[Senate Hearing 109-114]
[From the U.S. Government Publishing Office]




                                                       S. Hrg. 109-114
 
                      CONCURRENT RESOLUTION ON THE
                      BUDGET FOR FISCAL YEAR 2006

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED NINETH CONGRESS

                             FIRST SESSION

                               ----------                              


         February 1, 2005--THE CBO BUDGET AND ECONOMIC OUTLOOK

 February 8, 2005--REEXAMINING THE FEDERAL BUDGET FOR THE 21ST CENTURY

 February 9, 10, 2005--THE PRESIDENT'S FISCAL YEAR 2006 BUDGET PROPOSAL

           February 16, 2005--TRANSPARENCY OF BUDGET MEASURES

February 17, 2005--MEDICARE AND MEDICAID: RISING HEALTH CARE COSTS AND 
                    THE IMPACT ON FUTURE GENERATIONS

     March 1, 2005--THE PRESIDENT'S FISCAL YEAR 2006 DEFENSE BUDGET

                                     
                                     



           Printed for the use of the Committee on the Budget

        CONCURRENT RESOLUTION ON THE BUDGET FOR FISCAL YEAR 2006

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                                                        S. Hrg. 109-114

                      CONCURRENT RESOLUTION ON THE
                      BUDGET FOR FISCAL YEAR 2006

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                      ONE HUNDRED NINETH CONGRESS

                             FIRST SESSION

                               __________

         February 1, 2005--THE CBO BUDGET AND ECONOMIC OUTLOOK

 February 8, 2005--REEXAMINING THE FEDERAL BUDGET FOR THE 21ST CENTURY

 February 9, 10, 2005--THE PRESIDENT'S FISCAL YEAR 2006 BUDGET PROPOSAL

           February 16, 2005--TRANSPARENCY OF BUDGET MEASURES

February 17, 2005--MEDICARE AND MEDICAID: RISING HEALTH CARE COSTS AND 
                    THE IMPACT ON FUTURE GENERATIONS

     March 1, 2005--THE PRESIDENT'S FISCAL YEAR 2006 DEFENSE BUDGET

                                     
                                     



                                   2
                        COMMITTEE ON THE BUDGET

                  JUDD GREGG, New Hampshire, Chairman

PETE V. DOMENICI, New Mexico         KENT CONRAD, North Dakota
CHARLES E. GRASSLEY, Iowa            PAUL S. SARBANES, Maryland
WAYNE ALLARD, Colorado               PATTY MURRAY, Washington
MICHAEL ENZI, Wyoming                RON WYDEN, Oregon
JEFF SESSIONS, Alabama               RUSSELL D. FEINGOLD, Wisconsin
JIM BUNNING, Kentucky                TIM JOHNSON, South Dakota
MIKE CRAPO, Idaho                    ROBERT C. BYRD, West Virginia
JOHN ENSIGN, Nevada                  BILL NELSON, Florida
JOHN CORNYN, Texas                   DEBBIE STABENOW, Michigan
LAMAR ALEXANDER, Tennessee           JON S. CORIZINE, New Jersey
LINDSEY O. GRAHAM, South Carolina

                  Scott Gudes, Majority Staff Director

                      Mary Naylor, Staff Director


                            C O N T E N T S

                               __________

                                HEARINGS

                                                                   Page
February 1, 2005--The CBO Budget and Economic Outlook............     1
February 8, 2005--Reexamining the Federal Budget for the 21st 
  Century........................................................    85
February 9, 10, 2005--The President's Fiscal Year 2006 Budget 
  Proposal.......................................................   165
February 16, 2005--Transparency of Budget Measures...............   277
February 17, 2005--Medicare and Medicaid: Rising Health Care 
  Costs and the Impact on Future Generations.....................   395
March 1, 2005--The President's Fiscal Year 2006 Defense Budget...   459

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman Gregg................................1, 85, 165, 277, 395, 459
Senator Conrad...........................2, 85, 166, 277, 350, 396, 460
Senator Feingold................................................69, 251
Senator Johnson..................................................   248
Senator Stabenow.................................................    67
Senator Crapo....................................................    74
Senator Bunning............................................66, 295, 486
Senator Allard...................................................   349
Senator Enzi.....................................................   328

                               WITNESSES

Bolten, Joshua, Hon., Director, Office of Management and Budget179, 242
Brown, Jeffrey, PhD., Assistant Professor of Finance, University 
  of Illinois at Urbana-Champaign..............................417, 420
Holtz-Eakin, Douglas, Director, Congressional Budget Of17, 58, 356, 380
Jonas, Tina, Undersecretary of Defense/Comptroller, Department of 
  Defense........................................................
Pace, Peter, General, Vice Chairman of the Joint Chiefs of Staff, 
  Department of Defense..........................................
Quam, Lois, E., Chief Executive Officer, Ovations, A UnitedHealth 
  Group Company................................................429, 432
Saving, Thomas R., Director, Private Enterprise Research Center402, 407
Snow, John, Hon., Secretary, Department of the Treasury........279, 323
Walker, David M., Hon., Comptroller General of the United States 
  Government Accountability Office..............................96, 132
Wolfowitz, Paul, Deputy Secretary, Department of Defense.........   501

               ADDITIONAL MATERIALS AND CHARTS SUBMITTED

Questions and Answers
    Questions and Answers...................79, 218, 230, 254, 330, 511


                  THE CBO BUDGET AND ECONOMIC OUTLOOK

                              ----------                              


                       TUESDAY, FEBRUARY 1, 2005

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:55 a.m., in 
room SD-608 Dirksen Senate Office Building, Hon. Judd Gregg 
presiding.
    Present: Senators Gregg, Domenici, Allard, Enzi, Bunning, 
Crapo, Alexander, Graham, Conrad, Sarbanes, Murray, Johnson, 
Byrd, Nelson, Stabenow, and Corzine.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Dan Brandt.
    Mary Ann Naylor, Staff Director; Sue Nelson and Jim Esquea.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We are fortunate enough to have the 
director of CBO here, and Senator Conrad has been kind enough 
to be here early, which is, I expect, a North Dakota habit 
anyway, and so, now that we have everybody here, we can get 
started, even though it is a little early, and as other members 
arrive, we will be happy to have them participate.
    The purpose of this hearing is to hear from the director on 
the baseline. This is a traditional hearing of the Budget 
Committee and an important one. It is my first hearing as 
chairman, and I want to begin by thanking the staff of both 
Republican and the Democratic side for being so courteous to me 
and in my assuming this position, being so helpful.
    I want to thank Senator Conrad for his very kind and 
generous courtesy as we have sort of settled into this new 
role. We have served together a long time a time and have great 
respect for each other, and I especially want to express 
consideration and appreciation for all the work that Senator 
Nickles did as my predecessor. He was an excellent chairman and 
set a very high standard of fairness and objectivity and 
transparency, which I hope to carry on, obviously.
    This is an important committee for a lot of various 
reasons, but I consider it important because it sets the memo 
that controls the meeting; essentially, the budget drives the 
process around here, and we have an obligation to put out a 
budget that will effectively drive that process. The purpose of 
this memo over the coming year, I hope, will be to take control 
of the fiscal house of the Federal Government, move us back 
toward a position of balancing our budgets, reaching a goal of 
reducing the deficit in half in 4 years, that is my goal, and 
having effective enforcement mechanisms so that Members of 
Congress who feel they want to assert their rights to exercise 
fiscal discipline will have tools to do that, and it is my goal 
to produce such a budget, and hopefully, we can do that in a 
way that is, if not necessarily totally bipartisan, at least 
perceived as fair and honest in its approach.
    We obviously will hear from the President as to his budget 
at the beginning of next week, I believe, and that will set the 
tone as we move forward. But the initial step is to figure out 
where we are today, and that goes to the baseline. These are 
the figures off which we function. We need to have a fair 
number that everybody agrees on is what we are working off of. 
There are obviously some issues with any baseline, but it is 
critical that we do have a baseline, because otherwise, we are 
never going to be able to figure out what we are talking about 
relative to each other.
    So this is a critical issue for us, what the baseline is, 
and we very much appreciate the Director's coming by today to 
give us his thoughts and to set such a baseline for us, and at 
this time, I would yield to Senator Conrad.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Thank you, Mr. Chairman.
    Thank you first of all for the many courtesies that you 
have extended to our side of the aisle during the transition. 
We appreciate very much the way you and your staff have 
accommodated us as these changes were made. It is certainly a 
very good start to a relationship, and I want to thank the 
Chairman. I also want to welcome him to his new responsibility 
and to indicate that I very much look forward to working with 
him.
    We have a long relationship, having served for many years 
together in the Senate. We have areas where we very much agree. 
I think both of us believe that deficits do matter and that 
these budget deficits that we have now are too large, and they 
need to be reduced, and that we have a role with our 
colleagues, a responsibility in trying to put forward plans to 
get these deficits under control.
    I want to thank Mr. Holtz-Eakin for his appearance today 
and for the hard work of his organization. They help us judge 
where we are and where we are headed.
    If I could, I would like to start off with just a few 
charts with respect to our current condition and look ahead to 
what we see coming if we do not take action. This first chart 
shows what has happened over the last several years. Back in 
2001, we had a budget surplus of $128 billion. Every year since 
then, the deficit has grown larger: record deficits of $377 
billion in 2003; $412 billion last year; and now, the 
administration is projecting a deficit this year of $427 
billion, a new record.

[GRAPHIC] [TIFF OMITTED] T1173.001


    The great concern that I have is not just the next 4 years 
or 5 years. The President has set a goal of reducing the 
deficit, cutting it in half in the next 5 years. My great 
concern is what happens outside the budget window. The 
President has proposed making the tax cuts permanent. This 
dotted line shows the effect for the next 5 years of the budget 
window. But look at what happens after the 5-years of the 
budget window to the cost of the proposed tax cuts: they 
absolutely explode beyond the 5-year budget window.
    Let us go to the next chart. That is not only true of the 
tax cuts proposed by the President. That same pattern pertains 
to fixing the alternative minimum tax, the old millionaires' 
tax that is now becoming a middle class tax trap; 3 million 
people affected now. Ten years from now, there will be 40 
million people caught up in the alternative minimum tax if we 
fail to take action; the cost, over $770 billion to address 
that. That is not in any of the budget numbers; that is not in 
the CBO report today. I am not faulting CBO. It is not their 
fault that it is not there. It is the rules that they 
*COM007*are governed by.

[GRAPHIC] [TIFF OMITTED] T1173.002


    Let us go to the next chart. I think maybe we should make 
clear that CBO is required to do their estimates based on 
current law, and so, when the President proposes additional tax 
cuts, they are not in the CBO estimate. When we have a 
challenge of the alternative minimum tax, that is not in their 
estimates. We see the same pattern with respect to the cost of 
the war. There is the $80 billion that the President has just 
requested, but the long-term outlook over the next 10 years is 
$426 billion of additional spending for residual war costs.

[GRAPHIC] [TIFF OMITTED] T1173.003


[GRAPHIC] [TIFF OMITTED] T1173.004


    When put all those things back in, what we see over the 
next 10 years is red ink as far as the eye can see. We see 
massive deficits not only this year but every year going 
forward over the next 10 years with very little improvement 
during this period.
    Let us go to the next chart. If, as some are proposing, we 
fund the transition cost of changing Social Security, moving 
some part of Social Security into private accounts, that would 
make the deficit situation even more dire. We would go from an 
ocean of red ink to an expanding ocean of red ink so that by 
the end of the 10-year period, we would be approaching a 
shortfall of $800 billion a year.

[GRAPHIC] [TIFF OMITTED] T1173.005


    Let us go to the next chart. If we put all those things 
back in the calculation that CBO does not include because they 
are not allowed to under the rules that govern them, we see 
that the publicly held debt of the United States explodes to 
$11 trillion by 2015. And this money is being borrowed not only 
from ourselves, but from around the world. We have now borrowed 
over $700 billion from Japan; over $190 billion from China. We 
have even borrowed more than $69 billion from South Korea. Some 
of us are alarmed by this dramatic increase in our external 
debt. Our external debt has increased 82 percent in just the 
last 3 years.

[GRAPHIC] [TIFF OMITTED] T1173.006


[GRAPHIC] [TIFF OMITTED] T1173.007


    Let us go to the final chart. This is why it matters: the 
Financial Times ran this headline last week: Central Banks Shun 
U.S. Assets. And the point that they are making in this article 
is that increasingly, foreign banks are concerned about the 
debt of the United States, both the trade deficit and the 
budget deficit and the extraordinary borrowing that are 
required by both.

[GRAPHIC] [TIFF OMITTED] T1173.008


[GRAPHIC] [TIFF OMITTED] T1173.009


    That sums up the additional comments I wanted to make, Mr. 
Chairman, as we head into a review by Mr. Holtz-Eakin of their 
long-term outlook. I thank you.
    Chairman Gregg. Thank you, Senator.
    Chairman Gregg. And as the tradition with this Committee, 
the Chairman and the Ranking Member make an opening statement, 
and then, we turn to our witness. So, Director, we would love 
to hear your thoughts on where we are going with the baseline.

   STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Well, Mr. Chairman, Senator Conrad, thank 
you for the chance to appear today. You have our written 
testimony and our larger report, which I think is a tribute to 
the CBO staff and I hope a service to the Congress. I thought I 
would spend a few minutes hitting some of the main points and 
then would be happy to answer your questions.
    As you know, the Federal budget ran a deficit of $412 
billion in fiscal year 2004. Under the baseline projections, 
the deficit in 2005 will be $368 billion, including a 
reasonable allowance for the costs of operations in Iraq and 
Afghanistan, the fiscal year 2005 deficit is likely to be about 
$400 billion. This is a modest improvement. It is an 
improvement both in absolute terms and as a share of our 
national income, down from 3.6 percent of GDP to 3.3 percent.
    Nevertheless, the likely path in the future depends heavily 
on policies chosen by Congress and the administration. Clearly, 
the baseline, because of the conventions involved, does not 
include the cost of ongoing operations in Iraq and Afghanistan 
or other appropriations as necessary in the global war on 
terrorism, and that will likely cause spending to be higher.
    The baseline includes a tax policy that has taxes rising in 
2009, with the expiration of rates on capital gains and 
dividends, and sharp rises in 2011 with the expiration of the 
EGTRRA and JGTRRA tax provisions. We have heard much talk of 
taxes not going up, instead staying at their current levels or 
even being reformed, and the baseline importantly includes a 
path of mandatory spending that will not only accelerate during 
the course of the 10-year budget horizon but increasingly 
become larger thereafter.
    So it is important, I think, to look at changes in the 
recent budget situation since last summer, where they are 
modestly worse when done on an apples-to-apples comparison, and 
then, to think about the path going forward as largely dictated 
by policy choices of the Congress and the administration.
    We are building on a firm foundation. The U.S. economy is 
in the midst of a solid, private-sector led economic recovery, 
moving back toward its potential. It has experienced solid, 
long-term productivity growth, which is a great hope for the 
future, and as a result, it is best to think of the economy as 
not contributing to the budget deficit, that is a minor 
contribution, but rather, the policies chosen being built upon 
a stronger economy that will allow us to address these issues. 
Nevertheless, I think even given very strong growth, it is a 
bad bet to think that we will simply grow out of the current 
budget situation.
    And finally, in thinking about policy choices, I will close 
at the end by emphasizing again that mandatory spending 
represents the largest share of the Federal budget and the most 
rapid source of growth.
    So let me walk through those points in a little more detail 
and then take your questions. The graph indicates the CBO 
baseline budget projection. It is, as Senator Conrad noted at 
the outset, a current law projection. It represents the path of 
the Federal budget on essentially fiscal autopilot. If we were 
to simply track all discretionary spending that was on the 
books at the close of 2005 and raise it at the rate of 
inflation, if we were to allow all mandatory spending programs 
to execute as they are currently written in law, and if the tax 
code proceeds as currently written in law, we will see steadily 
diminishing budget deficits over the next several years, down 
from $368 billion or 3 percent of GDP; by 2010, it will be $189 
billion, 1.2 percent of GDP, and thereafter, a return toward 
surplus and a total over the 10 years of $855 billion or half a 
percent of our GDP in budget deficits.
    Now, this baseline has changed somewhat since last 
September, and those changes are a bit hard to discern, largely 
because of two important differences. The first and the largest 
is that in September, when we did our baseline projections, 
there were $115 billion in appropriations on the books, mostly 
for operations in Iraq and Afghanistan. Baseline conventions 
say include $115 billions on the books every year; assume 
policy is unchanged, and raise it at the rate of inflation. 
Doing so, 10 years of $115 billion, inflation, debt service, 
contributes to $1.4 trillion of 10-year spending from those 
appropriations alone.
    At the moment, we have no supplemental appropriations for 
Iraq and Afghanistan, so we follow the same conventions. We put 
zero in for 10 years, raise it at the rate of inflation; we get 
zero. It is an apparently large swing in the fiscal outlook, 
but it has to do with the baseline conventions and nothing 
real.
    This chart shows that if you put it on an apples-to-apples 
basis, indeed, the 10-year budget outlook has worsened 
modestly. About three-quarters of that is legislation and a 
quarter economic and technical revisions.
    We turn next to the economy and the likely outlook. The 
most important feature of the CBO forecast is the outlook for 
productivity growth. It certainly, as everyone knows, figures 
into the long-term standards of living in the United States. 
Accordingly, it figures heavily into the long-term capacity to 
fund both private-sector needs and wants as well as the 
Government budget. A one-tenth of a percentage point increase 
in a sustained way in the level of productivity contributes 
about $250 billion to 10-year budget deficit reduction. So 
swings in productivity are very important over the long-term.
    Over the near term, the assessment of productivity is 
simultaneously an assessment of the capacity of the economy to 
absorb this cyclical recovery without generating capacity 
constraints and inflationary pressures. At the moment, 
assessing future productivity is particularly difficult. As is 
widely known, post-1995, the United States has experienced an 
acceleration in productivity that has been a great boon to our 
economic fortunes.
    Most surprisingly, during the most recent recession and 
recovery, in contrast to the typical pattern of slower 
productivity growth and then a pickup as the economy comes out, 
we have seen an even more sharp increase in productivity in the 
United States. This leaves us with the difficult question of 
assessing whether to take the extrapolation of that sharp 
increase or to remain with a projection that looks like the 
post-1995 experience of the United States.
    Given the propensity for productivity to be revised and the 
value as a result of being patient before we certify something 
as permanent, we have adopted a middle course, where we assume 
that there is a greater level of productivity, a greater 
capacity for production and income in the U.S., but we are 
going to assume the post-1995 growth rate for productivity. It 
is an important issue that is probably the most important wild 
card in our outlook and one we are constantly reviewing.
    Other risks to the outlook that are worth just mentioning 
are, in no particular order, first, oil prices. Oil prices 
remain difficult to gauge in the current international 
environment. They are a bit higher at present than they were 
when we put the forecast to bed, about $4 a barrel likely in 
2005, $2 a barrel in 2006; those will have small impacts on 
economic performance. $10 a barrel of oil is worth about two-
tenths of a percent in GDP growth. Nevertheless, it is 
something we will watch closely.
    And more generally, it is the case that a wide variety of 
economic uncertainties exist. The most prominent is the 
economic consequences of a terrorist act, followed by concerns 
on international trade and international finance, the pace of 
world economic recovery, the potential for housing prices to 
moderate their growth somewhat in the United States or 
households to save more. All of those figure into the kinds of 
uncertainties that we have experienced in the past and are 
likely to revisit again in the future in mapping the course of 
the economy into the budget outlook.
    Let me turn now to the spending and the receipt side of the 
budget. Most of the attention recently has focused on 
discretionary spending, and it has been particularly difficult 
to judge the pace of spending growth, given the path of 
supplemental appropriations. This chart summarizes some of what 
we know. If we exclude supplemental defense spending between 
2004 and 2005, appropriations for that area rose by 6.7 
percent; in the non-defense, non-homeland section, 2.6 percent; 
homeland security appropriations rose by over 14 percent, with 
the net result that overall, appropriations grew 5.1 percent 
between 1904 and 1905, exclusive of all supplementals.
    Going forward, the baseline outlook that you saw assumes 
that outlays for discretionary spending will grow at a much 
slower rate. They will grow only at the rate of inflation, and 
as a result, there is a mismatch between the most recent 
experience and the projections that we have put before you in 
the baseline.
    However, the real dollars in the Federal budget are on the 
mandatory side. Mandatory programs now constitute over half of 
Federal spending; the three that are most notable in their size 
and growth are Social Security, currently the single largest 
Government program, $500 billion, which is growing at present 
about 4.5 percent per year but which will by the end of the 
budget window be growing at over 6 percent per year.
    Medicare and Medicaid, currently behind Social Security, 
will overtake the outlays for Social Security during the 10-
year budget window. They will grow at 9 percent from Medicare, 
a bit under 8 percent for Medicaid, and the net result will be 
that those three programs will constitute over one-half of 
Federal spending by 2015 in the baseline.
    This rapid growth in Federal spending is on the other side 
of the ledger confronted with fairly rapid growth in Federal 
receipts, on average, about 6.5 percent. Most of that is in the 
rapid growth of individual income tax receipts. The good news 
is that we have seen that receipts have begun to rise again 
this year as opposed to the past several years when they fell. 
We anticipate that individual income tax rates will rise about 
8.5 percent per year over the 10 years, with the result that 
total Federal receipts will climb from about 16.8 percent of 
our national income, nearly 17 cents on the national dollar, 
below the historic average of 18 percent in the post war, to 
about 19.6 percent of our national income by 2015.
    That rise in the Federal effective tax rate comes in two 
pieces. One piece is legislation, where about 1.5 percent of 
that rise is due to the sunset of tax provisions. The remainder 
is due to real economic growth and higher personal incomes and 
a bit from the cash-out of IRAs and 401(k)'s as the baby boom 
moves toward retirement and finally, a bit more from the 
alternative minimum tax that Senator Conrad mentioned at the 
outset.
    Given the importance of policies for the ultimate fiscal 
outlook going forward, we included in our reports some 
illustrative alternatives on the discretionary side and on the 
tax side. I leave those for you to read and simply note in 
closing that we did not include any illustrative scenarios for 
mandatory programs. They obviously presented themselves as 
central to the policy debate, but it is the case that over the 
longer term, the combined spending on Medicare and Medicaid and 
Social Security will place increasingly large demands on the 
Federal budget, and that left at historic rates, the growth in 
these health programs especially will likely outstrip our 
ability to finance them and place our fiscal policy on an 
unsustainable course.
    With that cheery close, I thank you for the chance to be 
here today and look forward to answering your questions.
    Chairman Gregg. Do you know Senator Conrad?
    [Laughter.]
    Chairman Gregg. Cheeriness.
    Just to return to the issue which you ended up on, and we 
are going to stick to the 5-minute rule; we have a lot of 
members, which is great. Willie Sutton used to say you rob 
banks because that is where the money was. And if you are 
looking at the long-term fiscal solvency of the Nation and how 
we address the deficit, it is fairly obvious from your numbers 
that it is in the entitlement accounts that we have to show the 
most management; is that correct?
    Mr. Holtz-Eakin. Yes.
    Chairman Gregg. And within those accounts, the ones that 
are driving the largest amount of increase, as you said, Social 
Security would be overtaken by health care, the health care 
accounts, primarily Medicare and Medicaid; is that correct?
    Mr. Holtz-Eakin. That is correct.
    Chairman Gregg. Now, we have just put on the books a new 
Medicare benefit, which is the drug benefit. Do you have any 
estimates as to where that drug benefit is going and how much 
it will cost and how it is rising in relationship to what the 
original estimates were, which that it would be $400 billion 
over 10 years?
    Mr. Holtz-Eakin. We do not track the subsequent cost of 
legislation that has been passed. To the extent that we can do 
an apples-to-apples comparison, we can look at the baseline 
outlays for the Part D benefit under Medicare; about $1.1 
trillion over the 10-year budget window. That is in line with 
the original cost estimate.
    The cost estimate, as it was in the bill, included some 
impacts on other Federal programs that we do not pull out and 
track separately in the baseline. So to the best of our 
knowledge thus far, the cost of the drug bill is essentially 
unchanged. It has crept up by about $5 billion compared to the 
$400 billion on the pieces that we can compare. Drug spending 
is growing more rapidly than health care spending as a whole, 
but it still represents a relatively small share, 10 percent of 
the kinds of outlays we face.
    Chairman Gregg. Do you have the capacity to break those 
numbers out?
    Mr. Holtz-Eakin. Once the bill is passed and put into the 
various baselines, Medicare, Medicaid, FEHBP, and all those 
other things, we cannot track the exact configuration that was 
in the bill as it was passed. We can show you and are happy to 
the pieces that we track separately and their comparison to the 
original cost, and there, they are up only modestly, about $5 
billion.
    Chairman Gregg. So you cannot do a Part D estimate.
    Mr. Holtz-Eakin. We cannot do the MMA reestimate circa 
2005. We can just look at the Part D as it appears in our 
baseline and that part of the MMA as it appeared in the 
original cost estimate.
    Chairman Gregg. And in the area of Medicaid, what are you 
projecting there in relationship to the baseline?
    Mr. Holtz-Eakin. Medicaid spending is growing a bit under 8 
percent per year. It grows more slowly than Medicare, in part 
due to legislation. The expiration of the extra Medicaid match 
that was in the JGTRRA provision makes growth a little slower, 
and the MMA moved the responsibility for prescription drugs 
from Medicaid to Medicare for those who are eligible for both 
programs, and that makes the 10-year growth a bit slower.
    Over the longer term, the core source of growth is rising 
health care costs in the United States, the underlying cost 
pressures, not the particular structures of these programs.
    Chairman Gregg. Looking at the discretionary accounts, if 
you take out the cost of fighting the war, it appears that the 
discretionary accounts were relatively flat in their rate of 
growth; is that correct?
    Mr. Holtz-Eakin. If one takes out the appropriations, you 
see the most recent year as I displayed on the chart, total 
growth at about 5 percent.
    Chairman Gregg. And what are you projecting for the next 5 
years in those accounts?
    Mr. Holtz-Eakin. Past the appropriations each year, we 
simply assume growth at the rate of inflation. Our inflation 
rate is going a bit above 2 percent per year over the budget 
window.
    Chairman Gregg. And I notice that you are projecting that 
the revenues of the Federal Government are going to go up by 
approximately 6 percent, did you say?
    Mr. Holtz-Eakin. They are going to grow fairly rapidly, 
under 9 percent per year.
    Chairman Gregg. And that is, in the first period, before 
the extension issue comes into play, what are you projecting 
revenue growth to be?
    Mr. Holtz-Eakin. Over the first 5 years, total revenue 
growth will grow at 8.7 percent per year on average.
    Chairman Gregg. So even with the tax cuts, you are talking 
about revenues going up significantly.
    Mr. Holtz-Eakin. Yes; over the 5 years, there is a bit of 
legislation that comes into play with dividends and capital 
gains, but we are getting some from recovery in the economy and 
some from a resumption of capital gains revenues closer to 
normal.
    Chairman Gregg. You are probably getting some from the 
dynamic fact that people with more income are more productive.
    Mr. Holtz-Eakin. We hope that our baseline incorporates the 
incentives that come with current law fiscal policy; they are 
constructed to do so.
    Chairman Gregg. Your baseline seems to be fairly 
constrained in that you always assume that spending programs go 
on forever, even if their authorizations terminate, but you 
assume that the tax liability of the American citizenry will go 
up if the tax law is not extended. Why would we make those 
seemingly inconsistent assumptions?
    Mr. Holtz-Eakin. Well, we would be happy to work with the 
Budget Committee if there is an alternative set of assumptions 
that you would like to pursue for preparing baselines. The 
intent is to provide a neutral benchmark against which you can 
measure changes from current policy.
    Chairman Gregg. Well, I guess my point is I understand you 
are constrained.
    Mr. Holtz-Eakin. Yes.
    Chairman Gregg. And that is not your fault. But it does 
seem to me to be inconsistent in its constraining efforts. I 
mean, let us assume that if an authorization is sunsetted, why 
not assume that the program ends if you are going to say that 
when a tax rate sunsets, it is going to go up? I mean, you are 
handling one one way and another one another way; it just seems 
to me that it is not appropriate to getting a level playing 
field for reviewing the two.
    My time is about up; I will yield to Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    What is the 75-year shortfall in Social Security?
    Mr. Holtz-Eakin. CBO's estimate of the 75-year shortfall as 
a fraction of GDP is about 0.4.
    Senator Conrad. Expressed in dollar terms, present-day 
dollar terms, what would the shortfall in Social Security be?
    Mr. Holtz-Eakin. Over the infinite horizon, it is $6.7 
trillion.
    Senator Conrad. Over the 75-year.
    Mr. Holtz-Eakin. I do not seem to have that number in front 
of me.
    Senator Conrad. I think it is $3.7 trillion.
    Mr. Holtz-Eakin. It would be similar to the Social Security 
Administration, a bit smaller.
    Senator Conrad. Does $3.7 trillion sound about right as the 
75-year shortfall?
    Mr. Holtz-Eakin. That is the Trustees' number. Ours would 
be a bit lower. We assume higher interest rates.
    Senator Conrad. Yours would be somewhat lower. What is the 
75-year shortfall in Medicare?
    Mr. Holtz-Eakin. That number, I do not know how to 
calculate, quite frankly. Given historic rates of growth of 
Medicare and Medicaid, health care in general, 2.5 percent 
faster than income per capita. It is not obvious how to do that 
calculation without assuming something grows slower in the 
future, and so, the range of possible answers is enormous. I 
could essentially make up any number by assuming a future 
slowdown in costs.
    Senator Conrad. Well, let me ask you this: do you think 
that it is safe to assume that the 75-year shortfall in 
Medicare dwarfs the 75-year shortfall in Social Security?
    Mr. Holtz-Eakin. Absolutely.
    Senator Conrad. Do you have any estimate of what the 75-
year cost of making the tax cuts permanent would be?
    Mr. Holtz-Eakin. We have never done such an estimate. The 
report contains an alternative to the baseline that says that 
the impact in 2015 is about 2 percent of GDP, it is a bit 
under. There is no reason to think that that fraction of the 
economy would be dramatically different going forward.
    Senator Conrad. I have an estimate that the 75-year cost of 
making the tax cuts permanent is $11.6 trillion. I would ask 
you to do an analysis of that. I would like to see what your 
numbers are, but that is in the range of the 75-year shortfall 
in Medicare and substantially more than the 75-year shortfall 
in Social Security. When you calculate the long-term imbalances 
in Social Security, what growth rate are you assuming?
    Mr. Holtz-Eakin. In our analysis of Social Security, we 
assume that long run real wage growth, which is the reflection 
of productivity growth in the United States, is 1.3 percent per 
year; the other factor that figures into overall economic 
growth is how many bodies will be available to take advantage 
of that, and there, we are going to have labor force growth 
that is on the order of a half a percent per year. It depends--
--
    Senator Conrad. So to come up with this calculation of 
long-term shortfall in Social Security you would be estimating 
an economic growth rate of about 1.8 percent; is that correct?
    Mr. Holtz-Eakin. Thereabouts; we can get the exact number.
    Senator Conrad. And what was the economic growth rate last 
year?
    Mr. Holtz-Eakin. Last year, we had a very good year. We do 
not know the final number for the fourth quarter yet, but it 
looks to be in the neighborhood of 4 percent.
    Senator Conrad. Four percent. And over the last 10 years, 
what has the economic growth rate been?
    Mr. Holtz-Eakin. I do not know off the top of my head but 
well below four.
    Senator Conrad. And one of the things I would be interested 
in. If the economic growth rate was 2.5 percent instead of 1.8 
percent, what would that do to the estimates of long-term 
Social Security solvency?
    Mr. Holtz-Eakin. Productivity growth is not a panacea for 
Social Security. To the extent that we experience higher or 
lower productivity growth, it is reflected in real wages. Those 
real wages do provide higher payroll taxes into the Federal 
budget, but they also give the recipients higher benefit awards 
out of the Federal budget. Over the long-term, it is 
essentially neutral with respect to productivity.
    Senator Conrad. And what about economic growth?
    Mr. Holtz-Eakin. That is the key source of long-term 
economic growth. One could imagine a shift in the demographics, 
which raise the total growth rate because there was a larger 
growth in the labor force. There, I think the key uncertainty 
would be the path of future immigration, which is, I think, 
central. The native-born population at the moment is not 
replacing itself. The fertility rates are below replacement.
    So all future population growth is ultimately derivative of 
immigration and immigration policy, and that will be the key 
uncertainty going forward.
    Senator Conrad. You know, I would imagine somebody 
listening to this at home must be utterly confused. I think it 
is hard to get your mind around the concept that economic 
growth is a product of productivity growth and the growth of 
the population. That is what you are saying to us this morning. 
And one of the key elements in population growth is how much 
immigration we have.
    What I hear you saying is that if there is more 
immigration, that would actually extend the solvency of Social 
Security.
    Mr. Holtz-Eakin. It certainly would be an important part of 
long-term economic growth. As I said at the outset, I think it 
is important to recognize that we are unlikely to grow our way 
out of this problem. We did a long-term budget outlook in 
December of 2003. Nothing has fundamentally changed since we 
produced that document. It suggests that between now and 2050, 
if we repeat in the future what we have experienced 
historically, Medicare, Medicaid and Social Security will be 
about 26 percent of GDP; the current Federal Government is 
about 20 percent, and economic growth will not dramatically 
alter that picture.
    Senator Conrad. Very good; thank you for that testimony.
    Chairman Gregg. You have raised a huge issue, which is 
whether you can immigrate your way out of Social Security 
problems.
    Senator Alexander.
    Senator Alexander. Do you count illegal immigrants when you 
consider the number of people in the work force?
    Mr. Holtz-Eakin. We use for our projections the information 
provided by the Census, which we have from 2001 as the jumping 
off point. That would include both legal and illegal 
immigrants, and we then do our best to project over the next 10 
years based on what we know from the Bureau of Labor Statistics 
and the Census annual data, so they are in there in an 
approximate fashion. I will not pretend to have great 
precision.
    Over the longer term, we use the Trustees' assumptions 
regarding the demographics in the United States.
    Senator Alexander. Do you have any--do you know how many 
illegal people are working, have jobs here?
    Mr. Holtz-Eakin. At this point in time, no. It is very 
difficult to know even legal immigration on a real time basis. 
Undocumented workers would be even harder.
    Senator Alexander. Your report says that the labor force 
participation rate has declined from its peak of 67 percent in 
2000 to 66 percent today, which you said means that we have 2.2 
million fewer workers, and in your conversation a moment ago, 
the suggestion was that, we have more contributions to the 
economy.
    Bear Stearns has a report that came out this month that 
estimates there may be up to 20 million illegal immigrants in 
the United States, more than double the 9 million people 
estimated by the Census Bureau, and that illegal immigrants are 
gaining a larger share of the job market, so says Bear Stearns, 
and hold approximately 12 to 15 million jobs in the United 
States, 8 percent of the people working.
    Now, if Bear Stearns is right, that would make a massive 
difference, would it not, in your figures about the number of 
people working? A 1-percent change in the work force is 2.2 
million workers, according to your report. So if there are 5 
percent more illegal immigrants here than we think, we could 
have a significantly larger contribution to the work force.
    So let me ask the question this way: there is a good deal 
of talk and the President has suggested very strongly that in 
order to live by the rule of law which we preach in this 
country that we need to create a guest worker status for people 
who work in this country. If we were to do that, how might that 
affect your budget projections?
    Mr. Holtz-Eakin. Well, there are really two impacts to 
think about: one is the starting point, and the second is 
future growth. With respect to the starting point, to the 
extent that workers, legal or otherwise, are employed and show 
up in the employment survey, they are counted in terms of 
employment. To the extent that they produce output, and it is 
measured in the standard accounts, we have already got them.
    If it is the case that a new policy toward immigration 
altered the growth of the labor force going forward, that would 
be a greater increase in the economic resources available in 
the economy. Labor is a central input and would allow us to 
grow faster, other things equal.
    Senator Alexander. I would encourage you to explore how we 
count people who are illegally here working. I have had some 
conversations about it with Mr. Greenspan, and it seems to me 
unlikely that the employer survey, which surveys employers, is 
going to turn up an accurate count of people that they 
illegally hire. And if there are as many as 20 million people 
here, we need to get a better grasp on that, both for our 
budget debates and our debates about the rule of law and about 
immigration policy and about tax policy, and some part of our 
Government needs to help us understand the number of people who 
are here and are not legally here and who have jobs.
    Mr. Holtz-Eakin. Well, Senator, I look forward to working 
with you on that. We are undertaking some work on immigration 
at the CBO and its impact on the budget and the economy more 
generally. I look forward to that.
    Senator Alexander. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you.
    Senator Stabenow.
    Senator Stabenow. Good morning.
    Mr. Holtz-Eakin. Good morning.
    Senator Stabenow. And welcome, Mr. Chairman, to the Budget 
Committee. I look forward to working with you.
    You have spoken about policy choices, and that is really 
our responsibility, working together to look at the values and 
priorities of the country and how they are reflected through 
the budget, just as we do that in our own checkbook when we 
look at where we spend our dollars.
    I want to speak about that for a moment, because it is my 
understanding that we are going to see from the administration 
cuts in investments in education, cuts in veterans' health 
care; at the same time, a supplemental that will be about $80 
billion for Iraq, and I have supported those, the funding for 
Iraq. But the 1-year funding, the $80 billion equals, in fact, 
surpasses the 1-year funding of the Department of Education and 
the Department of Veterans Affairs. So I raise that just to say 
this is always about choices, values and priorities.
    I want to speak specifically about Social Security with you 
today, though. In speaking about Social Security, when you are 
talking about entitlements and the spending of the Federal 
Government, I think it is important for us to remember and to 
say Social Security is privately funded, is it not? We pay into 
it. We pay through payroll taxes into that system. It is 
privately funded. It is an insurance policy. It is the way we 
decide, just like you buy car insurance or home insurance, we 
pay into an economic insurance policy that insures us at 
retirement that we will not be in poverty or that if we are 
disabled, we will have an insurance policy, or if we have minor 
children, and heaven forbid, something happens to us, that they 
will have a life insurance policy.
    So it is an insurance system paid into privately, and it is 
about choices when we look at whether that is a good program 
for the future or whether we do other things. And I wanted just 
to return to what Senator Conrad had said: there are various 
numbers, but it appears that the 75-year shortfall in Social 
Security is around $3.7 trillion; some have actually said it is 
actually less, $2 trillion, but we will take the higher number 
of $3.7 trillion.
    When we look at making the tax cuts permanent over 75 
years, we are looking at roughly $11.6 trillion. So what we 
doing is saying that those who have done well, have been 
blessed in our country will be receiving more than three times 
in the tax cut what the entire shortfall of Social Security is 
over 75 years.
    And one of the things that I want to put forward in the 
Committee in the debate is the proposition that we would say to 
those most blessed, who have worked hard, obviously, I am sure, 
but who breathe the air and drink the water and are secured by 
our troops in Iraq and around the world and drive on our roads 
and benefit from all of the blessings of the United States that 
they take 70 percent of the tax cut over the next 75 years, 70 
percent, and we could secure Social Security for the next 75 
years. I think that is an important value statement. It is an 
important priority.
    And now, to questions: let me just say is it not according 
to your estimates, the CBO budget outlook, Social Security 
will, in fact, take in more than it pays out in each of the 
next 10 years; is that correct?
    Mr. Holtz-Eakin. Our most recent estimates are that the 
surplus in Social Security, taxes above benefits paid out, will 
remain positive until 2020.
    Senator Stabenow. OK; and so over the next 10-year budget 
window, Social Security will take in about $2.6 trillion more 
than it pays out, roughly. Is that what you are looking at? So 
it does face long-term challenges, we understand, after the 
2052 that you have estimated. It can pay about 80 percent of 
its benefits; is that----
    Mr. Holtz-Eakin. We would expect that upon Trust Fund 
exhaustion, current estimate is 2052, not a lot of precision 
there, I would admit.
    Senator Stabenow. Right.
    Mr. Holtz-Eakin. But there would be about a 22 percent 
across the board reduction necessary to balance.
    Senator Stabenow. So, 22 percent, so 78 percent roughly. So 
we do have a challenge that we do need to fix working together 
long-term.
    My question would be, though, is not the rising cost of 
health care more of a challenge for us right now, not just 
Medicare and Medicaid, but large and small businesses in my 
State have had over an average 11 percent increase in their 
health care costs, and is that not a tremendous challenge and 
drain on the economy right now, and is health care not much 
more of a real crisis that we ought to be focused on?
    Mr. Holtz-Eakin. I think that the central domestic policy 
challenge that is evident at the moment is the rising cost of 
health care. It has a public sector evidence in the rising cost 
of Medicare and Medicaid. It has private sector implications 
for insurance and for the composition of wages versus fringe 
benefits. It is a very important issue. It will evolve in the 
same budgetary context as Social Security will over the next 
decades.
    Senator Stabenow. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Enzi.
    Senator Enzi. I want to congratulate you for your 
assumption of the chairmanship, Mr. Chairman.
    Chairman Gregg. I am sure you do.
    [Laughter.]
    Senator Enzi. I also want to thank Director Holtz-Eakin for 
being here today, too, and for the insightful information he 
has provided both verbally and in the more extensive testimony.
    We've talked about balancing the budget. Recently, I looked 
to see how we balanced it before. I wanted to see what kinds of 
cuts we had made in the budget in order to balance the budget 
in the late 1990's. I noticed we had not reduced the budget in 
any one of those years; that we grew the budget every single 
time. It appeared to me that the difference was we took in more 
revenue, which allowed us to spend more revenue.
    I noticed last year in the budget and again in 
appropriations that the President found 65 different programs 
that had failed their own evaluation based on their own 
criteria. Under the Government Performance and Results Act, 
they had listed what their goals were going to be, and then, in 
their evaluation of whether they had achieved those goals, they 
failed; 65 programs.
    We suggested those programs be eliminated, and there was 
not a one of them eliminated, not a one. Of course, the comment 
I heard was that the cut was only $5 billion. Now, anybody 
around here who says only $5 billion may have been here too 
long. That sounds like a lot of money to me. Yet, if we cannot 
start with eliminating $5 billion, we certainly are not going 
to be able to eliminate $500 billion.
    But after looking at it, it looks like growing the economy 
has been the key to balnacing the budget, not what we did with 
programs. Is that a correct assumption based on when we had a 
balanced budget?
    Mr. Holtz-Eakin. The swing from deficit to ultimately 
surplus in the late 1990's was the net effect of slow 
discretionary spending growth and, in particular, a very large 
investment boom that was reflected in large amounts of equity-
based compensation and ultimately tax receipts in the United 
States.
    Senator Enzi. When we did the tax cuts, part of those tax 
cuts were business incentives. If those business incentives run 
out, how would that affect the productivity? Have you made any 
estimates on that?
    Mr. Holtz-Eakin. Which particular tax provisions are--the 
2001, 2003 or earlier?
    Senator Enzi. The more recent ones.
    Mr. Holtz-Eakin. We have looked fairly carefully at the 
impact of the partial expensing provision that was in the 
JGTRRA act, the Job Creation and Worker Assistance Act and then 
expanded. It appears that it has a modest stimulative effect on 
business investment, and we have been looking fairly carefully 
to see if its expiration at the end of 2004 would affect the 
timing of investment, though so far, there does not appear to 
be a dramatic amount of evidence that it really significantly 
pushed investment into 2004 at the expense of 2005.
    Senator Enzi. Thank you. There is also some confusion or 
interest in the difference between the payroll and the 
household survey on the amount of employment. Which survey do 
you think more accurately measures job creation, and what is 
your opinion of why there has been a sustained gap between 
these figures?
    Mr. Holtz-Eakin. Both surveys have their virtues, and any 
projection that used one to the exclusion of the others is 
probably unwise. We rely heavily on the employment survey. It 
is a broader survey. It has historically been very successful 
at tracking employment. The household survey has known 
advantages in picking up startups and in many other sorts of 
transitions into business. We look at both in the course of 
putting together our estimates.
    Senator Enzi. Thank you.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    Good morning, Mr. Director. Would you mind holding up your 
chart right there? Yes, please. In your statement, it is my 
understanding that you clearly acknowledge that that chart does 
not reflect the cost of the war.
    Mr. Holtz-Eakin. That is right. There is no accommodation 
for appropriations in Iraq and Afghanistan from 1905 and 
thereafter.
    Senator Nelson. And that would not, that chart would not 
reflect the reflection of if the President's proposal on Social 
Security, on privatization, and a transfer of those costs, that 
is not reflected in that chart.
    Mr. Holtz-Eakin. No, it is a baseline, has only current 
law.
    Senator Nelson. And would not reflect if we do the 
alternate minimum tax reform. That is not reflected in that 
chart either.
    Mr. Holtz-Eakin. No, this is current law on the AMT.
    Senator Nelson. And that would not reflect the additional 
debt service that would go along with those additional 
expenditures as well.
    Mr. Holtz-Eakin. No.
    Senator Nelson. All right; then, that being the case, may 
I--all right; if you would show the other chart, the question 
is are we going to do the President's plan on Social Security 
privatization, which would cost about $1.9 trillion over 10 
years; the cost of making the tax cuts permanent, which is 
about $1.6 trillion; the ongoing funding for the war, which 
obviously, we are going to appropriate $426 billion; the 
defense buildup as indicated by the administration, another 
$230 billion; AMT, alternate minimum tax, which certainly, 
there is going to have to be relief there, and therefore, 
reforming it is a very expensive item, $642 billion, and the 
debt service on all of that in excess of a half a trillion over 
a 10-year period.
    If that is what happens, is that not more of an accurate 
reflection of what happens to the deficit over the next 10 
years?
    Mr. Holtz-Eakin. Well, certainly under an alternative 
policy projection, something like that might transpire. To be 
perfectly honest, I do not know what Social Security would look 
like, and an alternative minimum tax reform, again, I do not 
know exactly what that would look like, but qualitatively, that 
would be the kinds of implications you would have.
    Senator Nelson. Mr. Chairman, and our Ranking Member, I 
merely raise this point: yesterday, I had the privilege of 
speaking to what is known as the Forum Club. It is a bipartisan 
group that comes together in this case in Palm Beach County, in 
West Palm Beach, and we were talking about the question of the 
deficit.
    And there are so many figures flowing around, as you 
pointed out, Senator Conrad. And when you see a chart like 
that, it does not reflect the actual realities that we have to 
face, and so, as we judge the question of what we are going to 
do with Social Security, we have to be more realistic. There is 
not one of us here who is not going to support, with every 
dollar needed, our troops in the war, because it is in the 
interest, clearly, of the United States that we stabilize Iraq; 
otherwise, a vacuum would be filled by chaos and by terrorists.
    And so, as we do these projections, I would encourage us to 
look realistically at what we are looking at and then see the 
actual deficit figures, what they are going to be, and see the 
fact of how we are going to finance those figures. And the 
shocking thing is that of the debt that we went out and 
borrowed last year, almost all of it was borrowed from foreign 
sources. And the two biggest sources that we are borrowing from 
are banks in Japan and China, and this is just simply not a 
good position for us from a defense posture to be in.
    So thank you, Mr. Chairman, for the time to make this 
point.
    Chairman Gregg. Thank you, Senator.
    Senator Allard.
    Senator Allard. Mr. Chairman, I would also like to 
congratulate you on your chairmanship, and I do not have the 
conflict of interest that my esteemed colleague did here in 
Wyoming, but I do think you will do a great job for us. I am 
looking forward to working with you.
    You know, the $3.7 trillion that we saw put up on the 
charts here that goes out for 75 years, and I think 75 years is 
a ridiculous kind of--I mean, if what we are looking at here on 
your chart is apt to be wrong, 75 years out is certainly likely 
to be wrong. And the question I want to know, does that figure 
incorporate current law?
    Mr. Holtz-Eakin. Yes.
    Senator Allard. So in 2042, when we have a 30 percent cut 
in Social Security, that is incorporated in those figures?
    Mr. Holtz-Eakin. The gap that is reflected in those 
figures, and those are not ours; those are from the Social 
Security Administration----
    Senator Allard. Yes.
    Mr. Holtz-Eakin [continuing]. But ours would be 
qualitatively similar is the gap between benefits as scheduled 
under current law, and they stay above revenues, as scheduled 
under current law, as far as the eye can see, and so, the 
question is how do you add up that gap over different horizons?
    Senator Allard. But the point that I am getting to is that 
2042, I think, is what the Social Security Administration----
    Mr. Holtz-Eakin. Right.
    Senator Allard [continuing]. Has said that the Trust Fund 
will be spent out. I mean, all of the money in the Trust Fund 
of Social Security will be spent in 2042; that is their 
figures. Now, what current law provides for, as I understand 
it, is that then, money that goes in is expended out, so you 
are no longer relying on those Trust Funds that have been 
borrowed from the General Fund to sustain those payments.
    So the assumption is that there is a 30 percent, when the 
Social Security--all of the debt that has been paid out of 
Social Security has been paid in, paid out to the 
beneficiaries, you have a third cut in benefits to Social 
Security. That is current law. And what they are figuring, what 
I see putting in these charts, they put that cut.
    So I am assuming that everybody on that side thinks that 
cutting Social Security in 2042 is a good idea, because that is 
the figures they are using, and that is what they are using to 
somehow or the other discredit these tax cuts that have been 
proposed by the President, and many of us have supported. I 
just do not think in the real world that there is going to be a 
one-third cut in Social Security benefits to Social Security 
beneficiaries in 2042. And I think if we project out without 
that one-third cut, I think that what we will find is that 
Social Security will actually spend more than what the tax cuts 
have, and I would like to see some figures where we actually 
take Social Security, Medicare and Medicaid and combine them 
and look at their growth 75 years down the road, and I think 
when we are finished, we will find that is a lot more expensive 
than any of the tax cuts. Would you agree with that?
    Mr. Holtz-Eakin. I can give you the numbers, and you can 
decide for yourself. Between now and 2050, Social Security will 
rise from about 4 percent of GDP up to about 6.5 percent of 
GDP, so 2.5 percentage points of GDP.
    Senator Allard. Which includes the one-third cuts in 
benefits in Social Security.
    Mr. Holtz-Eakin. That is prior to the cut.
    Senator Allard. That is current law.
    Mr. Holtz-Eakin. That is prior to the cut.
    Senator Allard. Yes.
    Mr. Holtz-Eakin. It will then proceed along in excess of 
receipts until Trust Fund exhaustion and the cut.
    Senator Allard. Sure.
    Mr. Holtz-Eakin. Medicare and Medicaid over the same 
horizon could rise anywhere from 4 percent of GDP to either 12 
or maybe even 20 percent of GDP, given the growth of health 
care costs. And these are numbers that we have outlined in our 
2003 report. There is a large growth on the outlay side that 
will have to somehow be addressed, because it is unlikely that 
especially if the health care programs grow that large that we 
could ever finance them.
    Senator Allard. Do you think in your own mind that it is 
likely that the one-third cut proposed in Social Security in 
2042 under current law is going to sustain?
    Mr. Holtz-Eakin. That is a policy call, as you know. It is 
current law that if that is----
    Senator Allard. But historically, those kinds of cuts in 
entitlement spending have not occurred, have they?
    Mr. Holtz-Eakin. The fact that that is the current law 
projection, and that is how the program can sustain forever, 
the crucial policy issue will be that the rising benefits above 
dedicated payrolls will occur simultaneously in the budget with 
rising demands for resources from the health care programs 
especially and then others as well, and that what ultimately 
will have to prevail will be some sort of adjudication of the 
demands for spending with the financing that is put in place. 
It will happen in all programs.
    Senator Allard. So if benefits were to sustain themselves 
at what is projected, and, you know, if you were not to have 
that cut; it was projected out over time, you would have to 
have increases in taxes and increases and cuts in spending in 
other programs to sustain that.
    Mr. Holtz-Eakin. Our projections show that----
    Senator Allard. Or cuts in benefits, I guess, to the----
    Mr. Holtz-Eakin. Scheduled benefits under current law 
remain 2 percentage points above scheduled taxes and receipts 
under current law for the Social Security program out at the 
end of our 100-year horizon. So that is the mismatch in 
scheduled benefits and scheduled revenues.
    Senator Allard. I think to try and extrapolate something 
out for 75 years is just insane.
    Senator Domenici. Senator, would you yield just for a 
clarification?
    Senator Allard. My time is up, but go ahead.
    Senator Domenici. I ask unanimous consent for----
    Chairman Gregg. Yes.
    Senator Domenici. What is 1 percent of GDP, so everybody 
that listens to----
    Mr. Holtz-Eakin. Currently, this is about $120 billion.
    Senator Domenici. Every time you mention that $120 billion.
    Mr. Holtz-Eakin. Yes, and you can think of, thus, you can 
think of any future number in terms of currently having to come 
up with $120 billion per percent of GDP.
    Senator Domenici. Thank you very much.
    Chairman Gregg. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman, and I look 
forward to your leadership of the Committee and working with 
you in very difficult circumstances. As a matter of fact, some 
of the issues we talk about here I hope actually have a 
constructive impact on my future life, particularly Medicaid 
and some of the other issues that are so important on the 
agenda of our budget efforts here.
    I am curious here: you are very clear about the structure 
of Social Security. You talk about rising to 6.2 percent of the 
overall budget, but when we get to these Medicaid and Medicare 
costs, it is a little foggier in judgment, and I like the line 
of questioning of the Chairman and Ranking Member. Is it 
possible that we can sort through some of these discussions? 
You are saying that you did come up with a number of roughly 25 
or 26 percent of the budget, did I hear you say, for mandatory 
spending or entitlement spendings?
    Mr. Holtz-Eakin. Mandatory spending is over half of Federal 
spending right now.
    Senator Corzine. But these entitlements, Medicaid.
    Mr. Holtz-Eakin. Those three, Medicare, Medicaid, and 
Social Security, will rise to be over half by 2015 and then 
will continue to grow.
    Senator Corzine. Right; and Social Security is what 
percentage of that 50 percent or----
    Mr. Holtz-Eakin. Currently, it is $500 billion, and 
Medicaid and Medicare are a bit below it, so it is a bit above 
half, but in the next 10 years, Medicare and Medicaid are 
projected to exceed it. I do not know the exact percentage.
    Senator Corzine. And their pace of growth is at a higher 
trajectory than what Social Security projections are.
    Mr. Holtz-Eakin. Yes; all the programs grow, because, as 
the baby boom retires, there are more beneficiaries. It is also 
the case that health care costs per person have grown much 
faster than income per person over the long-term, and that is 
an additional source of growth in those programs.
    Senator Corzine. And if I am not mistaken, last year, we 
added Part D to this program.
    Mr. Holtz-Eakin. Yes.
    Senator Corzine. It is hard for me to quite understand how 
we believe that Social Security--I do not expect you to opine 
on this, but how we think Social Security is in such a crisis 
when it is becoming a diminishing proportion of the overall 
mandatory social safety net programs that we have that are 
protected. Particularly in the context that we as a Congress 
just decided that we wanted to put a Medicare prescription drug 
plan down that is going to increase those elements. I would 
just, if you wanted to opine on which was in crisis, I would 
ask you, but I can understand----
    Mr. Holtz-Eakin. I think CBO directors are allergic to 
words like crisis.
    Senator Corzine. Right; I think that one has to put these 
in the overall context of what is actually going to be driving 
expenditures as we go through time. It certainly looks like 
Social Security is one that has options that are relatively 
certain. You know, we talk about not ever having reduced 
benefits. I think we extended--the Greenspan Commission 
extended the time when retirees would receive benefits, which, 
you know, call it whatever you want, those people who are 
missing it for a year or two versus when they were was a 
discretionary judgment that Congress came to.
    So if Senator Nelson's projections are, you know, rough 
justice true, do I have this right that we will be running 
cumulative deficits--I think he had something like $5.4 
trillion? That would add to this $855 billion that you would 
say is a cumulative deficit over the next 10 years.
    Mr. Holtz-Eakin. Yes, if those proposals----
    Senator Corzine. If those projections are right.
    What implications would that have, in your view, on the 
cost of money and the country's ability to manage its current 
account deficit, and what kinds of economic implications does 
our borrowing $6.5 trillion versus $855 billion have? What 
would be the kinds of things you would expect from that kind of 
change in----
    Mr. Holtz-Eakin. Let me do it in two steps. First, if one 
looks at the trajectory exclusive of a Social Security 
proposal, deficits on average move the country's economic 
activity away from saving and toward consumption, and that, 
over the long haul, lowers our accumulation of wealth, of 
capital, of technologies, of education, and slows economic 
growth.
    Senator Corzine. That lowers that productivity curve, I 
presume, if we are to do that.
    Mr. Holtz-Eakin. Yes, and there may be, you know, capital 
market manifestations of that in terms of higher interest 
rates, lower exchange rates; the exact combination is not 
clear. But the core economic impact is to save and accumulate 
less for the future.
    The Social Security piece is harder, because without 
knowing the details, there are two pieces. One is what is done 
to the underlying program, the mismatch between benefits up 
here and dedicated receipts below it, and then, what is done in 
any Commission Plan Two-style individual accounts.
    And if one just looks at borrowing money and putting it in 
individual accounts, the economic ramifications are a bit 
different, because that is from a national perspective a wash 
initially, and any economic ramifications would come from 
changes in individuals' perceptions of the future, and that 
would probably hinge on what was done in the underlying 
program. So it is not easy to spell out what would happen to 
the economy there.
    Chairman Gregg. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Just as a comment on Senator Nelson's chart, that chart 
assumed that the Congress of the United States would do 
nothing, change no laws, change no tax law, change no Social 
Security law, change nothing, and that would be the result if 
we did nothing.
    Mr. Holtz-Eakin. I will let the Senator speak for his own 
chart, but I do not think that is what he showed. He showed 
something which had a proactive change in the alternative 
minimum tax; a proactive change in Social Security law, and I 
forget the exact list.
    Chairman Gregg. If the Senator would yield, it also had a 
$2.9 trillion number in there for Social Security borrowing.
    Senator Bunning. Oh, yes.
    Chairman Gregg. And that would be new policy, plus, he 
double-counted it, because first, he counted it as a direct--he 
directed that borrowing to the bottom line of the deficit, 
which is sort of ironic, because it is borrowing, and then, he 
counted the interest on top of that to the bottom line of the 
deficit, so the numbers themselves were a little confusing.
    Senator Bunning. There were many changes that we had not 
made.
    Chairman Gregg. Yes.
    Senator Conrad. Mr. Chairman, if I might just intercede----
    Senator Bunning. May I finish and then go ahead, Kent? 
After I get finished, you can do whatever you want as vice-
chairman of this Committee.
    Yes; I just am amazed that 2080 is 75 years from today; 
2080, there is not going to be too many people in this room 
still on this side of the Earth. And now, we are trying to 
project, because we have a law that says we must project, 
solvency for the Social Security for 75 years, solvency, not a 
30 percent reduction in the year 2042 or 2043; not in 13 years 
going from a positive inflow to a negative inflow in the amount 
of money coming in; yes, I know in 2018, there is an inflow 
that starts downward, and then, our supposedly, bonds will pay 
the taxes well enough to pay full benefits into 2042 or 2043.
    And then, that chart also showed that--or did not show that 
there would be about a 30 percent reduction starting in that 
year on Social Security benefits if current law were left like 
it is. I want the American people to understand, we do not want 
to do that. That is doing nothing about Social Security. We 
want the people now collecting it to collect the full amount, 
and I want my 35 grandkids and my nine children and their 
spouses to be able to collect the full amount that they expect.
    And if we do not do something, and we do not do it shortly, 
13 years maybe; why not do it before the 13 years? It is a lot 
easier to do it up front. We are going to be short, big time 
short, depending on who adds up the numbers, whether it is $4 
trillion, whether it is $10 trillion. As an economist, would 
you comment on the likelihood, economics and behavioral effect 
of Congress not extending the tax cuts, including individual 
tax rates and capital gains and dividend tax rates currently 
set to expire within the budget window?
    What effect would such a large tax increase have on 
economic growth? How would it physically or potentially affect 
the Social Security solvency?
    Mr. Holtz-Eakin. Two different questions. The first is the 
impact of letting those tax cuts go away as under current law 
would depend on what people are expecting. If people expect 
dividends and capital gains rates to remain at their current 
level past 2009, the rise would raise the cost of capital; it 
would serve in the long-term to diminish their spendable 
income, and they would presumably choose, as a result, to 
consume less and save more.
    Similar impacts could be expected in 2011. If they expect 
those to be made permanent, and they are not, that would be a 
surprise increase in taxes; they would feel worse off. They 
would save more to make up for it, and it would impact 
incentives to save, invest and supply labor.
    Senator Bunning. And Social Security?
    Mr. Holtz-Eakin. Social Security is narrowly financed by a 
payroll tax, and the formula is determined by the growth in 
real wages. Only the impacts on real wages and payroll tax base 
would show up in Social Security.
    Senator Bunning. Would you call 12.5 percent narrowly? That 
is the payroll tax.
    Mr. Holtz-Eakin. I do not understand the question.
    Senator Bunning. If you say 6.25 from the individual and 
6.25 from the corporate side, is that a narrow-based tax?
    Mr. Holtz-Eakin. I may not understand the question. I do 
not know of any changes in the payroll tax under current law, 
so if the question is if we changed one----
    Senator Bunning. Well, there is none proposed.
    Mr. Holtz-Eakin. If we changed it, it would have big 
economic impacts, yes.
    Senator Bunning. Thank you very much.
    Chairman Gregg. Thank you.
    Senator Byrd.
    Senator Byrd. Thank you, Mr. Chairman.
    I congratulate you on winning the election----
    Chairman Gregg. Thank you.
    Senator Byrd [continuing]. Which made you the Chairman. And 
I am going to look forward to working with you. I have found 
our past relations to be very cordial, and they will remain 
that way.
    Mr. Director, I am not one of those who believes that 
Social Security can continue to pay benefits without changes 50 
years into the future. A significant problem exists, and while 
it may not be on our doorstep, it certainly is on the horizon. 
The Congress has the responsibility to make the relevant facts 
known to the American public.
    At a recent event hosted by the New America Foundation, you 
referenced the, quote, important details, close quote, that you 
hoped would emerge from a, quote, high-level discussion, close 
quote, about Social Security reform. When you say high level 
discussion, are you referring to conversations behind closed 
doors at the White House, or do you mean to encourage an open, 
public discussion in which all of the details of Social 
Security reform emerge?
    Mr. Holtz-Eakin. That was intended to convey the benefits I 
would receive from a vigorous public discussion that looked at 
all of the policy issues from an economic, from a budgetary, 
and from a programmatic perspective.
    Senator Byrd. You might want to consider a point that I 
made in my letter to President Bush: what important details 
should the Congress know before it makes changes to Social 
Security?
    Mr. Holtz-Eakin. I think there are many dimensions to a 
Social Security proposal that will matter. It is well-
established that the current program will, in fact, 
automatically come into balance, in our projections, in 2053. 
The question is is there a better way to bring the underlying 
program into balance, and what would that entail in the way of 
benefit changes and tax changes? In addition, there is a 
threshold question that has been discussed about the 
desirability of moving from a fully pay-as-you-go to a system 
that is at least in part prefunded. That is a threshold policy 
question, and one would need to understand both the nature of 
the transition at the beginning and how it would be financed 
and then also the interaction of any ultimate private 
investments and the traditional program as modified at the end.
    There is an enormous number of details that are central to 
evaluating that from an economic policy point of view; 
certainly, its budgetary implications and then for the 
objectives of the program narrowly defined.
    Senator Byrd. The people pay for Social Security. Before we 
make any changes in the program, the people have a right to 
know all of the details. I have written to the President and 
ask that he explain the full costs of his Social Security plan 
and its effect on workers' benefits. What else should we ensure 
that our constituencies know?
    Mr. Holtz-Eakin. I think the range of information is 
enormous. The distribution of benefits and taxes, both prior to 
and after any alteration of legislation; the range of options 
that would be involved in any new elements of the Social 
Security program, the interaction of the disability program 
with the retirement program; the list could go on and on.
    Senator Byrd. What facts should the Congress require of the 
administration in order to make an informed decision about 
individual accounts?
    Mr. Holtz-Eakin. The Congress will probably decide in its 
own wisdom what facts it needs. I think that the legislative 
details of any proposal, individual accounts or otherwise, will 
have a very large impact, and knowing those details is central, 
at least in CBO's eyes, to giving an accurate assessment of the 
economic, budgetary and Social Security impacts.
    Senator Byrd. In discussing investment accounts at the New 
America Foundation, you were asked about the Federal Government 
providing a financial guarantee that is comparable to the 
guarantee afforded under the current Social Security system. 
Assuming that the Government guarantees a minimum benefit from 
individual investment accounts, how much of a cost would that 
impose on the Federal budget?
    Mr. Holtz-Eakin. It is not possible to calculate a dollar 
amount of that cost without knowing the nature of any 
individual investments and also the size of the guarantee, the 
minimum benefit. It is just my observation that with the 
presence of market risk that market risk can be transferred to 
the Government and ultimately to the taxpayer, but it cannot be 
made to go away, and that accurately assessing such an 
investment strategy would involve accurately assessing the cost 
of risk.
    Senator Byrd. Mr. Chairman, is my time up?
    Chairman Gregg. I am afraid so, Senator.
    Senator Byrd. I thank the Chairman.
    I thank you, Mr. Director.
    Chairman Gregg. Senator Domenici, the former chairman.
    Senator Domenici. Thank you, Mr. Chairman.
    First of all, let me not only congratulate you but say that 
I have wished for many things since I was a Senator, but I 
certainly do not wish to be in your place.
    [Laughter.]
    Chairman Gregg. Congratulations is faint praise.
    Senator Domenici. But when I was working on budgets, and 
there were deficits comparable to this, people were saying the 
same thing: they did not want my job.
    But let me suggest to all of you and Mr. Director to you 
also that the first chart you put up, put it up there again 
about where the deficit has been. See, that is a pretty good 
indication that the deficit changes rather dramatically. Do you 
see where it peaked out up there? That is a higher percent of 
GDP than we are now, substantially higher. So is the percent of 
GDP that accompanies a deficit an important number in terms of 
the American economy and what our people might expect in terms 
of their lifestyle?
    Mr. Holtz-Eakin. Yes, I think it is much more accurate to 
measure the deficit as a fraction of national income than just 
the dollar terms.
    Senator Domenici. So it is important that that be as low as 
you can get during good times.
    Mr. Holtz-Eakin. One would expect that you, as a Federal 
Government, decide what programs you want to have and how much 
they will cost, and then, you put in a financing plan that 
supports it.
    Senator Domenici. I am not sure I should ask you that 
question, because that is a sort of a policy thing. We should 
not be asking you those, but I think that is sort of well-
understood. Now, look at it, and everybody look at it. Look how 
quickly it came down. You see, at the bottom end, it was 
balanced, right? Follow that green line. It was balanced for 2 
years there. I might say to everybody I was privileged to be 
there when that happened.
    [Laughter.]
    Chairman Gregg. You did a great job.
    Senator Domenici. Yes; that made up for all the pain.
    [Laughter.]
    Senator Domenici. I am not sure how long it will last if 
this other one keeps going up, but Mr. Director, did I hear you 
say that there is nothing on the horizon that would indicate 
that that deficit might not come down precipitously like it did 
in the years up there, part of the Clinton years and part of 
the Reagan years; did you say that?
    Mr. Holtz-Eakin. I cannot rule that out. As a matter of 
science, I cannot. The uncertainty is too large. I think that 
as a matter of the odds, it is unlikely that we will simply 
grow our way out of this deficit using current policy, but I 
certainly could not stipulate that it could not happen.
    Senator Domenici. But we did grow our way out of that one.
    Mr. Holtz-Eakin. The growth in the late nineties, the big 
investment boom and the receipts that came with it were 
extraordinary, and I guess the sentiment I am conveying is it 
is unlikely to bet on that again.
    Senator Domenici. That is the era when we have a lot of 
arguments as to what caused it. If you were on President 
Clinton's side, you would say his tax increases caused it. Some 
people say that. If you are on my side, I would say that is 
ludicrous; it was a lot of other things that caused it but not 
that.
    In any event, to me, the most important thing is the 
economy and what happens to it and that there be sustained 
economic growth, not just for a few years but that we are not 
doing things that will hurt the economy in the out years. 
Everything we do ought to be measured against sustained 
economic growth, because the American people should know that 
those are fancy words, but that essentially means jobs; it 
means the potential for wages to go up and for more people to 
be employed.
    Now, we do not have to have a balanced budget to have a 
good economy, do we?
    Mr. Holtz-Eakin. No.
    Senator Domenici. And America, an economy as powerful and 
as strong as ours, can sustain and live with deficits; is that 
not right? We have.
    Mr. Holtz-Eakin. It is an issue of magnitude, sir. To the 
extent that there are enormously large deficits that reduce 
national saving, then, ultimately, growth will be impacted. But 
it is certainly the case that we have had good economic growth 
coexist with deficits.
    Senator Domenici. Now, we should be concerned about getting 
the deficit down, because we have had a very large accumulation 
of deficits, which means that debt is getting very large. Is 
that a fair statement? Concerned about it; I did not ask how 
quick or how, but we should be concerned about it, right?
    Mr. Holtz-Eakin. I think that certainly, going forward, 
fiscal policy is central to the U.S. economic outlook. I would 
say that the years past this chart are as important as any.
    Senator Domenici. Mr. Chairman, I do want to make one 
point. All this testimony, you know, we are listening to it, 
but so are a lot of people. And we use words that many people 
do not understand. You know, he made a statement, if this 
happens, the cost of capital will go up. What does the average 
American know? What does that mean?
    Chairman Gregg. Nobody understands that.
    Senator Domenici. That means interest rates will go up; is 
that correct?
    Mr. Holtz-Eakin. It means interest rates will go up, and 
businesses will find it harder to finance their investments.
    Senator Domenici. So, that is bad, right? I mean, for the 
economy, for jobs, for people.
    Mr. Holtz-Eakin. Yes.
    Senator Domenici. My second question on that line--am I out 
of time? OK; will we get another round?
    Chairman Gregg. Yes.
    Senator Domenici. I will stay.
    Chairman Gregg. Senator Murray.
    Senator Murray. Mr. Chairman, thank you. I join with my 
colleagues in welcoming you to this new position. You take it 
at a very difficult time with all of the challenges that we 
certainly face in the country today.
    I think we are the only two members of this Committee that 
are on this Committee, the HELP Committee and Appropriations, 
so we will be seeing a lot of the outfall of the decisions.
    [Laughter.]
    Senator Murray. Mr. Director, it is good to have you here 
as well. We all depend on your objective, unbiased outlook and 
assumptions; may not always agree with everything you say, but 
really do appreciate the work that you do, so we welcome you 
here today.
    Mr. Holtz-Eakin. Thank you.
    Senator Murray. Mr. Director, the CBO's most recent 
economic outlook assumes an fiscal year 2005 deficit of $368 
billion. You have acknowledged that that does not include any 
supplemental funding for Iraq or Afghanistan, any changes to 
the AMT or revenue changes from making the tax cuts permanent. 
If we simply include the additional supplemental spending, we 
are, I believe, looking at a deficit for 2005 of at least $420 
billion, which is another historic high.
    Now, I have heard the President say that he hopes to cut 
the deficit in half over the next 5 years, and excluding any 
funding for DOD or Homeland Security or revenue changes from 
extending the tax cuts, if we just look at the supplemental, 
what kind of cuts will we have to enact to Medicare and 
Medicaid and other mandatory programs in order to cut that 
deficit in half?
    Mr. Holtz-Eakin. Let me begin first with the fiscal year 
1905 number. Our estimate would be that the outlays, the 
additional outlays in 1905 for Iraq and Afghanistan would total 
about $30 billion. Our estimate of the deficit would be about 
$400 billion. The administration estimated something close to 
$430 billion. That is consistent with our recent experience 
that on baseline, outlays that are about $20 billion higher 
than us, and spending on supplementals, they are a bit above 
us.
    So we put the number closer to $400 billion. That is the 
one I would be comfortable with.
    Senator Murray. Fine.
    Mr. Holtz-Eakin. Cutting it in half over the----
    Senator Murray. Five years?
    Mr. Holtz-Eakin [continuing]. Next 5 years, I guess I would 
ask you starting from what point? Starting from $400 billion, 
you would have to get down to $200 billion. The arithmetic is 
pretty simple: you would have to take out $200 billion. If you 
did it as a fraction of GDP, it would be a bit less. Right now, 
$100 billion is about 42 percent of Medicare spending; 
Medicaid, it is a bit larger as a fraction of Medicaid, and 
those are mechanically the kinds of reductions in spending you 
would need to meet that kind of target.
    Senator Murray. Including in education and transportation 
and veterans' health care and housing, and all of those 
programs would all have to take a cut of about 2 percent, 
correct?
    Mr. Holtz-Eakin. That is if we just did $100 billion in 
Medicare and Medicaid; the broader thing, you would have a 
wider base. It would be lower. We can get an estimate for you 
if you would like.
    Senator Murray. But there would definitely have to be some 
significant cuts in mandatory programs and other programs as 
well.
    Mr. Holtz-Eakin. There would certainly have to be some 
reductions.
    Senator Murray. I listened carefully to my friend from New 
Mexico, who chaired this Committee for a long time, and agree 
with him that the sustained economic outlook is critical to us 
getting our budget in control, but we also know that to keep 
jobs out there, we have to have education and training and 
transportation infrastructure in order to create and sustain 
those new jobs. So I am very concerned that enacting major cuts 
will have a bigger increase on the deficit and make it very 
hard for us to reach that deficit reduction if we are making 
big cuts in programs that actually help sustain and create jobs 
plus health care.
    Mr. Director, you did point out that increases in Medicare 
and Medicaid reflect some of the overall increases in health 
care, and this administration has been arguing that caps on 
noneconomic damages on medical malpractice will slow increases 
in health care. Would caps on damages significantly reduce the 
Medicare and Medicaid costs that we are looking at?
    Mr. Holtz-Eakin. To the extent that we know the link 
between caps on damage awards and various costs in health care, 
our knowledge is pretty limited, but we did do some work that 
suggested that caps would reduce malpractice premiums 
significantly, by about 22 percent, but those are a small 
fraction of overall health care spending, and the impact on the 
broad spending basket would be under 1 percent.
    So that is the extent of a statistical link between caps 
and health spending that we found so far. It is an area we 
continue to work in and are interested in learning more about.
    Senator Murray. It is not going to save our way out of 
this?
    Mr. Holtz-Eakin. Not on what we know so far.
    Senator Murray. It was not that long ago that this 
Committee was looking at a fairly large surplus, and here we 
are with historic highs in deficit spending. We have heard a 
lot about the war on terrorism, recession, increased spending 
on domestic programs all contributing to this, but there is not 
a lot of talk about the impact of the tax cuts from 2001 and 
whether or not they have contributed to this deficit.
    What role did the President's tax cuts play in our rapid 
escalation in annual deficits?
    Mr. Holtz-Eakin. There are two answers to that. The first 
is that mechanically, if one does the arithmetic and looks at 
the CBO's projection of the budget surplus for this year and 
now the reality of a deficit for this year and does a 
decomposition of the swing from surplus to deficit, about 35, 
36 percent of that is economic impacts, economics and 
technicals; a comparable size, 35, 36, is on the spending side, 
and the remainder would be on the receipts side.
    More generally, the swing from surplus to deficit on both 
tax and spending during the course of the early 2000 period, 
when the economy was very weak, on balance did support a very 
weak economy, and that, other things equal, was an economic 
benefit. It is just now the case that the economy has 
recovered. Going forward, we have a private sector-led economy, 
and those kinds of sustained budget deficits have a very big 
and different impact going forward than they do looking back.
    Chairman Gregg. Thank you, Senator.
    Senator Murray. Well, thank you, Mr. Chairman. I just would 
say that I am very concerned about the deficit spending. We are 
looking at the war in Iraq, continuing costs, supplementals, a 
lot of talk about Social Security. I believe our generation has 
the responsibility to look at this budget from an honest 
perspective and say what we are spending; we should not be 
passing these costs on the next generation.
    Chairman Gregg. Senator Graham.
    Senator Graham. Thank you, Mr. Chairman. Congratulations. I 
am honored to be part of the Committee.
    I asked you some questions before the hearing, and I do not 
know if you got the information or not, but if the Congress 
decided to make the tax cuts permanent, and we borrowed the 
transition costs of a personal investment account bill like I 
proposed, which is, I think, $1.2 trillion, did you find how 
that would affect the deficit?
    Mr. Holtz-Eakin. We took the policy that your staff 
conveyed and consisted of the taxes and AMT, Social Security. 
That would lead in 2015 to a deficit on the order of $650 
billion and a total over the 10 years of about $5 trillion.
    Senator Graham. So to make sure we understand that, if you 
made the tax cuts permanent, and you borrowed the transition 
costs of personal investment accounts as described by my bill, 
one of the more modest ones, you would have a $650 billion 
deficit in 2015; is that correct?
    Mr. Holtz-Eakin. Yes.
    Senator Graham. All right; if you tried to make Social 
Security solvent just by putting new money without any other 
reform to 2075, how much money would you have to come up with 
in today's dollars?
    Mr. Holtz-Eakin. If the question is, you know, what would 
you need to solve the actuarial imbalance----
    Senator Graham. Right.
    Mr. Holtz-Eakin [continuing]. Then, that is a number that 
is on the order of $3.5 trillion, and the difference, of 
course, is in the timing, the gap between benefits and taxes.
    Senator Graham. OK; to avoid any benefit cuts between now 
and 2075, you would need $3.5 trillion in today's dollars right 
now.
    Mr. Holtz-Eakin. You would have to dedicate to Social 
Security those resources and find a way in the budget and the 
economy to get them.
    Senator Graham. OK; if you tried to solve the Social 
Security dilemma of reduced benefits coming over time, just by 
changing the age eligibility, how old would you have to be to 
meet that goal before you drew your first check?
    Mr. Holtz-Eakin. It is easiest for me to frame the long-
term problem as the fact that benefits are about 7 percent of 
GDP; taxes are about 5 percent of GDP, so there is a gap out 
there for as far as the eye can see between promised benefits 
and taxes.
    Raising the normal retirement age above 70, even to the 
midseventies, seems unlikely to close that gap.
    Senator Graham. So if you went up to 75 before you got your 
first check just by raising the age limit, it would not close 
the gap, you do not believe.
    Mr. Holtz-Eakin. We do not have a firm estimate, but it 
would take a substantial increase.
    Senator Graham. OK; there is a big issue going on debate in 
the country: is Social Security really a problem or not? Do we 
have a problem with the system? Whether it is 2042 or 2052, you 
are firm on the idea that we start paying more money out than 
we collect around 2020.
    Mr. Holtz-Eakin. I do not know what constitutes a problem, 
but I know the future. And the future is that at the moment, 
Social Security brings in more in payroll taxes than it pays 
out in benefits. Between now and roughly 2020, that would 
diminish and go to zero. Those funds would no longer be 
available to the remainder of the budget and cushion it, and 
thereafter, it will switch.
    Senator Graham. Well, if I started paying out--if I spent 
more than I took in, would I eventually have a problem?
    Mr. Holtz-Eakin. Yes, sir.
    Senator Graham. I would probably go to jail, because I 
would start writing bad checks, but that is not going to happen 
here.
    So the bottom line is by 2020, in that timeframe, the 
country has to deal with a phenomenon that we are paying more 
in benefits than we are collecting in Social Security taxes. 
Are you sure about that?
    Mr. Holtz-Eakin. It is the case that this will evolve in a 
budgetary framework, and to the extent that----
    Senator Graham. Did you just say yes or no?
    Mr. Holtz-Eakin. No.
    [Laughter.]
    Mr. Holtz-Eakin. It is the case that you could, you could, 
sir, as a matter of principle decide not to touch Social 
Security. But if you do that, you have to simultaneously 
address a larger budget problem everywhere else.
    Senator Graham. Right.
    Mr. Holtz-Eakin. And so, that is a policy problem.
    Senator Graham. That is not my question. My question is a 
very simple question: we have 12.4 percent payroll taxes coming 
into the system. We are going to pay benefits, and they have 
already been scheduled. There comes a point in time where the 
12.4 percent does not equal the amount you are paying out.
    Mr. Holtz-Eakin. Yes, absolutely.
    Senator Graham. OK; and once that happens, bad things 
follow.
    Mr. Holtz-Eakin. Once that happens, you must find the way 
to honor those benefits which will be statutorily due from 
somewhere in the Federal budget.
    Senator Graham. OK; when do you believe Social Security 
really becomes stressed? Is it 2020, or does it happen before 
then?
    Mr. Holtz-Eakin. I believe that when viewed from a 
budgetary perspective, it will be the case that shortly after 
the baby boom begins to retire in 2008, that the cushion that 
the program is currently providing to the Federal budget will 
begin to diminish. That will be noticeable to members of the 
Budget Committee and Congress as a whole, and thereafter, it 
will not only diminish; it will switch, and funds to honor 
benefits payable under current law will have to be found by 
either cutting other spending programs, raising taxes, or 
borrowing more.
    Senator Graham. And one last comment. I have gone over my 
time my first appearance; I apologize. The basic problem is 
that in the future, we are going to have a lot more people come 
into the system as retirees than are workers; is that correct?
    Mr. Holtz-Eakin. That is right. There is a sharp ramp-up 
with the retirement of the baby boom generation.
    Senator Graham. Thank you.
    Chairman Gregg. Senator Sarbanes.
    I notice that nobody has turned their mike on when they 
welcome me to the Committee.
    [Laughter.]
    Senator Sarbanes. Actually, now that the mike is on, I was 
going to repeat the welcome.
    [Laughter.]
    Senator Sarbanes. I join my colleagues in welcoming you to 
the Committee, and we look forward to working closely with you, 
and I want, as always, to acknowledge the chairmanship of 
Senator Domenici for many, many years.
    Senator Domenici. Thank you very much.
    Senator Sarbanes. I want to talk a bit about our 
international situation, but before I do that, I just want to 
be clear on this Social Security question. When you use these 
various projections, whose assumptions are you using with 
respect to growth of the economy?
    Mr. Holtz-Eakin. CBO's projections are built off of the 10-
year baseline projections, so we use the same economic 
assumptions in our Social Security as we do for the budget 
outlook that you saw today.
    Senator Sarbanes. That is for 10 years.
    Mr. Holtz-Eakin. Yes, beyond that----
    Senator Sarbanes. Beyond that, are you using the Social 
Security system's projections?
    Mr. Holtz-Eakin. We will use the Trustees' assumptions for 
fertility, mortality, immigration, disability. We use CBO's 
economic assumptions for the entire period.
    Senator Sarbanes. I see. Now, the Trustees' assumptions 
generally, on the figures I have seen used, are really the most 
conservative path, are they not? Is that one of the reasons 
that you project that the Trust Fund will still have something 
in it in 2052 as opposed to their 2042?
    Mr. Holtz-Eakin. There are really two big differences that 
contribute to that. The first is we assume that real interest 
rates will be higher, 3.3 percent as opposed to 3 percent for 
the Trustees. Mechanically, that allows higher interest on 
bonds in the Trust Fund, and they last longer, and then, we 
have a bit lower in the way of male benefits paid, and so, 
there is less going out, and that tends to extend the Trust 
Fund.
    Senator Sarbanes. Now, on your projections, as I understand 
it, the system, including the Trust Fund balances, which have 
been built up for the purpose of paying the benefits, would be 
able to handle that at a 100 percent level until 2052; is that 
correct?
    Mr. Holtz-Eakin. Our indications are that the Trust Fund 
accounting would keep benefits fully payable until 2052.
    Senator Sarbanes. 2052.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. In other words, 47 years from now.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Now, at that point, if all of these 
assumptions work out, and of course, we are assuming a lot of 
things, because we are talking about half a century in terms of 
what is going to happen, but at that point, assuming all these 
assumptions work out, there will not be any balances in the 
Trust Fund to help pay the benefits; is that correct?
    Mr. Holtz-Eakin. At that point, under current law, there 
would not be the legal authority to pay full benefits, and you 
could only pay payroll taxes coming in.
    Senator Sarbanes. Right; now, am I correct in understanding 
that payroll taxes coming in would still be sufficient to pay 
75 to 80 percent of the benefits?
    Mr. Holtz-Eakin. Yes; our projection has it 78, but as you 
well know, there is enormous uncertainty over all these 
numbers. It is the trajectories that really matter.
    Senator Sarbanes. Yes; of course, the uncertainties run in 
both directions.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes First of all, I would just make the 
comment that that does not sound to me as if the system is 
broke or insolvent. There is a shortfall which we need to 
address, and I recognize the sooner you address it, the smaller 
the adjustments you have to make; the longer you wait, the 
greater the adjustments you have to make. But even in 2052, if 
nothing else is done--and no one is operating on that premise--
this inflow into the system would cover 75 to 80 percent of the 
benefits; is that correct?
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. OK; now, I want to ask you about our 
international situation and the growing imbalances which exist 
internationally. It is my understanding that we are now running 
the largest trade deficit in our history.
    Mr. Holtz-Eakin. Yes.
    Senator Sarbanes. Now, that means, of course, that we are 
building up our external debt, does it not?
    Mr. Holtz-Eakin. Yes.
    Chairman Gregg. Senator, your time is up, but if you want 
to continue this for a minute or so, because we are going to do 
another round.
    Senator Sarbanes. Oh, we are?
    Chairman Gregg. I will give you a couple more minutes here, 
and then, we will start off on the other round.
    Senator Sarbanes. I will wait until the next round then; I 
will pursue that subject on that round. I do not want to impose 
on my colleagues.
    Chairman Gregg. Thank you.
    Just to followup on the line of thought that Senator 
Sarbanes has pursued here as to what really is the solvency of 
the Social Security fund, first, remember that this Committee's 
role in Social Security is prescribed by the statute, but all 
of us on this Committee have spent a lot of time working on the 
issue. But the point is this: the real issue that we confront 
is what Senator Graham points out, which is that we have a 
demographic adjustment in our nation coming at us, which is 
that historically, the genius of Social Security was that it 
was a pyramid.
    There were always going to be many more working people 
paying into the system than people who took out of the system; 
originally, in 1950, there were 12 people paying in for every 
one person taking out; today, there are 3.5 for every one. By 
the year 2019, where there will be two people paying in for 
every one person taking out, we go from a pyramid to 
essentially a rectangle, and there are just simply too few 
people working to support the tax burden to support the people 
who are retired.
    And the concept that there is a fund somewhere that is 
going to be redeemed that is going to be able to pay for the 
benefits is really a bit illusory, because what the fund is, is 
it is a put to the American taxpayer or a call to the American 
taxpayer, the working American, the American who is 20, 30 
years old, the American, our children, our grandchildren who 
are coming into the work force saying you shall pay taxes to 
redeem these bonds to support these people who are retired.
    And that tax burden has to go up to the point to support 
the benefit. So what we are basically saying is we are going to 
significantly increase the tax burden on those working 
Americans because there are so many fewer of them working to 
support the number of people retired; is that not correct?
    Mr. Holtz-Eakin. It is the case that there are no economic 
resources in the Trust Fund, and in order to avoid defaulting 
on the bonds in the Trust Fund, it will be the case that the 
Treasury will have to come up with funds from some source. 
There will be higher taxes or lower spending on other programs, 
or the Treasury will borrow from the public as a whole.
    Chairman Gregg. So essentially, what is happening here is 
that you have a generation that is so large that it is going to 
end up putting a tremendous burden on the younger working 
generation when it retires, and that was not conceived when the 
Social Security system was structured; it was always conceived 
that there would be a much larger working group, which is why 
we got into the immigration issue earlier on in this 
discussion, but I think it is important that people understand 
that, that there really is not some fund out there that people 
are going to be able to suddenly jump onto.
    That must be my wife saying I am not smiling.
    [Laughter.]
    Mr. Holtz-Eakin. I am not wearing the tie my wife bought me 
so----
    Senator Domenici. I have a wife like that, too.
    [Laughter.]
    Chairman Gregg. I do think that point is critical to this 
whole debate of how we address Social Security.
    I am not going to take any more time here, because I know 
that you have been very generous with your time, Mr. Director, 
and I have my wife calling me.
    [Laughter.]
    Chairman Gregg. So I will yield my time to Senator 
Domenici, I know, had some followup point, and then, we will go 
back and forth.
    Senator Domenici. Thank you very much.
    I want to tell you all one about wives calling. I was on 
the floor one night debating with Senator Kennedy, and, you 
know, we both have a tendency to yell.
    [Laughter.]
    Senator Sarbanes. I have never noticed it.
    [Laughter.]
    Senator Domenici. And somehow, we both think that the 
louder and more red we get, the more effective we are.
    Senator Domenici. And one night, my wife called and left a 
note and said please, the fact that you are getting louder and 
more red does not mean you are any more effective. In my 
opinion, you are getting worse.
    So I went back, and when I got the floor, I changed it, and 
I said Senator Kennedy, my wife called and said that you and I 
were both yelling too much and getting too red----
    [Laughter.]
    Senator Domenici [continuing]. And she suggested that you 
tone it down.
    [Laughter.]
    Senator Domenici. When I got back home, my wife was really 
fit to be tied.
    [Laughter.]
    Senator Domenici. She said if you ever do that again, you 
know, she did not say what would happen, but probably something 
bad.
    [Laughter.]
    Senator Domenici. Just two or three questions: one, I need 
you to check on the budgetary impact of parity for the mentally 
ill statutorily as it applies to the insurance companies of 
America, group policies. Would you do that for me?
    Mr. Holtz-Eakin. Certainly.
    Senator Domenici. I am saying that, looking at what you all 
have done in the past, I cannot understand why you estimate 
such a large budgetary impact, but I would like you to tell me 
that.
    Mr. Holtz-Eakin. Certainly.
    Senator Domenici. This balance of trade accounts that 
Senator Sarbanes was going to talk about, how much of that is 
attributable to our having to purchase oil overseas?
    Mr. Holtz-Eakin. I do not know the number off the top of my 
head, but oil imports are a substantial part of the net trade 
situation.
    Senator Domenici. Would you get the number and----
    Mr. Holtz-Eakin. Yes.
    Senator Domenici [continuing]. The percent and submit it to 
the Chairman? Maybe somebody there knows.
    Mr. Holtz-Eakin. It is about $180 billion. We have a $600 
billion--so it is not quite a third.
    Senator Domenici. Not quite a third.
    Mr. Holtz-Eakin. Of the deficit.
    Senator Domenici. So that is a very large amount that would 
be dramatically reduced if we did not have to buy oil overseas, 
right?
    Mr. Holtz-Eakin. Other things equal, yes.
    Senator Domenici. That is arithmetic.
    Mr. Holtz-Eakin. That arithmetic, yes.
    Senator Domenici. In your opinion, how risky is it that the 
Chinese are buying a significant portion of our debt, the 
Chinese, the Japanese----
    Mr. Holtz-Eakin. There are two levels to the question. One 
is purely economic, and it is not our central forecast that it 
is a problem; it is certainly a risk that there may be a shift 
in the desire of foreign investors to hold U.S. securities and, 
in particular, U.S. Treasuries. So it is a concern. We are 
looking at it.
    And the second is whether it is past economics and that 
there would be more strategic motives involved in foreign 
governments' purchases or sales, and on that, we are really not 
qualified to say, but it is something we watch, and it is out 
there.
    Senator Domenici. But the point of it is that there are not 
very many places they can put their money that is as secure as 
ours.
    Mr. Holtz-Eakin. No, it is unlikely we are going to see a 
big problem, because the U.S. remains a good investment 
environment; it remains, you know, a reserve currency. At the 
moment, a fraction of U.S. international liabilities, whether 
in total or Government, held by foreign governments is smaller 
than it was 10 years ago, smaller than it was 20 years ago, but 
it is certainly something that merits watching, and we do so 
with each forecast.
    Senator Domenici. My last question has to do with 
immigration. The fact that we, as the Chairman said, we do not 
have as many people working per Social Security recipient is 
part of the big, overall problem, but we also need an economy 
that needs more workers. You cannot just say we need more 
immigration; we need more immigration if the American economy 
can assimilate more employees.
    Is that an automatic thing, or is that related to the 
growth in the American economy and how we are doing versus 
competition in the world?
    Mr. Holtz-Eakin. The benefits of immigration are broadly 
the same as the benefits of being open in trade in goods, 
capital and also in skills and labor. The flows of immigration 
are determined by our performance economically and performance 
elsewhere in the globe and also on the policies toward 
immigration. I mean, there are clearly important considerations 
that go into this. So it is a broad, you know, set of 
influences.
    Senator Domenici. Thank you very much, Mr. Chairman.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Mr. Holtz-Eakin, I do not know if you had a chance to read 
the New York Times this morning.
    Mr. Holtz-Eakin. I did.
    Senator Conrad. There was an opinion piece by Mr. Krugman, 
noted economist, talking about the growth of the economy over 
the last 75 years compared with your projections of the growth 
of the economy over the next 75 years and this question of 
Social Security solvency. He makes an interesting observation 
that the growth has been, over the last 75 years, 3.4 percent. 
You told us this morning you are projecting growth over the 
next 75 years of 1.8 percent.
    His point is that if we are going to have that kind of 
slowdown in economic growth, how can we expect the same rate of 
equity growth that we experienced over the previous period? Did 
you have the chance to read that?
    Mr. Holtz-Eakin. I will not pretend to have studied it in 
any great detail. I think that there are, you know, two issues 
raised by it that I saw right away. The first is whether it is 
possible to have a rate of return on corporate equities in real 
terms, inflation-adjusted of, say, 6.8 percent, our assumption, 
that is above the long-term growth rate of the economy. And the 
answer to that, I think, has to be yes, because historically, 
it has happened. We have seen the 6.8 percent happen as a 
matter of history. As you note, his article says that the 
economy grew much slower than that in total.
    The second issue is whether----
    Senator Conrad. Can I just stop you on that?
    Mr. Holtz-Eakin. Yes; that is just the facts.
    Senator Conrad. Let me just stop you on that point, because 
if we had a growth of 6.5 or 6.8 percent in stocks over the 
previous period----
    Mr. Holtz-Eakin. Rate of return.
    Senator Conrad. A rate of return, but that was in an 
environment in which the economy was growing 3.4 percent----
    Mr. Holtz-Eakin. Yes.
    Senator Conrad [continuing]. Would it not be fair to assume 
that if economic growth slowed to 1.8 percent, that equity rate 
of return might also slow?
    Mr. Holtz-Eakin. The second point is what would be the 
future in the face of faster or slower economic growth, either 
as a matter of other stuff, like immigration, or policies, and 
there, you would want to look and see the extent to which 
national saving changed and the things that would determine 
long-run economic growth were going to alter future rates of 
return. That is certainly part of a comprehensive assessment of 
the future of Social Security.
    Senator Conrad. Well I had never thought of this point, 
frankly, but it raises an interesting question about how our 
equity growth is tied to economic growth? Is there a 
relationship? I assume there is. If we are going to have slower 
economic growth than we have had over the previous 75 years, 
does that mean we should expect slower equity growth? And how 
does that affect all of our calculations?
    And it goes back to the question of the economic growth 
that you project over the next 75 years. Are there things that 
we could do that would get stronger economic growth? What would 
be the factors that would contribute to stronger economic 
growth in terms of Government policy?
    Mr. Holtz-Eakin. Economists organize the sources of growth 
into nice little bundles, and the bundles are accumulation of 
capital, a term that encompasses all of the things that you do 
when you do not eat something today, and you save it for 
tomorrow, you put it into----
    Senator Conrad. That has to do with savings.
    Mr. Holtz-Eakin. So any policy toward savings. Then, the 
labor inputs, the number of bodies, how many people are around 
to work, what skills they bring to work: education, training, 
those kinds of policies are there. The third bundle is 
technology, and the technologies are driven by policies toward 
R&D, intellectual property rights, all the incentives to 
innovate and claim the returns to that innovation. And then, 
there is the rest, which is the large unexplained portion that 
comes from managerial efficiencies and smarter ways of doing 
business.
    Senator Conrad. All right; Senator Enzi, and I am sorry 
that he is not still here, talked about how we got back on 
fiscal track before, and basically, he suggested it was all on 
the revenue side. I do not agree with that, and I do not think 
the facts show that. This shows, going back to 1980, the 
relationship between spending, that is the red line, and the 
green line, which is revenue. This is all as a share of gross 
domestic product, so we are using the measure which you said 
was most appropriate.

