congress changes, and I am a little bemused 
by the debate that sort of suggests that it is all or one. You 
know, the cuts that are in place I think may well be challenged 
before they ever take effect, before they ever show up on 
Senator Conrad's charts. As we pointed out earlier, very little 
of that 1901 Act has taken effect so far. If Congress changes 
its mind, it could take that effect away tomorrow or next year 
or the next year, all kinds of multiple shots at it. So I am 
just thinking out loud here a little bit, but to me, as good a 
principle as permanence versus temporary is, let us be 
realistic. I mean this is a debate and a conversation that is 
going to keep on going every year.
    Senator Allard. Thank you for your response. I want to 
bring up another subject on the total debt. I think of it in 
terms of the total obligation on the General Fund, and I am 
looking at some figures here where over time, where we have the 
total Federal debt as a percentage of gross domestic product, 
there are some pretty substantial figures there, and that 
includes not only what you pay out what we would call the 
public debt is--that is interest and everything that you are 
paying out to the public--but it also includes future 
obligations to the General Fund as far as Social Security and 
the other trust funds, where those moneys get automatically 
transferred into the General Fund.
    When I look at that as a percentage of gross domestic 
product, has there been any discussion as to where that 
percentage could begin to have a real dramatic effect on 
economic growth, or do you just totally disregard it all 
together? I look at it as a public policy here. I am thinking, 
well, Social Security, both sides I think generally agree it is 
around 2017 Social Security is going to be spending more money 
than what it brings in in revenues. Then that is either going 
to mean a tax cut or it is going to result in a cut in 
benefits, or it is going to result in having to pay that money 
out of the General Fund, repaying what has been borrowed over 
these years. I think that is going to create a real challenge 
as we get closer.
    I am wondering if you looked at that sort of--there is a 
whole bunch of complex issues there. I wonder if you would make 
some comment on those for us, please?
    Mr. Daniels. I do think the total level of debt is 
something to be concerned about, something to watch, something 
we ought to try to make sure is controlled and reduced. That is 
true whether you measure it in gross debt or the debt actually 
outstanding in public hands. Clearly there are many nations of 
the world with a much bigger debt burden than we have. They 
tend to be the nations that already are facing an entitlement 
crunch that they constructed for themselves, and are getting 
there a little sooner than we are. I do not know where the red 
line is. A look at the history says we are not there now. We 
have been at much higher levels at different times in the past, 
but it is certainly something that the President and this 
administration keep a weather eye on and want to see brought 
down.
    The best way to do it, of course, is to have an economy 
that grows fast and outruns any borrowing that might be going 
on. That is how we brought it down most effectively in the 
past.
    Senator Allard. The Senator from South Carolina.
    Senator Hollings. Thank you, Mr. Chairman.
    Director Daniels, you just heard the Concord Coalition, and 
Senator Conrad observed that you cannot take it all, and you 
cannot have it all, and the way you said you cannot go in two 
different directions at the same time. I am back now to the 
observation that our distinguished astronaut, Senator Nelson, 
he was going right on down the list of how he was worried and 
how we had cut the budget and everything else like that, but 
then did not find us by any manner or means at fault. That 
worries me.
    I speak advisedly. I remember when we used to have just a 
singular Space Committee with the Senator from Utah, Ted Moss, 
heading it up. Otherwise, I have been intermittently either the 
Chairman of the overall or ranking member of the overall 
Commerce, Space, Science Transportation. I could see about 15 
years ago in the mid 1980's with that space station, that we 
could not afford both the space station and the shuttle. I 
admonished our friend, Sean O'Keefe when he came over--he used 
to be your Deputy Director--and Senator Nelson. I have got the 
highest regard for Sean O'Keefe. He was not sent over to NASA. 
You see he worked with us on the Appropriations Committee. He 
worked the Secretary of the Navy, then as your Deputy Director, 
now the Administrator of the National Aeronautic and Space 
Administration. He was not sent over to increase the budget.
    I said, ``I know you are over here trying to get on top of 
those overruns,'' because that is the reason we could not 
afford both. An $8 billion space station was all of a sudden 
$100 billion space station. Right to the point, Senator Nelson, 
these little upgrade you talk about, not going to do it. I do 
not think the team down there at Canaveral was shortchanging 
upgrades. I think they tried, and will find that they did 
everything possible on upgrades. They might could have had--and 
the astronaut can tell us about a procedure. I was wondering 
why they were not drilled and given the equipment to dock up 
with the space station and come back, if they observed critical 
damage had occurred when the insulation came off and knocked 
that wing. Then why cannot we go to the space station and then 
another shuttle come up uninjured or undamaged and save us?
    We have found out and we know that the particular vehicle, 
the shuttle itself, was of a 10-year duration. That is what 
they said they would last. Now we have had the Columbia 22 or 
21 years, and you cannot upgrade those tiles. I remember the 
first one that went up, the tiles flew off, and they have been 
flying off now for 20 years. What really needed to be done and 
needs, present tense, to be done is get us a new vehicle, not 
just upgrades. We could not get into the research and back the 
shuttle program.
    I told Sean when he came over. I said, Now, I am for the 
shuttle. You got a tremendous national value and investment 
here in these astronauts, takes then a long time, the best of 
the best Americans, and they are coming into this program and 
everything else like that, but we are not giving them--I do not 
know what that space station's going to do. I never have been, 
frankly, I have to plead guilty, I have never been enthused 
about it, because the shuttle can go up--this one went 16 days 
or whatever it was--and the experiments can be had.
    So give us the figures, Director Daniels, of what was 
requested by NASA for the space shuttle and what was approved 
by the Director of Office and Management and Budget. Not just 
your 2 years. Go back under Dan Goldin. Go back further than 
him. You will prove the point that Senator Nelson has made. 
They have been stultified. They have been starved. Coming up 
here and playing this sordid game of, yes, we all want defense, 
we all want homeland security, we all want health care, we all 
want space, we all want, we all want. That is the needs of the 
country. Then the needs of the campaign says, I am for tax 
cuts, I am for tax cuts. It is a total fraud to talk about 
stimulating it with 133 or 143. Senator Daschle is 143. 
President Bush is 133. At 12 billion more a month, you are 
putting in, as I said, $554 billion, Senator Domenici, this 
year is the estimate of the deficit, and 569 billion next year. 
That is a trillion stimulus there. So 12 billion a month more 
is not going to do it. I am for paying the bill.
    Now you say--and the intimation was with all of those 
senators present, they thought, well, old big mouth Hollings, 
he is talking one way and going in another direction. No. I 
believe in that freeze. In fact I was Chairman of State, 
Justice, Commerce Appropriations, and with Senator Judd Gregg, 
we froze that appropriation. We made an exception for the 
Securities and Exchange Commission, but we froze it. We have 
been operating at a frozen continuing resolution. I put in a 
value-added tax to pay for the war. You see, I do not want to 
just freeze spending. I want to freeze revenues, freeze taxes. 
We cannot afford to cut revenues, because we are just passing 
it off, as the Concord Coalition says, to the next generation. 
That is all it is.
    Please, there is that chart there. As far as paying for the 
war, I cannot stand to send those fellows into Afghanistan and 
Iraq and say, by the way, I got to go to Disney World. I cannot 
afford to pay for it. Do not give me the economics argument 
about stimulating. That is no stimulus at all, neither one of 
them are.
    Secretary O'Neill was right. He said it is not stimulus. We 
have got plenty of stimulus in there. We have got to start 
doing what we did in 1993. We had--you say history. I remember 
the history. We had high unemployment in 1992, 1993. We had low 
consumer confidence. We had a $400 billion deficit in 1992. So 
we had a lot of similarities. We went with Alan Greenspan, who 
says you are not only going to have to cut spending, you are 
going to have to increase taxes. Our problem is they invited 
Charles Schwab and he says cut the taxes on dividends. Come on.
    So here is what we have done. All of America has already 
paid for the war. In the Civil War they raised income tax and 
tax on dividends. Down here now we put a tax cut. World War I 
the rate went up to 77 percent; World War II, 94; Korea, 91; 77 
percent in Vietnam; and a 52 percent for corporations, and we 
paid for it. We believe in at least not just committing them to 
battles, but do not ask them to come home and get the bill. 
Come on.
    So that is our problem right there now. I know you believe 
in taxes. I see Senator Domenici is here. In trying to be 
fiscally responsible I authored the Seaport Security Bill last 
year, and from May until November I argued about paying with a 
use tax. We had a little use tax on on a container of around 
$17 for 40,000 pound of textiles or pharmaceuticals or 
whatever. It was just a little 17 bucks use tax. You folks at 
the Administration call it a tax, that would be increasing 
taxes. The House members said, we cannot vote to increase 
taxes. I see by the morning paper you are increasing taxes on 
meat producers. You are increasing taxes on Medicare claims. 
You are increasing taxes on veterans. All of those are use 
fees. But last year when I was trying to pay the bill and be 
fiscally responsible and not go in two different directions, 
they were increasing taxes. Now you call them user fees.
    Cannot we go along, just a VAT, because it will take a year 
for the IRS to pay for the war? Do you not believe in paying 
for this war? Do not worry about deficits right now. Let's get 
the country serious. They are ready for a sacrifice, and I am 
convinced you are agreeing with me, but you are constricted by 
the White House, are you?
    Senator Allard. Mr. Daniels, I would ask that you make your 
comments short so that we can get to Senator Domenici.
    Mr. Daniels. Well, I will just thank the Senator for his 
comments. It is a legitimate point of view. I think each of 
those wars was paid for by a mix of taxation and borrowing. We 
had borrowing in some of those wars far more than we are 
looking at now, and the question is, what is the right balance, 
what is the right balance in view of everything, the conflict, 
the state of the economy and so forth? But yours is an honest 
and legitimate viewpoint and deserves to be heard.
    Senator Allard. Senator Domenici.
    Senator Domenici. Thank you very much, Mr. Chairman.
    First of all, to all the staff and you, I apologize for 
being so late and continuing this hearing, but frankly, I was 
cheating and watching Secretary Powell, to be honest with you. 
I guess I am very pleased to say that it was a great, great 
presentation. But I think with reference to some of the points 
about spending money, we frequently wonder, some of us around 
here, what is in the CIA's budget, because an awful lot of it 
we do not approve in open, but, boy, that was just an hour and 
20-minute discussion just loaded with disclosing what we do by 
way of surveillance which was rather incredible. I would think 
the skeptics will not think as much about it as I do, but I 
believe it is about as conclusive as you are going to get.
    Let me ask just about 10 questions. One, what would you say 
is the percentage debt, not deficit, but debt to GDP, where a 
country of our type gets, where it gets powerless? I am not 
speaking now of--I am speaking of the conventional debt to the 
public, not inside debt.
    Mr. Daniels. Senator Allard and I talked a little about it, 
and I do not know exactly the number. I would say that this 
nation has been successful and prosperous in the past with 
levels higher than we have today, so I do not believe we are at 
that level today. I do believe there is a level beyond which 
you would not go or should not go. I do not know precisely 
where it is, but I think it is north of where we are.
    Senator Domenici. Do you have the capacity to go beyond the 
5 or 10 years and see what it would be in 15, 20 or 30 years in 
terms of this debt versus GDP, or is that beyond your capacity?
    Mr. Daniels. It is beyond our capacity, and I----
    Senator Domenici. I think the Congressional Budget Office 
is doing it and I think Alan Greenspan is doing it, because it 
is pretty obvious that is the time it will get dangerous in 
terms of debt.
    Mr. Daniels. We can give you a number. It is just that I 
have--I just think we have to be mindful how far off it might 
be.
    Senator Domenici. Right. Second, I note that we are 
bragging now about the amount of interest we are paying, and 
that is good, but it is principally because the percentage that 
we pay, the cost of debt is dramatically reduced. I recall when 
it started coming down, we were busy trying--excuse me. When it 
was high we were busy making it short term, hoping it would 
come down. Have we made the transition toward more of the debt 
being long-term debt now that it is down in the 3-1/2 or 4 
percent, or is it still short term?
    Mr. Daniels. That is a question for Peter Fisher and 
Secretary Snow. I do happen to know that we, like a lot of 
Americans, refinanced the mortgage pretty successfully, and my 
recollection from talking to Mr. Fisher is that something on 
the order of 40 percent of the debt did turn over in each of 
the last 2 years, so that you are exactly right that despite 
the fact that we have slipped into deficit, our borrowing costs 
have actually gone down, and they are as low as they have been 
in 20 odd years.
    Senator Domenici. See, if somebody were to ask me about a 
home mortgage, and they said, I am going to get 5.8 percent, 
and my next question would be the terms. Is that 1 year or 5 
years? I would suggest they get 15 or 20 years at that rate. I 
think, unless there is something different about the 
Government, when rates are at 3.4 you ought to get as much of 
the debt out there as you can, not as little. Could you just 
look in the record and tell us for the record where we have 
been and where we are going?
    Mr. Daniels. I do not know what the average maturity has 
been, but we will get you that answer.
    Senator Domenici. Thank you. I noticed in the staff 
preparation, which I found to be very good and I compliment you 
on it, there is a series of observations regarding PAYGO, and 
there is something that I do not quite understand. It says that 
the President's budget proposes a number of cap adjustments, 
one of which is entirely new, the one with respect to building 
of nuclear waste repository at Yucca Mountain. Is that the one 
that is entirely new?
    Mr. Daniels. I suppose. If there is only one that is new, 
that is it.
    Senator Domenici. What is it? What do you do with Yucca 
Mountain that is different that we call it a cap?
    Mr. Daniels. I would like to write you a letter about that 
if I may, Senator. It is a complicated subject, but the idea 
is, I believe, that we may have large and lumpy costs 
associated with that facility, and we would like to treat them 
separate from a predictable cap.
    Senator Domenici. Well, we have got the expert there 
sitting behind you. I know that. He used to work for me. He 
knows more than anybody else. But as long as you are not 
attempting to abolish the trust fund. The way we have treated 
trust funds, I will support. If you are going to take that in 
an isolated manner and say it is no longer to be treated as 
general revenue, we have got a lot of others who want to joint 
that parade, so it is not that; is that correct? Just a yes or 
no on that. It is not that?
    Mr. Daniels. I think that is correct, but let me----
    Senator Domenici. He is saying I am correct, so we can say 
it.
    Mr. Daniels. I never pay attention to them. [Laughter.]
    Senator Domenici. I would like to know what it is. It has 
been up and down, not only because of costs, but we have been 
very reluctant appropriators, as you know, because of 
personalities and other things.
    Mr. Daniels. Yes.
    Senator Domenici. The President's budget proposes that we 
extend the use of, quote, ``emergency designation.'' That has 
always been a disputable item with respect to both 
discretionary caps and PAYGO. Please explain to me what are we 
doing different? It says that we are going to change the 
process. The President's budget proposes that we extend the use 
of emergency designation.
    Mr. Daniels. Well, let me say this about the whole idea of 
caps. We think this is--we would like to indicate the 
President's support for renewal of a Budget Enforcement Act, 
including those two features. We know it is this committee's 
and this Congress's prerogative to take the lead here in 
exactly how that ought to be designed. So we did not presume to 
go further than laying out a few principles as to emergencies. 
We would like to make sure it is written in a way that 
minimizes misuse of this. Ultimately the President can try to 
enforce that, but it was used occasionally in the past to get 
around the caps, and we do not want that again.
    Senator Domenici. Could you explain that to us also? I 
would think this is extending the way we have heretofore 
treated emergency designation vis-a-vis emergency spending, but 
I am not quite sure from the summary that that is the case.
    Mr. Daniels. That is what we intended, but we will follow-
up.
    Senator Domenici. Could you, if you do not have it at your 
fingertips, state it for the record--and you might have been 
asked this--the exact amount of the growth in domestic spending 
year over year, as best you can do it, excluding defense, 
obviously, and excluding homeland defense, even though some of 
homeland defense has heretofore been in discretionary. It might 
be a little bit difficult, but what do you assume the growth in 
domestic, as I have defined it, is?
    Mr. Daniels. If I heard you right, Senator, domestic 
discretionary spending, so exclusive of defense and what we 
call homeland security.
    Senator Domenici. Go ahead.
    Mr. Daniels. 3.8 percent, and so this would be 11, $12 
billion, something like that.
    Senator Domenici. With reference to that category, could 
you tell us for the record what programs you have suggested for 
elimination if any, and what programs you have suggested should 
be reduced by more than 5 percent?
    Mr. Daniels. Well, not all of them from memory, but I 
will----
    Senator Domenici. No, you do not have to, just state them 
for the record.
    Mr. Daniels. We absolutely will. Let me just cite, for 
example, there are 45 programs, most of them small and of 
recent vintage at the Department of Education that we proposed 
for elimination, those funds to be redirected and more to other 
programs, but those are some good examples. There are some 
programs that were set to expire that we propose to let expire.
    Senator Domenici. Might you have one of your analysts tell 
us comparably, how many programs have we eliminated over the 
past 5 years that you all know as budgeteers?
    Mr. Daniels. Sure.
    Senator Domenici. Put that in the record so we will have it 
when we begin debating this.
    Homeland Security, well, we do not have anything to compare 
it with in the past. I assume you are doing your best to 
compare it with the 1903 appropriation for Homeland Security. 
How much does Homeland Security go up under however you figure 
it?
    Mr. Daniels. As a category it goes up 7.6 percent. Now this 
does not count that part of it that is at the Department of 
Defense. That is another 6 to $7 billion. But most people, when 
they ask us this, they are thinking about the activities of 
guarding our ports and our airports and better intelligence and 
all, infrastructure protection and all of that. So the answer 
to that is 7.6 percent, more or less from 32 billion to 35 
billion.
    Senator Domenici. In reference to the increases in defense, 
how much do you have as your estimate of growth in the defense 
spending? You have already told us that.
    Mr. Daniels. It is 4.2 percent, and that comes to--it is 
calculated at $10 million plus inflation. That is the steady 
track that the President and Secretary Rumsfeld and I have 
settled on and put into both the baseline of the budget, both 
into our forward policy I should say, and into the--it is 
matched exactly in the Future Years Defense Program. This may 
be--as far as I know this is the first time you have actually 
had inconsistency there. In other words, there have been a lot 
of times in the past there was a so-called FYDE (fid-up), that 
had all kinds of ideas in it that were not reflected in 
anybody's planning or the eventual budget. We are trying to 
make this thing much more business like and predictable.
    Senator Domenici. Just an observation. Seeing the staff 
behind you there and some of their valiant efforts with 
reference to what the U.S. Government could count on with 
reference to the selling of--what do we call it when we sell to 
the telecommunication companies?
    Mr. Daniels. Auctions and spectrum auctions?
    Senator Domenici. Spectrum auction. I note that after all 
these years and all the people in Government telling us we 
would win that case, we lost it in the Supreme Court, right? We 
lost all that money we thought we were going to get. I would 
have bet money the other way as a lawyer, but they have made 
some pretty good history about what a bankruptcy does to a 
Federal license. It does not matter how much you owe the 
Government, it is just like any other asset.
    Mr. Daniels. We should have settled that case.
    Senator Domenici. Should have, you are right. We had a 
pretty good offer is my recollection. After all the work the 
staff did, we had a good offer.
    One last question with reference to the stimulus. Why is 
the stimulus in the first year so small?
    Mr. Daniels. We've got it down at $40 billion. You are 
right, it is relatively small. It is our best estimate. It 
matters a lot what the timing of passage would be, and even if 
Congress moves quickly, we would not see it passing with too 
many months left in the fiscal year. So it is worth noting that 
if the President's package passed intact, it would have much 
more effect, 113 billion in the next fiscal year, as we count 
it anyway today, than about 39 to 40 in this year.
    Senator Domenici. While we all would like tax cuts and tax 
reform, it would seem to me that more is needed in the first 
year rather than the second year if you are looking at 
stimulus. If we are looking at we would just like to cut taxes, 
it might seem we cut them any year and that would be good. But 
there was no way to come in with more in the first year that 
made sense; is that it?
    Mr. Daniels. Well, that was just our best faith estimate, 
but I think the President would agree with you. If the Congress 
did decide to move quickly, he would be happy about that, and 
of course, some of the provisions are retroactive to the 1st of 
January, so he clearly agrees that we ought to move now.
    Senator Domenici. Yes, a lot of them are.
    Mr. Daniels. As fast as we can.
    Senator Domenici. A lot of them are retroactive and thus 
count in the early years, but some are adding them as if they 
continue to count again, as they put the two packages together.
    Mr. Daniels. That is right.
    Senator Domenici. Some are pulled back and thus should not 
be counted twice. Can you do that for us on a separate account? 
Can you tell us how much of the taxes are moved forward that 
were already in place and would have come into effect in the 
out years?
    Mr. Daniels. Oh, yes, absolutely.
    Senator Domenici. Just tell us what that is. My guess is it 
is a pretty good chunk.
    Mr. Daniels. Yes, it is.
    Senator Domenici. I have no other questions. I thank you 
for the good work, and I hope all the staff are doing well over 
there. I never see Capretta over here. I guess there are no 
issues with reference to Medicare or Social Security.
    Mr. Daniels. We have him working too hard, Senator.
    Senator Domenici. You hired him out?
    Mr. Daniels. We've got him busy. He is working on Medicare.
    Senator Domenici. Thank you.
    Senator Allard. Thank you, Senator Domenici. You always 
bring a very interesting perspective to our discussion.
    Mr. Daniels, thank you for showing before this committee.
    Mr. Daniels. Yes, sir.
    Senator Allard. Appreciate your time and effort.
    Mr. Daniels. Thank you.
    Senator Allard. The committee is adjourned.
    [Whereupon, at 12:42 p.m., the committee was adjourned.]

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              THE PRESIDENT'S INTERNATIONAL AFFAIRS BUDGET

                              ----------                              


                       TUESDAY, FEBRUARY 11, 2003

                                       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. Don Nickles 
(chairman of the committee) presiding.
    Present: Senators Nickles, Gregg, Allard, Enzi, Sessions, 
Bunning, Crapo, Ensign, Cornyn, Conrad, Hollings, Murray, and 
Stabenow.
    Staff present: Hazen Marshall, staff director; and Roy 
Phillips, senior policy analyst.
    For the minority: Mary Ann Naylor, staff director; and 
Dakota Rudisell, analyst.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. The Budget Committee will come to order. 
Today we will hear testimony from Colin Powell, Secretary of 
State. I think everyone is well aware that the Secretary is one 
of the most distinguished and accomplished individuals in the 
country, as a professional soldier, as Chairman of the Joint 
Chiefs of Staff, and presently as Secretary of State.
    Mr. Secretary, we welcome you to this Committee, compliment 
you for your leadership. I complimented you in private for your 
presentation before the United Nations last week. That was a 
superb presentation; well documented, well presented, forceful 
case, so I compliment you for that. Today we look forward to 
hearing from you on a variety of issues, budget and other 
issues confronting and challenging our country today.
    First I will call upon my colleague, Senator Conrad, if he 
has any opening comments before I proceed.

                OPENING STATEMENT SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman, and special thanks 
to you for holding this hearing. Special thanks to you, Mr. 
Secretary, for being here. As an American I would just like to 
say how proud I was of the presentation that you made and the 
way you conducted yourself. I think it makes us all proud.
    I think no one should doubt that the Congress of the United 
States will provide the resources necessary to defend this 
Nation and protect American interests. There should be no doubt 
about that in anyone's mind. That if war comes, America will 
stand as one. With that said, I have just returned from my home 
State and I thought I would share with you, Mr. Secretary, the 
questions that I am receiving. As I spent time in North Dakota, 
people came to me and asked me questions, asked me why we are 
not doing certain things, why we are doing others. Let me just 
give you a sampling of what I heard, and perhaps you could 
address it as you move through your remarks.
    One question I receive frequently, perhaps more frequently 
than I have any others, is: Why doesn't containment work with 
respect to Iraq? I know the President has said that he believes 
containment is no longer viable after the attack of September 
11th. People have asked me--they can see why it wouldn't work 
with a terrorist organization because there is no country to 
retaliate against. But in the case of a nation state, why 
doesn't containment work as it did against the Soviet Union?
    To extend this, Morton Halperin has a piece in this 
morning's Washington Post arguing that containment has worked 
with respect to Saddam Hussein, that he has not attacked 
anybody since 1991, and raises the question why it can't 
continue. That is a question I have received frequently.
    Second, and, again, a frequent question is: Why the 
difference in policy toward North Korea and Iraq? The question 
that has been put to me is that Korea is developing nuclear 
weapons, perhaps already has some, has kicked out the 
inspectors and warned that they may launch a pre-emptive attack 
against us. But we say there is no crisis with respect to 
Korea, that it can be solved diplomatically. But in the case of 
Iraq, where they have inspectors and they have not yet 
discovered evidence of a nuclear capability, we are prepared to 
launch a war against them.
    A third frequently asked question is the terrorist threat 
against the United States. In my meetings at home this last 
weekend, I was asked: Senator, isn't our top priority still 
Osama bin Laden and Al-Qaeda? Aren't they posed to attack us 
again? Aren't we diverting our attention by focusing on Iraq 
first?
    A final question I would put to you that has been raised to 
me, most recently yesterday morning in a meeting with a 
businessman that does substantial business overseas, and with 
other businessmen who have been in my office in the last 10 
days, saying that they are facing an increasing tide of anti-
American sentiment. That, too, was talked about in this 
morning's paper in an article headlined, ``Sneers From Across 
the Atlantic: Anti-Americanism Moves to West Europe's Political 
Mainstream,'' and a second story on the front page, ``U.S.-
Europe Rifts Widen Over Iraq.''
    I found a really rising tide of concern back home about 
this question. One man that I had breakfast with yesterday was 
saying that he is increasingly concerned about the anti-
American sentiment he is finding in business dealings overseas.
    Those are kind of a grouping of questions that I am 
receiving most frequently, and I would be very interested in 
your take on all of that.
    Chairman Nickles. Mr. Secretary, unless other colleagues 
have remarks, welcome to the Committee. Thank you.

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

    Secretary Powell. Thank you very much, Mr. Chairman, and I 
thank you also, Senator Conrad, for your opening remarks, and I 
will get to all of those questions in the course of my opening 
remarks.
    Mr. Chairman, I do have a statement for the record and 
would like to submit it at this time and then go to a shortened 
presentation. At the end of this shortened presentation, I will 
talk to the questions raised by Senator Conrad.
    Mr. Chairman, members of the Committee, I am pleased to 
appear before you to testify in support of the President's 
international affairs budget for fiscal year 2004. Funding 
requested for fiscal year 2004 for the Department of State, 
USAID, and other foreign affairs agencies is $28.5 billion.
    Let me say at this point, Mr. Chairman and members of the 
Committee, how deeply appreciative I and all of my colleagues 
in the Department of State and USAID are for the support that 
this committee has provided to us during the last 2 years, the 
first 2 years of the Bush administration; and it has been a 
source of real encouragement to the people of the Department to 
know that we are making the case to the Congress that we need 
this kind of support, we are deserving of this kind of support, 
but, more importantly, we are receiving the support we need to 
take the case of the American people out to the world and to 
support our diplomats who are on the front line of offense with 
respect to our foreign policy and to taking the American case 
to the people of the world. In light of what Senator Conrad 
said, never has it been more important for us to be giving that 
kind of support to our diplomatic efforts across the world.
    Mr. Chairman, the President's budget of $28.5 billion will 
allow the United States to: First, target security and economic 
assistance to sustain key countries supporting us in the war on 
terrorism and helping us to stem the proliferation of weapons 
of mass destruction;
    Launch the Millennium Challenge Account--a new partnership 
generating support to countries that rule justly, invest in 
their people, and encourage economic freedom;
    Strengthen the U.S. and global commitment to fighting HIV/
AIDS and alleviating humanitarian hardships;
    Next, combat illegal drugs in the Andean Region of South 
America, as well as bolster democracy in one of that region's 
most important countries, Colombia; and
    Finally, reinforce America's world-class diplomatic force, 
focusing on the people, places, and tools needed to promote our 
foreign policies around the world.
    I am particularly proud of that last goal, Mr. Chairman, 
because for the past 2 years I have concentrated on each of my 
jobs--first, as primary foreign policy adviser to the 
President, but also as chief executive officer of the 
Department. Under my CEO hat, we are asking for about $8.5 
billion within that $28.5 billion for the running of the 
Department.
    Let me give you some highlights of what these funds are 
for. First, we have been reinforcing our diplomatic force for 2 
years and will continue in fiscal year 2004. We will hire 399 
more professionals to help the President carry out the Nation's 
foreign policy. This hiring will bring us to the 1,100-plus new 
foreign and civil service officers we set out to hire over the 
first 3 years of the Bush administration to bring the 
Department's personnel back in line with its diplomatic 
workload.
    For a period during the 1990's, we were not hiring anyone, 
foreign service or civil service. We were not administering the 
foreign service exam. It was a very unfortunate period for the 
Department. New blood wasn't being brought into the Department. 
If you want to have a career Ambassador 15 years from now, you 
have got to hire one today. If you want to have the right kinds 
of people in your embassies years from now, you have got to 
hire them today. It is the same concept that I followed when I 
was Chairman of the Joint Chiefs of Staff. If you want a great 
battalion commander 15 years from now, you have got to bring in 
a second lieutenant now. If you want squad leaders to lead 
young Americans in battle 6 or 7 years from now, you have got 
to bring in a private now.
    We shortchanged the Department, and it has been my No. 1 
priority to fix that problem by bringing in wonderful young 
people who want to serve their Nation as diplomats or as civil 
servants within the Department of State. I am proud of what we 
have been able to do. Over the last 2 years, we have 
administered the foreign service written exam to some 80,000 
Americans who stepped forward and said, ``I want to be part of 
this operation.'' This is multiples of what we have been able 
to do in past recent years before this administration came in. 
On the last Foreign Service written exam that was administered 
some 38 percent of the people who passed the exam were 
minorities. So we are diversifying our work force. We are 
making the Foreign Service increasingly look like America, and, 
frankly, look like the rest of the world. That sends a powerful 
signal to the rest of the world, because there is no point in 
my giving these exams and encouraging people and reaching out 
to the minority community to come and apply if I can't hire 
them at the end of the day. So I thank the Congress and 
especially the members of this Committee for the support you 
have provided to that Diplomatic Readiness Initiative.
    Second, I promised the employees of the Department that we 
would bring state-of-the-art communications, information, and 
technology capabilities to the Department, because people who 
can't communicate rapidly and effectively in today's 
globalizing world can't carry out our foreign policy. We are 
approaching our goal in that regard as well.
    For example, when I spoke at the U.N. last week, within 
minutes after my speech was finished we were transmitting it in 
all sorts of different languages to every point on the face of 
the earth. All of our embassies were getting in real time 
information on the speech, the visuals and backup materials 
that I used, so that our Ambassadors could immediately go out 
and explain our position around the world.
    As I have discussed with my staff the morning after my 
speech, one of the most impressive things about the speech was 
the audience and the size of the audience listening to it, all 
in real time. There was one picture in one of the newspapers--I 
forget whether it was the New York Times or the Washington 
Post--of a group of Marine aviators sitting on an aircraft 
carrier in their ready seats, looking at the screen, and there 
I was on the screen. It kind of snapped me back.
    The point is they are not waiting for somebody to write the 
story. They are not waiting for one of the learned talking 
heads to tell them what they should have heard or seen or 
analyzed. They were watching me in real time, instantaneously. 
So, increasingly, knowledge and information is being 
communicated directly to consumers instantaneously. We all know 
this phenomenon. Call it what you will: 24/7, CNN, Fox, MSNBC, 
you name it, radio, instant wire service information. But that 
is the way we communicate to the world right now, 
instantaneously, directly to the consumer. We have to make sure 
that that information technology is also available to all of 
our diplomats, all of our embassies, every action officer, 
every desk officer everywhere in the Department of State. So I 
will not be satisfied until every employee of the Department of 
State at every one of our 260 installations around the world 
have instantaneous access to the Internet and to the world of 
modern communications. With your support, we are going to make 
that happen.
    It goes to one of the points that Senator Conrad made 
earlier: getting the message out and dealing with anti-
Americanism when we find it by getting out our product and our 
message as fast as possible. The daily message line that is 
coming out of our new strategic communications operation run 
from the White House, that daily message sheet I am now having 
distributed to every single embassy, every single facility 
around the world as soon as we get it from the White House and 
add our own product to it. We are not sitting around punching 
up cables on telefax machines anymore. Scan it and send it, and 
let's get going, let's get it out there, and let's expect our 
people to know what we know here in Washington as fast as we 
know it. As I say to all of my Ambassadors, I want you to use 
it coming back the same way. You are my experts; you are my 
battalion commanders. Tell me what is going on out in those 
countries. I am counting on you, not just the expert within the 
Department on C Street. This information technology knits us 
all together. We have a first-class, world-class website now 
that gets more and more hits every single day. We are trying to 
make it more lively, more interesting to people.
    Ambassador Boucher, my Spokesman, is here. He is the face 
of the Department of State as you see him brief every day. But 
I told him I am tired of seeing his face on the website. It is 
either my face or his face on the website. Usually it is his 
face more than my face, which is also disturbing. [Laughter.]
    Secretary Powell. I told him I didn't want to see either 
one of our faces on the website. I want to see our diplomats. I 
want to see the people who work for us. I want to see exciting, 
different things that are happening around the world. I want 
people to go to that website and see the central font of 
knowledge about what is going on in the world, presented to you 
by your Department of State. So let's put the kids that we 
bring in to mentor on the website. Let's put what one of our 
Ambassadors is doing to help people in need in a particular 
country. But let's mix it up. Let's make it lively. Let's use 
information technology to take America's story to the world, 
not as a lecturing way of taking our story to the world but 
just showing who we are, what we stand for, how we care about 
the world, talking about HIV/AIDS, talking about poverty, 
talking about the need to feed people throughout the world 
these days, and taking that value system through the power of 
information technology. But I need the money to do it, and I 
thank this Committee and I thank the Congress for supporting me 
in that effort.
    Finally, with respect to my CEO role, I wanted to sweep the 
slate clean and completely revamp the way we construct our 
embassies and other overseas buildings, as well as improve the 
way we secure those buildings. In turn, this will secure the 
men and women who occupy them and take care of their family 
members in our embassies around the world. It is dangerous 
business out there. I lost three members of our State 
Department family last year. We put them in danger, and we have 
an obligation to protect them to the best of our ability.
    I think when I first took over as Secretary of State, and 
during some of my transition discussions with members of this 
Committee, we had extensive discussions about how to build 
embassies, how to build them cheaper, how to build them better, 
how to make sure the system was efficient. We want to make sure 
we are not wasting the taxpayers' dollars, but make sure we are 
doing it right.
    I am very pleased at what we have been able to accomplish 
over the last 2 years. General Chuck Williams, whom you have 
heard me brag about before this Committee, is in charge of our 
overseas building program. He and his team are doing a great 
job in getting the costs down and rationalizing our entire 
management structure for overseas building facilities. I think 
we have a good record to present to the Committee, and I know 
the Committee has followed this very, very closely as well. I 
am pleased that we have gotten on top of that situation.
    Mr. Chairman, as principal foreign policy adviser, my other 
hat for the President, and principal hat, I have budget 
priorities in that portfolio as well. Let me highlight our key 
foreign policy priorities before I stop and take your 
questions. While I am talking about foreign policy, I want to 
ask the members of this committee for their strong support, and 
I hope you will all find your way clear to vote for the Moscow 
Treaty that is now out of committee and will be on the floor in 
the very near future. I would sure like to see a 100-0 vote for 
that treaty. It is a good treaty. It serves the interests of 
the American people as well as the people of the Russian 
Federation and, I believe, the world.
    Mr. Chairman, the 2004 budget proposes several initiatives 
to advance U.S. national security interests and preserve 
American leadership. The 2004 Foreign Operations budget that 
funds programs for the Department of State, USAID, and other 
Foreign Affairs agencies is $18.8 billion of the $28.5 billion 
total. Today, our No. 1 priority is to fight and win the global 
war on terrorism. The budget furthers this goal by providing 
economic, military, and democracy assistance to key foreign 
partners and allies, including $4.7 billion to countries that 
have joined us in the war on terrorism. Of this amount, the 
President's budget provides $657 million for Afghanistan, $460 
million for Jordan, $395 million for Pakistan, $255 million for 
Turkey, $136 million for Indonesia, and $87 million for the 
Philippines.
    In Afghanistan, the funding will be used to fulfill our 
commitment to rebuild Afghanistan's road network. In addition, 
it will establish security through a national military and 
national police force, establish broad-based and accountable 
governance through democratic institutions and an active civil 
society, ensure a peace dividend for the Afghan people through 
economic reconstruction, and provide humanitarian assistance to 
sustain returning refugees and displaced persons. United States 
assistance will continue to be coordinated with the Afghan 
Government, the United Nations, and other international donors.
    Now, that is bureaucratic language. The reality is we have 
done one heck of a job in Afghanistan. But the problems are not 
all behind us, and it is still a fragile situation. But we can 
be very proud of the fact that over the last 16 or 18 months we 
have now seen the government take over, getting ready for the 
election next year. We have seen a National Army start to form, 
and this morning I was reading through my briefing materials 
how these battalions that were trained are now starting to go 
to other parts of the country outside of Kabul and starting to 
make their presence known, starting to put the imprint of the 
central government on the rest of Afghanistan. A National 
Police force is being brought up. A judicial system is slowly 
being created. Institutions are being formed. The road is under 
construction. It is not just a road, it is more than a road. It 
is a line of communication that allows the exertion of central 
control over other parts of the country. Because there is a 
road, commerce will flow and people will be able to get around. 
Displaced people, refugees coming back into the country can now 
move. So, all sorts of good things will happen with this road.
    However, there are still dangers in Afghanistan. Operation 
Enduring Freedom will continue to go after Al-Qaeda and Taliban 
remnants. But, we have accomplished a great deal, and we should 
be proud of the work that we have done working alongside 
coalition members, working alongside ISAF, and working 
alongside United Nations organizations. A great deal has been 
accomplished. You can see it in the eyes of the children who 
are now being educated, and you can see it in the eyes of 
women, who are now playing a role in the life and in the future 
of Afghanistan.
    Mr. Chairman, I also want to emphasize our efforts to 
decrease the threats posed by terrorist groups, rogue States, 
and other non-state actors with regard to weapons of mass 
destruction and related technology. To achieve this goal, we 
must strengthen partnerships with countries that share our 
views in dealing with the threat of terrorism and resolving 
regional conflicts. The 2004 budget requests $35 million for 
the nonproliferation and disarmament fund, more than double the 
2003 request. It increases funding for overseas export controls 
and border security to $40 million and supports additional 
funding for science centers and bio-chem redirection programs.
    Funding increases requested for these programs will help us 
prevent weapons of mass destruction from falling into the hands 
of terrorist groups or States by preventing their movement 
across borders and by destroying or safeguarding known 
quantities of weapons or source material, especially in the 
Russian Federation, former Soviet Union.
    The science centers and bio-chem redirection programs 
support the same goals by engaging former Soviet weapons 
scientists and engineers in peaceful scientific activities, 
providing them an alternative to marketing their skills to 
States or groups of concern, give them a healthy, positive 
alternative and keep them from thinking in any way about going 
to those States or those non-state actors who might be working 
on weapons of mass destruction.
    The budget also promotes international peace and prosperity 
by launching the most innovative approach to U.S. foreign 
assistance in more than 40 years. The new Millennium Challenge 
Account, an independent government corporation funded at $1.3 
billion, will redefine what development aid is all about. As 
President Bush recently told African leaders meeting in 
Mauritius, this aid will go to nations that encourage economic 
freedom, that root out corruption, and that respect the rights 
of their people. Moreover, this budget offers hope and a 
helping hand to countries facing health catastrophes, poverty, 
and despair, those countries who are suffering from the effects 
of humanitarian disasters.
    The budget includes, in addition to the other things I have 
talked about, more than $1 billion to meet the needs of 
refugees and internally displaced persons. The budget also 
provides more than $1.3 billion to combat the global HIV/AIDS 
epidemic. The President's total budget for HIV/AIDS is $2 
billion, which includes the first year's funding for the new 
emergency plan for HIV/AIDS relief announced by the President 
in his State of the Union Address. These funds will target 14 
of the hardest-hit countries in Africa and the Caribbean.
    This budget also includes almost half a billion dollars for 
Colombia. This funding will support Colombian President Uribe's 
unified campaign against terrorists and the drug trade that 
fuels terrorist activity. The aim is to secure democracy, 
extend security, and restore economic prosperity to Colombia 
and prevent the narcoterrorists from spreading instability to 
the broader Andean Region.
    To accomplish this goal requires more than simply funding 
for Colombia. Therefore, our total Andean Counterdrug 
Initiative is $731 million. Critical components of this effort 
include resumption of the Airbridge Denial program to stop 
internal and cross-border aerial trafficking in illicit drugs, 
stepped-up eradication and alternative development program 
efforts, and technical assistance to strengthen Colombia's 
police and judicial institutions.
    Mr. Chairman, members of the Committee, to advance 
America's interest around the world, we need the dollars in the 
President's budget for fiscal year 2004. We need the dollars 
under both of my hats, CEO and principal foreign policy 
adviser. The times we live in are troubled, to be sure, as was 
noted earlier. I believe there is every bit as much opportunity 
as there is danger in the days ahead. American leadership is 
essential with both the danger and the opportunity.
    With regard to the Department of State, the President's 
fiscal year 2004 budget is crucial in order for us to exercise 
the leadership that will deal with the dangers and the 
opportunities.
    Before closing, Mr. Chairman, I would like to pause and 
comment to some extent on the issues raised by Senator Conrad.
    First, with respect to Iraq, why doesn't containment work? 
Containment is a strategy that we have followed for many, many 
years. I have been an advocate of containment. I worked very 
hard in the first year and a half of this administration to put 
in place smart sanctions, another form of containment. Yet we 
found that even with all of these containment efforts of the 
past 12 years, they have not served to stop Saddam Hussein in 
his pursuit of weapons of mass destruction or to encourage him 
to get rid of the weapons of mass destruction that we know he 
has. Notwithstanding all our efforts at containment, we see 
evidence that he continues to try to break out of the box. 
Containment was able to control some of the money that is going 
to the regime through the Oil for Food Program, but he is still 
able to get additional money through smuggling and illicit 
activities activities across the borders of neighboring States. 
What really brought this all home to roost, that we couldn't 
just rely on containment, was after 9/11 we see these non-state 
actors, terrorist organizations, Al-Qaeda, bin Laden, others, 
terrorists that are trying to develop weapons of mass 
destruction, seek weapons of mass destruction.
    This morning it was brought home to me once again when I 
read the transcript of what bin Laden, or who we believe to be 
bin Laden, will be saying on Al-Jazeera during the course of 
the day. You will be seeing this as the day unfolds, where once 
again he speaks to the people of Iraq and talks about their 
struggle and how he is in partnership with Iraq. This nexus 
between terrorists and States that are developing weapons of 
mass destruction can no longer be diregarded and ignored.
    As the President has said, 9/11 changed things, and so we 
have a regime led by Saddam Hussein who has not accounted for 
all the weapons of mass destruction they have had in the past, 
and who continues to pursue them. We have non-state terrorist 
actors such as Al-Qaeda, led by Osama bin Laden, that would do 
anything to get their hands on this kind of material. As I 
tried to demonstrate before the United Nations last week, there 
are linkages. They are not as firm as some would like to see in 
order to conclude that it is actually happening. However, they 
are firm enough to give us every indication and sufficient 
evidence that if allowed to continue, if this regime was 
allowed to continue to develop weapons of mass destruction, it 
is just a matter of time before coincident interests between 
the Iraqi regime and organizations such as Al-Qaeda will raise 
the likelihood that these kinds of weapons could fall into 
their hands. It is that nexus, especially in the post-9/11 
environment, that persuades us even more that this is the time 
to deal with this regime once and for all.
    This is not just the isolated view of the United States of 
America. We brought this case to the Security Council last 
September 12th when the President, in response to people all 
over the world saying if you have a case, bring it to the 
Security Council, bring it to the United Nations. The President 
did just that. He didn't act unilaterally. He came to the 
Security Council and made the case that Saddam Hussein, 
notwithstanding containment, after 12 years was still in clear 
violation of his obligations. Then the President charged me to 
work with the Security Council to come up with a strong 
resolution that would be a different resolution, not like all 
of the previous 16, a resolution that had teeth.
    We worked for seven and a half weeks on that problem, and 
we came up with a resolution, 1441, that was unanimously agreed 
to by every member of the Security Council that was sitting 
there on the morning of the 8th of November. That resolution 
clearly says: first, Iraq is guilty, you have been doing this, 
you are in material breach. All of us agreed on that morning 
that Iraq continued to be in material breach of its 
obligations, meaning it was guilty of having weapons of mass 
destruction, of not having accounted for the anthrax, for the 
botulinum toxin, for the missiles, for all the other programs, 
for the nuclear program, all the other things they have been 
doing. We all agreed.
    The second thing the resolution said was we are giving you 
one last chance--one last chance to come into compliance, one 
last chance. Not one of ten more chances. One last chance. Put 
forward a declaration in 30 days that tells us everything you 
have been doing. Make sure it is complete, full, and accurate. 
All 15 members voted for Iraq to put forward such a 
declaration. Then it said we are going to provide a rigid 
inspection regime, not to play detective running all over Iraq 
looking for these things, but to work with you in disarming. 
The obligation and the burden is on Iraq, not on the 
inspectors. Finally, we said if you fail to put forward a full, 
complete, and accurate declaration and if you do not cooperate 
with the inspectors in helping you to disarm, then this will 
constitute further evidence of your unwillingness to comply, 
your ignoring of the will of the international community. New 
material breaches to pile on top of old material breaches, and 
at that point, the Security Council has a responsibility to 
meet again to consider what serious consequences might be 
appropriate.
    We are reaching that moment. We are reaching the moment 
when the Security Council can no longer look away. The 
inspectors have reported to the Council on the 27th of January 
that Iraq was only providing passive cooperation. Dr. Blix said 
on the 27th of January that Iraq still does not yet understand 
as of that day that its obligation was to disarm. Dr. Blix and 
Dr. Elbaredi have now returned from Iraq on their weekend trip, 
and they will be reporting to the Council this Friday. We all 
anxiously await their report. There are some on the Security 
Council, there are some in the international community, who are 
saying, well, we just need more monitors. Dr. Blix dealt with 
that yesterday. When asked about it, Dr. Blix said--not Colin 
Powell, not President Bush--Dr. Blix said we don't need more 
monitors and inspectors, we need Iraq compliance and 
cooperation. That is the issue, not more inspectors, not more 
technical means. All the technical means and all the inspectors 
in the world aren't the answer. The answer is Iraqi compliance, 
Iraqi full, active, complete cooperation. If we had that, we 
could probably do with fewer inspectors because we would not be 
running around looking for needles in haystacks. The haystacks 
would be brought before the inspectors and peeled apart to show 
you where the needle is or where the needle was and what 
happened to the needle that used to be there. That is not what 
we are getting from Iraq.
    So while this debate continues--and it is a very vigorous 
debate, a debate with some of our best friends and allies--
reasonable people can argue and debate over this issue. But it 
is clear that a moment of truth is coming with respect to Iraq 
and with respect to the Security Council as to whether it will 
meet its responsibilities.
    This is not just some academic exercise or the United 
States being in a fit of pique. We are talking about real 
weapons. We are talking about anthrax. We are talking about 
botulinum toxin. We are talking about nuclear weapons programs. 
We are talking about chemically-filled bombs that are missing, 
and that Iraq has not accounted for.
    We are talking about evidence that came from Iraq. They 
acknowledged and admitted under duress; after pressure was 
applied to them; after the truth was put in front of their 
face. They acknowledged that these systems existed. They have 
not accounted for them.
    The United States will not look away from this challenge. 
Guess what? Nor will many of our friends and allies who perhaps 
are not being heard quite as vigorously as other friends and 
allies. The Group of Eight European nations stepped forward not 
too long ago and expressed their support for President Bush's 
approach.
    Last Wednesday, after I spoke before the United Nations, 
the Vilnius 10, some of the newer free nations in Europe that 
have a clear understanding of what the future holds and why 
these dangers have to be dealt with, also stepped forward and 
expressed their support.
    Much is being said this morning about disagreement in NATO 
as to whether or not our Turkish friends and our Turkish ally, 
our Turkish NATO colleague should be given support in this time 
of danger. Three of the European nations in NATO are saying, 
well, let's not do it at this time. But 16 nations are saying 
we should do it at this time.
    So while we are hearing a lot about the three, let's 
remember 16 nations, including, of course, Turkey and the 
United States, that have stood up for Turkey. Turkey has now 
said under Article IV to the Alliance, we want to consult with 
the Alliance as to what our needs might be. I think this the is 
time for the Alliance to say to a fellow Alliance member we 
agree with you, and if you are concerned, we are concerned. 
That is what alliances are all about, and I hope NATO will be 
doing the right thing with respect to Turkey within the next 24 
hours.
    With respect to North Korea, we are following this 
situation very, very closely. It is not in the second-tier 
position, but it is not a 12-year problem, as we had with Iraq, 
with Iraq invading its neighbors, with Iraq using chemicals 
against its own people and its neighbors. This is a problem 
that emerged in recent months. We have been working it for just 
about three months now.
    For a period of years, the international community had been 
led to believe that North Korea was acting in a way consistent 
with its obligations under a variety of agreements. A North-
South agreement of the early 1990's between North and South 
Korea, where both sides agreed in writing that they would not 
pursue nuclear weapons. But North Korea was pursuing them. Then 
the Agreed Framework of 1994 when North Korea agreed to cap its 
activities with respect to reprocessing material into usable 
plutonium for nuclear weapons at the site known as Yongbyon. 
That was an agreement. Then between 1994 through the fall of 
2000, other statements and agreements were entered into between 
the United States and North Korea. In the fall of 2000, 
President Clinton issued a statement that essentially said that 
the United States had no, hostile intention toward North Korea 
and assumed North Korea was following its obligations with 
respect to nuclear weapons.
    The Nuclear Nonproliferation Treaty dealt with this. The 
IAEA was dealing with this. Then we came into office in early 
2001. We took a long time to examine our policy with respect to 
North Korea because we were concerned about their proliferation 
activity. We were concerned about their sale of missile 
technology and what they were doing. Then after a long review, 
President Bush authorized me to begin engagement with North 
Korea. But it was about that same time that intelligence 
information became available to us. We could put it all 
together now and see that while everybody was looking at 
Yongbyon as having been sealed up, North Korea was pursuing 
nuclear weapons through another technology, enriched uranium. 
So everything they had been assuring us about turned out to be 
not good enough. They were working somewhere else.
    So we could have ignored it. We could have looked another 
way, say let's not have a problem, let's not have a crisis, 
let's not call them on it. But we didn't. I met with the North 
Korean Foreign Minister. This business about we won't talk to 
them--I talked to him in Brunei at the end of July last year. I 
asked if he would like to have a cup of coffee. He agreed. We 
sat and we talked. I said, ``look, we want to do things for 
your country, your people are hurting. But we need to deal with 
some issues having to do with proliferation and nuclear weapons 
and the size of the army that you have hanging over the 38th 
parallel. These are issues we will bring to the table, and we 
want to have a bold approach as to how we might be able to help 
you.'' He said, ``fine, let's talk.''
    We then sent Assistant Secretary Kelly to North Korea a few 
weeks later. It took a while because there was a small problem 
in the region and we had to let that calm down. Assistant 
Secretary Kelly went in, but he had to say to them right up 
front that we know about this enriched uranium facility and 
program that you have got going. They were stunned that we knew 
it and that we had faced them with it. They thought about it 
overnight and came back the next day and said,``yes, we have 
it.'' `` We do it, we are trying to develop the capability.'' 
They acknowledged it. We had to take that into account. They 
essentially said, ``what are you going to do about it''?
    What we said is this is not acceptable. It puts the whole 
Agreed Framework and all of the other agreements that you 
entered into at risk. It is not going to get you anywhere. We 
will not be cowed into giving you a new document or a new 
statement simply because you have admitted this. So let's find 
a way to discuss this, and let's find a way to move forward. 
But you must be held to account for these actions.
    So over the last several months, we have been engaged with 
the international community. We have called upon the IAEA to 
meet its responsibilities, and they did. The Board of Governors 
called North Korea to account for its actions. North Korea 
responded by unsealing Yongbyon, and the Board of Governors of 
the IAEA will meet again in Vienna tomorrow to see what further 
action might be required.
    We have said to the North Koreans we have no intention of 
invading or attacking North Korea. We have no interest in that. 
But we will defend our interests, and we have all of our 
options available to us. The option we are pushing is a 
diplomatic one, and we want to do it within a multilateral 
framework. Why not a multilateral framework? We are forever 
being accused of being unilateralist, and now when I want to be 
multilateralist, people are saying, no, be unilateralist. But 
it is a regional problem that affects more than the United 
States. It affects China, it affects Russia, it affects Japan, 
it affects South Korea. It affects other nations in the region. 
We believe those nations should be part of this solution.
    We cannot, once again, have a solution that involves some 
direct engagement between the United States but does not 
include the rest of the region. The rest of the region can play 
a role in giving North Korea the kinds of security guarantees 
it is seeking, but at the same time making sure that this time 
we remove nuclear weapons as a threat in the Korean Peninsula 
and do everything we can to help the people of North Korea 
overcome the economic problems they have, the problems of 
starvation and deprivation that is affecting their people in 
such a negative way, and see if we can help them, help the 
society to deal with their problems and see if we can help them 
with the transformation that is going to be necessary for them 
to deal with their problems.
    There is a tide of anti-Americanism, and there still is a 
threat from Al-Qaeda and Osama bin Laden. But our attention has 
not been diverted. Every morning the President starts out 
thinking about and talking to his senior advisers about Al-
Qaeda, what they are doing, and the threats that we are facing. 
We can handle more than one issue at a time, and I think we are 
doing it rather well.
    There is anti-Americanism out there. But there is also a 
groundswell of support for America. We are having difficulties 
right now with respect to some of our policies. There are 
concerns about our policies in the Middle East. The President 
intends to engage in the Middle East more aggressively than we 
have been able to in the past, now that the Israeli election is 
over and now that one way or the other we are going to deal 
with weapons of mass destruction with respect to Iraq.
    I think that the current problems we are having with 
respect to anti-Americanism can be dealt with and can be 
reversed and changed as we move through to the conclusion of 
this issue with Iraq and as we engage more fully on the Middle 
East peace process. So I think there is still that groundswell 
of support for America, even though we are running through some 
difficult times right now with respect to some of our policies.
    Mr. Chairman and members of the Committee, forgive me for 
taking so long with this opening statement, but Senator 
Conrad--I won't say asked for it but, invited it. [Laughter.]
    [The prepared statement of Colin Powell follows:]

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    Chairman Nickles. Mr. Secretary, thank you very much for 
your comments. We are delighted that you are here today. I 
think you have done a lot to dispel this anti-Americanism 
sentiment that seems to be somewhat more prevalent in Europe, 
and maybe it is exaggerated in some areas.
    I also want to compliment you and the Bush administration. 
You have inherited some big problems. You are Secretary of 
State, but in August 1998, two of our embassies were attacked 
and a couple of hundred people were killed, over a couple of 
hundred people were killed in Tanzania and Kenya. That was in 
August 1998. So it is part of your responsibility, part of our 
responsibility to make sure we protect those embassies.
    You have asked for a significant amount of funds, I believe 
$4.7 billion, to combat terrorism, and I think included in that 
is also protection of our embassies and our American personnel. 
But you inherited that problem. Those embassies were attacked 
by Al-Qaeda. When you and the President mentioned that you are 
going into Afghanistan, many people predicted a quagmire. You 
have been very successful. I compliment you. I think very few 
people have looked back and maybe patted you enough on the 
back. The success that we had with the--I am going to say the 
minimal loss of life in Afghanistan is really historic. The 
liberation of Afghanistan, that is a monumental achievement. 
You are certainly to be complimented on it. You were breaking 
up Al-Qaeda. Now, maybe they have moved and they have hidden, 
and the hunt continues. But that is a problem that you 
inherited. Those embassies were attacked in 1998. The USS Cole 
was attacked in 2000. Not much was done or at least not much 
visible or aggressive enough, at least in this Senator's 
opinion. Why didn't we do more to get Al-Qaeda earlier? But you 
have gone after that problem.
    You inherited a problem in Iraq. With respect to the 
noncompliance, there was, I think, 16 U.N. resolutions. 
President Clinton spoke very forcefully in February 1998, when 
he said, talking about Saddam Hussein, that if Hussein fails to 
comply and we fail to act or we take some ambiguous third 
route, which it sounds like the French are pursuing now, this 
gives him yet more opportunities to develop this program of 
weapons of mass destruction. It allows him to continue to press 
for release of sanctions, continue to ignore the solemn 
commitments he has made, and he will conclude that the 
international community has lost its will. He will then 
conclude he can go right on and do more to rebuild an arsenal 
of devastating destruction and someday, some way, I guarantee 
you, he will use the arsenal.
    I think every one of you who has really worked on this for 
any length of time believes that is true. That was Bill Clinton 
in February 1998. But we didn't do much. Certainly the 
collective community didn't do much, and the arms control 
inspectors were kicked out in 1998, and Hussein continued to 
build his arsenal.
    So now this administration, and you particularly, has 
really led and said we need to enforce these resolutions, so 
that the United Nations will have some credibility. You were 
successful in passing--not easily, I might mention--the last 
U.N. resolution. Then you presented the case very forcefully, 
very clearly, and very diplomatically last week before the 
United Nations.
    So I just mention those events. You have inherited some big 
problems. You have gone after it and had exceptional success in 
Afghanistan. We still have work to do. Now you are going after, 
I believe, trying to clean up this problem, that Bill Clinton 
and others have identified, as really there, Iraq building 
weapons of mass destruction and which you put together so well 
in your speech last week. It is really not acceptable to think 
that Iraq can be building these tons of weapons such as anthrax 
and giving those or possibly distributing those to terrorists.
    There are some of reports suggesting the dissolution of 
NATO with three countries, particularly led by the French in 
undermining NATO. Correct me if I am wrong, but France is not a 
military partner in NATO. Is that correct?
    Secretary Powell. It is part of the Alliance but not part 
of the military component of the Alliance, the integrated 
military component.
    Chairman Nickles. I am amazed at their presumption that 
they are controlling the alliance, but they are not a part of 
the military alliance. I don't believe NATO has bases in--or 
the U.S. doesn't have them. Does NATO have bases in France?
    Secretary Powell. As you recall, France evicted NATO 
headquarters back in 1966, or thereabouts.
    Chairman Nickles. I was just pointing that out. I am kind 
of interested in that. Also, the alliance and NATO's interests, 
the Persian Gulf War in 1991 was not a NATO operation. That was 
a coalition that you and President Bush and his team and 
Secretary Baker at the time put together. Is that correct?
    Secretary Powell. Yes, sir. It was a Coalition of the 
Willing under a U.N. Security Council resolution. Many NATO 
nations joined us there, but it was not a NATO operation.
    Chairman Nickles. Well, budget-wise, you mentioned $4.7 
billion you have requested for the war on terrorism. Are you 
receiving the funds that you need? Many in Congress may say we 
want to give you more whether you want it or not. Are you 
getting adequate funds for rebuilding, sustaining our efforts 
in Afghanistan and Pakistan and other countries of concern and 
interest and cooperation in the war against terrorism?
    Secretary Powell. Sir, we are getting good support, and I 
just might mention that the embassy construction account, is 
$1.5 billion on top of the $4.7 billion that you mentioned a 
moment ago.
    Obviously I cannot tell you that it is all the money I 
could use. But I think within the constraints that exist in the 
Federal budget, and after the President has examined all of his 
priorities, I think that the allocation that the State 
Department is getting in the overall Federal budget is 
adequate. And we are pleased that we have a real increase in 
our budget, including the Millennium Challenge Account, which 
showed a very significant increase, but even without the 
Millennium Challenge Account, we are getting an increase in our 
budget. We have fared well in the budget deliberations.
    Chairman Nickles. Secretary Powell, thank you very much.
    One additional comment. You mentioned in North Korea that 
when this became more public that they were working on the 
enriched uranium facility, can you tell us when we believe that 
work started?
    Secretary Powell. I can't be precise, but it started 
certainly by 1998 or 1999. As we looked into it, when it became 
clear to us in 2002, and we could start now to look backward in 
time to see what had been missed earlier. Clearly it was begun 
in 1998, 1999 at the latest. When political decisions were made 
at the start of it at that time, I haven't been able to 
determine. But it was during the years of the previous 
administration. But they had no way of knowing it. President 
Clinton and Secretary Albright had no way of knowing that. 
Frankly, we didn't know it for the first year-plus of our 
administration.
    So I am not being critical of the previous administration. 
They didn't know it, nor did we until last summer when the 
pieces started to come together. The Intelligence Community 
made us aware of it over the summer. We kept pressing back 
saying you have got to make sure of this before we go anywhere 
with it and start telling our friends about it and face the 
North Koreans with it. We have got to make sure. The more we 
looked, the more they went back in time, the pieces started to 
come together.
    Chairman Nickles. Well, correct me if I am wrong, but when 
they were building the plutonium plant--in Yongbyon?
    Secretary Powell. Construction of the 5 mega watt reactor 
at Yongbyon, began in the early 1980's and was completed in 
1986.
    Chairman Nickles. When they were building that, that was in 
violation of the Nuclear Nonproliferation Treaty, which they 
had previously signed.
    Secretary Powell. Yes.
    Chairman Nickles. Then they were paid in terms of oil and 
nuclear power plants not to produce at that plant, and they 
shut that plant down. Shortly after, then, they started a new 
plant which was in violation of their framework agreement.
    Secretary Powell. Yes, sir. The Agreed Framework froze the 
activity at Yongbyon, shut down the 5-megawatt reactor, and the 
reprocessing facility. Unfortunately, it didn't take it out. It 
didn't remove it. The Agreement that was arrived at at that 
time was that work would stop, the reactor wouldn't work, the 
reprocessing facility and another facility there would not be 
operated. Light water reactors would be provided to the North 
Koreans to satisfy their power needs, and until the light water 
reactors came on to assist them with their power needs, we 
would provide heavy fuel oil for their generating capacity. 
That was the Agreed Framework deal.
    It did serve the purpose for 8 years of not allowing 
plutonium to be developed at Yongbyon for the use of weapons, 
so that was good. But at the same time, somewhere in that 
period, early in that period, North Korea made a political 
decision that, fine, while everybody is looking at Yongbyon, 
let's start using enriched uranium as another technique to 
develop a nuclear capability.
    Chairman Nickles. Wasn't that agreement to prevent types of 
technology or different nuclear facilities?
    Secretary Powell. The Agreed Framework specifically dealt 
with Yongbyon, but it was in the spirit of no nuclear weapons 
development. There were other agreements: the Nonproliferation 
Treaty, the Safeguards Agreement, and the North-South Agreement 
between South Korea and North Korea. So there is no question 
that the entire international community as a result of the 
Agreed Framework, NPT, Safeguard Agreement, and the North-South 
Agreement all were going through the 1990's with the clear 
understanding and expectation that North Korea had made a 
commitment through these agreements not to further develop a 
nuclear weapon. But they weren't doing it.
    Chairman Nickles. Thank you very much.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Secretary, for your 
excellent presentation this morning. Two follow-up questions, 
if I could.
    First, with respect to containment, you indicate that 
containment is not a strategy that makes sense with respect to 
Iraq because it failed to disarm Saddam. My understanding of 
the strategy of containment was it was not a disarmament 
strategy. Certainly the Soviet Union had weapons of mass 
destruction in great number--chemical, biological, nuclear. We 
never sought to use containment to get them to disarm. We 
sought to use containment to prevent them from using it. 
Basically what we had was mutually assured destruction.
    In the case of Iraq, what we would have is an understanding 
that if we ever had any sense that he was going to use them or 
did use them, we would simply obliterate the country.
    Why is that not an effective strategy?
    Secretary Powell. I think an argument can be made that that 
might have been effective prior to 9/11. But when you see the 
emergence of groups such as Al-Qaeda, when you see Al-Qaeda 
presence in Iraq, when you see contacts taking place between 
Al-Qaeda and Iraqi leaders, and when you see that Iraq has been 
a state sponsor of terrorism and has demonstrated its 
willingness to participate in terrorist activities over the 
years, and when you see the nature of that regime, I think it 
is no longer a prudent course of action to rely solely on 
containment.
    With the Soviet Union, we had a more rational actor. We had 
a series of agreements that we could verify, and I participated 
in negotiating a number of those agreements, whether it was the 
INF Treaty or START-I or the Conventional Forces in Europe 
Treaty--a variety of agreements in international law between 
two very, very powerful nations that understood the nature of 
their power. Frankly, during my days as Chairman and my days as 
National Security Adviser, I wasn't worried about the Soviet 
Union leadership in the Kremlin 1 day deciding that, gee, it 
might be clever and useful of us to let some of this stuff slip 
out and be used by a terrorist organization.
    They understood the seriousness of having such weaponry, 
and they protected it and took care of it. In fact, it was 
after the Soviet Union broke up that we started to worry that 
some of that material might leak out. Along came the Nunn-Lugar 
Program and a number of other comprehensive threat reduction 
programs to get rid of this material before it could leak into 
the hands of terrorist organizations. With the rise of 
terrorist fundamentalist organizations such as Al-Qaeda over 
the last 10 to 12 years, I think it fundamentally changes the 
situation.
    Senator Conrad. Could I ask just one follow-up, which would 
be: Why doesn't that same analysis apply to North Korea? Not 
only are they bad actors and unpredictable, I think everyone 
would say, but more than Iraq, they appear to be much further 
along in terms of developing nuclear weapons, perhaps already 
have some. They are desperately poor, and could make money by 
selling weapons. Why doesn't that same analysis that applies to 
Iraq apply to North Korea?
    Secretary Powell. It does. We are very concerned about 
proliferation. We know that North Korea has shared its 
knowledge. We know that it sells weaponry. The previous 
administration tried to deal with this problem through the 
Agreed Framework which capped Yongbyon. When this 
administration came into office, the previous administration 
was working with the North Koreans to try to bring under 
control their proliferation activities and to find a way to get 
them out of that business.
    But, the problem was not solved when we came into office. 
We came into office, reviewed the situation, and began to 
engage the North Koreans on why there was a better way to move 
forward to a better future for their people than selling 
weapons and proliferating knowledge and activities. That still 
remains our policy. It doesn't mean that the only way to go 
about this problem is to immediately reach for a military 
solution.
    I think that there are still diplomatic ways, working with 
our friends and neighbors in the region, powerful friends and 
neighbors in the region who have influence over North Korea, to 
convince them that it is time to get out of this business. 
North Korea, with no natural resources that people are terribly 
interested in, with an economy that is not functioning, with a 
population that is in enormous distress, still clings to the 
possibility that missile technology and weaponry of this type 
gives them political currency that they would not otherwise 
have. What we have to do as part of our diplomatic strategy is 
to persuade them, slowly--and it will take time; they are not a 
regime that responds instantaneously--but slowly over time 
persuade them and convince them that the possession of this 
kind of capability will not cause us to give them something or 
to provide them with something that does not ultimately deal 
with the problem.
    They want a security guarantee. Will they give up all of 
their weapons, finally, totally in response to being provided a 
security guarantee from the United States or from regional 
powers? That is what we will have to see.
    What would not be acceptable, it seems to me, Senator, is 
for us to say we will provide some kind of document that 
guarantees your security in return for your thinking about 
giving up your nuclear weapons or giving up--resealing Yongbyon 
but continuing to do something else. We need a total, 
comprehensive solution, and it will take time to get there 
because the North Koreans obviously are wary of, you know, the 
integrity of their regime and what threats their regime may be 
under. We have said we have no plans to invade. We are 
desperately concerned about the starving people of North Korea. 
We want to help them. The solution lies in diplomatic efforts 
that engage them, multilaterally, and ultimately us talking to 
them within that multilateral setting that can start to roll 
this back. But at the same time, we must make them absolutely 
aware of the fact, and the reality, that we have not taken any 
of our options off the table. We remain strong and our options 
are all on the table, but we are looking for a peaceful, 
diplomatic solution.
    Chairman Nickles. Senator Gregg.
    Senator Gregg. Thank you, Mr. Chairman, and thank you, Mr. 
Secretary, for an excellent presentation. You touched on a lot 
of issues which are very important and which I think you have 
fully explained. One issue, however, that you didn't touch on 
which I would be interested in is the question of Turkey and 
the recent veto of Turkey's request for defense from the NATO 
allies, which it is a member of--I think it is a military 
member of NATO--and whether or not the United States will 
unilaterally--and in my opinion, it should--stand by Turkey so 
that Turkey feels some comfort from our support.
    Secretary Powell. We will stand by Turkey, and not just the 
United States alone. Sixteen of the 19 NATO nations said that 
they wanted to respond to Turkey's request. NATO works by 
consensus.
    Senator Gregg. Unanimous rule.
    Secretary Powell. Sir?
    Senator Gregg. Doesn't NATO work by unanimous----
    Secretary Powell. It works by unanimity. That is what these 
Alliances are about. And it is soon going to get to 26, and it 
may be even more difficult to get a consensus at some point in 
the future. But we still are hopeful that a way can be found 
for the Alliance to respond, and we are undertaking the most 
intense diplomacy today, talking to France, Germany, and to 
Belgium to see if they would not change their position because 
all we are essentially doing is responding to a member nation's 
request for planning assistance in the event of some trouble 
that may lie ahead. I think that is a perfectly reasonable 
request, and France and Germany and Belgium at the moment are 
using their blocking power for really a different purpose, and 
that is to signal their disagreement with the approach that we 
need to bring this to a resolution with Iraq in the very near 
future in the U.N.
    So we hope that intense diplomacy will persuade those three 
countries that this is the time to stand by a fellow NATO 
member who has asked for help. If we do not succeed in breaking 
that deadlock in NATO, I think that would be unfortunate, but, 
nevertheless, we will go ahead with those nations who are so 
inclined. There are nations willing now to provide that support 
to Turkey to make sure that Turkey gets the support that it 
needs.
    Senator Gregg. I would just note as a side comment that we 
have had experience with unanimity as a form of government in 
Poland--I think it was in the 1600's, maybe the 1700's--and it 
totally failed. Doesn't that undermine the capacity of NATO to 
function? Isn't this a classic example of the risks that NATO 
puts itself in with the rule of unanimity and now the expansion 
of member States?
    Secretary Powell. Well, for over 50 years it has operated 
under these rules, and it is perhaps the most successful 
political and security alliance in history. But it does mean 
that you have to work with each member nation and persuade and 
convince and cajole and debate, and sometimes you succeed. Most 
times you do succeed; you do end up with full agreement on most 
of the things that the alliance has done for peace and security 
in Europe and the world. Sometimes you aren't able to achieve 
it, and then you find another way to solve the problem.
    Senator Gregg. On another subject, the Administration has 
proposed--and I congratulate it for its moving in this 
direction--a significant expansion of our efforts to fight AIDS 
internationally. But my concern is that you are running it 
through the Global AIDS Fund. There is a GAO report which will 
be coming out fairly soon on this fund. It does mean that these 
dollars--$15 billion is the projected amount--will be running 
through a third-party organization, which, although we now have 
the Chairmanship of, we do not have the voting control over. 
Europeans basically control this fund. I am wondering if the 
GAO report finds, as I suspect it might, that this fund is 
filled with patronage, mismanagement, and inefficiency and 
waste, which is unfortunately a common event in these 
international groups, whether the Administration would be 
willing to consider a different approach to how we get this 
money into these needy countries and to the people who need it.
    Secretary Powell. I have not seen the GAO report. We would 
be deeply concerned if there were suggestions that patronage, 
mismanagement, and all the other things you mentioned were 
contaminating the work of the fund. It is a new organization, 
just up and running. My knowledge of it suggests that it is off 
to a pretty good start. I am sure there are some startup 
problems, however. We are very pleased that Secretary Thompson 
will now be the Chair of the Board. I am sure he will bring 
dynamic leadership to it, even though, it is a multilateral 
organization and others will have their say on where the funds 
should be distributed. But it has selected a number of projects 
already that seem to be worthy programs going in the right 
direction. But obviously, Senator, when the report comes out, I 
will read it with intense interest. We have no intention of 
ignoring problems if they exist of the kind you mention.
    Senator Gregg. Well, philosophically, why would we use this 
fund versus going on a more unilateral basis and making sure 
that these tax dollars did end up where they are supposed to 
go?
    Secretary Powell. Well, we do have a number of other ways 
of distributing funds. As you know, the President's new 
Emergency Plain for HIV/AIDS will not flow money through the 
Global AIDS Fund, the fund you are talking about, except for $1 
billion of the $15 billion. We also have a number of bilateral 
arrangements with countries on supporting them in their HIV/
AIDS programs. But the Global AIDS Fund was a way of generating 
resources from many nations throughout the world, as well as 
private organizations and individuals. I think it is just up 
and running, and I think it is off to a pretty good start. It 
was a U.S. initiative working with the United Nations, and I 
think we ought to at least give it the benefit of the doubt as 
it goes through this second year of existence with the $2 
billion that it has been able to raise.
    Senator Gregg. I have some other questions, but I will 
wait.
    Chairman Nickles. Senator Gregg, thank you very much.
    Senator Hollings.
    Senator Hollings. Mr. Secretary, like the others, I want to 
thank you for the excellent presentation and the calming 
influence you have had in the past 2 years. With all of this 
big talk, braggadocio, you are either with us or against us, I 
am sick and tired, it is all over with, it is a bad movie and I 
am not going to listen to it, that sort of frightens the 
international community, much less some here in this country. 
When you are running around deploying a couple of hundred 
thousand troops and all the weaponry you have got, it is need, 
the calming influence.
    Let me tell you from whence I come. I don't have any idea 
of any immediate threat from Iraq of weapons of mass 
destruction. If there were an immediate threat of weapons of 
mass destruction, we have got the Israelis, the best assault 
team in the world. They have already proved their mettle. They 
know what is going on. Their Mossad intelligence is the best. 
They have already knocked out a nuclear plant, and if there was 
a weapon of mass destruction that was of an immediate threat, 
there is no question that the Israelis--they wouldn't dilly 
around and look for more inspectors or make telephone calls or 
anything else. They would hit it. They would knock it out. So I 
am not worried about that.
    That being the case, will war lessen the use of weapons of 
mass destruction? Will that cause more likely the use of 
weapons of mass destruction or the less likely use of it?
    Secretary Powell. First and foremost, it will remove one of 
the sources of such weaponry, because if it comes to war 
because Iraq would not disarm peacefully, Iraq will be 
disarmed. In this place that has devoted so much money, time, 
energy, and political leadership to developing these kinds of 
weapons, that will all stop. The place will be sanitized. It 
will be cleaned out. There will be no weapons of mass 
destruction for any future Iraqi leadership to use or for any 
terrorist to get their hands on. I can assure you, Senator, 
that the Israelis, who, you are quite right, are very 
knowledgeable about these sorts of matters, have shown no 
reservations about the need for someone to disarm Iraq, either 
peacefully or otherwise.
    It is not so much whether there is an imminent threat I can 
see. Unfortunately, imminent or immediate threats, those are 
not the troublesome ones. It is the one that you didn't think 
was immediate or imminent, but suddenly, bang, it has happened, 
it is there. We didn't think there was an immediate threat of 
somebody flying airplanes into our buildings, the World Trade 
Center or the Pentagon.
    Senator Hollings. But the flying of the planes into the 
buildings was caused by Osama bin Laden, who didn't like us 
having an air field in Saudi Arabia.
    Secretary Powell. Yes, well, I would not like to think 
that.
    Senator Hollings. That was the presence there. Now, what we 
are demanding here by invading Iraq is the presence in an Islam 
country, and the question arises: Are we really getting rid of 
Al-Qaeda or are we creating more Al-Qaeda with an invasion?
    Secretary Powell. First of all, I would not like to see Al-
Qaeda going into the subways of New York or some other crowded 
facility in our Nation or in a nation of Europe and releasing 
anthrax or botulinum toxin or using ricin as a way of killing 
people, and the source of that material was Iraq or some other 
nation. So I think getting rid of the source of such material, 
potential source of such material would be in our interest.
    I think that if it becomes necessary to use military force 
in Iraq, it will be done in a way that will be seen as 
surgical, it will be seen as a military operation that is not 
targeting the people of Iraq or the institutions or the 
infrastructure of Iraq. After it is over, I think you will see, 
as so many people and nations have seen in the course of the 
last 100 years, that the United States comes not to occupy, it 
comes not to impose its will, it comes not to gain sovereignty 
over a place but to make a place better than when we went in.
    I think you will see humanitarian aid immediately start 
flowing to the people of Iraq. I think you will see us trying 
to build on the institutions that are existing in Iraq. We 
don't want to have to run all of Iraq. We want to build on the 
institutions. What we want to do is cut out the abscess, get 
rid of the infection and see if we can put in place a political 
system that will represent the people of Iraq, that will create 
a country that wants to live in peace with its neighbors, no 
longer has weapons of mass destruction, and is using its $20 
billion a year of oil revenue to build schools, to build 
infrastructure, to put in place a health care system, and to 
make a better Iraq which could be a model for the rest of the 
region.
    Senator Hollings. Well, we both hope that is the case, Mr. 
Secretary, because there is a majority in that region that 
would think that we were the infidel in the land, in the Holy 
Land of Islam. So I have got my fingers crossed about the cost, 
whether it will work, and everything else. But as Secretary of 
State, I know you put a lot of trust, a lot of value in 
alliances. Now, you have got to make a command decision. Do you 
cause the break-up of the alliances in NATO and the United 
Nations by barreling in? Specifically Belgium is a wonderful 
friend, France, Lafayette, we are here, I fought with the 
French in World War II. Don't call them cowards. I can tell you 
that right now. I would be glad to come before this committee 
and testify. Germany we have got now, that is a good friend; 
Russia, China. Don't give me the political poll of 15 versus 4 
or whatever it is. I was tempted, listening to Chairman Nickles 
when he wants to deride the Clinton administration, the 
majority of the people of America voted for it. So let's don't 
start that game.
    I think we have got to be a little bit more deliberate. You 
are the Secretary of State. You have been the calming 
influence, and you really believe that, regardless of China, 
Russia, and everyone else in the alliances, that we just go 
ahead and break up the alliance just to get Saddam, who is not 
an immediate threat.
    Secretary Powell. France, Russia, China, all voted for 
1441. We took our time. We were deliberate. We consulted. We 
talked. We aren't breaking up the Alliance. We are just making 
sure the Alliance, both the U.N. Alliance and the NATO 
Alliance, deals with this responsibility and remains relevant 
to the task put before it. If the United Nations passes 16, 17, 
18 resolutions saying to a country like Iraq and a dictator 
like Saddam Hussein, ``You must disarm'', and he says, ``No, I 
am not''; and the Alliance doesn't do anything about it, 
doesn't respond, particularly when a resolution was passed by 
all of them saying what would happen if he did that, then who 
is breaking up the Alliance? Not the United States. The 
Alliance is breaking itself up because it will not meet its 
responsibilities.
    Now, with respect to the infidel charge, the people of 
Kuwait didn't think we were infidels when we went in there and 
kicked out the Iraqi army in 1991. They welcomed us.
    The people of Kosovo didn't think we were infidels when we 
went in there to help the people, the Muslims of Kosovo. I can 
assure you that the people of Afghanistan do not think we are 
infidels, because we went out there and took out a terrible 
regime and the people of Afghanistan can see that all we are 
trying to do is help them put in place a new government 
responsible to the people and that the international community 
has come to help them. They know we are going to leave as fast 
as we can.
    Senator Hollings. Well, this is the Budget Committee. Do 
you think we ought to pay for the war?
    Secretary Powell. I think we have to do what we think is 
right.
    Senator Hollings. No, I mean pay for the war. Of course, I 
think it is right. We have always paid for all the other wars. 
But you have got another gentleman from the Federal Reserve 
testifying, as you are testifying, that what we really need is 
a tax cut and that we ought to send those boys into Iraq and 
hope they get back. The reason we hope they get back alive is 
they are going to have to pick up our bill, because this 
Congress is not going to pay for it.
    Secretary Powell. Mr. Chairman, I can't speak on that 
issue. The issue I can speak on is that we have to meet our 
worldwide responsibilities, and if conflict is necessary--and 
we hope it is not, the President is still hopeful for a 
peaceful solution--then we have to do what we have to do. 
Whatever it costs, the cost has to be borne, hopefully not just 
by the United States but by other nations who will be in this 
coalition with us.
    We are not going into this alone, and there has been a 
steady stream of visitors to the Oval Office to make the case 
to the President that he is not going in alone. You heard Prime 
Minister Howard yesterday, the Prime Minister of Australia. You 
heard Prime Minister Berlusconi, Prime Minister Blair. We are 
not going in this alone.
    Senator Hollings. Thank you, Mr. Chairman.
    Chairman Nickles. Thank you.
    Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman.
    Secretary Powell, thank you for your leadership. This 
Congress is behind you. We voted in the Senate 77-23 to 
authorize you and the President and the whole team to evaluate 
this circumstance in Iraq, to guarantee that this dictator 
would disarm, and we authorized you to use force if necessary--
without a vote of the United Nations, without a vote of NATO, 
and alone if need be. I thank you for the work you have done to 
assemble a majority of the nations in the European area 
overwhelmingly to be supportive of that, and I think we are 
making great progress. It is just good to see. Some of the 
nations, I am sure, in Europe are under a good bit of pressure 
from France and Germany perhaps to not stand with us, but they 
stood with us. They have written editorials and letters 
affirming our policy. They voted with us on the Turkey 
question.
    So I think a lot of progress has been made, and I salute 
you for that, and I believe that in the long run, if the United 
States does not stand firm now to allow the resolutions of the 
United Nations and our own firm commitments to be eroded and 
not be acted upon, then we have not done well. In the long run, 
peace and stability in the world will not be there. I know 
other people in the world may be nervous about this, but if it 
turns out--certainly it won't be perhaps as quick as the Afghan 
operation. But if it turns out it is good for the people of 
Iraq, even partly as good for those people as it did for 
Afghanistan, then I think the people of the world will 
appreciate what we have done.
    We are not there to take oil. We are there to protect our 
security interests and liberate the people of Iraq. I just 
salute you for it. It is a difficult time, and I wanted to make 
that comment.
    I really would be surprised if Senator Hollings would 
suggest that we would expect some other nation to defend our 
security interests. I don't think that is reasonable. I don't 
think we should do that. It would be a stunning development 
were we to do that.
    You know, we had in our committee--Senator Gregg chaired 
the Health, Education, Labor, and Pensions Committee, and we 
had Sir Elton John talk about AIDS. His call was very 
passionate for us to do more. I believe we should do more. I 
support the President, the great increase in efforts for this 
colossal worldwide tragedy. But I asked Sir Elton John, What 
can we do to make sure the money is well spent? I referred to 
his foundation that he meticulously monitors to help with the 
AIDS circumstances in Africa. I noted that many experts say if 
you give the money to the governments in Third World countries, 
it oftentimes does not get to the people who really are in 
need. We have got this new group, this Global AIDS Initiative, 
that perhaps can be effective in that regard.
    But can you give us some assurance--and let me just mention 
to you what Sir Elton John said when I asked him about this 
problem. He replied, ``I concur with you totally. What that 
money has to go toward is training people to build an 
infrastructure so people can get drugs they need in remote 
parts of countries, and it needs to be run on a government 
level. But I know what you are saying. I do not know how you do 
that, because I am just a singer. This is something that the 
politicians have to make sure that when the money goes to 
governments, the money is spent in the right way. I have said 
before that we are a small AIDS organization. We can control 
where everything goes, and we do. We know where every penny 
goes. But when you get these vast sums of money that we are 
talking about here today, you are going to run into those kinds 
of problems, and I do not personally know myself how you solve 
them. But I concur that it is a major problem.''
    I know you have thought about that. What can you tell us 
about your plans?
    Secretary Powell. With respect to the President's new 
Emergency Plan, it will be run by a Special Coordinator with 
the rank of Ambassador representing the President and me, 
located in the State Department. We are now looking at the 
right organizational arrangements.
    The money will be used in a way that will support sometimes 
government efforts, sometimes directly to private efforts.
    There is a certain surface attraction to the idea to 
forgetting all about governments and go right to private NGO's. 
But, in reality, when you get into many of these countries, you 
really have to use and buildup and assist their government 
health care system to deliver these services.
    What we have to do is make sure that we build the 
infrastructure in a sensible way for them to deliver the 
services. Sometimes it will go directly to a private NGO over 
the government but with the knowledge of the government because 
you don't want conflicting policies. We have to make sure that 
we put in place solid systems for accountability and solid 
systems for transparency and solid systems for making sure that 
it goes through the government agencies and out to the people 
in need; and that we are actually delivering services, not 
getting ripped off, and not seeing the money go into 
bureaucratic ratholes. That is a challenge for us and a 
challenge we have to meet.
    To some extent, it also bounces against the Millennium 
Challenge Account where we are going to be investing and 
looking at those countries that are committed to democracy, 
committed to transparency, committed to the rule of law, 
committed to ending corruption. That same sort of test should 
be applied with respect to the global initiative to make sure 
it is going to countries that truly are committed to this and 
will use the money for the intended purpose and make sure it 
gets out to the delivery system and not just to the 
bureaucratic system.
    Senator Sessions. Well, you know, you lose a few million 
dollars here and a few million dollars there, and tens of 
thousands of victims of AIDS will not be getting the medicines. 
So we want to make sure that every single dollar gets there.
    Will this new Ambassador, for the lack of a better word 
around here, be a czar-like person that would have the ability 
to convene all the agencies involved and speak to the Congress 
as to the effectiveness of the program?
    Secretary Powell. Yes, we intend for this person to not 
just be another bureaucrat who can't go to the washroom without 
my permission, but somebody who is carrying not only my 
authority but the authority of the President to bring together 
whoever needs to be brought together to deal with the issue of 
cross-agency boundaries.
    It would have to be somebody who has the ability to work, 
however, closely and in close coordination with AID and with 
the Global AIDS Fund and all the other other organizations such 
as HHS that are involved in the AIDS fight. But for this 
program of $15 billion over 5 years, it will be somebody with 
unique authority and responsibilities and able to do just what 
you just described and also be available to speak to the 
Congress, testify before the Congress, and justify the program 
before the Congress.
    Senator Sessions. If this Global AIDS Initiative that we 
are going to work closely with and you plan to contribute to--
it makes me somewhat nervous because we do lose some management 
control there. If that organization fails to function 
effectively, are we able to get out of it? Are we signing some 
sort of long-term contract that we would have to continue?
    Secretary Powell. Well, the first year request is for $450 
million, and you have the power of the purse every year, and it 
is a totally owned U.S. Government organization subject to the 
will of the Congress. So you have full control over it.
    I would hope that control would not be exercised with too 
many earmarks and legislative direction.
    Senator Sessions. I just think we will need to, Mr. 
Chairman, make sure that those agencies are actually utilizing 
the money that they receive as effectively as absolutely 
possible, and if they are not, we shouldn't hesitate to use 
another route.
    Thank you, Secretary Powell, for your leadership.
    Secretary Powell. Thank you, Senator.
    Chairman Nickles. Senator Sessions, thank you very much for 
your statement.
    Senator Stabenow.
    Senator Stabenow. Well, thank you, Mr. Chairman. Thank you 
very much for your service to our country.
    First just a comment following up on Senator Hollings in 
terms of the budget, and just a comment that as we are facing 
possible war with Iraq, as we have the war on terrorism, we are 
seeing on this Budget Committee numbers that show us going 
further and further in debt as a country. I have deep concerns 
about what that means. We should be paying for these efforts 
and not putting it on the American credit card. I hope that as 
we discuss the budget we will be discussing that as well.
    Mr. Secretary, as we are talking about the issues of 
terrorism--and you mentioned earlier Al-Qaeda, heaven forbid 
that they are back here in our country and another outrageous 
attack killing Americans happens, I would like to speak for a 
moment about the issue of homeland security or hometown 
security, as I think it is appropriately called. While this is 
not within your realm in terms of the budget, I know that you 
play an important role as we are determining priorities. I 
would just share with you I have now had nine different 
meetings around Michigan, small towns in the Upper Peninsula to 
Detroit, to the west side of the State, one yesterday in Port 
Huron, Michigan, along the river between Canada and the United 
States as we go into Lake Huron. I hear the same thing 
everywhere I go, and that is, very deep concern about the lack 
of partnership from the Federal Government in terms of funding 
at this time.
    We have local police chiefs and fire chiefs that are not on 
the same radio frequency in the same town, let alone between 
cities and counties. We have great communications concerns.
    I am sitting with a group of people yesterday who tell me 
that they are finding out about the increased alert through CNN 
like we do instead of through other ways.
    I am concerned about the lack of training, not only 
trainers being available, whether it is bioterrorism or other 
efforts that are needed, but the cost when a police officer or 
a fire fighter or others go into training, the replacement 
costs so that officers are there on the streets covering their 
normal duties, their increased costs of training as well as 
increased costs for personnel. I am very concerned that we are 
not stepping up, that we are not partnering with them, and we, 
in fact, I don't believe are ready--they are working hard. They 
are working overtime to be prepared and taking on more and more 
responsibilities. But I know in a State like Michigan, where we 
are a border State and we have issues of bridges and tunnels 
and waterways and all of the other issues--drinking water that 
needs to be protected, drinking water sources, nuclear plants, 
all of the other things, I am very concerned that we are not 
providing them the support that they need, and duct tape is not 
going to do it. We are going to need dramatic increases, I 
believe, in resources going directly to local communities.
    So I share that with you. I know that is not in your 
international budget. But I have a great concern as I move 
around the State, obviously not a partisan issue. I am hearing 
from Republican sheriffs and Democratic sheriffs and people of 
all stripes and all persuasions, philosophically who are asking 
for our help. I would ask that you convey that as part of this 
strategy to be able to respond, particularly as we move closer 
to war when we know we heighten the possibility of an attack on 
our homeland.
    Secretary Powell. Thank you very much, Senator.
    As you all well know, issues with respect to the 
Administration and the specific issues you mentioned with 
respect to training and how to announce alerts and how to 
communicate that down, and some of the other needs that exist 
in local communities, I will convey all of that to my 
colleague, Secretary Ridge, and to the President.
    Senator Stabenow. I would just say that we continue to try 
to pass amendments, pass supplementals as long ago as last July 
we passed in the Congress a supplemental that went to the 
President's desk that was not released. So while there may be 
philosophical differences about whether the Federal Government 
should play a role in helping local communities fund these 
efforts, they will not be able to do it without our help.
    One other comment in a different vein, Mr. Secretary. I 
would ask you to step back for a moment, and if you might 
comment, as we look in a broader view on America's role now as 
it relates to nuclear threats, nuclear issues and how you would 
view our leadership on these issues when we start 3 years ago 
now with the Senate voting no on the Comprehensive Nuclear Test 
Ban Treaty; the President pulls out of the ABM Treaty. We say 
that all types of weapons are on the table with Iraq including 
nuclear, so we are sending one set of messages. Then we have 
very great concerns about India and Pakistan, about what is 
happening now in North Korea, which I believe to be extremely 
serious threats to us. When you put this all together now in 
the United States of America, what messages are we sending with 
our own actions, and how do you view the situation in what is 
clearly a highly disturbing and tense situation as it relates 
to nuclear proliferation around the world?
    Secretary Powell. There are other messages that I think are 
just as important, Senator. One is the Treaty of Moscow which 
is now before the Senate for its consideration, and I hope it 
gets a 100 to 0 vote which represents a huge reduction in the 
number of nuclear weapons that the United States and the 
Russian Federation will have pointing at one another or 
available to be pointed at one another. I think that sends a 
signal to the world that the two most important nuclear holding 
powers in the world are going down with the number of nuclear 
weapons, not up. I think that is an important signal.
    Yes, we did get out of the ABM Treaty, and we did it after 
long discussion with the Russians. Why did we get out of the 
ABM Treaty? The principal reason was it was keeping us from 
defending ourselves against these very weapons that you make 
reference to. The ABM Treaty prevented us from moving forward 
on missile defense. Missile defense is for the purpose of 
destroying these horrible weapons that might come our way or 
might come at one of our friends and neighbors. Interestingly, 
after we finally said to the Russians, ``Look, we cannot find a 
solution on this one; we are going to have to withdraw,'' they 
said, ``Fine. Let's continue to work together on strategic 
issues. Let's cut the number of offensive weapons.'' Lo and 
behold, within the past few weeks the Russians have even 
indicated more of a willingness than just a couple of months 
ago to work with us on missile defense because they see it in 
those same terms.
    So the ABM Treaty, rather than encouraging proliferation, 
shows that proliferators should think twice if they are facing 
missile defenses that can essentially void the value of your 
missile.
    With respect to India and Pakistan we have been working 
very closely with both sides, and I think we have played an 
important role in de-escalating the tension last year. I 
remember vividly some very long and difficult conversations I 
had with both India and Pakistan, their leaders, to tell them 
knock it off with respect to using rhetoric that might suggest 
that nuclear weapons were a weapon that was usable in this 
confrontation, and they both did. That situation has calmed 
down.
    With respect to North Korea, we are trying to convey a 
message to them that says, ``You will get nowhere with this 
kind of activity, this kind of proliferation, because we will 
not be terrified, we will not be scared, we will not be held 
hostage by this kind of weaponry. The sooner you understand 
that you are doing nothing but pursuing fool's gold that will 
not achieve any political purpose, the better off you will be 
and we will be, but in the interim, you should know, that we 
are a strong and powerful Nation and we have all of our 
options.''
    It has been part of U.S. declaratory policy for the 50 plus 
years of the nuclear age that the best deterrent is to simply 
not talk about what we might or might not do, but nobody can 
have any thought in mind right now that the United States is 
thinking of a nuclear option. We are not. There is no need for 
it in any of the theaters that we have been talking about this 
morning. But nevertheless, the United States has available 
within its armed forces a full range of capability and options. 
It is that full range and what we might or might not do that 
has served a strong deterrent purpose for the last 50 years, 
and I think it has served the interest of world peace by people 
understanding that we have that full range of options.
    Senator Stabenow. I appreciate that. Thank you.
    I would just say in conclusion that it is very important 
that our actions--people listen to our actions as well as our 
words. I think both are being judged. So thank you.
    Chairman Nickles. Thank you, Senator Stabenow.
    Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    Mr. Secretary, I want to start with the AIDS epidemic. 
There have been some questions asked about that. I met with 
several of the leaders from African countries last week. We had 
a round table discussion that Senator Santorum put together to 
discuss the AIDS problem in Africa. It truly is a calamity. The 
representative from Kenya talked about the 2 million people in 
Kenya that are infected with the HIV virus, and out of the 2 
million people, or about 2.2 million people I think it was, 
about 2,000 of them are actually getting treatment. Just doing 
some simple math it costs about $300 one person. The cost of 
treatment is down from a few years agon. Just to treat the 
people in Kenya is $600 million a year. I think that it tells 
us that there is no way that we have enough money to get 
everybody on treatment. It is important that we educate as we 
try to prevent the disease from spreading.
    Representatives from Uganda participated in the roundtable 
discussion last week, and from what I understand the infection 
rates in that country went from 20 percent down to 6 percent. 
Recently, they went back to more of their traditional values. 
They were a monogamous society that had unfortunately gotten 
into what a lot of the rest of the world has gotten into, the 
sexual revolution. Because of behavioral attitudes and it is 
almost all heterosexual--we have seen a dramatic increase in 
the spread of AIDS.
    There are many concerns about the Global AIDS Fund. One, 
that it is bureaucratic, anf therefore very slow. I have strong 
concerns about that. Also the governments that you mentioned, 
in almost every case, it is the local NGO's that actually does 
the work. It is true that the Ugandan Government was involved 
in implementing its AIDS prevention policy, but it really was 
the NGO's that were the most effective. So I would hope that in 
putting together the Global AIDS Fund that all of these things 
are taken into account. A lot of us have concerns that this 
money is going to be wasted, and then there is going to be a 
backlash against support for the fund. An average American 
would say ``Why don't I get prescription drug coverage instead 
of you helping out these African countries?'' I think that we 
have the responsibility to help in the global fight against 
AIDS as long as we are being good stewards of those hard-earned 
tax dollars provided by the American people.
    I have a question on the HIV front--right now we are being 
told that the Mexico City language does not prevent AIDS money 
from--there is no Mexico City language associated with the AIDS 
money. It only is associated with family planning, population 
control money. We are getting reports that indeed, because 
money is fungible, a lot of the people who are providing 
abortions overseas are using the AIDS money we provide for 
abortions. Could you make a comment on that?
    Secretary Powell. Yes, sir. As a matter of fact, in the 
very near future we will be meeting within the Administration 
to examine the various new programs, Global AIDS Fund, but 
especially the new Emergency Plan for HIV/AIDS. Balancing it 
against other policies such as the Mexico City policy to make 
sure that we have a consistent approach across the whole 
administration. I am aware of your concern, and we will be 
meeting on that within the next few weeks.
    Senator Ensign. I appreciate that because there are many of 
us up here in Congress that would like to put the restraints on 
the spending to make sure that we are not going to fund 
abortion around the world.
    I want to ask a question though on North Korea, switching 
gears just a little bit. It seems to me that the reasons to 
identify how we have gotten to where we are in North Korea is 
not to place blame, but to prevent this in the future--we need 
to learn from the past. It seems to me that the way that you 
are dealing--and I congratulate you and the whole 
administration on how you has handled the Iraq situation and 
the global war on terrorism. I believe that if you study 
history, dictators do not respond to diplomacy. Very rarely do 
they just respond to talking. A lot of them, especially the 
ones that are the evil dictators of the last century, and 
certainly the ones that we have around today respond to 
strength. They respond if there is something at stake.
    In North Korea we have one of those dictators. How did we 
get in this situation? What mistakes were made during the 
1990's that led us to this situation, and, if we have a country 
like North Korea in the future, how can we assure that we do 
not make the same mistakes.
    Secretary Powell. North Korea certainly does understand 
America's strength. In fact they are very fearful of America's 
strength, and we have made it clear to them that we have all of 
our options, but it is not necessary right now, as we are 
trying to find diplomatic solutions, to sort of beat them over 
the head with it. They know what we have and they know what we 
can do.
    Senator Ensign. I agree with that.
    Secretary Powell [continuing]. North Korea knows that it 
cannot win a war on the Korean Peninsula, but they sure can 
create a lot of havoc and they can destroy a lot of people and 
destroy quite a few cities, especially the city of Seoul in the 
process. So we both have a good understanding of what the other 
can do.
    North Korea elected to use a route of missile proliferation 
and weapons of mass destruction programs to give itself more 
strength and authority on the world stage than it would have 
otherwise on the basis of its economy or its system. I think in 
the course of the last decade or so, as these programs became 
more obvious, attempts were made to capture these programs and 
to eliminate them over time. At the same time you are not 
precipitating a crisis or a war on the Korean Peninsula that 
nobody wanted, especially the South Koreans. We have to be 
especially mindful of the views of our South Korean friends. 
They are interested in unification with their brothers. The 
Korean people are very homogeneous. They want to be one Nation 
again. No Korean leader will ever be elected to the leadership 
in South Korea without a commitment to ultimately bringing the 
two peoples back into being one people, so they are not anxious 
to see a conflict.
    So efforts were made over the last 10 years to remain 
strong, keep our presence in Korea, watch that army of theirs, 
but at the same time find ways to corral these programs, 
eliminate them, bring them under control. The previous 
administration worked hard on it. I give them credit, and not 
at all criticism on my part. They worked hard to control what 
was going on at Yongbyon, and they brought it under control, 
but unfortunately, they were not able to eliminate that 
capacity, but they brought it under control. The capacity to 
restart it remained, and it was not going to go away under the 
Agreed Framework until the light water reactors were up and 
running. Only then would the cells be removed and sent off 
somewhere else for storage and destruction and made safe.
    Unfortunately, the previous administration had no way of 
knowing, nor did we--we were in the same boat as the previous 
administration when we came in--that the North Koreans had the 
ability to move in another direction with respect to nuclear 
weapons, because they frankly, I guess, saw the value of 
nuclear weapons. They saw how they could extract things from 
the rest of the world by saying they were moving toward nuclear 
weapons, and so they did not want to give away the card that 
everybody thought they had at least pushed off to the side.
    So when we found out about it, we had to call them on it. 
The solution we are going to find this time has to be a 
solution that deals with it once and for all.
    Senator Ensign. If I may interrupt just for a second. I 
want to go back though because we need to learn from this. I 
understand not wanting to encourage a war, but it seems to me 
that we tried to appease his father, and now we have a second 
generation of madmen in North Korea. The agreement was broken, 
and North Korea continued to develop weapons of mass 
distruction with the means to misuse, while the U.S. paid them 
not to do so. Any agreement now must include proper 
verification measures.
    Secretary Powell. This was a major concern that we had when 
we came into office, and that a number of the arrangements that 
had been made were lacking in verification. The previous 
administration understood that as well, and in our transition 
conversations between my team and the outgoing team, we talked 
about the need for verification, and that is why their efforts 
have not moved even more rapidly along, because they could not 
sort of crack this nut with respect to verification and 
assuring that no more technologies would be sold.
    But on the handoff we were more skeptical, and we wanted to 
make sure we knew what we were doing and took our time to 
review our policies. But at the same time we still think there 
is the potential for diplomatic solution. What we will not do, 
and what a lot of people are pressing us to do, but we are 
going to resist the pressure, is suddenly say, ``Just tell us 
what you want, tell us what you want just to get this problem 
off the table, and then we will give you whatever you want.'' 
That is not the best way to solve this problem. It is not going 
to be our approach.
    Senator Ensign. I totally agree.
    Chairman Nickles. Senator Ensign.
    Senator Ensign. Can I just conclude with this, Mr. 
Chairman?
    It is such an important lesson for us to learn, the danger 
of nuclear weapons of mass destruction, in the hands of 
somebody like this. I think that we need to learn from the past 
that it is virtually impossible to verify with a dictator like 
this. So empowering them just to avoid a situation at the time 
is a very dangerous thing for us to do. I think it was wrong at 
the time. I think you can look back on those situations and 
say, ``It was a mistake. We should not make these agreements in 
the future because once weapons of mass destruction are 
available to a country like North Korea, the situation becomes 
much more dangerous and much more difficult to control with in 
the future.''
    I thank you for your indulgence.
    Chairman Nickles. Senator Ensign, thank you very much.
    Mr. Secretary, I was hopeful that we would be able to get 
you out of here by 12. I think we have at least three senators, 
maybe four. Can you go another 15 minutes?
    Secretary Powell. Yes, sir.
    Chairman Nickles. I will ask my colleagues, try and be 
mindful, and I probably should have been rapping the gavel a 
little earlier.
    Senator Murray.
    Senator Murray. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for your very informative and 
candid discussion today. I wanted to talk about foreign 
assistance programs because I really think that the case needs 
to be made that each military threat facing our country is 
really first a foreign policy issue, and it is not enough to 
address the threats to this country solely through our capacity 
to respond militarily, but we need to do more on the foreign 
policy side as well. I was struck by a statement that Senator 
Lugar made last week in a Foreign Relations Committee. He said 
that the United States spends 8 cents on foreign policy for 
every dollar that goes to defense. I am curious if you could 
share with us what you think might be the appropriate ratio 
with your background for these two functions.
    Secretary Powell. I do not think it is appropriate to 
compare Foreign Operations funding with Defense funding or 
Foreign Operations with Social Security or any other function. 
I think it can stand on its own merit. I think eight cents 
compared to a dollar for the Pentagon is not the right 
comparison. The fact of the matter is only about one percent of 
our Federal budget is allocated to this function. I would like 
to see it be a lot more, but as a result of the priorities that 
we have and the resources available to the Congress and to the 
President, I am pleased that President Bush has been able to 
increase it every year that he has submitted a budget, and he 
has taken some dramatic steps with respect to the Millennium 
Challenge Account, which is a 50 percent increase in what we 
had been doing previously with respect to development 
assistance, and what he has now done with the Emergency Plan 
for HIV/AIDS is another significant increase, and so we are 
doing a lot better with respect to our commitment to these 
kinds of programs. I would like to see it be a lot more because 
the needs around the world are great. Senator Ensign was 
talking HIV/AIDS. He described it as a calamity. That is 
certainly true, but it is far more than a calamity. It is an 
absolute catastrophe on the world stage that we have to do 
something about; poverty, famine, they all interact. People who 
are hungry are more susceptible to the diseases that flow from 
HIV/AIDS and then go into malaria and tuberculosis. So I would 
like to see us do a lot more. I would double and triple it if I 
were king for the day.
    But I recognize that the President has to shape his budget 
in accordance with a large number if priorities and the 
Congress has to do the same thing, and so I hope that you will 
fully fund the President's request, and that is the best I can 
do, support the President's request.
    But obviously, if the President has requested more, I would 
be even more pleased.
    Senator Murray. Well, thank you for that. I know that 
without question the war on terrorism is a top priority for 
this country, but that is what I am having a little bit of 
trouble with the President's budget and rhetoric on our 
assistance programs. In your testimony you said this budget 
contains 4.7 billion for countries that have joined the war on 
terrorism, and I think there is no question we should not work 
with countries as you have done, Pakistan, Turkey, Jordan. It 
is in our national interest obviously, but is this assistance 
really foreign assistance, helping people in the traditional 
sense of health or education or democracy? It seems to me, if I 
look at this, the budget really significantly redirects foreign 
assistance to the war on terrorism, so I am kind of troubled by 
your assertion that the budget increases foreign assistance 
funding.
    By taking $4.7 billion away from other foreign assistance 
initiatives are we not really reducing our foreign assistance 
globally?
    Secretary Powell. No. It is for all kinds of assistance. It 
is not simply for terrorism activities. It is for a variety of 
assistance efforts in these countries that have been 
particularly helpful on the war on terrorism. The Millennium 
Challenge Account, that additional, that 50 percent increase in 
the budget.
    Senator Murray. Is that part of the 4.7?
    Secretary Powell. No, separate. It is on top of the $4.7 
billion. For this year it is $1.3 billion for the Millennium 
Challenge Account to get it up and going and running.
    Chairman Nickles. Senator Murray, thank you very much. If 
you do not mind, I would like to move kind of quickly.
    Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Secretary, for being here. I 
appreciate your long-time exemplary service on behalf of the 
Nation, and I just, particularly at this time I wanted to say 
that.
    But quickly I have one question. Really it relates to our 
relationship with Mexico. As you know, we have a very important 
relationship based on geography and history and culture, and I 
was gratified when the President, the first international trip 
he took after he became President was to see President Fox in 
Mexico. I am a firm believer in the need to deepen and improve 
our relationship, strengthen our relationship with Mexico. I 
would like to work with you and your department on that.
    But I am very concerned about Mexico's failure to live up 
to an international treaty that was passed in 1944 governing 
the distribution of vital water resources, and particularly 
disturbed by Mexico's most recent failure to abide by an 
interim agreement which at least promised some hope to South 
Texas farmers, and that interim agreement called for the 
delivery of 200,000 acre-feet by the end of January. 
Unfortunately, at that time there was no schedule for the 
repayment of the remaining 1-1/2 million acre feet, but for 
those who like to be optimistic and hopeful, that at least it 
offered some hope. Now we know Mexico has delivered only 
129,000 of that 200,000 acre-feet, even under that interim 
agreement on January the 31st. I have to tell you that 
particularly folks in the agriculture business in South Texas 
have been devastated by Mexico's failure to live up to this 
obligation. It has had a ripple effect in our economy. Over a 
billion dollars has been lost over the last 10 years due to the 
failure to abide by the treaty.
    So some have, in their frustration, voiced several options 
that they think the United States ought to consider. One would 
be possible sanctions against Mexican agricultural produce 
grown by the very water that they feel should have been 
delivered under the treaty, but which has not been. Second, 
possible renegotiation of the Colorado River Treaty that 
actually sends Colorado River water to Mexico. Third, to just 
terminate the treaty entirely, just to walk away from it.
    I would appreciate your thoughts on Mexico's failure to 
abide by the interim agreement, as well as the negotiations, 
which I believe are occurring even today in San Diego on this 
matter.
    Secretary Powell. We are very disappointed that Mexico has 
been unable to meet its obligations under the 1944 treaty and 
there is such a backlog of 1.5 million acre-feet. The interim 
agreement to provide 300,000 acre-feet for this growing season 
we thought was an important step. They have been working hard 
to try to fix this problem. The President raises it with 
President Fox in every conversation. I raise it with my Mexican 
colleagues in every conversation. It was the subject of 
considerable discussion when we had the Binational Commission 
meeting in Mexico City in December. At the time they said they 
would be coming forward. So they made a commitment to 300,000 
acre-feet, but as you know, Senator, they only provided the 
129,000 or 130,000 acre-feet that you made reference to. We are 
pressing them very hard, trying to get another increment right 
away of 55,000, trying to get back up to their obligation for 
the 300,000 acre feet for this growing season.
    We will continue to press. As you noted, they are meeting 
on it now. There are often technical debates as to how much 
water is or is not in a particular reservoir, or set of 
reservoirs in Mexico, but it receives the highest level 
attention from our government. I would try to avoid the sorts 
of remedies that you described, Senator, either a boycott or 
embargo on certain quantities of goods coming from Mexico, or 
abrogation of the 1944 Treaty, or redoing the Colorado River 
Agreement, and let us continue to pound away to see if we 
cannot get them to meet the commitments they made for this 
growing season, as a start toward resolving ultimately the 1.5 
million acre-foot backlog.
    Chairman Nickles. Senator Cornyn, thank you very much.
    Mr. Secretary, thank you for that. We have two additional 
senators that wish to speak. I will call on Senator Allard. Mr. 
Secretary, I apologize. I need to step out, and then after 
Senator Allard, it is Senator Bunning.
    Senator Bunning, if you would be kind enough to wrap up the 
hearing.
    Just for notification of our colleagues, the next Committee 
hearing will be on Thursday with Michael Jackson to discuss 
transportation, Deputy Secretary of Transportation.
    Mr. Secretary, I apologize, but I need to leave.
    Secretary Powell. No, I fully understand.
    Chairman Nickles. But this has been an outstanding hearing. 
Your presentation last week--I complimented you on it a couple 
of times--was outstanding, and also your presentation today has 
been superb. So thank you very much.
    Secretary Powell. Thank you, Mr. Chairman.
    Chairman Nickles. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    I would also reiterate what some of my colleagues already 
said, at least on this side since I have been here, I think you 
are doing a great job. I think you are an important part of the 
Administration team, and so I have a great deal of respect to 
the way you are conducting yourself on foreign affairs.
    I understand that you are engaged in discussions with the 
Government of Israel over the possible U.S. multi-year 
assistance packages that consists of loan guarantees as well as 
some military aid. This is to try and address the current 
economic and security crisis we have there in Israel. I wonder 
if you would share with me briefly the feeling from the 
Administration--apparently they have been somewhat supportive--
and has there been any thought about when this money may be 
made available, and when you might be making requests?
    Secretary Powell. We have been in intense discussions with 
the Israelis, and we are familiar with their needs, really 
sensitive to the needs of our Israeli friends. No decision yet 
is forthcoming with respect to the amount that we will be able 
to provide, and no commitments have been made to Israel yet, 
and so we do not have something to put before the Congress at 
this time.
    Senator Allard. The other brief question I have concerns 
the Millennium Challenge Account. It brings forth a lot of 
concepts, I just wonder why are they not being addressed in the 
agencies we already have? So I would like to know just what 
your thinking is, why you felt like it was necessary to set up 
a new separate agency and why the current agency structures you 
have cannot address some of your problems, and if you could 
share some of that thinking with this member, I would 
appreciate it.
    Secretary Powell. Thank you, sir. The Administration, 
especially the President of course, felt very, very strongly 
that the Millennium Challenge Account should not be just seen 
as aid in the old traditional sense. He wanted a specific 
program that encouraged democracy building, infrastructure 
building, the end of corruption in development nations, a rule 
of law, transparency, economic development, education, and he 
wanted to reward those countries that have made a solid 
political commitment to that end. New democracies, emerging 
democracies, perhaps even older democracies that now firmly put 
their path on completing the democratic transition and to 
getting into a globalized 21st century world, where they had to 
take care of their people and had to prepare their people for 
the demands of the 21st century world. Very often our usual 
USAID programs deal with needs that may be related to one of 
these kinds of countries or not, may be related to a country 
where there is a specific need. But he wanted it to be new and 
different and focused on that kind of capacity building.
    Senator Allard. So this is much more proactive. The other 
ones, they kind of comes after the fact. This is a more----
    Secretary Powell. Yes, it sometimes comes after the fact 
and it really is sort of need based as opposed to having this 
specific dynamic to it, to encourage these kinds of countries. 
In order to make sure that everybody understood that clear 
message, he felt it best to do it through an independent agency 
which we are in the process of setting up now.
    Senator Allard. Thank you very much for your comments.
    Secretary Powell. Thank you, Senator.
    Senator Bunning. [Presiding] Mr. Secretary, thank you for 
being here. I am sorry that I was at a prior meeting on the 
Banking Committee, some of us were.
    Let me ask you just one question, and get you out of here. 
First of all, congratulations on your speech at the United 
Nations. I thought it was targeted and right directly to what 
we needed to do, and I am very proud of it.
    Secretary Powell. Thank you, sir.
    Senator Bunning. In the past years the U.S. has, to some 
degree, tied economic assistance to Egypt to that country's 
willingness to make economic reforms that will move it closer 
to a free market economy. Could you address what assurances, if 
any, that the United States has asked from Egypt that they will 
engage in political reforms that will move them toward a 
greater democratization?
    Secretary Powell. We try to encourage Egypt in every way 
that we can to undertake economic reforms we believe are needed 
within that country to make its economy more viable and to do a 
better job of taking care of its people. With respect to 
specific programs and specific initiatives that we have used 
over the years to do that and we are using now, I would like to 
provide you a more fulsome answer for the record. But certainly 
we encourage them, push them, discuss with them, and use our 
embassy team in Cairo to given them ideas as to things that 
they can be doing and should be doing in order to make their 
economy more productive and to make better use of the aid that 
we are providing to them.
    Senator Bunning. If you would follow-up with a written 
response, I would appreciate that.
    Secretary Powell. Yes, I would like to give you some more 
specifics. There are some new and exciting things we have been 
doing, and there has been some progress in Egypt that I would 
like to report for the record.
    Senator Bunning. Kent, would you like to?
    Senator Conrad. I would, if you do not mind, Mr. Secretary, 
just a final question. We are often advised to hope for the 
best and prepare for the worst. What would you advise us is the 
worst case situation we might confront with respect to Iraq and 
North Korea that this Committee should be prepared to deal 
with? If you were looking ahead, what are possible outcomes, 
possible consequences that we should be especially sensitive 
to?
    Secretary Powell. I hope the Committee, with respect to 
Iraq, will be sensitive to the needs that might immediately 
exist if a conflict were to come, if we are not able to avoid a 
conflict. There will probably be immediate needs to assist the 
Iraqi people in provision of food, provision of other 
humanitarian needs. In due course they will be able to take 
care of themselves because they have the money, but the system 
may be shaken so badly initially the Oil for Food Program may 
be thrown into disorder. So that the Congress, I hope, would 
support us in any emergency supplemental requirements we have 
to take care of the people of Iraq until such time as we can 
get their systems back in place and running.
    Senator Conrad. Do you have any sense of what the size of 
such a supplemental might be?
    Secretary Powell. No, sir. I could not even begin to 
speculate, but I want to assure you, sir, and the Committee, 
that there is an enormous amount of work being done within the 
Department of State, Department of Defense, where an office has 
been created to work on this, and will look at all of the 
issues having to do with humanitarian needs, medical needs, how 
to protect the oil fields of Iraq for the benefit of the Iraqi 
people.
    This canard that is constantly being tossed out, that all 
we want is their oil. The oil of Iraq belongs to the people of 
Iraq, and we will help the people of Iraq use that oil for 
their benefit and not to threaten their neighbors. That is not 
only a matter of principle, it is a matter of international law 
if we go in there. I cannot at this point though give you an 
estimate of any supplemental needs that would be required.
    With respect to North Korea, the only thing I would suggest 
at this point is that the Congress support us in our diplomatic 
efforts, and that we be given a little bit of room to maneuver, 
and that there is some patience shown. It took 14 months for 
the last agreement to be dealt with back in the 1990's. We are 
not intending to have a similar process or a similar agreement, 
but these things take time. Diplomacy does not always produce 
instant results, but very often produces good results, and I 
hope we will have a good result there.
    Senator Conrad. Thank you very much for your testimony here 
this morning.
    Senator Bunning. Thank you, Mr. Secretary.
    Secretary Powell. Thank you, Senator.
    Senator Bunning. We appreciate you being here.
    Secretary Powell. Thank you.
    Senator Bunning. We are dismissed.
    [Whereupon, at 12:10 p.m, the committee was adjourned.]