[GRAPHIC] [TIFF OMITTED] T1173.010


    And what we see is, in fact, outlays did come down markedly 
during the 1990's. Outlays came down markedly. Revenue went up 
markedly during the nineties as a percentage of GDP. That is 
what produced budget surpluses. It was a combination of 
spending restraint and increased revenue, partly as a result of 
tax increases; partly as a result of strong economic growth.
    Now, we can see what has happened to take us back into 
deficit. We have had a tick up in spending, although spending 
is still far below where it was in the eighties; the tick up is 
almost entirely homeland security and national defense. Ninety-
one percent of the increase is just in those two categories. 
But the revenue has fallen out on us. We have the lowest 
revenue last year since the late 1950's.
    So just as a factual matter, this is what I believe the 
facts are. This is what occurred. This is what occurred in 
terms of bringing down expenditures as a share of our national 
income, raising revenue as a share of our national income, and 
it shows us where we are now. It tells me that if we are going 
to solve this problem, we have to work both sides of the 
equation. We have to work the spending side of the equation and 
the revenue side.
    I thank you.
    Chairman Gregg. Thank you.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    I come from a State where we do a lot of dynamic scoring in 
our budgeting process, and I want to make sure that I 
understand to what extent you use dynamic scoring with the CBO. 
And my understanding is that what might be referred to as 
dynamic, in quotes, that you actually take behavioral changes 
into effect, but that everything else is pretty much statics, 
particularly as it applies to the macroeconomic feedback 
effects.
    Has the Congressional Budget Office studied ways to account 
for the macroeconomic feedback effects in its budget estimates?
    Mr. Holtz-Eakin. Why do I not tell you how we put these 
numbers together that you saw today, and you can decide what 
labels are appropriate.
    A baseline projection takes into account current law and 
the economic incentives provided by current law. In particular, 
in this baseline projection, we have the difficult problem of 
assessing what happens in 2009, when dividend and capital gains 
rates go up; what happens in 2011, when marginal tax rates go 
up and all the provisions in EGTRRA and JGTRRA sunset.
    We build into not just the evolution of taxable incomes but 
the macroeconomic performance feedbacks from that current law, 
from that current law. The hard part is actual economic 
performance depends on what people expect, and we do not know 
what the private sector expects about the permanence of the 
current tax rates.
    So we take, as a matter of internal consistency, the 
assumption that people believe current law will execute as 
written: that the rates will go up in 2009 and 2011. We build 
that into our macro and our micro behavior. And whether that is 
fully dynamic or not, I do not know, but that is how the budget 
projections are done.
    Senator Allard. So the CBO has moved--you are saying that 
the CBO has moved more toward, historically here in the last 
decade, has moved more toward using dynamic scoring, but as it 
applies to the macroeconomic effects, your policy has stayed 
pretty much the same.
    Mr. Holtz-Eakin. Baseline projections have always tried to 
incorporate whatever the fiscal policies are, and so, that, I 
believe, is a virtue, because it is the right way to do it, and 
it has always been done that way, to my knowledge. The biggest 
change has been in analyzing the President's budget, where we 
have, at the request of the budget committees, done an analysis 
that includes the macroeconomic impacts of the President's 
budgetary proposals.
    Senator Allard. Yes.
    Mr. Holtz-Eakin. We have done that for 2 years now, and we 
hope that it is useful to the Committee.
    Senator Allard. OK; so you are doing that now, where you 
had not done it in the past.
    Mr. Holtz-Eakin. Yes.
    Senator Allard. And you plan on continuing to do more of 
that in the future?
    Mr. Holtz-Eakin. Absolutely; we would provide anything the 
Budget Committee would find useful in doing that analysis.
    Senator Allard. It is kind of interesting to look at how 
States, and I want to talk a little bit about Medicaid here, 
that States will allocate in order to make up their share of 
the Medicaid, will take and overallocate the amount of dollars 
they send to their hospitals, and they get that rebated at the 
end, and the net effect is that probably, they have 
overleveraged Federal dollars. Would you comment on that 
problem some?
    Mr. Holtz-Eakin. We are unsure of the magnitude of these 
intergovernmental transfers and how they are affecting the 
Feds' share going to the States. We know that CMS is looking at 
them; that this is an important issue, and we are working with 
them and trying to learn from their investigations to see how 
many dollars are on the table. We are really not sure at the 
moment.
    Senator Allard. So you cannot give us an estimate of how 
many States might be doing this?
    Mr. Holtz-Eakin. We do not know at the moment. It is 
something that we are looking at now.
    Senator Allard. That would be a part of your investigation 
at the time?
    Mr. Holtz-Eakin. Yes.
    Senator Allard. Thank you.
    Chairman Gregg. Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    As recently as the 1980's, the U.S. was a creditor nation. 
U.S. investment abroad exceeded foreign-owned assets here by 
more than 10 percent of GDP. In today's economy, if that were 
still the case, it would be $1 trillion in a positive position. 
Regrettably, today, the U.S. is the world's, largest debtor. 
Our external debt in 2003 was $2.4 trillion, or nearly a 
quarter of our GDP, and we continue to run enormous trade and 
current account deficits. They are projected to be over $600 
billion in 2004, which would mean that our external debt would 
then be over $3 trillion.
    Just a few weeks ago, the President of the Federal Reserve 
Bank of New York, Timothy Geithner, noted in a speech: the size 
and concentration of external imbalances in the system are at 
an unprecedented scale, between 5 to 6 percent of GDP in the 
case of the U.S. current account deficit. The counterpart of 
this deficit is a large inflow of capital from elsewhere in the 
world. The expected trajectory for this imbalance produces a 
dramatic deterioration in our net international position and 
cannot be sustained indefinitely. And Geithner concluded: what 
is new is that we are significantly more dependent today on the 
confidence of the rest of the world in U.S. economic policy and 
the safety and stability of our financial markets.
    And the Financial Times, in an editorial earlier in the 
year, said: like Tennessee Williams' ill-fated character, 
Blanche DuBois, the United States has long been dependent on 
the kindness of strangers. And that is the issue I want to 
examine with you here this morning.
    Now, first of all, given some questions that were asked, 
which of our trading partners hold substantial dollar reserves, 
in other words, have these claims against the U.S.?
    Mr. Holtz-Eakin. The largest outstanding are Japan, in most 
recent years, the largest increase has been in China.
    Senator Sarbanes. And then, would Korea and Taiwan come in 
behind them?
    Mr. Holtz-Eakin. I could check. I think that is right.
    Senator Sarbanes. Do we import oil from any of those 
countries?
    Mr. Holtz-Eakin. I do not know.
    Senator Sarbanes. I do not think so.
    Mr. Holtz-Eakin. If I say no, I am probably wrong, but I do 
not think they are substantial.
    Senator Sarbanes. Well, I do not think so, just to clear 
that off the deck.
    Now, you say in your report, the trade deficit has widened 
by an estimated $230 billion in nominal terms or about 2 
percent of GDP, but then, you say you expect a decline or a 
reverse in the near future, and by 2006, the growth of exports 
is likely to outpace that of imports.
    Now, OECD projects that for 2005, the trade imbalance is 
going to go up to about $700 billion negative, and you are 
saying that by 2006, namely, in the next year, that the growth 
of exports will outpace that of imports. It is a shift in the 
trajectory; is that what you are telling me?
    Mr. Holtz-Eakin. Broadly; what we have underneath our 
projections is an improvement eventually in the U.S. current 
account position.
    Senator Sarbanes. Yes, but I want to know how fast. What 
are you projecting for 1906?
    Mr. Holtz-Eakin. We expect a turnaround after 2 years.
    Senator Sarbanes. In other words, then, instead of being 
$700 billion, it will be $675 billion or some figure like that; 
is that what you are telling me?
    Mr. Holtz-Eakin. I do not know what the number is for 1905, 
but what we expect is for 1905, it will continue to worsen; 
1906, we will begin to see a turn. That is the mechanics of the 
projection.
    Senator Sarbanes. When are you projecting that we will be 
back in balance?
    Mr. Holtz-Eakin. I do not think we have a projection of 
that.
    Senator Sarbanes. You cannot glimpse it on the horizon, can 
you?
    Mr. Holtz-Eakin. No.
    Senator Sarbanes. No; now, even in this projection you are 
making, the projected trend in the trade balance largely 
reflects the expected decline of the dollar relative to the 
currencies of the U.S. trading partners, especially those of 
Asian economies. What makes you think that is going to happen? 
What has happened in the depreciation of the dollar over the 
past 3 years has been relative to the euro and other non-Asian 
currencies, has it not?
    Mr. Holtz-Eakin. The trade-weighted dollar has depreciated 
in nominal terms, and that is the core of both the history and 
our projection, and the questions then become how quickly does 
that change prices of imports relative to exports?
    Senator Sarbanes. How is it going to change if the Chinese 
are pegging the value of their currency? John Snow tells them, 
they should go to flexible rates. Now, they are not going to go 
to flexible rates. Everybody knows that, because it invites a 
banking crisis in China, at least that is what everyone tells 
us. And Snow has not asked them to repeg, so if they stay at 
the peg, how are you going to correct the Chinese imbalance?
    Chairman Gregg. Senator, we are going to have to move on 
here, but we are going to have Secretary Snow here next week, 
and that is a good question for him.
    Senator Sarbanes. Yes, but this guy is pretty good.
    [Laughter.]
    Chairman Gregg. Well, why do you not go ahead and answer 
his question, Mr. Director?
    Mr. Holtz-Eakin. I am flattered.
    Senator Sarbanes. What I meant by that is I regard you as a 
straight shooter and not a spin artist. I think that is 
important.
    Mr. Holtz-Eakin. The Chinese peg, let us just assume it 
stays. China is not our only trading partner, and the current 
account is the net effect of all trade transactions with all of 
our trading partners. So our forecast does not assume that the 
Chinese change their peg a bit. It assumes that relative to all 
of our trading partners, the dollar does, in fact, continue to 
decline somewhat.
    But that is not the only mechanism by which the current 
account reverses. To some extent, we count on oil prices 
moderating a touch. It is the case that world economic growth 
has been very slow relative to the U.S., and part of the 
forecast, both for the United States and more generally is for 
world economic growth to improve. So that will help.
    Senator Sarbanes. No, I want to go specifically on what you 
said in the report.
    Chairman Gregg. Could we move on, and----
    Senator Sarbanes. Could I just ask this one question?
    Chairman Gregg. OK.
    Mr. Holtz-Eakin. I hope we said that in the report. I 
believe----
    Senator Sarbanes. Let me quote from the report: ``The 
projected improving trend in the trade balance largely reflects 
the expected decline of the dollar relative to the currencies 
of the United States' trading partners, especially those of 
Asian economies.'' How do you expect there to be a decline of 
the dollar--let me be very specific--relative to the currency 
of China, if they continue to do the peg?
    Mr. Holtz-Eakin. Again, we do not have a projection that 
relies on bilateral exchange rates with particular countries. 
It is the broad trade-weighted one, and we can do it by Asian 
or non-Asian countries, if you would like. We would be happy to 
work with you on this.
    Senator Sarbanes. Well, that is not what this statement 
says.
    Chairman Gregg. Senator Bunning.
    Senator Bunning. I am the last one here, I guess. Thank 
you, Mr. Chairman.
    You know, I once heard that budget forecasting was referred 
to as being about as accurate as forecasting earthquakes. As an 
economist, could you please comment on the historical accuracy 
of long-term projections of the Federal budget deficit by CBO, 
by OMB, by others who might get into the forecasting business?
    Mr. Holtz-Eakin. We can not only comment on it; we try to 
display it in the report. We show the uncertainty around our 
baseline projections in a fan chart. The fan chart tells you, 
for example, that under the baseline, take all its flaws at the 
moment, but under the baseline, the deficit is 1.2 percent of 
GDP 5 years from now. Based on historical uncertainty in the 
economic performance and in technical relationships between the 
budget and the economy, there is a 5 percent chance that that 
number could be 6 percent of GDP or greater. There is a 35 
percent chance that it could be in balance or better.
    Senator Bunning. OK.
    Mr. Holtz-Eakin. There is an enormous range of uncertainty 
that should be acknowledged and should be used in evaluating 
policies.
    Senator Bunning. If you have a $2.5 trillion economy, and 
you are off by 5 percent, what is that in dollars?
    Mr. Holtz-Eakin. We have a $2.5 trillion budget; 10 percent 
of that is $250 billion; 5 percent is $125 billion.
    Senator Bunning. $250 billion----
    Mr. Holtz-Eakin. Five percent would be $125 billion; no, 
that is not right.
    Senator Bunning. Uh-oh.
    Mr. Holtz-Eakin. Of the budget, yes.
    Senator Bunning. OK; and I wanted to get to what Senator 
Sarbanes has been talking about, because we would like for you, 
Senator Sarbanes, to join Senator Schumer and myself in trying 
to get China to unpeg their currency from the dollar. We have a 
bill in to do just that. Would you like to comment on the 
impact, if any, the weak dollar has had both on the assumptions 
behind your analysis and the conclusions of your report?
    Mr. Holtz-Eakin. The dollar narrowly, the international 
situation more broadly, are all part of the forecast for the 
U.S. economy in terms of its cyclical recovery, where we 
anticipate better net export performance over the next 2 years, 
and as a result, they feed into the budgetary outlook. And so, 
it is the case that the budget projections and the economic 
projections are an internally consistent whole, and the 
economic projections in particular add up. We take into account 
international conditions and domestic conditions and make sure 
that it is an internally consistent forecast.
    So we are, in fact, cognizant of the dollar and the future 
path of the dollar as part of our forecast.
    Senator Bunning. Has CBO always done that? I mean, have 
they used that projection in their past? I have been on budget 
committees for 8 years, both the House and the Senate Budget 
Committee, and it seems to me that the accuracy in forecasting 
the deficits, the surpluses, the growth in the economy, the 
growth in the CPI, have been so skewed by CBO over the last 8 
years that I have been on budget committees that it has just 
been unbelievable to try to get a handle on the current budget. 
Is that an incorrect assumption?
    Mr. Holtz-Eakin. I think that CBO's forecasts of the budget 
and of the economy are comparable in quality to anyone. You and 
I could have a discussion about whether the economics 
profession as a whole has progressed to the point where they 
provide forecasts that you are happy with, but the CBO 
projections are of equally high quality to those of the OMB, 
the private sector, and many.
    Senator Bunning. Is it true that if I brought 10 economists 
in here, not one of them would have the same projection given 
the same numbers?
    Mr. Holtz-Eakin. It would be true that it would be unlikely 
that you would get exactly the same projections, but given the 
range of movements, I think our projection is qualitatively 
very similar to the blue chip consensus, for example. It is in 
the report, the comparisons, and other forecasters.
    We do display on our Website our forecasting record. You 
can go check for yourself. And we are always looking to improve 
it. We are cognizant of the gap between what happens in fact 
and what we project, and everywhere we can close that gap, we 
have attempted to do so over the years.
    Senator Bunning. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you. You have been courteous with 
your time, Mr. Director. I know Senator Sarbanes had just a 
couple of followup questions.
    Mr. Holtz-Eakin. Sure.
    Chairman Gregg. And then, we will give you a break.
    Senator Sarbanes. Well, thank you very much, Mr. Chairman. 
I know this hearing has been going on for quite some time, and 
you wish to draw it to a close.
    I just have a couple of questions I want to pursue. Do you 
regard the dollar being the world's reserve currency as an 
important economic or financial factor or asset for the United 
States?
    Mr. Holtz-Eakin. It represents another source of demand for 
dollars and dollar-denominated assets and fits in the 
constellation of reasons why you would not expect a precipitous 
shift away in international portfolios. So it is one feature.
    Senator Sarbanes. Do you think that the U.S. would have 
lost something of import and value if the dollar ceased to be 
the world's reserve currency?
    Mr. Holtz-Eakin. Again, other things equal, if people have 
less of a standing desire to hold dollars in their portfolios 
and do so strictly on other considerations, risk, return and 
the others, then, that represents a diminished appetite for 
dollar-denominated assets.
    Senator Sarbanes. What are the implications of that for us?
    Mr. Holtz-Eakin. Qualitatively, I think more sensitivity in 
dollar demand, in the demand for dollar-denominated assets to 
prices, but I do not know numerically how large that would be.
    Senator Sarbanes. The Financial Times a week ago yesterday 
said ``central banks are shifting reserves away from U.S. 
assets and toward the euro zone in a move that looks set to 
deepen the Bush administration's difficulties in financing its 
ballooning current account deficit. In actions likely undermine 
the dollar's value on currency markets, seventy percent of 
central bank reserve managers said they had increased their 
exposure to the euro over the past 2 years. The majority 
thought euro zone money and debt markets were as attractive a 
destination for investment as the United States.''
    That has serious implications for us, does it not?
    Mr. Holtz-Eakin. As the Senator knows, the current account 
reflects the desire to make capital investments, both in a 
portfolio and in actual factories in the United States, and to 
the extent that that desire diminishes, it will have negative 
implications as to financing.
    Senator Sarbanes. Some of that is not investment. Some of 
that is buying our Treasuries, in order to impact the value of 
the currency to gain a trade advantage. Otherwise, why are the 
central banks of China and Japan building up such large dollar 
reserves?
    Mr. Holtz-Eakin. There is no question that central banks 
intervene to manage currencies.
    Senator Sarbanes. To manage currencies.
    Mr. Holtz-Eakin. To manage currencies, no question.
    Senator Sarbanes. And that is clearly going on.
    Mr. Holtz-Eakin. And that is part of the overall 
determination.
    Senator Sarbanes. Mr. Chairman, I think this is an 
important issue. I am just trying to help the President out. He 
seems to be searching around for a crisis on which to focus his 
attention, and I want to suggest and will continue to suggest 
that, between the internal deficit, which Senator Conrad talked 
about, and this external situation, we have a crisis at hand.
    Thank you very much.
    Chairman Gregg. I appreciate your thoughts, Senator, and we 
certainly thank the Director for his courtesy and the time he 
has granted us this morning, and we look forward to continuing 
to work with him and his excellent staff, who do such a good 
job for us.
    Thank you very much.
    Mr. Holtz-Eakin. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Holtz-Eakin follows:]

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    Chairman Gregg. The next hearing will be on February 8, and 
the Comptroller General is going to be participating.
    [Whereupon, at 12:15 p.m., the hearing was adjourned.]

                  STATEMENT OF SENATOR BUNNING

                 SENATE COMMITTEE ON THE BUDGET

               CBO'S BUDGET AND ECONOMIC OUTLOOK

    Thank you, Mr. Chairman.
    I was concerned, as I'm sure were most members of this 
committee, to read new CBO estimates of a $368 billion budget 
deficit for fiscal 2005.
    This number brings into stark reality the magnitude of the 
job before us in this committee and in the Congress. 
Certaninly, we need to see spending reigned in.I11I was please 
with recent statments from the Administration regarding the 
President's commitment to control spending. We, as a country, 
have faced difficult challenges over the past few years and we 
will continue to face them. Protecting our citizens does not 
come cheap, but it must be our highest priority.
    However, we must be disciplined in all areas of the budget 
we are about to produce in this committee. We must make 
difficult decisions and we must lead the Senate in sticking to 
them.
    My review of the recent CBO report shows that freezing 
discretionary spending during the 10-year window would reduce 
the deficit by about $3 trillion compared to letting 
discretionary spending grow at the rate of GDP.
    While a true freeze on discretionary spending may be 
difficult, we must at least work toward reigning in the rate of 
spending growth.
    Additionally, and maybe even more importantly, we must 
examine mandatory spending. Our chairman has mad clear that he 
is willing to look at this often-ignored part of the budget and 
I support his plan to put these entitlement items on the table 
and examine them.
    Congress must also take a hard look at our Social Security 
System and make some reforms. In only 13 years, Social Security 
will begin paying out more in benefits than it collects in 
revenue. By the year 2042, the program will be insolvent. 
Without any reforms, the current system has an unfunded 
liability of over ten trillion dolloars. We owe it to our 
children and grandchildren to have an honest debate on this 
issue and put this program on a financially sound path.
    I thank Dr. Holtz-Eakin for the hard work and dedication of 
his office and for his willingness to appear before us today to 
explain the most recent analysis in detail.
    Thank you.
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    Testimony inserts in response to Questions from Mr. Crapo
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    Testimony insert in response to economic growth rate 
questions posed by Senator Byrd from 2/1/05 Senate Budget 
Committee hearing entitled ``The CBO Budget and Economic 
Outlook''
    Q1. For your projections of the Social Security long-term 
deficit, what is the assumed average annual growth rate in the 
economy?
    Answer: The average assumed real growth for the 204-2079 
period is 2.0%
    Q2. What was the annual average growth rate for the last 75 
years?
    Answer: The actual real growth rate over the last seventy-
five years (1929-2004) was 3.4%
    Q3. What was the average annual growth rate over the last 
10 years?
    Answer: The actual real growth over the last ten years 
(1994-2004) was 3.3%


          REEXAMINING THE FEDERAL BUDGET FOR THE 21ST CENTURY

                              ----------                              


                       TUESDAY, FEBRUARY 8, 2005

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Domenici, Allard, Sessions, 
Cornyn, Alexander, Graham, Conrad, Nelson, Stabenow, and 
Corzine.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Jim Hearn, analyst.
    Staff present: Mary Ann Naylor, Staff Director; and John 
Righter, analyst.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We are fortunate to have with us today the 
Comptroller General of the Government, David Walker, who does a 
superb job, and he has some very interesting ideas and thoughts 
that he wants to share with us, I know, especially about the 
outyear impact of contingent liabilities of the Federal 
Government, which I am extremely concerned about. In fact, one 
of my goals in this budget, although the Budget has done it in 
the past well, but I hope we can do it even better, is to have 
a very clear and transparent statement of what the liabilities 
are of this Government not only for the 5-year and 10-year 
period, but 20- and 30-year period to the extent we can project 
them accurately not only in the area of Medicare and Social 
Security, which are obviously big numbers, Medicaid, but also 
in the areas such as PBGC, student loans, things that are out 
there and maybe either somewhat sleeping or completely 
sleeping, but we know they are going to come back and hit us in 
the back of the head here with fairly high costs.
    I know that the Comptroller has done a lot of work in this 
area, and we look forward to his presentation, which we have 
had a little bit of a preview of, and thank him for taking the 
time to come and testify.
    Senator Conrad.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Well, I, too, want to welcome you, Mr. 
Walker, to this committee. Your work has been very valuable. 
And I want to just go through a couple of slides, if I could, 
to put this in some perspective, at least from my perspective, 
and then I look very much forward to your testimony.
    You said, on February 2nd, to the National Press Club, 
``The American people need to realize that the fiscal choices 
being made in Washington today have profound consequences for 
the future of our country and our children. In a nutshell, 
these fiscal choices will directly affect our future national 
security, economic vitality and quality of life.'' I think you 
summed it up very well. These decisions, if I were to sum up 
your statement, really matter. They matter to our economic 
security. They matter to our children.

[GRAPHIC] [TIFF OMITTED] T1173.041


    As I look at the President's budget, I believe it continues 
to push us toward bigger and bigger deficits and more and more 
debt. I look back to before he took office--we actually were in 
surplus. In fact, for 2 years, we did not use Social Security 
funds for other purposes. And since the President took office, 
we have plunged back into the red. And the President says the 
deficit is going to significantly improve over the next 5 
years, but he only gets there by leaving out things. He leaves 
out war costs past September 30th of this year. He leaves out 
fixing the alternative minimum tax all together, which is 
becoming a middle-class tax trap. He leaves out the second 5 
years of his tax cut, which is when the cost of it explodes. He 
leaves out item after item. When you put them back in, what you 
see is quite a different pattern than what the President is 
telling the Nation. And, of course, he leaves out the cost of 
his Social Security privatization plan.
    All those things are left out. When you put them back in, 
here is what we see happening: A deepening of the deficit, 
additional debt and all at the worst possible time, before the 
baby boomers retire.
    Let us go to the next chart.

    [GRAPHIC] [TIFF OMITTED] T1173.042
    

    As we look at this turnaround, dramatic turnaround, from 
surplus to deficit, 74 percent of the reduction in our fiscal 
condition is a result of changes on the revenue side of the 
equation. Now, not all of this is tax cuts. About half is tax 
cuts. About half is other things. Twenty-six percent is an 
increase in spending. Virtually, all of the increases in 
spending have been for national defense and homeland security, 
and, of course, the big change in entitlements, the 
prescription drug bill that we passed, which apparently is 
exploding in cost as well. As Senator Gregg was concerned 
about, he is being proved to be correct, that the cost of that 
program is dramatically increasing beyond what we were told at 
the time.
    Let us go to the next.

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    This chart I think is very important to keep in mind 
because it looks at spending--that is the red line, and the 
green line is revenue--and this goes back to 1980. We can see 
spending, even now, even after the increase--largely due to 
defense and homeland security, and rebuilding New York--we can 
see this spending level is still well below what it was 
throughout the 1980's and into the 1990's. Revenue's have had 
tremendous changes, and the last several years they have 
dramatically fallen. So we have a problem on both sides of the 
equation here, longer term on spending and also on revenues, 
and this gap is the reason for the deficit.
    Let us go to the next.

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    The President says to us we have a deficit problem, and 
then he increases spending this year, 2004 to 2005, spending is 
increasing 8 percent. Next year, according to our calculations, 
they will go up another 5 percent. But the President is also 
saying make the tax cuts permanent. And when you overlay that 
against what is happening to the trust funds of Medicare and 
Social Security, what you see is the tax cuts explode just as 
the trust fund cash surpluses become deficits. The combined 
effect is to drive us deeper and deeper into deficits and debt.
    Let us go to the last one.

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    This looks at the shortfall in Social Security over 75 
years, $3.7 trillion. I, also, asked my staff to do an analysis 
of what the tax cuts, what is the 75-year cost of the tax cuts 
that the President has proposed, and that is $11.6 trillion. 
Now, the tax cuts are three times the 75-year shortfall in 
Social Security. Let me just say I do not conclude from that we 
do not have to do anything about Social Security. I believe we 
do. I believe we have to address the Social Security shortfall. 
I believe we have an even more urgent need to address the 
Medicare shortfall because Mr. Walker, as you have indicated, 
the shortfall there is eight times the shortfall in Social 
Security.
    And so I believe we should be working on both of those 
problems, as well as the revenue base of the country, and I 
look forward to your remarks. I want to thank you for sounding 
the alarm that we are on a fiscal course that simply is not 
sustainable.
    Chairman Gregg. Thank you, Senator.
    Mr. Walker, we look forward to hearing your thoughts.