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    DEPARTMENT OF TRANSPORTATION'S FISCAL YEAR 2004 BUDGET PROPOSALS

                              ----------                              


                      THURSDAY, FEBRUARY 13, 2003

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:34 p.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Don Nickles 
(chairman of the committee) presiding.
    Present: Senators Nickles, Allard, Burns, Cornyn, Conrad, 
Sarbanes, Murray, Wyden, Byrd, and Corzine.
    Staff present: Hazen Marshall, staff director; and Don 
Kent, senior analyst.
    For the minority: Mary Ann Naylor, staff director; and 
Sarah Kuehl, analyst.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. The committee will come to order.
    Today we will hear testimony from Michael Jackson, who is 
U.S. Deputy Secretary of Transportation. Mr. Jackson, we 
welcome you to this committee.
    Mr. Jackson serves as the Department's chief operating 
officer with responsibility for day-to-day operations of 11 
modal administrations and works with over 100,000 DOT employees 
nationwide. Prior to coming to this position, he served as 
chief of staff of the Secretary of Transportation during 
President George H.W. Bush's administration, and prior to that 
served in the private sector both with Lockheed Martin, IMS 
Transportation Systems and Services, and also worked as 
president of the American Trucking Association.
    Mr. Jackson, we welcome you. Before I call upon you for 
your opening remarks, I will ask my colleague, Senator Conrad, 
if he has any opening remarks he wishes to make.

                OPENING STATEMENT SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman. Thank you for 
holding this hearing. Thank you, Mr. Jackson, for being here 
today. We appreciate your appearance.
    Let me talk about what we see in this budget proposal and 
things that concern us, if I can, and then perhaps you could 
address some of these matters in your testimony, or perhaps we 
can do it when we get to questions. But let me just start with 
a quote from the Director of OMB before this committee earlier 
this month, in which he said, ``A better infrastructure is very 
good for the economy. When I think of highways, I think first 
of all of the ways they enable businesses and individuals to 
practice more commerce. We need a good infrastructure to do 
that.''

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    I personally strongly agree with the opinions expressed by 
the Director of the Office of Management and Budget. But when I 
look at the President's budget, I see something that doesn't 
match the words. The President has put forth a transportation 
spending plan that will force States to cancel or postpone 
hundreds of road, bridge, and transit projects at a time when 
they are facing their own fiscal crises. States such as Texas 
and Virginia have already served notice that they will be 
canceling hundreds of millions of dollars in highway projects 
in the wake of large State deficits. I am very fearful that the 
plan put forward by the Administration will only make that 
circumstance worse.
    Let's go to the next chart. The President has proposed 
reductions, almost 11 percent below the 2002 level, and 6.7 
percent below the level expected to be enacted for 2003. We can 
see the baseline for 2004 would be $32.9 billion. What passed 
for 2003 was $31.8 billion. That is the Senate-passed version. 
For 2004, the President is proposing $29.3 billion.

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    That is a proposal--let's go to the next chart--that we are 
told will cut jobs by 171,000, that at the time the President 
is proposing a growth package to increase employment, increase 
economic activity, and yet, on the other hand, is proposing a 
budget for transportation that will reduce the number of jobs 
by almost as much as what he is talking about increasing the 
number of jobs. This to me does not make sense.

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    Let's go to the next chart. Your own Department issued its 
conditions and performance report last week. For the highway 
program alone, adjusted for inflation, the report says that we 
need an average annual Federal investment of $41.2 billion to 
maintain the existing interstate highway system. To actually 
improve the system, we would need an average annual Federal 
investment of nearly $53.4 billion. Yet the Administration has 
come forward with a proposed highway funding level that starts 
at $29.3 billion and only reaches $33.9 billion by the end of 
fiscal year 2009. I really question whether this is a credible 
budget proposal.

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    Now, Mr. Jackson, I could go down a list of other cuts in 
the transportation budget proposal, but I think the other one I 
would like to focus on is Amtrak, cutting Amtrak funding by 
14.2 percent below what is now expected to be in the 2003 
omnibus bill that we will act on perhaps as early as tomorrow. 
Hopefully we will.

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    The President has proposed $900 million in Amtrak funding, 
nearly $900 million less than what Amtrak is expected to ask 
for in order to maintain its existing system and to avoid 
further delay in critical capital improvements in fiscal year 
2004.
    Finally, I am also concerned about your proposals to 
require communities to contribute large subsidies to 
participate in the essential air service program. I can tell 
you, in terms of growth, economic development, the single most 
important thing that companies talk to me about when they are 
talking about operations in North Dakota, bringing operations 
to North Dakota, is: What is your air service? This move on 
essential air service threatens that vital lifeline.
    So these are areas of concern that I hope you will address 
in your testimony or, again, perhaps in questions that we get 
to afterwards. Again, thank you for being here.
    Chairman Nickles. Senator Conrad, thank you very much.
    Secretary Jackson, just a couple of comments. Correct me if 
I am wrong, but in 1998, in highway funds we were spending 
about $200 billion. In the year 2000, when we had a big 
increase in highway funds, it went up to $27 billion. The year 
just completed, in 2002, it was $32 billion, so that went up by 
60 percent between 1998 and 2002. Correct me if I am wrong, but 
that is a tremendous increase, funded primarily by gasoline 
taxes. So I just want to kind of put this in relative--some 
people say, well, wait a minute, that might be less than what 
we just appropriated--we haven't finished, but the 
appropriation bill we will finish tonight or tomorrow. Like I 
say, it has been on a very steep climb if you increase spending 
for highways between 1998 and 2002 of 60 percent. That is a 
pretty significant increase. I just wanted to point that out.
    Secretary Jackson, we welcome your testimony today. We have 
a lot of big challenges, certainly in highways, mass transit, 
essential air service. You have some proposals. We look forward 
to hearing you explain some of those. So welcome to the 
Committee.

     STATEMENT OF MICHAEL P. JACKSON, DEPUTY SECRETARY OF 
   TRANSPORTATION, UNITED STATES DEPARTMENT OF TRANSPORTATION

    Mr. Jackson. Thank you, Chairman Nickles. I appreciate it. 
Members, I appreciate the ooportunity to be here today.
    Secretary Mineta is unable to be here but sends his warm 
wishes. He is recovering from back surgery but is doing 
terrifically well and expects to be back in the office soon.
    Chairman Nickles. Please give him our regards as well. He 
is a friend of all of ours on the Committee.
    Mr. Jackson. Yes, sir, I certainly will do that.
    On his behalf then, I am pleased to present to you an 
overview of the Department of Transportation's 2004 budget. As 
you know, President Bush is requesting a $54.3 billion budget 
for the Department, a 6-percent increase. Also, as you know, 
two modes of the Department of Transportation--the 
Transportation Security Administration and the U.S. Coast 
Guard--will be departing the Department on March 1st to go to 
the new Department of Homeland Security. We celebrate their 
many successes with us, and we look forward to working with 
them as we go forward in this new departmental arrangement.
    I would like to discuss the highlights from the DOT 2004 
budget and just point to a few key initiatives, and then 
perhaps we can answer some of the questions raised, Mr. 
Chairman, by you and Senator Conrad.
    As you know, the current laws authorizing surface and 
aviation transportation are up for reauthorization this year, 
and we will be spending a significant amount of our energy 
working with the Congress working on these reauthorizations 
during the course of the year. We will release before too long 
the details of our aviation and surface transportation 
reauthorizations, but I want to share just a couple of the 
principles that will be animating our work.
    For the surface transportation programs, we will include 
increased funding flexibility for States and local authorities. 
We will continue to encourage innovative financing tools, and 
DOT will seek to improve efficiency for freight transportation 
networks and to support the more efficient movement of freight 
transportation. We will support efficient environmental review 
processes and make them a priority. We will continue a strong 
emphasis on public transportation by simplifying transit 
programs and fostering a seamless transportation network. 
Finally, our proposals will include an emphasis on 
consolidating and expanding Federal safety programs.
    I would like to repeat myself on that point. For DOT, 2003 
will be a year of special focus on highway and aviation safety. 
Secretary Mineta has challenged the Department to take the same 
type of innovation and focus and discipline that we used to 
stand up the Transportation Security Administration during this 
past year and focus that same passion on addressing the safety 
issues that confront the Department. There are forty-two 
thousand deaths a year on our highways. Almost one out of four, 
or over 9,000 of these lives, could be saved if people would 
just buckle up. We have to do better in this. We will do better 
in this. The President's proposals include some concentration 
reducing highway fatalities by focusing on seat belt usage, 
impaired driving, and other safety initiatives.
    Regarding the highway reauthorization budget, let me begin 
with the fundamental principle. We are committed to maintaining 
the guaranteed funding levels that link highway funding to 
Highway Trust Fund receipts. We are committed to the firewalls.
    In fact, the President's budget request will actually 
propose to obligate more for highway programs than we expect to 
collect in the Highway Trust Fund. We will squeeze everything 
we can out of the Highway Trust Fund. We will preserve the 
principle of the firewalls. We will actually partially spend 
down the trust fund balance, and we will try to squeeze as much 
value out of the trust fund as we can. But the President's 
budget does not propose to increase highway user fees.
    For the Federal Highway Administration, the 
Administration's 2004 budget request proposes that all revenue 
from gasohol taxes be deposited directly into the Highway Trust 
Fund rather than the General Fund, as it is currently 
structured. That is a $600 million a year boost in Highway 
Trust Fund obligations, and it goes throughout the course of 
the reauthorization.
    In addition to making obligations above the level of 
estimated receipts into the Highway Trust Fund, we unveil a 
brand new $1 billion infrastructure performance and maintenance 
initiative specifically aimed at addressing immediate highway 
needs with projects that can be implemented quickly--getting 
money out to States and localities to make essential repairs 
and to do work quickly. We hope this will improve operating 
efficiency and remove bottlenecks and put people to work in the 
transportation industry.
    All up, our proposed program spends at a level that keeps 
the Highway Trust Fund balance relatively constant. The 
obligation limit for 2004 is $29.3 billion. This is a 6-percent 
increase above the President's amended request for 2003.
    I would be happy to talk in greater detail in the Q and A 
session, Mr. Chairman, about the annual movements and the 
levels of investment in the trust fund, and I suspect that your 
questions will point us in that direction.
    When comparing the President's 6-year surface 
transportation reauthorization proposal in total--including 
highways, highway safety, transit, and motor carrier safety--to 
the 6 years of TEA-21, the President proposes an overall 
increase of 19 percent.
    Reducing highway fatalities is priority one for the 
National Highway Traffic Safety Administration, and the 
President's budget requests $665 million for NHTSA to reduce 
fatalities, prevent injuries, and encourage safe driving 
practices; $447 million of NHTSA's 2004 funding request will 
support grants to States to enforce safety belt and child 
safety seat use, and to reduce impaired driving.
    At DOT we are also working to keep our highways safe 
through the work of the Federal Motor Carrier Safety 
Administration by focusing on ways to prevent fatalities and 
injuries resulting from accidents involving commercial motor 
carriers. The 2004 budget request includes $447 million to 
address these problems.
    Another way to improve transportation safety is to continue 
to encourage the use of public transit, a dependably safe and 
efficient way to get people where they need to go. The 
President's 2004 budget request includes $7.2 billion to 
strengthen and maintain our public transportation networks. It 
includes $1.5 billion to fund 26 new start projects that will 
carry 190 million riders annually when completed.
    Having touched briefly on these surface issues, I would 
like to turn to the reauthorization of our aviation program. 
While we will soon release policy details of our aviation 
reauthorization proposal, let me say the President is 
requesting $14 billion for FAA programs.
    Because travel demand in air services will inevitably 
return to pre-9/11 levels, and because we will face once again 
capacity problems and constraints in our aviation system, it is 
important to continue our Federal investment in this area. It 
is also important to continue to remain focused on aviation 
safety issues to meet our goal of reducing aviation fatality 
rates by 80 percent over the period from 1996 to 2007.
    To meet both safety and mobility needs, the budget proposes 
to spend a greater portion of the accumulated cash balances in 
the Airport and Airway Trust Fund. Again, we propose to spend 
down the trust fund. In the post-9/11 environment, receipts 
into the trust fund have dropped. We are proposing to work hard 
to use the money that we have available in the trust fund and 
extend it as far as possible.
    The President's budget request and our reauthorization 
proposals maintain current levels of aviation infrastructure 
investment and expand FAA's safety staff, including the number 
of air traffic controllers needed to man our air traffic 
control system in the future as we face an anticipated cycle of 
retirements in the next several years.
    Let's turn now to railroads, a topic that has already been 
raised. First, Amtrak. Amtrak faces severe and persistent 
financial challenges. The Administration has asked Congress to 
adopt reforms that will strengthen Amtrak's business operations 
and its financial condition, but Amtrak continues to request 
funds, indeed request more funds, to maintain the same mode of 
operation that has existed for the last 30 years. The Federal 
Government simply cannot afford business as usual at Amtrak.
    The 2004 budget request includes $900 million for Amtrak. 
This is a funding level with a message. We need to do better at 
Amtrak. We need to make core business improvements.
    Passenger rail, I would like to say, is an important part 
of the overall transportation infrastructure. We need viable 
passenger rail, and we look forward to working with Congress on 
an economically viable reauthorization proposal.
    Finally, I want to share with you the President's request 
for our maritime programs. The Maritime Administration supports 
essential transportation and intermodal connections for 
domestic and international trade, and the President has 
requested $219 million for MARAD. One of MARAD's continuing 
challenges is the disposal of obsolete ships, those that pose a 
potential environmental risk to our Nation's waterways. The 
2004 budget request includes $11.4 million for removal of the 
highest risk vessels.
    My prepared remarks focus on these and many other parts of 
the Department's transportation objectives. I would like to 
thank you again for the opportunity, Mr. Chairman, to speak 
today with the Committee. I look forward to responding to any 
questions that you may have, and I would ask that my prepared 
remarks be considered part of the record.
    [The prepared statement of Michael Jackson follows:]

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    Chairman Nickles. Secretary Jackson, thank you, and we will 
include your remarks, and I appreciate your presentation. Let 
me just ask you a couple quick questions, and then we will go 
to our committee members.
    You are going to be asked repeatedly and maybe--the 
recommendation that you have for highways is a total of $29 
billion?
    Mr. Jackson. $29.3 billion is the total Federal aid highway 
obligation limit.
    Chairman Nickles. The bill that is just now being passed is 
$31.8 billion or something like that.
    Mr. Jackson. That is what I am told.
    Chairman Nickles. So many people will come to you and say, 
well, wait a minute, we are having a reduction. How do you 
justify or explain that reduction in highway funds? Granted, I 
mentioned historically it is a 60-percent increase from where 
we were just a few years ago, in 1998, I believe. But, still, 
the highway users, when they receive those funds, they only 
want to go up.
    Mr. Jackson. Yes, sir.
    Chairman Nickles. So how do you explain that?
    Mr. Jackson. It is an excellent and important question, and 
I appreciate it, and I will try to unpack it in a couple of 
different ways.
    First, the Administration supports the principle that 
receipts into the highway program should fund the highway 
program.
    In addition, we have offered to spend down the trust fund 
balances by slightly over $1 billion annually over the course 
of this 6-year reauthorization cycle, leaving about a $14.6 
billion balance at the end of this period. It fluctuates above 
and below that during the course of this period, but call it 
$15 billion, and we think that is a prudent balance in the 
trust fund. All of those moneys are obligated, and if the 
States asked us to spend them out at a rate that is different 
than our historical rate, we would be obligated to pay those 
funds. So we think that is a prudent balance.
    Chairman Nickles. Secretary, let me ask you a question. You 
mentioned all the funds in the trust fund are obligated. You 
mean there are already existing contracts, highway contracts, 
out in the States? Those contracts are initiated so if there is 
a trust fund balance of--of 20?
    Mr. Jackson. About $15 billion is what is projected in our 
proposal for the course of the reauthorization cycle.
    Chairman Nickles. What are the existing obligations against 
those trust funds right now if you just stopped? If we 
completed every contract that is on the books, how much----
    Mr. Jackson. About $42 billion, roughly. I can explain a 
little bit. There is a pretty standard spendout rate for our 
obligations. Approximately 68 percent outlays over the first 2 
years, and then you spend out the remaining funds over the next 
seven years. So we have a lot of experience and a pretty clear 
picture about how these obligations spend. But the first point 
here is that we have proposed to spend down the trust fund by a 
little over $1 billion a year. That is part one.
    The second part gets us into the so-called RABA discussion. 
In TEA-21, the target obligation level set by the authorizers 
was $27.18 billion--$27,180,000,000--in 2002. We had, however, 
the benefit of a $4.5 billion RABA, revenue aligned budget 
authority, plus-up. It is like this. I can explain it as 
working in a regular job where you have a salary, and if you 
get the benefit of a bonus at the end of the year you have that 
added to your salary and that to spend. That is exactly where 
we were in the year 2002 with the States. We had a baseline 
target that the bill authorized for us to shoot for. That is 
the $27 billion figure. But the economy was doing very well, 
and we had created a mechanism in the previous authorization to 
allow us to enjoy the benefit of that booming economy.
    What has happened is that people have come to expect that 
not just their base salary, but also their bonus, is their 
entitlement. That is the problem that we are facing here. The 
trust fund revenues simply will not justify paying at this 
level. If we took the $31.8 billion number and we simply 
adjusted that for inflation over the course of the next 6 
years, the Highway Trust Fund would be bankrupt by the end of 
this reauthorization cycle. So the Administration is saying 
that we have put a proposal on the table that is prudent. It is 
balancing what is a difficult set of decisions for the Nation 
at a time when there are tremendous strains on our budget and 
tremendously important priorities to choose from.
    So we think it is a prudent budget. We think it is a fair 
budget. We think it is a reasonable budget. But most of all, it 
is a budget that lives within the context of the existing law.
    Chairman Nickles. Secretary Jackson, thank you very much.
    We have several members. I am going to ask all of our 
members--and I was trying to keep my remarks with 5, 6, or 7 
minutes. I would like to ask all members to do that as well.
    Senator Conrad.
    Senator Conrad. If the Chairman would alert me at the end 
of 5 minutes, I would appreciate that so I don't go over 
either.
    Mr. Jackson, you are familiar with the conditions and 
performance report on highways done by the Department of 
Transportation?
    Mr. Jackson. Yes, sir, I am, Senator.
    Senator Conrad. Is my reading of that correct that they are 
saying to maintain the current system we would need $41.2 
billion a year?
    Mr. Jackson. That is the report's finding, yes, sir.
    Senator Conrad. The investment needed to improve the 
system, $53.4 billion? That is my reading of the report.
    Mr. Jackson. That is the finding of the report, yes, sir, 
but it depends on what you mean by ``improve.'' You could 
obviously improve the highway system by every dollar that you 
add into it if you spend those dollars wisely.
    Senator Conrad. But I guess we would go back to the 
fundamental there, to maintain the current system, $41.2 
billion. So would you agree that a budget that the President 
proposes of $29.3 billion, according to your own Department's 
analysis, will not maintain the current system?
    Mr. Jackson. I think we can use our money better, and we 
can address the concerns raised by this report by spending 
wiser and spending appropriately. Let me say that in my 
experience with the Department dating back to the last Bush 
administration, the Congress has never appropriated these 
target-level funds. They are based on descriptions and analyses 
of what professionally the highway engineers would like to see 
as a maintenance level, and to my knowledge, those levels have 
never been reached in appropriations for us in recent times.
    Senator Conrad. So would I be correct in concluding that 
you don't agree with your Department's report that $41 billion 
is necessary to maintain the current system?
    Mr. Jackson. The report of the Department lays out an 
approach and a program to use $41 billion wisely, and I am 
telling you we don't have $41 billion to use.
    Senator Conrad. Let me just ask you this: You have 
indicated that you are using all that the trust fund has 
available. Are you familiar with the Congressional Budget 
Office's runs that have looked at assuming that additional 
revenue would be credited to the trust fund from the 
President's proposed policy of transferring 2.5 cents a gallon 
in ethanol tax to the trust fund that currently is being 
credited to the general fund and how much money that would 
raise? I am told that the CBO's runs indicate that if we simply 
grew at the rate of inflation from the 2003 level, the trust 
fund balances would never fall below zero and never trigger a 
gas tax increase, but that $3 billion would be available for 
2004 above what the Administration has recommended.
    Mr. Jackson. I am not familiar with that study, sir. Our 
own internal Administration projections estimate that moving 
the 2.5 cents from the general fund to the Highway Trust Fund 
will yield $600 million annually.
    Senator Conrad. Yes, that is exactly what CBO has found, 
$600 million a year, but that that would permit an expenditure 
of $3 billion more in 2004 than what the President has 
recommended.
    One other scenario that they have run was starting at $31.1 
billion in 2004, growing at the rate of inflation thereafter, a 
balance of $5 billion would still be maintained in the Highway 
Trust Fund, and that 2004 funding level of $31.1 billion would 
be $1.8 billion above the President's recommendation. Are you 
familiar with that analysis?
    Mr. Jackson. I have not seen that run, sir. I would be 
happy to look at it. The $5 billion is what we would consider a 
perilously low balance in the Highway Trust Fund. We have 
looked at these numbers very carefully. There certainly is a 
zone for reasonable disagreement about what an appropriate 
level of balance is in the trust fund. But that level would be 
perilously low and below where we think it should be. That 
strikes me as approximately a 2-month reserve.
    Senator Conrad. That is the calculation, a 2-month reserve.
    Let me just conclude by saying that when you say the Nation 
can't afford $900 million more for Amtrak, it strikes me that 
this administration is recommending a $1.5 trillion tax cut. 
That to me is unaffordable. This is a matter of choices. We are 
going to have to make choices. I don't think it is a good 
choice to decide we are going to cut highway and bridge 
construction in this country and lose 171,000 jobs when the 
economy is weak. I must say that doesn't make sense to me.
    I thank the Chair.
    Chairman Nickles. Senator Conrad, thank you very much.
    Senator Burns.
    Senator Burns. I am going to pass. I am working on 
something. I have some information coming.
    Chairman Nickles. Senator Allard.
    Senator Allard. I want to get some clarification on the 
unobligated dollars that we have in the Highway User Trust 
Fund.
    Mr. Jackson. Yes, sir.
    Senator Allard. Now, the Chairman was talking about 
obligated dollars. I guess my question is: Do we have any 
unobligated dollars at all sitting in the trust fund?
    Mr. Jackson. No, sir. All of the trust fund balances are 
obligated. That is different than, for example, the FAA's AIP 
program where we do have some portion which is not obligated.
    Senator Allard. OK. So just so we get this and I understand 
it correctly, there are no funds in the highway transportation 
budget that have not been obligated?
    Mr. Jackson. That is correct. That is what the balance is, 
all of that roughly $15 billion.
    Senator Allard. So when city and county people come to us 
and say we want the unobligated amounts, what they are wanting 
is a lower balance in the obligated funds, which may mean if we 
get into a shortage of money that somebody's project that was 
started doesn't get completed.
    Mr. Jackson. Exactly.
    Senator Allard. OK. Generally what likelihood do we have 
that we will not be able to measure up to those obligations 
that we have now in the trust fund? Do you have confidence that 
we'll be able to meet all those obligations we currently have?
    Mr. Jackson. I do. We think that the level that we have 
proposed, which reduces the trust fund balance to about $14.6 
billion by the end of this authorization cycle, is a fair and a 
prudent balance to maintain in the account, and that is based 
on a fair bit of history and a lot of close scrutiny.
    Senator Allard. You are willing to spend out the $1 
billion?
    Mr. Jackson. Yes, sir.
    Senator Allard. That has been obligated?
    Mr. Jackson. Right. So----
    Senator Allard. That is $1 billion out of somebody's 
project that is going on out there.
    Mr. Jackson. It is $1 billion----
    Senator Allard. Are you comfortable with that?
    Mr. Jackson. Yes, sir, we are. We are accelerating down, we 
are spending down that balance a little bit, and we think that 
a modest spend-down--it is sort of hard for me to think of a 
spend-down of $1 billion as modest, but in the scheme of this 
program, that spend-down level seems reasonable to us. We have 
had extensive conversations in the Administration about that, 
and that is the comfort zone.
    Senator Allard. So that is based on current law?
    Mr. Jackson. That is exactly right.
    Senator Allard. So the Congress would have to be careful 
that they don't enact laws in what length of period that might 
have an adverse impact on the balance of that? Because you are 
assuming under current law that there will be money there that 
you can spend down your obligated dollars, and if we do 
something that would reduce the collection of fuel dollars in 
some way or another, it could have even a greater impact on 
those dollars, right?
    Mr. Jackson. Yes, sir. It assumes that the sources of 
revenue proposed in the President's budget are adopted. It is 
basically not proposing a change in any of the user fees that 
drive revenue into the trust fund.
    Senator Allard. I guess it is possible, if things really go 
bad, that you would come back and ask for a tax increase if you 
some way or another saw that trust fund get into trouble and we 
have overobligated it, right?
    Mr. Jackson. That is not something that we are 
contemplating. We are trying to find a reasonable proposal and 
a fair proposal that doesn't require any changes in taxes and 
user fees.
    Senator Allard. You are 100 percent confident of that, 90 
percent, 75, 50 percent?
    Mr. Jackson. I am very, very confident that it is a fair 
and prudent level to maintain.
    Senator Allard. So 90 percent confident.
    Mr. Jackson. And RABA, the revenue aligned budget 
authority, does provide a mechanism to reduce the obligation 
limitation if the economy does not perform and revenues into 
the trust fund are below where they were anticipated to be. 
That is what happened in 2003. The trust fund didn't generate 
enough money to support the $27 billion baseline, not to 
mention the $31.8 billion funding level which we had enjoyed as 
a result of the boom economy in 2002. However, when we adjusted 
our 2003 budget request downward per the law, it turned into a 
no-starter. Frankly, the Administration, after some brief 
discussions with the Congress, agreed that we should at least 
use additional funds to bring us to the $27 billion baseline 
level. I understand that Congress is proposing to pass 
legislation at the $31.8 billion level, which is to add the 
bonus that came through the good years to 2003 as well, even 
though the revenues into the trust fund don't support that 
level of expenditure.
    Senator Allard. Is that a transfer out of general revenues? 
Or where is that?
    Mr. Jackson. Well, it comes out of the trust fund money and 
does reduce the trust fund balance, but it is a deficit impact 
because this is money that we hadn't intended to spend on the 
program.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Nickles. Senator Allard, thank you very much.
    Next I will call upon our distinguished colleague, and the 
first time I have had him join our committee during our 
hearing. Senator Byrd. Senator Byrd, just for your information, 
we usually call on people, recognize them on their order of 
appearance. If you wish to defer, we will be happy to 
accommodate you as well.
    Senator Byrd. Thank you, Mr. Chairman.
    Mr. Jackson, does the Administration support Amtrak serving 
as their national passenger rail system?
    Mr. Jackson. We do believe that Amtrak is an essential part 
of intercity passenger rail for the foreseeable future, 
although we have tried to lay open the prospect that, some 
competition could be injected into intercity passenger rail in 
a modest and thoughtful way. We have had expressions of 
interest from other competitors or potential competitors of 
Amtrak to provide some service of that sort.
    Senator Byrd. But the Administration does support Amtrak as 
the national passenger rail system?
    Mr. Jackson. We have proposed $900 million worth of support 
for Amtrak in our 1904 budget, yes, sir.
    Senator Byrd. When will it begin to propose a realistic 
funding level that will address Amtrak's long-term viability?
    Mr. Jackson. This year we hope that the reauthorization 
cycle, Senator, will allow us to take a good hard look at the 
fundamental business problems that face Amtrak. Working with 
you and your colleagues in the Senate and with the House, we 
hope to come up with a plan that would allow them to be viable 
for the long haul. We believe that fundamental business reforms 
are needed. I will say that I very much think that the current 
president of Amtrak, David Gunn, is making some very important 
strides in bringing some business discipline to Amtrak, so we 
hope to continue to work closely with them as well.
    Senator Byrd. Mr. Gunn took the reins at Amtrak just last 
spring. He was given the mandate to strengthen Amtrak's 
performance, and yet it seems as though the Administration is 
constantly dictating reforms to Mr. Gunn and the Amtrak board. 
Mr. Gunn has asked for the time and opportunity to meet the 
mandate given to him just a few months ago. Should we not let 
him do his job and find the best plan for Amtrak?
    I think that it is really the responsibility of Congress 
and the Administration and our partners, which include Amtrak, 
include the States, and include all the people with equity in 
this system to set a vision for Amtrak and tell them where we 
think they need to go, and then David will be a good executive 
and take the railroad where the Congress and the Administration 
point him to. So the budget that was placed before us just 
earlier of $1.8 billion is really a budget that does not fix 
Amtrak. It just tries to stabilize a patient that is already in 
the ICU, and what we think we need to do is figure out not just 
how to stabilize the patient, but to make the patient healthy, 
and so we think that the time spent in reauthorization to look 
at all the core problems that we have had for 30 years and see 
if we can find a better way of doing business is time well 
spent.
    Senator Byrd. I think the Administration will be supportive 
of Amtrak's long-term viability. I live in an area of the 
country that does not have much of an opportunity. It cannot 
count on much by way of airline service, and when it comes to 
building highways, we have spent enormous sums per mile on 
highways. We have to have some kind of a rail system we would 
think, and I hope that the Administration will be realistic 
when it comes to dealing with Amtrak.
    If the $1.8 billion budget request from Amtrak sustains the 
patient, a $900 million budget from the Administration kills.
    Mr. Jackson. Sir, I think that the way I would characterize 
it is that the patient is in ICU and we need to look at what 
they need to live, and then we need to see where they need to 
go. The proposal to maintain business as usual for the next 4 
years while we try to figure out how to run the operation is 
not, in our view, a viable proposal. We ought to face the tough 
choices now and tell Amtrak where it needs to go and what it 
needs to do to make fundamental business reform. So we do 
believe that Amtrak and intercity passenger rail are vital 
parts of the transportation network. We need intercity 
passenger rail, and we will support it and work with you as we 
take on the reauthorization challenge.
    Senator Byrd. I hope we will do that. We are supportive of 
the airlines when they lose money. We are quick to come up with 
a bagful of money when the airlines need money. We are helpful 
to the waterways. I have been around here since--I was with Mr. 
Eisenhower when he proposed the highway system. I voted for it, 
and have voted for the moneys to sustain it over these many 
years. I have voted for appropriations for the Appalachian 
highway system. When it comes to the rail system we want to 
pinch pennies. We expect too much. We need a rail system in 
this country. I would hope that the Administration would keep 
that in mind. The States have already great financial burdens 
on them. They are experiencing severe budgetary difficulties. I 
hope we are not suggesting that the States should cut their 
programs and public services even further to finance a national 
rail system.
    Keep this on mind on the rail system, will you, please?
    Mr. Jackson. Yes, sir.
    Senator Byrd. As to the Highway Trust Fund, even in the 
wake of the disturbed funding increase accomplished through 
TEA-21, we continue struggling to maintain the current 
inadequate conditions of our highway network.
    Mr. Phil Gramm is here. He was so helpful as we worked 
together a few years ago on our highway bill.
    As an example, the Road Information Program reports that 
one in four of our Nation's bridges is classified as deficient, 
and that the average age of bridges in the U.S. is 40-years-
old. In the light of the action by the Conference Committee, 
does the Administration stand by its proposed fiscal year 2004 
highway funding level of $29.3 billion which will be a $2.5 
billion cut from the level of funding tentatively due to be set 
for fiscal year 2003?
    Mr. Jackson. Yes, sir. Although, Congress has not yet 
passed this bill, I understand that it is headed in that 
direction. The Administration is mindful of the many, many 
challenges that face the Congress in making prudent budgetary 
decisions, and we think that $29.3 billion is a prudent funding 
level for this program.
    Senator Byrd. It has been estimated that every one billion 
dollars of spending on our Nation's infrastructure produces 
approximately 47,500 good paying jobs. With the 
Administration's stated focus on the creation of new jobs to 
replace those that have been lost during the past 2 years, why 
has the Administration chosen not to avail itself of the 
opportunity to invest in the creation of approximately 132,750 
jobs for our economy.
    Mr. Jackson. Well, the understanding that transportation 
investment does help stimulate economic growth was a part of 
the consideration that impelled us to add $1 billion a year to 
the program. The Administration takes the position that in 
order to stimulate growth within the economy, the most 
efficient tools are the tax policy tools that apply across the 
spectrum of the economy as proposed by the President.
    Senator Byrd. When it comes to the matter of future highway 
spending, your formal opening remarks, Mr. Jackson, state that 
the Administration will squeeze everything we prudently can 
from the trust fund, but the President's budget request does 
not propose new user fees. Your budget request for the FAA have 
included appropriations from the General Fund totaling about $6 
billion over the last 3 years. You have asked for these moneys 
out of the General Fund because you know that there are not 
adequate resources in the Airport and Airways Trust Fund to pay 
for it. If, as you claim, the Highway Trust Fund does not have 
adequate resources to address all of the infrastructure 
spending that we need to address the congestion problem, why 
have you not requested appropriations from the General Fund to 
address this need?
    Mr. Jackson. On the whole, the Administration believes that 
we should try earnestly to fund the highway needs with money 
generated by the trust fund, that money in to money out of the 
trust fund is the right way to provide stability and long-term 
common sense for the country on surface transportation 
investments, in this hugely important program. So we feel like 
that we ought to try to live within the walls that we have 
constructed there, and that is what our proposals represent.
    Senator Byrd. Do I have any time left, Mr. Chairman?
    Chairman Nickles. I have given you about twice as much as--
--
    Senator Byrd. Have you really?
    Chairman Nickles. I was very interested in your questions.
    Senator Byrd. Oh, thank you. Thank you. I have some more 
interesting questions. [Laughter.]
    Chairman Nickles. Well, we can have a second round. I would 
like to let other senators ask a question.
    Senator Byrd. Well, thank you very much.
    Chairman Nickles. Thank you, Senator Byrd, and we are 
delighted to have you on this committee.
    Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Chairman.
    I would like to, Mr. Jackson, ask a few questions about 
Amtrak as well, because like Senator Byrd, I would like to see 
Amtrak succeed, but things are not looking too good. I note 
that the omnibus, the Conference Committee approved a $1.1 
billion for Amtrak for 2003, but your budget request for 2004 
is $200 million less than that; is that correct?
    Mr. Jackson. Yes, sir.
    Senator Cornyn. Could you sort of describe for me sort of 
what your vision is, what the Transportation Department's 
vision is about the future of Amtrak? Do you envision it as a 
national passenger rail system? I hear you talking about 
intercity, and certainly we know that in places like the 
Northeast it is perhaps more financially viable, where people 
are closer together.
    Mr. Jackson. Yes, sir.
    Senator Cornyn. But do you envision it continuing as a 
national rail system?
    Mr. Jackson. I do think that a network of intercity rail 
service is something in our future and should be in our future, 
but precisely what that network will look like and how we will 
manage it in a businesslike and publicly responsible fashion is 
the subject for the reauthorization debate. We do not go into 
that debate with an assumption that we will do everything that 
we are doing today, nor does it assume that we are limited and 
not able to add different and new types of service in the 
future. It says that we just have to figure out how to do it in 
a common sense businesslike way. So we are asking for some 
reasonable competition, and we are asking for States and 
localities to help pay the load if there is a need for an 
operating subsidy, not unlike the way that we manage our 
Federal transit programs. We are, at the Federal level, focused 
on the infrastructure investment, and if that infrastructure 
investment needs an operating subsidy, we feel the States 
should share that burden. Senator Murray's State is an 
excellent example of a State that has stepped up to the plate 
and made a very significant investment in railroad service.
    So we are trying to encourage more States to do what her 
State has done. We are looking for a way to work with the 
States in a prudent fashion. When Secretary Mineta and I met 
with the President on this topic, he said that we want to make 
change, but he is mindful of what his previous job was as 
Governor of your State, sir. He knows that the States are 
pressed and that we have to be able to put a proposal on the 
table that is prudent, measured and allows us to transition 
from where we are today to where we need to be. We need a 
separate plan for the Northeast corridor that can be understood 
in much different economic terms than our long-term rail 
system.
    Senator Cornyn. Well, I am intrigued. For example, you talk 
about competition. What would competition look like for 
something that is bleeding as much red ink as Amtrak is now? 
Who do we expect to compete to lose money on the order that 
Amtrak has been losing money?
    Mr. Jackson. Well, what you would have to decide is whether 
you can run a railroad with a more cost effective operating 
structure than Amtrak has done. I believe the answer to that is 
yes. I believe if you talk to the President of Amtrak, he would 
tell you that he can reduce operating expenses as well. For the 
last two years, I have had the privilege of serving on the 
Amtrak board representing the Secretary of Transportation. I 
have had the benefit of looking at that operation, and, I 
certainly believe that we can do better.
    But the idea is, if a State wants to guarantee that a given 
route is run, it could run a competition among any interested 
parties to operate rail service in a given corridor. Then if 
some sort of subsidy is needed, the State would have to face up 
to the question of whether among all the transportation 
investments that it has to make, this is a reasonable and 
prudent subsidy. Right now the States do not have to make those 
investments. They just wait for the Federal Government to fund 
the program.
    Senator Cornyn. Let me ask you about that last point. Do 
you have a spreadsheet, or does it exist somewhere in the 
Department of Transportation, a comparison of the per capita--
the per mile cost of the Federal--excuse me--the subsidy that 
the Federal Government pays for rail, air and highways, and how 
those compare?
    Mr. Jackson. I am certain we can get you some numbers like 
that. In the case of Amtrak we have figures about the 
individual subsidies for individual routes. That data is fairly 
widely available from Amtrak, from the Inspector General, and 
from the Department and other analyses. In other modes of 
transportation it depends on whether you characterize user fees 
as a subsidy or not. If you are paying highway taxes, you are 
paying for what you get.
    Senator Cornyn. I would be interested to see if you could 
put your hands on something like that or----
    Mr. Jackson. I would be happy to put something like that 
together.
    Senator Cornyn [continuing]. Or approximating that, I would 
be interested.
    Mr. Jackson. Yes, sir.
    Senator Cornyn. Finally, and quickly, as you know, my State 
has a 1,200 mile border with Mexico, and as a result of NAFTA 
we have seen a tremendous increase in the amount of traffic, 
commercial traffic, which benefits the Nation, coming across 
our roads, so obviously they are burdened with additional 
traffic. There is concerns, of course, about safety issues. No 
one wants to look in their rear view mirror and see an 18-
wheeler with bald tires and bad brakes bearing down on their 
family. But can you sort of describe in summary fashion what 
this budget includes in terms of enhancing the safety of our 
roads along the border and maintaining those roads to 
accommodate that huge increase in traffic, as well as 
population?
    Mr. Jackson. Yes, sir. First of all, the budget does 
include some very considerable investments, and I would be 
happy to pass very detailed budget information to you about the 
border investment in particular. But let me just characterize 
it this way for you to get oriented on it. In the 
appropriations act 2 years ago, we had quite a bit of 
conversation about how to meet our NAFTA obligations and what 
type of investments were needed at the border for safety 
inspectors and for weigh-in motion or weigh scales to do the 
business of enforcement. We have made some very, very 
considerable investments there. The Federal Motor Carrier 
Safety Administration's enforcement tools at the southern 
border have grown by about 25 percent overall, so we have a 
very large number of people. We have invested in border 
crossing technology with the States of Texas, California, New 
Mexico and Arizona, but a very large part of that investment 
went into Texas. We are awarding safety education grants for 
the States that have this border work to do with us, so we are 
making some considerable investments and putting a very 
considerable number of our staff and enforcement folks into the 
field in our border states.
    Senator Cornyn. Like the Amtrak information you are going 
to get for me, that comparison, I wonder if you could help 
direct my staff and I to the specific investment that is made 
under this proposed budget to deal with that----
    Mr. Jackson. Yes, sir, I would be happy to put a little 
package of that together and convey it to you, and we would be 
happy to brief your staff if you would like detailed questions 
answered on any of those issues.
    Senator Cornyn. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Cornyn, thank you very much. 
Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman. Welcome the 
witness.
    First I would observe, I would like to see some of those 
subsidy numbers, too, for various modes of transportation.
    Mr. Jackson. Yes, sir, Senator.
    Senator Corzine. Second, I would identify with a number of 
the Senators who have talked about the difference between a 
conditions and performance report with regard to highways, and 
what needs to maintain, and then obviously to improve the 
system. But I note with regard to mass transit the percentage 
differences between those are even greater than they are 
actually for highways. Got almost double, over double, just to 
maintain the mass transit system, if I have read your report 
right, 7.2 is the number, flat line number year to year, and 
14.9 is the maintenance number, and $20.6 billion is suggested 
as bringing it up to a level that would improve the condition 
and performance. Am I right on those numbers?
    Mr. Jackson. I think that you have the basic numbers from 
the report as printed.
    Senator Corzine. So I think the need of maintenance and 
improvement with regard to mass transit is equally important, 
and certainly in our highly urbanized areas it is true.
    I just want to make sure that I am reading this that we are 
not changing--you are not suggesting changing the formulation 
that funds mass transit on its relative basis to highway funds.
    Mr. Jackson. We are suggesting making some awfully 
important programmatic improvements in it, but we are still 
funneling money into the transit program through the trust fund 
mechanism that is in place. Actually, transit----
    Senator Corzine. At roughly the same percentages, if I 
have----
    Mr. Jackson. Actually, the transit portion grows by 2 
percentage points relative to the previous authorization cycle 
and the money that is required to be spent out of the Highway 
Trust Fund.
    Senator Corzine. I have a little trouble tracking all the 
math, but----
    Mr. Jackson. I don't blame you. There are some pretty big 
numbers.
    Senator Corzine. I would say that flat-lining mass transit 
in a world where we clearly have new safety needs in the 
context of homeland security is a tough task. That is before 
any allowance for inflation, which is an absolute down. So I 
think in some context, given the challenges for our mass 
transit system to be secure for those that use it, and given 
that many of the identified targets that we hear about or 
potential targets identified, I think the overall decrease that 
is actually happening to mass transit with a flat-line number 
is really substantial relative to performance and service to 
the communities that are at hand.
    Mr. Jackson. Let me help unpack that one just a little bit, 
if I could, Senator, because I share your concern about the 
importance of transit and the focus on security. We certainly 
feel like the transit agencies that operate in your State and 
in the New York region just were phenomenal stars--the story of 
well-trained and professional folks--on 9/11. I can help unpack 
it a little bit this way.
    First of all, the Administration's proposal gives States a 
significant amount of new flexibility to address their needs 
rather than have very stovepipe categories and say they can 
only apply this much for buses, this much for research, etc. We 
are trying to say give the States the flexibility to use that 
money. That is a very significant help.
    Second, we are proposing a 25-percent increase in the New 
Starts program, which funds is our major transit investments, 
and, finally, a 20-percent increase and support for rural 
areas. So that is a significant thing.
    Let me talk about the top-line dollar. You are a man who 
understands top-line dollars--and bottom-line dollars.
    Senator Corzine. I like bottom-line dollars.
    Mr. Jackson. Those, too. Well, I will talk to you about the 
bottom line then. $1.2 billion was flexed out of the Highway 
Trust Fund to support, mass transit programs in 2002. So we 
created in TEA-21 the capacity to take Highway Trust Fund money 
and use it on transit projects. Frankly, you can go both ways. 
If I remember correctly, $2 million went from transit accounts 
into highways and $1.2 billion went the other way.
    So when we looked at the experience of States and how they 
were using the money with their localities, what we found is 
that there is a significant kicker that is embedded in the 
program that has grown over time and that communities have come 
to understand and use to make effective transportation 
investments. So I think that one thing that is not present on 
that bottom-line number of transit funding is this experience 
of flex funds being used to substantially improve what we have 
got there. We expect that to continue.
    Senator Corzine. I know I am getting down to the long end 
of my 5 minutes. I want to totally identify with the series of 
questions that Senator Byrd asked with regard to Amtrak. I am 
sure other folks will. I do want to emphasize, though, that 
tunnel safety money and safety money with regard to Amtrak has 
not flowed, either from FEMA or from the Transportation 
Department, at least to my knowledge, for the on-the-ground 
folks like the Port Authority of New York and New Jersey, and I 
suspect we will hear the same thing from Maryland and other 
places. I think that for those safety considerations and 
security considerations, it is money out of one pocket which is 
continuing--you may call them stovepipes, but, you know, it is 
a very hard choice that we are putting on States that are 
actually in fiscal crisis right now and have constitutional 
responsibilities to balance their budgets.
    I understand we have overall budget constraints. That is 
why we are having these hearings. But this is a very, very 
tough choice that we are backing our States into making.
    Chairman Nickles. Senator Corzine, thank you very much.
    Senator Murray.
    Senator Murray. Thank you, Mr. Chairman, and thank you, Mr. 
Jackson, for being here today, and I join my colleagues in 
sending with you our speedy recovery wishes to Secretary 
Mineta.
    Mr. Jackson. Thank you, Senator. I will pass those along.
    Senator Murray. Thank you. The conference agreement that 
closed this morning provides close to the level of funding that 
Amtrak requested for 2003 when you consider the decision to 
delay the $100 million. I think we have $1.15 billion for 2.3, 
and you have heard the concern expressed here on the Budget 
Committee about that today.
    Last year, in a hearing in front of the Transportation 
Appropriations Subcommittee, you testified that the 2003 budget 
request of $520 million was a place holder and that your Amtrak 
reauthorization proposal would be coming to Congress shortly. 
As you and I know, we have had this conversation a number of 
times. Your 2004 budget, which we now have, contains $900 
million for Amtrak, which is $250 million below what we agreed 
to last night. But Amtrak is telling us they need $1.8 billion 
to stay functional.
    You have said now for over a year that we are going to get 
an administrative proposal on reauthorization. Can you tell us 
when we expect to see that?
    Mr. Jackson. We have a proposal that is reaching the final 
stages within the Department, and we expect to move it up in a 
timely fashion this spring. I can't give you an exact date, but 
I can tell you that the Department has had extensive 
conversations within the Administration. We are absorbing those 
into some actual----
    Senator Murray. Are you planning on putting a written 
proposal before Congress?
    Mr. Jackson. We are, yes, ma'am.
    Senator Murray. I know you represent Secretary Mineta on 
that Amtrak board and know all of the tremendous problems 
facing it. Do you think that if we appropriate your request of 
$900 million for Amtrak in 2004 that we will be forced to cut 
routes or services?
    Mr. Jackson. I think that we will have to look at what the 
Congress chooses to do in the reauthorization to answer that 
question fully. Just to give you an example--I am not trying to 
dodge the question, but if every State were to belly up to the 
bar the way your State has done in making a partnership 
commitment with Amtrak----
    Senator Murray. With current State budget deficits, I don't 
know how much longer any of them will be able to do that.
    Mr. Jackson. Right. Well, there is a rather large budget 
deficit that is associated with this year's budget Federal 
proposal as well, and so we are all juggling those multiple 
good objectives. So I think that we have to dig into this 
reauthorization program. We look forward to engaging in that.
    Senator Murray. I look forward to seeing your written 
proposal when it comes.
    Mr. Jackson. OK.
    Senator Murray. I did want to thank you. Your budget 
includes $75 million for a Sound Transit link light rail, and I 
want to thank you and Secretary Mineta and FTA Administrator 
Jennifer Dorn for really working hard on this project. It is an 
extremely important one for the Seattle-Tacoma area. I wanted 
to ask you if in putting this money in your budget, is it your 
Department's belief that the revised $500 million FFGA will be 
signed this year?
    Mr. Jackson. I can do you one better than that. We hope it 
will be signed before the end of this fiscal year, and we are 
having a very good relations in the conversation with Sound 
Transit. So I am very hopeful. I think Administrator Dorn----
    Senator Murray. Do you know when you are going to send it 
to Congress for our review yet?
    Mr. Jackson. I don't know that. I know that they are 
working very hard on it, and at the risk of being obsequious, 
let me say that we are very grateful for your intervention in 
this particular application. It has made a big difference, and 
thank you for your work in bringing this project to the point 
where it can be considered for an FFGA this year.
    Senator Murray. Great. Thank you. I look forward to working 
with you again. Thanks for your work on that.
    One last question really quickly. I wanted to follow-up on 
Senator Cornyn's question on the Mexican border. You know the 
Ninth Circuit decision, which I noticed you didn't answer in 
your response to him. The transportation appropriations bill 
required you to beef up the safety checks and inspection 
procedures, and now the Ninth Circuit Court of Appeals has 
forbidden you from opening the U.S.-Mexican border because 
there was not an environmental impact statement, I believe is 
the court decision. Do you know how long it is going to take 
you to prepare that EIS?
    Mr. Jackson. We don't. We did an environmental review, and 
I may not have the exact term of art for what it is called. It 
is an environmental assessment shy of the full-blown EIS. We 
believe that that was the appropriate level of review for this 
particular project. Regrettably, the Ninth Circuit Court did 
not share that view, and we are in the process of discussions 
with the Justice Department on our----
    Senator Murray. Do you have an estimation of when the 
border will be open at this point?
    Mr. Jackson. I don't. We need to reconcile this issue. It 
is pending a legal matter and so I need to defer to the lawyers 
who have the lead in this area to help us take an appropriate 
course of action.
    Senator Murray. Well, we did appropriate money for truck 
inspectors on the border and inspection stations. What is being 
done with that money since the border is not open?
    Mr. Jackson. Right now we are trying to bring additional 
focus to truck safety enforcement in the border zone, which is, 
as mentioned in our previous discussions, a priority issue for 
us as well and part of the overall effort to bring greater 
scrutiny to border traffic. So we are putting those people to 
good use. As you know, there are restrictions written in the 
appropriations language directing that we not take those assets 
and use them elsewhere in the system. If it turns out that we 
feel that we should have the flexibility to use those assets in 
a different way, then we will come back to the Congress and ask 
for that type of flexibility.
    Senator Murray. Thank you very much, Mr. Chairman, and 
thank you, Mr. Jackson.
    Mr. Jackson. Yes, thank you, Senator.
    Chairman Nickles. Senator Murray, thank you very much.
    Senator Sarbanes.
    Senator Sarbanes. Thank you, Chairman Nickles.
    Mr. Jackson, I have a number of questions, and I will try 
to run through them with you very quickly.
    Mr. Jackson. Yes, sir.
    Senator Sarbanes. Two days ago, the Washington Post had an 
article reporting that the new security and flight rules for 
three nearby airports in Maryland--College Park, Washington 
Executive, and Potomac Air Field--are taking a heavy toll on 
operations and on employee income and revenues of the airport 
owners and businesses located there. The three airports are 
currently operating at only about 15 percent of the pre-9/11 
levels. What thought is the Administration giving to 
compensating these airports and their fixed based operators for 
their losses in revenue and income during these restrictions? 
For all intents and purposes, these airports have been closed 
down, through no fault of their own, for national security 
reasons. Shouldn't the Federal Government undertake some effort 
to provide them compensation for their financial losses?
    Mr. Jackson. At this juncture, we have not proposed 
anything, Senator, but I do not want to close the door on a 
discussion with you. We do believe that these three airports 
pose a particular vulnerability for the capital, which has 
necessitated, similiar to all the general aviation airports in 
the country, that we impose some specific security restrictions 
on traffic in and out of these places. As a result of raising 
the national threat level to Threat Level Orange, we have put 
some enhancements in place over the last weekend at these three 
airports.
    So I recognize that it makes flying in and out of those 
three locations more burdensome. I wish that I could----
    Senator Sarbanes. More burdensome? It, in effect, is 
putting them out of business. If you are going to treat them as 
acceptable collateral damage in the fight against terrorism, it 
seems to me you ought to undertake some program of recompensing 
them. Simply by virtue of their location, through no other 
fault of their own, they have had imposed upon them such 
restrictions that they, in effect, have been closed out of 
business.
    Mr. Jackson. Well, they have certainly seen their business 
significantly diminish.
    Senator Sarbanes. The number of flights in and out of 
College Park has plummeted from 1,800 a month to 164 last 
month. They don't even have 10 percent of their previous 
business.
    Mr. Jackson. The budget for this, I have to say--this 
sounds like a classic bureaucratic dodge. This is not a DOT 
budget issue. This is a Secretary Ridge budget item for the 
Transportation Security Administration. So I don't bring to 
this table the ability to commit the Department of 
Transportation to a security program of the sort that you are 
talking about. But what I will commit to you, sir, is if you 
would like us to engage with you in a discussion about options 
on that topic, I would be happy to do that.
    Senator Sarbanes. Were the limitations imposed upon them a 
DOT act?
    Mr. Jackson. They are a Transportation Security 
Administration act, yes, sir, and the Transportation Security--
--
    Senator Sarbanes. It seems to me when you carry it to the 
point of putting somebody virtually out of business, you ought 
to figure out what you can do to compensate in that situation. 
We intend to pursue this. You have two problems. One is: Are 
the restrictions you are imposing reasonable given the 
circumstances? One could examine that. But I know you are on 
very high alert and all the rest of it, and it is difficult to 
raise those kinds of issues in the current environment. But, 
nevertheless, if you are going to impose these kind of 
restrictions to the extent of virtually putting these people 
out of business--that is what it amounts to. I don't think the 
Federal Government ought to just come along and do that and not 
do something to make up for it.
    Can you take that back to the Department and undertake to 
look at it?
    Mr. Jackson. Yes, sir, I will. I will tell you that that 
question has been a topic of debate, and we will take that back 
for further scrutiny and be happy to follow-up.
    Senator Sarbanes. All right. Let me----
    Chairman Nickles. But you are basically saying, though, 
that you believe that is in Secretary Ridge's Department.
    Mr. Jackson. Not to split a budget hair, but the budget 
money for that program is in Secretary Ridge's Department. DOT 
didn't get the passback for the Transportation Security 
Administration in our 2004 budget.
    Senator Sarbanes. I do think that is a bureaucratic dodge. 
[Laughter.]
    Mr. Jackson. But I am not trying to give you a bureaucratic 
dodge because I personally----
    Senator Sarbanes. Well, I know. You come along and you take 
the action that causes the problem, and then you say, well, if 
you are going to get that problem alleviated, you have got to 
go look somewhere else. Then you go somewhere else, and the 
other guy says, ``I never caused this problem.''
    Mr. Jackson. Well, Senator----
    Senator Sarbanes. ``Why are you coming to me? I didn't 
create this problem.'' Right?
    Mr. Jackson. Let me be a very non-bureaucratic guy. I hate 
bureaucratic solutions. I will take the responsibility to do 
what you asked, which is to discuss this with Secretary Ridge, 
and get back in a straightforward way with you.
    Senator Sarbanes. All right. I appreciate that.
    Mr. Jackson. Yes, sir.
    Senator Sarbanes. Your budget proposes lowering the cap on 
the Federal match for transit projects to 50 percent. Is that 
correct?
    Mr. Jackson. On New Starts program, sir.
    Senator Sarbanes. Currently the cap is 80 percent for both 
highway and transit projects. Does your budget lower the cap 
for highway projects as well?
    Mr. Jackson. No, sir. Let me try to unpack this one a 
little bit as well. The 50-percent match is for the New Starts 
program--I am going to avoid getting the big budget book here.
    Senator Sarbanes. What are you doing on the highway 
projects?
    Mr. Jackson. 80/20 is the standard----
    Senator Sarbanes. We always had the same match in order not 
to skew the decision for local decisionmakers as between 
highways and transit. We didn't want the Federal Government 
coming along and tipping scales because of the different match. 
We wanted to leave that neutral so that decisions would be made 
on the basis of what would meet local transportation needs.
    Mr. Jackson. Senator, let me explain it this way: The core 
program, the largest portion of our transit expenditures are an 
80/20 match. The core program, thank you for the chart--which 
is $5.6 billion, is formula grant research program. That is an 
80/20 match.
    Then there is this one fund of approximately $1.5 billion 
that is called Major Capital Investment Grants. These are very 
large capital projects, which are intended to be a 50/50 match. 
We have been working backward from the 80/20, and I will just 
give you some recent experience on this one. On average, with 
the funds that States and localities bring to these projects 
the Federal share for these projects is slightly under 50-
percent right now.
    Senator Sarbanes. But that is because they are willing to 
make that extra commitment. But when you structure the thing up 
front for their choice, it is still 80/20 between transit and 
highways, is it not?
    Mr. Jackson. It is not for this program, but it is for the 
bulk of the transit program 80/20. For New Starts, our proposal 
is 50/50.
    Senator Sarbanes. What is it for new starts in highways?
    Mr. Jackson. We don't have a comparable equivalent program 
in highways. They are all, of course, as you know, very large 
investment programs.
    Senator Sarbanes. So if I am a locality and I undertake to 
do a new highway project, what is my match?
    Mr. Jackson. 80/20 is the standard.
    Senator Sarbanes. If I am a locality and I undertake to do 
a new start transit project, what is my match?
    Mr. Jackson. Our proposal is 50/50.
    Senator Sarbanes. So you have lost the level playing field, 
and it seems to me you are tipping the scales.
    Mr. Jackson. We are trying to balance a program which has 
far exceeded the capacity to meet demand. So what we are trying 
to say is we can fund more projects if we bring a 50 percent 
match to it, and we feel comfortable with that proposal because 
the programs on the table in recent years have managed to bring 
a 50/50 match to the table and jump-start the----
    Senator Sarbanes. But you could do the same thing with 
highways. You could fund more highway programs if you did a 50/
50 match. Could you not?
    Mr. Jackson. That is right. That is absolutely----
    Senator Sarbanes. Don't you have requests for highways far 
in excess of available funds?
    Mr. Jackson. We have a program that has a long history, and 
we are sticking to that with the highway program. I am trying 
to tell you that in a constrained budget environment, we are 
making a business judgment, which, by the way, has been a very 
high priority of the Appropriations Committees in the House and 
Senate, particularly in the House, to push----
    Senator Sarbanes. It has been a priority of the Chairman of 
the sub-committee in the House.
    Mr. Jackson. Yes, sir, a very big priority of his.
    Senator Sarbanes. Not in the Senate. Not in the Senate. You 
have a comparable situation. You have highway demands far in 
excess of available money. You have transit demands far in 
excess of available money. Now, if you are going to reduce the 
match and you can put a rationale out for doing that, I don't 
see why you wouldn't reduce the match in both categories. The 
same logic would apply. You said----
    Mr. Jackson. Yes, but----
    Senator Sarbanes You can do more highway projects at a 50/
50 match.
    Mr. Jackson. It is, Senator, a prudential judgment about 
how to stretch limited funding in order to support more big 
transit capital investments, and it is our prudential judgment 
that this is a fair way to do it.
    Senator Sarbanes. Fair to whom?
    Mr. Jackson. Fair to the users and to the taxpayers that 
need these systems and that would otherwise be deprived of the 
financial capacity to start one.
    Senator Sarbanes. Let me ask one final question. You state, 
``The President proposes an overall increase of 19 percent for 
the next surface transportation reauthorization as compared to 
the 6 years of TEA-21.'' Is that correct?
    Mr. Jackson. Yes, sir.
    Senator Sarbanes. For the last year of TEA-21 transit, was 
guaranteed $7.22 billion. Will transit get a 19-percent 
increase in the reauthorization proposal, bringing it up to 
$8.6 billion in the last year of the reauthorization?
    Mr. Jackson. Transit over the course of the reauthorization 
period would go up from $36.2 billion to $45.7 billion during 
the period of this proposed reauthorization.
    Senator Sarbanes. What would it be in the last year of the 
next authorization?
    Mr. Jackson. In 2009, the mass transit category will total 
a little over $8 billion.
    Senator Sarbanes. That is not a 19-percent increase over 
the 7.22.
    Mr. Jackson. The 19-percent increase referred to the entire 
surface transportation program, which grows from $207.252 
billion to $247.1 billion.
    Senator Sarbanes. If transit is not growing, what is 
growing? Highways?
    Mr. Jackson. Highways is growing and transit is growing, 
but the overall surface transportation program will grow by 19-
percent figure, sir.
    Senator Sarbanes. Well, how much does transit grow by?
    Mr. Jackson. It grows from $36.2 billion----
    Senator Sarbanes. Percentage.
    Mr. Jackson. The percentage, I would have to ask somebody 
to do----
    Senator Sarbanes. Ten percent? You gave me an $8 billion 
figure as against the 7.22 base. That would be 10 percent, 
would it not?
    Mr. Jackson. I am sorry, sir. I missed that question.
    Senator Sarbanes. You gave me an $8 billion figure against 
a 7.22 base. That would be a 10-percent increase, would it not?
    Mr. Jackson. Yes, sir.
    Senator Sarbanes. All right. You have an overall 19-percent 
increase, so highways is increased by how much?
    Mr. Jackson. Highways is increased by 23 percent over that 
period of time.
    Senator Sarbanes. Well, we have tried very hard to develop 
some equity or equitable parity between highways and transit, 
and, as I read your proposals here, you have completely thrown 
that in the wastepaper basket.
    Mr. Jackson. Senator, I don't think so, and I share very 
much your commitment to the transit investments that we need to 
make. In fact, the total money that we are committing over the 
period actually grows from TEA-21 to the new reauthorization 
proposal by some 26 percent. So we are putting more money in 
this investment. Then the point that I made to a previous 
question about the flex funds being used in the transit is a 
very important part to understand about how we are going to 
fund transit going forward.
    When we first gave this flex funding authority in ISTEA, 
which Secretary Mineta was an author of, we didn't have a 
baseline and understand how to do it and how to use it. What we 
found, as I said, $1.2 billion is now flowing annually from 
highways to transit; $2 million went the other way. So flex 
funding becomes a significant tool to help States deal with 
these issues, and they are not represented in percentage 
increases that you and I were talking about.
    Senator Sarbanes. Well, now, wait, let me just----
    Chairman Nickles. Senator Sarbanes----
    Senator Sarbanes. I know my time is up, but let me just 
stop him on that right now. Have you eliminated the bus 
discretionary program, the one that makes capital investment 
grants for bus and bus facility improvements?
    Mr. Jackson. What we have done is combine a number of 
programs, I believe five programs combined down to two, and we 
put the bus money with some additional flexibility into the 
Formula Grants and Research category.
    Senator Sarbanes. Well, I mean, come on. You talk about 
flex money. It is not flex money. You are taking money that was 
there for particular purposes. You are eliminating the 
purposes, and then you say, we are providing additional 
funding. You are not providing additional funding.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Sarbanes, thank you very much.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman. My apologies to 
you, Mr. Chairman, and to our witness. We also had an Energy 
hearing, which, of course, touches on this issue. Going last, I 
guess we are at the point in the hearing where almost 
everything has been said and almost everyone has said it. I 
just have one question that perhaps you can shed some light on 
how we have evolved on these transportation issues through this 
year, because it seems to me, Mr. Jackson, the Administration's 
position on transportation is sort of a movable feast. It just 
varies depending on the time, and I would like to see if I can 
make some sense out of the process.
    The fiscal year 2003 budget started for Transportation at 
$23 billion. That was the President's budget proposal. Then it 
went to $27.7 billion with respect to the supplemental. That is 
where it went next. As of last night, it went to $31.8 billion.
    What I am really interested in is your explanation as to 
how this process works, because I want to see if I can take 
that information and figure out how to use it to get this 
account up. I think that transportation is, dollar for dollar, 
just about the best investment the country can make, and I 
would like to see if I could get your sense of how this process 
has worked over the year. Circumstances didn't change that 
dramatically, as far as I can tell, in terms of the 
transportation situation. But somehow it went through these 
three stages and went from $23 billion to $31.8 billion. If you 
will give me some information as to how you all went about 
making these judgments, I think then I may be able to divine a 
strategy that will help me get this account up that is so 
important for 2004. That is what my constituents want. They 
thought it was useful that I voted for the Gregg amendment to 
cut capital gains and joined Senator Nickles on estate taxes 
and the like. But what they think is really useful is 
transportation. That is what they think makes sense dollar for 
dollar in terms of a stimulus package, and I want to get this 
account up. Tell me how it went through these stages throughout 
2003.
    Mr. Jackson. I will be happy to give you a concise history 
of that as best I can, and since you had an important role in 
this, I think you probably have a fairly good understanding on 
some of these elements yourself.
    It is a very simple thing. We talked earlier about a 
working man and his paycheck, working for a company that has 
done very well and that individual is given an opportunity to 
have a bonus at the end that supplements the paycheck.
    If you think of that example, which many working men and 
women have in the course of their budgeting for their families, 
year in and year out, there is a lesson for what happened here 
in the plan laid out by Congress for managing our investments 
in the highway program.
    We had a projected baseline obligation limit for each year 
of the authorization. It was $27 billion. We also had this 
tool, RABA, that said if the revenues into the trust fund are 
not as large as we expect, we will spend less, we will cut our 
budget and we will live on less. So last year, the President 
simply took the law passed by Congress and said we promised 
ourselves as a Nation that if we had less into the trust fund, 
we would live on less. That is the number we began with. It was 
$4.4 billion less than the previous year's baseline target.
    That budget proposal was immediately pronounced a 
difficulty that we should not impose upon ourselves, and the 
Administration, after some conversations with the Congress, 
agreed to put the $4.4 billion back into the pot, which is to 
say to fund this program at the level that the TEA-21 
authorization limits promised. What we didn't agree to, until 
the omnibus bill got to the point of closure, was that we 
should put the additional, if you will, bonus payment that came 
from having a good economy in 2002 and make that part of the 
baseline in 2003.
    What has happened here is that the Congress has come to 
expect that the bonus payment is part of our salary. It is not 
part of the baseline salary. It is a bonus payment that came 
from a good economy. We didn't have a good economy last year, 
yet we have just voted ourselves another $4 billion bonus.
    I know the money is going to a good purpose. I certainly 
appreciate and understand that. But what we did was pass a law 
and say here is how we will discipline ourselves, and what we 
have now done is consider the bonus the entitlement. That is 
simply what happened.
    At the end of the day, the Administration agreed that this 
was an investment that it was willing to make as part of the 
overall assessment of what we needed to do to deliver a set of 
appropriations bills.
    Senator Wyden. I am still mystified as to how we are going 
to do all this again in 2004.
    Mr. Jackson. It was very painful this year, so I am 
somewhat mystified myself.
    Senator Wyden. One can kid about it, I guess. My 
constituents think that this is tremendously important from an 
economic and a stimulus standpoint, and I want to be able to 
explain in something resembling English how these decisions are 
made. I think you are saying there was a good year in 2002, but 
we really did not think it was a good year in 2002. Eventually 
we decided there was a good year in 2002, so we will give you 
some more at the final calculation for 2003.
    If that is what you are saying, and tell me if that is the 
case. I do not know where we end up in 2004, because this 
obviously has not been such a good year.
    Mr. Jackson. Well, I will try to go through this from the 
point of view of the budget mechanism of the RABA, and it is 
probably a longer conversation than can be sustained by the 
time allotted to me, but the RABA mechanism has two provisions 
that help us decide whether we can go up or should go down 
around the baseline that was passed. One part of it is a so-
called look back, which considers the amount of money that 
actually came into the trust fund. That is the look back. Then 
it takes the Treasury forecast of what will happen in the year 
ahead--the look forward--and it adds that into the equation. So 
the combination of look forward and look back becomes a 
projection for RABA that allows us either to adjust upwards or 
downwards from the authorized level of the 6-year program. In 
most of TEA-21 we had a plus number. At the end we had a 
negative number. So that is the law and that is the way the law 
works.
    What I would say to your constituents is that the 
President's budget overall imposes a 4 percent increase in 
discretionary programs and that we have proposed a 6 percent 
increase in the highway fund.
    Senator Wyden. Well, I am not going to belabor this. I 
guess the look back and the look forward seem to have gotten it 
up once, which sounds useful, but now it sort of looks like we 
are ignoring this exercise because some of us think that this 
ought to be a good stimulus, and we cannot yet get a bipartisan 
agreement on it. I hope that we can. I want to engage the 
Chairman just for a moment. I think the Chairman has been 
absolutely right in coming back to the importance again and 
again of the value of getting a bipartisan agreement on this 
issue. Certainly if we cannot get a bipartisan agreement on 
every account, there ought to be an effort to get a bipartisan 
agreement on some key accounts. If ever there was one that was 
a natural, this one is. I mean there is not a single person who 
comes up to any of us and says, ``This ought to be a Democratic 
road and this ought to be a Republican road.''
    All they do is talk about potholes and traffic jams and the 
like, and I want to end this by saying I am very anxious to 
work with the Chairman and pick up on his message that we try 
to do as much of this in a bipartisan way as we possibly can, 
and if ever there was an account that would lend itself to 
that, I think this would be the natural.
    Mr. Jackson has been patient--I was late--and put this into 
something resembling English, but we need a process to get to 
the higher number quickly, rather than this water torture 
exercise that we have gone through in 2003.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Wyden, thank you very much.
    Just a couple very quick questions, Secretary Jackson.
    Administration believes it ought to abide by the law?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. Is not RABA part of the law?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. So should we not be spending 23 billion 
in 1903 instead of 31?
    Mr. Jackson. That was our initial proposal, sir.
    Chairman Nickles. I am just--I think Congress passed RABA.
    Mr. Jackson. Yes, sir.
    Chairman Nickles. With the previous administration, I might 
mention.
    Mr. Jackson. Yes, sir.
    Chairman Nickles. But the idea of that was to get money out 
of the trust fund, and I guess maybe people never really 
thought the negative might happen.
    Mr. Jackson. Right. We had 3 years during the 6-year period 
where it was a plus, and we had 3 years of a down.
    Chairman Nickles. What I think we are seeing is that 
Congress has no intention of abiding by the down side.
    Mr. Jackson. That appears to be true.
    Chairman Nickles. We will take the up side, but the down 
side, Congress is going to kind of ignore the law, and I think 
put us on a course that is either going to--I started to say 
bankrupt the trust fund, but inevitably lead to either higher 
gasoline taxes, or we are going to have some contractors that 
are going to be severely disappointed.
    I might mention, I will drive some of our people nuts, but 
I think the 80/20 ratio is a little high for highways. Now, 
Senator Sarbanes was not really trying to get you to say we 
should go 50/50 on highways. He was trying to make the 
distinction between mass transit and highways, but 80/20 
encourages a whole lot of things, that if it was a more 
balanced ratio--and I have been looking at Federal tax versus 
State tax. I think you would have a more balance--right now 
everybody wants all the Federal money from highways because the 
Federal Government is paying 80 percent. You have a more 
balanced structure. Even if you moved it to some extent--and 
you might be looking at different ways to help us out of this 
quandary, because obviously the votes are going to be there for 
continuing at 31 billion plus. We may have to try and figure 
out a way to do this. Some people would like to say they want a 
tax increase, but that is not going to pass in my opinion. So 
we have to kind of figure out how we handle this in the future, 
and maybe some ratio change, maybe even gradually or something. 
I do not know. We will just have to be thinking about it, 
because I can easily see RABA has just been ignored. We might 
as well repeal it, just ignore it, because it was just an 
excuse to get more money, but they never want to go down. It is 
kind of--you are right, that bonus became base and nobody wants 
it cut. But I also read the law.
    One other little section of the law. I believe we passed a 
law that said that Amtrak is going to be self sufficient by 
1902. Is that not a law? Was that not part of the 1997 bill 
that we passed that was trying to send a signal to Amtrak, you 
are going to have to get off the Federal subsidy train?
    Mr. Jackson. Yes, sir, it was.
    Chairman Nickles. Is that still the law? Is it still on the 
books?
    Mr. Jackson. That is the law that would be replaced by the 
reauthorization, but Amtrak failed to hit that self-sufficiency 
target.
    Chairman Nickles. I understand we failed to--is Amtrak due 
for reauthorization?
    Mr. Jackson. This year, yes, sir.
    Chairman Nickles. This year. I hate to see very 5 years we 
keep coming back, well, yes, we are going to have to fix it, 
and also in the meantime, if I remember the subsidy for Amtrak 
back in 1997 was, what, 600 million?
    Mr. Jackson. Just 2 years ago it was $521 million in the 
Administration's budget.
    Chairman Nickles. 500 or 600 million. Now the bill that 
just passed was--500 or 600 million, and now it is 1.1 billion 
in the bill that just passed. Your proposal is 900 million, 
which is a significant increase over 2 years ago.
    Mr. Jackson. Yes, sir.
    Chairman Nickles. Still people are clamoring that they want 
it to be more. Would you do me a favor and give me a list? I 
noticed in your budget proposal you mentioned several routes 
that had significant subsidies per passenger, per trips?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. Did you do that--I am assuming you have 
it for all the lines. Would you go ahead and give that to us 
for all the lines?
    Mr. Jackson. Yes, sir, I would.
    Chairman Nickles. Would you do the same thing for essential 
air service?
    Mr. Jackson. We can give you those numbers on essential air 
service, yes, sir.
    Chairman Nickles. I would appreciate it. I know you had 
some reforms scheduled for essential air service, and I believe 
you are working--I believe I heard you say to Senator Murray's 
request, that you are planning on doing a--or introducing or 
proposing an Amtrak reauthorization reform proposal as well?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. I would encourage that. I think we need 
to pass it. We did not really get it done last time. I think we 
passed in 1997, ``hope you get there, but we did not really 
give you any direction.'' Maybe Congress this time can lend 
some seriousness to the proposal, try to make it happen, try to 
save what maybe is economically a viable spinoff to other 
areas, maybe encourage States and other areas, maybe give 
States flexibility to use some of the mass transit funds that 
they cannot utilize, us that for Amtrak or other public 
transportation.
    But anyway, the list of--also you mentioned that you have 
26 mass transit projects that are new starts.
    Mr. Jackson. In this proposal, yes, sir.
    Chairman Nickles. In this proposal. I believe you mentioned 
the new starts would total $1.5 billion, and that was just in 
the 1904 budget. Would you give us a list of those and what 
their projected total cost is?
    Mr. Jackson. Yes, sir. I believe we have a list of all the 
New Starts program in this Budget in Brief book that we have 
provided to your staff, but if there are any questions, we 
would be happy to answer the questions about those.
    Chairman Nickles. I apologize because I tried to review 
most of this material and I did not get that far.
    Mr. Jackson. You could not possibly keep up with all that 
flow of paper, sir.
    Chairman Nickles. But I am concerned about getting started. 
I happen to be one that compliments you on moving to 50/50. I 
am concerned about encouraging new starts and having people 
think this is the grand salvation for some areas, and starting 
on projects that frankly are economically not viable and they 
would not be starting them if it was not for the fact that they 
thought the Federal Government was going to be picking up 80 
percent of the cost or more, and I think if you increase the 
percentage cost at risk from the local area, then they will be 
much more prudent with their own dollars than they would be 
with Federal dollars. I really do believe there is this idea, 
that whether you are talking about highway funds, you are 
talking about Medicaid funds, you name it, if it is coming from 
the Federal Government, it is free, and let's leverage this to 
the hilt, and with minimal consequences if their contribution 
is that small.
    So anyway, you are supplementing the subsidy, and also I 
believe Senator Cornyn was asking for information on relative 
subsidies compared to different transportation modes.
    Additionally, the Highway Trust Fund, you mentioned trying 
to transfer or your proposal to transfer the 2.5 cents gasohol 
tax, which now goes to General Revenue, and I believe I heard 
you say that that would raise about $600 million per year, 
would be moved from General Revenue that it is presently going 
into General Revenue, and will be going into the Highway Trust 
Fund. Is that correct?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. Part of your theory is on that, you are 
looking at gasoline taxes, a user fee.
    Mr. Jackson. Exactly.
    Chairman Nickles. So people that are using the roads should 
pay for the roads.
    Mr. Jackson. Exactly.
    Chairman Nickles. Does a gasohol car do as much damage on 
the road as a----
    Mr. Jackson. Yes, sir, there is no material difference.
    Chairman Nickles. How much additional fund would be going--
how much additional money would be going into the trust fund if 
the Federal excise tax was the same on gasohol vehicles as it 
is on other gasoline vehicles?
    Mr. Jackson. I believe there is a delta of 5.3 cents 
between what is collected in the tax on gasohol presently, and 
what is collected presently for gasoline.
    Chairman Nickles. The volume of that times the number of 
gasohol gallons would be equal to how many dollars?
    Mr. Jackson. It would be--roughly, since it is $600 million 
for the 2.5 cents, call it $1.4 billion, something in that 
range, probably would be a seat of the pants guess there.
    Chairman Nickles. So if it is 1.4 plus the 600, if you had 
basically gasohol you would be close to $2 billion per year if 
gasohol vehicles paid the same gasoline taxes as other 
gasoline?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. There is also a very large category of 
vehicles that do not pay Federal excise tax. Correct me if I am 
wrong. Vehicles by some tribes, Native Americans, some are 
exempt from State tax. Are they also exempt from Federal tax?
    Mr. Jackson. To be honest, I do not know the answer to that 
question, sir. I will be happy to get that for you.
    Chairman Nickles. I notice in my State there is a growing 
number of tribes that I believe are exempt from Federal excise 
tax. I would be interested in knowing that, so if you could do 
that.
    Mr. Jackson. I would be happy to provide you a list of any 
exemptions that are available under current law.
    Chairman Nickles. Also with the amounts it would raise if 
that exemption was not there.
    Mr. Jackson. Yes, sir.
    Chairman Nickles. I happen to look at roads as users should 
be paying for them, and I think that would make sense. Would 
you agree that possibly some State--right now part of the 
Federal excise tax on gasoline, part of that 2.86 cents per 
gallon is for mass transit?
    Mr. Jackson. Yes, sir.
    Chairman Nickles. Some States do not have mass transit, or 
they have limited mass transit. It is in the form of bus, maybe 
some light rail or some other alternatives.
    Mr. Jackson. Yes. I do not think I could find a State that 
does not have some meaningful mass transit and makes use of 
those. There is the ability to flex part of your mass transit 
formula funding into highways if you are not going to be able 
to use it for mass transit purposes. As I explained earlier, I 
believe in the year 2002 it was slightly over $2 million that 
flexed from----
    Chairman Nickles. 2 billion?
    Mr. Jackson. $2 million. It was $1.2 billion that went the 
other way, and it was a couple of million dollars that went 
that way. So that says that the States are actually using their 
formula for transit projects, and they are taking some of that 
highway money, a significant amount, $1.2 billion net through 
out the country, and putting it into transit investments.
    Chairman Nickles. I thought maybe you misspoke a little 
earlier. So you are saying that some States have taken as much 
1.2 billion out of highway funds and used those for mass 
transit?
    Mr. Jackson. Exactly. All the States collectively spent 
that much in 2002.
    Chairman Nickles. Only a couple of million that actually 
went from transit to highways?
    Mr. Jackson. Exactly.
    Chairman Nickles. Maybe I am being parochial, but my 
recollection is, like a State like mine, we receive very little 
out of the transit funds, very little, de minimis, 10 percent 
of what we contribute, something like that. That is for bus in 
Oklahoma City and Tulsa. I worked some time ago to try to get 
some flexibility on some of that money to be used to subsidize 
Amtrak, which at that time we did not have in our State. So 
that was an effort that I made, which it is kind of a form. So 
we would be connected to this interstate system that we were 
not presently.
    Mr. Jackson. Yes.
    Chairman Nickles. We are presently on it. Do you think that 
makes sense? Should States be able to have some flexibility to 
be able to at least get some de minimis amount of the transit 
funds if they so desire for Amtrak?
    Mr. Jackson. I think that is something we should take a 
hard look at, and I would be happy to do that. We are, as a 
principle, in President Bush's proposals for transportation, 
trying to give States a maximum amount of flexibility to spend 
their money in the way that the States think is appropriate. So 
that would have to be something that we look at in our TEA-21 
reauthorization and also think about it in the context of the 
Amtrak reauthorization.
    Chairman Nickles. I would appreciate it. Did I ask you 
for--I did ask you for a list of the Amtrak subsidies by route?
    Mr. Jackson. Yes, sir, by route. We can give you that, yes, 
sir.
    Chairman Nickles. So we can kind of figure out which ones 
are breaking even, which ones are not, which ones are 
subsidized, which ones are subsidized by their States.
    Mr. Jackson. Yes, sir.
    Chairman Nickles. I believe you mentioned Washington might 
be subsidizing or helping their State. We are in our State.
    Mr. Jackson. You are in your State, and California is in 
their State. There are a few States that do that in a 
systematic way, but there are only a few that provide that type 
of assistance.
    Chairman Nickles. I believe in your Amtrak proposal you are 
going to try and make that opportunity available for more 
States.
    Mr. Jackson. We are, yes, sir.
    Chairman Nickles. I understand. Secretary Jackson, I 
appreciate your cooperation before the Committee, and your 
endurance of maybe repetitive questions, but thank you very 
much.
    Mr. Jackson. Not a problem at all.
    Chairman Nickles. I appreciate your appearance and look 
forward to some of your answers to our questions. Thank you 
very much.
    Mr. Jackson. Thank you, Mr. Chairman. I appreciate your 
having me here.
    Chairman Nickles. The meeting is adjourned.
    [Whereupon, at 4:18 p.m., the committee was adjourned.]