 STATEMENT OF THE HON. DAVID M. WALKER, COMPTROLLER GENERAL OF 
       THE UNITED STATES GOVERNMENT ACCOUNTABILITY OFFICE

    Mr. Walker. Thank you, Mr. Chairman and Senator Conrad. It 
is a pleasure to be back before the Senate Budget Committee 
again, and with your approval, I would respectfully request 
that my entire statement be entered into the record.
    Chairman Gregg. Of course.
    Mr. Walker. Thank you. I will now move to summarize it, 
with assistance from Ty Mitchell.
    I appreciate the opportunity to be before you to talk about 
the Nation's long-term fiscal outlook and the challenge that it 
poses for our country, our children, and our grandchildren. I 
realize that most people are focused on the President's budget 
for fiscal 2006, which was just unveiled yesterday, and that is 
obviously a very important document. At the same point in time, 
I believe it is important that we think about tomorrow in order 
to be able to put the issues that are in that document in 
context, which will be debated within this body and your sister 
body over the coming year.
    This first chart, which also is in my written statement, 
represents the result of GAO's latest long-range budget 
simulation, which we do twice a year. Our long-range budget 
simulation, is based upon CBO's baseline and other longer-range 
assumptions, based on input from CBO and others. What it shows 
is this is what our fiscal future looks like based on three key 
assumptions, which CBO is required to make, which I would 
respectfully suggest are not very realistic.
    No. 1, no new laws will be passed. You can bet on that, but 
I would not bet anything on it:

[GRAPHIC] [TIFF OMITTED] T1173.046


    Second, discretionary spending grows by the rate of 
inflation after 2015. Discretionary spending includes national 
security, homeland security, education, our judicial system, 
transportation, et cetera;
    And, third, that all tax cuts sunset.
    Those are three key assumptions that underlie this and with 
it you can see that we start to have serious problems starting 
out after 2015 that grow with the passage of time, but I would 
respectfully suggest you need to have alternative scenarios to 
look at because there are unrealistic assumptions and 
conditions backing this one.
    The next simulation only changes two assumptions, and I am 
not saying this is good, bad or indifferent. I am just trying 
to give you the facts. The only difference between this 
scenario and the last is that, A, discretionary spending grows 
by the rate of the economy rather than the rate of inflation 
during the first 10 years and, B, all tax cuts are made 
permanent. Under this scenario, the only thing the Federal 
Government can do in 2040 is pay interest on the massive debt 
that has accumulated over that period of time.
    The bottom line, Senators, is that we face a large and 
growing structural deficit due primarily to known demographic 
trends and rising health care costs. There are other factors 
that are contributing, clearly, including the fact that 
revenues, as a percentage of GDP, are at the low end of the 
range that they have been over a number of decades. They will 
come up somewhat as the economy grows, but we have a structural 
imbalance that is going to require very tough decisions.
    I believe, Mr. Chairman, it is going to require us to do 
nothing less than engage in a fundamental baseline review of 
entitlement programs and other mandatory spending, of 
discretionary spending, as well as tax policies and related 
enforcement programs. The gap is too great to simply grow your 
way out of the problem. You cannot solve it just by looking at 
discretionary spending. You cannot solve it just looking at 
other mandatory spending and without looking at the entitlement 
programs. We also have to recognize that the Government spends 
hundreds of billions of dollars a year in tax expenditures 
through tax preferences, which are largely off the radar 
screen, that may or may not be achieving the desired outcomes 
and may or may not be affordable and sustainable in the years 
ahead.
    Next, chart please.

    [GRAPHIC] [TIFF OMITTED] T1173.047
    

     [GRAPHIC] [TIFF OMITTED] T1173.049
    

    Let me give you the bottom line on this chart, Mr. Chairman 
and other Senators, because there are a lot of numbers here, 
and these numbers, by the way, are in billions, which is a big 
number, in and of itself, with nine zeroes.
    The bottom line here is, according to the latest financial 
statements of the U.S. Government for the year ended September 
30, 2004, if you add up all of our liabilities, if you end up 
considering, also, the commitments that we have made for such 
programs as Social Security, Medicare, veterans health care, et 
cetera, and if you were to accumulate all our liabilities and 
commitments that existed as of September 30, 2004, and if you 
offset the dedicated revenues that have been earmarked for 
those programs, such as payroll taxes for Social Security and 
Medicare, premiums for certain Part B and Part D, and you only 
consider the portion that the taxpayers will have to fund, then 
our accumulated liabilities and commitments exceeded $43 
trillion as of September 30, 2004. That is about $350,000 per 
full-time worker, and it is a big number, and it is growing 
every day, due primarily to demographic trends.
    Next, chart please. And one of the problems that we have 
is, is that these numbers are largely off the radar screen, and 
Congress does not have access to this type of information as 
part of the normal budgetary process and as part of legislative 
deliberations, as evidenced by the fact, Mr. Chairman, that you 
talked about the Medicare prescription drug bill. There was a 
great debate last year about whether the cost was $395 billion 
or $534 billion, depending upon who you asked and when. The 
real number came out about 3 months after the bill was passed, 
according to the annual report of the Medicare trustees and 
their actuaries--$8.1 trillion. That is the estimated current 
dollar cost of the Medicare prescription drug benefits. That is 
how much money we would have to have today invested at Treasury 
rates to deliver on the unfunded promise for the next 75 years 
alone, and it is going up every day. That is more than the 
entire debt of the United States outstanding since the 
beginning of the republic, which is about $7.6 trillion, I 
believe.

[GRAPHIC] [TIFF OMITTED] T1173.048


    So one of the things I know you are interested in, Mr. 
Chairman, and other members of the committee, is what can be 
done to try and help provide more transparency and to provide 
more safeguards with regard to considering not only the short-
term costs, but the long-term affordability and sustainability 
of decisions that you have to make on an ongoing basis as a 
member of the U.S. Senate.
    My written statement has a lot of details. I will touch on 
three high-level points:
    First, there clearly is a need for more transparency. There 
is clearly a need to provide supplemental information as part 
of the budget process as to the number nature and magnitude of 
the existing unfunded commitments that we already have;
    Second, there is clearly the need to consider additional 
mechanisms, through the legislative process, whether it be 
points of order, triggers or otherwise, whereby this body and 
your sister body would have the opportunity, if not be 
required, to discuss and debate the cost not only in the short 
term, but the long term cost, of various legislative proposals;
    And, third, there is a need to consider, for certain types 
of items, whether or not we ought to move more toward an 
accrual-based approach for things like insurance, or Federal 
employee pension and health obligations, where accrual-based 
concepts have clearly existed for many years in the private 
sector and, some, State and local Governments, I might add. So, 
therefore, we might want to consider whether or not there is 
additional transparency that is necessary there, either through 
an accrual-based approach or, if not an accrual-based approach, 
further supplemental disclosures.
    Next chart, please.

    [GRAPHIC] [TIFF OMITTED] T1173.049
    

    [GRAPHIC] [TIFF OMITTED] T1173.050
    

    The other thing I want to bring to the Senators' attention 
is the fact that, as you know, every 2 years we update our 
strategic plan for serving the Congress, and we do that through 
outreaching to members and key staff on both sides of the aisle 
and, both ends of the Hill, to try to help us do a better job 
in serving you, and you do a better job in serving your 
constituents. These are the latest themes in our strategic 
plan, which were validated by the members. These are trends and 
challenges that have no geopolitical boundaries, domestically 
and internationally, and that serve to frame the work that we 
do for the Congress and, hopefully, improve its value and 
contextual sophistication.
    They are pretty much self-explanatory. But the first one, 
which overrides everything, is our long-range fiscal challenge 
because it overrides everything that we are doing or thinking 
about doing today and for tomorrow. The others speak for 
themselves, so I will not go through them, but I think they are 
fairly compelling.
    Next chart, please.

    [GRAPHIC] [TIFF OMITTED] T1173.051
    

    One of the things that we are going to be doing, Mr. 
Chairman, that we plan to unveil on February 16th is a new 
product to try to help the Congress by providing input for its 
consideration as it deems appropriate in setting its oversight 
agenda and other types of activities. This report is based upon 
our years of work at GAO, 90 percent plus of which, as you 
know, is done at the request of the Congress or mandated by 
Congress, as well as based upon my experience at having run 
three agencies in the Government, two in the executive branch, 
and one in the legislative branch.
    I would respectfully suggest a vast majority of the Federal 
Government, whether it be on the mandatory spending side, the 
discretionary spending side or the tax policy side is based 
upon an America that existed in the 1950's and 1960's. And a 
vast majority of the Government is based upon an accumulation 
and an amalgamation of programs, policies, functions and 
activities that have been aggregated over the years and have 
never been subject to fundamental review, reexamination, or 
reprioritization in light of the trends that I just mentioned 
and 21st century realities.
    Our gap is so great that we can afford to do nothing less 
than engage in that fundamental review and reexamination that 
will take as much as a generation to deal with. Obviously, the 
Congress has to decide what to do, when to do it, and how best 
to do it. But one of the things that will be included in our 
report, that is scheduled to be unveiled on February 16th, is a 
series of generic questions that should be asked about every 
major Federal program, policy, function and activity. These are 
just a few examples. There are a lot more.
    For example, what is the relevance, the purpose of the 
Federal role? When did we put this in place? Why did we put the 
program in place? What were the conditions that existed? What 
were we trying to accomplish? And have things changed since 
that point in time?
    Measuring success. How do we measure success? How do we 
know that we are making a difference on an outcome-based basis? 
Do the programs and the agencies have outcome-based measures? 
If not, why not? If they do, is the program successful based 
upon those measures? Same thing for tax policies. What were we 
trying to accomplish? How do we measure success? Are we 
successful based upon those measures? Targeting benefits. All 
too many times the decision is to try and do it for everybody, 
rather than base it on need, value and risk. And in a time of 
constrained resources, you may not be able to afford to do it 
for everybody or sustain it if you try to do so.
    Affordability and cost effectiveness. Are we using the most 
cost-effective and beneficial approaches in trying to achieve 
the objective while employing best practices? If the program 
makes sense, is it still a priority. Does it have outcome-based 
measures? It is being successful based upon those outcome-based 
measures? Are they employing best practices in order to 
accomplish their mission as economically, efficiently and 
effectively as possible?
    Next chart, please.

    [GRAPHIC] [TIFF OMITTED] T1173.052
    

    This document will also divide the Government into 12 
areas. Based on our strategic plan, which was developed in 
conjunction with the Congress and to serve the Congress. It is 
going to take these areas, which span all of Government, on the 
spending side and the tax side, and it is going to raise a 
series of illustrative questions that we would respectfully 
suggest that the Congress may wish to consider, as it deems 
appropriate, in looking at the base of Government.
    Next chart, please.

    [GRAPHIC] [TIFF OMITTED] T1173.053
    

    Let me give you four examples, if I can:
    There will be many questions presented, and they will be 
balanced. And, by the way, we will not give answers because we 
are not elected officials. You are elected officials. We do, 
however, stand ready to assist the Congress in getting 
additional facts, come up with options and identify pros and 
cons, if you so desire. However, we think that our future 
fiscal gap is so great that the time has come that we need to 
help the Congress try to be able to at least raise some of the 
questions that it might wish to consider, but only you can 
decide whether, when and how best to proceed.
    Defense. How should the historical allocation of resources 
across the services and programs be changed to reflect the 
results of a forward-looking, comprehensive threat and risk 
assessment and a capabilities-based approach to determining 
defense needs? Bottom line, we are talking about the need to 
look at credible threats and risks, what capabilities are 
necessary to address those threats and risks, and how you 
allocate resources to the different services and other entities 
that are part of the Department of Defense in order to maximize 
the impact and mitigate risk? That is not being done right now. 
A vast majority of the resources of the Defense Department are 
allocated based on methodologies that have been used for 
decades.
    Health care. How can industry standards for acceptable care 
be established and payment reforms be designed to bring about 
reductions in unwarranted medical practices, as well as related 
liability concerns? What can or should the Federal Government 
do to promote uniform standards of practice for selected 
procedures and illnesses? Now, there are many, many questions 
under health care. This is but one that is designed to address 
quality, cost, litigation access and other issues.
    Retirement and disability. Believe it or not, our 
definitions of disability have not been updated for decades. In 
the case of the Defense Department, the last time it was 
updated was 1945. Things have changed a little bit since 1945.
    The tax system. What tax incentives need to be reconsidered 
because they may not be achieving the intended objectives? For 
example, the largest tax incentive in the Internal Revenue Code 
today is for health care. Individuals never pay income tax on 
employer-provided and paid health care or payroll tax 
irrespective of how much money is involved and what percentage 
of their compensation is being represented by health care. That 
is an area I think you need to look at, how much money is 
involved, what type of incentives is it creating and what type 
of impact is it having with regard to our ability to control 
health care costs.
    In summary, Mr. Chairman, the Congress, obviously, is 
focused on what to do with the budget that is being proposed, 
and that is important, but it is also important to be able to 
consider the size, the nature, the extent, the magnitude, and 
the driving forces behind our large and growing long-range 
fiscal imbalance. Addressing this imbalance is going to require 
a considerable effort over many years. It is going to have to 
involve discretionary spending, as well as mandatory spending, 
including entitlement programs, as well as tax policy, 
including tax preferences and enforcement efforts. It is going 
to have to involve all three because the numbers are simply too 
great, and realistically there is no way, we are going to grow 
our way out of our fiscal imbalance. The math just does not 
work, and the sooner we get started, the better.
    Thank you, Mr. Chairman and Senators.
    Chairman Gregg. Thank you, Comptroller. That is a sobering 
presentation, an appropriate presentation and an important 
presentation. Obviously, the numbers which you cite, relative 
to the outyear issues, are hopefully going to cause us to 
reflect on what the best way is to address them--this $43-
trillion number that you have cited as being basically the 
contingent liability of the Government, which is already in 
place. Other Congresses may come and add more to it, but that 
is in place. It is a staggering number.
    I was interested in the point you made, which is an 
undeniable point, which is that this is driven primarily by a 
demographic shift in our society and the cost of health care as 
it relates to that demographic shift. I mean, the baby boom 
generation is alive, and it is headed toward retirement, and it 
is the bubble that has moved through the system ever since it, 
in the 1950's, caused the country to have to buy a whole lot 
more cribs and create a whole lot more kindergartens.
    So we cannot deny it, and we cannot avoid it, and we need 
to get ready for it. That is your message, and the way you are 
putting it, the context of the way you are putting it is 
excellent because you are setting out the parameters of the 
problem and asking us the hard questions to resolve them. I 
hope we have the courage to step up on this.
    On a couple of issues, to help you with transparency, what 
do you think the budget--the budget is a 5-year budget or it 
can be a 10-year budget, but it is going to be a 5-year budget 
I presume this year--the problem is a 30-year problem, a 40-
year problem, but if we do not get to it now the problem 
becomes huge for us. What can we do in the budget to make the 
budget document a more transparent, action-oriented document 
that, when people look at it, they will say, wow, we have a 
problem here; we have to address it; this is the issue? Do you 
have recommendations in that area?
    Also, in that context, you mentioned mechanisms to empower 
Members of Congress who want to raise the fiscal issues and 
capacities to do that. Can you go through some of those and how 
they would relate to a budget document that was authored this 
year.
    Mr. Walker. Mr. Chairman, some of it has to do with the 
budget document and some of it has to do with what happens as a 
result of the legislative process that flows from the budget 
document. In my written testimony, I have some details, but a 
few examples I would give are:
    First, I think it is important, as part of the budget 
document, that there be more transparency about where our 
existing commitments are:
    Second----
    Chairman Gregg. How do you suggest we do that?
    Mr. Walker. Well, that could be a supplemental schedule 
that is provided as part of the budget document.
    Chairman Gregg. Nobody looks at schedules. Give me another 
idea. Can we go to neon lights? I mean, is there----
    [Laughter.]
    Mr. Walker. We might need a burden clock or something, but 
we can come back to that, Mr. Chairman, if you want.
    As you know, the budget document sets the President's 
priorities. It has a number of proposals in it. One of the 
things that has to be considered as part of that budget 
document, is what are the long-range costs, affordability and 
sustainability, of those proposals that are being made through 
the budget document.
    I also think it is important, whether they be made through 
the budget document or not, that, when Congress is considering 
legislation, it needs to consider the long-range cost, 
affordability and sustainability of those proposals before it 
actually acts on legislation. The example that I gave of 
Medicare prescription drugs I think is a perfect example.
    Chairman Gregg. Well, if I can stop you there because my 
time is----
    Mr. Walker. Yes, Mr. Chairman.
    Chairman Gregg. The problem is it is not the new programs--
well, it was the new program when they put prescription drugs 
on--but it is the programs that are on the book. So how do we 
get back to those? Are there mechanisms, besides 
reconciliation, that you are recommending that get us back to 
those?
    Mr. Walker. What I am suggesting with regard to the base of 
Government, that is the accumulation and amalgamation of 
policies, programs, functions and activities that are there 
that do not get a whole lot of attention each year because the 
attention is what are you plussing up and what are you 
proposing to cut, with the assumption that the base is OK. The 
base is not OK.
    What I am suggesting, Mr. Chairman, is that Congress needs 
to engage in a fundamental review and reexamination effort of 
the base of Government. In some cases, it is through oversight, 
in some cases, it may have to involve commissions. In the 
document that will be coming out on the 16th, we are going to 
give specific examples of how the Congress has addressed these 
types of issues in the past and potential vehicles that it may 
wish to use in addressing them in the future, but it is not a 
one-size-fits-all approach. Depending upon what the nature and 
extent of the challenge is, whether or not there is recognition 
that there is a problem that needs to get solved, whether you 
have enough facts, the maturity of the issue, you are going to 
use different approaches.
    Chairman Gregg. You suggested accrual-based accounting for 
some of our accounts. Do you have a specific proposal on that 
that we could look at as a committee and possibly incorporate?
    Mr. Walker. We have made some recommendations in the past. 
I would be happy to get something up for you and the 
Committee's consideration. I do think it is important to note 
this. Accrual budgeting is not a panacea. There are some areas 
where accrual budgeting may make sense. On the other thing, 
what is critical is that even if you do not go to accrual 
budgeting, that you consider the long-term cost, affordability 
and sustainability of items on the front end. That is critical. 
And right now that, does not get done.
    Chairman Gregg. And you suggested outcomes-based 
approaches. Can you give me a little more thought on how we 
would take a program that is presently on the book and analyze 
it on an outcomes-based approach within a budget context.
    Mr. Walker. Well, one of the things that the President has 
tried to do, to the administration's credit, is to try to start 
looking at the results of programs, has its initiative called 
the Program Assessment Rating Tool. It is not perfect, by any 
means, but, conceptually, recognizing the need, we need to 
start looking at Federal programs and start asking what kind of 
results are they delivering with the resources and authorities 
that they have.
    And if agencies cannot even tell you, that is a problem. 
And if they have not defined what type of outcomes are desired 
or if the Congress has not helped them to define that, that is 
a problem. And so I think that is a good first step, but I 
think it has to be expanded far beyond discretionary spending. 
You are not going to be able to solve the problem just looking 
at discretionary spending. You are going to have to look at 
entitlement programs and other mandatory spending as well as 
tax policies.
    Chairman Gregg. Thank you.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman. Thank you, Mr. 
Walker.
    You talked here about $43 trillion of unfunded liabilities. 
Over what period is that?
    Mr. Walker. The $43 trillion? That is how much money we 
would have to have today to be able to deliver on promises that 
have already been made for up to 75 years.
    Senator Conrad. For the next 75 years. How much has that 
number increased in the last 4 years?
    Mr. Walker. In the last year, it increased by over $13 
trillion. Fiscal 2004 was not a good year, from a financial and 
fiscal standpoint, and that resulted in an emphasis paragraph 
in our audit report.
    Senator Conrad. So just in 2004, that increased $13 
trillion.
    Mr. Walker. That is correct, most of which related to 
Medicare, and most of the Medicare increase related to Medicare 
prescription drugs.
    Senator Conrad. Now, does that figure capture the proposed 
tax cuts?
    Mr. Walker. This is on the commitment side, the liability 
and commitment side. So, no, it does not capture that. That is 
on the revenue side.
    Senator Conrad. And what is the growth estimate that you 
have behind these numbers. I know that CBO and the Social 
Security Administration, for the next 75 years, are looking at 
a growth estimate between 1.8 and 1.9 percent, even though 
growth over the last 75 years has averaged 3.4 percent. What 
are the growth estimates behind these projections?
    Mr. Walker. The main drivers, Senator, are entitlement 
programs, Medicare being No. 1, and Social Security being 
another major entitlement program. What we use for assumptions 
on those programs are the assumptions that have been adopted by 
the Medicare and Social Security trustees, their so-called 
best-estimate assumptions. As you know, every year, they make 
three projections: low cost, high cost and intermediate or best 
estimate. And we are using the intermediate or best estimate, 
so it would be their assumptions.
    Senator Conrad. So that would be an estimate of economic 
growth of about 1.8 percent.
    Mr. Walker. Senator, candidly, I do not know what 
assumptions they use. I can provide it for the record, if you 
would like.
    Senator Conrad. That is the testimony they have given in 
another committee, in the Finance Committee, specifically, just 
the other day, that their long-term economic growth estimate is 
1.8 percent, even though the last 75 years, the economy has 
grown at 3.4 percent.
    Now, when quizzed as to what appears to be a pretty 
conservative outlook with respect to growth, fairly pessimistic 
outlook in terms of growth, they say the major driver is a lack 
of new entrants to the work force; that is, that economic 
growth is a result of two factors--increases in productivity 
and new entrants to the work force. Do you agree with that 
basic understanding?
    Mr. Walker. Yes. It is my understanding that the primary 
reason that they are being more conservative with regard to 
future economic growth is because we will have had a dramatic 
decline in the rate of growth in the work force and a 
flattening out is going to occur.
    Senator Conrad. So, if we could have stronger economic 
growth, that would help address all of these problems, would it 
not?
    Mr. Walker. No question about it.
    Senator Conrad. And so part of our strategy has to be 
taking those steps that give us the biggest bang for the buck 
in terms of economic growth.
    Mr. Walker. Clearly, additional economic growth will help, 
but I would respectfully suggest, when you do the math, you are 
not going to get there through economic growth alone. There is 
still going to be a huge gap.
    Senator Conrad. I want to make very clear that while I 
believe we have to be aggressive at measures to increase 
economic growth because that helps deal with this, there is no 
conceivable scenario that I have seen that allows you to grow 
out of it. The structural imbalance is here now, which is the 
reference you are making.
    Can I just go very quickly to the point of the $43 
trillion. What makes up, in broad categories, the $43 trillion? 
I believe the other day you told me that Medicare is more than 
$20 trillion of that $43 trillion; is that correct? Did I hear 
you correctly?
    Mr. Walker. It is over $27 trillion.
    Senator Conrad. Medicare alone is over $27 trillion of the 
$43 trillion of unfunded liabilities.
    Mr. Walker. That is correct, Senator.
    Senator Conrad. And how much would Social Security be?
    Mr. Walker. About $3.7 trillion.
    Senator Conrad. About $3.7 trillion. So, just doing quick 
math, the Medicare problem, in terms of an underfunding, is 
eight times the shortfall in Social Security; is that correct?
    Mr. Walker. That is correct.
    Senator Conrad. That would tell me that our top priority 
ought to be looking at Medicare, and obviously we need to deal 
with Social Security as well. My own view is we ought to be 
dealing with both of them because the Medicare problem is so 
enormous, and the cost escalation that you are estimating is so 
significant.
    My time is up, Mr. Chairman.
    Mr. Walker. Mr. Chairman, if I may real quick, I agree with 
you that we need to be dealing with both, but I think we have 
to be cautious. The last time Medicare legislation was acted on 
by the Congress, it increased the fiscal imbalance by $8.1 
trillion.
    I do, however, think that it is possible to reform Social 
Security and exceed the expectations of every generation of 
Americans. And if you can do that--and I think you can--then, 
that would send a positive signal to the markets as to the 
ability of Congress to be able to address challenges before it 
has to and also would send a positive signal to the public that 
the Congress is concerned about this long-range imbalance that 
threatens our future.
    Senator Conrad. Could I just say, in conclusion, Mr. 
Chairman?
    Chairman Gregg. Of course.
    Senator Conrad. Could I just say that I believe in Medicare 
the biggest opportunity is that 5 percent of the beneficiaries 
use 50 percent of the budget, the chronically ill, and we ought 
to focus like a laser on that population, better coordinate 
their care. The things that we have done so far by way of pilot 
programs show that if you do that, you better coordinate their 
care, you save big amounts of money, and you get better health 
care outcomes.
    Chairman Gregg. Thank you, Senator.
    Senator Alexander?
    Senator Alexander. Thank you, Mr. Chairman, Mr. Walker.
    A Comptroller General's forum I guess month, that one of 
the participants, according to the report, suggested biennial 
budgeting might be one approach at making more oversight 
possible again. I've been looking at Congress from outside 
Congress for a long time, and I have always thought that. And 
now that I am here, I see that making the budget pushes the 
appropriations to a late process, leaves very little time for 
oversight, and then we end up with this big omnibus 
appropriations bill, and it is all a big mumbo jumbo.
    Do you have any recommendations for us about the pros and 
cons of a 2-year budget which might be adjusted in the second 
year, if there emergencies? But would that not leave us a lot 
more time for structured oversight of the kind you are 
suggesting?
    Mr. Walker. Senator, candidly, several factors are 
relevant.
    No. 1, that if you went to biennial budgeting, that would, 
theoretically, give you more time to do more things. Hopefully, 
one of the things that the Congress would do would be more 
oversight and engaging in a much-needed and long overdue 
baseline review of Government. I do not know that there is a 
guarantee that that would happen, but that would be my hope. 
But you need more time to be able to do it. There is no 
question.
    Second, there are States, as you know, that have biennial 
budgeting. And the other thing that I would note is that we 
have been having supplementals every year now, and it is likely 
that there are going to be supplementals for several more 
years. They are a vehicle that could be used to adjust things 
if you went to biennial budgeting. So there are pros and cons, 
but, again, how would the Senate and the House actually use 
their time if you went to biennial budgeting is a real 
question.
    Senator Alexander. Disciplining a legislative body is 
always difficult, but that has always appealed to me as a 
possibility.
    Another thing, and again maybe this naive, but I have 
looked at Washington mostly from outside as a Governor, has 
there been any serious consideration, in this report you are 
coming up with, is there any consideration in separating the 
budget back into component parts? We now have a unified budget, 
but of course in the States we have a different approach. We 
take capital items, and we put them over here because those are 
investments for the future. And then in our State, at least, we 
pay them back in an aggressive way, and we see what that debt 
is for, and it helps us keep it under control. Then, we have an 
operating budget. And borrowing for the operating budget is 
very, very limited. And then I would guess on the Federal 
level, and in the States, you might have a pension budget.
    Why do we not have a capital budget, an operating budget, 
and a pension budget? Would that not provide more transparency 
and would it not permit us, also, while we are in the midst of 
this deficit, not to squeeze out necessary investments we need 
to make that we might need to do for our future in higher 
education research development, for example?
    Mr. Walker. Well, Senator, we have done work in the past in 
a number of these areas, including capital budgeting. I would 
be happy to provide some of that information for you. I do 
think that we need to disaggregate more, and we need enhanced 
transparency. You talk about capital budgeting, which is one 
element. The other thing that you touch on is the so-called 
operating budget versus other types of programs.
    We, clearly, need to be able to disaggregate, provide more 
transparency on these numbers, and try to be able to make more 
informed judgments as to what we should be investing in and 
what is generating a rate of return. Although I am sure that 
you can appreciate, Senator, that one person's investment might 
not be another person's investment, and being able to 
demonstrate that, in fact, there is a rate of return that we 
are getting on that investment is very important. It is easier 
for capital items than it is for other types of items.
    Senator Alexander. Well that is true. But if the States are 
the laboratories of democracy, and some of them are pretty big, 
and some of them have done this way for a long time, that is at 
least one place we can look to see how we might learn.
    You have described to us a fiscal challenge that is new in 
its severity, and maybe that is a spur to these ideas.
    Thank you very much.
    Mr. Walker. Thank you, Senator. One other thing I would 
note is the Federal Government, obviously, has a responsibility 
for overall fiscal policy, and what it does has a direct impact 
on the economy as a whole. And so that is why, while we need to 
look at some of these disaggregated numbers, we cannot lose 
sight of the unified budget because the unified budget does 
have economic impact.
    Senator Alexander. You could have, I suppose, a unified 
policy and a disaggregated budget.
    Mr. Walker. We should have a strategic and integrated 
approach to everything you do. It is just a matter of how you 
show the information and some additional disaggregation would 
be appropriate.
    Senator Alexander. Thank you, Mr. Chairman.
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    I appreciate Senator Alexander's questioning in terms of 
how we look at investments in capital improvements and so on. I 
think we really should be looking at that in terms of what our 
values and priorities are and how we are evaluating that. I 
think that makes a lot of sense to take a look at that.
    Thank you, Mr. Walker, for coming in.
    There are a number of things I would love to ask you about 
as it relates to this because we really do need to be 
evaluating what we are doing, in terms of revenue, as well as 
expenditures, as well as interest payments for the long haul. 
And on this committee, Mr. Chairman, we really are the folks 
that lay out what the priorities and the values are for 
American families, and that is how I see this committee.
    It is, also, I think, important to recognize that even 
though we include Social Security in the bottom line, certain 
streams of revenue coming in, those are dollars paid in by 
individuals. There is not general fund money involved in this. 
So we are including those dollars as it relates to what our 
debt is. Essentially, some would argue to mask the debt because 
we have it in a unified budget, but Social Security is 
something that has been a program where folks pay in, and then 
they receive a benefit out based on basically an insurance 
policy. So it is important we look at these numbers to say that 
as part of it.
    But, Mr. Chairman, I find it really interesting when we 
look at these numbers that we have received. To put it in 
context, the President is proposing a nondefense, none homeland 
security budget, domestic budget--education, research, the 
environment, health care and so on--of $389 billion for next 
year--$389-. The deficit for next year is projected at $390-. 
So you literally could wipe out every penny of nondefense, 
nonhomeland security dollars in order to be able to wipe out 
the debt next year. I think that is very important for us to 
remember as we talk about what I view as sort of tinkering 
around the edges on this, in terms of how much we put into 
education or research and development, which I believe do spur 
economic activity and investments in the future. And if we are 
not paying attention to those things, we are going to be left 
behind by other countries like China and so on who are.
    But I, also, wanted to put in perspective something else. 
If you take out Social Security, you are saying that our 
interest payments will be $213 billion next year, interest. It 
would be $415- if we included Social Security. So, if we take 
that out, $213 billion that does not educate a child, does not 
provide health care, does not build a road. It is interest. And 
the cost of the tax policy that we passed, the cost for 2006, 
is $252 billion. So we are paying more on that tax policy than 
the interest. And when you put that all together, I just hope 
that we will have a real honest debate about what all of this 
looks like and what our priorities are in terms of the overall 
budget.
    Now, my question. When we look at Social Security, and the 
fact that we are seeing Social Security is growing at a certain 
level and Medicare is growing at a certain level, and you have 
indicated that Federal health care costs will go from 4.2 
percent of GDP to 11.5 percent in 2030. At the same time Social 
Security will go from 4.3 percent of GDP to 6 percent.
    Are we not avoiding, as they would say, the ``gorilla in 
the middle of the living room'' here by not focusing on health 
care? There is a lot of effort going in to talking about Social 
Security, plans that will not even strengthen Social Security, 
privatizing, which I would argue do not add a day to the length 
of the solvency of the trust fund, but yet we are avoiding the 
big issue, which is the explosion in health care costs.
    Mr. Walker. I would come back to what Senator Conrad said. 
I think you need to work on both. I think you need to work on 
health care, and you need to work on Social Security. The 
fundamental difference is, in the case of health care, the 
problem is much more complex, there are huge expectation gaps. 
We are not only going to have to reform Medicare and Medicaid, 
we are going to have to reform the entire health care system in 
installments. It is going to be very heavy lifting. It is going 
to take many years. And, whereas with Social Security it is 
possible, with or without individual accounts to reform Social 
Security to make it solvent, sustainable, and secure for 
current and future generations and for every generation will 
get more than they think they are going to get.
    And I think if you can achieve that, there are a lot of 
positive reasons why that is desirable to do, with or without 
individual accounts. It is going to take many years to deal 
with the health care problem and that is going to be very heavy 
lifting. So, yes, work on both, but recognize that one is a lot 
more solvable a lot quicker than the other one is.
    Senator Stabenow. Just in conclusion, and I would agree 
with you that there are small changes we can make now, I would 
argue, instead of privatizing, but there are small changes we 
can make now with big impacts 5 decades from now. But, Mr. 
Chairman, I hope we will have a real discussion on health care. 
There is not a business person in Michigan I talk to, there is 
not a worker, there is not an older person, there is not a 
younger person going off of their parents' insurance that is 
not concerned about health care as the top priority. And there 
are things we can do. Allowing Medicare to negotiate for group 
prices would bring down the cost of the Medicare bill, and I 
would hope that we would aggressively begin now because it is 
not going to go away. It is only going to get worse and, today, 
I would argue it is a bigger crisis in terms of health care 
than it is on most other issues.
    Thank you, Mr. Chairman.
    Chairman Gregg. Senator Cornyn.
    Senator Cornyn. Thank you, Mr. Chairman. It is good to be 
back on the committee this year and under your leadership. We 
certainly have a tough job set out for us, and it is always a 
pleasure to be back on the committee with Senator Conrad and 
see what kind of new charts he has to show.
    [Laughter.]
    Senator Cornyn. I think, Mr. Walker, what you have said and 
what we have already heard discussed here so far is powerful 
refutation of those who have said that we really do not have 
any problem in Social Security. We really do not have a problem 
in Medicare, in Medicaid, and entitlement programs because 
plainly we do.
    I know there are those who would like to point to the tax 
cuts as a source of all of our fiscal woes, but the fact is 
last year we grew about 2.5 million jobs in the country.
    I believe in no small part to the economic stimulus 
provided by reduced taxes, which are a powerful incentive for 
people to work a little harder, and earn more money, and be 
able to keep more of what they earn. But I have two specific 
questions that I would like to ask today. One has to do with 
collections--tax collections--and the other has to do with 
information technology.
    I understand several of IRS studies suggest that increasing 
enforcement will lead to additional revenue. One, in 
particular, suggests that doubling the examination rate would 
increase assessments and collections by $16.7 billion. But my 
question is not so much about that, but estimates that we have 
currently working in the United States now, about six million 
undocumented immigrants who work in a cash economy, maybe do, 
maybe do not pay taxes. I know, in Mexico alone, they estimate 
that the value of remittances from the United States back to 
Mexico, by Mexicans working in the United States, is about 
$14.5 billion a year, Central America and other places 
similarly.
    Do you know whether anyone in the U.S. Government has 
calculated the increase in revenue that might be gleaned from 
providing some sort of legal way, legal framework, for 
undocumented immigrants, that 6 million who are currently 
working in the economy, to work and pay taxes?
    Mr. Walker. Senator, I am not aware of any study that has 
been done on that. I can check with my staff and see if they 
are aware of anything, and if we can come up with anything I 
would be happy to provide it to you.
    Senator Cornyn. That would be great. I would appreciate 
that very much.
    My second question has to do with information technology, 
and I will give you a quick background. When I was in State 
Government--attorney general--we had a broken computer system 
that basically monitored child support payments, and it was a 
disaster. It was a huge, complex project, but we ultimately got 
those problems worked out.
    When I see that the FBI, for example, is going to throw 
away $100 million of taxpayer money because of a poorly 
conceived, poorly executed computer upgrade, I just wonder how 
much of that is happening out of our sight and how much waste 
of taxpayer money and poor execution on the part of Government 
agencies because they do not have the technology in place that 
provide better services to the American taxpayer. Can you give 
us any insight or any thoughts about what we can do, what we 
should be doing to address that waste and lack of poor 
services?
    Mr. Walker. Senator, GAO issued its latest update of its 
high-risk list the last week of January, and on that high-risk 
list there are several examples of different departments and 
agencies that have serious problems in this regard. You 
mentioned the FBI's latest problem. Probably the biggest 
problem that exists right now is at the Defense Department. The 
Defense Department has 14 of 25 high-risk areas. They added two 
more this year. Many of them have been on the list for years. 
If you take information technology as an example, they have 
over 4,000 legacy information systems that are not integrated, 
and that is the latest count. Every time I go over there, it 
goes up.
    And so part of it is getting control of what we have and 
then creating a more positive future and making sure that we 
streamline our processes, define what our standards need to be 
and to make sure that we do not just turn it over to 
contractors. We have to have enough people to manage cost, 
quality and performance in any type of contracting activity. We 
have many different recommendations and I would be happy the 
talk to you about it separately if you want.
    Chairman Gregg. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman. Welcome, Mr. 
Walker.
    Let me try to frame this a little bit, and I am going to 
back into a question that deals with shifting costs to the 
States. You have identified big programs that are going to 
drive the future expenditures, entitlement programs, if you 
will, at the Federal level. We are operating at something like 
16.5, 16.7 percent of GDP in revenues to the Federal 
Government, and the average over----
    Senator Domenici. Would the Senator yield on that? How much 
did you say?
    Senator Corzine. I think it is something like 16.5, 16.7. 
Memory does not serve me for the last digit, but the average is 
slightly over 18 percent, and the end of the 1990's was 
something slightly north of 20 percent.
    As the Federal Government has decreased the amount of 
revenues it has taken, and we have not changed the mandates to 
States and we have not changed the entitlement policies, have 
we not just shifted tax burden to our State and local 
governments? At least in the place I come from people have been 
looking at compounded rates of 7 percent increase in property 
taxes year over year. And we have mandates from the Federal 
Government on education and a whole host of issues that we have 
to deal with; such as environmental protection.
    If we no longer continue, particularly in the Medicaid 
program--and Medicare has some of the same implications--aren't 
the solutions we are talking about here only just transferring 
exposures and responsibilities to our State and local 
governments? So that we take it out of one pocket, or we give 
it out of one pocket and get it taken out of in another pocket. 
I would love to hear your comments on it because it seems to be 
a pattern that is happening over and over. I happen to be a 
little more sensitive to it today than maybe I was 6 months 
ago, but it certainly is an analysis that absolutely, I think, 
needs to be raised in this context.
    We can make ourselves feel good here under certain 
circumstances, but all we are doing is offloading this on other 
poor, unwilling folks that have to meet mandates. I wonder if 
you could comment.
    Mr. Walker. Senator, I think it is important to consider 
the ripple effects of whatever decisions are made at the 
Federal level, because to the extent that the Federal 
Government decides that something needs to get done, but it may 
or may not want to fund it itself, or it may only want to fund 
part of the cost, then the question is, who is going to end up 
making up the difference?
    As you know, the fastest growing cost at the State level is 
Medicaid. In fact, Medicaid is among the largest budget item in 
my States budget. So that brings me back to the issue of health 
care. It is not just Medicare. It is Medicaid. It is the entire 
health care system, not just for the Government but for 
employers, that we have to look at.
    So it is facts and circumstances. It depends upon the area 
that you are talking about. I know that there are going to be 
proposals with regard to Medicaid, GAO itself has found 
instances where States, have used the rules in a way to try to 
get more of a reimbursement than arguably they should have. We 
have made related recommendations to the executive branch.
    I also know of examples where the formulas for 
transportation spending should be changed. So I think it is 
facts and circumstances. But you are exactly correct in saying 
that a number of instances where the Federal Government does 
less and yet it still wants to see national progress, that can 
put additional pressure on the States and one needs to consider 
that, hopefully, in your deliberations.
    Senator Corzine. Just changing subjects. I think I have a 
split second here. Do you have a view on PAYGO rules, two-way 
PAYGO rules with respect to revenues as well as spending?
    Mr. Walker. Senator, I am a bottom line person. The bottom 
line means, whether it is red or whether it is black, and how 
big it is on the bottom line. Obviously, red being a deficit 
and black being a surplus, which we probably will not see any 
time soon. I believe it is important that you consider both 
sides of the ledger. You should consider both the tax side and 
the spending side when you adopt PAYGO rules and when you 
should consider the long term cost, affordability and 
sustainability of legislative proposals.
    Now reasonable people can and will debate that, and 
obviously, to the extent that you have certain tax actions that 
could be stimulative, that should be considered. But not all 
tax cuts are stimulative, and not all spending is necessary. 
But I think exempting one-half of the ledger from the analysis 
will help our bottom line, or help us deal with our long range 
fiscal imbalance.
    Chairman Gregg. Senator Domenici.
    Senator Domenici. Mr. Chairman, thank you very much. First, 
I want to thank you for today's testimony, in particular for 
the constructive ideas that you have given us. I am going to 
try to do two or three and see if you will answer them. That 
might permit me to cheat on the time. I am not sure. Maybe your 
answer will take all 5 minutes plus some more.
    First, we gave you a job once that we called a trade-in 
trade-out assessment, and that had to do with looking at 
Federal programs to see how many programs did the same thing. 
The goal was for us to try up here, when we start a new 
program, to trade a new one in for trading out some old ones. 
You did a series of studies on that. I wonder if you would give 
us that again, and then take what the President has suggested 
as terminations and do an analysis of those in the same way. If 
he is eliminating something, what other programs are there that 
do the same thing?
    I am trying to figure out a budget way to push that. Right 
now, Committee members and the Chairman, as I told him 
yesterday, we know that a budget resolution does not do that. 
It just plugs in the numbers, but then there is nothing that 
requires that you do that. Say you got rid of 15 programs, they 
may never show up in appropriations bills and we may never get 
an authorizing bill to do it because you cannot pass it.
    So if you would do that, it would help us. I am thinking 
about a reverse reserve where you would set up the reserve and 
get a bonus if you cut a program, and lose the bonus if you did 
not, as part of a budget resolution. But I will work on that, 
and give it to the Chairman and ranking member myself. You can 
talk about that in a minute.
    Second, you mentioned in answer to the ranking member that 
growth was dependent upon entrants to the marketplace, workers 
entering the marketplace, and productivity. And he said, if we 
had more growth we would be able to hire more people. But which 
comes first? What if we had 5 million more immigrants--do not 
say that out loud, but what if we did, would that help the 
economy? If not, why not?
    And my last question has to do with outyear obligations. We 
keep mentioning outyear deficits or outyear obligations, and 
that we need to do something about them. You keep mentioning 
that obviously we have to reform Medicare. Doesn't reform mean 
that we cannot afford the size of the program? Why do we call 
it reform? Why shouldn't we say restrain it? Why shouldn't we 
say cut it?
    My own observation--this is not an answer to the question--
but the ranking member said, it looks like we ought to take on 
Medicare before Social Security because it is bigger. The 
problem is, it would be the same argument if you took on 
Medicare. It is almost the third rail. If it is not the third 
rail, it is 2.9 to one rail. So if you started doing it, it 
would be the same argument, you are hurting the old people; you 
are cutting.
    So I do not know which comes first. I think which comes 
first is that which you can do. In that regard, you mentioned 
you can do Social Security reform and create more for the 
pensioners rather than less. I assume that means some kind of 
savings account, but would you tell us what that means, please?
    Mr. Walker. Thank you, Senator. Four things. First on the 
trade-in, trade-out I do recall that. I believe that was very 
early in my tenure. As you know, I have been in office about 
six and-a-half years, only eight and-a-half left. I would be 
happy to take a look at that and see how that compares with 
what the President is putting forward.
    One of the things that we are encouraging the 
Administration to do is to focus on the base. The 
Administration has developed the Program Assessment Rating Tool 
(PART). They tend to look at each program and you look 
vertically within that department or agency. The other thing 
that we are encouraging the Administration to do is to look 
horizontally. Look at different types of activities or 
different types of programs where they exist in many different 
departments and agencies, for example, food safety. A recent 
one that I became aware of is financial literacy. We have over 
20 Federal agencies involved in financial literacy. We do not 
need 20 Federal agencies, and I doubt very seriously they are 
even saying the same thing.
    Second, more people. It depends on a number of things, 
including the skills and knowledge of the people. We are now in 
a knowledge-based economy. We need to compete based upon 
innovation, quality and productivity. We cannot compete on 
wages. So it depends to a great extent on the skills and 
knowledge of those people and what would they be doing and what 
value they would be adding.
    Third, with regard to Medicare, there is no way we are 
going to deliver on all the Medicare promises that have been 
made. No way. So I think we need to recognize that reality, and 
I think that Medicare needs to be restructured as part of a 
broader restructuring of our overall health care system. I 
think we need to answer basically two fundamental questions 
which we have never answered.
    First, what are broad-based societal needs in health care 
that irrespective of your income, irrespective of your 
geographic location, irrespective of a variety of other facts 
that from a societal standpoint there is a need that we ought 
to try to make sure that it is addressed? I did not say by 
whom. I said that it is addressed. Versus individual wants. 
Because individual wants are absolutely unlimited, and if there 
is one thing that could bankrupt the country it is health care.
    Second, what is an appropriate division of responsibility 
between employers, individuals and the Government for 
addressing health care? That is going to take fundamental 
change in Medicare, Medicaid, employer-provided arrangements, 
and it needs to be done. And we are going to have to do it in 
installments. It is just too heavy a lift to do all at once.
    Then last, Social Security. What I meant by Social 
Security, and as you probably recall, Senator, I have been a 
trustee of both Social Security and Medicare. I was a trustee 
of Social Security and Medicare from 1990 to 1995 so I am 
pretty deep in these two programs. I previously said that you 
have an opportunity to reform Social Security and exceed the 
expectations of every generation of Americans. Let me give you 
my family as an example of that.
    My father is retired. You are not going to touch his Social 
Security benefits. I am a baby-boomer under 55. Most people of 
my generation are discounting what they think they are going to 
get from Social Security. I have a daughter 31, and a son 28, 
they are discounting it big time. They do not have confidence 
that Government is going to be able to deal with the issue. I 
am not saying it is right or wrong. That is the situation.
    You therefore have the opportunity to restructure the 
program, making progressively greater changes the younger the 
person is, with or without individual accounts, and structure 
it in a way that current retirees and near-term retirees will 
not be affected at all. They will get exactly what they have 
been promised and therefore they should not worry. Baby-
boomers, Generation X and Generation Y will get more than they 
think they are going to get. You may decide that you want to 
have individual accounts for younger people as part of the 
equation. They may want it.
    But my point is this, you can restructure it and everybody 
gets more than they think they are going to get. I call that a 
win. You do not have a prayer doing that in health care.
    Senator Domenici. Thank you.
    Chairman Gregg. Thank you. Excellent answer.
    Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman. Here we go 
again.
    You, Mr. Walker, have given us some serious matters to 
think about. We thank you for that. We thank you for your 
agency and what it does. I would join with those who discussed 
this question of productivity and our projections for the 
future. I noticed that United States' growth this past year 
exceeded the other industrialized nations according to the 
economists and their poll expects us to outgrow every one of 
those nations next year, or this year that we are in. Some of 
that is indeed a result of our placing less burden on the 
private sector.
    We can do several things. I think one is remember that the 
private sector is what drives us. It is what lifts our boats. 
Also, we can make the public sector more efficient and 
productive, saving money. Too often when we do save it though, 
we spend it, what we save. It is not as if we save it and then 
pay it down on debt. When we improve efficiency in one or more 
agencies it goes back in some other spending program that may 
or may not be efficient. So, I did want to make that point.
    I know Senator Domenici just left but he is a champion of 
nuclear power. He believes that has a potential to increase our 
productivity. We have talked about all kinds of visions for the 
future there that when you get out 75 years I think we do not 
need to make ourselves too depressed because I believe 
something else will help us meet this challenge if we continue 
to invest in creativity.
    You have worked on a number of things that deal with 
systemic problems in Government. One that I have thought about 
recently is concern over the nature and procedures and 
effectiveness of Government contracting. We contract out more 
now than we have done before. Sometimes those contracts are, I 
believe, poorly drawn and leave us less able to enforce them 
effectively. We had the FBI problem, as has been mentioned 
earlier. You have looked at that. Mr. Mueller is one of the 
finest FBI leaders that we have ever had, but I am sure he is 
not a thorough expert in how to put in a computer system. He 
called on GSA and they were supposed to help. But somehow we 
end up with a system that is not working.
    The same has happened in defense. I have been impressed 
with the idea that some of the FEMA contracting after disasters 
is not effective, and it appears one reason is that the 
contractor themselves are required to evaluate their own 
performance, and that this has left a lack of evaluation there.
    Do you think we can do a better job of contracting, and 
could that amount to real dollars?
    Mr. Walker. Senator, there is absolutely no question that 
interagency contracting is a new Government-wide high risk 
area, and there are a number of items with regard to 
contracting dealing with specific departments and agencies, 
DOD, DOE, NASA where contracting is also on the high risk list. 
So we are continuing to work to try to help people have the 
right type of controls in place, the right type of people that 
have the skills and knowledge necessary to manage cost, quality 
and performance. You can contract out the responsibility but 
you cannot wash your hands of it. That all too frequently is 
what happens. It is as if, we have hired a contractor and they 
are going to take care of it. No, you have to have people who 
can manage cost, quality and performance.
    You also have to decide certain things up front in computer 
systems. You have to reengineer your processes. You have to 
decide what you need to accomplish versus what you want to 
accomplish, because everybody has got a dream about the 
computer system in the sky that can do everything and that is 
where you end up getting nightmares because you try to build 
things that you do not need and the specifications keep on 
changing. So, yes, we are on the case.
    Last thing. Let me mention, you are correct in saying that 
we have the strongest economic growth of any major, 
industrialized nation. We are projected to continue to have it. 
But it will not be strong enough, because if you just do simple 
math on these numbers, on that second scenario it would take 
double-digit real GDP growth every year for decades to close 
that gap. It has never happened in the history of this country. 
It is not going to happen. So we need to get serious. Yes, we 
need to encourage economic growth.
    The other thing is, even if you look in the short term, at 
last year's unified deficit which offsets the Social Security 
surplus--an amount equal to less than 25 percent of the FY2004 
deficit had anything to do with Iraq, Afghanistan, or 
incremental homeland security costs. And we have not been in a 
recession since November 2001 and we had the strongest economic 
growth of any major industrialized nation. What is the other 75 
percent and what are we doing about it?
    Senator Sessions. I would just note that I will ask you 
also about some of the laws and rules we impose on our agencies 
and departments that interfere with their ability to do their 
job. I know that is a concern that you have and I think we can 
do better about that.
    Mr. Chairman, my time has expired.
    Mr. Walker. We need to do a baseline review on those as 
well, Senator, because they have aggregated up over the years. 
We need to do a baseline review of those too.
    Chairman Gregg. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    The information that I am getting is that Medicare is the 
one that is carrying the huge future liability out there, 
larger than any other program. What aspects of Medicare is 
driving those future obligations most?
    Mr. Walker. It is a variety of factors. One is just 
demographics, that we have more and more people that are 
becoming eligible for the program. It is known that it, on 
average, costs more money to insure senior citizens than it 
does younger people. Senator Conrad also mentioned the fact 
that a very, very high percentage of the cost for Medicare is 
used by a fairly small percentage of the population covered by 
Medicare. So there are a number of contributing factors.
    Plus, health care cost increases continue to far outpace 
economic growth. I think one of the reasons it does is because 
for any system to work you really have to have three things in 
place: incentives for people to do the right thing, 
transparency to provide reasonable assurance they will because 
somebody is looking, and accountability mechanisms if people do 
not do the right thing. I would respectfully suggest, we do not 
have any one of the three in health care.
    Senator Allard. How would we do that? How would you 
accomplish those three objectives? Is it performance standards 
we need to put in there? Or what is it that we do to accomplish 
it? Do we reduce eligibility requirements? What is it that we 
do?
    Mr. Walker. Senator, I honestly believe in the case of 
Medicare, for example, you are going to need to look at 
eligibility requirements. You are going to need to look at 
standards of practice. You are going to need to relook at 
prescription drug coverage. One of the things that was just 
announced in the new Medicare prescription drug benefits. It 
was just announced that under Part D you are going to be able 
to get Viagra. I do not know how that affects extending life.
    Senator Allard. So if you are 65 years of age or older you 
can qualify for Viagra?
    Mr. Walker. Under the new Medicare prescription drug bill, 
that was announced within the last week. Now as you know, that 
program does not kick in for several years yet.
    Senator I am happy to speak with you. I will tell you this, 
that in the document that is going to be issued on February 16 
we raise a number of very thought provoking questions in this 
area and others that are a starting point. And the Congress may 
wish to ask us to do additional work to come up with specific 
options and the related pros and cons, which we are happy to do 
if you want us to do it. But we have a lot of recommendations 
out there already.
    Senator Allard. I think it would be interesting to get some 
of that. I do not know how the other members of the Committee, 
maybe other committees haveten some of it. But I would be 
interested in it personally.
    Last year is when I paid more attention to GPRA. That is 
how we did the performance and results, and it was put in the 
President's budget that he submitted to the Congress. I felt 
that helpful on a number of things. I have not have a chance to 
go clear through the budget but I assume those kind of 
proposals or provisions or ratings are in the budget again this 
year. Do you feel that that is helpful?
    Mr. Walker. There is absolutely no question that we need to 
understand what type of results are being achieved by various 
programs with the resources, the responsibilities and 
authorities that they have. That is fundamental. But I would 
also respectfully suggest that it is not just with regard to 
spending. We should also do it with regard to tax policies as 
well.
    For example, the tax incentives of health care. It is the 
No. 1 tax preference in the Internal Revenue Code and growing 
very rapidly. Is it achieving the desired objective or are we 
spending a lot of money there that may be fueling the health 
care cost increase rather than helping?
    By that I mean, 80 percent-plus costs are paid for by a 
third party. The individuals who end up receiving the service 
do not necessarily even see what is being billed for. 
Individuals never pay income tax on the value of employer-
provided and paid health care benefits, no matter how 
lucrative. They never pay payroll tax on it either. It is not 
on your W-2. It is not on your tax return. People do not really 
have any idea that health care costs are out of control. And to 
the extent that they are concerned about it, which they are, 
the relative burden of bearing the health care cost has changed 
dramatically over the last 40 years. Much more is being borne 
by Government. Much more is being borne by corporations than 
individuals, and yet corporations have to compete in a global 
economy.
    Senator Allard. I see that my time is about ready to 
expire. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you.
    Mr. Walker, you have raised a whole lot of very interesting 
to issues, but I think if you sugar it all off we do come back 
to how we address the issue of health care in the outyears as 
being probably, along with Social Security, the core issue of 
fiscal responsibility. You have also pointed out tax 
expenditures, which I hope will be taken up in this tax reform 
initiative that is being promoted by the President and which I 
strongly encourage. But if you have specific proposals on how 
Medicare you think should become more transparent and more 
responsible as to usage, we would be very interested in them.
    The President in his request did not address Medicare 
relative to addressing the programmatic activity. In fact in 
the budget it is projected Medicare will jump by about 17 
percent, which is the largest item by far in this proposed 
budget. A lot of that is a function of the drug benefit. The 
drug benefit has not even started yet and it is already out of 
control as far as I can see. So if you have some thoughts there 
we would be interested in them. We can maybe pass them on to 
some of the Finance Committee members who are members of this 
committee.
    I will turn to Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Mr. Walker, a couple of things were said by the former 
chairman referencing me that I want to make very clear. He said 
that I have suggested more workers mean more economic growth. 
This is not my formulation. The head of the Congressional 
Budget Office and the head of the Social Security 
Administration in determining their projections for economic 
growth, say economic growth results from two things: growth in 
productivity and new entrants to the work force. That is the 
way they make their determination and projection on future 
economic growth. It is not my formulation. It is the 
economists' formulation.
    The second thing he referenced was Medicare, suggesting 
that I say, do Medicare before you do Social Security. That is 
not my position. I believe we have to do both. And there is a 
inreference here that it is hard to do. Yes, it is hard to do, 
but if you are right, if the shortfall in Medicare is eight 
times the shortfall in Social Security, to delay beginning to 
address that imbalance is just a mistake, because the sooner we 
get at it, the better.
    I have laid out very specifically here today something that 
I think should be pursued aggressively by this committee and 
the other committees of jurisdiction, and that is to focus like 
a laser on the 5 percent of the eligibles in Medicare who use 
50 percent of the money. Five percent use 50 percent. Those are 
the chronically ill.
    We did a pilot project with 22,000 patients in which we 
more closely coordinated their care. What we found is that you 
could reduce hospitalizations dramatically. They reduced 
hospitalization 20 percent. They reduced costs 40 percent, and 
they got better health care outcomes. The Senator indicated, he 
said, why not just call it a cut? I do not consider that a cut. 
You are spending less money but I do not consider it a cut 
because you are getting better health care outcomes.
    What we have found is that nobody is coordinating these 
chronically ill people's care. Now that is not true in every 
case certainly, but by and large it is the case. What do we 
mean by that? People have a doctor, if they live in Washington 
they have a doctor here. They have a doctor at the beach. They 
have a heart specialist. They have a lung specialist. There is 
a lack of coordination of all these health care providers. As a 
result there are duplicate tests that waste a lot of money and 
are a drain on the patient. There are people with too many 
prescription drugs.
    Just to be personal about it, we have found this with my 
own father-in-law. We went down and spread out all his 
prescription drugs on the table. He was taking 16 different 
prescription drugs. I got on the phone to his primary care 
doctor and I started reading through the list of the 
prescriptions he was taking. He said, oh, my God, he should not 
be taking that. That was two and-a-half years ago. He should 
not be taking that any more. Get to the next one; he should not 
be taking that along with this other drug. Those drugs interact 
adversely. That could send him to the hospital.
    Now the problem is, the way our health care system works is 
you have all these different people that patients are going to. 
Nobody is on top of managing the overall case. I really believe 
this is something we have to aggressively address--this 
Medicare problem, this $27 trillion unfunded liability. Now 
that is real money, even in Washington, $27 trillion. It is by 
far the lion's share of our long term obligations. I really 
believe we have an obligation to start now, and everybody come 
up with their best ideas on what we could do, and maybe we 
would make real progress.
    I thank the chair.
    Mr. Walker, I want to again thank you as well. I think you 
have been a real leader for the country in firing the warning 
shot about where this is all headed, and that we have to work 
on all sides of this. It has got to be on the spending side, 
discretionary and mandatory--including entitlements. It has got 
to be on the revenue side of the equation as well. All of these 
things have to be on the table. We have an obligation to avoid 
the long term serious adverse consequences of piling up 
deficits and debt.
    Chairman Gregg. I join you in that. I join Senator Conrad 
in expression of appreciation. Senator Allard, one followup and 
then we will let the Comptroller go back to trying to 
straighten these things out. He has only mentioned about 200 
things we need to straighten out. He may have a busy day today.
    Mr. Walker. That probably will take many years, Mr. 
Chairman.
    Senator Allard. Mr. Chairman, and my colleague from North 
Dakota, Senator Conrad, had talked about a gatekeeper approach. 
I have a feeling that some of that is being done at the State 
level.
    I think the State of Colorado, for example, we do have a 
primary care physician as a gatekeeper approach before they 
provide any benefits, and you have to go through the primary 
care physician and he is supposed to do that. If this is being 
done on a State by State basis we might already have the 
information out there where we can look at the way one State is 
doing it and another State is doing it and see if there is 
anything that can be reflected, bringing some efficiencies to 
the program. That is the only other comment that I would make. 
I think if we look at some of the States as to what they have 
been doing on that perhaps something can be extrapolated out of 
what they are doing.
    Mr. Walker. Yes, I think that is important, Senator. We not 
only look at States, we look at the private sector, and 
frankly, we look at other governments around the world because 
we lead in many things but we do not lead in everything, so we 
can learn. Thank you.
    Chairman Gregg. I think you hear a general consensus from 
this committee that we would like to get your ideas that are 
specific, especially relative to health care and Medicare, and 
be able to maybe use them as a committee or at least pass them 
on to the committee of jurisdiction, which is the Finance 
Committee, of primary jurisdiction.
    So thank you. Thank you for, as Senator Conrad said, 
putting a warning shot across the bow. Hopefully notice will be 
taken of it. That was the purpose of this hearing. We look 
forward to your report coming out on the 16th. It should be 
something that will be very informative and very useful for us 
as a Government and hopefully for people generally, and we will 
do whatever we can to draw attention to it. Thank you for the 
good work.
    Mr. Walker. Thank you, Senators.
    [The prepared statement of Mr. Walker follows:]