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   THE PRESIDENT'S FISCAL YEAR 2004 BUDGET PROPOSAL FOR MEDICARE AND 
                                MEDICAID

                              ----------                              


                      WEDNESDAY, FEBRUARY 26, 2003

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 3:11 p.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Don Nickles, 
(chairman of the committee) presiding.
    Present: Senators Nickles, Gregg, Allard, Enzi, Crapo, 
Ensign, Cornyn, Conrad, Murray, Wyden, Stabenow, and Corzine.
    Staff present: Hazen Marshall, staff director; and Megan 
Hauck, health policy director.
    For the minority: Mary Ann Naylor, staff director; and Sue 
Nelson, deputy staff director.

           OPENING STATEMENT OF CHAIRMAN DON NICKLES

    Chairman Nickles. The committee will come to order.
    Today, the Budget Committee will hear testimony from the 
Secretary of the Department of Health and Human Services, 
Secretary Tommy Thompson. Prior to becoming Secretary of HHS, 
Tommy Thompson was Governor of the great State of Wisconsin for 
14 years, and did a fantastic job as Governor. He was a pioneer 
in welfare reform, in Medicaid, in health care, in education. 
He really has been, and I say that not just bragging about a 
friend who happens to be testifying today as Secretary of HHS, 
but as a member who worked on welfare reform and health care 
issues, Governor Thompson was maybe the premier Governor who 
was leading the fight for real reform and real successful 
reform, I might mention, that saved a lot of people from the 
chains of welfare dependency and also changed the whole 
operation of welfare and saved money in the process. It is a 
real success story in this Senator's opinion. I was pleased to 
be a participant in, I believe, a very positive, evolutionary, 
significant reform.
    The Secretary has proposed significant reforms in Medicare 
and Medicaid as well. We look forward to hearing from him on 
both of those issues today.
    Before I make any further comments, I would call upon the 
ranking member, my friend Senator Kent Conrad.

              OPENING STATEMENT OF SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman. I want to add my 
voice to yours in commending the Secretary. I always thought he 
was innovative and creative and focused on issues that really 
make a difference. As Governor, I very much appreciated the 
work he did on welfare reform and was glad we were able to move 
forward with that at the Federal level. I think we made 
dramatic improvements, and a lot of it was based on work that 
you did as Governor, and we want to recognize that.
    I also have always felt as a Midwesterner a certain kinship 
and I have especially appreciated the sensitivity that you have 
shown on issues that relate to rural health care. We have a lot 
of problems out there, and you are acutely aware of them. 
Differential medicare reimbursement levels around the country 
create very serious problems for rural parts of our Nation.
    I have used the example many times that Mercy Hospital in 
Devil's Lake, North Dakota, gets half as much as Mercy Hospital 
in New York to deal with a heart attack; exactly the same 
illness but half as much money. Rural hospitals don't get rural 
discounts when they buy equipment, and they don't get any rural 
discounts when they have to pay salaries for the people that 
work in those institutions.

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    Today, in terms of an opening statement, Mr. Chairman, if 
you will permit, I want to point out the things that concern me 
deeply, because as I look ahead, this is what I see. These are 
projections from the Social Security Administration. They show 
that we are in the sweet spot now in terms of the Social 
Security Trust Fund. It is throwing off nearly $200 billion a 
year in surpluses, but we see that in 2017 it goes cash-
negative. When it goes cash-negative, it does so in a big way. 
It is like falling off a cliff. We have got to prepare for that 
time.

[GRAPHIC] [TIFF OMITTED] 


    Let's go to the next chart that shows the same pattern with 
respect to Medicare. The Medicare Trust Fund is running cash 
surpluses that are much more modest than Social Security, but 
it goes cash-negative in 2016. Proportionally, it is an even 
more stark and more serious story in terms of the trajectory.

[GRAPHIC] [TIFF OMITTED] 


    Let's go to the next chart. This one is really the most 
important because it puts all the information together with the 
President's proposed tax cuts. And this is why, I must confess, 
I don't comprehend what the President has proposed. It seems to 
me that it doesn't add up, and it has us headed over a cliff.
    On this chart, to the tax cuts are in red, the Medicare 
surplus deficits are in blue, and the Social Security surplus 
deficits are in green. The Medicare and Social Security 
estimates are based on GAO's analysis. Frankly, I think they 
are somewhat conservative, but we are using their numbers.
    We prepared the tax cut estimates, because they are for an 
extended period of time going out to 2023. What one sees is 
that when the costs to the Federal Government in Social 
Security and Medicare explode, the cost of the tax cuts' 
explode. What we are left with is deficits of staggering 
proportion.

[GRAPHIC] [TIFF OMITTED] 


    Let's go to the next chart. The revenue loss from the 
President's tax cut proposal is larger than Medicare and Social 
Security shortfalls combined. The Social Security shortfall--
according to GAO--is $3.4 trillion and Medicare's shortfall is 
$5 trillion. The tax cut is larger than both combined, at $11 
trillion over that period.

[GRAPHIC] [TIFF OMITTED] 


    Again, I don't think we have a program in front of us that 
makes sense or adds up. The final chart is from the President's 
budget document, and it shows that we are in the sweet spot of 
the budget cycle now, with the trust funds throwing off 
substantial surpluses. But look what happens after 2013. Again, 
this is from the President's own budget document. After 2013, 
the deficits are totally unsustainable. This does not include 
war costs, the cost to fix the alternative minimum tax, or a 
number of other things that are likely to happen.

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    So, Mr. Secretary, I think we are going down a budget path 
that makes no earthly sense to me, and that is what I want to 
talk about when we get to the questioning period.
    Chairman Nickles. Senator Conrad, thank you very much.
    Mr. Secretary, Senator Conrad's chart showed a $5 trillion 
negative deficit, an unfunded liability in Medicare over the 
next 75 years. I think it is closer to $13.3 trillion, at least 
the figures--I am not sure what the differences are, but----
    Senator Conrad. If I might say, this is GAO's estimate of 
the shortfall counting the general fund transfer to Medicare. 
Your estimate excludes transfer, which is required by law.
    Chairman Nickles. I believe the unfunded liability on 
Medicare is $13.3 trillion. I believe the unfunded liability in 
Social Security is less than that. So we have significant 
problems, and I appreciate Senator Conrad's admonition. We need 
to do something about it.
    I believe you have proposed some changes both in Medicare 
and Medicaid that would help alleviate the deficit. One of the 
fastest-growing accounts in Government today is Medicaid. You 
have a proposal to fix it. The States are all screaming. State 
governors have been coming into town to see us recently. 
Medicaid growth has compounded at really unsustainable rates. 
It needs to be changed, and you have a proposal to change it. 
We look forward to hearing from you.
    Last year, Medicaid grew 14 percent. This is the Federal 
cost. The year before 9.7 percent; the year before that, 9.1 
percent. Even the rate of growth been increasing every year. It 
is obviously not sustainable. It is not sustainable to the 
Federal Government or to the State governments. States have 
been saying, Federal Government, you pick up a greater share. 
It is not sustainable for the Federal Government either. So, 
you have some proposals to reform it. I compliment you for 
that. This may be the first significant reform in Medicaid in 
some time.
    You also have some Medicare reforms to propose in an effort 
to save Medicare. I compliment you for those, and we look 
forward to hearing your explanations and suggestins regarding 
both of these very important, significant programs. I 
compliment you for your service in the past, and I look forward 
to working with you on these issues as well. Please present 
your statement.

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

    Secretary Thompson. Good afternoon, Mr. Chairman. Thank you 
so very much for your kind words, and thank you for inviting me 
here.
    Mr. Conrad, thank you as well for your kind words and for 
your charts and for your explanations.
    Members of the committee, it is an honor for me to appear 
in front of you and thank you so very much for inviting me to 
testify this afternoon.
    Mr. Chairman, I want to thank you for your continued 
leadership on so many issues that are vitally important to the 
American people. I have enjoyed our previous meetings, and I 
know that this whole committee wants what I want, which is for 
all Americans to be as healthy as they possibly can be.
    In my first 2 years at the Department, we have made 
tremendous progress in our efforts to improve the health, the 
safety, and the well-being of the American people. We continue 
to make extraordinary progress in providing health care to 
lower-income Americans. Through waiver and State plan 
amendments which have been granted to States, we have expanded 
access to health coverage for more than 2.2 million 
individuals. We have expanded the range of benefits offered to 
6.7 million other Americans.
    To expand on our achievements, the President proposes 
outlays for HHS of $539 billion. That $539 billion represents 
an increase of $37 billion, or 7 percent, over last year's 
request, and an increase of more than $109 billion, or 25 
percent, since 2001.
    The discretionary part of the budget increase is $1.6 
billion, or 2.6 percent, to $65 billion of budget authority. 
This would be $600 million, or 1.5 percent, higher than the 
enacted fiscal year 2003 appropriation bill. The $539 billion, 
ladies and gentlemen, is a big number, and I have a solemn 
responsibility as Secretary to make sure that every one of 
those dollars is put to good, effective use. I owe it to the 
people who pay the taxes, and I owe it to the people who 
consume the services.
    One way to ensure these dollars are effective is to work 
with this committee and other committees to improve and 
strengthen our two largest health programs: Medicare and 
Medicaid. These are the two topics I would like to outline for 
you this afternoon.
    As you well know, Mr. Chairman, Senator Conrad, our 
Nation's Medicare program needs to be strengthened and needs to 
be improved to fill in the gaps in current coverage. The 
President has proposed numerous principles for Medicare 
enhancements to ensure that we are providing our seniors with 
the best possible care. We have dedicated $400 billion over the 
next decade to achieve this ambitious goal, and we look forward 
to working closely with Members of Congress to develop and pass 
a responsible and effective Medicare bill this year.
    The budget proposes a prescription drug benefit that would 
be available to all beneficiaries, would protect them against 
high drug expenditures, and would provide additional assistance 
through generous subsidies for low-income beneficiaries to 
ensure ready access to needed drugs.
    Passing Medicare legislation will be a huge task, and 
improving Medicaid is also urgent. In fact, Medicaid is growing 
even more rapidly than Medicare. The Federal portion is $162 
billion this year, and the program is growing about 9 percent a 
year. But State Medicaid programs are under tremendous 
financial pressure, and beneficiaries risk losing coverage. 
Two-thirds of the States currently have already made reductions 
or have reductions pending. The President has proposed a plan 
to preserve coverage, make Medicaid more efficient, and provide 
better health care delivery.
    We must begin by addressing the immediate fiscal needs of 
the States. President Bush's plans would meet the 9-percent 
base growth in the program, and then would allow forward 
funding by $3.25 billion in the first year and $12.7 billion 
over 7 years. The forward funding would help people during the 
current economic conditions, and the flexibility would put the 
States in a better position to handle future economic downturns 
without having to cut people from Medicaid. They will have the 
flexibility to make adjustments to weather the storm.
    I had a chance to discuss this proposal with many 
Governors, Republicans and Democrats, on Monday and throughout 
the weekend, and their reaction was very positive.
    Let me be very clear about two things: first, State 
participation in a new program would be optional; second, 
mandatory populations would continue to receive all of their 
mandatory benefits. The Medicaid entitlement for mandatory 
populations would be unchanged. States will have much more 
flexibility in covering optional populations, which account for 
a large part of Medicaid spending. They will gain the ability 
to target special-needs populations such as those suffering 
from mental illness and AIDS and those who prefer home- and 
community-based coverage. If we do not improve Medicaid, 1 
million Americans could lose coverage this year, and millions 
more next year. I look forward to working with Congress to make 
sure they keep it.
    While I am here, I would like to mention one other item in 
our budget. President Bush recently announced a new initiative, 
Project Bio-Shield, that would help prepare this country for a 
bioterrorist attack. He would spend roughly $6 billion over 10 
years on new counter measures. This proposal would speed up 
research, the approval of vaccines and treatments, and ensure a 
guaranteed funding source for their purchase, just the latest 
in our forward-looking efforts to protect the homeland.
    Mr. Chairman, Americans have made many great discoveries 
over the years, and the discoveries that will endure the 
longest have expanded our understanding of nutrition and 
exercise, birth and aging, and how to prevent, treat, and cure 
disease, disability, and suffering. Our doctors have better 
knowledge and technology at their disposal than ever before. 
The rest of us also have access to a treasury of good advice 
about getting and staying healthy and energetic.
    We have much more to discover, Mr. Chairman, and at the 
same time we also have the opportunity to put our recent 
discoveries into practice, to make sure America's Federal and 
State health programs and the entire medical industry reflect 
the best work of our researchers and the kindest impulses of 
our hearts. By working together, we have made great progress 
toward that goal. As the major proposals in the President's 
budget show, there is much more that we can do together.
    The President has made improving our Nation's health and 
health care one of his highest priorities for the year, and by 
working together, we can make it one of our proudest 
achievements.
    I look forward to all the work, and I know our discussion 
this morning will be able to get things rolling. So thank you, 
Mr. Chairman and members of this committee, for giving me this 
opportunity to come before you and answer your questions.
    [The prepared statement of Secretary Thompson follows:]

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    Chairman Nickles. Secretary Thompson, thank you very much. 
Let me just make a couple of comments and ask a few questions.
    You mentioned Medicaid was growing at a rate of 9 percent. 
Last year, the Federal amount grew 14 percent.
    Secretary Thompson. That is correct.
    Chairman Nickles. As a matter of fact, if you look all the 
way back to 1998, it was 5.9 percent, then 6.7, then 9.1, 9.7 
in 2001, then 14 percent in 2002. That ramp really concerns me. 
If there was a 1-year spike and you expected it to come down 
but it has been getting bigger, then I am concerned that it may 
be bigger next year.
    Now, you have proposed changing it, but part of that is 
because of congressional add-ons. Part of that is because we 
have changed some of the laws in the Finance Committee and 
others, a result of which is that we have given States great 
incentives to add people. I might mention that I believe about 
three-fourths of Medicaid spending is optional; in other words, 
you have mandatory Medicaid spending, but you also have 
optional Medicaid spending, optional on individuals, optional 
on income levels. Optional spending is where a lot of the 
explosion has been. I have been troubled by the fact under 
SCHIP we have a much greater Federal subsidy for higher income 
than Medicaid, and I think that needs to change. It bothers me 
to think that we would subsidize people with higher incomes 
more percentage-wise than we do people with lower incomes, and 
that is what we have done under SCHIP as an incentive for 
States, to cover some additional kids.
    I believe your proposal, and maybe you can better explain 
it, would allow States to take the moneys that they are 
presently receiving under Medicaid, SCHIP as well as Medicaid 
mandatory and optional, and block that money together. Maybe 
``block'' is not the right terminology--have flexibility on how 
they would cover those same people as far as benefits, and 
incentives, to participate. Is that correct?
    Secretary Thompson. That is somewhat correct. If I could 
just take a few minutes to explain.
    It is not a block grant because the mandatory population 
and the mandatory coverage for the mandatory population is not 
touched. We have a trend line that we have to decide each year 
somewhere around October, and it is based upon the cost 
accounting of the States. We project out a 10-year trend line, 
and for the next 10 years we project that the trend line is 9 
percent.
    Now, next year, if drugs keep going up, the trend line 
could be 10 percent, and that would change the trend line for 
the next 10 years, maybe at 10 percent. So we would project out 
for 10 years. That continues. That will continue. That will 
remain static.
    The second part of it, however, allows for the one-third of 
the population which are the optional population--two-thirds of 
the population in Medicaid is mandatory; one-third is optional. 
Two-thirds of the services are optional and two-thirds of the 
costs in the budget are for the optional population and two-
thirds of the options. So, we have allowed the States--we have 
taken the most successful parts of TANF, the most successful 
parts of SCHIP, and rolled it into Medicaid, so that States 
would have the discretion to be able to allow them to develop a 
better program in their Medicaid system and be able to get the 
Federal dollars to be able to allow for optional service 
without asking for waivers.
    For example, the State of Utah had a Medicaid budget in 
which their health benefits were higher than the Governor and 
the State employees. They want to be able to reduce their 
health benefits in their Medicaid population to be able to buy 
into their State health plan, save money, and allow for more 
people to be covered. They couldn't do it under the Medicaid 
law because everything has to be uniform, so they will be able 
to change that and allow that to take place.
    Your State, you have rural areas and you have urban areas. 
Under the Medicaid law, you have to have uniform and the same 
services from one part of the State to another. So if you add 
an optional population, you will then have to make sure of that 
in the urban area and in the rural area. So you may have an HMO 
that you want to put some people in. You can't do that unless 
you have HMOs in both to save money.
    So, the States right now only have the capacity of 
continuing funding allowing the program to grow or be able to 
have the flexibility to define the kind of program they want 
for their particular State. That is the beauty of the changes. 
It is voluntary. So States could either accept it or not. Plus 
we would forward-fund $12.7 billion over 7 years. The first 
year would be $3.25 billion. We would ask the States to divide 
up the Medicaid pot into two blocks: one for acute care, which 
is not growing as rapidly, but the second one is long-term care 
and prevention, which is growing much faster.
    What we would like to see happen is that States would be 
able to start addressing the long-term population, the elderly 
population. We would like to give them the flexibility for 
keeping more of their senior citizens in their homes, therefore 
lessening the cost and improving the quality of care. We are 
also putting more into prevention because that is where we are 
going to save the most dollars and improve the quality of 
health. They really don't have the capacity to do that under 
the existing law. This would allow them, if they want to go 
into it, to be able to do that.
    Chairman Nickles. Secretary Thompson, thank you.
    I have additional questions on the upper payment limit 
which I think is a rip-off in the present system, one which is 
driving costs very high.
    Secretary Thompson. That is true.
    Chairman Nickles. I want to try and stay on the 5-minute 
limit for myself and for all of our colleagues, so I will come 
back to you on that. By chance I don't get a second round, I 
will submit that question to you as well. I think upper payment 
has to be addressed, and the phase-out is very long, I think, 
under existing plans.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Let me follow-up if I can on where the Chairman started, 
because he talked about the increasing costs in Medicaid, which 
are sobering indeed. But it think it is very important to point 
out that it is not just in Medicaid that we have seen these 
escalating costs. In 1999 Medicaid increased by 5.8 percent, 
but private health insurance went up 5.5 percent. In 2000 they 
both went up 9 percent. In 2001 private health insurance 
actually went up more (10.5 percent) and Medicaid went up 10.4 
percent. So I think from that one could conclude Medicaid is 
doing a relatively good job, given the fact the program has a 
sicker and more disabled population than private insurers.
    But what is happening here is that health care costs are 
driving everything up in a way that is clearly unsustainable. 
There is no way we can afford these double-digit increases in 
health care costs, either in Medicaid, Medicare, or in the 
private sector.
    When I go home there is nothing brought to my attention 
more frequently by the business community and other 
institutions than what is happening to private insurance costs. 
We have without question, a serious challenge to the Medicaid 
system in terms of these costs, and Medicare as well. But more 
largely, this is a problem of health care costs in general in 
this country.
    One other point I wanted to make is this. When we talk 
about optional groups, I look to what is happening in my home 
State. In North Dakota, medically needy individuals with 
catastrophic medical needs are allowed to spend down to meet 
income eligibility levels. The North Dakota income eligibility 
level for one person is $500 a month in net income. If they are 
above that, they are out. The leel for a family of two is $516. 
These are very, very low levels of income. What absolutely 
confounds me is how the President's tax cuts go together with 
the escalating costs in Medicare and Social Security.
    You were a Governor. You had to balance budgets. You had to 
make tough decisions, and you did. I am sure you had a balanced 
budget requirement, or if you did not, you balanced the budget. 
This is the thing that absolutely strikes me as extraordinarily 
serious for the country. Again, the blue part of those bars is 
the Medicare surplus which turn to deficits. The green bars are 
Social Security. What started out as a surplus turns to 
deficits. The red is the effect of the President's tax cuts. 
What this chart shows us is at the very time the costs to the 
Federal Government explose because of the retirement of the 
baby boom generation, the costs of the President's tax cuts 
explode, driving us deeper and deeper into deficit.

[GRAPHIC] [TIFF OMITTED] 

    Mr. Secretary, how do you explain this?
    Secretary Thompson. Let me try to explain it this way. The 
health care costs in America are going up a lot because we 
spend, I think, money the wrong way. Our Medicare budget really 
drives medical care costs, and we spend 90 to 95 percent of our 
Medicare dollars on getting people well after they get sick, 
and less than 10 percent of the money on keeping people well in 
the first place. We spend $155 billion a year on tobacco-
related illnesses in which 400,000 people die. We spend $117 
billion a year on obesity, of which 300,000 people die. We 
spend $100 billion on diabetes, of which 200,000 die. 17 
million Americans have diabetes today. 16 million more 
Americans are prediabetic. 90 million plus Americans have one 
or more chronic illnesses. That is driving up. If you add those 
three figures, that adds up to $384 billion a year on three 
diseases which can be prevented, and we only spend $269 billion 
on Medicare, and we spend $284 billion a year on Medicaid. So 
if you are going to have an impact on health care costs, we 
have to put more into prevention and we have to do something 
about changing human nature, about eating, exercising and not 
smoking. You will have the biggest impact of anything possible 
to lower the health care costs.
    In regards to the taxes, I am not the President, but the 
President feels very passionate about the fact that he wants to 
make sure that the economy gets moving. He rightfully believes 
that the tax cuts will energize the economy and make up the 
deficits that you are talking about in the outer years by 
getting more people working and generating more money in the 
economy, and that is why the President is pushing the tax cuts.
    Senator Conrad. Let me just say though, the President's 
numbers do not show what you have just said. You have suggested 
that the tax cuts are going to energize the economy and lead to 
lower deficits. The President's own numbers show that the 
deficits explode under his spending and tax policy. This is his 
estimates of what happens.
    I know my time is up, Mr. Chairman.
    Secretary Thompson. All I can answer is that as I 
understand the way that matters are scored in Washington, 
nothing takes into consideration enhanced economic growth or 
development. So you do not have the positive side to a tax cut 
that goes into a chart like that.
    Senator Conrad. I just say to you, 2 years ago we had that 
same pitch made to us when we were told that we had 5.6 
trillion in surpluses over the next 10 years. We passed the tax 
cut, and now we are $2 trillion under water, a $7.7 trillion 
reversal.
    Chairman Nickles. Thank you very much.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I just would 
follow-up on that thought a little bit. That tax cut that 
happened 2 years ago, many economists said that we would have 
been worse off today if we had not had that in place, and even 
individuals who had not supported the tax cut 2 years ago had 
to admit that it did hold up the economy, buoy up the economy. 
In fact the editorial in the Washington Post, for example, in 
September, made that admission in their editorial page. So I do 
believe, and I think many economists do believe, that that tax 
cut that we had 2 years ago did hold up the economy. I think 
that your point is well made in that regard.
    You are probably getting a lot of pressure now, if I may 
move on to another issue, from the States. I mean they are 
suffering a lot of shortfall as far as their revenues are 
concerned. I think they made the mistake in many cases, when 
the economy was doing well, they instituted a lot of programs. 
In the Medicaid program, I think about two-thirds of those 
programs in Medicaid are optional to the State, that about a 
third are mandated. I would guess that they are coming to you 
and asking for you to sustain some of those programs that they 
elected to go in partnership with as an optional program.
    Would you share with me some of your thinking in regard to 
those issues as they bring them up to you?
    Secretary Thompson. Absolutely, and thank you very much for 
the question. Senator, 38 States last year made reductions in 
their Medicaid budget. 32 plus of those States are going to 
make reductions to their Medicaid populations this year. The 
easy answer is just--and my fellow Governors came to me and 
said, ``Just give us more Federal dollars and everything will 
be well.'' But to me, that does not solve the problem because 
the program is old, it is tired, it needs some streamlining and 
modernization, just anything else does. So instead of just 
putting more Federal dollars into it, I wanted to develop a 
system that is going to be more workable, more flexibility, 
more innovative, and so we have set up a program in which the 
States will get some additional money up front, $12.7 billion 
over 7 years, and $3-1/4 billion the first year. The trend line 
goes up at about 9 percent, which is adjusted each year in 
October and November, and we announce it in December and 
January.
    If those States want to go into it on a voluntary basis, 
they would get for the first year an additional $3-1/4 billion 
and there would be about a 12 percent increase from the Federal 
dollars. The second thing we allow for them is that the States 
every year, in order to determine the State's share, they have 
to compute. They have a base thing. Usually it goes from 50 
percent partnership from the Federal Government up to 77 
percent in Mississippi. But each year, in order to readjust the 
base, States have to compute in September and October what 
their population increases are going to be, what their 
utilization is going to be, and what the medical indexing costs 
are going to be for their particular State. Those three factors 
are added on to their base budgets. So what we are saying, we 
are going to forego at the Federal level, if you come into the 
program on a voluntary basis, the fact that you will not have 
to increase your allotment based upon population or 
utilization, just the indexed cost of Medicaid, which would be 
a great savings for every State.
    For that, for that good deal, we are asking the States to 
come in and divide up their population into two groups. The 
first one is acute care, which is not growing very rapidly, and 
the second one is long-term care and prevention, which is the 
most expensive and is the one that is growing the fastest. We 
are asking them to develop programs in how to manage that 
population better. We are going to set up a clearinghouse in 
the Department of Health and Human Services of the best 
practices. We will be sending out suggestions for the States 
that are in this, how they could handle this population better 
and be able to prevent illnesses. Disease management would hold 
down a lot of cost, both for the Federal and State level. 
Managing individuals with diabetes, obesity, asthma and so on, 
and we could save money.
    We would also encourage them to try and find ways in which 
they would keep their senior citizens in their own home using 
home health care, using other things, and giving them the 
flexibility to do that.
    Then on top of that, we would allow them to have a 15 
percent for administration for special needs population. For 
instance, if you have a State in which a factory closes down, 
we would allow them to be able to use the special needs 
population, or HIV/AIDS, or mental health, which they cannot 
get under this current medical assistance program, to be able 
to use money on a temporary basis for those categories of 
population to help them over this.
    So it would be less money for the State. They would get an 
advance on their money, and they would have the responsibility 
for developing new, innovative programs to take care of their 
acute care and their long-term care, and developing more areas 
of prevention, as well as trying to keep their senior citizens 
in their homes.
    Senator Allard. What kind of impact does that have on those 
programs that we are mandating down on the States? We do not 
give them an option. We just say there is a third. You got to 
take them.
    Secretary Thompson. That is not being changed at all, 
Senator. The mandated programs, the mandatory populations will 
stay the same way under this existing law. That is why it is 
not a block grant. It continues to rise. A block grant is a 
flat leveled source of revenue, like the TANF bill. It is $16.8 
billion a year for 5 years, $16.8 billion annually over 5 
years. That is a block grant. This continues to grow. Plus it 
excludes the mandatory population with the mandatory options. 
They are maintained the same way under the new law as they will 
under the old law.
    Senator Allard. Now, the first year is 3-1/4 billion?
    Secretary Thompson. 3-1/4 billion.
    Senator Allard. 12 percent increase?
    Secretary Thompson. Pardon?
    Senator Allard. Which is a 12 percent increase?
    Secretary Thompson. Well, no. It is a 9 percent growth 
rate, and on top of that will be an additional 3-1/4 billion 
dollars. The total program is $284 billion. So about 2 percent. 
So 2 percent above the 9 percent.
    Senator Allard. 11.
    Secretary Thompson. About 11, 11 and 12 percent. So then in 
order to maintain----
    Senator Allard. That is the first year, right?
    Secretary Thompson. Yes, and the second----
    Senator Allard. Is it constant?
    Secretary Thompson. No. It is advanced funding of $12.7 
billion over 7 years. There are different amounts.
    Senator Allard. OK.
    Secretary Thompson. It is about $2-1/2 billion. So if you 
draw on your piece of paper, you see a trend line like this 
going up here at 9 percent a year, and then for those States 
that would voluntarily go into it, they would be above the 
trend line out to year 2011, would by the seventh year. Then 
those States would fall below the trend line, would only be 
getting maybe 6 percent, 7 percent, instead of the 9 or 10 
percent from the Federal Government, which would maintain and 
get their budget neutrality.
    So the Federal Government would not spend any more money, 
but it would have the ability of allowing the States right now 
to get the money up front and be able to use the flexibility 
for developing a better program.
    Senator Allard. When they get used to that amount of growth 
at the end of that curve, because you have it going up higher, 
then it drops down below.
    Secretary Thompson. Below the trend line.
    Senator Allard. Do you not kind of establish an appetite 
for the State and it is going to be very difficult to say no 
to, and they are going to expect that? Because you are talking 
about probably a whole different group of elected officials and 
policymakers?
    Secretary Thompson. I am developing a program, Senator, 
that is going to work now. It is going to bring efficiency in. 
It is going to bring disease management in. It is going to 
bring in prevention and so on. There is no question--and being 
a Governor, I have to be absolutely candid with you--there is 
an insatiable desire at every level of Government to have 
somebody higher pay for the bill. But I developed a budget 
neutral program that is going to allow for flexibility and for 
new kinds of thinking in the Medicaid arena to really provide 
for States the opportunity to develop a better health care 
system.
    Senator Allard. Mr. Chairman, I will wrap it up, but I just 
want to compliment Secretary Thompson. He is bringing in some 
new thinking, and thinking about reform. I think we need to do 
that. I appreciate it. I wanted to challenge you a little bit 
during the questioning.
    Secretary Thompson. Please, challenge me.
    Senator Allard. I appreciate that very much. We need people 
like you thinking out how we can make people more responsible 
on these programs.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Allard, thank you very much.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman. I share my 
colleague's view. Tommy Thompson is one of the finest people in 
public life.
    Mr. Secretary, as you know, my State is the poster child 
for Medicaid and health care flexibility. There is no State 
that has more waivers, for example. You could probably call me 
the Senator from the State of Waiver, because we basically 
waived out of the programs all together.
    I am very troubled about the Administrations's Medicaid 
proposal, and I want to talk to you about how we might find 
some common ground here.
    Flexibility is something the Governors are very much for. 
We have all been meeting with them. However, they are very 
worried about how this proposal ramps up on money and then 
reduces it. As the proposal is written, basically, the money is 
pulled away when the demographic tsunami hits in 2010 and 2011, 
when we have all these baby boomers. That is when the money 
would essentially go away. What I am hearing from the 
Governors, and I think my colleagues are hearing too, is that 
we might have a leave-no-child-behind experience, where it is 
not even 7 years before the money starts to disappear.
    What could be done to guarantee to the Governors, to lock 
it in, that if they are part of this flexibility effort, that 
the money will actually be there 2, 4, 6 years out? That, at a 
minimum, is what I think we need to get to a compromise, 
because as I say, I think a lot of Governors are very troubled 
about the fact that the money is going to be gone just when 
that baby boomer tide rolls to shore.
    Secretary Thompson. Let me answer it in three ways. The 
first way is the State of Oregon is not able to use its full 
SCHIP money. Your SCHIP money gets sent back to the Federal 
Government and redistributed to other States because you have a 
very progressive program that you passed before the SCHIP bill, 
same way as Washington. This would be ideal for you, because 
you would be able to use to SCHIP money to be able to help pay 
for low-income working parents, and that money would be able to 
be used in Oregon and Washington for that category of people, 
which would lessen the State's responsibility in that arena, 
and would be able to use your SCHIP money for a very good 
cause.
    Second, the States would be able to lessen their payments 
because when you look at it, every September, those three 
factors that I mentioned--let me use it this way. It is about 
$122 billion a year which States are paying right now, and it 
is rising about 10 percent. So figure $12 billion a year 
increase that the States have to pay. The States, you have got 
to increase that payment. There is a base of $122 billion, and 
above that, they are going to have to pay an additional $12 
billion next year into the Federal Government to meet their 
match. So we are reducing that match by two-thirds because we 
are waiving the requirement for the States to be able to have 
to increase their population base or their utilization, just 
their indexing. So it is wonderful deal for Oregon because they 
get their SCHIP money and they will have to pay less into the 
Federal Government to get their Federal dollars, which equates 
out to about a 1 percent increase on the Federal match for 
Oregon.
    The third thing is, during this period of 7 years when the 
money has been increased and front-loaded, we are expecting 
them to develop programs that are going to help administer 
disease management, preventative care, and being able to keep 
seniors in their home. That is where we are dividing up the 
categories into long-term care and prevention and acute care, 
and it will allow for transferability of up to 10 percent of 
the money.
    But those three reasons we think Oregon will be much better 
off, even when it goes below the line because there still will 
be an increase of about 6 or 7 percent each year in the out 
years, years 8, 9 and 10.
    Senator Wyden. Mr. Secretary, you say little that I 
disagree with, but it does not respond to the question that I 
asked, which is what can be done to lock it in, to guarantee 
it? That is what the resistance is all about. The flexibility 
you are talking about, we are for, and frankly, I can figure 
out some ways with you to do it as well. We could pass a law to 
just let people roll over their SCHIP money for example and do 
exactly the same thing. I am on board for the flexibility. What 
I am troubled about, and what your three points did not address 
is that if we do not have a guarantee, if we do not lock this 
in so that the additional funds accompanies the flexibility, I 
think we are going to find it very hard to move forward with 
what could be an extraordinarily helpful initiative. As I say, 
I could not be more supportive of the flexibility, the waivers. 
Your demonstration projects on the insued make sense. Frankly, 
the only quarrel I really have with you is, unlike Orrin Hatch 
and I, we actually have a bill, we have introduced a bill that 
has got the AFL-CIO and the Chamber of Commerce on it.
    Secretary Thompson. I like your bill.
    Senator Wyden. We are still looking for your concepts to be 
translated into a bill. I know that is going to come. But if 
you can figure out a way, working with--and I think I reflect 
the views of a number of my colleagues and Democrat Governors, 
if you can figure out a way to guarantee these dollars are 
going to be there, I think we can do business on this 
flexibility issue, and do something to make a huge difference 
for scores of low income people.
    Secretary Thompson. First off, the mandatory population is 
open ended, so that money is always there. The same way as the 
existing law is. The only thing is, is that on the optional 
population, in order to drive efficiencies, you have to make 
sure that the States are willing to make some changes. If you 
do not have that reduction in the years 8, 9 and 10, which is 
not a reduction from what they are getting or from the previous 
year, they will always go up. It is just that I do not see how 
you are going to make the States make changes to improve in 
prevention and treatment. I will be more than happy to work 
with you. I thank you for your ideas, and I will be looking 
forward to them, but that is my concern.
    Senator Wyden. I think you do have good ideas, but without 
the accountability, without the assurance on the part of the 
States, I think given the precarious financial straits of these 
States, a lot of them are going to be reluctant to do it. That 
will be too bad, because I think there is an opportunity here 
to do something effective.
    One last question if I might, Mr. Chairman? I think I am 
probably on my time limit.
    Mr. Secretary, on the Medicare program, one of the things 
that is exasperating our part of the world, and I know Senator 
Murray is concerned about this as well, is Medicare essentially 
penalizes people for holding costs down. What we need to do 
again to get ready for 2010 and 2011 is to send a message that, 
look, if you are going to be innovative, if you are going to 
come up with ways to stretch your dollars, and the like, that 
the Federal Government will send a message that we are not 
going to stick it to you. What happens now is our providers get 
penalized for being efficient with health care dollars. I mean 
why come up with anything innovative? Why not just continue 
bumbling on through with clunky volume-driven services and 
rewarding people for being inefficient. What can we do in that 
area?
    Secretary Thompson. Senator, we can do a lot, and you are 
absolutely correct. The problem is the Federal Government moves 
way too slow for me and for you and for most people, but that 
is the nature of the vehicle. In rural areas we have put in a 
rural health task force to look at this, and we have got a 
rural open door program which involves monthly toll free 
telephone conferences for interested parties to call in and get 
advice on how they can make changes for the better. We have a 
Sole Community Hospital Initiative that we started 
administratively last July. It changes its inpatient hospital 
payment regulation to allow more isolated hospitals to benefit 
from higher Medicaid payments which they did not know about 
that we allow. We have started an inpatient rehabilitation 
facility, incorporates a special adjustment for rural providers 
to account for the fact that the data showed it is more costly 
to provide rehabilitation service. We have a physician 
assistant ownership of rural health clinics, which they could 
not under the current law. We allowed that to be changed. We 
have a pass-through payment for the nurse anesthetist services 
which was not possible before. We have got a phase down of 
certain graduate medical education and costs from wage index 
calculation which helps rural areas, and helps Oregon, 
Washington, and Wisconsin and Oklahoma, and we have done that 
administratively. We have also allowed for staffing flexibility 
for certain critical access hospitals that rural areas 
desperately needed. Those are just some of the things we have 
done administratively.
    Finally, our actuaries wanted us to raise the wage portion 
of the reimbursement formula from 71 percent to 72 percent, and 
we said that--which would have been a reduction in payments to 
rural hospitals. We said no, or I said no, and it stayed at 71 
percent. I think it would be great, Senator Wyden, if we could 
set up a committee of individuals that really want to look at 
the overall Medicare system and try and find ways in order to 
improve it. I would love to be able to be part of that. I have 
several suggestions and ideas, and I would need somebody like 
you, Orrin Hatch, and Don Nickles, and anybody that wants to 
work on it, really wants to come in and roll up their sleeves. 
We could make some great progress in this are, and I am willing 
to do the heavy lifting to give you the ideas if you could just 
tell me what we can get passed.
    Senator Wyden. You always have been.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Wyden, Thank you very much.
    Mr. Secretary, we will give you that chance this year.
    Secretary Thompson. Thank you.
    Chairman Nickles. I am serious about that.
    Senator Enzi.
    Senator Enzi. Thank you, Mr. Chairman.
    Mr. Chairman, I have a statement that I would like to have 
included in the record.
    Chairman Nickles. It will be so included.
    [The prepared statement of Senator Enzi follows:]

    [GRAPHIC] [TIFF OMITTED] 
    

    [GRAPHIC] [TIFF OMITTED] 
    

    [GRAPHIC] [TIFF OMITTED] 
    


    Senator Enzi. Mr. Secretary, we appreciate your being here, 
and I share your interest in creating more health care choices 
for the Medicare beneficiaries.
    I am very concerned about the rural programs. You just 
mentioned some a moment ago, but in the rural areas, we do not 
have any real competition between health plans, and I would 
like to know how the President's plan to strengthen Medicare 
health plan competition would work in rural and frontier areas. 
We get a little bit beyond rural, actually.
    Secretary Thompson. Senator Enzi, I cannot give you the 
details of the Medicare plan as of yet. We are very close to 
making the decisions, but the decisions have not been finally 
made. In fact, I have another briefing session with the 
President at the end of this week. We are very close, it is 
very imminent, and I would like to be able to hold my answer to 
your question until the final details are made so that I can 
give you all the correct information. I would hate to mislead 
you in any way, because I pretty much know where it is going, 
but I want to be absolutely certain before I give you an 
answer.
    I can tell you that it would be based upon the Federal 
Employees Health Benefit Plan, FEHBP. Just like in your State, 
your foresters, law enforcement officials, your civil service 
and social service workers are able to have several different 
choices under the Federal Employees Health Benefit Plan, and 
that is the model that we are looking at.
    Senator Enzi. So you are assuring me that there will be 
some rural and frontier components to it, then.
    Secretary Thompson. That is correct, Senator.
    Senator Enzi. I appreciate that.
    Secretary Thompson. There will be some other changes, too.
    Senator Enzi. I appreciate the emphasis that you are 
placing on preventive.
    Secretary Thompson. Thank you.
    Senator Enzi. We think there are some great strides that 
can be made there. Now, of all the times that I have talked to 
people about how much their program will save, I have never 
seen anybody come back with the numbers that show that it did 
after we implemented whatever it was. So I hope that we will 
have some of those numbers with it, too.
    But what I am wondering about is that right now, two-thirds 
of the seniors can receive, say, the flu vaccine, and Medicare 
covers it. That is, all of them could receive it, but only two-
thirds of them take advantage of the program at the present 
time.
    Does the President's Medicare plan consider how to increase 
the utilization of that? If we are going to have the 
prevention, will they take advantage of the prevention?
    Secretary Thompson. The President is very passionate about 
prevention, as I am. I cannot say at this time what is going to 
be in there on prevention, but I can certainly tell you what we 
are trying to do in the Department on prevention, because we 
are doing a tremendous amount, and I would love to enlist your 
help and be able to do more.
    Senator Enzi. I am just concerned about that utilization 
and figuring out how to market it so that we can--if we put the 
prevention out there and people do not use it----
    Secretary Thompson. We should require every Medicare 
recipient before they go into Medicare to have a physical, to 
be able to be examined, to be able to determine benchmarks, the 
condition. We would save millions if not billions of dollars on 
preventive care if we would just do that--if we set up programs 
requiring people with diabetes to walk 30 minutes a day, lose 
10 to 15 pounds--you can reduce the instance of diabetes by 60 
percent. We have just done an exhaustive study out at NIH. We 
have a program of $100 million that we are requesting in this 
budget, Senator, in which we would like to set up healthy 
cities, at least 10 healthy cities across America, that would 
have to reduce the incidence of obesity, asthma, and diabetes 
in their city in order to quality. They would be designated a 
``healthy city.'' We think that a lot of cities are going to be 
vying for that; we think it is great.
    We have a $125 million program for ``tweeners,'' those kids 
between the ages of 9 an 13, to become physically active, to 
pick a verb--walk, run, jump, ski, dance, whatever the case--
and we are putting out a lot of information on this.
    We are going out into the minority communities where 
diabetes and obesity are very high, and we are trying to figure 
out ways in which we can address those particular issues. That 
is where we are going to save the dollars, and that is going to 
improve the quality of health of so many Americans.
    Senator Enzi. I certainly appreciate your enthusiasm on it. 
I saw that enthusiasm when you were starting the welfare reform 
movement in the country, and I have a lot of confidence that 
that is going to happen now in this program as well.
    I know that I am out of time. I do have a couple more 
questions; I will submit those. I know that you have some very 
able staff who can help in answering these questions, too, 
because she came from my office.
    Secretary Thompson. Senator, I always say I have the best 
people in the Federal Government working for me, and I stand by 
that statement, sir.
    Senator Enzi. Thank you.
    Secretary Thompson. Thank you very much for allowing us to 
hire her.
    Chairman Nickles. I would vouch for that, Senator Enzi, 
absolutely.
    Chairman Nickles. Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman.
    Thank you, Mr. Secretary, for being here today. Just to 
follow-up on one of Senator Wyden's questions, you mentioned 
the SCHIP allocation and some of the funding challenges that we 
face in Oregon and Washington and other State returning 
dollars. A question I have on the Medicaid dollars that you are 
putting out there and how you are going to allocate it--are you 
going to base that on expenditures or allocation, because that 
is really important to our States. If you are going to base it 
on expenditures, that will be very different than if you base 
your formula on allocation.
    Have you determined that? You kind of used the words 
interchangeably in your testimony.
    Secretary Thompson. It is based upon expenditures because 
of the States' match and the Federal match.
    Senator Murray. But for those of us States who have to 
return our SCHIP dollars because we haven't been able to use 
them----
    Secretary Thompson. But under this proposal, you would get 
your allocation and be able to use it. It would not be sent 
back.
    Senator Murray. That is where I am challenged with 
understanding what you are saying. If you base it on 
expenditures after we have had to return some, that is a very 
different formula funding than if you base it on what our 
allocation is.
    Secretary Thompson. It is different. Under Medicaid, it has 
to be based upon expenditures, because there has to be a State 
contribution. It will be less under the new provision than it 
is under the old, but it is still there.
    SCHIP is going to be allowed to go to the State and be 
given to the State, and there will be an allotment given to the 
State, but it will be on top of the Medicaid proposal.
    Senator Murray. Then, you are saying it is based on the 
allocation.
    Secretary Thompson. It will be an allotment allocation to 
the State of Washington. So you will not have to send your 
SCHIP money back. You will be able to use your SCHIP money in 
the State of Washington not only for children but for low-
income parents.
    Senator Murray. Let me turn to Medicare, because that is a 
huge issue for us.
    Secretary Thompson. I know it is.
    Senator Murray. I think we all know that we need to 
modernize Medicare and increase prevention, but I am very 
concerned that if we turn Medicare over to the private 
insurance market, we are going to add to the current inequities 
in the system. I know you have said many times in the past few 
months that seniors will not be forced into HMOs in order to 
receive prescription drug coverage, but I think it is pretty 
clear that the Administration is looking to expand the role of 
private insurance in Medicare, and to me, that approach is 
fairly troubling. I think we have to remember that Medicare was 
created a long time ago because of the failure of the private 
insurance industry.
    Secretary Thompson. That is true.
    Senator Murray. If we look at Medicare-Plus-Choice right 
now, we see some pretty painful limits of private insurance. It 
works great in some of our large urban areas, but in a lot of 
places in my State, it does not work well. Some States have 
plans that offer prescription drugs or vision benefits, but 
seniors in my State do not have access to that.
    Let me put up this chart. I know that you know this; we 
have talked about this before. This is the Medicare 
reimbursement chart that shows a number of States--or, the 
inequities in the Medicare reimbursement system that Senator 
Wyden actually referred to a few minutes ago. We see where 
Louisiana gets reimbursed at over $7,000----
    Secretary Thompson. Take a look at Wisconsin.
    Senator Murray. Yes, you are down there with us.
    Secretary Thompson. Yes, I am right down there; you had 
better believe I am.
    Senator Murray. This is my concern. There is a huge gap, 
and if these amounts are used to determine the Medicare-Plus-
Choice reimbursement rates, we are going to exacerbate a 
problem that is already there. It punishes States like 
Wisconsin, Washington, Oregon, and others----
    Secretary Thompson. Iowa.
    Senator Murray [continuing]. As Senator Wyden said, it sort 
of benefits States that have been inefficient. As he said so 
eloquently, there is no reason to do anything innovative, to 
work toward preventive care, to try to make changes. If all you 
do is reduce your costs, then we get a benefit system 
reimbursement like this, and if you are going to put your 
proposals based on these inequities, it is only going to make 
States not want to do something that reduces their costs.
    Secretary Thompson. You have said a lot of things, most of 
which I agree with, so let me try to answer and allay some of 
your fears.
    First off, the Medicare-Plus-Choice program is HMOs. The 
model that we are talking about is not an HMO model.
    Second, you are very satisfied I am certain about the 
Federal Employees Health Benefits Program, and your Federal 
employees in the State of Washington have many choices, and 
every one of your Federal employees in the State of Washington 
is covered under the Federal Employees Health Benefits Program. 
That is the model that we want to use in the Medicare system.
    Finally, most of the reimbursement formulas are statutory, 
and I cannot change them.
    Senator Murray. But you can give us proposals to change 
them.
    Secretary Thompson. I can give you proposals. I could set 
up a committee and sit down and talk to you about ideas and how 
we can do it.
    Senator Murray. I think that is important to do, because it 
is hard for Congress to move forward on this when you have 
winner States and loser States, and we do not have anything 
from the Administration to help us deal with this.
    Secretary Thompson. But this administration--we have only 
been in office for 2 years, and we inherited this system. We 
cannot change everything. I am trying to come up with 
innovative ideas on Medicaid. I have many ideas on the 
uninsured that I would like to sit down and talk to you about; 
quality assurance; preventive health--ways in which we can 
really improve the system. Most people do not ask me for my 
ideas. I wish they did.
    Senator Murray. Well, I would like to work with you on 
this, because if we just base the prescription drug benefit on 
the same inequities that we already have and the same formulas 
that we already have, there will be States who are going to 
lose all over again in a way that just simply is not fair. So I 
think it is important that we talk about how that formula is 
going to be--whether you are going to provide a flat per-
beneficiary amount, the same for everybody in the country, when 
you come to prescription drugs, or you are going to base it on 
an inequitable formula. If you base it on an inequitable 
formula, you are going to have a number of us who are going to 
absolutely oppose you.
    Chairman Nickles. Senator Murray, you made an excellent 
comment, and I concur.
    Secretary Thompson, I will again say that several of our 
colleagues are saying we all recognize that we need to make 
significant Medicare reforms, improvements, to resolve some of 
these inequities in the system.
    Secretary Thompson. Absolutely.
    Chairman Nickles. I will work with them.
    Senator Murray. Great.
    Secretary Thompson. You are going to find that this 
administration wants to work with you and accomplish those 
reforms. How many of those reforms can be adopted is a 
political decision, and we have to--the problem is that 
prescription drugs is the dessert, and unless we are willing to 
make the necessary changes to strengthen and improve Medicare 
right now, with prescription drugs being the dessert, we will 
never get back to Medicare and make the necessary changes until 
it is in a crisis situation.
    So I think we have an opportunity this year.
    Senator Murray. Mr. Secretary, let me just say that if the 
only people who get the high-calorie dessert are the people 
with the high-calorie dinner, we are all going to be 
overweight, and this Medicare program will never work. 
[Laughter.]
    Secretary Thompson. You know me--I have everybody on a diet 
in my Department, so I do not like that, Senator.
    Chairman Nickles. Well-said.
    Senator Gregg.
    Senator Gregg. Well, there is nothing that kills good 
policy faster than a good formula fight. I sympathize with the 
Senator from Washington because our State is in the same 
situation as hers, but stepping into the territory of formula 
fights can really undermine policy very quickly.
    Secretary Thompson. You are absolutely correct, Senator.
    Senator Gregg. We should probably fight out the formulas 
amongst ourselves, and the Administration should set policy.
    On the issue of policy, I am interested in the basic theory 
here of your Medicaid proposal which, as I understand it, is 
that you are going to incentivize States to be more efficient 
with their dollars, create more preventive activity, create 
more health care cost containment by giving them more 
flexibility over how they use their Medicaid dollars. Is that 
essentially where it is?
    Secretary Thompson. That is correct.
    Senator Gregg. The theory is that you are going to give 
them more up front because when they produce more preventive 
health activity and more efficiencies, they will be able to do 
more with less as they move out into the outyears. Is that the 
theory?
    Secretary Thompson. That is the theory.
    Senator Gregg. Historically----
    Secretary Thompson. But they will still not do less because 
it is still growing.
    Senator Gregg. Right. The basic Medicaid population is 
required to be covered under any scenario.
    Secretary Thompson. That is correct.
    Senator Gregg. But theoretically here, and arguably, a 
State will get more money to use for its optional population 
and use it more effectively for that population because they 
will have more flexibility over it, and they will know they 
need to use it more effectively because in the outyears, they 
are going to have to do more with less; right?
    Secretary Thompson. That is correct.
    Senator Gregg. Some States have occasionally used the 
Medicaid money in a fungible manner, and----
    Secretary Thompson. In a what?
    Senator Gregg [continuing]. In a fungible manner----
    Secretary Thompson. Yes.
    Senator Gregg [continuing]. I am just wondering what sort 
of protections there are to address that.
    Secretary Thompson. States have got the statutory authority 
to change their optional programs, because there are no 
restrictions. They can change the optional programs, and they 
can ask for waivers. We have to make sure that the waivers are 
budget-neutral. That is the accountability. The optional 
programs are still going to have a limitation based upon the 
dollars and the flexibility that is granted, but there is going 
to be a lot of flexibility for them to develop the program, as 
you indicated, Senator.
    But the mandatory populations, the mandatory options, and 
the mandatory protections, are all still existing in the law.
    Senator Gregg. I understand that. Is there going to be 
within the waiver application a requirement for preventive 
activities and good health care and things like that?
    Secretary Thompson. We are going to set up----
    Senator Gregg. They are not going to be that categorical; 
it is just going to be simply here is the money, and we 
encourage you----
    Secretary Thompson. We are going to set up a clearinghouse 
in the Department in which we are going to make prevention the 
key element, and we are going to send out these templates to 
each and every Governor and State legislature and say these are 
the kinds of things that we think you should do with your 
program; it will save you money and improve the quality of 
health for your citizens.
    Senator Gregg. Let me move on to another subject because my 
time is limited here. The Bio-Shield program that you 
proposed--is it your view that this should be a mandatory 
funding stream or come through discretionary funding?
    Secretary Thompson. We think it should be mandatory.
    Senator Gregg. You are thinking of $6 billion over what 
period of time?
    Secretary Thompson. Six billion dollars over 10 years.
    Senator Gregg. Do you think this should be joined with 
addressing the issue of compensation for injury and liability 
in order to get utilization of this funding stream up?
    Secretary Thompson. We do not think so, Senator. I know 
that has been a concern of yours. We do not believe that you 
should tie the two together. We think this is a whole new 
concept that is going to be very difficult to pass in this 
current thing; putting anything more on is going to be more 
difficult.
    Senator Gregg. Well, if we look at the experience under 
smallpox, it appears that there are two reasons why smallpox 
vaccinations are not progressing very effectively, or at least 
in the expansive way that we had hoped. One is that people do 
not perceive the threat, I think, and that is unfortunate, 
because the threat is real----
    Secretary Thompson. That is correct.
    Senator Gregg [continuing]. If it hits, it is going to be 
multiple. It is not going to be a single incident, in my 
opinion; it will be all over the country. If you are going to 
attack us with a biological weapon, you are not going to just 
attack one place--you are going to attack 20, 30, 40 places, 
and the panic will be considerable, and the response will be 
very difficult to coordinate.
    But the second element appears to be the fear of lack of 
compensation should there be an injury. Why wouldn't you think 
the same framework would play into the effort in Bio-Shield, 
where you are going to bring on line vaccines which are fairly 
unique for fairly unique diseases, diseases which represent a 
national security threat, and people who are getting those 
vaccinations are going to want to know, well, if it does not 
work the way everybody says it is going to work, am I going to 
have a chance to get some sort of compensation.
    Secretary Thompson. Senator, you are absolutely correct in 
your analysis of smallpox. These are the two issues that are 
causing us a lot of concern, because people do not perceive as 
big a threat as you and I both know it is.
    Second, we think that it is the compensation. I have talked 
to the Association of Nurses and the hospital associations and 
the SEIU, the employees union, and all of them indicate that 
they would be more than happy to cooperate much more so and 
enthusiastically, I might add, if in fact we have a 
compensation fund. We are working on that, as you know. I 
believe my staff has been meeting with your staff, and OMB 
staff has been meeting with you on that particular question.
    We think that Bio-Shield really is not to the 
implementation of the counter-measure. We think it is in the 
development as well as getting it approved and being able to 
get it manufactured and getting FDA to grant its approval. We 
think that utilization as the next step is something different 
and should not be tied to Bio-Shield.
    Senator Gregg. Thank you.
    Chairman Nickles. Senator Gregg, thank you very much.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for your service, and I commend 
you on wanting to bring some flexibility for the States. Coming 
from State government myself, I know that the concern, as 
Senator Wyden mentioned, is that in return for flexibility that 
the States will be left at some point having the flexibility as 
to whom to eliminate from health care services, and that is the 
concern about whether or not resources will be there in the 
long run. I think I would like to have the opportunity to work 
with you as well, with others, on that piece, because I think 
that that is a very, very big concern as to what that 
flexibility ultimately means for people.
    I wanted to just make a couple of comments and then ask a 
couple of questions. First, I think it is important when we are 
always talking about numbers and we are talking about optional 
services under Medicaid and mandatory to really talk about what 
those are, because ``optional'' sounds like they are really not 
needed.
    Secretary Thompson. This is very important.
    Senator Stabenow. Yes. Ultimately, we are talking about 
health care for people; we are not talking about buying a car--
although I would like everyone to buy three or four and buy 
them from Michigan----
    Secretary Thompson. At least manufactured in Michigan.
    Senator Stabenow [continuing]. That is right--but the 
reality is that this is health care that we are talking about. 
It is not a pair of shoes, it is not a car. It is not something 
that people are running out to do, getting sick just so they 
can go get health care.
    So when we look at this and the explosion, I think it is 
important to remind ourselves of the context. We have more 
people out of work right now, so the number of people on 
Medicaid goes up. We have 2 million-plus private sector jobs 
that we have lost in the last 2 years, so we have more people 
going onto Medicaid.
    When we look at optional, what we see is the States trying 
to respond to things that certainly people do not think are 
optional. Prescription drug coverage--most people who have 
cancer or high blood pressure do not consider it ``optional'' 
to take medicine. When we look at the other things, prevention 
is already there. States that are trying to do prevention is 
viewed as an optional service. Dentures are an optional 
service. If you do not have your front teeth as a senior, and 
you cannot eat meat, they probably do not consider that 
optional. Things like glasses are considered optional.
    I just mention that because these are not optional as in 
not necessary for someone. They are just optional in the way we 
have designed the program, the bureaucracy.
    The same thing with the individuals--according to the 
Kaiser Commission on Medicaid and the Uninsured, they say that 
many optional beneficiaries are among the most vulnerable 
people enrolled in Medicaid, including disabled individuals and 
the elderly who need nursing homes. Again, if you have a mom or 
a dad who needs a nursing home, that family certainly does not 
view that as optional.
    So I just say that to say that it is important to 
understand that these are optional only because we have chosen 
to call them optional, not because people consider them 
optional in their lives.
    The other thing I would just comment on--and I would like 
to talk about prescription drugs for a moment--is that when we 
talk about choice, I understand that you are talking about lots 
of different choices or kinds of insurance systems. I am 
pleased that you are no longer saying--at least the initial 
information we had was that people would have to go into an HMO 
under Medicare in order to be able to receive help, and in 
Michigan, that has been a real failure. In fact, my mother was 
in a Medicare HMO and had a very good experience but was 
dropped along with over 36,000 seniors because plans were 
pulling out of Michigan. So this has been a serious, serious 
issue for us.
    But when I hear about choice from people, they are not 
asking for more insurance companies to choose from. They are 
asking for prescription drug coverage. They think that Medicare 
works. It is dependable, it is reliable. It has worked except 
for one thing--it does not cover prescription drugs.
    What my seniors are saying is that the choice they want is 
the choice to pick their doctor, the choice for their doctor to 
pick their medicine.
    So I appreciate where you are going, but that is not what I 
am hearing from people in Michigan. That is not the choice that 
they are wanting. The choice that they are wanting is to be 
able to have prescription drug coverage, and I want very much 
to work with you to have something that makes sense.
    On prescription drugs, one of the things that we have not 
talked about today is why we are seeing an explosion in health 
care costs. I hear from business after business in Michigan, 
including the Big Three, that the biggest reason their health 
care costs are going up is because of the explosion in 
prescription drug prices. Doctors are getting less money--
although I am glad we could address their concerns in the last 
budget. I wish we had addressed hospitals and nursing homes and 
home health agencies and others. But no one else is seeing 
large increases in reimbursement, yet the average brand name 
prescription drug is going up three times the rate of 
inflation, and that is being paid for by business, it is being 
paid for by individuals, and so on.
    So I would like to talk to you about the whole question of 
how do we bring these prices down. If we continue paying prices 
that are three times the rate of inflation, and we just add 
Medicare coverage, we break the bank. We have to deal with the 
question of prices.
    We had a bill that passed the Senate, Senate bill 812, last 
year that closed loopholes on generic drugs. I know the 
President has moved forward part of the way on that, and I 
commend the Administration----
    Secretary Thompson. We think quite a bit of the way.
    Senator Stabenow. I guess my first question would be will 
you support going the additional steps in order to really close 
the loopholes. It is my understanding that things like 
enforcement of the new Orange Book listings, late-filed 
patents, collusion, and other important elements in S. 812 have 
not yet been implemented, and I am wondering if you are willing 
to work with us to take the bipartisan bill passed with over 70 
votes in the Senate--Senator Schumer and Senator McCain's 
bill--would you support doing the rest of the job in terms of 
generic drugs so that we can lower prices?
    Secretary Thompson. You have raised many things. Can I go 
through them----
    Senator Stabenow. Sure.
    Secretary Thompson [continuing]. First, on Medicaid, I know 
you are from the State and you understand it, but most people 
do not understand that this is a tremendous buy for the States 
because it is going to lessen their payments each year to get 
the Federal dollars. So the Federal share will go up, and the 
States' share will go down.
    So over a period of time, even over this 10 years, the 
States' involvement will be less, and the Federal involvement 
will be more, because they will not have to pay as much in on 
an annual basis.
    It equates to about a 1-percent increase in the Federal 
match.
    Second, under the existing Medicaid law, it is so strict--
for instance, you mentioned that you have some companies that 
are closing down----
    Senator Stabenow. Many.
    Secretary Thompson [continuing]. The State cannot go in and 
do anything for those poor people under the Medicaid law. It 
does not allow them to. Under this provision, the States could 
have the discretion to go in for a period of time and pay the 
health insurance for those employees under the Medicaid system.
    Senator Stabenow. I appreciate that. I also know there is a 
tradeoff in that if there is a pot of dollars, and they are 
moving it to those who are unemployed, then it means they are 
not able to do prescription drug coverage or they are not able 
to handle senior citizens' dentures and so on.
    Secretary Thompson. But it is an optional thing. Right now, 
38 States this past year have cut back on optionals; 42 States 
are going to cut back this year. The States--and you will know 
this from your background--do not have a choice. When they get 
to the point where they have to make a decision, they have to 
drop the whole class or the whole option. They cannot redesign 
the program.
    Under the new provision, let us say the States have one or 
two choices right now--maintain the program as it is or drop 
it--don't you think the State of Michigan, the Governor, and 
the legislature would like to have a third option--maybe lessen 
the benefits or increase the copays, but allow the program to 
continue. They cannot do that under existing law. Under the new 
law, they will be able to.
    Senator Stabenow. I do appreciate that, and I do believe 
that flexibility is a good item. I guess my comments earlier 
were more toward the lack of our willingness to have health 
care be a priority. We put all of these boxes out there----
    Secretary Thompson. It is my priority.
    Senator Stabenow [continuing]. I understand that, and mine 
as well----
    Secretary Thompson. And the President's.
    Senator Stabenow [continuing]. But there is not a sense of 
urgency about addressing what is an urgent matter for people in 
their daily lives.
    Secretary Thompson. I think this is extremely urgent, and 
that is why I am pushing it so hard and trying to elicit your 
support, because I know that you understand it, and I think you 
should support it, because I think it would be great for 
Michigan.
    Senator Stabenow. One other quick question, if I might----
    Chairman Nickles. Senator Stabenow, you have already gone 
about 10 minutes. Let me call on Senator Enzi now.
    Senator Stabenow. Well, I will follow-up, because I did 
want to ask you also about the dramatic increases in 
advertising for prescription drugs and how that affects our 
pricing. So I would like very much to follow-up.
    Secretary Thompson. You asked me if I would like to assist 
you.
    Senator Stabenow. We need to bring prices down, because it 
is a tremendous pressure on the economy at this point.
    Secretary Thompson. Well, there are things that we can do, 
and I think we can do it together, and I am willing to work 
with you.
    Chairman Nickles. Senator Stabenow, thank you very much.
    Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    Mr. Secretary, I have so many questions and so little time. 
I am very passionate about these issues, as you are, and love 
some of the things that you are doing and certainly what you 
did as Governor, leading the country, especially on the welfare 
reform revolution which really led to the landmark legislation 
that we passed here in Washington, D.C.
    My only charge, I guess, would be to encourage more States 
to do what you did and not just cut the rolls in half, but cut 
them up to 95 percent, from what I understand when you were 
Governor.
    Secretary Thompson. I only got to 94 percent. I did not get 
to 95.
    Senator Ensign. Sorry, sorry, excuse me. I always 
exaggerate. But certainly the State budgets could use that, and 
you and I both know that those people are better off than when 
they were on welfare.
    The thing that I have been stressing for a long time also 
in health care is the importance of prevention. It was one 
thing that a few years ago, we could not get the bean-counters 
up here in Washington to score some of the preventive measures. 
For instance, you mentioned diabetes. Dieticians working with 
diabetics, teaching them how to eat better, is crucial. When I 
was in the House, I authored a bill to do that. We were only 
able to get the study. Now we are going forward with some more 
things like that such as the idea of physical therapy caps. It 
just makes a lot more sense if you can get somebody through 
physical therapy and get them back into society instead of 
having to be institutionalized or in a nursing home or 
whatever. Those are some simple solutions, but those are still 
tiny compared to preventing the onset of diabetes in the first 
place. Other important health issues we need to address are the 
smoking problem, eating right and exercising. If you do those 
three things, you will, as you said, dramatically cut the cost 
of prescription drugs, the cost of health care, and the cost of 
hospitalization. We are talking about doing that kind of stuff 
with some of the older populations, but unfortunately, our kids 
are being trained in the worst possible habits today. The junk 
food that they are feeding our kids in schools is promoting the 
worst possible eating habits. They allow soda pop machines in 
our schools because that is a way they can make a little extra 
money. The claim that kids will not eat good food if we feed 
them is not true. Well, if that is all that you feed them, they 
will eat it. [Laughter.]
    Secretary Thompson. I really like you.
    Senator Ensign. Well, it is one of those things we learn at 
home first. When my wife and I--and we are just as soft as any 
other parents sometimes--we give them too many choices. But 
then, we finally say, ``You know, this is really ridiculous. 
Instead of giving them three or four choices for dinner--no--
this is what is for dinner tonight, and you are going to sit 
there--and there is no snack--and you are going to eat your 
vegetables, and you are going to eat the right things.'' 
Training our kids when they are young is absolutely critical in 
this.
    A big part of this is leadership from the President in 
talking to kids and then setting up programs through the 
Department of Education. Specifically, in Medicaid and 
Medicare, can you give me some feeling--I know you do not have 
the exact specifics on what you are going to encourage the 
States to do--but can you give me some idea, for example, on 
smoking. My State leads the country in the number of smokers 
and smoking-related deaths. A large part of that is because a 
lot of people move to Nevada and work in the casinos and there 
is a lot of smoking in the casinos.
    Secretary Thompson. On smoking, I am trying to come up with 
some discretionary dollars to use in the program to have people 
stop smoking. Seventy percent of people who smoke want to stop; 
they just do not have the intestinal fortitude to do it, they 
do not have the medicine, the counseling, and so on. I think it 
would be smart of we had some dollars with which we could 
utilize programs that are out there that are effective when 
people want to stop smoking. Get it advertised, get it 
throughout the State Medicaid program, and say these are some 
programs that will help you stop smoking. If 70 percent want to 
stop smoking, let us help them. It would save us many dollars 
in the future--$155 billion a year on tobacco and 400,000 
deaths. That is the one best way in which we can have the 
biggest and most direct impact on the health care budgets in 
America.
    Senator Ensign. Once again getting back to the kids, does 
it make any sense to anybody else that kids are not allowed to 
buy cigarettes, but we do not do anything if they smoke 
cigarettes? If you walk onto the parking lots at high schools, 
the kids are smoking cigarettes; yet it is against the law in 
my State to buy them.
    Secretary Thompson. It is against the law to buy them.
    Senator Ensign. It is against the law to buy them, but they 
can go ahead and smoke them. Personally, I think we are sending 
the wrong message.
    The other commentary that I would like to make on smoking 
is that I think Hollywood and the music industry have a huge 
responsibility here. We always hear about the evils of the 
tobacco companies and the way they are persuading kids. I 
remember growing up and remember how companies used to go after 
Hollywood actors to get them to endorse their products because 
they knew how important stars were in influencing people's 
behavior.
    Well, in almost very major motion picture and in many music 
videos what are the people doing? They are smoking. The lead 
actors make it cool. So that is something that I think 
Hollywood needs to be held accountable for. We know that if we 
can get people not to smoke by the time they are about 20 years 
old, the chance of them smoking is incredibly small. So that is 
a huge area in the future to save on health care costs.
    Secretary Thompson. All I can say is amen. You are right 
on. I wish I could put you on every television station in 
America.
    Senator Ensign. Mr. Chairman, can I ask one more question 
on prescription drugs?
    Senator Hagel and I had a prescription drug bill last year 
that we actually got 51 votes on. We ended up having four 
Democrats vote for our bill. It was the only one that fit 
within the budget last year. Unfortunately, it did not come 
through the Finance Committee, so it was subject to a budget 
point of order.
    But it addressed something that I think is fundamentally 
wrong with our health care system, and that is if you are going 
to give a prescription drug benefit, and you just give the 
drugs to people, there is no accountability to the patient.
    Our bill said that the patient is going to be responsible 
for the first dollar expenses unless they are very, very poor. 
They would pay up to a certain amount it was around $1,200 and 
then it went up from there depending on income. But the bottom 
line was that they paid the first dollars, and after that, the 
Federal Government picked up the cost.
    In health care today, with low-deductible policies or low 
copays, there is no accountability in the system. One person 
provides the service, somebody else pays for the service, and 
one person receives the service, so there is no connection 
there.
    I think it is very important for us when we are designing a 
prescription drug proposal--because these costs will skyrocket 
in the future--that we add accountability.
    Senator Stabenow talked about that somebody will go out and 
buy a car just to buy a car, but they do not just go out and 
get health care. That is bunk. People go out and get 
prescription drugs. There are a lot of hypochondriacs in this 
country, and there are a lot of seniors who are lonely, and 
they may go to the doctor to have somebody to talk to. We know 
there is a tremendous amount of overutilization. There has got 
to be some accountability in the system for some of the costs; 
otherwise health care costs will continue to spiral out of 
control.
    So we really want to continue to work with you and your 
staff, to try to make sure that the prescription drug proposal 
that is enacted in is not only good for seniors but is 
responsible to the next generation.
    Thank you, Mr. Chairman.
    Secretary Thompson. You raise some very valid points, and I 
want to work with you very much, Senator. Thank you very much 
for your comments.
    Chairman Nickles. Senator Ensign, thank you very much.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Welcome, Mr. Secretary.
    Secretary Thompson. Thank you, Senator. How are you?
    Senator Corzine. I, like my colleagues, appreciate the 
flexibility and creativity that you have tried to bring to a 
complex subject. I think the preventive care elements that have 
been talked about repeatedly are extraordinarily important 
elements of trying to rein in costs, and I hope that all of us 
can be a part of the process to make that more a fundamental 
element of what we are trying to do here.
    I do want to express, though, some frustrations. It strikes 
me that in a number of States--I am obviously reflecting the 
experiences that we have in New Jersey--where people have been 
creative, where they have been flexible, where they have moved 
in a forward-looking way, for instance, with regard to 
prescription drugs, and made choices, it would appear--and 
again, obviously, since I have a vested interest in 
representing my State--that they have often been punished, or 
at least not rewarded, for those kinds of innovation and 
flexibility.
    The same thing with the SCHIP. Our State has been one of 
the most aggressive under both a Republican and a Democratic 
Governor, in a bipartisan way, in reaching out to register.
    Secretary Thompson. You have done a good job. 
Congratulations.
    Senator Corzine. They have done a great job. But it is 
unclear to me--well, first of all, there is the technical issue 
of the reallocation, which the current administration is 
looking for in this difficult time, and I guess CMS has not 
moved to actually reallocate those funds this year, which is a 
problem, one of several, with regard to what people would count 
on in their budget based on what the law said and what was 
supposed to happen. I can understand why you want to correct 
and use it in other States, appropriate in the long run; I 
think that is a good idea. But at least as the law works today, 
there are supposed to be funds that are flowing to 13 States, 
and a decision on that has not been taken, and I think that 
just compounds some of the other issues that go on.
    I am also worried about where SCHIP will fit in the reform 
program that you are suggesting--the flexibility program that 
you are suggesting. Will those funds that are allotted be 
required to be used for SCHIP, or will they fit into a larger 
block that potentially will pull away from kids? I know you 
talked about acute care and long-term care. One of the most 
successful bipartisan initiatives that has come out in recent 
years, at least in my view and certainly for New Jersey, is the 
SCHIP program and its application to bring more kids in. I am 
very concerned that the dough that gets block-granted here then 
moves away from that particular area and will not be used for 
dealing with children's health, which is such an important 
issue for education, and then have long run implications. So I 
would like to hear how you think that is going to work.
    I am going to be remiss again if I do not say something 
about I thought your initiative to make sure that SCHIP could 
be used for low-income pregnant women and the confusion with 
the fetus as opposed to the child is a concern of mine. I think 
we are getting issues that do not necessarily relate to what I 
think is a very, very important issue to be prenatal care, 
post-partum care, for low-income women and children mixed up in 
another debate, and I would encourage that we reconsider and 
move on that.
    But most of my questions, a lot of them, are not unlike 
what my colleagues brought forward, but this SCHIP issue I 
think may be one of the vital areas in Medicaid that I am very 
concerned the reforms will undermine.
    Secretary Thompson. Thank you very much, Senator.
    Let me go down the list. First, you are concerned about the 
waiver being applied for by the Governor of New Jersey on 
drugs. I had a nice meeting with the Governor this week. I was 
with him and his staff I believe on Friday for an hour and a 
half, and we worked through as much as we could.
    The problem I have is one in which the law requires me to 
be budget-neutral. I cannot break the law. So we are trying to 
work out different figures which might be able to give New 
Jersey some relief. We are working on that. I cannot promise 
you; all I can tell you is that we are working on it, and I 
think the Governor was quite satisfied with the meeting, and 
hopefully we can make some progress.
    On SCHIP, I understand that New Jersey would like to get 
the reallocation. If I were New Jersey, I would love it, too. I 
just think the concept of States like Washington, Oregon, New 
Mexico, and Tennessee--the States that cannot use their SCHIP 
because they were out in front and developed the program that 
is too rich now for SCHIP to fund--that they should not be 
penalized by not being able to get the SCHIP dollars. We are 
trying to----
    Senator Corzine. I would only remark that I thought that 
that was dictated by law. Maybe we ought to change the law.
    Secretary Thompson. That is dictated by law.
    Senator Corzine. Therefore, sort of in the same way that 
you spoke about the other issue----
    Secretary Thompson. I am talking prospectively, and I think 
you will agree with me on that.
    Senator Corzine. I actually think that IGT and all the 
other things--if we had a level playing field, people would be 
a lot less frustrated about how these things work.
    Secretary Thompson. I agree.
    Senator Corzine. I suspect the Chairman is going to ask 
about that upper payment limit in the same way.
    Secretary Thompson. You have the upper payment limit, you 
have the IGs, you have disproportionate share--all of those 
things.
    Senator Corzine. I guess my point is that in a number of 
instances where you have been good citizens, and you have been 
creative and used the flexibility that was available and some 
resources that the State put in to make sure it happened, it 
does not always work out to your advantage in the transition.
    Secretary Thompson. No, it does not. In my own State of 
Wisconsin when I was Governor, one of my biggest gripes was 
because we were being very progressive and doing some neat 
things, and we always got penalized for doing that.
    Senator Corzine. It is a concern as we go through a reform 
toward flexibility and the kinds of innovations you are talking 
about--and I think this is what Senator Wyden was referencing--
it may end up having some hardships for those who have already 
done a lot of the things or have begun to do a lot of the 
things that you are suggesting.
    Secretary Thompson. In the SCHIP program part of Medicaid, 
we want to be able to use more flexibility. I think the SCHIP 
program has been an exceptional one, but there have been some 
problems with it, and the problem I see with it is that it does 
not allow the parent or parents of that child to also be 
enrolled, and I am looking for ways to be able to do that, and 
that in the SCHIP program will be able to be utilized by the 
States to do that.
    I developed a very successful program in Wisconsin doing 
that. It saved money, and it got more children enrolled--it 
took me 24 months to get a waiver from the Federal Government 
in order to do that. That is part of this provision in this 
one.
    In regard to the abortion question, I want you to know that 
that was not considered at all. The Medicaid law allows for 
prenatal care right now. We just extended the same thing in the 
Medicaid law to the SCHIP for children. I believe that those 
children deserve prenatal care.
    Senator Corzine. You would agree that the mother needs 
prenatal care?
    Secretary Thompson. I certainly do.
    Senator Corzine. I think we are both on the same page in 
what we are trying to accomplish here, and at least my reading 
of the initiative is that that is not necessarily how it gets 
interpreted.
    Secretary Thompson. It does not get interpreted that way, 
and I just want you to know, because I made the decision, and 
it was based upon making sure that that child would come into 
the world healthy, and if that child was born to a Medicaid 
mother, that mother would have prenatal care. But if that child 
was an SCHIP child, that child's mother could not get prenatal 
care. That did not make any sense to me.
    Senator Corzine. We agree 100 percent on that, and we need 
to make sure that we have it in the way that it is meant.
    Secretary Thompson. That is the reason for it.
    Senator Corzine. Thank you.
    Chairman Nickles. Senator Corzine, thank you very much.
    Mr. Secretary, I have just a couple of quick questions that 
I was not able to ask you. I mentioned the fact of upper 
payment limit abuses that are presently in the system. The 
Administration, and I compliment you for this, you have taken 
action to curtail some of the abuses. A lot of States have 
really found ways to gimmick the system or almost scam the 
system where they move repayment rates or reimbursement rates 
on Medicaid substantially up in a Government-owned hospital, 
community-owned hospital, or State-owned hospital up to the 
Medicare limit. They are reimbursed and then they reimburse the 
smaller amounts. You would end up having basically a Medicaid 
procedure that would be entirely paid for by the Federal 
Government. Isn't that correct?
    Secretary Thompson. Absolutely.
    Chairman Nickles. Now, you have tightened it up, but you do 
not stop it. You kind of phase it out, but you phase it out 
over a 10-year period. You save, according to your report----
    Secretary Thompson. There are five States--which we have 
preliminarily determined have UPL transition periods phased out 
over 8 years.
    Chairman Nickles. Eight years. Excuse me.
    Your report says that it saves $55 billion. It really seems 
to me to be a scam. If we eliminated it totally, what would the 
savings be?
    Secretary Thompson. I do not know, Senator.
    Chairman Nickles. Would you report that back to us?
    Secretary Thompson. Sure. It would be a lot.
    Chairman Nickles. I expect that it would be. If you haven't 
gotten the thrust, I am really concerned about something that 
is growing from 6 to 9 to 14 percent in cost when I see some of 
the gains where the States have been very innovative I am 
afraid that some of the States, now that you have tightened up 
on UPL, are finding other ways.
    Secretary Thompson. Yes, they are.
    Chairman Nickles. Some of the State health directors are 
very adroit, and I would imagine they have hired professionals 
to figure out how they can make Medicaid a 100 percent Federal 
program and avoid the State match.
    Secretary Thompson. That is correct.
    Chairman Nickles. I do not think we should allow that to 
happen.
    Secretary Thompson. I do not, either.
    Chairman Nickles. I would appreciate suggestions from you 
and some of your experts that we might incorporate so we can 
stop the cheating on the system and come up with a Federal-
State program that is run by the States and not have this be 
entirely a Federal program. If we are going to change it into 
an entirely Federal program, then let us do it for all States.
    Correct me if I am wrong, but in this particular program, I 
believe there are 28 States that are participating, using UPL, 
States I would say are cheating on the system.
    Secretary Thompson. Well, you have the use of Inter-
Governmental Transfers, Senator. There are three IGT programs. 
You have the use of Inter-Governmental Transfers, as part of 
the upper payment limit; and then you have the use of IGT's as 
part of disproportionate share and you have began to use IGT's 
in other payments. Each one of those has some merits, but there 
are a lot of abuses, and we are trying to tighten up the system 
so there are not abuses in it. The Inter-Governmental Transfer 
is the one that right now needs to be tightened up.
    The upper payment limit is on a glide-path down to 100 
percent.
    Chairman Nickles. I am not convinced that we need to phase 
it out over 8 years.
    Secretary Thompson. I understand. There are only five 
States that are still in the 8-year. Some are at 5 years, some 
are at 4 years, some are at 3, and some are at 2. But you are 
going to have to change the law in order to do that.
    Chairman Nickles. Well, I am in that business.
    Secretary Thompson. I know that, and I am very appreciative 
that you are, Senator.
    Chairman Nickles. I am happy to work with you. I notice one 
of your----
    Secretary Thompson. But I would like to point out that the 
upper payment limit is small compared to the IGT. That is the 
one that I am much more concerned about, and I would like to 
spend some time discussing it with you.
    Chairman Nickles. Could you give me a thumbnail, what do 
you mean by IGT?
    Secretary Thompson. It is an agreement between the State 
and the county. The county for home and community based health 
care spends $100 for the service. They bill the State for $100 
as the rate for that service. But the State says we will 
increase your rate and you bill us $200, we will then bill the 
Federal Government $200 for that service. Then, if it is a 50-
50 matching State, the Federal Government pays to the State on 
a quarterly basis $100 for this bill, because the Federal 
Government's share is $100, and the State's share is $100. So 
in this example the State was supposed to pay $100, and they 
get $100 for this from the Federal Government, and they pay the 
$200 to the county; the county keeps $100 plus $25 commission 
and sends $75 back to the State. So the State has only provided 
$25 instead of their statutory match rate of $100 in this 
example.
    Chairman Nickles. Are you talking about for home health?
    Secretary Thompson. For anything--for doctors, for home 
health--anything that includes counties or local providers.
    Chairman Nickles. All this under Medicaid?
    Secretary Thompson. Under Medicaid, yes.
    So the counties have reached an agreement with the State 
that they will increase their billing to the State, which 
increases the billing to the Federal Government, which lowers 
the percentage the State has to pay because the Federal 
Government gets the higher bill, and they pay their percentage 
on the higher bill, and they send that percentage back to the 
State, and then the State transfers that on to the county or to 
the city, and the city takes a commission, and they turn around 
and send the balance back to the State, which lessens what the 
State's participation is.
    Chairman Nickles. It is pretty close to the upper payment 
limit.
    Secretary Thompson. Well, that is part of the upper 
payment, but IGT is used in conjuction with the upper payment 
limit and other payment mechanism.
    Chairman Nickles. Is that right? Well, I would be very 
receptive to some ideas on stopping some of these things. I 
would like to even go further to tighten them up but impose 
penalties for the people who are abusing the system. If people 
are going to be rewarded for coming up with games to figure out 
how to make this an entirely Federal program, and/or if we 
include that, I am a little concerned about your Medicaid 
proposal. I do not want to use the word ``block grant,'' but 
the level that you are submitting to the State, if they have 
that built into their base, are we rewarding them vis-a-vis the 
22 States that do not do that in setting up the Medicaid 
program as you have proposed?
    Secretary Thompson. I am not sure if the IGT is in the 
base. It is in the base.
    Chairman Nickles. If it is in the base, you are somewhat 
rewarding them for that. I would hope that as this progresses, 
we would not have that included in the base. I think that 
rewards some devious planning. It may be legal, and maybe some 
people are doing it because they say, ``We know that other 
State are doing it.'' I notice the number of States that have 
done this went from 12 to 28 just in the last couple years.
    Secretary Thompson. Yes, but now there are more.
    Chairman Nickles. Now there are more than that, you are 
telling me. How many more?
    Secretary Thompson. I do not know, but we are getting 
applications every day. There are corporations out there that 
are making money off this, coming up with ideas. Every time we 
close one idea, they come up with another idea.
    Chairman Nickles. Well, you know, the IRS is now coming 
down hard on some firms that came up with tax shelters that 
were really pretty abusive. I look at this as somewhat in the 
same vein, and I look at us paying the bill. When I see our 
Medicaid bills climbing by 14 percent and climbing every, 
single year percentage-wise, I want to stop this kind of abuse. 
Maybe we can come up with some penalties for those who 
participate in this kind of scheming. So suggestions that you 
have, whether they be the Inter-Governmental Transfers or 
whether it be UPL or others, I solicit those, I welcome those, 
I want to work with you.
    Secretary Thompson. UPL is going down. It is on a glide-
path. You do not think the glide-path is fast enough.
    Chairman Nickles. That is correct. Look at the glide-path. 
If somebody has been ripping you off, and you say, ``Next year, 
if you rip us off a little less, maybe we will be pleased 
because we are making savings,'' that does not satisfy me. I 
think we ought to close the door.
    Secretary Thompson. I understand that, but that was 
negotiated before I got here, Senator.
    Chairman Nickles. I understand that, and I understand there 
are certain hospitals that have done exceptionally well and 
have powerful members. It does not change the fact that we have 
to try to save this system, and you are to be complimented 
because you are proposing the most significant reforms in both 
Medicare and Medicaid that we have considered, frankly, in my 
career in the Senate, which has been 23 years. Both need to be 
improved and saved. So I compliment you for it; I just happen 
to think we ought to tighten up on these abuses.
    We have enhanced and improved some benefits, whether you 
are talking about prescription drugs, lower deductibles or 
catastrophics, there are a lot of positive things we can do in 
Medicare, and maybe more preventive possiblilities in both 
Medicare and Medicaid. Those are some of the positive things, 
but likewise if we do not stop some of the abuses, we will not 
be able to afford it.
    So I look forward to working with you and other members of 
the committee to really make significant improvements in these 
two major programs, and I appreciate very much your 
participation before the committee.
    I do hope that you will respond to additional questions if 
submitted to you by myself or others.
    Secretary Thompson. Thank you very much, Senator, for 
giving me this opportunity. I really appreciate the cooperation 
from both sides here today wanting to really take a look at 
this and work on it.
    I think we can come up with a Medicaid plan that everybody 
can buy into and really support, improve the system, and save 
some dollars, make it more people covered and more efficient. I 
know that that seems almost impossible to say, but I think we 
can do that just like we did under welfare.
    Chairman Nickles. I look forward to that, and we will work 
together to make that happen.
    Mr. Secretary, thank you very much.
    The committee is adjourned.
    [Whereupon, at 5:01 p.m., the committee was adjourned.]