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    Chairman Gregg. The Committee is adjourned.
    [Whereupon, at 11:33 a.m., the Committee was adjourned.]


            THE PRESIDENT'S FISCAL YEAR 2006 BUDGET PROPOSAL

                              ----------                              


                      WEDNESDAY, FEBRUARY 9, 2005

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Domenici, Allard, Sessions, 
Bunning, Crapo, Ensign, Cornyn, Alexander, Conrad, Sarbanes, 
Murray, Wyden, Feingold, Stabenow, and Corzine.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
David Pappone.
     Mary Ann Naylor, Staff Director; and Sue Nelson.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will get started. It is 10 o'clock.
    We very much appreciate the Director of the Office of 
Management and Budget for participating here for this hearing 
today, which is a hearing on the President's proposed budget, 
which becomes, as I describe it, the memo that controls the 
meeting, so to say. Actually, I should footnote that. That was 
Henry Kissinger's term.
    In any event, the administration has sent us a budget which 
I believe sets out some fairly aggressive and appropriate 
fiscal initiatives in the area of trying to control our 
deficits. We all know that the deficit is too high and that we 
need to have action on the deficit. We also know that this 
divides into two issues: the short-term deficit and the long-
term structural problems of our Government.
    The short-term deficit, of course, is the fact that we are 
running very large numbers in deficit right now, and the 
President's budget has suggested ways we can reduce that in 
half over the next 4 to 5 years. And that is a very positive 
step, and he has done that through basically, as I have called 
it, goring everybody's ox. Everybody sort of takes a hit in 
this budget, which has not made anybody happy, which is 
probably a sign that it is a good budget.
    The second issue of the structural deficit involves the 
fact that we have this demographic shift in our society which 
we cannot deny, as we all exist, and which is going to put huge 
pressures on our society as the baby-boom generation retires. 
Essentially, my generation, the baby-boom generation, is going 
to end up requiring of our children and our children's children 
significant support, which will translate into taxes on their 
earnings, which will translate into a reduction of their 
quality of lifestyle, unless we address the retirement benefit 
structure for my generation so that it is affordable for our 
children and effective in the way that it covers people who are 
retired, especially low-income and middle-income seniors.
    The President has stepped forward on that issue, both in 
his suggestion that we address the issue of Social Security and 
in the budget itself and his suggestions on Medicaid, which is 
one of the big items in the issue of long-term structural 
concern for the Government.
    I have said all along that you cannot get to where we need 
to go in getting the deficit under control unless you address 
entitlement spending. This administration, with the exception 
of one item, which I am sure there will be some discussion 
about, has stepped forward on the entitlement accounts and made 
very strong proposals, proposals which I believe are 
appropriate and timely in Medicaid, in agriculture, and in a 
variety of other entitlement accounts.
    So as a general statement, I congratulate the 
administration's initiative here. It is a document that the 
Congress is obviously going to work over because that is why we 
are here, as the administration knows. But in the end I hope 
that we can conclude that we will agree to the basic goals 
here, which are to control discretionary spending aggressively, 
especially nondefense discretionary, to pay for the war, but to 
also make sure that we do it in a responsible way that does not 
allow the defense base to overwhelm us, and to look at the 
entitlement accounts and make sure that we are fiscally 
responsible there--all of which will lead us toward reducing 
this deficit in half over the next 4 years, and in the out-
years addressing the long-term concerns we have with 
entitlement spending.
    So I thank the Director for being here. I thank him for his 
document, which is a well-prepared and well-thought-out and 
aggressive approach toward fiscal responsibility, and I yield 
to the Ranking Member, Senator Conrad.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. I thank the chairman. I do not think it 
will come as a surprise to you that I have a somewhat different 
take on this budget.
    First of all, let me say I welcome you, Mr. Director. I 
enjoyed our conversation the other day. I want to stipulate 
right at the beginning that I think you are a fine public 
servant. In many ways, the country is fortunate to have people 
of your quality who are willing to step forward in public 
service.
    With that said, I think this budget----
    Chairman Gregg. Is that the end of the kindness? Is that 
all the love we are going to feel here?
    [Laughter.]
    Senator Conrad. It is kind of a wind-up. You know these 
baseball metaphors, Mr. Chairman.
    Seriously, I say to you I have been here 19 years, and I 
think this budget is completely off track. I believe that very 
genuinely. I have to say to you I think this is not so much a 
budget, it really strikes me more as camouflage, because I 
think it is hiding the true fiscal condition of the country 
from the American people and even from Congress. Maybe this 
administration is even fooling themselves.
    Let me go directly to some slides to make my point. You 
have a budget here that shows progress on the deficit, but as I 
see it, the only way it makes progress is it just leaves out 
things. It leaves out the funding for the ongoing war costs 
beyond September 30th of this year.
    Now, the President says he has no timetable for withdrawal, 
but this budget provides a timetable. It says they are not 
going to spend anything on Iraq past September 30th of this 
year. Now, that is not credible.
    It says that there is no cost to the President's 
privatization plans for Social Security. We all know that is 
not true. There is a massive cost, over $700 billion the first 
10 years, according to the administration's estimates, but you 
cannot find that anywhere in this budget.

[GRAPHIC] [TIFF OMITTED] T1173.086


    Alternative minimum tax reform. Last year they at least 
provided funding for 1 year. The old millionaire's tax that is 
rapidly becoming a middle-class tax trap costs $700 billion to 
fix over 10 years. There is not a dime in the President's 
budget.
    And then on the spending side of the ledger, you provide 
only details for 2006, no details for future years. I think 
there is a reason for that, because it gets really ugly after 
this year, and in some accounts it gets ugly this year.
    So as I look at this budget, I do not see a real fiscal 
plan for the country or something that really reveals the 
fiscal condition of the country. Instead, I see something that 
hides what I believe to be the true fiscal condition.
    Let me go to the next chart.

    [GRAPHIC] [TIFF OMITTED] T1173.087
    

    The President reveals the effect of his budget proposal for 
just the first 5 years. But look what happens just beyond the 
budget window. The costs of the President's tax proposals 
explode. It is not surprising that you have gone from 10-year 
budgeting to 5-year budgeting, because you do not want Congress 
to see this and you do not want the American people to see 
this. But this is what happens. It is also the case with the 
alternative minimum tax where you have provided no funding in 
your budget. The Congressional Budget Office tells us this is 
the cost to deal with the alternative minimum tax, over $700 
billion over the 10-year period. You cannot find it in the 
President's budget.

[GRAPHIC] [TIFF OMITTED] T1173.088


    And why is that important? It is important because 3 
million people are affected today. It is going to be 30 million 
people 10 years from now. Some are saying it may be 40 million 
people. The middle class is going to be in for a big surprise 
when they find themselves caught up in the alternative minimum 
tax.
    For the war, there is $81 billion in the budget, but there 
is nothing for it past September 30th. And I heard your 
testimony in other venues where you have said it is hard to 
estimate. That is what you told us last year. It is hard to 
estimate. The one thing we know for sure though is that the 
right answer is not zero. That is for sure not the right 
answer. The Congressional Budget Office says another $383 
billion needs to be included in the budget to give a real 
reflection of the ongoing war cost.
    On Social Security, the President has included nothing in 
terms of a cost for his privatization plan, but we know from 
the administration's own estimates that from 2006 to 2015, it 
costs $754 billion. The 20-year cost is a staggering $4.5 
trillion. Now, you know, that is real money and it is not in 
the budget.
    Let's go to the next.

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    When we put back all of the things you have left out, here 
is what we see. This black line is the administration's claim 
that the deficit is going to be improving. This red box 
represents the administration's claim about improvement in the 
deficit. When we add back the things that are left out, here is 
what we see. We see a very modest improvement in the coming few 
years, but then things get much worse. I think an honest 
reflection of this budget would tell the American people that 
the fiscal condition gets much worse, if the President's plans 
are adopted and at the worst possible time, right before the 
baby boomers retire.
    Finally, the President has said that Social Security is in 
crisis. But if you look at his budget, he is taking $2.6 
trillion from Social Security over the next 10 years to pay for 
other things. If it is in crisis, why is he taking money raised 
by payroll taxes, designed to strengthen Social Security, by 
either paying down the debt or prepaying the liability? The 
President takes every dime of surplus Social Security money and 
uses it to pay for other things.
    There is some disconnect between his language that there is 
a crisis in Social Security and his budget that takes all of 
the money that is available in Social Security that could be 
used to prepay the liability or pay down debt. He is taking 
$2.6 trillion over the next 10 years to pay for other things.
    Finally, the Washington Post this morning now that says the 
drug benefit, instead of costing $400 billion, could cost as 
much as $1.3 trillion over the next 10 years. Now, in this 
story, I think in fairness, the Medicare chief, Mr. McClellan, 
said that there are various offsets and savings that will 
reduce the bottom-line costs to $724 billion. But we were told 
by this administration that was going to cost $400 billion. Now 
the administration is saying, oops, it is not $400 billion, it 
is not the $534 billion that we were told right after it 
passed, but instead $724 billion, and in gross terms 
potentially $1.2 trillion.

[GRAPHIC] [TIFF OMITTED] T1173.092


    Let me just say that this new information damages the 
credibility of this administration in a very serious way with 
respect to the rest of their budget proposal because there is a 
pattern here. There is a pattern of concealing, the true fiscal 
condition of the country from the Congress and from the 
American people.
    I thank the Chair.
    Chairman Gregg. Thank you. We are going to subscribe to the 
5-minute rule here. Unfortunately, the Director has to go over 
to the House and testify after he comes here, which is an 
unfortunate experience for you. But we do want to give people 
the opportunity to speak to you and ask you questions.
    Let's start with this Medicare number, the drug number, 
which has become the cause du jour. And I would be interested 
in your thoughts on the story in the Washington Post, which 
says it is a $1.2 trillion number over the next 10 years as 
versus what I would guess would be a $720 billion number if we 
were talking apples to apples in the 10 years comparing the--in 
other words, the $400 billion number was for 2 years' startup, 
2004 to 2014. This number of 1.2, I guess is from 2006 to 2015. 
If you compare 2006 to 2015 under the projected numbers, I 
presume the number we are dealing with is 700-something.
    What is the actual increase in the drug benefit cost over 
the original estimate? is the question.

    STATEMENT OF HON. JOSHUA B. BOLTEN, DIRECTOR, OFFICE OF 
                     MANAGEMENT AND BUDGET

    Mr. Bolten. Mr. Chairman, thank you, and thank you for the 
nice welcome, and Senator Conrad as well, other members.
    Mr. Chairman, I have a compelling opening statement that I 
would like to have included in the record.
    Chairman Gregg. I apologize for skipping your opening 
statement.
    [Laughter.]
    Chairman Gregg. This issue interests me so much, I wanted 
to get to it.
    Mr. Bolten. All right, sir.
    Chairman Gregg. So let me withdraw my question, save it for 
you, know that you will answer it in your opening statement, 
and allow you to make your opening statement.
    Mr. Bolten. Mr. Chairman, if you prefer, I will skip the 
opening statement.
    Chairman Gregg. No. I think you should make it because I 
think that you have a good case, and I think the Senator from 
North Dakota has made a case, I have made a case, and we would 
like to hear your case. So we definitely want to hear your 
opening statement.
    Mr. Bolten. I hope you will find it compelling, Mr. 
Chairman, and thank you, Senator Conrad and other members of 
the committee, for your welcome.
    The President's budget, which was transmitted on Monday to 
the Congress, meets the priorities of the Nation and builds on 
the progress of the last 4 years.
    We are funding our efforts to defend the homeland from 
attack. We are transforming our military and supporting our 
troops as they fight and win the global war on terror. We are 
helping to spread freedom throughout the world. We are 
promoting the pro-growth policies that have helped produce 
millions of new jobs and restore confidence in the economy.
    Over the past 4 years, the President and Congress rose to 
meet historic challenges: a collapsing stock market, a 
recession, the revelation of corporate scandals, and, of 
course, the terrorist attacks of September 11th.
    To meet the economy's significant challenges, in each year 
of the first term Congress and the President enacted major tax 
relief that fueled recovery, business investment, and job 
creation.
    The strong economic growth unleashed by tax relief is 
reflected in this chart. Since the recession year of 2001, 
economic growth has increased in each of the following 3 years. 
A primary goal of the budget that we have just sent up is to 
assure that our economic growth continues.

[GRAPHIC] [TIFF OMITTED] T1173.339


    Now we can take the next chart. A strengthening economy 
produces rising tax revenues. Last year, after declining 3 
years in a row, Federal revenues grew by nearly $100 billion. 
Reflecting strong continued growth, we project that Federal 
revenues will grow by an even larger figure this year.

[GRAPHIC] [TIFF OMITTED] T1173.340


    The President and Congress have also devoted significant 
resources to rebuild and transform our military and to protect 
our homeland. In the first term, the defense budget grew by 
more than a third, the largest increase since the Reagan 
administration, can we see the next chart. To make our homeland 
safer, the President worked with Congress to create the 
Department of Homeland Security and nearly tripled funding for 
homeland security governmentwide.

[GRAPHIC] [TIFF OMITTED] T1173.341


    While committing these necessary resources to protecting 
America, the President and Congress have focused on spending 
restraint elsewhere in the budget. Working together, we have 
succeeded in bringing down the rate of growth in non-security 
discretionary spending each year of the President's first term. 
In the last budget year of the previous administration, non-
security discretionary spending grew by 15 percent as 
represented by the green bar. In 2005, such spending will rise 
by about only 1 percent. Because of this increased spending 
restraint, deficits are below what they otherwise would have 
been.
    In order to sustain our economic expansion, we must 
exercise even greater spending restraint than in the past. When 
the Federal Government focuses on its priorities and limits the 
resources it takes from the private sector, the result is a 
stronger, more productive economy.
    The President's 2006 budget proposals build on that 
enhanced restraint. As you can see from this chart, the 2006 
budget proposes a reduction in the non-security discretionary 
spending category of the budget. This is the first proposed cut 
in the non-security spending category since the Reagan 
administration.

[GRAPHIC] [TIFF OMITTED] T1173.342


    The budget proposes more than 150 reductions, reforms, and 
eliminations in nondefense discretionary programs, which save 
about $20 billion in 2006 alone.
    As a result of this enhanced restraint, overall 
discretionary spending, even after significant increases in 
defense and homeland security, will grow by only 2.1 percent. 
That is less than the projected rate of inflation of about 2.3 
percent. In other words, under the President's 2006 budget, 
overall discretionary spending will see a reduction in real 
terms.
    The budget also proposes savings from an additional set of 
reforms in mandatory programs, which save about $137 billion 
over the next 10 years.
    As this committee well knows, both mandatory and 
discretionary categories of spending are inherently difficult 
to control, but mandatory programs are especially difficult 
because of their auto-pilot feature. The administration looks 
forward to working with this committee and the rest of the 
Congress on a package of mandatory savings.
    We will also work with Congress on budget process reforms. 
Last year, I transmitted to Congress, on behalf of the 
administration, proposed legislation to establish statutory 
budget enforcement controls. We will have similar proposals 
this year.
    In addition, the administration proposes other enforcement 
and budget process reforms, such as the line-item veto, a 
Results Commission, and a Sunset Commission. These reforms 
would put in place the tools we need to enforce spending 
restraint and would bring greater accountability and 
transparency to the budgeting process.
    The budget restrains spending in a responsible way by 
focusing on priorities, principles, and performance. We were 
guided by three major criteria in evaluating programs:
    First, does the program meet the Nation's priorities?
    Second, does the program meet the President's principles 
for the use of taxpayer resources?
    Third, does the program produce the intended results?
    The Bush administration is comprehensively measuring the 
effectiveness of the Government's programs, and the results are 
helping us make budgeting decisions. As part of the President's 
Management Agenda, the Program Assessment Rating Tool, or PART, 
for those who are cognoscenti of these management tools, was 
developed to measure the performance of Federal programs. 
Roughly 60 percent of all Federal programs have undergone the 
PART, and those scores figured into our budgeting process.
    By holding Government spending to these accountability 
standards, by focusing on our priorities, and by maintaining 
pro-growth economic policies, we are making progress in 
bringing down the size of the deficit in 2006 and beyond.
    Last year's budget initially projected a deficit of 4.5 
percent of GDP in 2004, or $521 billion. The President set out 
to cut this deficit in half by 2009. Largely because economic 
growth generated stronger revenues than originally estimated, 
and because the Congress delivered the spending restraint 
called for by the President, the 2004 deficit came in $109 
billion lower than originally estimated.
    At 3.6 percent of GDP--that is the figure in the far dark-
blue column on the left--the actual 2004 deficit, while still 
too large, was well within historical range and smaller than 
the deficits in 9 of the last 25 years.
    We project the 2005 deficit to come in at 3.5 percent of 
GDP or $427 billion. If we maintain the policies of economic 
growth and spending restraint reflected in this budget, the 
deficit is expected to decline in 2006 and each of the next 4 
years. In 2006, we project the budget deficit to decline to 3.0 
percent of GDP. In 2007, the deficit is projected to fall 
further to 2.3 percent of GDP.
    By 2009, the deficit is projected to be cut by more than 
half from its originally estimated 2004 peak, to just 1.5 
percent of GDP, which is well below the 40-year historical 
average deficit of 2.3 percent of GDP, and lower than the 
deficit level in all but 7 of the last 25 years.
    The administration intends to submit shortly a supplemental 
appropriations request of approximately $81 billion, primarily 
to support operations in Iraq and Afghanistan for the remainder 
of the fiscal year. The 2006 budget spending and deficit 
projections fully reflect the outlay effects of this 
supplemental request, as well as the prior $25 billion 
supplemental bill already enacted by the Congress. However, the 
budget does not reflect the effect of undetermined but 
anticipated supplemental requests for ongoing operations in 
Iraq and Afghanistan beyond 2006.
    The published version of the 2006 budget also does not 
reflect the effects of transition financing associated with the 
President's proposals to create personal retirement accounts as 
part of a comprehensive plan to fix Social Security. As the 
administration announced last week, the type of personal 
accounts the President is proposing will require approximately 
$664 billion in transition financing over the next 10 years, 
with an additional $90 billion in related debt service. This 
transition financing would result in a deficit in 2009 and 2010 
of 1.7 percent of GDP. Let's see that on the chart. Those 
levels are still consistent with the President's goal to cut 
the deficit in half by 2009 and still well below the 40-year 
historical average deficit.

[GRAPHIC] [TIFF OMITTED] T1173.342


    It is important to remember that this transition financing 
does not have the same impact on national savings, and thus on 
the economy, as does traditional borrowing. Every dollar the 
Government borrows to fund the transition to personal accounts 
is fully offset by an increase in savings represented by the 
accounts themselves. In addition, the transition financing of 
retirement benefits does not represent new debt. These are 
obligations that the Government already owes in the form of 
future benefits.
    Perhaps most important, comprehensive Social Security 
reform that includes personal accounts can eliminate the 
system's current $10.4 trillion in unfunded obligations.
    Senator Sarbanes. Mr. Bolten, could you pull that 
microphone closer to you? I think it would be helpful. If you 
keep it too far away, we do not pick up your voice.
    Mr. Bolten. Am I doing better now?
    Senator Sarbanes. That is better.
    Mr. Bolten. Those of us who devote our time to thinking 
about fiscal policy all share a common interest in averting 
this danger. There is no task as vital to fiscal policymakers 
this year than removing these unfunded obligations by enacting 
comprehensive Social Security reform.
    Confronting these long-term obligations, combined with our 
near-term deficit reduction efforts, will help assure a strong 
economy both now and in the future.
    I look forward to working with the committee and Congress 
on this budget, which meets the priorities of the Nation in a 
fiscally responsible way.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Mr. Director, and I apologize 
again for skipping over that. It was a good point, and a couple 
points which I would just pick up on is that to the extent that 
we reflect these transition costs, the deficit will still be 
going down by half, and the issue of Social Security. But the 
most important point is that if we reform Social Security, in 
the out-years we will have a $10 trillion essentially 
correction occurring in the fiscal situation of the Federal 
Government in that we will be able to, instead of facing 
massive deficits in the out-years in Social Security, actually 
have a fund that is solvent.
    Unfortunately, the budget process by definition does not 
really structure itself to address Social Security, and that is 
why we are out of the process, because we are a 5-year budget, 
and Social Security is a lifetime-of-earning issue, which is a 
30-, 40-year experience. And so if you are going to adequately 
reflect Social Security and if you make changes in Social 
Security, you really need to see what the 30-year impact is, 
not put it in a 5-year window because that really perverts the 
answer, which is an excellent point that you have made.
    Let me put two questions on the table. The first is the 
question which was raised by Senator Conrad, which is the 
question of what is the number for the drug benefit in 
relationship to the number that was estimated? How much higher 
it? Is this $1.2 trillion number an accurate apples-to-apples 
comparison? And what is in that number, if you know?
    Second--well, why don't we answer that question first, and 
then I will get into my second question.
    Mr. Bolten. Mr. Chairman, thank you. It is not an accurate 
apples-to-apples comparison. This has come up just recently, so 
I would like to have the opportunity to submit something more 
detailed, perhaps from Dr. McClellan, for the record. But your 
description was exactly right, which is that our estimates, I 
think, remain in exactly the same range that they have been. In 
fact, I think our estimates in this budget for Medicare costs 
may have come down slightly from the estimates we put out 6 
months ago.