                THE PRESIDENT'S FISCAL YEAR 2004 BUDGET

                              ----------                              


                      THURSDAY, SEPTEMBER 3, 2003

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:37 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Don Nickles, 
(chairman of the committee) presiding.
    Present: Senators Nickles, Allard, Bunning, Crapo, Conrad, 
Corzine, Stabenow, and Sarbanes.
    Staff present: Hazen Marshall, Majority Staff Director; and 
Mary Ann Naylor, Staff Director

             OPENING STATEMENT OF CHAIRMAN NICKLES

    Chairman Nickles. The committee will come to order. I want 
to thank everybody for their cooperation. Senator Conrad and I 
both had some challenges since we are returning this week, and 
so we moved the hearing from 10 o'clock to 10:30. I understand 
that Director Holtz-Eakin also has other commitments.
    So, Director Holtz-Eakin, I thank you very much. I want to 
thank my friend and colleague, Senator Conrad, for his 
attendance, and also Senator Crapo for his participation and 
Senator Corzine for his participation. You are welcome to come 
up a little closer, if you prefer to do that. We will call on 
Senators by their time of arrival.
    I will call on my colleague, Senator Conrad, for any 
opening remarks that he wishes to make.

              OPENING REMARKS FROM SENATOR CONRAD

    Senator Conrad. Thank you, Mr. Chairman. Again, thank you 
very much for moving this hearing to accommodate other hearings 
and other committees, and welcome to Dr. Holtz-Eakin for his 
first testimony, I think, before the Senate Budget Committee.
    The report that you have just issued should send alarm 
bells sounding throughout Washington and really throughout the 
country, because what it tells us very clearly, as a part of a 
series of reports, is that we are on a course that is utterly 
unsustainable, and it is going to require us to make 
substantial changes in budget policy as we go forward.
    I go back to what the President told us 2 years ago when he 
said ``Tax relief is central to my plan to encourage economic 
growth, and we can proceed with tax relief without fear of 
budget deficits, even if the economy softens.'' Well, that has 
proven to be simply wrong.

[GRAPHIC] [TIFF OMITTED] 

    Then, the President told us last year that ``our budget 
will run a deficit that will be small and short-term.'' That 
has also proved to be wrong. These deficits are not small, and 
they are certainly not short term. They are very large 
deficits. They are record budget deficits in dollar terms, even 
large as a percentage of GDP, and we see no end in sight.

[GRAPHIC] [TIFF OMITTED] 

    If we look at the report that you have just issued from the 
Congressional Budget Office, and of course you are required to 
report in a certain way, you are required to report based on 
what is, not with changes that people are advocating. But if we 
take just three of the things that are out there that we all 
know are going to have to be dealt with, the President's 
proposal to make the tax cuts permanent, the President's 
endorsed prescription drug bill, a reform of the alternative 
minimum tax, which if we fail to do will affect 30 million 
people by the end of this decade----just those three changes 
and what we see are deficits that go on for the next 10 years 
in very large amounts. This also includes, by the way, treating 
Social Security as a trust fund; that is, not using Social 
Security Trust Fund surpluses to pay other bills.

[GRAPHIC] [TIFF OMITTED] 

    What we see are truly large deficits throughout the entire 
rest of the decade. When we look at where the money went 
because, remember, just 2 years ago we were told there were 
going to be nearly $6 trillion of surpluses, if we look at that 
same period of time, here is where the money has gone: Nearly 
40 percent for tax cuts; 28 percent increased spending, almost 
all on defense and homeland security; 27 percent technical 
changes, largely lower revenues not associated with the tax 
cuts, so almost two-thirds of the loss of the projected surplus 
and turn to deficit is on the revenue side of the equation and 
some 7 percent from the economic downturn.

[GRAPHIC] [TIFF OMITTED] 

    We clearly have a revenue problem and a tax and a spending 
problem. The revenue problem is really quite dramatic, and we 
have gone from having revenues that were very high as a share 
of our gross domestic product to now having revenue this year 
that is projected to be the lowest since 1959. So, clearly, 
we've got a revenue problem, as well as a spending problem.

[GRAPHIC] [TIFF OMITTED] 

    If we look at the spending, we look at the increases that 
have occurred there, look at the increase that has occurred on 
spending, just for this year, over the baseline, 92 percent of 
it is in just three areas: defense, homeland security, and 
rebuilding New York and support for the airlines. That is where 
the increase in spending has occurred. If you look at the last 
2 years, it is the same thing. It is actually a larger 
percentage for just defense, homeland security, rebuilding New 
York and the other items I have mentioned, the support for the 
airlines, and of course the international piece of this because 
of Afghanistan and Iraq.
[GRAPHIC] [TIFF OMITTED] 

    What that leads us to conclude is that the gross Federal 
debt, instead of being reduced, which we were told would 
happen, is instead skyrocketing, in fact, it is more than 
doubling over this next 10-year period to nearly $15 trillion 
at the end of 2013.
[GRAPHIC] [TIFF OMITTED] 

    All of this--let us go to the final chart--all of this 
occurs at the worst possible time, because this is a time we 
ought to either be prepaying the liability of Social Security 
and Medicare or paying down the debt in preparation for what we 
all know is to come. In many ways, this chart is the most 
alarming because what it shows is that the trust funds of 
Social Security and Medicare turn cash negative at the very 
time the cost of the tax cuts explode, driving us deeper and 
deeper into deficits and debt to levels that are clearly 
unsustainable.
[GRAPHIC] [TIFF OMITTED] 

    Mr. Holtz-Eakin, I will conclude by saying what you said: 
that budgets, economics teaches us, are about making choices, 
and that is really the importance of this committee and the 
importance of a budget. We have to make choices. I would submit 
to my colleagues we are going to have to make very difficult 
choices on both the revenue side and the spending side if we 
are going to get back on a fiscal course that is sustainable.
    Chairman Nickles. Senator Conrad, thank you.
    I am going to make just a couple of comments. I do not want 
to get into a debate with you. I want us to listen to the 
Director, but I would like to show a couple of charts to give a 
little different viewpoint. Some of my observations are exactly 
the same.
    Senator Conrad mentioned that we have a revenue decline, 
and this shows that revenues declined rather precipitously 
since the year 2000, when we had revenues over $2 trillion a 
year, forecast this year to be $1.77 trillion. That is a rather 
significant reduction in revenue, part of which was caused by 
the tax reduction, part of which was caused by the recession. 
It also shows that spending--the red figures--have gone up and 
gone up rather dramatically. Senator Conrad mentioned most of 
that increase is for defense. We did have a terrorist attack on 
9/11, and we have also had a war in Afghanistan and Iraq. Those 
have been very expensive propositions.

[GRAPHIC] [TIFF OMITTED] 

    We have also had spending grow in a lot of other areas. Let 
me show the next chart.

[GRAPHIC] [TIFF OMITTED] 

    The tax cuts that we enacted last year have made a 
significant difference. Many people said the tax cuts would not 
help the economy, but, frankly, if you look at the economy, 
since we passed the tax cuts, the economy has grown. Last 
quarter, it grew at 3.1 percent. That is significant. It has 
made a significant difference in the stock market, it has made 
a significant difference in the economy. So we have now had 
several quarters in the positive. The stock market has gone up 
over $2 trillion just in the last few months, in the next 
chart, as well.

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

    I did want to show that nondefense discretionary spending 
has grown as well. So I just make those points. We are debating 
the Labor-HHS bill, which has grown dramatically, in double-
digit figures, frankly, over the last several years. Spending 
over the last 5 years, and, Mr. Holtz-Eakin, you can correct me 
if I am wrong, but I think it has grown an average 7.7 percent. 
Labor-HHS has grown about 12 percent. So there has been some 
big increases in spending. I just wanted to allude to those, 
but also I wanted to point out that, yes, we did make a 
decision to pass the tax cuts, and I think they have helped.
    When we were debating the tax bill earlier this year, I 
believe Dow Jones was at about 7,500. It is now at 9,500. That 
is a big change. I think we have made a significant 
contribution to that change with some of the tax changes that 
we have made. We will have to make some tough decisions for the 
future. We will have to make tough decisions on limiting the 
growth of spending.
    In the budget update that we have before us, you assume 
that the Iraq expenditures, the supplemental, is built into 
your base, about $80 billion per year for the next 10 years. 
That is an assumption that will not turn out to be true. I hope 
it is not true. I hope we do not spend $80 billion a year for 
the next 10 years. So I hope that is a one time expenditure. 
Granted, we are going to have some expenses, but it will be 
significantly less than that, probably hundreds of billions of 
dollars less than that.
    Senator Conrad mentioned AMT. Well, some people said we 
fixed it. Maybe we can fix it, maybe we can modify it--other 
changes maybe.
    We have a proposal on prescription drugs, and I am 
concerned about that proposal. Many have said it is not near 
enough, and I will be working on that. Actually, we are in 
conference on that as we speak, and I am a conferee, but I hope 
to make that proposal more affordable for future generations. 
It could be much more expensive for future generations.
    We have a lot of challenges. That is part of what this 
committee is all about, and we welcome Director Holtz-Eakin to 
join us. We now have a few other colleagues that have joined 
us. I would like to call on the Director, unless anybody would 
like to make a couple of opening comments. If not, I will call 
on the Director.
    [No response.]
    Chairman Nickles. If not, Director Holtz-Eakin, thank you 
for joining us and welcome to our committee.

      STATEMENT OF DOUGLAS HOLTZ-EAKIN, Ph.D., DIRECTOR, 
                  CONGRESSIONAL BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you, Mr. Chairman, Senator Conrad. 
It is a great pleasure to make my first appearance before the 
committee. The report we put together, our summer update to the 
budgetary baseline, has been out for a week. I submitted the 
summary of that report as my written testimony, and I thought 
that in my remarks, I would confine myself to a few of the key 
points, and then we would discuss things as Members were 
interested.
    Let me walk through it in roughly this order: first, talk a 
little bit about the facts and then spend a couple minutes on 
what I think are key features of the baseline projections and 
close with some observations about the economic outlook that 
underlies our baseline projections.
    First, on the facts. As many of you are well aware, the 
CBO's summer update projects that the deficit will reach $401 
billion in fiscal year 2003. We are projecting a baseline 
deficit of $480 billion in fiscal year 2004, $341 billion in 
2005, and a total of $1.4 trillion in cumulative deficit over 
the 10-year budget window, with all of that in the first 5 
years and a modest surplus in the final 5 years of the budget 
window.
    The dollar figures; the fiscal year 2004 budget deficit 
are, in fact, the largest ever. But compared to GDP, 4.3 
percent is not the largest deficit in recent history. The 6 
percent of GDP in the early 1980's is larger. Our baseline 
projection shows a return to surplus in 2012. Over the course 
of the budget window, there is a pattern of diminishing 
deficits and an ultimate return to surplus.
    If you look at a different indicator of the fiscal year 
status of the budget, the ratio of debt in the hands of public, 
which measures both receipts in and outlays from the Treasury 
as a fraction of GDP, this baseline projection shows the debt-
to-GDP ratio rising from 37 percent at the outset to a high of 
40 and then diminishing throughout the 10-year budget window 
and closing at 30 percent in the year 2013.
    So those are the basic facts regarding the outlook that we 
put in our report, and what I wanted to do was to spend a few 
minutes talking about what I think are three key features of 
this baseline projection. We can show the pattern here. This 
displays--and these charts are in the handouts that I hope are 
in front of all of you--our baseline projection at this time, 
and then the one in March that we put out. It shows deficits as 
a fraction of GDP, and it is also in your handout if we need to 
look at it more closely, I hope.
    Three key features of this projection:
    Key feature No. 1 is that it is, in fact, a baseline 
projection. As Senator Conrad noted at the outset, CBO projects 
the implications of current law on both the receipts and outlay 
sides, in performing its baseline projections. And, in 
particular, this projection embodies the assumption that 
discretionary spending grows at the rate of inflation, 
inclusive of the supplemental appropriation in 2003. That 
supplemental appropriation had $80 billion in budget authority 
and about $60 billion of that was devoted to operations in Iraq 
and Afghanistan. The presumption in the baseline is that that 
would continue and increase at the rate of inflation over the 
budgetary window.
    It also embodies the assumption that the tax cuts, both 
those passed in 2001 and also those passed by Congress earlier 
this year, will sunset, as scheduled within the legislation. So 
our budgetary outlook is a projection, as opposed to a forecast 
of precise outcomes. It is an implication of current law and 
serves as a neutral baseline against which Members may measure 
any changes that they might pursue as a matter of policy.
    The second feature I would like to note is that this 
projection is actually quite similar to the one in March. Its 
basic character has not changed. It features larger near-term 
deficits, diminishing throughout the budget window and an 
ultimate return to surplus. As a result of the legislation 
enacted earlier this year, both on the spending side and 
supplemental appropriations and on the receipts side in the 
form of the Jobs and Growth Tax Act, the near-term deficits are 
larger. And the projection shows that coming to balance later 
than we showed in March, but the basic character is similar to 
the projection that CBO issued earlier this year.
    Over the budget window, the projection shows a return to 
balance in the form of two things:
    First, revenues grow, on average, at a rate of 7.5 percent 
per year during this budget projection, with receipts as a 
fraction of GDP rising from a low of 16.2 percent by 4 
percentage points, up to 20.5 percent. That over-4-percentage-
point rise in receipts as a fraction of GDP comes both from the 
sunset of the tax cuts of this year and 2001, but also from 
increases in receipts as a fraction of GDP stemming from a real 
bracket creep, from rising real incomes in the economy, from 
the influence of the alternative minimum tax, and from the 
taxation of funds in tax-deferred savings plans as those are 
withdrawn. The bulk of the 2.3 percentage points is the from 
sunsets. The remaining factors offer a smaller contribution to 
the rise over the course of the budget window.
    On the outlay side, mandatory spending rises at a rate of 
5.2 percent, on average, during this projection. It accelerates 
later in the budget window, reflecting is the leading edge of 
the influence of the retirement of the baby-boom population on 
the Federal budget. The number of, for example, enrollees in 
Medicare grows at 1 percentage point per year in the first 5 
years but after 2008 begins to grow at a rate between 2 and 3 
percentage points per year. Over the longer term, the demands 
of entitlement spending, even in the absence of a new 
prescription drug benefit in Medicare will be such that under 
current law, Medicare, Medicaid and Social Security will rise 
from 8 percent of GDP to 14 percent in 2030. That long-term 
pressure of entitlement spending remains a key feature of the 
budgetary outlook in the United States.
    Finally, on the outlay side, the rate of growth of 
discretionary spending is assumed to be 3.1 percent. That is 
according to the baseline projection rules under which CBO 
constructs these estimates. Because that is lower than the 
assumed rate of growth of nominal GDP that the baseline 
embodies, the assumption that discretionary spending is 
shrinking as a fraction of GDP is a fact that should not be 
lost on people in interpreting the results.
    The last feature, I think, that merits mention, in looking 
at our baseline projection, is that there is a tremendous 
amount of uncertainty associated with the baseline projection. 
There is the normal uncertainty with which CBO and many other 
analysts have struggled over the years that stems from 
attempting to see the future path of the economy, from 
technical adjustments to the baseline projection which reflect 
shifts in the relationship between the underlying economy and 
budgetary receipts and outlays; but in this circumstance, it 
also reflects a greater uncertainty about the evolution of 
policy. In the report, we made an attempt to provide Members 
with some guidance as to the possible range that one could 
envision due to policy uncertainty.
    Now, it should be noted, there are some pieces of 
uncertainty that we did not attempt to quantify in the report. 
The most notable would be the costs of reconstruction or 
ongoing occupation in Iraq. We did not have sufficient policy 
guidance to include those projections in the summer update. We 
have since, as I hope members are aware, released a bit of 
information about particular scenarios regarding occupation in 
Iraq, at the request of Senator Byrd. We did not, and were not 
able to quantify costs associated with energy legislation, 
which has assumed a new priority in the aftermath of the August 
blackout.
    We were, however, able to quantify those areas where we did 
have some guidance on the nature of potential policy 
directions. In particular, on the receipts side, what would be 
the implications of keeping the tax cuts of 2001 and 2003 in 
place and not permitting them to sunset, and what would be the 
implications of fixing, in the technical sense--of not having 
pure inflation place people under--the alternative minimum tax? 
On the outlay side, we took a look at the implications of the 
Medicare prescription drug bill as it was embodied in the 
budget resolution passed by the House and Senate earlier this 
year and at alternative paths for the growth rate of 
discretionary spending.
    Over the past 5 years, discretionary spending has grown at 
a rate of about 7.7 percent per year, on average. That rate is 
closely matched between defense and nondefense discretionary 
spending, and we tried to show the influence of a more rapid 
impact from, of a more rapid growth of, discretionary spending 
by using that historical average.
    What you see, as a bottom line, is not intended as a 
projection or forecast in any way, but as a band of the 
uncertainty that these possible policies would encompass. As 
shown in the graph, and at the upper end, if one were to freeze 
discretionary appropriations, there would be a clear and more 
rapid return to surplus, and we would have a lower debt-to-GDP 
ratio than the 30 percent in the baseline.
    At the other extreme, if one were to embody into the 
baseline projection all of the possibilities that include 
permanent tax cuts, fixing the AMT, a Medicare prescription 
drug bill and very rapid discretionary spending growth, you 
could see that the budget would not return to surplus. Indeed, 
the indicator of the fiscal sustainability, the debt-to-GDP 
ratio, would rise from 30 percent in the baseline out in 2013 
to something like 67 percent under that particular scenario. We 
offer those not as particular projections, but to give you some 
sense of the importance of alternative choices in policy and 
their impact on the budget going forward.
    Now, let me close--and take your questions after that--by 
talking a little bit about the denominator in that debt-to-GDP 
ratio, which I think is a good way to summarize the outlook 
going forward.
    Our projection for the economy comes in two pieces. Over 
the near term, CBO attempts to produce a roughly 2-year 
forecast that includes the cyclical recovery that we anticipate 
coming in the U.S. Then over the longer term, we restrict 
ourselves to baseline projections of the trend rate of growth 
in the economy and do not attempt long-term forecasts of 
business cycle fluctuations.
    In the former, our baseline embodies an assumption that we 
will have faster near-term growth, rising from 2.2 percent in 
calendar 2003 to 3.8 percent in 2004. The key features of the 
economy that will go along with that more rapid growth are a 
relatively slow recovery in the rate of unemployment, which 
will hang up in the vicinity of 6 percentage points. That 
reflects the net effect of two factors. As the economy grows 
faster, we do anticipate that more jobs will be created. That, 
on the one hand, would lower the unemployment rate.
    At the same time, our reading of the labor force evidence 
is that many workers have, many more workers than is perhaps 
typical in a cyclical downturn, have elected not to participate 
in the labor force. They will be drawn back into the labor 
force, which will slow the decline in the unemployment rate. 
Inflation will remain modest in the near term, and as a result 
of that, there will not be great upward pressure on interest 
rates from an inflationary standpoint.
    Over the longer term, we expect the economy to grow, on 
average, at a rate of 3.3 percent, between 2005 and 2008 and 
then to average 2.7 percent from 2009 to 2013. As this 
committee is well aware, the key to long-run economic growth 
projections is the rate of productivity growth in the economy. 
Our projections embody the assumption that productivity growth 
will continue at a rate of about 2.1 percent, a bit below the 
high point of the post-1995 acceleration but still very healthy 
productivity growth in the U.S. economy.
    The diminished rate of overall GDP growth comes as a 
reflection of, again, the baby-boom population beginning to 
withdraw from the labor force and a slower growth in the number 
of workers available for production. And, as a result, the 
combination of robust productivity growth, and a slower growth 
in the labor force will lead to a bit slower long-run GDP 
growth.
    In closing, I want to note that our projections attempt to 
include the impacts of the fiscal policies that are in place in 
the budget projections. In particular, we take into account, in 
our long-run projections, the impact of the baseline spending 
on deficits and, thus, on pressure on credit markets, higher 
interest rates, and any diminished investment that might 
result.
    We, in the same way, on the receipts side, take into 
account the incentive effects of the tax cuts, which would 
increase labor supply and incentives to save, as well as the 
crowding-out effects that come from the deficits associated 
with the tax side.
    The net effect is a modest negative. But if you read 
through the detailed discussion of that, in Chapter 2, what you 
will see is that to do such a projection requires us to 
struggle with a very tough analytic problem, quite frankly.
    The behavior of the economy will depend primarily on how 
the private sector views the fiscal policies. In particular, 
will the tax cuts be made permanent or not, or will some 
features of the tax cut be made permanent or not? We, quite 
frankly, do not know, in any precise way, what the private-
sector believes about the future of that fiscal policy. We have 
constructed our projections, in the spirit of baseline 
projections, by assuming that private-sector agents will, in 
fact, believe that the sunsets occur on schedule and believe 
that the discretionary spending will grow as in the baseline. 
In fact, expectations could differ greatly, and the actual 
impacts would differ as a result.
    This problem with trying to discern what the private sector 
thinks about the future path of policy shows up not only in the 
economics, but it is also difficult in doing the baseline 
projections themselves. For example, in the face of a sunset, 
there are clear incentives to shift tax activities across 
years. That will affect our baseline receipts on a year-to-year 
basis, and the usual problems associated with doing baseline 
projections of revenues are, in fact, much more complicated in 
this setting.
    So it is important to keep that in mind, that the 
underlying baseline policy adds to the uncertainty associated 
with our projections at this point in time, and we have made a 
good-faith effort to get both the economics and the budget 
projections correct in that context.
    So, with that as the highlights, I think the key messages 
are associated with the nature of baseline projections and the 
uncertainties. I would be happy to take your questions.
    [The prepared statement of Mr. Holtz-Eakin follows:]
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    Chairman Nickles. Director Holtz-Eakin, thank you very much 
for your presentation. I notice our colleagues are here. I will 
defer any questions at this point. I have some, but I would 
like to give our colleagues a chance.
    Senator Conrad. I have a few questions, if I could.
    First of all, thank you for that presentation--very 
professional and very clear.
    You know, we go to the point of uncertainty. You indicated 
there is great uncertainty looking forward, and you have given 
reasons for that uncertainty. Let me just go back to 2 years 
ago when CBO produced a similar fan chart of potential 
uncertainty. You will recall at the time you adopted--CBO 
adopted, you were not there--the midpoint of the range telling 
us, and telling the country, that we were going to have $5.6 
trillion of surpluses. I think it is useful to go back and fit 
what has really happened. What we see is the red line. What 
that shows us is we are below the bottom of what was projected 
just 2 years ago, with respect to what the deficits would be, 
and quite far below the bottom.
    Let me go to the next chart. This is from the Washington 
Post. I do not know if you saw Alan Sloan's column of yesterday 
in the Washington Post. Alan Sloan said that after adjustment 
for political reality, deficit projections get scary. What he 
has done is he took your baseline numbers, and then instead of 
using Social Security to offset the cash shortfall, he set that 
aside. So he started with, here, $1.4 trillion. He then set 
Social Security aside, $2.4 trillion over the 10 years. Then, 
he added in what the President has proposed and what is in our 
budget for $400 billion for prescription drugs because that is 
not in your baseline; is that correct?
    Mr. Holtz-Eakin. That is correct.
    Senator Conrad. Because that has not happened, so you 
cannot put it in your baseline.
    He then put in $400 billion for fixing the alternative 
minimum tax, which by the end of this decade is going to affect 
$30 million American people unless we do something. Then he 
extended the tax cuts, and I think he had $2.8 trillion there, 
and he added that all up. Instead of $1.4 trillion of deficits, 
he had, on an operating basis, $7.4 trillion of deficits over 
this period of time.
    While $1.4 trillion is daunting, $7.4 trillion, which he 
asserts is more realistic in terms of what will actually 
happen, is truly stunning. Just 2 years ago, we were told we 
are going to have $5.6 trillion of surpluses over the next 10 
years. Now, we are talking about $7.4 trillion of deficits.
    The first question I have for you in this Sloan 
calculation, are there any elements of that with which you 
disagree, in terms of the numbers?
    Mr. Holtz-Eakin. I think the numbers strike me as 
reasonable. I will not pretend to have done a detailed analysis 
of Mr. Sloan's column.
    Senator Conrad. Well, I would ask you to take a look a that 
when you have more time and just to tell me whether or not you 
think those numbers are roughly accurate because it tells me 
that we are on a course here that is utterly unsustainable, 
especially given the fact the baby boomers are about to retire. 
You know, this is all happening at what I call the worst 
possible time.
    If, in fact, we face deficits of that magnitude, $7.4 
trillion over the next 10 years, what would your advice be to 
this committee and to the Congress on fiscal policy?
    Mr. Holtz-Eakin. It, as you well know, is not the role of 
the CBO Director to offer up specific policy advice. I think 
that, in looking at the impact of deficits on the economy, one 
really needs to focus on the fact that deficits represent, on 
net, a diminishment of national saving. There are circumstances 
in which shifting from saving to spending can prove beneficial. 
Indeed, in times of economic slack, this is widely recognized 
as one of the things that can support an economy and, if done 
with appropriate discretion, timing, and skill may even be 
beneficial.
    Going forward, in an economy that has reached full 
employment, that has achieved its capacity utilization, that 
additional spending places a strain on the economy. The symptom 
of that strain is typically higher interest rates or greater 
capital inflows, and that, other things equal, will slow the 
accumulation of capital, in both its physical and human forms, 
and reduce the rate of overall economic growth and the pace at 
which the economy will expand. That is the ultimate tradeoff in 
examining the impacts of policies that might increase the 
deficit--are the gains in the near term sufficient to outweigh 
those particular costs?
    Senator Conrad. Let me just say, and I would say to my 
colleague, the chairman, with respect to his opening statement, 
I did not quarrel with having tax cuts in the near term. In 
fact, I proposed bigger tax cuts than the President proposed, 
in the near term, to give lift to the economy. The great 
concern I have is the combination of tax cuts that go on into 
the future, that explode in costs at the very time the cost of 
the Federal Government explodes because of the retirement of 
the baby-boom generation is taking us toward a fiscal cliff. I 
think it is just as clear as it can be, and it is utterly 
unsustainable, and we have to change course.
    Does that mean tax increases? No. I do not think tax 
increases would be a wise thing with the economy weak. I think 
that would be counterproductive. I do think we have to look on 
the revenue side of the equation down the road, and I think the 
first place to look ought to be the over $200 billion a year 
that is owed that is not being paid. That is truly stunning, a 
tax gap. The difference between what is owed and what is being 
paid, the vast majority of people pay what they owe.
    Have you done any estimates on the tax gap that are more 
recent than those numbers which are now some 4 years old?
    Mr. Holtz-Eakin. No, we do not have any recent estimates, 
but we would be happy to work with you if it was a topic that 
you wanted to pursue.
    Senator Conrad. I would ask that you do an estimate for me, 
and the chairman might join me for the committee----
    Chairman Nickles. Certainly.
    Senator Conrad [continuing]. On the difference between what 
is owed and what is being paid because I think that is 
something we are going to have to look at very closely.
    Mr. Holtz-Eakin. Happy to do that.
    Senator Conrad. I thank you.
    Chairman Nickles. Senator Conrad, thank you very much, and 
I appreciate those comments.
    Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Dr. Holtz-Eakin, I wanted to go back with you and your 
discussion about Chapter 2 of the report. Primarily, if I 
understand you or understood your testimony correctly, you were 
talking about the potential for doing what I call dynamic 
scoring; is that right? You were talking about the difficulty 
of trying to understand what the impact on the economy truly 
would be of the tax relief, and the spending, and how those who 
operate in the economy will view those.
    Mr. Holtz-Eakin. I would choose a different term, quite 
frankly. Dynamic scoring is typically associated with scoring a 
particular bill or piece of legislation. What we were trying to 
do was the best baseline projection, which involves, I 
understand, the impact of policies in place, as these are on 
the future path of the economy. It is, at an analytic level, 
very similar. You have to find out how the policies will 
influence the future path of the economy, and what we try to do 
is outline our thinking and the different dimensions on the 
policy front.
    Senator Crapo. So, although I may be using the term 
differently than you do, does the Budget Committee, as it makes 
these projections, actually try to determine what the impact 
of, say, the extension of the tax relief would be on the 
economy, in terms of increased economic activity or decreased 
economic activity and then build that into the budget 
projections?
    Mr. Holtz-Eakin. Indeed, we tried to place in our baseline 
projection, in particular, the impact of the sunset of the 2001 
tax cuts at the end of 2010, and show the impacts on labor 
supply, which in this case would be negative, as well as all of 
the other possible impacts of the many policies in place. So 
you see the net effect of all of the spending and all of the 
tax policies in our projection.
    Senator Crapo. So, for example, on Page 12 of the report, 
you have some of the alternative policy options that Congress 
could adopt, and you have projected out what those impacts 
would be if Congress did adopt them; for example, if Congress 
extended the expiring tax provisions or adopted a prescription 
drug benefit and so forth.
    Just taking the tax provisions, there is a number there 
that you have for each of the years, and then a total for the 
10-year period. Does that number simply total up the expected 
fiscal impact of the lost revenue to the Federal Government or 
does it also include projections of what might occur, in terms 
of increased revenue to the Government, from increased economic 
activity, if the tax policy were correctly implemented?
    Mr. Holtz-Eakin. It is a static estimate of the budget 
costs built on our baseline economic projection. We did not 
include any feedbacks from particular entries in Table 1-6 on 
the underlying economy.
    Senator Crapo. Would it not be more accurate to try to 
project those kinds of impacts? Let me ask the question this 
way: Would it not be correct to say that if we have an 
extension of the expiring tax provisions, for example, that 
that would have an impact on economic activity in this country 
and generate an increase in revenue in other taxation?
    Mr. Holtz-Eakin. There is no question that if that were the 
baseline policy, we would estimate our underlying path of the 
economy differently. The net effect of the incentives from 
lower marginal tax rates, the incentives to consume from tax 
credits, for example, and from the overall deficit or surplus 
is not clear, but certainly you would want to take all of those 
considerations into account when doing the projection.
    Senator Crapo. But you have not done that in this chart.
    Mr. Holtz-Eakin. No.
    Senator Crapo. I guess my question is would it not be much 
more accurate to do that?
    Mr. Holtz-Eakin. It would be perhaps more accurate, but the 
spirit of the chart is to allow people to rank things in a very 
technical projection sense. We know the ordering of things 
because they are done on a level basis with the same underlying 
economy. So we thought that that clarity was outweighed by the 
virtues of doing a more particular forecast. As a computational 
matter, it is quite difficult to do this once in the baseline. 
To do every line in that table would have extended the project 
somewhat.
    Senator Crapo. I understand that. In fact, my next question 
was going to be, if we decided to try to do it, and that is 
where I call it dynamic scoring, if we tried to do dynamic 
scoring of something like extending the tax cut or adopting a 
prescription drug benefit, is it doable?
    Mr. Holtz-Eakin. It is doable. The questions are really at 
the practical level: Is it doable in a timely fashion, in the 
legislative process? Is it doable with sufficient understanding 
to be useful to the Members? Can we get well enough specified 
policies to actually implement it? It requires one of the 
advantages of baseline policies, which is that we know them 
down to the last detail, whereas proposals are often less 
detailed and harder to implement. But, in principle, one could 
do this kind of analysis on any particular proposal.
    Senator Crapo. All right. Just one last question, and that 
is you mentioned that the impact on the labor market or the 
labor supply would be negligible. Was that the impact of 
extending the tax cuts or the impact of allowing the tax cuts 
to expire?
    Mr. Holtz-Eakin. As it is mentioned in our report, the 
impact of allowing the tax cuts to expire, having higher 
marginal tax rates, has a negative impact on labor supply, 
although the size of that impact is small relative to the kinds 
of uncertainty associated with just going out 10 years in an 
economic projection.
    Senator Crapo. That is another aspect of this dynamic 
scoring that I am talking about, is it not? If we do allow the 
tax cuts to expire, and that has a negative impact on the labor 
supply, then that, in itself, will then play into the deficit 
numbers in some way.
    Mr. Holtz-Eakin. Yes, but the deficit numbers will 
ultimately reflect all of the influences of the policy not just 
any one particular piece, and we would have to work through 
that.
    Senator Crapo. Understood. All right. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Nickles. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman, and, Director, 
for a very informative presentation.
    I am awestruck, frankly, by the negative cash-flow that we 
have experienced relative to what people think. Seven trillion 
dollars between the 2001 and, using your baseline number, and 
if I use this bottom-line number on your last chart that you 
presented to us, where we get to 67 percent of debt-to-GDP, 
that would be a $13-trillion cash-flow, negative cash-flow, 
swing in two/three years. I do not know anyone who would, you 
know, I would be hard to find anyone considering that sound 
fiscal policy.
    I know it is not your issue to comment on, but I think it 
puts us in a devastated fiscal situation. If I read the 
assumptions that you are putting in, which really ties into the 
Sloan article that Senator Conrad spoke about, reforming 
Medicare with a prescription drug benefit, alternative minimum 
tax and expiring tax provisions with some allowance for 
discretionary spending on defense, whether it is missile shield 
or boutique nuclear weapons or increased force structure, those 
things seem like probabilities that are something north of 50 
percent, if you were going to assign probabilities, and I just 
wonder if you think moving to a GDP or debt-to-GDP of 67 
percent is one that is going to have the kind of impact you are 
all projecting on interest payments and level of interest 
rates, that I see in these projections, we are talking about 
really still fairly historic low interest rates, 2005-2008, 
interest payments which actually are going to get close to what 
we are spending on discretionary domestic spending anyway if we 
follow along the paths we are.
    I wonder if those are realistic assumptions in the context 
of the assumptions that could be made with regard to the 
spending that we think is likely to occur on defense, Medicare 
prescription drugs, AMT adjustment.
    Mr. Holtz-Eakin. The interest rate and other assumptions in 
the economic projection are built on the baseline budget 
projections. They do not, in fact, reflect the various 
alternatives that are in that table. It is the same issue that 
arose earlier. We believe that the interest rate assumptions in 
our economic projection are consistent with the baseline 
budget, but they do not attempt to accommodate all possible 
ranges of budgetary outcomes.
    Senator Corzine. Would you care to make any guess of what 
would happen if we actually went to debt-to-GDP of 67 percent? 
Would that impact interest payments in a context of dynamic 
scoring?
    Mr. Holtz-Eakin. I think you would want to distinguish 
between two things. The first is a consistent, steady, high 
debt-to-GDP ratio as, for example, other countries have had, 
where you would have, at the same interest rates, higher 
interest payments on the Federal budget, no question.
    The second is whether you believe that the debt-to-GDP 
ratio has stabilized or is continuing to rise. If markets 
recognize a fiscal policy that is not stable and shows an ever-
rising debt-to-GDP ratio, you would expect much sharper 
increases in interest rates.
    Senator Corzine. You certainly would associate that with 
the bottom end of the projection that you had in your chart, I 
would presume.
    Mr. Holtz-Eakin. Yes.
    Senator Corzine. That would lead to real competition in 
capital markets, the Federal Government competing with the 
private sector for capital and would undoubtedly weaken 
economic growth relatively substantially, I would suspect, the 
kind of thing that we saw in the eighties, as we saw our budget 
deficits balloon.
    Mr. Holtz-Eakin. The projections in that particular 
scenario, which again represent a particular combination that 
may not have any special features, but the numbers in there 
are, in fact, much larger than what we experienced in the 
eighties. The deficit as a fraction of GDP is larger than the 6 
percent, which was the highest in the eighties, and the average 
was much lower. So that would have substantial impacts, one 
would expect, on capital markets and on the capital 
accumulation in the economy.
    Senator Corzine. Have you happened to calculate, and I 
would like actually to see this, what the debt burden per 
individual would be under baseline projections and maybe your 
two other projections that you show on the fan? How much does 
each individual end up having responsibility for and, using 
your assumptions on what interest rates would be, what the debt 
tax is for each individual?
    Mr. Holtz-Eakin. We would be happy to work through it and 
get you that number. I do not actually have it with me.
    Senator Corzine. I think those things would be interesting 
to understand how each individual is, in the U.S., is taking on 
a responsibility, a financial responsibility to fund the kind 
of deficits that we are running.
    Thank you.
    Chairman Nickles. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    I would just like to followup on a letter that the chairman 
had sent out requesting an analysis of the tanker aircraft 
study. I serve on Armed Services, and we will have a hearing on 
that tomorrow, and there might be a hearing on it today.
    I would just like to have, for the record, your comments on 
how the Air Force's lease proposal compares to a direct 
purchase of the tanker aircraft.
    Mr. Holtz-Eakin. Our analysis shows that the particular 
financing arrangement in the Air Force proposal would, in fact, 
deliver the same planes on the same schedule at a higher cost 
than would buying the planes through the appropriations 
process. Over the life of the lease, it would be a difference 
of about $5.7 billion.
    Senator Allard. Now, would you talk a little bit on the 
uniqueness of that proposal. They have, in my looking at it, 
they have set aside a special purpose fund or trust. There are 
bonds that are sold to bring money into that fund. It is also 
there is a loan provision in there, and then the expenditure 
goes out. What implication does that have over the oversight of 
this committee and Congress in general?
    Mr. Holtz-Eakin. I think, if you read through our report, 
there are two features that they are mentioning in that regard.
    The first is that the trust that would be set up would, in 
fact, issue bonds. It would also engage in some construction 
financing, and it would purchase the planes from Boeing. The 
trust itself would exist solely for the purpose of borrowing 
and making those purchases, and it would, in fact, be 
controlled by the Air Force. From that perspective, it is 
clearly a governmental activity and ought to be reflected in 
the Government's budget, with interest payments reflected in 
the usual outlay stream and purchases of planes in the usual 
outlay stream and all transactions between the Government and 
the trust as intergovernmental transfers. It is our view that 
this is best viewed as an activity of the Government that 
should be in the budget.
    To the extent that one sets the precedent of allowing this 
kind of special financing arrangement to go forward, it does, 
in fact, allow projects to be given a greater priority, through 
an apparent cheapness on the budget. This makes the cost of 
those airplanes appear to occur largely in the end years of the 
life of the lease; it``back-loads'' the cost in some budgetary 
sense. That is a misleading impression, in our view, of the 
true way that should be budgeted, since our view is that the 
goal of the budget should be to present policymakers with the 
various proposals on a level playing field so that those 
projects that merit priority on policy grounds receive it. To 
the extent that projects get to move up just by arranging this 
kind of a financing scheme, that would be at odds with what we 
view as the objective of presenting the budget in a clear and 
level fashion.
    Senator Allard. You are viewing this as a lease purchase.
    Mr. Holtz-Eakin. We believe it is best viewed as a purchase 
of these aircraft. If one did manage to draw the conclusion 
that the activities of the trust were not, in fact, 
governmental activities, which is not an opinion we share, but 
if one drew the opinion that that was outside the boundaries of 
the Government, it is still difficult to believe that this is 
an operating lease for these very specialized aircraft. So the 
transaction should be put in the budget as a lease-purchase.
    Senator Allard. Yes. Lease purchases traditionally get 
treated as the expenditure occurs at that particular point in 
time that the agreement is entered into.
    Mr. Holtz-Eakin. In contrast to the operating----
    Senator Allard. I think I have been involved in some of 
that before, and so this looks to me like kind of a different 
animal than what we have had ever had to deal with as far as 
accountability.
    And so when they, what is your understanding, when they 
sell those bonds, I mean, when you sell bonds out on the 
market, there is some assurance that there will be revenue 
coming in somewhere, and where is that, your understanding, 
where is the assurance that that revenue will come from?
    Mr. Holtz-Eakin. The Air Force report to Congress discusses 
this. Reports in the press indicate that there will be three 
kinds of bonds issued. Two of those would be retired using the 
lease payments from the Air Force to the trust. The third would 
depend upon the ultimate sale of the aircraft to the Air Force 
and, as a result, the underlying source of the credit-
worthiness of these is the flow of resources from the Air Force 
to the trust.
    Senator Allard. But there is some assumption there that 
there will be a flow of resources from the Congress during 
these years in the budget process; is there not?
    Mr. Holtz-Eakin. Indeed, yes.
    Senator Allard. I mean, that has a budgeting impact. If, 
for some reason, the dollars do not come, then they began to 
have an impact on our budget; is that correct?
    Mr. Holtz-Eakin. Ultimately, these are purchases of 
aircraft. Boeing receives $131 million per aircraft, on 
average, and the Air Force pays $161 million, on average, 
through the trust in order to acquire them. Those resources 
will have to come from the U.S. budget.
    Senator Allard. Can you ever recall when we've had this 
type of budgetary mechanism used to finance any type of capital 
investment like that?
    Mr. Holtz-Eakin. My tenure as CBO Director makes me the 
worst study in this room, quite likely, but it is, upon 
analysis, inconsistent with both broad Federal budgeting 
principles and with precedence for what constitutes an 
operating lease.
    Senator Allard. Well, I assume, though, that you spent some 
time looking it up, as though we have ever done this before, 
and the simple answer is, no, we have never done this before; 
is that correct?
    Mr. Holtz-Eakin. Not to my knowledge.
    Chairman Nickles. Senator Allard, thank you.
    I am going to take a little time as chairman. I did not ask 
any questions, but this is one that I was going to raise. It is 
one that I sent a letter to the Director asking.
    Let me ask you just to kind of paraphrase a couple of 
things. The net present value of the cost of purchase is $131 
million and lease would be $161 million?
    Mr. Holtz-Eakin. That is not a present value, but if you 
look at the flow of financing, as we understand the 
arrangement, Boeing would get an average of $131 million in 
constant dollars, so ignore inflation. But it would get an 
average of $131 million for each plane.
    The Air Force would pay, in total, for lease payments plus 
purchase at the end of the lease, $161 million. The difference 
can be ascribed to the particular financing arrangement that 
requires payment of interest to bondholders and also 
construction financing.
    Chairman Nickles. No, Boeing would not get more money, but 
the cost of the--or would they?
    Mr. Holtz-Eakin. Boeing would, if one compared this 
particular arrangement with simply appropriating budget 
authority and purchasing the airplanes, Boeing would get the 
same. It would simply be less costly for the taxpayer.
    Chairman Nickles. The taxpayers would end up paying more 
because the financing mechanism is not the same.
    Mr. Holtz-Eakin. Yes.
    Chairman Nickles. Your letter to me states, and I will 
include this in the record, ``CBO analysis of the proposed 
arrangements would cost between $1.3 billion and $2 billion 
more in present-value terms or 10 to 15 percent more than an 
outright purchase''; is that correct?
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    Mr. Holtz-Eakin. That's correct.
    Chairman Nickles. So 10 to 15 percent more or $1.3 to $2 
billion in present value more if we did the lease versus the 
outright purchase.
    Mr. Holtz-Eakin. Yes. If you asked the hypothetical 
question, how much would I have to put aside in an account 
right now to buy 100 of these planes either through the 
appropriations process or through this leasing arrangement, it 
would be $1.3 to $2 billion more expensive. You would need that 
much more right now to do it via the lease route.
    Chairman Nickles. Now, you mentioned, over the term of the 
purchasing arrangement, it was a difference of about $5 
billion, did you not?
    Mr. Holtz-Eakin. That is adding up year-by-year differences 
and not taking into account the time value of money as the 
present value would.
    Chairman Nickles. So, nominally, if you looked at the 
number of dollars, as that would spread out over, what, a 20-
year period?
    Mr. Holtz-Eakin. Roughly, yes.
    Chairman Nickles. That the total difference would be about 
$5 billion more?
    Mr. Holtz-Eakin. Yes, $5.7 billion is our estimate.
    Chairman Nickles. I appreciate that.
    Senator Allard. Would the chairman yield on that time 
value----
    Chairman Nickles. Sure.
    Senator Allard. In that agreement, there is no set value on 
interest. So that is a floating figure out there. We do not 
know what they are going to pay on interest on that, do we? We 
do not know what the maintenance costs either on that, do we?
    Mr. Holtz-Eakin. Indeed, we know, at this point, until the 
lease is signed, some of the terms are not settled. This is our 
best estimate, given our understanding of the arrangement. The 
particular interest costs would be----
    Senator Allard. That is not fixed in contract, in this 
agreement at all. I mean, that will change.
    Mr. Holtz-Eakin. The lease payments would be fixed in an 
expectation of covering the expected borrowing costs. So there 
is imbedded in this arrangement, an expectation of borrowing 
costs that could then differ.
    Chairman Nickles. Senator Allard, thank you very much, and 
thank you, Mr. Director.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman, and thank you 
for your presentation, Mr. Director.
    First, a few observations when we look at where we are 
going. I would share Senator Corzine's reaction in looking at 
these numbers of tremendous, tremendous concern about where we 
are going; and if we factor in decisions that will be made by 
this Congress, we are looking at huge, huge budget deficits. I 
know it is your job to report that, not to create it, but it is 
a great, great concern. It seems to me we have two basic 
questions we are debating: one is how to create jobs, and one 
is how to balance the budget, and do deficits matter?
    I think it is self-evident, Mr. Chairman, that we have lost 
3 million private-sector jobs in the last 2-1/2 years. That is 
not debatable. Those are real numbers which say to me that we 
should be looking at a different way to create jobs. In my 
State, the unemployment number is going up, not down, which is 
of deep concern to me.
    In terms of balancing the budget, I was there in 1997 when 
we balanced the budget. I was a proud member of the House to 
vote for that, the first time in 30 years bringing deficits 
down, which I think helped certainly the private sector. But 
now we are looking at these huge deficits again, and we debate, 
Do they matter? There are a lot of ways to spin it, but just to 
share with the colleagues and putting this in perspective, am I 
correct that the projected interest on the public debt for 
2003, this year, is $322 billion, my understanding? $322 
billion a year, that is 1 year, which is almost as much as the 
10-year costs of a Medicare prescription drug plan. So in 1 
year, we are talking about interest that is almost as much as 
that. It is almost 10 times what we spent on homeland security, 
and I am very concerned, representing the largest border 
crossing in Northern America, in Detroit, that there has been 
proposals to actually cut back 30 border inspectors right now 
when we have deep concern about what is happening there. So we 
are talking about 1 year's interest payments costing more than 
10 times our homeland security costs, and it is almost as big 
as the entire nondefense discretionary budget. Wouldn't you 
agree? I mean, we are looking at about $391 billion for most of 
homeland security, education, health care, environmental 
protection, basically everything nondefense, nondefense 
discretionary. So you are looking at 1-year interest payment 
that almost is as much as the entire nondefense discretionary 
budget. We could wipe that out, basically, and not touch this 
deficit.
    So this is a big number. This is a huge number. I am deeply 
concerned about where we are right now and the amount of money 
that we are putting out in interest compared to other critical 
needs that people have, just balancing the budget for the 
future, for the 2008 number that you are talking about.
    I would say one other comment, and that is, when Senator 
Conrad spoke about the $200 billion owed in unpaid taxes by 
people who are not following the law, not playing by the rules 
like the majority of Americans, that is basically half of the 
entire discretionary budget, nondefense discretionary budget, 
if people were just following the law.
    So, Mr. Chairman, I would hope that we would look for those 
numbers and find, in fact, what is happening with people who 
are avoiding paying their taxes and following the law.
    That is more of a statement. I am going to switch to--
because I realize you are reporting the numbers. You are not 
determining the numbers. But I know people in the State of 
Michigan are deeply concerned about the money going out in 
interest that could be going out to fund their child's 
education or health care or more homeland security at the 
border or police and fire folks to answer 911.
    Mr. Holtz-Eakin. If I could clarify one thing.
    Senator Stabenow. Yes.
    Mr. Holtz-Eakin. The number for net interest payment by the 
Government to debt held by the public would be $157 billion. 
The $322 billion is a gross interest cost, which includes 
intergovernmental transfers among holdings within various 
funds.
    Senator Stabenow. So it is Social Security, it is--
basically, what we are looking at, no matter how you spin the 
numbers, is a huge amount of money going out in interest at a 
time when we are struggling to meet homeland security needs and 
to meet other critical needs. If we also put that in the 
context that--Senator Conrad has another chart that shows that 
96 percent of the spending that we are talking about right now 
in the last 2-1/2 years has been defense, homeland security, or 
rebuilding the sites that were attacked on 9/11, 96 percent. So 
no matter how you look at those numbers, this is a question of 
limiting our ability to respond to job creation efforts or to 
meet other needs.
    I would like, though, to ask one question on a different 
topic and get your response to that. There has been a growing 
concern about the currency intervention of foreign countries, 
such as Japan and China, and this is of particular concern to 
leading manufacturing States, such as mine, in Michigan. These 
aggressive economic distortions are hurting our economy; they 
are hurting working families.
    Recently, I joined with several colleagues in writing to 
the administration about this issue. If our manufacturing 
sector and our economy as a whole are to thrive, we need 
currency markets that reflect the true value of currencies. 
This manipulation is giving Chinese and Japanese workers unfair 
advantages over American workers. I am disappointed that 
Treasury Secretary Snow has been thus far, while in China, 
unable to convince China to allow its currency to float freely.
    But my question to you is: Could you comment on how foreign 
currency manipulation stymies economic growth here in America 
and what impact on our own economy there might be if Japan and 
China stopped what I believe is clearly an unfair trade 
practice?
    Mr. Holtz-Eakin. Well, the question raises a number of very 
hard economic issues. From the point of view of the economic 
growth, both in our projection and more generally, one of the 
key features of the outlook at the moment is that the United 
States is one of the few countries that has any substantial 
prospects for rapid economic growth. To the extent that there 
is more rapid economic growth abroad, in Japan, China, or 
elsewhere, that would have the most direct impact on our 
ability to both grow faster and to export more, probably 
outweighing the particulars of currency values, certainly in 
the near term.
    With respect to the impacts of distorting relative prices, 
no economist would favor providing misleading price signals 
through currency intervention or otherwise. It is best if 
companies faced the appropriate incentives to produce products 
and consumers faced the appropriate incentives to purchase 
them. The issue is the degree to which empirically it has been 
a successful strategy on a sustained basis, actually, in 
currency markets, and there is a great dispute about that among 
economists.
    Finally, with respect to China, magnitudes matter, and at 
this point, while the flow of Chinese goods has increased in 
recent years, it still represents--manufacturing imports from 
China represent about 2 percent of U.S. manufacturers' 
shipments. So the degree that we would quantitatively see 
dramatic differences in manufacturing or broader economic 
growth from that particular quarter is open to question.
    Senator Stabenow. Well, they are growing about 8 percent a 
year, and so when you look at what is happening with China----
    Mr. Holtz-Eakin. They have certainly grown rapidly in 
recent years.
    Senator Stabenow. Yes, absolutely.
    Thank you.
    Chairman Nickles. Senator Stabenow, thank you very much.
    Next, Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. I am sure glad 
Senator Stabenow voted for our balanced budget bill. For 40 
years we tried to get that out of the House of Representatives. 
As a member of the Budget Committee, and as John Kasich has 
tried to do for, I guess, the 8 years he was Chairman of the 
Budget Committee, we finally got a bill before President 
Clinton, and he finally signed it into law, and we balanced the 
Federal budget for the first time in over 40 years. The House 
of Representatives didn't seem to have much interest in it.
    Senator Conrad's charts brought to mind some interesting 
things, especially the last chart that he put up on the 
projections of 2001 and showed the red line going straight 
down. There was no mention on that chart of the two wars that 
we have been involved in since that time or the New York-D.C. 
9/11 attacks. They did have a dramatic, dramatic effect on the 
budget and the budget deficits and the spending of this Federal 
Government over the last two years.
    I am sure, Senator Conrad, that you will be someone who 
will be glad to take credit, and I will be, too, if we finally 
pass a prescription drug benefit for our senior citizens, 
something we have promised them for the last 10 years. In fact, 
this Budget Committee put $400 billion in a prescription drug 
benefit for seniors. My prayer is that it won't explode after 
the 10 years and will not cost more than the $400 billion that 
we have allocated. I am hoping that the conference committee 
will bring back a very substantial bill that will do what we 
want it to do in the right manner of doing it.
    Let me ask some questions of our Director of the CBO. Could 
you comment on the GDP growth assumed in the CBO projections? 
It seems to me that you have assumed 2.2percent real GDP growth 
through 2003 and assume a 3.8percent real GDP growth in 2004 
and assume an overall average of 3.3percent from 2005 to 2008, 
and a 2.7percent from 2009 to 2013. Is that on the laws that 
are now on the books?
    Mr. Holtz-Eakin. Yes.
    Senator Bunning. They are?
    Mr. Holtz-Eakin. Yes.
    Senator Bunning. I wonder how you came up with that number.
    Mr. Holtz-Eakin. The near-term projection reflects the 
expectation that, in fact, the economy will grow faster. It 
reflects the expectation that we will see a recovery in 
investment, which has been the predominant feature of the 
economic downturn in recent years. That investment recovery 
will be stronger in 2004 than in 2003, aided in part by the 
partial expensing provisions that are current law.
    Senator Bunning. Did that also take in consideration the 
recession that we picked up in 2000 and carried into 2001?
    Mr. Holtz-Eakin. These are built on the current state of 
the economy reflecting that recession.
    Senator Bunning. OK. Go ahead.
    Mr. Holtz-Eakin. We see a cyclical recovery returning the 
economy back to its potential GDP over the next several years. 
That particular forecast, the short-term economic forecast, 
should be distinguished from the long-term projection, which 
does not attempt to forecast business cycles, but instead 
focuses on growth in the potential for the economy to produce. 
That particular potential reflects capital accumulation, the 
availability of labor supply (both in numbers of people and 
hours worked), skills, and productivity growth from 
technological advance.
    Senator Bunning. Did you consult with the Fed?
    Mr. Holtz-Eakin. We have a panel of economic advisers, 
which includes members of the academic community, business 
forecasters, and our panel meeting was attended as well, in 
particular, by Vincent Reinhart, who is Director of Monetary 
Affairs at the Fed. We have been working in conjunction with 
all experts that we can bring into the process.
    Senator Bunning. So, in other words, you are in 
consultation with the Fed on the monetary policy of this 
country. Are you also consulting the Congress of the United 
States on the fiscal policy?
    Mr. Holtz-Eakin. I would hesitate to say that we are in 
consultation with the Fed on monetary policy. We have a 
representative come attend our forecast meetings and give us 
whatever advice he may have to offer. In that way, it reflects 
whatever critique the Fed may have provided.
    Senator Bunning. Would you think that would be a pretty 
difficult job in assuming the overall average of 3.3percent 
from 2005 to 2008 and 2.7percent from 2009 to 2011? That would 
be a guesstimate rather than an actual forecast?
    Mr. Holtz-Eakin. It is our best estimate given what we know 
about the underlying trends. It is subject to tremendous 
amounts of uncertainty that we----
    Senator Bunning. If we had another 9/11, would that affect 
that, do you think?
    Mr. Holtz-Eakin. Certainly.
    Senator Bunning. You are also suggesting that we are going 
to have low inflation and rapid productivity growth.
    Mr. Holtz-Eakin. Yes.
    Senator Bunning. Is there any special reason for that?
    Mr. Holtz-Eakin. Well, the two, in fact, play into one 
another, given the underlying trends in productivity, our 
analyses of the source of advances in productivity growth in 
the high-technology sectors, and its diffusion through the 
economy. If you have rapid productivity growth, the capacity 
for the economy expands more rapidly, and that lessens 
inflationary pressures, other things equal.
    Senator Bunning. There was someone who was talking--I think 
it was Senator Corzine--about the Government competing with 
private sector for money if interest rates happen to go up. I 
can remember a time in this country--and I know that Senator 
Corzine can--when the prime rate in this country was over 20 
percent. I wonder if we have any more pressure at 1 percent 
than we do at 20.
    Mr. Holtz-Eakin. Well, I think the correct barometer of 
credit market pressure is real interest rates, adjusted for 
inflation. Over the long term, one would expect all interest 
rates to rise to overcome the effects of inflation, so a 1 
percentage point increase in sustained inflation is to move up 
all interest rates. So what we are trying to do is adjust for 
that----
    Senator Bunning. But we also have a short-term projection, 
and what I read, the Fed--and that is very difficult to do--it 
looks like they are saying you are pretty well set for the rest 
of this year and for the first 4 months of next year at a prime 
rate of about 1 percent. Then all bets are off, and 
particularly if there is any kind of inflation that comes into 
this market.
    My projection, or my looking at the market in the monetary 
policy and in the security and bond market, particularly the 
corporate bond market, where Chairman Greenspan seems to peg 
the interest rates, I see a slight inclination to go up. So I 
would suspect that by next March or April or May, we will see 
the Fed start to move the prime in direct relationship to the 
corporate bond rate, which is what he pegs it to--many other 
things, but, I mean, he also looks at the corporate bond rate 
very seriously.
    Is that an accurate picture?
    Mr. Holtz-Eakin. Well, what the Fed will do, we will see. 
In our projection, what we assume is that interest rates will 
rise over the course of the next year and a half. Indeed----
    Senator Bunning. That is a pretty----
    Mr. Holtz-Eakin [continuing]. Consistent with the Federal 
funds futures, which show Federal funds rates rising in early 
2004. Our projection shows a rise as well.
    Senator Bunning. OK. I have taken my time, Mr. Chairman. 
Thank you.
    Mr. Holtz-Eakin. Mr. Senator, if I could take the liberty 
of----
    Senator Bunning. Yes.
    Mr. Holtz-Eakin. You said at the outset of your remarks 
that you had budgeted $400 billion and that you would expect 
$400 billion as well for Medicare prescription drugs in the 
second 10 years. I want to----
    Senator Bunning. No, I didn't say the second 10 years. I 
said for the first 10 years.
    Mr. Holtz-Eakin. OK. Well----
    Senator Bunning. That is what is in the budget. I am hoping 
that it will be restrained in the second 10 years.
    Chairman Nickles. I heard you. I think you were talking to 
me instead of the Director.
    Senator Bunning. That is because you are on the conference.
    Chairman Nickles. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Mr. Director, welcome. We are pleased to have you here. I 
know this is your first appearance before this committee, I 
believe.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. It has really been quite a mild, calm 
hearing thus far, and I hope to keep it on that track.
    I must say that the figures you are giving us are really 
daunting, to put it mildly. You are now projecting, as I 
understand it, a deficit for 2003 of $401 billion. Is that 
right?
    Mr. Holtz-Eakin. That is correct.
    Senator Sarbanes. That is as of September 30th, in other 
words, just a few weeks away. That is what you project the 
deficit will come in at.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Now, that is the total deficit. That 
includes the surplus we are running in Social Security. Is that 
correct?
    Mr. Holtz-Eakin. It is the unified budget deficit, yes.
    Senator Sarbanes. Unified budget deficit. What is the on-
budget deficit?
    Mr. Holtz-Eakin. For 2003, our projection is that it would 
be $562 billion.
    Senator Sarbanes. $562 billion. Now, you are projecting for 
next year a deficit, as I understand it, of $480 billion?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. That is the total deficit. What is your 
projection for the on-budget deficit, in other words, without 
the Social Security revenue?
    Mr. Holtz-Eakin. $644 billion.
    Senator Sarbanes. $644 billion.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. What were you projecting in March of this 
year that the deficit would be in 2004, in other words, at the 
end of next year, the total deficit?
    Mr. Holtz-Eakin. Our baseline projection in March was $200 
billion.
    Senator Sarbanes. $200 billion, and you are now projecting 
$480 billion. Is that correct? Almost two and a half times as 
much.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. These are very large number, are they 
not, for deficits?
    Mr. Holtz-Eakin. They are large in dollar terms. They are 
not the largest relative to the economy.
    Senator Sarbanes. I want to address that in a minute, but 
in dollar terms, nominal terms, they are by a substantial 
margin the biggest we have ever had. Is that correct?
    Mr. Holtz-Eakin. The previous largest was $290 billion.
    Senator Sarbanes. $290 billion?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. That is the unified budget?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Next year you are projecting $480 
billion.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Now, as I understand it, when you make 
your projections, you work with certain assumptions that are 
called a baseline approach, which encompasses certain 
assumptions. Is that correct?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Now, I want to try to develop this 
because I think it is very important to try to lay all of this 
out. The baseline assumes that the existing statutory 
arrangements will continue. Is that correct?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. So it would not encompass the 
prescription drug benefit?
    Mr. Holtz-Eakin. No.
    Senator Sarbanes. Which has not yet been enacted, which we 
are working on. Is that correct?
    Mr. Holtz-Eakin. That is right.
    Senator Sarbanes. It would not encompass the--many people 
are saying there is going to be a necessity for AMT reform 
because more and more people are becoming affected by it, and 
at some point there will be pressure to change that. So there 
is no allowance for what reform might be done with AMT. Is that 
correct?
    Mr. Holtz-Eakin. That is correct.
    Senator Sarbanes. Then you are assuming, I guess, in your 
baseline that these tax cuts which were enacted will expire 
toward the end of the 10-year period. Is that correct?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. In fact, I noted that the sort of budget 
benefits that hold down the size of this deficit depend very 
heavily on an influx of revenue in the end years, of course, 
resting, as you do with your analysis, on the assumption that 
those tax cuts--that the taxes will come back into effect, that 
the tax cut will not become permanent. Is that correct?
    Mr. Holtz-Eakin. That is correct.
    Senator Sarbanes. But I do note that, of course, the 
President and many in the Congress are pushing very assiduously 
now to make those tax cuts permanent. Is that correct--well, I 
won't ask you that. I will just make that as an observation. We 
are anxious to preserve your nonpartisan status. I think it is 
very important both for the Director and the Congressional 
Budget Office.
    Now, if those three things were all to change, the 
surpluses you are projecting right at the tail end of this 10-
year period would not be there, would they?
    Mr. Holtz-Eakin. That is right.
    Senator Sarbanes. So, in effect, we would be looking at--
while the projections at the moment are that right at the end 
we would move the budget back into--at the end of this 10-year 
period, having experienced very large deficits in the interim, 
we would move it back into surplus. If those three things 
happen, let alone other things that might happen, including 
whether the assumption that the increase in programs will 
parallel inflation rather than running ahead of inflation, 
leaving that one to one side, we wouldn't be showing any 
surplus projections for your 10-year period. Is that correct?
    Mr. Holtz-Eakin. That is right.
    Senator Sarbanes. Now, you make a point, and you do it in 
your statement--and I know you are trying hard here to be 
balanced. You say, ``Although such deficits for this year and 
next year would be smaller than those of the mid-1980's 
relative to the size of the economy, they would reach record 
levels in nominal dollar terms.'' You repeated that here today.
    Now, if I factor in these three items that we discussed--
extension of expiring taxes, AMT reform, and a prescription 
drug benefit--I am really getting to a point where the 
deficits, even relative to the size of the economy, are really 
getting very close to those that were in the mid-1980's, am I 
not?
    Mr. Holtz-Eakin. I don't know the exact figure, but the 
chart I showed at the outset included those three items and 
very rapid discretionary spending growth. If those four were 
together, they would, in fact, at the end of the projection 
produce deficits exceeding those in the 1980's.
    Senator Sarbanes. Yes, would exceed them. If you had the 
spending projections plus these other three items?
    Mr. Holtz-Eakin. That is right.
    Senator Sarbanes. Or without these other three items?
    Mr. Holtz-Eakin. With those other three. All four in 
conjunction.
    Senator Sarbanes. So we would then, in effect, be running 
record deficits, not only in dollar figures, so-called nominal 
terms, but record deficits as a percentage of the economy 
relative to the size of the economy. Would that be correct?
    Mr. Holtz-Eakin. If you did all four of those, yes.
    Senator Sarbanes. Yes. Now, I am interested in the spending 
increases. There is a chart here, I think--if I could see the 
92-percent one, because there is a lot of talk about increases 
in discretionary spending as though somehow the Congress has 
gone on some sort of spending binge or something. But as I 
understand it, the increase in defense spending--and this chart 
indicates that--92 percent of the increase in discretionary 
budget authority in the current fiscal year is accounted for by 
an increase in defense, 75 percent, an increase in homeland 
security, 10 percent, and 7 percent for trying to make up for 
9/11, the special money to New York City, the airline relief, 
and so forth and so on.
    Now, does that correspond with the CBO's analysis?
    Mr. Holtz-Eakin. We haven't looked at those numbers, and I 
would be happy to go through them with the Senator. The 
projection that I have discussed, the 7.7 percent discretionary 
spending increase per year, is build on a 5-year historical 
average. It excludes the impact of the 2003 supplemental, so it 
is discretionary spending growth, in exclusion of that. If one 
looks at those numbers, the growth rate is very similar for 
defense and nondefense discretionary spending, and within 
nondefense discretionary spending there are growth rates 
comparable to that or greater in a wide number of areas.
    Senator Sarbanes. Do you differ with this analysis that the 
percent of change in discretionary budget authority, that 92 
percent of it in 2003 is attributable to these items?
    Mr. Holtz-Eakin. Without looking at the construction of 
those numbers, I really can't say. I would be happy to do that.
    Senator Sarbanes. Well, this is a very intimidating 
projection, is it not? I mean, you yourself in some of your 
statements have made the point that the deficits when the 
economy is--you are projecting now that the economy is going to 
pick up and it is going to be closer to full capacity--is that 
right?--over this time period.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Is it your view that running substantial 
deficits when the economy is close to or at full capacity is an 
inadvisable economic policy?
    Mr. Holtz-Eakin. To the extent that going forward we run 
large sustained deficits in the face of full employment, it 
will, in fact, crowd out capital accumulation and otherwise 
slow economic growth.
    Senator Sarbanes. It will slow economic growth. Is that 
right?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Chairman Nickles. Senator Sarbanes, thank you very much.
    I have a couple questions, and I think Senator Conrad does, 
too. Let me just touch on a couple of those.
    Senator Bunning asked if you gave consultations on fiscal 
policy, and you are consulting us; at least you are appearing 
before the committee, and we appreciate that. You have done it 
very professionally, and I think all of us are appreciative of 
that.
    Let me ask you for a little advice. Last year, we debated 
at length whether we should have a 5- or a 10-year budget. If 
you were giving a recommendation to Congress, is it your 
thought that a 5-year budget would be more realistic than a 10-
year budget?
    Mr. Holtz-Eakin. I believe it is a matter of the science of 
budget projection. The uncertainty associated with 10-year 
budget windows is extremely large, and I could make a good case 
for going to 5 years.
    But I would attach two caveats to that, quite frankly. The 
first is the degree to which there are sophisticated consumers 
of 10-year numbers who understand the uncertainties and don't 
believe them as point estimates; then more information is 
better than less. The second caveat is that in some cases, for 
example, in the growth of the entitlement programs (the numbers 
I mentioned earlier, for Social Security, Medicare, Medicaid), 
the underlying determinants are sufficiently easy to project 
(demographics and structures of programs) that the message of 
going out to even (2030 where spending that would be 14 percent 
of GDP) is important information as well for Members to have. 
That will be the real economic cost of those programs. It will 
be financed one way or another. But that level of spending is 
important to bring to the budget process.
    Chairman Nickles. I appreciate that. I raise that for a 
couple reasons. One, we wrestle with budgets, and we also--when 
you are trying to put together a 10-year budget, you spend a 
whole lot of time arguing about things that Congress may or may 
not do in the next 5 years. Most of the things that Senator 
Sarbanes just mentioned that may have a negative impact, all of 
which are going to have to be dealt with by Congress. We make a 
change in the alternative minimum tax. We make a change on 
extension. We make a change on discretionary spending. We make 
a change on entitlement spending. All those have to have an act 
of Congress, which a future Congress is going to have to 
wrestle with.
    Now, we can guess what we might do, but, anyway, I just 
mention that.
    Let me ask you your advice on another subject. The debt 
limit right now is for public and government debt?
    Mr. Holtz-Eakin. Yes.
    Chairman Nickles. Some have proposed that maybe it really 
should be debt held by the public alone. Do you concur with 
that?
    Mr. Holtz-Eakin. Well, as I noted in several of my remarks, 
I think that the debt in the hands of the public relative to 
GDP is a very useful indicator of the future path of fiscal 
policy. It reflects in a summary statistic cash in and cash out 
of the Treasury in the numerator and the performance of the 
economy in the denominator. Those are the issues that this 
committee faces all the time. So it is a useful piece of 
information.
    To the extent that you want to align budgetary control 
mechanisms like a debt limit with that indicator, then you will 
have both the information and the policy matching up.
    Chairman Nickles. I appreciate that.
    Let me ask you a question on entitlements. You mentioned 
that presently on entitlements, Social Security, Medicare, 
Medicaid, presently that is 8 percent of GDP in 2002, and it is 
projected to grow to 14 percent by 2030?
    Mr. Holtz-Eakin. Yes.
    Chairman Nickles. That is present law? That doesn't include 
prescription drugs?
    Mr. Holtz-Eakin. That is right.
    Chairman Nickles. I can't remember if it was CBO, or maybe 
it was OMB, priced the 75-year projections of Medicare and 
Social Security and showed that Social Security had an unfunded 
liability of $4.9 trillion and Medicare, $15.8 trillion? Does 
that sound right?
    Mr. Holtz-Eakin. Those are ballpark figures. There have 
been a variety of estimates provided by both the Treasury 
Secretary as well as OMB.
    Chairman Nickles. The Medicare 15.8 does not include 
prescription drugs.
    Mr. Holtz-Eakin. No, it doesn't.
    Chairman Nickles. Most estimates of the bills that were 
considered last year and are presently being considered are in 
the $4, $5, $6 trillion range, at least the two bills that are 
in conference, I believe. Is that correct?
    Mr. Holtz-Eakin. Yes, at CBO we have been trying to build 
the capacity to do 75-year cost estimates, for lack of a better 
word, and while that is not yet completely up to use at the 
moment, we did use that capacity to take a preliminary cut to 
see if these reports of a $6 trillion number were in the 
ballpark. Indeed, they appear to be in the ballpark, if not a 
little low.
    Chairman Nickles. I appreciate that. Also, I asked you for 
a study of the two bills that are now pending in conference, 
the House and the Senate. If my memory serves me correctly, the 
Senate bill, which we purported to have at $400 billion, but 
because of an amendment or two that were added, I think you 
estimated it to be as much as $460 billion. Is that correct?
    Mr. Holtz-Eakin. That is right.
    Chairman Nickles. So we do have a challenge. I happen to be 
one--and maybe I am incorrect--that thinks that those estimates 
are low. Again, it is very important how we design the program, 
designing copayments and others; if not, utilization will 
explode and the costs will greatly exceed estimates. I am just 
concerned about it. I appreciate your providing the committee 
some information.
    We have a vote ongoing, and I know Senator Conrad has 
additional questions, so I will turn to him. I have an interest 
in this question as well.
    Senator Conrad.
    Senator Conrad. I would like to go back to the lease 
agreement with the Air Force because I think it is a very 
important public policy question. The difference here, when the 
time value of money is taken into account, is $1.3 billion to 
$2 billion. Is that not correct?
    Mr. Holtz-Eakin. That is right.
    Senator Conrad. That is the difference. What the Air Force 
is saying to us is, look, CBO does not take into account the 
difference in the capacity that we are buying, so the question 
of value of what we are getting versus cost. Of course, you 
can't do that. That is not your charge.
    The Wall Street Journal had an editorial today in which 
they say they are mistaking cost for value in an attack on the 
tanker leasing deal, and they point out that these planes are 
more than 43 years old, that then Air Force Secretary James 
Roche realized the urgency of the problem when he peeled back 
the skin of a tanker being refurbished and found the metal 
underneath was disintegrating.
    They go on to point out that age isn't the only problem. 
Not only will the new 767s be able to refuel all planes in the 
military's inventory, unlike the existing planes, but they 
carry up to 20 percent more fuel and 3 times the cargo.
    They go on to point out that Boeing's main competitor is 
the European consortium that produces Airbus, which virtually 
defines corporate welfare.
    Their final point is that the real issue is not just 
lifetime cost but value for money. They conclude that the Air 
Force needs tankers now, and the leasing arrangement was deemed 
the way to get tankers into its hands most expeditiously, not 
least because it bypasses procurement procedures that could 
stretch out a buying decision for years.
    I make these points because I think all of these facts have 
to be on the table when people make a determination. Cost is 
obviously an important factor, and there is a differential, 
$1.3 to $2 billion, when the time value of money is taken into 
consideration.
    There also is a hard reality we have been presented with. 
The Air Force has told us they need these planes, they need 
them urgently, and that these planes have more capacity, 
substantially more than the existing fleet, and that these 
planes, unlike the existing planes, can refuel all planes in 
the inventory.
    You know, we have a very curious situation right now. The 
tankers can only refuel Navy planes. Then they have to land. 
Then they have to retool. Then they can refuel Air Force 
planes. These new tankers would be able to refuel both Navy 
planes and Air Force planes without having to land to retool.
    So I think all these issues have to be in front of us 
before we make a decision.
    Chairman Nickles. Senator Conrad, thank you.
    Just one final comment on Boeing, and I guess you are going 
to make a presentation today before the Commerce Committee.
    Mr. Holtz-Eakin. Yes.
    Chairman Nickles. From a budgetary standpoint, you have 
already mentioned that a lease is going to cost $1.2 to $2 
billion more, and that is on present-value dollars. Over the 
life of the contract, it will be as much $5.7 billion, for a 
difference of at least $31 million if you are trying to say the 
purchase price today per plane. That seems to me to be--the Air 
Force, I believe, was saying that they thought it would be a 
total difference of cost of $150 million. Do you know what 
that--not $4.6 billion. They were saying $150 million. What is 
the difference?
    Mr. Holtz-Eakin. The difference comes from a variety of 
sources. One would be the assumption by the Air Force that if 
one were to get the same planes at the same schedule through 
the regular appropriations process, Congress would not provide 
it with multiyear procurement authority, which indeed Congress 
could provide, and there is precedent for that taking place.
    The second difference is the assumptions about the kinds of 
interest costs built into the lease arrangement, and there we 
have tried to detail it out. There are some interaction factors 
as well. But the bulk of it is the procurement authority and 
the assumption that using the appropriations process to deliver 
the same 100 planes on the same schedule would somehow not 
yield the cost savings associated with multiyear procurement.
    Chairman Nickles. OK. From a budgetary standpoint--and this 
is one of my big concerns about it--it seems to me just to 
bypass the budget. This is a way--we are going to go into 
leasing; therefore, it won't show up until outyears when we are 
writing the checks and when they are ultimately purchased. So 
you would have a cash-flow chart that won't have as much money 
up front, and it will have a big swing at the end when in the 
last years you will be writing big checks.
    Mr. Holtz-Eakin. What I would emphasize in response to 
Senator Conrad's remarks is that indeed our analysis is 
independent of value. It is focused on budgetary treatment, 
which the Chairman just mentioned, and on two alternative 
routes, the cost of two alternative routes. One route is the 
leasing arrangement. The second route would be for Congress to 
provide additional budget authority to the Air Force to 
purchase the same planes on the same schedule, either at the 
expense of other military programs or perhaps just by raising 
total BA. If it did that, the overall costs of the program 
would be lower.
    Chairman Nickles. What about the budgetary aspect--does it 
seem to you that this type of a mechanism really just bypasses 
the budget?
    Mr. Holtz-Eakin. Yes.
    Chairman Nickles. To me, I think we need to be very 
cognizant of that. We could have any of the authorizing 
committees say, well, we are going to do lease-purchase 
arrangements and make all kinds of financial commitments that 
really wouldn't be noted, except for maybe asterisks, there 
will be some expenses coming down in the future. But there is a 
liability to the Federal Government that is coming, and I kind 
of think it should be on budget. So I make mention of that.
    We have a vote. The time is almost expired.
    Senator Sarbanes. Mr. Chairman?
    Chairman Nickles. I will call on Senator Sarbanes to 
conclude.
    Senator Sarbanes. I wanted to ask one quick question. What 
real GDP growth rate do you think we could sustain and be at a 
full-capacity economy?
    Mr. Holtz-Eakin. Our long-term projections, the 3.3 percent 
from 2005 to 2008, and 2.7 percent thereafter, are our 
estimates of full-employment growth rates in the outyears.
    Senator Sarbanes. What is the unemployment rate that goes 
with those projections?
    Mr. Holtz-Eakin. 5.2 percent.
    Senator Sarbanes. Now, we were at 4 percent for a while and 
seemed to be able to sustain it without an inflationary 
economy, 4 percent unemployment and sustain it without an 
inflationary economy. Why wouldn't we seek a higher growth 
figure that would bring with it a lower unemployment rate and--
well, if we base it off this recent experience, not an 
inflation problem?
    Mr. Holtz-Eakin. In the long run, the inflation problem 
will reflect more the Federal Reserve's targets in monetary 
policy. With respect to the real growth rate of the economy, it 
will be dictated by the rate at which we accumulate capital, 
labor, and technologies, the key of those being productivity 
growth. The difference between very rapid productivity growth 
in some years in the late 1990's and our sustained average 
productivity growth in the outyears is probably the biggest 
difference.
    Senator Sarbanes. Well, now, Greenspan seemed to have the 
view that we had done something of a breakthrough on 
productivity growth, and I thought there were figures recently 
that seemed to sustain that given where we are. Is that not 
right?
    Mr. Holtz-Eakin. I can't speak to the Chairman's views, but 
our productivity growth, 2.1 percent over the budget window, 
is, in fact, a rate which is close to but not equal to the 
peaks of the post-1995 acceleration.

    Senator Sarbanes. All right. Well, thank you very much, and 
the hearing is adjourned.
    Mr. Holtz-Eakin. Thank you.
    [Whereupon, at 12:16 p.m., the committee was adjourned.]
    

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