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    The reason it is not an apples-to-apples comparison is that 
when you were considering the Medicare bill, there were a wide 
variety of offsets that were not considered. I have a list of 
some of them here: that States are now contributing to the cost 
of the benefit, that is about $134 billion; beneficiary 
premiums are adding about $145 billion. The number that was 
cited in the newspaper does not take into account that the 
Federal Government is saving almost $200 billion on Medicaid 
now because seniors are receiving their coverage through 
Medicare.
    So all of those offsets bring the number down to the one 
that I think Dr. McClellan cited in the low $700 billion 
figure, and then a true apples-to-apples comparison would be 
over the same time period. When you were looking at the 
Medicare bill, the years covered were, I think, 2004 to 2013. 
That was the relevant 10-year period. Now the 10-year period is 
2006 to 2015, as you identified. And when we make that shift of 
just 2 years in the 10-year period, what we are adding at the 
back end are years in which the drug benefit is fully phased 
in. So naturally those costs are going to be higher. And what 
we are dropping off are the early years of the 10-year Medicare 
plan in which the drug benefit was not fully phased in. We have 
had a drug card and so on, but the full Medicare benefit arises 
in 2006.
    So if I may, I would like to submit something detailed for 
the record, responding on the numbers, but the short answer is 
that I think the numbers that are reflected in this budget are 
completely consistent with the numbers that the administration 
has produced before for the costs of the Medicare system.
    Chairman Gregg. As you know, I am not a great defender of 
the drug benefit because it is scored to be about an $8 
trillion unfunded liability over the next--over the actuarial 
life, which is 75 years, and I do think we are going to have to 
go back and readdress it. But I do think these numbers are 
misleading as they have been reported, and I think by saying 
that I might have more credibility than others because I would 
be the first to be aggressive were they not.
    As I see it, basically what the 1.2 is, it has not netted 
out the income that will come in, which would be about $300 
billion. So you are back down to about 900. And then it has not 
netted out the fact that you are moving $200 billion out of 
Medicaid over to Medicare, so that gets you down to the $700 
billion. And as you mentioned, the out-years, as we hit the 
out-years, we are into full participation and your annual cost 
is about $138 billion a year as versus the 56 that it starts 
out at.
    So that is where the numbers come from, as I see them, but 
I am still very suspect of this program as to its cost, and I 
certainly want to know what the real numbers are, and so we 
will look forward to getting more specifics.
    What I would like to do is go on, though, to the other 
entitlement issues. In your budget submission, you propose a 
fair number of entitlement accounts which you wish to slow the 
rate of growth of, you do not cut any. And then there are a 
number of other issues where you actually create new 
entitlement accounts.
    Could you give us a general statement of what accounts you 
are slowing the rate of growth in and what the number is, 
approximately, and then the accounts that you are adding and 
what the 5-year or 10-year number is?
    Mr. Bolten. Mr. Chairman, again, I would like to submit 
something formal for the record that will put precise numbers 
on it. But we are proposing to slow the growth in the rate of 
Medicaid spending from about 7.4 percent per year to about 7.2 
percent per year out over the next 10 years. The net savings in 
the Medicaid system would be about $45 billion over 10 years, 
and we are hoping to achieve that through program integrity 
measures. More importantly--and without reducing the actual 
service that we can provide to the lowest-income folks who 
depend on Medicaid.

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    The more important thing is that we are also proposing a 
comprehensive reform of the Medicaid system, which is very tied 
up and has a lot of structures in it to prevent Governors from 
using the funds appropriately. We can go into more detail on 
that. We are proposing a reduction in farm programs and farm 
subsidies of about $5.4 billion. I do not recall exactly what 
percentage decrease that is. I will ask my staff to help me 
out.
    It is in the low single digits as a percentage of total 
projected farm spending that we are proposing to reduce--3.8 
percent.
    We are also proposing to increase--to capture some savings 
from power marketing authorities by asking them to charge a 
market rate for the electricity. Those are some of the largest 
elements. And then in addition, we are proposing to capture 
savings in the student loan programs by making it possible for 
the government to deliver some of the benefits, without the 
middleman in the process collecting quite as large a fee.
    Chairman Gregg. And the new programs, new entitlement 
programs?
    Mr. Bolten. We are continuing to carry a health credit in 
the budget, that is, a credit for the uninsured to purchase 
health insurance on their own. This is not new. This has been 
in our budgets in the past. But in terms of new entitlement 
spending, I think it is very restrained.
    On the Medicaid side, we are proposing a program to sign up 
more kids for S-CHIP, which has been a relatively effective 
program, and there is about $1 billion of spending over the 
next 2 years to get more, more of the eligible kids signed up. 
But there is also an associated cost with that within the S-
CHIP program, because as we sign up more eligible children, 
there will be more burden on the Federal budget, and we are 
carrying those costs as well in our budget.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Just to go back to the Medicare estimates. Mr. Foster, who 
was Medicare's chief actuary for nearly a decade, said that 
administration officials threatened to fire him if he disclosed 
his belief in 2003 that the drug package would cost $500 to 
$600 billion.
    That is why there is a credibility problem here. We were 
told as we were dealing with the legislation that the cost 
would be $400 billion. Then after it was passed, they let it be 
known that, oops, that was wrong, the real cost is over $530 
billion. And now we are talking about a 10-year cost of $724 
billion, accepting your offsets, which I do accept, $724 
billion.
    Now, this is the pattern as I see it. In 2001, the 
President told us we can proceed with tax relief without fear 
of budget deficits. That was clearly wrong. Then he told us in 
2002, our budget will run a deficit that will be small and 
short-term. Obviously that was wrong because these are record 
deficits and they are for as far as the eye can see. In 2003, 
he told us that the current deficit is not large by historical 
standards and is manageable. I would submit to you that, 
correctly considered, these deficits are not small by 
historical standards either. The way he gets there is he just 
leaves out things.
    In fact, I would like you to put up that chart, if you 
would again, showing the deficit reduction as a percentage of 
GDP, because I have to tell you, I think this hurts your 
credibility again because I think it misrepresents the true 
state of our fiscal condition.

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    That is the that I want. Let me just say this to you: First 
of all, that chart leaves our war costs past September 30th of 
this year. That is No. 1.
    Senator Sarbanes. Is that correct?
    Mr. Bolten. That is correct, and I would----
    Senator Sarbanes. Leaves out war costs after September 
30th?
    Mr. Bolten. It leaves out any supplemental spending after 
September 30th, and I think I was clear about that in my 
testimony, and it is clear in the budget documents as well.
    Senator Conrad. No. 2, what that chart leaves out most 
significantly is the money that you are taking from Social 
Security to pay for other things.
    If you go back, because you are making a comparison back to 
the 1980's, back in the 1980's there was virtually no Social 
Security surplus. So if you look at this on an operating basis, 
you get quite a different picture. If you look at this on an 
operating basis, you know, no private sector company could take 
the retirement funds of its employees and use those to pay 
operating expenses. That is a violation of Federal law.
    But in your budget, in the President's budget, he takes 
$2.6 trillion of Social Security money over the next 10 years 
to pay other operating costs. That is nowhere in these figures.
    By the way, you do not have alternative minimum tax in 
there. Last year, at least you had it in for 1 year. This year 
you do not have it in at all. It costs over $700 billion to 
fix. It is not there.
    So this is not a budget. This is a political document. It 
is a talking point. It fundamentally misleads people as to our 
fiscal condition. Even more serious is if you just go beyond 
the 5-year window, many of the costs of the President's 
policies explode, for example, the cost of making the tax cuts 
permanent. You only have the first 5 years there. You know and 
I know what happens after the first 5 years. The costs of those 
tax cuts in lost revenue to the Treasury absolutely explode.
    So you have a chart here that does not reflect reality. It 
is not what is going to happen, and it is part of a pattern.
    You know, I do not even know what to say to you in terms of 
how seriously I believe this misleads the American people. We 
are not on a course to substantially reduce deficits. We are on 
a course to a train wreck. We had the Comptroller General of 
the United States here yesterday. Boy, what a difference his 
testimony was from the testimony we are hearing today. He 
talked about $43 trillion of unfunded liabilities, $28 trillion 
of it in Medicare alone, and there is nothing in this plan that 
deals with that.
    My time has expired, but I would just say that you have a 
presentation here that I do not think reflects reality.
    Chairman Gregg. Thank you. That was a good question.
    Senator Alexander.
    Senator Alexander. Thank you, Mr. Chairman.
    I have some questions about Medicaid and then an 
observation about higher education. You said that you would 
reduce the growth in Medicaid spending from 7.4 to 7.2 percent. 
Do you know about what the rate of growth annually for Medicaid 
spending has been in the Federal Government and the State 
governments over the last 4 or 5 years?
    Mr. Bolten. We will give that to you for the record, but I 
think it has been at about that level.
    Answer: Average, annual Federal Medicaid growth was 9.8 
percent from FY 2001 through FY 2005.
    Senator Alexander. State spending might have been higher.
    Mr. Bolten. States, in fact, probably are experiencing a 
slightly higher rate of growth in their costs than even the 
Federal Government's 7-percent rate.
    Senator Alexander. What I would like to drive at here is a 
question really of federalism. You have a predecessor of yours 
who is now Governor of a State. You have a former Governor, 
Chairman of the Governors, who is the head of Health and Human 
Services. And if I am putting myself back into--if I were the 
Governor of Tennessee today, I would be looking at a State 
budget that might have, for example, approximately $10 billion 
of Federal funds that I manage and about $10 billion of State-
collected tax dollars. And of the $10 billion of State-
collected tax dollars, that would be most of the funding for 
kindergarten through the 12th grade, for colleges and 
universities, for parks and police, when you add in the local 
spending--in other words, many of the things that people really 
rely on for Government and that have to do with our future. To 
keep our competitiveness in the world marketplace, we need 
brain power, and that comes from improving our early education, 
our schools, and our universities. A lot of that is State 
funding.
    So what is happening in Tennessee, as an example, is when I 
left the Governor's office 15 years ago, we were spending 51 
cents of every dollar on education; today it is 40 cents. The 
reason is because 15 years ago it was 16 cents on Medicaid and 
today it is 26 cents, going up.
    So if we are to continue to have quality universities and 
schools funded by State and local governments, we have to make 
sure that whatever we do here does not have the unintended 
consequence of tying the hands of Governors and Mayors who are 
trying to allocate funds so they all do not get eaten up by 
health care.
    So what I want to urge you to do is to--and you said you 
would, but I just want to urge you to listen to the Governors 
as you restrain Medicaid spending. Because if I am sitting down 
there with $10 billion and that situation of health spending 
going up, there are two people who get in my way: one is the 
Federal Government, and one is the Federal courts. Because you 
say here is a cap, and then other agencies of the Federal 
Government say, ``But you have to spend money on this person 
instead of third grade or this person instead of the community 
college.'' And then the Federal courts come in.
    So that is just a general comment. I am working on some 
legislation that will make it easier for State and local 
governments to amend and adjust Federal consent decrees, which 
might help with that. But what is your attitude toward giving 
maximum flexibility to Governors and legislators as you seek to 
restrain the growth of Medicaid spending?
    Mr. Bolten. Senator, that is precisely the direction we are 
trying to take the system because the restrictions that 
Governors face in the rules often make it very difficult for 
them to provide the care that is needed to the people who need 
it most and is eating an ever larger portion of State budgets. 
So we are headed toward proposals of exactly the kind of 
flexibility you are talking about. Governor Leavitt understands 
that, I think, as you do because he is a former Governor. He 
made an excellent speech last week, which I commend to you--and 
we will gladly provide you a copy of it--outlining the 
principles that we are going to be pursuing in Medicaid reform, 
and I think you will find them entirely consistent with what 
you have just said.

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    Senator Alexander. I have one observation I would like to 
make, and if there is time for you to comment, fine. When I 
left the former President Bush's Cabinet as Education Secretary 
in 1993, when the voters ushered us out of office, there was 
one regret I had and it was that I had not volunteered to be 
the point person for higher education, because as I have looked 
through all of Government, it was all over the place. It was in 
the Defense Department. it was in NSF. It was in the National 
Institutes of Health. It was in Pell grants. It was in a 
variety of places. And about half our economic growth since 
World War II has come as a result of our investments in science 
and technologies, the national laboratories, the research that 
we do.
    I think administrations need a point person on all that we 
spend and all that we do in science and technology and higher 
education, especially now that competitiveness is such a major 
issue and other countries are keeping their better students 
home, building up their universities, trying to compete with 
our national laboratories. And I just offer that to you since 
management is another part of your responsibility, and it is 
something that I would like to suggest that the administration 
consider.
    Mr. Bolten. Thank you, Senator.
    Chairman Gregg. Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman.
    Mr. Director, appreciate your being here today. I listened 
to the President's State of the Union Address last week, and he 
told us he was going to send the budget and would focus on 
essential priorities, so I was looking forward to seeing it. I 
guess I was really disappointed to find out what was not 
essential priorities, things like veterans and students and 
securing our ports and borders and affordable health care and 
nuclear waste cleanup, and I think that sends a very bad 
message to our country right now. I do not know how we can 
maintain a strong defense if we are going to cut veterans' 
access to health care or how we can make sure we have strong 
homeland security if we are eliminating funding for our port 
security grants, and I do not believe we can strengthen our 
economy if we are going to reduce our investments in education 
and job training and infrastructure at a time when everyone is 
asking how can we be secure. I think this budget really 
undermines that security, and I echo the comments of Senator 
Conrad on what this budget really is, how real it is and 
masking it.
    But let me for this time, since my time is short, focus on 
a very parochial issue. Actually, it is not real parochial. It 
is the Pacific Northwest which you should know is up in arms 
over your proposal to force our power marketing administration 
to charge market-based rates for electricity. I think there are 
eight Senators on this committee alone who are going to be 
affected by that, and I want you to know that our region does 
not want to see this budget balanced on the back of our rate 
payers.
    But that is not the only legislative proposal in your 
budget that is going to undercut Bonneville Power 
Administration. You also propose to hold certain financial 
transactions, such as third-party financing, against BPA's 
borrowing authority. I have to tell you that is really rich 
with irony because for 2 years OMB opposed our efforts to raise 
BPA's borrowing authority in order to make necessary 
investments in transmission and other capital projects that 
were needed. And in 2003 OMB finally supported half of BPA's 
needed borrowing authority but said that they should use other 
financing means like third party financing to meet the 
remainder of its investment needs. So here we are a couple of 
years later, and you are proposing to undercut the ability of 
BPA to use third party financing by holding these and other 
types of transactions against their borrowing authority limit. 
These kinds of proposals are going to cripple BPA's ability to 
meet their investment needs.
    Mr. Bolten, President Bush came out to my home State, 
Washington State, in July 1999, and he came out again in 2003, 
and stood at Ice Harbor Dam, and he promised to save the dams. 
I cannot believe that this budget is making two different 
proposals that is going to severely undermine the value of 
those very dams that he promised he was going to save.
    My question to you this morning is, is it the intention of 
President Bush to privatize BPA and other PMAs?
    Mr. Bolten. No, that is not reflected in these proposals, 
and I do not think these proposals in any respect undermine the 
value of the dams out there. All that we are asking in these 
proposals is that the power marketing authorities charge their 
customers a reasonable market rate, not a subsidized rate for 
which the rest of the taxpayers in this country are paying, but 
a----
    Senator Murray. The rest of the taxpayers are not 
subsidizing Bonneville. We pay the rates.
    Mr. Bolten. I think we have a disagreement on facts on 
that, and CBO has found that most of the PMAs in fact do 
receive a subsidy from the Federal Government. But even beyond 
that, when the Government is engaged in a commercial venture, I 
think using assets created with Federal taxpayers' dollars, 
especially in these times of deficit, it is reasonable to 
expect that those commercial ventures charge their customers a 
reasonable market rate. That is all we are asking, and I think 
particularly the customers of BPA will find that we are talking 
about a very modest increase in the subsidized rates that they 
now----
    Senator Murray. 20 percent increase in our cost of heating 
our homes, providing electricity to many businesses who rely on 
it is going to cripple the economy in the Pacific Northwest. We 
are just beginning to drag out of the economic damages from the 
last 4 years which started with an electricity crisis which I 
will not go into, that had to do with Enron. I believe there 
are a number of other members on this committee who share that 
viewpoint with me, but we cannot cripple the Pacific Northwest. 
These are not subsidized rates. We pay the rates for our 
electricity out there. I will tell you what, the Northwest is 
not going to stand there and take this, we are going to fight 
back.
    Mr. Chairman, I know I am out of time. I have a number of 
other questions for you including the proposed cuts to Hanford 
Nuclear Reservation Cleanup, and you will be hearing more from 
me on that on the next round.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    I just want to understand what has happened in Social 
Security since its very inception. It seems that every 
President has used the surplus coming in from the Social 
Security money, the FICA tax, and spent it because we have 
bought bonds, put the bonds in the trust fund, and spent the 
money that we got from those bonds for other government 
functions. Is that a fact?
    Mr. Bolten. That is true.
    Senator Bunning. Since the inception of Social Security?
    Mr. Bolten. I believe that is true, yes.
    Senator Bunning. It is true. In 13 years, 2018, is it also 
true that Social Security will then be paying out in actual 
dollars more than they take in in actual dollars?
    Mr. Bolten. That is the currently projected date that 
Social Security will go into cash deficit.
    Senator Bunning. If we do nothing, if we do nothing in that 
respect, then eventually if we deem every bond that is in the 
trust fund, and we pay all the interest due on that bond, there 
is a difference of opinion between CBO and the trustees when 
eventually we run out of money, and if we do not change the 
current law which says you cannot pay out more than you take 
in, somewhere around 2042, between 2042, 2052, there will be a 
reduction of about 25 percent in benefits if we do not change 
the law. Is that correct?
    Mr. Bolten. That is correct, Senator. That is the Social 
Security actuaries estimate is 2042, and I believe they 
expect----
    Senator Bunning. CBO's was 2052.
    Mr. Bolten. On some different assumptions.
    Senator Bunning. We will give them a 10-year leeway, and 
maybe in the middle.
    Mr. Bolten. Yes. And I think their estimate was that 
thereafter the system would be able to pay only slightly more 
than 70 percent of the promised benefits.
    Senator Bunning. There is a difference of opinion there 
too, from 72 to 78 percent, but somewhere under 80 percent. 
That is the law as it is now written.
    Mr. Bolten. Correct.
    Senator Bunning. So if we do not change the law, the Social 
Security law, we are not going to be able to pay my grandkids 
their benefits, the ones that would retire after 2042 or 2052?
    Mr. Bolten. Correct.
    Senator Bunning. So it is not unusual to use that money, 
but perfectly normal?
    Mr. Bolten. Well, that has been the practice in Government. 
And the way we have accounted for it has been the consistent 
practice.
    Senator Bunning. In the Department of Energy's budget the 
administration has proposed to cancel funding for the Clean 
Coal Technology Program, which researches advanced clean coal 
based technologies, and instead redirect the funds to 
FutureGen, which researches creating hydrogen power from coal. 
Why is the administration focusing more on the FutureGen than 
on other types of technologies to burn coal cleaner to produce 
electricity?
    Mr. Bolten. Senator, I will ask to come back to you on the 
record for that. But my understanding is that we are continuing 
to fund a variety of clean coal technologies, that FutureGen 
holds a lot or promise and----

[GRAPHIC] [TIFF OMITTED] T1173.354


    Senator Bunning. Yes, but that is not a huge expenditure, 
but it is transferring out of what we had proposed in the last 
bill, energy bill that did not quite get through. But the fact 
is we need to develop every technology possible so that when we 
are producing 52 percent of our electricity from coal 
generation, we ought to at least try to do the best job we can 
in America, in the United States at least to clean up. I know 
if we do nothing China will suffocate us all with the amount of 
coal-based non-clean technology that they are burning and 
producing power from, but I think it is very important that we 
develop all the clean coal technologies that we can, and I will 
work hard to alter some of the things that have been put in 
this budget.
    Thank you.
    Chairman Gregg. Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Welcome, Mr. Bolten. I want to ask a question. I read 
something in the Post that said that you acknowledged yesterday 
in a House committee that private accounts and personal 
accounts do not in themselves solve the full Social Security 
problem. Is that correct?
    Mr. Bolten. The personal accounts that the President is 
proposing----
    Senator Corzine. Do not deal with the problem of solvency 
from 2042 or 2052?
    Mr. Bolten. They do not in and of themselves solve that 
problem, but I believe they are an integral part of any reform 
program that does solve the permanent problem.
    Senator Corzine. But it is really addressing an issue other 
than the solvency, part of promoting savings or some other 
objective other than dealing with the solvency?
    Mr. Bolten. The view I take is that the personal accounts 
are an integral part of a plan that fully addresses the 
permanent solvency of Social Security.
    Senator Corzine. Could you explain to me how that is going 
to improve the solvency of the Social Security accounts?
    Mr. Bolten. The creation of personal accounts?
    Senator Corzine. Yes. I mean it may be an integral part of 
something, but how is it dealing with the solvency question?
    Mr. Bolten. In and of themselves they do not address the 
solvency question, but they do provide the recipients of the 
personal accounts an opportunity to get a better return than 
they otherwise would----
    Senator Corzine. Given whatever the sort of efficient 
market would allow people to be able to do. I just wanted to 
make sure that I had read that there is a difference between 
how they impact in dealing with the issue of solvency in 2042, 
2052.
    Let me a second--and I will not go through this issue of 
credibility with regard to what I would call two sets of books 
if I were seeing budgets like this back in the world that I 
used to live in, and you left out revenue flows or expenses 
that were broad and deep into what people would want to see on 
getting to a bottom line, whether it is this Medicare issue, 
Social Security transition, AMT full implementation, war costs. 
I think it is very troubling because I do not know how any of 
us can go sit with our constituents and tell them that we have 
a budget, when we know that is not reflective of the challenges 
we have to take on. So I certainly identify with the articulate 
analysis that Senator Conrad brought forward, and I think it 
hurts our ability to deal with some of the other tough issues 
because we do have entitlement problems in this country. But if 
we are not fair and square about what it is that the costs are 
of both sides of the ledger, whether it is revenue raising from 
taxes or how we are going to spend money, I do not know how we 
can sit down and ask the American people to make clear choices. 
We are leaving out so much here, that I think we leave that in 
a very failed position.
    I also want to take a follow-on to what Senator Alexander 
said or talked about. If State Homeland Security grants are cut 
30 percent, if my favorite railroad, Amtrak, was cut from $1.2 
billion to $360 million for operating basis, if Medicaid at 
$100 million was cut to States, COPS programs, Fire Acts, 
Perkins Vocational Technical Education grants, what do we think 
would be the result to State budgets, and after school and day 
care, community development block grants, what is the end 
result when we push this off the budget? Are we going to say 
that our poverty levels are going to go down, that health care 
coverage is going to go up in the country? Is that the 
conclusion that these kinds of cuts, that educational levels 
are going to improve? What are our State and local governments 
going to do when they have mandates and the Federal portion of 
support does not happen?
    What is the expectation on the end results with regard to 
people's lives, with regard to poverty, with regard to health 
care, with regard to quality education if the money does not 
flow and shared by the Federal Government?
    Mr. Bolten. Senator, let me come back first to your 
concerns about what is not reflected in the budget. I believe 
that the presentation I have made, the charts that I have put 
up here are an accurate reflection of what our budget picture 
looks like. I have said explicitly in my testimony, and it is 
explicit in this budget, that war costs beyond those that are 
contained in the 2005 supplemental are not included. So we do 
have to expect that there will be an addition there.
    Senator Corzine. Respectfully, do you--and I mean that in 
all sincerity--respectfully, aren't we going to deal with AMT 
in this country sometime in the next, one, two, three, 4 years?
    Mr. Bolten. I hope we will deal with AMT, but the President 
has asked the Secretary of Treasury to deal with that in the 
context of revenue neutral, overall fundamental tax reform. So 
we have not carried a patch, and it seems to me it is 
inappropriate to carry a patch year after year for a system 
that is as broken and complex and unfair as the AMT is. It 
seems to me that AMT is a proper subject to be considered in 
fundamental tax reform that the President has also called for.
    Chairman Gregg. Senator, we are going to have to move on, 
unfortunately.
    Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Director Bolten, I am going to make a couple of statements 
first just to commend you on some things and raise a concern on 
a couple of things, and then talk to you about some questions I 
would like you to answer.
    The first thing I would like to commend you on in the 
budget, is the Administration's commitment to nuclear power. 
You and I have had several meetings on this issue and I 
appreciate the fact that you heard and responded well to the 
concerns that we have raised about the importance of making 
sure that this budget supports our movement in our energy 
policy in this country toward a strong nuclear power program. I 
just wanted to, first of all, commend you and thank you on 
that.
    On the other side of the ledger, I have to say that I agree 
with those who say you have it wrong on the Bonneville Power 
Administration. There is no subsidy there and I believe that 
when we get into the details of that you will see the 
distinction that we are making.
    I want to, in my questions, I wanted to go back to the 
question that you answered from Senator Corzine about the 
solvency issue with regard to Social Security, because, 
frankly, I understand it a little different and I want to get 
this straight. I clearly understand that initiating a system of 
personal accounts will not impact the short term solvency 
issues because, frankly, it takes a number of years for 
investment in accounts and for the buildup in those accounts to 
take place before you can start having the growth that we want 
to see develop.
    However, in terms of the outyears of Social Security where 
we are seeing the big problems, it is my understanding that all 
these transition costs that we are talking about are, in 
reality, the costs that we are going to try to incur up front 
now for debt obligations of the Social Security system that 
will be present in the outyears. Is that not correct?
    Mr. Bolten. That's correct.
    Senator Crapo. If we are utilizing a personal account 
system to create a better investment opportunity with a greater 
return to handle outyear debt, how can that not have an impact 
on the ultimate solvency of Social Security in the outyears as 
we have a much stronger fiscal position in those years as the 
obligations of the system then come due?
    Mr. Bolten. I think you have given a clearer explanation 
than I was able to give earlier, and you are absolutely right. 
As we create personal accounts, all we are doing is taking an 
obligation that the Government will owe in the form of future 
benefits to a beneficiary and letting them keep that money 
earlier on and earn a higher return on it than the Social 
Security system can possibly promise to pay. So in that 
respect, it is largely neutral to the Government. It is a cost 
that we are just moving forward.
    In the context of an overall, comprehensive reform plan 
that allows people to keep more of their money earlier on and 
increase the amount of benefit they can get from that, that is 
part of the whole plan of bringing the whole social security 
system into solvency.
    Senator Crapo. Thank you. In the time that I have left I 
want to shift gears yet once again. That is, it is my 
understanding that you have introduced a proposal in this 
budget that I guess we could basically call it administrative 
PAYGO, in terms of a proposal to have the administrative 
actions that any agency may take which could increase the cost 
of an entitlement program, to be subject to a PAYGO principle 
or equal reductions would have to be kept in place so that the 
net cost would not be driven up in entitlement programs by 
agency actions.
    Could you explain that a little better? I think it is a 
tremendous idea but I would like to know exactly how that 
works.
    Mr. Bolten. You described it accurately. It is still in 
gestation. It is a new idea for us, but we have found that a 
lot of the growth in costs in our entitlement programs is not 
just the result of the automatic pilot feature of legislation. 
It is administrative decisions made by individual agencies. As 
a way of helping us at OMB and elsewhere in the Government get 
control of costs that might just be growing without any 
particular action having been taken, we are going to be asking 
agencies, as they make proposals for administrative changes for 
changes in regulations, when we assess that those proposals are 
going to result in an increase in the cost of those programs, 
we are going to ask the agencies to come forward at the same 
time with an offsetting decrease in cost. So we are going to 
ask them to do the same kind of PAYGO exercise that we are 
asking you to go through as you consider mandatory legislation.
    Senator Crapo. Are you going to do that through some type 
of executive order, or would this be something better done by 
legislative action?
    Mr. Bolten. We were planning to do it through 
administrative action internal in the Administration, but we 
would be happy to work with you on appropriate legislation if 
that is of interest to you.
    Senator Crapo. Thank you very much.
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    Good morning. Thank you for being here. It is hard to know 
where to begin there are so many questions that I would like to 
ask. I am drawn to your opening statement when you indicated 
that you presented a budget on behalf of the President that 
meets the priorities of the Nation. I think it is important to 
look at what those priorities are and then I want to ask a 
question about Social Security.
    Some veterans under your budget will be greeted with a new 
$250 prescription drug coverage enrollment fee and a doubling 
of their copayments. Are you suggesting that meets the 
priorities of the Nation?
    Mr. Bolten. Senator, we have proposed these additional fees 
in the past. They are for category seven and eight veterans. 
What we are asking those veterans to do is pay an enrollment 
fee of $250 to be part of the VA medical care system, and to 
pay a copay on their drugs that would rise from $7 to $15. I 
think most people who are operating under good health plans 
would not consider a $15 copay to be something out of range.
    But here is the reason we are doing it. While we are 
expanding the expenditure on veterans health care, which by the 
way has grown by almost 50 percent over the course of this 
Administration, while we are expanding what we are spending on 
veterans health care, we are trying to focus on the core 
mission of the Veterans Administration, which is to take care 
especially of those who have service-related disabilities and 
similar categories, the higher up categories. When we ask those 
in the lower down categories to pay some higher fees, the 
purpose of that is to capture some extra revenue to be spending 
it on those higher priorities, which we are doing.
    Senator Stabenow. I understand that. So some veterans are 
going to be greeted with a new $250 prescription drug coverage 
enrollment fee and a doubling of their copays. I would just 
remind you that we have certainly been spending more on 
veterans health care but still have long lines of folks waiting 
to see doctors. We are creating more veterans also every day 
because of our brave men and women. I had an opportunity to 
spend time with some in the Upper Peninsula of Michigan on 
Sunday to thank them for their service. They expect to come 
home to a fully funded veterans health care system that does 
not continue to fund the system by asking additional dollars 
from them.
    But another question, on first responders. Very important 
to us certainly in Michigan and around the country. The budget 
cuts overall first responder funding by 38 percent, the formula 
funding by 26 percent below current levels. Firefighter grants, 
which have been critical to us in Michigan are being cut 30 
percent below last year's levels and below homeland security 
levels. A 96 percent cut in the COPS program, which has put 
over 3,500 new officers on the streets in Michigan. I could go 
on.
    I would just suggest to you, that does not meet the 
priorities of the Nation.
    The final thing I would say is that we look at a number of 
areas of research and development, the manufacturing extension 
partnership for small and medium-sized manufacturers which 
gives them the technology and the support to be able to compete 
in the global economy; dramatically cutting that back. It is 
about jobs. It is about loss of profit. It is about inability 
to compete. It is penny-wise and pound-foolish, and I would 
suggest does not meet the priorities of the Nation.
    One question though on Social Security. There is a lot of 
confusion about what has been called the clawback provision; a 
very lovely title. The clawback provision basically really goes 
to the question of what happens when people put money into the 
privatized accounts. We frequently hear about, it is your money 
and it is your money whether it is payment into an insurance 
system in Social Security, 100 percent funded by all of us 
working, or whether it is the privatized accounts.
    But is it not true that at this point from what we are 
hearing from briefings, from reports and so on, that workers 
who choose privatized accounts would have to pay a portion of 
those accounts back in terms of their retirement? In other 
words, get less in traditional benefits. Some estimate that 
this provision, which is also being called a retirement tax, 
could be between 70 and 100 percent of the value of the 
person's privatized account.
    For example, if someone set up a private account and it 
grew only 3 percent above inflation, the net effect would be 
that all of his or her privatized account earnings would be 
taken away in benefit cuts. Is that not correct?
    Mr. Bolten. I do not believe so, Senator, but I think you 
have to look at whatever the Social Security plan is in its 
totality. What I do know about the personal accounts that the 
President has talked about is that his intention is that people 
be able to keep all of what they invest in those accounts and 
realize all of the returns which, over any historical measure, 
are likely to be far better than what they can get in the 
public sector.
    But may I take a moment on your point on priorities? 
Because you listed a lot of programs, and you listed a lot of 
tough cuts. But that is what this budgeting is about. If we are 
going to get control of our spending situation, we do have to 
set some priorities and take down the numbers in a lot of 
programs that are very popular all over the country, and that 
includes some of the grants that you talked about. What we need 
to focus on is making sure that our grants go toward actually 
improving homeland security. It would be----
    Senator Stabenow. Mr Bolten, since my time is up I am going 
to just ask--I apologize for cutting you off because I assume I 
am going to be cutoff here in a moment to move on to other 
colleagues. I want to talk to you more about what the reality 
of these privatized accounts is at some later point, but let me 
just suggest this.
    We all know that we could eliminate the entire non-defense, 
non-homeland security, domestic budget and not solve this 
year's deficit. We are talking about focusing on small 
investments with huge impacts in terms of safety, and security, 
and education, and research, and supporting our veterans, and 
yet we have no discussion of the larger issues that have been 
raised by my colleagues in terms of the tax plan and where 
revenues go versus what we are asking of our veterans to pay 
for prescription drugs, or what we invest to keep people safe. 
I would just suggest that this does not reflect our priorities, 
nor does it reflect a true budget and I would hope that we 
could do better.
    Thank you.
    Chairman Gregg. Senator Sessions.
    Senator Sessions. Thank you, Mr. Chairman.
    I believe that first chart or two that you had there showed 
revenue coming into the Government. If you could find that and 
put that up, I would appreciate it. We have had an increase in 
revenue and one reason I believe, Mr. Bolten, is that we have 
created a tax system that really focuses on the affluent. The 
income tax is heavily skewed to the affluent, and it seems to 
me that it is a reality all of us need to consider that when 
the economy goes down and the affluent, who have been making 
high incomes and paying 35, 39 percent tax on that, do not pay 
it. If the stock market goes down and they sell stocks, they 
take losses instead of gains, and maybe their investments do 
not pan out as well and they just do not pay as much in taxes.
    That shows to me a little bit of a confirmation of that 
thought I have had for some time. Are you concerned that that 
is a problem for us in the way we collect taxes in terms of our 
ability to predict each year what the revenue will be?
    Mr. Bolten. I certainly agree with the description of the 
problem which is that we had surpluses, or we thought we had 
surpluses at the end of the last decade because the Federal 
Government was receiving huge revenues in large part from a 
stock market bubble. When that bubble burst and wealthy people, 
instead of paying large capital gains, had capital losses, 
revenue dropped off a cliff for this Government. I think what 
you see reflected up here is that in the first 3 years of this 
Administration, as a result largely of that situation that the 
President encountered on entering office of a burst stock 
market bubble, a recession, then the 9/11 attacks, for the 
first time since the 1920's the Federal Government experienced 
actually declining revenues for three straight years in a row.
    Now you and the President put in place some very effective 
tax cuts that helped restore economic growth----
    Senator Sessions. Those tax cuts, according to conventional 
liberal wisdom would result in reduced revenue to the 
Government, would it not? We cut taxes. Why don't revenues go 
down?
    Mr. Bolten. What this reflects is that revenues are coming 
back strongly. After this 3-year actual decline in revenues, we 
now have revenues coming back strongly, $100 billion last year; 
and we project more than that for this year. It is because we 
have a strongly growing economy. That is the most important 
fiscal tool we have. There is nothing else in the toolbox that 
comes close to a vigorously growing economy to determine 
whether we are in a good fiscal situation.
    Senator Sessions. I do not mean to totally argue with my 
colleagues here, but I do think that growth in the economy has 
resulted in increased revenue even though we have a lower tax 
rate.
    With regard to how we got into some of this and the 
spending that we incurred. I remember the last year of the 
Clinton Administration, the increase in appropriations that 
year was 15 percent. I do not know how that all happened, but 
it happened, and I think a lot of us regret that we 
participated in such a large growth rate. If we contain 
spending I think we have a way to work through this.
    I am concerned, as several have expressed, the prescription 
drug bill. We went from zero on prescription drugs under 
Medicare basically to a very substantial commitment to increase 
that. We did not, I do not believe, any of us think that we 
were doing an open-ended program that would grow completely out 
of control. I think we may need legislation. I think we may 
need tough regulations from the Administration. But I believe 
there is a commitment here to contain Medicare prescription 
drug spending to the $400 billion over the first 10 years, as 
you noted. We all knew it was going to go up over years two 
through 12; it would be higher. But not that much higher.
    So do we have any interest on the part of the 
Administration in trying to be faithful to the basic commitment 
that we had when we passed this bill to see that this 
prescription drug program not get out of control?
    Mr. Bolten. Sure we do, Senator, and we would be glad to 
work with you on whatever cost control measures you are 
interested in pursuing.
    Senator Session. I would just ask, Mr. Chairman, that I 
submit a written question about Medicaid and the impact on the 
States. I am very concerned about that.
    Chairman Gregg. Thank you.
    Senator Sarbanes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Senator Domenici. Senator Sarbanes, I wonder if you would 
yield for an observation.
    Senator Sarbanes. Not out of my time, but otherwise, yes.
    Senator Domenici. I want to say, Mr. Chairman, as chairman 
of the Energy and Natural Resources Committee I have a markup 
of 10 or 15 bills for Senators that have to be voted out. It 
takes a very little bit of time, and I do want to come back, if 
I can. If you are finished, then you are finished. But could I 
just say, first I would compliment you----
    Senator Sarbanes. Mr. Chairman, I will yield my time to 
Senator Domenici. He can get his questioning in and then go to 
the markup and he will not have that problem.
    Chairman Gregg. That is very generous of you, Senator 
Sarbanes. Then we will come back to you.
    Senator Domenici. That is very good. Thank you, Senator.
    Chairman Gregg. Very nice of you, Senator Sarbanes. Thank 
you.
    Senator Domenici. First, let me say I congratulate you on 
your efforts. Considering the things that nobody wants to touch 
around here, which are entitlements, and in particular, health 
care, which sooner or later we are going to have to realize we 
cannot afford what we are trying to do in health care. I do not 
ask you to comment. I do not want you to commit to that 
terrible proposition. But it is obvious we cannot pay for the 
entitlements that we have over time if we want a growing 
economy and low inflation, which are the really cornerstones of 
America's prosperity. That is my absolute conviction. I do not 
think we have done much about that.
    But for those who say we should, it is very interesting. 
You are trying to do something with Social Security. They 
suggest you should do Medicare. If you had tried Medicare they 
would all be saying, why don't you do Social Security? Or, we 
cannot cut Medicare. So at least you took one of them on and 
you are going try.
    I have two observations for you and I really urge you to 
think about it and urge that you tell the President about it. 
You have some things in this budget that say we ought to make 
changes. We ought to get rid of some programs. There is no 
question, three-quarters of those programs that you want to cut 
are just not needed. They are duplicative. There are four or 
five of them doing the same thing. But you know what happens? 
We do not do them because we do not have an easy way. We cannot 
do them. There is no way to authorize their death, so it is all 
up to appropriators.
    I submit that you have to do more to see, and force, and 
insist that Congress do what you have asked for. Now that is 
not easy. I never hear the Administration say, this 
appropriation bill did not cut the 10 programs that we asked 
for. Have you ever done that as a budget director? I do not 
think so. How are we going to get them? It is your program. So 
I urge that you do that.
    My last one has to do with energy. I note the President's 
speech to the Detroit Growth Club, or whatever it is, on 
energy. I also want to tell you, again, that he got the 
greatest applause, according to the report, when he said we 
have to do something about nuclear power. Thank you and thank 
him for proceeding with it. We are going to try. I hope you 
help us.
    My last question is ANWR. Now there is some rumbling around 
that the Administration may not be for pushing ANWR to the 
maximum. It is in your budget by way of expected revenues, 
right?
    Mr. Bolten. Yes, it is.
    Senator Domenici. Now you intend for us to try to do that, 
do you not?
    Mr. Bolten. Yes, we do, Senator.
    Senator Domenici. So you support doing whatever we can do 
that is legitimate up here and consistent with our processes to 
get ANWR done, right?
    Mr. Bolten. Only legitimate activity, yes, sir.
    Senator Domenici. Of course. I do not mean illegitimate in 
that sense, but that are consistent with our rules.
    Mr. Bolten. Yes, sir.
    Senator Domenici. Whatever we can do you would ask us to 
do. You would have no objection if we put ANWR in our budget as 
an item that we should mandate, do you?
    Mr. Bolten. I do not expect we would, Senator.
    Senator Domenici. Now my last point is way, way out in left 
field. Would you support, as a reform measure, 2-year budgeting 
and 2-year appropriating? I look around here and I do not know 
how you can get your agenda down because we cannot get our work 
done. It seems to me we ought to try to do something different. 
What do you think about that?
    Mr. Bolten. It is an interesting concept. The President 
actually talked about that in the 2000 campaign and we have 
carried it before in our budgets. It did not attract a lot of 
interest up here in the Congress, but I would be interested in 
opening the dialog on it because I think it would provide an 
opportunity for us to focus 1 year on the numbers and the 
appropriating and another year on the implementation.
    Senator Domenici. Now my last issue has to do--I have been 
watching people who either do not like the President--it seems 
there is a large group of people that even though he has been 
elected seem to want to get on and express their extreme 
dislike for him, and when it gets to the budget they do that, 
and they really criticize you for not putting the 1-year 
appropriation supplemental for defense in this budget. Could 
you just tell us, since there are a few people watching, in 
very simple language, why shouldn't you put that in the budget 
in terms of this 5-year budget?
    Mr. Bolten. As a budget director, it is very important to 
me that we not include one-time, extraordinary war costs in a 
budget because if you put it in the basic budget it ends up in 
the base and you never get rid of it. It just grows from there.
    So we are restoring our underlying military strength 
through progressive increases in the base defense budget. But 
when we have an extraordinary episode, like a war, we need to 
fund that separately. We try to show those costs as 
transparently as we possibly can, including the supplemental 
request that you will be receiving shortly. But I think as a 
budgeting matter it is very important that we not let these 
things float into the base because then I think we will have 
been fiscally irresponsible in not preventing those costs from 
being permanently in the defense base.
    Senator Domenici. So a way of saying it is if you put these 
costs in the budget and they are supposed to be one time 
expenditures, Congress could in fact expect them to be in 
beyond that time and plan their spending, to include the 
spending as if it were in there permanently, so you keep it 
out.
    Mr. Bolten. Senator, I fear that not just Congress but a 
lot of other people who are interested would assume that we 
would be doing that spending in perpetuity.
    Senator Domenici. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator Domenici. And thank you, 
Senator Sarbanes, for allowing Senator Domenici to go. Which 
means that after Senator Sarbanes, Senator Wyden would be next.
    Senator Sarbanes. Mr. Bolten, I have been listening to you 
with great interest this morning and I was really struck by the 
feeling that the qualities that are needed nowadays to be a 
good OMB director, at least as you all are doing the business, 
are those of a magician. I just want to put that out at the 
outset.
    Now let me ask you a couple of questions. You said earlier, 
as I understood it, that it has always been the case that the 
Social Security surplus has been used to pay for other 
programs; is that correct?
    Mr. Bolten. I believe it has, but there have been periods 
when the surplus has actually been paid down. So I think there 
was a brief period in the 1990's when the money went the other 
way, when the Government was actually in surplus.
    Senator Sarbanes. That was not your answer. That is an 
elaboration on your answer. That was not how I understood it at 
the time. You said it was always the case, and I would just 
refer you to your own budget document which shows that in both 
1999 and 2000 we had an on-budget surplus.
    Mr. Bolten. Correct.
    Senator Sarbanes. So we were not using the Social Security 
surplus to pay for other programs, correct?
    Mr. Bolten. Yes, that is correct, in those years when the 
Government was running a surplus.
    Senator Sarbanes. I just want to get things clarified and I 
want to make sure we at least try to see if we cannot get some 
agreement on what the facts are.
    Second, you just talked about a 2-year budget, but I 
understand that in the budget you have just submitted there is 
a major departure in that with respect to projections of 
discretionary domestic spending you provided only 1 year; is 
that correct? In the past we haveten either five or 10-year 
projections, depending on whether we were getting a five or 10-
year budget; is that correct?
    Mr. Bolten. We have now, for the last couple of years and 
for many years before that, been doing 5-year budget 
projections. But I think what you are referring to is that we 
are, providing less detailed account by account information in 
future year discretionary expected expenditures.
    Senator Sarbanes. There was a departure in the budget you 
submitted this year from past practice, so you are not giving 
us the projections out beyond just this year, correct?
    Mr. Bolten. We are giving the projections in broader 
categories than we have in the past, and if you will give me a 
moment to explain why.
    Senator Sarbanes. Would you say it is fair to say it is 
substantially different from the past?
    Mr. Bolten. It is different, and the reason why----
    Senator Sarbanes. That is all I want to know.
    Now let me ask the next question. What is the 10-year cost 
of making the President's tax cuts permanent?
    Mr. Bolten. I do not have that figure off the top of my 
head.
    Senator Sarbanes. Let me try to help you. I have a 
wonderful chart here of Senator Conrad's.
    If you do your 5-year budget, which you are now doing, this 
is what you show on the cost of the tax cuts. But if we do a 
10-year projection of the cost of the tax cuts, look what 
happens. I think the word up there is ``explodes.'' You get a 
1.6 trillion dollar 10-year cost of the Bush tax cuts. Do you 
quarrel with that figure?
    Mr. Bolten. I think I do, although I am told that what we 
are carrying in the budget is $1.1 trillion. But what I would 
point out is----
    Senator Sarbanes. Let us do 1.1 trillion. Take that point 
and proceed on that one. There is a 1.1 trillion dollar cost 
for the tax cuts, you say?
    Mr. Bolten. Correct, the extension of the President's, of 
the existing tax cuts above the current baseline.
    Senator Sarbanes. Does that include the interest cost on 
the debt from those tax cuts?
    Mr. Bolten. It does not.
    Senator Sarbanes. No. It would be $1.4 trillion roughly if 
that were included?
    Mr. Bolten. I do not know, but that would be a substantial 
increment.
    Senator Sarbanes. Why do you not submit that for the 
record?
    Mr. Bolten. Be glad to.

    [GRAPHIC] [TIFF OMITTED] T1173.355
    

    Senator Sarbanes. Let me ask you this question. I gather 
you have cut first responders in this budget by about $1.6 
billion from the 2005 level, correct? That is fire and police, 
first responders.
    Mr. Bolten. There are reductions in a number of first 
responder grants, but what we are also increasing on the other 
side many of the grants that do not just go out by formula to a 
lot of first responders but are focused on the highest priority 
homeland security needs. This is what I was trying to get at 
with Senator Stabenow, which is that we have tough choices to 
make in the budget, and that is one of the things that we are 
trying to do with the allocation----
    Senator Sarbanes. You do indeed have tough choices, and 
that is the next point I want to make. This is what we figure 
the cut is to the first responders, 1.6 billion dollars. Now, 
this big column over here is the cost of the Bush tax cut in 
2006 for those making over a million dollars, just the 
millionaires. The cost of the tax cut they received, $32 
billion. What that tells me is if you would just reclaim 5 
percent of that wonderful tax cut, 5 percent only, you could 
fund the first responders. Now, that is priorities. You just 
said to Senator Stabenow, this is all about priorities, and you 
have just told me the same thing. It is certainly all about 
priorities, and there they are. There are the priorities, this 
excessive tax cut for people making over a million, and we are 
cutting the first responders, the fire fighters and the police 
all across the country.
    I welcome the formulation because I think it is important 
to focus on the priorities question, and the priorities 
question encompasses, in my view, the tax cuts that have been 
given and who benefits from them, compared with who is impacted 
and hurt by the spending cuts you are making in this budget.
    Thank you very much, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Wyden.
    Senator Wyden. Thank you. Mr. Chairman, I have always 
enjoyed working with Mr. Bolten, and he has always been 
interested in bipartisan approaches and that is what I want to 
ask about today as it relates to containing the cost in the 
Medicare prescription drug benefit.
    I think people look at this program, and at a time when 
Senators on both sides of the aisle are up in arms about the 
costs of the program. People look at the program and are just 
mystified as to why Medicare is not using the cost containment 
strategies that are used in the private sector of our country. 
I have talked with Chairman Gregg about this in the past, but I 
think it is fair to say, colleagues, that what Medicare is 
doing as it relates to prescription drugs, is essentially the 
equivalent of a guy standing in the Price Club and buying one 
roll of toilet paper at a time. The program is not using the 
common sense cost containment strategies that are used every 
day at Goldman Sachs, at timber companies, auto companies and 
the like.
    Now, there is a bipartisan bill that will let us change 
this, and this is something I want to talk with Chairman Gregg 
and Senator Conrad about because I have introduced this with 
Senator Snowe, Senator McCain, and Senator Feingold, my 
colleague on this committee. It is bipartisan, and allows us to 
say, at a time when the costs of this program are going through 
the stratosphere, that we are going to use not some cost 
control regime run out of Washington, but private sector 
bargaining power to control the costs of the program. I mean I 
do not know of anybody on the planet, Josh--I am going to call 
you that, we have been known each other a long time--who, when 
they are buying something in volume and they are going to buy 
some more of it in volume, does not say, ``Hey, pal, how about 
a discount? Let us negotiate.''
    So I would like to work with you on it. We have senior 
Republicans on the Finance Committee, Senator Snowe, Senator 
McCain, not on the committee but very influential in the health 
debate, myself, Senator Feingold, my seat mate here. Can we 
not, at a time when the costs of this program are going through 
the stratosphere, instead of spending our time wrangling about 
the numbers--I mean I happen to share Senator Conrad's view 
about it and Senator Sarbanes--but here we have a chance to do 
something bipartisan that we can do now to rein in the costs. 
It is not just the program. We have seen that already the last 
few days. I mean Lipitor has gone up 5 percent just in the last 
few weeks, the big cholesterol-fighting drug. Would it not make 
sense--the number of the bill, in case you want to send us an 
endorsement letter quickly, is S. 239, Snowe, Wyden, McCain, 
Feingold and the like. Can we not work together on something 
like that, to start reining in these costs?
    Mr. Bolten. Senator, you know I am all about cost 
containment, so we are glad to talk with you about any 
proposals that you have. I know Secretary Leavitt will be 
interested in engaging with you.
    Senator Wyden. So you are open then, Mr. Bolten, to the 
idea of lifting the restriction? Right now there is in the law 
a statutory ban that prohibits the kind of cost containment 
strategy that goes on every day, Goldman Sachs, Weyerhauser, 
goes on every day in America. I have talked to the chairman 
about this. It just defies common sense when everybody else in 
America sits down to buy something they try to get a bargain, 
they try to get something for it. I would be satisfied today if 
you would say that you are willing to look at lifting the ban 
that is now in the law so as to allow us to have private sector 
cost containment strategies.
    Mr. Bolten. I am going to leave it, Senator, to Secretary 
Leavitt to do the actual negotiating with you on this. I do 
know that the administration has looked at what I think you are 
referring to, and has relied on CBO and some other estimates 
that have concluded that the price negotiations would not 
produce substantial savings to the system, but as the Budget 
Director, if there are any savings to be captured, I of course 
do not want to preclude ever having that conversation. My 
telephone line is always open as you know.
    Senator Wyden. First of all, they actually sent us a 
revision of that original one and pointed out a situation in 
particular, sole source drugs, were cost savings, but this is 
just common sense. I mean, again, it would be one thing if 
somebody was talking about price controls and having a one-
size-fits-all, run from Washington, D.C. kind of program.
    I will give you an example.
    Chairman Gregg. Senator, we are going to have to----
    Senator Wyden. Can I just finish my thought on this?
    Chairman Gregg. Of course, yes.
    Senator Wyden. I appreciate it because we represent a lot 
of rural communities. In a lot of rural communities there is 
going to be a fall-back plan, so we will have maybe 1,000 
seniors in rural Oregon or New Hampshire, for example, that 
will have no bargaining power whatsoever to control the costs 
down. So what Senator Snowe and I want to do is let those 
seniors in those communities where there is absolutely no 
leverage whatsoever to hold down the cost of medicine, to be 
able to pool their power, which everybody does in the 
marketplace. S. 239, hope we can work together on it.
    Thank you for the extra time, Mr. Chairman.
    Chairman Gregg. Senator Ensign?
    Senator Ensign. Thank you, Mr. Chairman. I want to comment 
quickly on the first responders, and tell you shame on your for 
trying to eliminate pork. In a lot of these cases, in parts of 
my State, in parts of States all over this country, that is 
exactly what a lot of these grants have become. They are not 
related to terrorism. They are not related to homeland 
security. Every little community wants something, they want a 
new fire truck, they want a new this and that. They may be 
meritorious but they are certainly not related to national 
security. So I applaud you for that and I think that that 
needed to be pointed out.
    Mr. Bolten. Thank you, Senator.
    Senator Ensign. There are a couple other things that I want 
to mention about the budget. First of all, you had to provide 
details to make sure that the number, the top line number that 
you have is legitimate. That is the reason that you have to put 
in details. We will disagree sometimes on policy, and you know 
some of my disagreements with you. We may disagree on specifics 
but I think the bottom line is that we all agree that we have 
to get deficits under control.
    The major disappointment that I have with this budget is 
that I do not think it goes far enough on controlling some of 
the entitlements. I would have liked to have seen a much bolder 
proposal on health care reforms from the administration. I know 
the administration does not want to re-open up debates on the 
new prescription drug program yet. We are going to work with 
the new Medicare reform law, but I think that there are serious 
problems. I thought there were serious problems with the bill. 
I thought there were some really good things in it but there 
were no real cost controls, especially for lower-income 
seniors. The copays I believe were too low, and that is going 
to have to be reviewed. You just raised copays for some 
veterans and it is something that I think we are going to have 
to look at, for Medicaid, for Medicare and the like.
    But an overall bold health care proposal, some of the 
things that Senator Enzi and others of us are working on, can 
save not only Medicare and Medicaid but the whole health 
insurance system by bringing down costs. Obviously, medical 
liability reform is very important. Putting in the electronic 
medical records and going to best practices are as well. The 
reason it is important for Medicare and Medicaid to adopt these 
measures is because the insurance industry and the companies 
that are out there financing health care, will follow Medicare 
and Medicaid's lead. We will have significant savings if we 
adopt some of these reforms. That does not even go to 
preventative medicine, which I believe in the long run is going 
to save us a lot of money as well.
    Just disappointment there, but I understand you are not a 
policymaker in that regard. I wish the administration would 
have been a little bolder in some of the things that they did 
with respect to health care. I believe this long-term liability 
is a bigger problem, for our country than even Social Security. 
Which takes me to my next point: Social Security.
    First of all, Senator Stabenow mentioned private accounts. 
Let us get it straight once and for all, these are not private 
accounts. This is not privatizing Social Security. They are 
similar to what we have in the Thrift Savings Plan. All Federal 
employees including Members of Congress and Senators, can 
participate in the Thrift Savings Plan. The plan is tightly 
regulated by the Government. It is not just my own personal 
Charles Schwab account that I can go out and do with whatever I 
want. It is very tightly regulated.
    I was just talking with someone who was down in Chile when 
they did this back in 1980. Chile transitioned much faster than 
we are talking about transitioning. Of all of the index funds 
that they have, not a single one of them since 1980 has ever 
lost money. They get a better rate of return. Even if you look 
at the public employee retirement systems that we have for our 
State employees across this country, they get a better rate of 
return. In my State of Nevada, since its inception, FERS has 
averaged an 11 percent return on their money over a 25-year 
period of time. That is not too shabby. Even if you take 
conservative numbers, 5 or 6 percent, that is a lot better than 
what a younger worker will get back under Social Security. 
Younger workers can expect a negative return on their money 
under Social Security. Even if you are optimistic and give them 
a 1.6 percent return it is nowhere near 5 percent.
    So looking at the long-term liabilities, and I think that 
Senator Crapo addressed this with you, that long-term liability 
offsetting, should be the bottom line. Let us ask what does the 
individual get? If the individual is getting more money, they 
are not getting cut. Whether it is from a private account or 
the traditional way that we pay out Social Security benefits. 
The bottom line is if the money is there, they are getting more 
money for it, that is a pretty good deal for the younger 
workers. That is why younger people in the United States are 
really excited about this. We protect older workers, put it in 
there, and I think that it can be a very good thing.
    Would you care to address any of those things that I 
mentioned? I just wanted to make some of these comments. You 
can feel free to comment on any of the things I just mentioned.
    Mr. Bolten. Thank you, Senator. I cannot improve on any of 
that.
    [Laughter.]
    Senator Ensign. Thank you.
    Chairman Gregg. Excellent questions.
    [Laughter.]
    Senator Ensign. I would like to find out more about one of 
the things that the Director talked about at the beginning. I 
think would be important for all of us to understand how the 
PART program works when trying to evaluate whether programs are 
working or not. I would like to find out how that works. So if 
you could get us that and the type of metrics that you are 
using. I do not think that Congress is using very good metrics 
in a lot of the things that we are doing. If a program is not 
measuring up, we need to find out. To do that we need to find 
out how we are measuring, and not just the number of people 
going through. For example with a jobs program, are people just 
going through the program or are they actually getting jobs? I 
would appreciate the opportunity to learn more.
    Mr. Bolten. We would be grateful for a chance to brief you 
in detail and appreciate your interest in it, Senator. Thank 
you.
    Chairman Gregg. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I was sort of 
amused by Senator Sarbanes' chart up there. I do not think it 
is entirely accurate. But I think what it does point out is 
that if we let these temporary taxes expire it will result in 
the largest tax increase in the history of this country. I just 
bring up the tax issue, and it seems to me that it has had a 
positive impact on the economy. We have heard millionaires sort 
of referred to, but you know, the small business sector, a lot 
of them have their value, farmers and ranchers have value that 
puts them over in the millionaire bracket, and they are the 
producers, but certainly they are the drivers of this economy, 
and I would like to have you just comment a little bit about 
what you have seen happen with the tax cuts and how it has 
motivated Americans to produce and how it has helped to sustain 
our economy.
    Mr. Bolten. Senator, the Council of Economic Advisers at 
the White House and the Treasury Department did a study about 
the effects of the tax cut, and they concluded that we today, 
or last year rather, had 3 million more jobs and 3-1/2 
percentage points higher gross domestic product than we 
otherwise would have without those tax cuts. The first charts I 
put up during my presentation were charts about economic growth 
in this country and Federal revenues, which is my 
preoccupation, and I do not believe we would have had that 
strong economic growth in this country, and I certainly do not 
believe we would have had the resurgence of Federal revenues 
absent the strong economic growth that I believe is in large 
part a product of those very effective tax cuts.
    Senator Allard. How would you attribute Government spending 
to economic growth, think that helps any?
    Mr. Bolten. Most economists will tell you that Government 
spending, and particularly Government borrowing, is not as 
useful as money in the private sector, that when we borrow to 
spend more, that tends to be a net dissavings nationally for 
the economy. If I can just detour for a second into Social 
Security and point out one of the things I mentioned in my 
statement that we have not discussed much here, is that the 
creation of personal accounts, while it may require some 
additional Federal borrowing in the short run, does not have 
that same dissavings effect. It is neutral with respect to 
national savings because the money is being borrowed by the 
Federal Government to go into personal accounts which are 
savings.
    So it is very important that we restrain our Federal 
spending appetite to promote economic growth, but if people are 
concerned about the economic effect of creating these personal 
accounts, that is very different from additional borrowing to 
spend. The borrowing to create the personal accounts I think is 
in the long run actually a very good thing for this economy.
    Senator Allard. My time is starting to run out. One thing I 
did want to bring up is this, I think you have referred to it 
as PART. That is Program Assessment Rating and Priority Tool, 
and you use what we refer to as the GPRA, Government Procedures 
and Results Act to come up with a test. Can you kind of lay out 
a little bit how you used this assessment tool to decide which 
programs are performing and which re not, and maybe use some 
specific examples if you are prepared to do that?
    Mr. Bolten. Sure. The Program Assessment Rating Tool asks 
about 25 different questions. What we are trying to do is 
assess whether the programs on which we are spending money have 
clear goals, are they real Federal priorities, is the program 
being properly managed, and do we have metrics that make it 
possible for us to assess whether that program is actually 
performing. Then we do a review, using metrics, to ask, is the 
program actually performing? So we try to bring all those 
questions together in a relatively comprehensive and consistent 
way so we can compare programs, many of which have the same 
purpose, but do not necessarily have the same effect or the 
same kind of PART rating. As we put the budget together, one 
question we have asked consistently and are asking more and 
more as we put the budget together is, what is the PART rating 
on the program? Those ratings are and will be available to you 
as you make your own budgeting decisions, and you will see that 
many of the programs that the administration is proposing for 
reduction or elimination are programs with very poor PART 
ratings.
    Senator Allard. Are those ratings in the budget that was 
sent up to the Hill here?
    Mr. Bolten. I am not sure exactly which document the PART 
ratings appear in. It is in the document called Analytical 
Perspectives that you will see the actual PART ratings of the 
programs, but we are glad to provide additional detail on all 
of the programs that we have proposed for reduction or 
elimination, and you will see that many of them are based on 
poor PART ratings for those programs.
    Senator Allard. Thank you.
    Mr. Bolten. Thank you, Senator.
    Chairman Gregg. We appreciate your time, Director. There 
are only three of us left here, and I suspect that Senator 
Conrad and Senator Sarbanes may have a followup question. Am I 
right?
    [Laughter.]
    Chairman Gregg. But we are going to have a vote here, so we 
will limit those followup questions to 5 minutes too, and 
essentially the members here, those are the members who will 
ask the questions, and I will begin.
    I want to get back to this issue of tax policy because I 
look at these suggestions from the other side of the aisle, and 
basically what they are saying is, ``Well, we just have to 
raise taxes to address the deficit.'' Of course they also 
suggest spending money with the taxes they raise. And in fact, 
I had a chance to study some of the proposals of the nominee of 
the Democratic Party on this point, and he suggested that all 
you had to do was raise the taxes on the top 2 percent of 
American wage earners or top 10 percent of American wage 
earners, income brackets, not wage earners. And as a result, 
you would raise X billions of dollars. Then his proposals came 
forward, and he spent that plus another trillion dollars. So 
the debt would have actually increased by about a trillion 
dollars under the net effect of his proposals. So I guess we 
await the other side's budget and we will look forward to their 
proposals and tax increases and their belief that the American 
taxpayer is under taxed.
    But there is also the economic impact. We were confronted 
with two rather serious events when this President became 
President. First was a recession which came out of the largest 
bubble in American history, probably the largest bubble in 
world history, even bigger than the South Seas Bubble or the 
Tulip Bubble for all intents and purposes. But we could have 
expected as a result of that bubble that we would have had an 
extremely severe recession, but we did not. One of the primary 
reasons we did not, I believe, was because we cut taxes at the 
beginning of the recession, which is classic economic reaction 
to recession, reduce taxes, give people more money to spend, 
create more economic activity, create more productivity in the 
marketplace, and it translated into a shallowing out of the 
recession, which is in turn, as we are now seeing, generating 
more revenue. You had a very interesting chart there that 
showed our revenues are now going up rather dramatically, 
projected to be 9.2 percent this year, 6.5 percent next year, 7 
percent projected for the next year. Those are huge increases 
and jumps in revenue. We are headed back to what is basically 
the historical revenue of the Federal Government, which will be 
about 17.9 percent of gross national product with the present 
tax structure.
    So I guess my question to you is if you were to throw a new 
tax increase on top of this fledgling economy that is growing, 
this fledgling recovery that we are in, which is becoming 
fairly robust, would you not expect that that would have a 
fairly significant dampening effect on our economy, create job 
loss, probably in the end reduce revenues because you would see 
reduced economic activity potentially, or certainly slow the 
rate of growth of revenues?
    Mr. Bolten. Senator, I am in complete agreement. Our 
economists believe that a tax increase at this point would be 
very detrimental to the strong and stable growth that we are 
projecting out into the future. For our fiscal position, for 
the positive movement in our deficit picture, the most 
important thing, the most important element for ensuring that 
we continue to bring that deficit down is that we realize those 
relatively strong and stable growth numbers in gross domestic 
product the you see projected in our budget.
    We are projecting growth in the mid 3 to low 3 percent 
range out over the next 5 years, which is entirely consistent 
with blue chip expectations. We would not be able to project 
that growth if in fact we had a substantial tax increase which 
our economists believe would dig heavily into the economic 
growth, and as a result, dig heavily into the kinds of revenues 
we could expect to receive in the Federal Treasury.
    Chairman Gregg. I do not want to cut you short but I am 
running out of time here. The one major tax that needs to be 
extended, or one of the major taxes, but the one with the 
biggest number in this 5-year window--and I accept the argument 
that when you get outside the 5-years you have the rate issue 
and you have the death tax issue, but that does not have to be 
addressed this year. The tax that probably has to be addressed 
this year is the capital gains and dividends extension. Am I 
not right, but did not Microsoft just pay out a massive 
dividend of something like $32 billion, which actually 
increased Americans incomes significantly. It was a staggering 
event. Was that not almost purely a function of the fact that 
we cut the dividend rate back to 15 percent?
    Mr. Bolten. I believe it was, Senator, and there was an 
associated increase in gross domestic product as a result of 
that one-time event. I think it was .1 or .2 percent of GDP 
that was associated with Microsoft paying that one dividend 
which I believe was substantially the product of the dividend 
tax cut that you put into the law a couple of years ago.
    Chairman Gregg. So we do need to extend that.
    Mr. Bolten. I think we do need to extend it. It expires in 
2008, so within this budget window, and the cost of extending 
that is fully reflected in our budget proposals.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman. I am really glad 
you started this debate on economics, basic economics. This is 
where we really do have a disagreement about history and what 
happened.
    This is what CBO told us was the range of possible outcomes 
for deficits back in 2001 when the administration came in and 
had a projection of budget surpluses of 5.6 trillion dollars. 
CBO said this was the possible range of outcomes of budget 
deficits. Yes, pre-9/11, this was the range of possible 
outcomes. You know, the CBO and the administration took the 
midline. That is what led them to believe there were going to 
be all these surpluses. I warned at the time betting on this 
was most unwise.
    Look at where we came out in terms of the deficits. I tell 
you, my colleagues on the other side of the aisle, let us 
revisit history. They told me at the time, ``Kent, you are way 
too conservative. It is not going to be the midline because 
that does not take account of the tax cuts we are going to put 
in. The tax cuts are going to unleash this massive increase in 
revenue. The deficits are not going to be there at all.'' I had 
colleague after colleague on this side of the aisle tell me, 
``Kent, there is going to be way more money.''
    Well, look what happened in the real world. Not a lot more 
money, a lot less money, the biggest deficits we have ever 
seen.
    Let us have a history lesson what happened with economics 
in the real world, not in some ivory tower world, in the real 
world. Back in the 1990's President Clinton came into office. 
Here is where outlays were as a percentage of national income. 
Here is where the revenue was, had an enormous gap, had record 
budget deficits then, only eclipsed by the deficits we have 
now. And we put in a plan that reduced the outlays each and 
every year of the 5-year plan, raised revenue, which according 
to what you have just said should have tanked the economy. What 
happened in the real world? Did the economy tank? No.
    We had the longest period of economic growth in our 
Nation's history. We had the lowest inflation in 30 years. We 
had the lowest unemployment in 30 years. We had the highest 
period of business investment in the Nation's history. That is 
with reducing spending and increasing revenues and eliminating 
deficits and eliminating the growth of debt, and stopping, 
which you acknowledged yourself earlier in your testimony, 
stopping for 2 years the raiding of Social Security Trust Funds 
to pay for other things, which would have meant, if that 
pattern had been continued, we could really have strengthened 
Social Security by prepaying the liability or paying down the 
debt.
    But those are not the choices that have been made now. 
Instead here is what happened to spending. We had a tick up, 
still well below the levels of the 1980's and 1990's. We had a 
tick up for three primary reasons: defense, homeland security, 
rebuilding New York, 91 percent of the increase.
    Look what happened to the revenue. The revenue collapsed. 
And you never mentioned the effect of the tax cuts on the 
revenue collapsing. That is half the reason for this collapse. 
The other is the economic weakness.
    But look where we are. Even with your forecast of where 
things head in the future with pretty strong economic growth, 
we have an enormous gap between the spending you advocate and 
the revenue you advocate. You have deficits that go on forever. 
Some of us believe that puts our economic strength at risk, 
that that hurts us, that that will inevitably threaten the 
United States' position of economic strength in the world. You 
cannot borrow your way to strength.
    One other point I would want to make, I have a few seconds 
here. Our colleague from Nevada--I wish he was still here--said 
something that really struck me. He said you never lose money 
in these TSP like accounts. Whoa. I tell you, I have a lot of 
people on my staff are going to be surprised by that, because 
if they started in 2000 they have not made money. I tell you, I 
lost a lot of money in the TSP account, a lot of money, and so 
have a lot of other people.
    When he said this is all pork that is being cut, look, we 
have to have cuts, but this is a matter of choices. When you 
cut the COPS program 96 percent, you are cutting a lot more 
than pork. That put 100,000 police on the street. When you cut 
the firefighters 30 percent, that is more than pork. I had the 
Republican Attorney General of my State come to me, Republican 
Attorney General, on the question of Byrne grants for law 
enforcement. I said to him, ``You know, the claim will be it is 
pork. Is it pork?'' He said, ``Absolutely not. Those Byrne 
grants are essential to our war on illegal drug use, especially 
methamphetamines.''
    Well, I have exceeded my time, Mr. Chairman.
    Chairman Gregg. Thank you.
    Senator Sarbanes, for the last 5 minutes.
    Senator Sarbanes. Thank you very much, Mr. Chairman.
    Director Bolten, do you think that the increase in defense 
spending and the increase in homeland security spending 
contributed to the increase in economic growth in terms of 
stimulating the economy?
    Mr. Bolten. I suppose they may have, but money spent in the 
private sector, most economists agree, is a more effective 
stimulus to the economy.
    Senator Sarbanes. That all depends. When yo do a tax cut, 
people are going to hold on to some of it. They do not spend it 
all so you do not get 100 percent infusion of that into the 
economy. On the defense and homeland security spending, just to 
take those two examples, you do get 100 percent infusion in the 
first round and then you get the multiplier effect thereafter.
    But in any event, even if I want to concede a little bit to 
your point, the difference is not very great. In other words, 
if I take someone who is making more than $1 million--and this 
is income, not wealth, as one of my colleagues said--it is good 
to hang around here so you can keep clearing up the 
misconceptions. Let us say I put a surtax on people making more 
than $1 million in order to fully fund the COPS and the FIRE 
grant programs, which were established before 9/11. They were 
not a response to 9/11. They were an earlier response to 
upgrade our police and fire fighters all across the country, 
and most observers think they have worked pretty well. I do not 
know the situation in my colleague's State when he labels it 
pork, but I know the situation in my own State pretty well and 
that money has been put to very good use.
    If I take some of this money that the millionaires have and 
fund the police and the fire fighters, in a macroeconomic 
sense, I am still putting money into the economy, am I not?
    Mr. Bolten. Most economists would say not nearly as 
effectively as if you allowed people in the private sector to 
keep the money on their own, especially if the Federal 
Government is borrowing that money in order to make 
expenditures.
    Senator Sarbanes. Of course you are borrowing it in order 
to do the tax cuts. Let us address that right now. You are 
borrowing in order to do the tax cuts. So there is no 
difference on that point. You say you are borrowing in order to 
do the spending. You are borrowing in order to do the tax cuts. 
Let us be clear about that. So the choice becomes, in terms of 
priorities, what is more important. And second, I would argue 
that in terms of the macroeconomic impact on the economy there 
is not much difference.
    Do you think paying unemployment insurance has a 
macroeconomic effect?
    Mr. Bolten. I am sure it does, Senator. But I think 
almost----
    Senator Sarbanes. Do you support it?
    Mr. Bolten. Sure. But I think almost all economists would 
agree that Government spending and Government tax cuts are not 
equal with respect to their effect on the economy. There is a 
much more stimulative effect to the economy from tax cuts.
    Senator Sarbanes. I think they would also ask what are you 
spending the Government money on.
    How about Government spending for research and development, 
what do you think about that as an impetus to the economy?
    Mr. Bolten. It can be very positive.
    Senator Sarbanes. It is very important, is it not, for the 
future? What about Government spending on education?
    Mr. Bolten. It can also be very positive.
    Senator Sarbanes. The age cohort in this country that is 
most in poverty is our youth. That is a sad commentary if you 
are thinking about the future strength of the Nation. If you 
look at what other countries are doing that we are engaged with 
in global competition, they are putting a lot of resources into 
developing their human resources, the skilled labor force, 
which our people are going to have to compete with.
    So I think we need to strip away from this, first of all, 
the argument that, in terms of the overall impact on the 
economy, you do not get that both on the tax side and the 
spending side. Then you have to make the judgment, which is the 
better priority? What is your sense of priorities? What does 
the society need?
    I am frank to tell you, I would put as a higher priority 
educating our children or strengthening our fire and police 
forces ahead of giving large tax breaks to very wealthy people. 
That is what has happened. You gave these large tax breaks and 
you got a deficit out of it.
    Thank you.
    Chairman Gregg. Do you wish to comment on that, Director?
    Mr. Bolten. Mr. Chairman----
    Chairman Gregg. Or would you rather leave? Which I can 
understand. You have been very generous with your time.
    Senator Conrad. We do have more questions, Mr. Director.
    Chairman Gregg. You have been very generous with your time, 
and obviously there was a bit of rhetorical----
    Mr. Bolten. I am always honored to have an opportunity to 
engage in dialog with the members.
    Chairman Gregg. We thank you for your time. We thank your 
staff for its cooperation with our staff. They have also been 
very generous with their time.
    Tomorrow we will convene here to hear Secretary Snow.
    Senator Conrad. Mr. Chairman, might I just add a final word 
as well to the director and thank him for his courtesies? We 
have very real differences and it is important that we debate. 
Hopefully it never becomes personal, and it certainly has not. 
I have high regard for you as an individual and for your 
background. I just wish that you came with a different budget 
plan for the future.
    Mr. Bolten. Senator, I appreciate your courtesy and I know 
we are seeking the same objective if different paths.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Bolton follows:]

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    Chairman Gregg. Thank you. The hearing is adjourned.
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            THE PRESIDENT'S FISCAL YEAR 2006 BUDGET PROPOSAL

                              ----------                              


                      THURSDAY, FEBRUARY 10, 2005

                                       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. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Domenici, Allard, Enzi, Bunning, 
Alexander, Conrad, Sarbanes, Murray, Stabenow, and Corzine.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Cheri Reidy.
    Staff present: Mary Ann Naylor, Staff Director; and Steve 
Bailey.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will convene the hearing. We appreciate 
the Secretary of the Treasury joining us today for a hearing on 
the President's budget, and he is going to give us some insight 
on tax policy within the budget, and I suspect tax policy 
outside the budget, and maybe a little insight on the value of 
the dollar and a few other issues that may be of interest to 
the committee.
    My understanding is that the Senator from North Dakota has 
recovered from his recent slight illness, so we can also look 
forward to a wonderful presentation from the Senator, and we 
shall turn to his opening comments and then hear from the 
Secretary.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. I thank the chairman. Mr. Chairman, I want 
to take just a moment and go back over some history I reviewed 
yesterday because I keep hearing things that I think are 
mistaken in terms of our economic history.
    This is the chart I wanted to refer to that shows the 
relationship between our spending and our revenue since 1980, 
and the red line are the outlays, the green line is the 
revenues. The last time we had a huge gap, major budget 
deficits, was in the previous Bush administration. You can see 
outlays were running 22, 23 percent of gross domestic product. 
Revenues were varying between 17 and 19 percent, so we had that 
gap, and that gap is what created the deficit and increases in 
the debt.
    Then in 1992 President Clinton was elected and a 5-year 
plan was passed that reduced outlays as a percentage of gross 
domestic product, as a share of our national income, and 
increased revenue. Some of our colleagues, in fact on the other 
side most of our colleagues said at the time this set of 
policies would crater the economy. It still rings in my ears, 
Senator Dole's final speech, that increasing taxes is going to 
crater the economy. We can go back down, check the record and 
see what in fact happened. It did not crater the economy. It 
set off the longest economic expansion in our Nation's history, 
the lowest unemployment in 30 years, the lowest inflation in 30 
years, the strongest business investment expansion in our 
history.
    How can that be? How can it be if you are reducing spending 
and raising taxes that the economy strengthens? One key reason 
is the other part of policy that affects the economy. That is 
monetary policy under the control of the Federal Reserve Board. 
Because the Congress and the President were being responsible 
on fiscal policy, the Federal Reserve was more accommodative on 
monetary policy, and that helped us grow. We even had 2 years 
where we were not only in balance, but we stopped using Social 
Security Trust Fund money for other purposes.
    Then we ran into 2001, the recession, and of course the 
horrible attack, and the response was a plan of tax reductions 
and of course spending increases mostly for defense and 
homeland security. You can see the increase in spending, the 
reduction in revenue. About half of the reduction was tax cuts, 
about half of the reduction was because of economic slowdown 
and other factors.
    Tax cuts, without question, were an important thing to do. 
Now, we had a great difference about how big the tax cut should 
be, who it should go to. We had great disagreements about that. 
We also had disagreements about how long lasting they should be 
in light of our long-term fiscal imbalances. But I want to make 
clear I proposed almost a trillion dollars of tax relief at the 
time to give a lift to the economy.
    The problem that I see with the President's policy is there 
is no closing of this gap going forward. The spending line 
remains well above the revenue line under the President's 
projections, under CBO's projections, under the blue chip 
forecasters' projections, and I do not see any plan by the 
administration to close this gap. What strikes me as most 
dangerous about this is this gap which constitutes a deficit, 
which means the debt is growing because it is happening at the 
worst possible time. It is happening right before the baby 
boomers retire, and that is going to dramatically increase 
pressure on the Government.
    So my own reading of this history is that we have to work 
on closing this gap, and we have to work on the spending side 
of the equation, you also have to work on the revenue side of 
the equation, and I do not see any proposal from the President, 
none, to deal with the revenue side of this equation.
    I hope, Mr. Secretary, we can address this as we get into 
your remarks.
    I thank the chair. I look forward to the testimony of the 
Secretary and we welcome you to the committee.
    Secretary Snow. Thank you.
    Chairman Gregg. Thank you.
    Senator Domenici. Mr. Chairman, could I just ask you a 
question?
    Chairman Gregg. Certainly.
    Senator Domenici. I am not going to ask him a question. 
That is your job. Is there any way to answer that or do you 
want to wait until my turn?
    Chairman Gregg. Why do we not wait? I know the Senator from 
North Dakota tends to get juices fired on our side, but we did 
come to hear the Secretary of the Treasury. I am sure he will 
have some ideas on what the Senator from North Dakota said. He 
always manages to get us thinking, usually with enthusiasm.
    [Laughter.]
    Senator Domenici. Mr. Chairman, I am enthused. The reason I 
will not push you is that I just wanted to make sure that there 
was continuity. He presented one side, and there is a hole on 
the other side, and I did not want it to get away.
    Chairman Gregg. We are going to let the Secretary talk 
about that, and I am sure in our questions, to the extent we 
feel that the Senator from North Dakota needs response, we will 
do that too.
    Senator Domenici. Thank you.
    Chairman Gregg. Mr. Secretary, thank you for coming, and 
thank you for your presentation today.

   STATEMENT OF HON. JOHN SNOW, SECRETARY, DEPARTMENT OF THE 
                            TREASURY

    Secretary Snow. Thank you very much, Mr. Chairman, Senator 
Conrad, members of the Budget Committee. It is always a 
pleasure to be up here with the Senate Budget Committee, engage 
on a dialog with you on these critically important issues that 
come before the committee.
    Let me say that this year I am pleased that the American 
economy is doing a lot better than it was a year ago at this 
time. We just got the news this morning that the U.S. jobless 
claims fell to a 4-year low. That is good news, 303,000, lowest 
in 4 years. Of course that is on top of the good news about the 
GDP coming in at 4.4 percent for the year; the 2.7 million 
additional jobs; productivity remaining strong; exports getting 
stronger--we need to close that gap--but exports are getting 
stronger; home ownership at an all time high; net worth of 
American families, household wealth at the highest in history; 
unemployment rates fallen down to 5.2 percent.
    Mr. Chairman, we have made a lot of progress with the 
American economy, and I think it is undeniable that lower tax 
cuts that the Congress made available through the Jobs and 
Growth Bill lie at the center here of this good recovery we are 
enjoying. It is a recovery I would note that we are enjoying 
without inflation. We still continue to have a very benign 
inflation environment with mortgage rates low, with interest 
rates low, and of course interest rates tend to follow 
inflation. The low interest rates reflect I think the 
competition that is in the American economy and the high 
productivity that is in the American economy, conditions we 
want to make sure continue.
    The President's budget also recognizes the need for fiscal 
discipline. It is a budget that calls for continuing focus on 
reducing the deficit, and calls for cutting the deficit in half 
over the budget window, taking it down to well below 2 percent. 
As Senator Conrad knows, as an expert on those numbers, the 
historic average of the deficit is about 2.2, 2.3 percent of 
GDP. The plan we have is to bring it down to well below 2 
percent, so low by historical averages.
    I would agree with the Senator the real issue is those 
outyear numbers that are driven by unfunded mandates, by 
Medicare, Medicaid and Social Security, which is why the 
President has put Social Security front and center, proposed 
that we make it a legislative priority for this year, as he 
said in the State of the Union message. The system is 
unsustainable. The sooner we get to it, the sooner we address 
it, the easier the answers will be and the better the 
retirement outlook will be for younger people. Remember, we are 
reducing a huge overhang liability on the American economy, the 
10.4 trillion dollars that the actuary of the Social Security 
system has identified as the unfunded obligation there, an 
unfunded obligation that grows according to the actuary at 
about 600 billion a year. So I agree with Senator Conrad. We 
need to be thinking about these longer-term deficits. They are 
driven by the unfunded mandates, by Social Security and by 
Medicaid and Medicare. Those are the really big issues for the 
future of our country. I have seen comments you have made, Mr. 
Chairman, on that subject as well, with which I want to be 
identified. We clearly need to find answers to those problems.
    In the course of today's hearing I hope to offer some 
thoughts on that in response to your questions. We know that 
deficits matter. We know that the current deficit levels and 
the projected deficit levels are too high. There are really 
only two ways to deal with deficits. One is grow the revenues, 
the receipts of the U.S. Government. To do that we have to keep 
the economy growing and expanding. That is where a low tax 
environment I think is very helpful. We see now that revenues 
are coming up. So far this year they are up about 10 percent 
over last year year-to-date receipts. That is a direct 
reflection of the fact the economy is growing, expanding, jobs 
are being created, businesses are more profitable, because when 
that happens of course the Government gets a bigger take, they 
get more receipts. But I will agree with all of you that that 
alone is not enough. Growth will not get us out of this 
problem. We also have to focus on spending.
    The President has sent up a disciplined budget to the 
Congress, one that constrains spending. Yes, the budget 
increases in the military area, and yes, it increases in 
homeland security. Those are national priorities that need to 
be funded. Outside of those areas you will see that the 
President's budget is very, very tight, many will say too 
tight. They said that last year. In fact, I recall last year 
testifying up here. The comments, not from the committee, but 
the comments in the media were: this budget is dead on arrival. 
Well, you did not adopt every line item of the President's 
budget, but Congress came out with a number that was right in 
line with the President's number, and I commend you for that. 
We do not expect every line item in this year's budget to be 
adopted either as sent up. You have your work to do in the 
Senate and in the House, but we would hope that you could stay 
in line with those overall numbers. That is what happened last 
year, and of course we came in with numbers last year that were 
well below the projections. I would hope that might even be, 
might be able to do that again this year.
    But in any event, growing the economy, sustaining high 
rates of growth, and that is where low tax environment counts, 
and discipline on the spending side are the critical components 
of finding the answer, Senator Conrad, to the gap between those 
lines that you showed on that chart.
    Mr. Chairman, I thank you very much for the opportunity to 
be here, and look forward to responding to your questions.
    Chairman Gregg. Thank you, Mr. Secretary, and I appreciate 
the points you have made, and I think they are good and they 
should be reinforced. The main point of course is that this 
administration is addressing and has been willing to step 
forward on the long-term structural problems which we face as a 
society, which is the entitlement spending issue.
    The President has, you may not agree with his positions or 
the colleagues on the other side may not agree with it, but he 
has stepped forward and put Social Security on the table for 
discussion. I regret that our colleagues across the aisle--and 
I am not speaking here about the Senator from North Dakota 
because he has been an exception--but that the leadership from 
across the aisle, especially the House leadership, has said 
there is no problem and that they are not going to address the 
Social Security issue because there is no problem.
    The President has also been willing to step forward on the 
entitlement questions with a Medicaid proposal. I will be 
interested to see how many colleagues from the other side of 
the aisle decide that they are willing to address that huge 
health care question, which is how we pay for health care in 
the outyears and next year in the Medicaid area. It is a big 
question that needs to be addressed. The President has also 
taken on the sacred cow of agriculture subsidies. So the 
President has stepped forward on the entitlement side, which is 
critical. I am hopeful that we will also review Medicare at 
some point, but I can understand that the administration wants 
to allow its Medicare proposal to run a little bit here, at 
least startup before we get back to that issue.
    On the discretionary side again the administration deserves 
to be congratulated because you have made the tough decisions. 
You have sent up a budget which is stringent, which gores 
everybody's ox, including the defense base, and we are hearing 
of course from defense contractors across the country about 
their concerns about defense spending. The budget is very 
responsible on the spending side of the ledger.
    On the tax side of the ledger, I guess my questions would 
be, since you are the Secretary of Treasury, what would be the 
practical implications in this fledgling recovery, which is now 
getting to be fairly robust of increasing taxes? Was the fairly 
severe recession alot less severe because of the tax cuts?
    Secretary Snow. Absolutely, Senator, absolutely.
    Chairman Gregg. What would be the effect of putting in 
place a major tax increase on small business in this country 
today, and especially small businesses which generally create 
jobs?
    Secretary Snow. Senator, I will not surprise you by my 
response. I think it would be a terrible mistake. The lower tax 
rates the small businesses are enjoying through the expensing 
provisions and through the lower marginal tax rates, because so 
many of them pay their taxes through the ordinary income tax 
system as subpart S organizations. You would raise their tax 
rates significantly, and if you raise the tax rates of small 
businesses, they are going to be far less inclined to expand 
and to grow and to hire, and of course they do an awful lot of 
the hiring in the United States. Two out of three new jobs come 
from small businesses. I think it would be a terrible mistake.
    Chairman Gregg. So when our colleagues from the other side 
of the aisle subscribe to the policies of Senator Kerry, who 
during his Presidential campaign suggested that the way you 
solve our budget problem is to significantly increase taxes on 
high-income Americans, as he described them, which are for the 
most part small businesses in those top brackets that are 
practicing as subchapter S corporations, and then of course he 
put in place another trillion dollars of spending on top of 
whatever he would have raised in revenue, so he would haveten a 
negative number anyway. But independent of the negative number 
that his proposals would have created in the deficit situation, 
the tax policy of dramatically increasing taxes on small 
businesses through a increase of marginal rates aimed at the 
top two quadrants of the marginal rates would have, in your 
opinion, a negative impact on economic growth and therefore 
cost jobs and reduce revenues probably in the long run?
    Secretary Snow. Yes, Senator, absolutely. I think it would 
be a wrongheaded decision. It would surely reduce small 
businesses' ability to invest in their businesses, and what 
creates jobs is small businesses investing in growing. Behind 
every job is some investment that somebody has undertaken. 
Roughly, it is $100,000 of investment behind every job. Small 
business will only invest when they see good returns, and lower 
tax rates mean higher returns for those investments.
    Chairman Gregg. We will look forward to the other side 
putting forward their budget with that type of a tax increase, 
and then we can have that debate.
    The one tax increase which clearly will occur if we do not 
take action in this 5-year window is the 15 percent dividend 
rate and the 15 percent capital gain rate will jump back up. I 
guess I would like to get your thoughts on that specifically in 
relation to an event which happened I guess about 3 weeks ago, 
where Microsoft paid out the largest dividend in the history of 
the country, I think something like $32 billion, which 
yesterday I believe Director Bolten said created more than a 
0.1 percent jump in the GDP of the country, and meant that 
literally hundreds of thousands if not millions of Americans, 
who have investments, who work on the line at the UAW and have 
their UAW funds invested in Microsoft, or who work at a small 
restaurant and have their 401(k) invested in Microsoft, 
millions of Americans saw their income jump as a result of that 
dividend distribution, which was done as a proximate result of 
the reduction of the rate to 15 percent, which put Microsoft in 
a position where they felt that sort of dividend was 
appropriate.
    I would be interested in knowing what your feeling is about 
first what happened as a result of the dividend cut to 15 
percent, and then also the capital gain cut. How much have we 
seen revenues jump as a result of that cut? And then what will 
happen if we do not extend those two tax cuts, which clearly 
the other side of the aisle appears to be resistant to?
    Secretary Snow. Senator, I think the evidence here is 
pretty clear even if it is hard to quantify fully. Both the 
reduction in the dividend rate and the reduction in the capital 
gains rates have affected behaviors. We see that in the fact 
that not only Microsoft but many more companies are now paying 
higher dividends than was the case before. As a former CEO who 
wrestled with the question of the amount of dividends to pay 
out and whether to raise dividends or reduce dividends, the 
question always was: is this a tax efficient way to reward 
shareholders? When shareholders had 39.6 percent marginal tax 
rates, paying them a dividend at that tax level always met 
resistance from the finance people in the company and from 
others, even stock analysts, saying that is a very tax 
inefficient way----
    Chairman Gregg. If you could explain that for a second 
because I think it is important to the extent--I know everybody 
at this table understands it, but the fact that dividends when 
they are distributed have already been taxed once, and maybe 
you could explain that just so people understand it.
    Secretary Snow. Sure, Senator. The argument behind the 
President's initial proposal was that it is appropriate to tax 
income once, but once is enough. As an investor in a company 
you are looking for dividends. You are looking for appreciation 
too, but one form of income you would like is dividends. Before 
the company can pay you a dividend it has to pay a tax on its 
corporate income, and then the dividend is paid out of the 
after tax corporate income of the company. So by the time you 
get your dividend it has already been taxed at the corporate 
level.
    The proposal that the President sent to the Congress last 
year you will recall was once is enough, let us not have that 
second tax on the dividend. If it has been taxed at the 
corporate level, then it should not be taxed at your level. 
While that did not carry the Congress, what did carry the 
Congress was I think a very thoughtful proposal to reduce the 
dividend rate to 15 percent. Many people were paying 25 
percent, 30 percent, 35, 39 percent tax rates on their 
dividends. If you were paying 35 percent tax rate, personal tax 
rate, you got the dividend after the company had paid their 35 
percent, you can see that ends up being a very high marginal 
tax rate, 35 at the company, 35 at the individual, 70 percent 
tax rate on the dividend, which is why I say in the old tax 
environment prior to the Jobs and Growth Bill, executives 
would, in response to shareholders' requests for more 
dividends, would often say: Mr. Shareholder or Mrs. 
Shareholder, that is a very tax inefficient way for us to 
distribute the earnings of this company to you.
    Today, because of the action of the Congress, it is far 
less tax inefficient. That is the basic point.
    And the same with capital gains. It should come as no 
surprise to anybody that the stock market did a nice pickup in 
2003 subsequent to the time it became clear the dividend tax 
and the corporate gains reductions would be part of that 
legislation because the earnings of companies are now worth 
more in the marketplace since they are not taxed as highly. 
They are not discounted as much by taxes as once was the case. 
So the market puts a higher multiple on the outlook for the 
company, and that takes the marketplace up. We saw I think in 
2003 roughly a 30 percent increase in equity values, and last 
year about a 10 percent increase in equity values.
    Senator I would assert that there is a direct relationship 
between the improvement in equity values and the market 
performance and the lower tax rates on corporate earnings 
through the dividend and capital gains that you made available.
    Chairman Gregg. Thank you, Mr. Secretary.
    Senator Conrad.
    Senator Conrad. Mr. Secretary, should we cut taxes another 
25 percent in your judgment?
    Secretary Snow. I would not recommend that at this point.
    Senator Conrad. Why not?
    Secretary Snow. Because I think at current tax rates we are 
on a path, as your charts show, to bring the revenue stream 
back up to its traditional roughly 18 percent. It seems to me 
we should be able to fund this Government with a revenue stream 
of about 18 percent of GDP which is the historic average.
    Senator Conrad. Mr. Secretary, you mentioned in your 
opening statement that the deficit is going to get cut in half 
under the President's plan. Is that correct?
    Secretary Snow. Yes. The plan is to reduce it to about 1.7 
percent of GDP by the end of the President's term, which would 
be more than cutting it in half.
    Senator Conrad. Of course that gets into a question of what 
the goal is, and is it in dollar terms or percentage GDP. But 
without getting into that, let me just tell you why I think 
that misses the mark. When I looked at 2009 here is what I see. 
The President is saying in his budget he is going to reduce the 
deficit to $233 billion. But he leaves out the money he is 
taking from Social Security itself. In that year alone he is 
going to take $242 billion of payroll tax money that was meant 
to strengthen Social Security and he is going to use it to pay 
for other things.
    Back in the 1980's there was virtually no Social Security 
surplus to use in that way, so these historical comparisons 
have a big disconnect, and the big disconnect is in the 1980's 
a Social Security surplus in any 1 year was not in the 
billions, it was in the hundreds of millions. Now the Social 
Security payroll taxes were increased to prepare for the 
retirement of the baby boom generation, the Social Security 
surplus in that year is going to be $242 billion. Under the 
President's plan he is going to take all of it, not going to 
use it to strengthen Social Security, he is going to use it to 
pay for other things. CBO tells us the residual war cost in 
that year is going to be $55 billion, so that is not counted. 
Costs, according to CBO, to fix the alternative minimum tax, 
the old millionaire's tax that is rapidly becoming a middle 
class tax trap, is $54 billion in that year, and none of that 
is in the President's budget.
    So what is going to get added to the debt that year? And it 
is interesting how the focus has been on deficits. There has 
been almost no focus on what is happening to the debt. The debt 
is going to increase that year, not by the $233 billion of 
deficit that the President is asserting, but the debt is going 
to increase by $584 billion. When we are running massive budget 
deficits and having masses increases in the debt, and at the 
same time we have huge increases in our trade deficits, those 
twin deficits are requiring us to borrow staggering amounts of 
money and from all around the world.
    Let me ask you this. In your judgment, does this increase 
in foreign borrowing, which by the way, just during this 
administration has increased 91 percent, increase in foreign 
borrowing has increased 91 percent, does that concern you at 
all? Here is the increase. We had four holdings of U.S. debt in 
January 2001, just about a trillion dollars. It has gone up to 
almost 2 trillion in just these few years.
    Secretary Snow. No, Senator. Those are the numbers. There 
is no arguing with them. What those numbers reflect, of course, 
is the fact that the American economy has been doing well 
relative to other economies, and as a result, we are importing 
more from those other economies, because we are developing more 
disposable income than they are relatively, and we recognize 
the issue there. I think the answer though is three things 
basically. One, we have to reduce our own dissavings through 
attacking the deficit problem you are putting on the table and 
the chairman is putting on the table and all of you are putting 
on the table, because our dissavings contribute to that 
problem. We need to improve national savings.
    Second, it sure would be helpful if Europe and Japan and 
our trading partners would grow faster because if they would 
grow faster they would create more disposable income and be 
able to buy more from us. We are working with them on 
suggesting what they might be able to do, encouraging them to 
adopt growth policies.
    The third piece of the answer I think is getting the 
Chinese to move toward--and this is a matter I have discussed 
with a number of you privately--the Chinese to move to greater 
flexibility in their currency, so that their currency reflects 
market values rather than some arbitrary determination on what 
the exchange rate would be. We are pushing all of those 
initiatives, Senator, but of course that is a matter we 
continue to monitor and monitor very closely, the current 
account deficit.
    Chairman Gregg. Senator Domenici.
    Senator Domenici. First, thank you, Mr. Chairman, and also 
I want to thank you for your analysis of the President's budget 
and the situation right now.
    Just two observations before I ask a couple of questions. I 
do not have time to give the counter arguments to what the 
distinguished ranking minority member suggests has happened in 
the last 7 or 8 years or 10 years, including the Clinton 
administration's growth. Suffice it to say that there is an 
indication on the part of Democrats that this big era of growth 
that occurred that yielded the increase in tax revenues that he 
showed came because they increased taxes and from increasing 
the tax under the IRS. I think neither are true. I do not think 
very many people believe the tax increase caused the great 
growth. I think it was going to happen, and it had already 
started, and maybe it pushed it a little just because it 
affected the attitude of the investing community. Certainly tax 
increases do not account for what happened. Something else 
caused it to happen. In any event that is one observation.
    Second, the big growth during that period that brought in 
all the revenue. I was there. That is how we balanced the 
budget, Senator, we had a big tax growth, unexpected revenue to 
the Treasury. That happened for two or three reasons. It 
happened because of capital gains that were occurring because 
of this huge stock market bubble. There is no question about 
that, and all the actions surrounding it brought these 
incredible revenue surges. Those revenue surges were not singly 
because of the growth, they were because of this very different 
set of economic facts regarding securities, regarding equity. I 
do not know if we will ever have that again so we are not going 
to get the benefit of that situation.
    Second, my analysis is that looking at the long term, the 
biggest problem we have is that we are kidding ourselves if we 
think we can afford the cost of health care. Everything else 
pales as you look at the outyears, the future of America. When 
you look at the expected medical benefits that the American 
people perceive, they are almost so big when added to the 
private sector expenditures for health care, that most of our 
productivity will go to taking care of ourselves. I have been 
thinking that the time will come when you walk down the street, 
Senator Alexander, and you can say ``Hello,'' and every third 
person you can say, ``Thank you for taking care of my health,'' 
because that is how big the cost will be.
    I am very concerned because our colleagues on the other 
side criticize the President while they know that their 
position is that we should not do Social Security and we should 
do Medicare. Maybe they ought to do Medicare. I have not seen 
any plan to reduce health care costs coming from the other 
side. Second, very simply, if they think we ought to increase 
taxes to take care of this, that is a simple proposition. They 
do not have to wait for us to do it. We are going to mark up a 
budget. Why do they not propose increasing taxes to show us 
that that will fix the budget? I would like to see the proposal 
and I would like to see how much it is. It would be very 
interesting to analyze its effect on America's growth.
    Having said that, I want to ask you if you have done any 
studying about energy and energy prices and America's energy 
problems as it relates to our economic growth? I guess 
specifically, would you tell the committee what you project 
prices to be for major energy components during the next 5 
years? Do you have that estimate as part of your Treasury 
analysis?
    Secretary Snow. Senator, we do not do those projections. To 
the extent they are done, they would be done by the Energy 
Department. The new Secretary there, Sam Bodman, comes from 
Treasury.
    Senator Domenici. I understand.
    Secretary Snow. He had been the Deputy. But I defer to 
Secretary Bodman and the Energy Department on those 
projections.
    I would say though that one of the striking things about 
the American economy, its flexibility and its dynamic qualities 
is how we have come through the energy shocks of the last year. 
If anybody had told you we would be living with $50 a year oil, 
you would not have forecasted 4.4 percent growth rates, and 
clearly those high energy prices have taken a toll on the 
growth rates, and yet we have plowed right through it. That is 
a testimony to the inherent strength of this economy, its 
flexibility, its adaptability, and I think again, for the low 
tax rates.
    Senator Domenici. Mr. Secretary, we understand that, but 
that is almost stopped. That occurred because the changing 
nature of what caused productivity gains here. We used new 
equipment and the like which used less energy. I do not know if 
that is going to continue, but could you supply us, wherever 
you get it, with the 5- and 10-year projections on what you 
assume in the budget on energy. Will you answer in that what 
you assume energy, the condition of the energy market, what 
impact it will have on the American economy? Could that be an 
answer, would it have a drag, and if you can find out how much 
of a drag, we would like to know that.
    Secretary Snow. We do know that higher energy prices are a 
drag. They act like a tax.
    Senator Domenici. Would you put that together with the 
other information?
    Secretary Snow. We will, absolutely.
    Senator Domenici. Thank you, Mr. Chairman.
    Secretary Snow. Senator, if I could just make a comment on 
your earlier observations, because I think you helped frame the 
1990's well. Most economists were surprised by the growth rates 
in the 1990's, and it was a nice time to be Treasury Secretary 
or in that case President of the United States, because there 
was this surge of revenues that had not been anticipated. It 
came from technology. It came from productivity increases 
associated with technology that drove equity markets and 
created a stream of revenue that could not have been 
anticipated. It is unrealistic to think that we are going to 
have a 21.6 percent revenue receipts level and sustain that.
    So I would agree completely with you it was an unrealistic 
number, it was an unforeseen number, and it was an 
unsustainable number due entirely to the fact that we had the 
bubble. The bubble created a huge amount of capital gains and 
options returns, returns on options that raised the Federal 
income stream. That is not a sustainable situation.
    Senator Domenici. Mr. Chairman, I understand your properly 
presenting the growth in tax receipts, as you have shown, that 
is correct. All I am saying is that if you look at the years we 
balanced the budget, that was not 10 percent growth in taxes 
like you described, it is much, much more, and I was trying to 
say that did not come from tax increases. It came from 
something phenomenal happening in the economy that you are not 
going to have while you are chairman, because there is a 
different ambience out there.
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman, and Secretary 
Snow, welcome.
    Mr. Chairman, I would hope that we might have an 
opportunity at the Budget Committee just to really talk about 
economics and what grows the economy. I think there is an 
honest and serious discussion that we can have about supply 
side economics versus supply and demand, and I think there is a 
very big--there is just a philosophical difference between one 
side of the aisle and others in terms of whether it is supply 
side, everything is focused on the top and it trickles down, or 
whether you need a balanced economy with supply and demand. 
Personally, I think to bring us back to--and I do have a 
question for you, Secretary Snow--but to bring it back to where 
we were, 2001, the highest budget surplus in the history of the 
country, 4.6 trillion projected, now the highest budget deficit 
in the history of the country using predominantly a strategy of 
a supply side tax cut for the majority of that, understanding 
there were other costs. I think that pretty much basically 
starts with speaking for itself about where we are.
    I had a gentleman, an investment banker, very wealthy, in 
the country, say to me yesterday he wanted to convey, to please 
convey to my colleagues that while he appreciated the huge tax 
cut he received, he knows he is going to pay for the deficit 
plus interest as well as the other investments in education and 
science that will be eliminated that we need to grow the 
economy, and he said thank you very much, please do not do 
that, let us have a more balanced strategic approach about how 
we do this.
    When we talk about how we address jobs, I would just say a 
couple of things. One, a transportation bill like we passed on 
an overwhelming bipartisan basis a year ago in the Senate would 
create more jobs immediately than anything else we could do. 
99,000 jobs are created for every one billion dollars spent. So 
I hope you will look at that. That is the demand side. Money in 
the pocket, good paying jobs for people who are customers of 
the businesses we all want to succeed.
    Second, the No. 1 issue I am hearing from businesses is 
health care, which I do not know how in the world we address 
with these huge deficits we have. If my businesses had one 
request of us, whether it is the Big Three auto makers or 
whether it is small businesses, or seniors, or workers for that 
matter, it would be lower my health care cost.
    And second, I am pleased to hear you talk about China and 
what is happening in terms of manipulating their currency 
because the second thing my businesses, particularly small and 
medium size businesses say to me, is level the playing field, 
enforce the rules on trade, and stop China from what they are 
doing.
    Move to Social Security where my question is, and I would 
love for us to have a chance to really debate what I think are 
on the economy, serious and honest differences about how to 
approach economic growth.
    Chairman Gregg. I think that is called when the budget hits 
the floor.
    Senator Stabenow. Yes. Well, even in the committee though, 
I think that would be a good thing to do.
    On Social Security, a couple of things. One, I feel 
compelled to go back. You were talking about unfunded mandates 
in passing Medicare, Medicaid. Just to remind all of us, Social 
Security is not an unfunded mandate. I pay in, you pay in, 
everybody pays in to an insurance plan that they expect to be 
there at retirement. The baby boomers have paid in more on 
purpose so there would be a surplus there. This is something 
people pay into and they own, it is not general fund dollars. 
And they expect it to be there, and that is our job, to make 
sure it is there, working together.
    When we look at privatization, and most people today, many 
people would agree that privatized accounts do not do anything 
to lengthen the trust fund. It is a philosophical difference 
but it does not do anything to meet the gap in 2042 or 2052. 
When we talk about how those would work, I think it is 
important to have a discussion even though we know all the 
details are not there. And I would ask you to followup on a 
comment that you made in response to a question in the House 
Ways and Means Committee earlier this week concerning what has 
been called the clawback or the privatization tax, as we would 
call it, where you indicated that that exists, that this 
clawback or payback exists. And you said if retirees earned 
less than 3 percent on their privatized account, they would do 
worse, but that is very unlikely.
    So in fact this process is being talked about in terms of 
people not getting the full value of what has been put into the 
account, and in fact we are being told that what is being 
looked at is that a retiree would have to earn 3 percent plus 
inflation, which is about 5.7 percent, before they actually 
would see any benefit to the account. I would, in simple lay 
person's terms say, that is like giving my daughter, who is 25, 
$1000 for retirement; she moves forward and invests it. At 
retirement I say, ``I want the $1,000 back plus 5.7 percent of 
your investment earnings. You get everything on top of that.'' 
Is that a good deal?
    Secretary Snow. Senator, let me address your question here. 
First of all, the Social Security system is not on a path where 
it can pay your daughter the benefits that it has promised.
    Senator Stabenow. I would only interject, with all due 
respect, it is also not going bankrupt, and the differences we 
certainly on a bipartisan basis want to work to fix.
    Secretary Snow. I appreciate that and we should. But it is 
going bankrupt in the sense that a company goes bankrupt if it 
has obligations that it cannot cover. In that sense, which is 
the meaning of bankruptcy under Chapter 11 of the U.S. Code, or 
Chapter 7, it is going bankrupt because it cannot meet the 
future obligations. The idea of fixing it now is we can 
restructure it, we can modernize, we can put it on a sound 
financial footing at a lower cost than if we wait for what 
President Clinton called ``this looming crisis'' comes in on 
us.
    Senator Stabenow. Secretary Snow, there is no disagreement 
with anybody on this. We have good faith discussions going on 
about how we make small changes now that have big impacts 40 or 
50 years from now. It was certainly done in the 1980's when it 
was more imminent. I think the real question is, overwhelmingly 
we hear evidence that the privatized accounts are really about 
a philosophical change. It really does not--you are mixing the 
two together. It really has nothing to do with what do we do 
about the gap. It is about wanting to change to a privatized 
system. And my question to you would be, why is that a better 
deal for people, when (A) it puts an individual's dollars more 
at risk, requires them more to administer the accounts. They 
may not be better off. And essentially it begins to dismantle 
an insurance system. In a way it is kind of like if I put in a 
proposal say with my car insurance, instead of having the 
insurance company get the full premium I pay, I want to take 
two-thirds of it and put it in a private account. If I never 
have an auto accident, I am going to keep it. I do not think 
the insurance company would appreciate that.
    Chairman Gregg. Senator, why do we not let the Secretary 
answer that question. Then I am going to have to move on.
    Senator Stabenow. Thank you.
    Secretary Snow. Senator, what I can say I think without any 
fear of contradiction is that under a system of properly 
constructed personal accounts, the beneficiary will do better 
than they will under the current Social Security system. Your 
daughter will do better by being able to take some part of her 
payroll taxes and put it into these personal investment 
accounts, and use her working years to see those accounts grow. 
No less than the General Accounting Office rendered the 
judgment here that across cohorts, and I am just going to quote 
them, ``Across cohorts,'' meaning the various age groups 
retiring, ``median monthly benefits of those choosing accounts 
are always higher despite the benefit offset than for those 
that do not make the choice.'' And the gap, the difference, 
grows over time. Over any period of time these investments will 
do well and do better than the return you could get on the 
moneys going into Social Security.
    I appreciate your comments. We really do want to work with 
you and your colleagues to find some answers here, and I 
appreciate your sentiments that something needs to be done.
    Senator Stabenow. I would just say--and I know my time is 
up, Mr. Chairman--just that in looking at the numbers being 
used for people to be able to benefit from private accounts, it 
actually raises enough money that ironically the Social 
Security fund, where if we were growing at that rate, there 
would not even be a gap. So there are a number of questions we 
need to address. Thank you.
    Chairman Gregg. I think it is also important to stress that 
the personal accounts the President is proposing are optional.
    Secretary Snow. Entirely optional.
    Chairman Gregg. And voluntary.
    Secretary Snow. Entirely voluntary.
    Chairman Gregg. Senator Alexander.
    Senator Alexander. Thank you, Mr. Chairman.
    Mr. Secretary, thank you for coming this morning. I would 
like to step back a little bit and ask you about 
competitiveness, how we keep our jobs in the world marketplace 
and how this budget affects that because my sense is if there 
is a point person in the administration on competitiveness, it 
might be you. I would like to approach it this way. If I had to 
think of what the great challenges that face us are, one would 
be terrorism, one would be competitiveness and one might be 
preserving our common culture. When we talk about 
competitiveness, we have talked a lot about taxes here, and I 
am big for low taxes. Our State had the lowest taxes, and I 
voted for tax cuts. And I will vote for them again.
    But if all we had done since World War II is cut taxes, we 
would not have a third of all the money in the world today for 
5 or 6 percent of the people. We did a lot of other things. We 
created a telecommunications system, an interstate highway 
system, and perhaps the most important think we did was focus 
on brain power. We created the 50 greatest research 
universities, 20 Federal laboratories, this remarkable system 
where 60 percent of our students have grants and loans to help 
them go to college. And the President has a pretty good record 
on that, the President and the last two Congresses I mean. Pell 
grants are up 50 percent. There has been a doubling of funding 
for research for NIH.
    But my question is this: we have a real challenge here just 
as we did on terrorism, and on terrorism we looked around the 
Government and we saw that intelligence was spread all over the 
Government and not coordinated very well, so we created a 
Director of National Intelligence to make sure the President 
got advice. I am wondering if we should not be thinking about 
that for competitiveness, because we have $132 billion of 
research and development in this budget, but it is in 
agriculture, energy, defense, NASA, health and human services, 
commerce, transportation, interior, et cetera. It is as spread 
out as intelligence was. I wonder whose job it is to go to the 
President and says, ``Hey, Mr. President, the Oak Ridge 
Laboratory researchers who went up to Canada for a conference 
could not get back for 6 months because of their visa,'' or 
``States are not properly funding universities and the quality 
is going to go down,'' or ``We need to double the funding in 
physical sciences if we really want to create jobs.'' I mean 
the National Academy of Sciences says that half of our new jobs 
since World War II came from science and technology.
    So I am not suggesting we need to have a budget of more 
than 2.5 trillion, and I admire what the President has already 
done, and I like tax cuts. But I am wondering whether if 
terrorism is one big challenge and competitiveness is another, 
if you or someone in the administration ought not to be the 
point person for competitiveness and can keep our focus on 
this.
    Just one last thought. The rest of the world is focused. 
You know that because you are in the rest of the world. China 
and India are keeping their best students home now. Germany and 
England are improving their universities because they see a big 
outsourcing of brains to the United States. While we talk about 
outsourcing of jobs, they are worried about outsourcing of 
brains.
    So what can you tell me about your role as the point person 
for competitiveness and whether this administration in the next 
4 years might organize itself in a different way, as we have 
with intelligence, to make sure we meet this challenge in the 
same way we have met terrorism?
    Secretary Snow. Senator, that is a very thoughtful 
question. I remember talking about a year ago to one of your 
successors, Secretary of Education, Rodney Paige, a very able 
person as you know, who was asking me about the economy. I was 
talking to him about the economy and the outlook and jobs 
coming back and so on. And all of a sudden it dawned on me that 
he really was going to have a lot more to do with the jobs of 
the future than I was. I said to him, ``Rodney, Mr. Secretary, 
interesting you would ask me about that, but the fact is more 
hangs in the balance with respect to the quality of our 
education in the future than anything I am working on right now 
at Treasury. I am the spokesman for the economy, but you are 
driving the economy because the quality of the products that 
come out of our education system determine the jobs of the 
future and the productivity of the American economy for the 
future.''
    Your point is very well taken. So is your point on the 
visas, a subject that I have talked to Secretary Powell about a 
number of times when he held that post, because clearly things 
like visa policy affect the performance of the American economy 
and our ability to sustain our high growth rates.
    From the Treasury point of view let me say we are trying to 
work on things like tax policy and making the tax code simpler, 
fairer, more growth-oriented. It seems to me Government's role 
on the economy, which is really your question, how to keep 
America competitive, essentially has to do with putting in 
place the foundations or the framework so that the dynamic 
qualities of the American people in this great economic system 
of ours can be unleashed. But part of that is investing in the 
right things, technology, research, our great universities and 
so on. So let me think about that and come back to you for a 
more detailed question. But clearly, clearly we have to keep 
our eye on that question, what drives American competitiveness?
    One thing it does is keeping the free enterprise system 
working, keeping our education system capable of turning out 
educated people because educated people are productive people, 
and productive people drive GDP, and they also, productive 
people lead to the innovations that allow us to have those 
higher standards of living in the future. So let me come back 
to you with a fuller answer to that excellent question.
    Senator Alexander. Thank you, Mr. Chairman.
    Chairman Gregg. Senator Murray.
    Senator Murray. Thank you, Mr. Chairman.
    Thank you, Mr. Secretary, for being here today. I listened 
to your exchange with Senator Stabenow about her daughter and 
how she would be better off. I think you said you guaranteed 
she would be better off with the private personal account than 
she would today. I just wanted to go back through that because 
I was surprised to hear you say that. Perhaps she would be.
    But according to Peter Orszag, who is a former economic 
adviser to the White House under the Clinton administration, 
walked us through this, and he said under current law a 25-
year-old worker is scheduled to receive a monthly benefit of 
$1,708 in today's dollars. If there is absolutely no changes in 
the law, that that worker, that is what they would get today, 
but if we do nothing they will get $1,642, which is $66 less. 
So if we do not do anything, they will get $66 less than they 
are expected today.
    But under the President's plan, the Commission Model 2, his 
calculations are that that person would receive only, $1,192, 
which is $516 less than what they are scheduled to get today. 
So there are disputes about that.
    But let me be more specific because you are assuming that 
Senator Stabenow's daughter does really well, nothing wrong, 
nothing happens in her life. Well, if horrible happened and she 
became disabled in her 40's, she would not be better off 
because under today's current Social Security system she would 
get full benefits. If she only pays in to private accounts for 
8, 10, 7, 20 years, would get much less, and so you cannot 
guarantee that she is going to be better off.
    Another thing that could happen, which happens to many 
women, is that when she retires she buys the annuity, she lives 
to be 85. Under current law today Social Security has a COLA so 
that if you are on Social Security for 20 years you are not 
expected to live at the same amount of income the you would get 
throughout that 20 years. You would be able, as hopefully we 
all can, to be able to have a COLA so that you will have an 
increased amount.
    So I would say Senator Stabenow's daughter, if something 
happens unfortunately to her, would do worse, or if she does 
what many women do today and lives to be over 80, she would do 
worse. Or if you go by Peter Orszag's model, she would do 
worse. So I do not think there is any guarantee that anybody is 
going to do any better, and in fact I think the facts show that 
it is highly unlikely that she would.
    So if you want to comment on that, you can.
    Secretary Snow. I would like to.
    Senator Murray. And I have another question.
    Secretary Snow. Let me reply very quickly then.
    Senator Murray. Well, my other question is, as I hear about 
this clawback provision I think very few people understand that 
the money that you take out to put into private accounts is not 
yours to keep, you pay back the Government, and I would like 
you to explain that clawback provisions so we all understand 
that.
    Secretary Snow. OK. I have not seen Professor Orszag's 
numbers, but I think the facts are pretty clear on this, that 
in 2042 there will be, when the system reaches the point where 
it can no longer pay the benefits, the money is not in the 
account, in the trust fund----
    Senator Murray. And the President is saying private 
accounts will fix that?
    Secretary Snow. No. Let me just finish. Your daughter will 
receive, or a young person today who retires then will receive 
a big reduction in their Social Security benefits. That is the 
course we are on. The system is only capable of paying about 72 
cents on the dollar of the promised benefits.
    What I am saying is, with the personal accounts, the young 
person today who retires post-2042 will be able, with the 
personal accounts, to do better than they would otherwise be 
able to do.
    Senator Murray. Should nothing bad happen to them.
    Secretary Snow. Pardon me?
    Senator Murray. Should nothing bad happen to them.
    Secretary Snow. Now, on the disability issue, let me say 
the President's principles include sustaining the benefits of 
the disabled, so that anybody who is disabled, the President's 
proposal, his principles--he has four or five big principles. 
One is nobody over 55 is adversely affected. The system should 
be fixed permanently. Another one is the disabled provisions 
should be continued in a way that people get good protection 
for disability.
    And on the dying, living a long time, which we hope 
everybody does, our proposal would be that people could take 
out an annuity and that annuity would then carry them through a 
long life.
    Senator Murray. But I do not know of any annuities today 
that have a cost of living built in.
    Secretary Snow. Well, the----
    Senator Murray. Social Security does.
    Secretary Snow. Yes, Social Security has a cost of living, 
but remember, you built up over your long working career an 
amount of money which is much larger than anything Social 
Security could deliver to you.
    Senator Murray. Except go back to the clawback provision, 
which means that you will not buildup that huge annuity.
    Secretary Snow. I think there is a misunderstanding on the 
clawback. That is a word that is ascribed to what we are 
proposing, but it is not what we are proposing. There simply is 
no clawback. Let me describe what we are proposing and then 
respond further. The idea here is that people are today 
contributing money to Social Security. They would be allowed to 
take some part of that, and put it into these personal 
accounts. The money withdrawn from Social Security would, as it 
goes into the personal accounts, would result in an equivalent, 
present value equivalent reduction in the long-term liabilities 
of Social Security. That is, as you take the money out, you are 
not contributing that money to it, your future claim on Social 
Security would be reduced by an equivalent amount. But that is 
all it calls for is reduction in future claims on Social 
Security equivalent to the amount of money that you are taking 
out, which seems only fair.
    Chairman Gregg. And which makes a lot of sense if you are 
honest about the way you set up a personal account.
    Senator Bunning?
    Senator Bunning. Thank you, Mr. Chairman. I would like a 
statement that I have prepared to be put into the record.
    Chairman Gregg. Of course.
    Senator Bunning. Thank you.
    [The prepared statement of Senator Bunning follows:]

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    Thank you, Mr. Chairman.
    Welcome to the committee today Secretary Snow. I look 
forward to a meaningful discussion of the provisions contained 
in the President's budget proposal.
    As I have reviewed the many revenue proposals released this 
week, I have been pleased to see the attention paid by the 
Administration to so many important areas--making health care 
more affordable, simplifying the tax laws, encouraging savings, 
as well as extending many expiring provisions.
    Of utmost importance, of course, is that we do no allow our 
economy to face the largest tax increase in history. I support 
the President's call to make permanent the tax cuts that have 
contributed to the 11 consecutive quarters of economic growth 
that we have experienced recently.
    I was also pleased to see that, in this year in which we 
plan to finally take a serious look at the Nation's Social 
Security System, the Administration is also taking a serious 
look at private retirement savings and employer-supported 
retirement plans.

    Senator Bunning. Secretary Snow, thank you for showing up. 
There are an awful lot of things I would like to ask you about, 
but I was pleased to see that the administration is finally 
looking at all aspects of retirement financing in addition to 
important Social Security changes. In particular, with regards 
to employer provided pension plans, I have long been concerned 
that our current funding rules, however well-intentioned, can 
have the effect of worsening the lows of the business cycle. 
Those rules can act to require large pension contributions from 
sponsoring companies just when those companies are facing a 
downturn in their business. I understand that the 
administration is proposing some changes to allow plan sponsors 
to contribute additional funds during good economic times when 
they have the money available. I have long thought this was a 
very sensible idea. I am hoping that you will comment on these 
proposed changes to the funding rules and how you think the 
changes will impact employer sponsored pension programs.
    Secretary Snow. Senator, thank you very much. Yes, this is 
a major initiative of the administration. We took the better 
part of the last couple years to think about the problems 
affecting the defined benefit pension plans, and the sponsors, 
and the Pension Guarantee Board, and have concluded that the 
system needs a major overhaul for some of the reasons you are 
talking about.
    One of the biggest changes we are proposing is to allow 
employers, as you are suggesting there, to put moneys into 
those pension plans during the good years, put more money in, 
and to take the deduction that would go with it. The problem 
was always about the deduction and could they take the 
deduction. The rules would be changed to allow a deduction to 
accompany those higher levels of contributions in the good 
years. We think that will encourage employers in good times to 
put more money in, and thus help sustain the viability of those 
pension plans. There are a whole number of other rules as well 
that I think will help improve the financial status of the 
defined benefit plans, which will help both the employees, the 
employers, and ultimately the taxpayers.
    Senator Bunning. One of the rules must be that they cannot 
in the good years put it in and then the bad years take it out 
and use it for other purposes.
    Secretary Snow. You are absolutely right, absolutely right.
    Senator Bunning. OK. Congress has previously enacted many 
types of incentive programs, such as Renewal Communities and 
Empowerment Zones in order to jump start local economies in 
distressed areas. I am very interested in the Renewal Community 
Program as part of Eastern Kentucky participates in it. In 
fact, I included a provision in the Jobs bill last year 
addressing this program, an issue I worked with Chuck Schumer 
on. Can you address for me how the Opportunity Zones that are 
proposed in the President's budget exceed the capabilities of 
existing programs? What do you envision happening to 
participants in the existing programs, specifically Renewal 
Communities, and do you see them applying and being accepted as 
Opportunity Zones?
    Secretary Snow. Senator, as I understand these programs--
and I am not an expert on them--the President's proposal is 
designed to be in addition to accompany the sort of program you 
are talking about, not in lieu of.
    Senator Bunning. In other words, an add on?
    Secretary Snow. Yes, yes. It is complementary to it. It 
does not withdraw it. It adds onto it. But I will have to----
    Senator Bunning. In other words, from what my quick--and it 
is quick when you get books about that thick--there is no cuts 
or no reduction in the funding for those other programs?
    Secretary Snow. I think the funding remains. The proposal 
would call for the establishment of a number of new zones, 28 
urban, 12 rural, to be designated by the Commerce Department, 
who would select the zones through an application process 
designed, as you say, for distressed areas, focusing on what I 
think the words of art are, communities in transition. The idea 
is some communities have been hard hit by changes in the 
economy, and these economies in transition who had a steel 
plant or a textile mill or something----
    Senator Bunning. Under the current--I do not want to get 
into a confrontation--but under the current set up, Renewal 
Communities give tax breaks to companies to move there.
    Secretary Snow. Right.
    Senator Bunning. Are you saying that those things that you 
talked about would do likewise? In other words, the new zones 
you are talking about?
    Secretary Snow. Yes. There is a provision for income tax 
exclusion inside these--tax advantages inside the zones for 
enterprises inside the zones, but I will give you a full layout 
on it once I understand it better myself.
    Senator Bunning. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator Bunning.
    Senator Sarbanes.
    Senator Sarbanes. Mr. Secretary, I know you all are looking 
for a crisis and you seem to think you have found it with the 
Social Security system because you project, and I think you use 
the earliest date of the estimates, that in 2042 the amount of 
money going out will be greater than the amount coming in, and 
at that point it will be able to pay about 75 percent of the 
benefit levels. You all are using 2042; CBO says 2052. So that 
is about 45 years away.
    I want to submit for your thoughtful consideration some 
other crises that seem to me to be looming right in front of 
us. One is the internal budget deficit crisis. The deficit now 
is, in nominal terms, the largest it has ever been, if I am not 
mistaken. Is that correct?
    Secretary Snow. In nominal but not real terms, yes.
    Senator Sarbanes. When you say real terms you are talking 
about percent of GDP?
    Secretary Snow. No. Even, I am talking about real dollars, 
inflation adjusted dollars.
    Senator Sarbanes. I noticed the Budget Director yesterday, 
when he talked about cutting the deficit in half, used percent 
of GDP. He did not refer to the dollar figure. Is that how the 
administration is now treating the budget deficit when they 
make these statements?
    Secretary Snow. I think the reason the Budget Director is 
using that formulation is probably the most authoritative way 
to look at it, the best way to look at it, because it is the 
way you would look at the mortgage on your house, it is 
relative to your income.
    Senator Sarbanes. Is that the formulation you use now? Has 
the administration in a sense shifted over, and is now using 
that formulation to talk about the budget deficit?
    Secretary Snow. Senator, I think we are talking about in 
both nominal terms, those dollars terms, and as a percent of 
GDP.
    Senator Sarbanes. Do you regard the budget deficit as a 
serious problem?
    Secretary Snow. Yes, I think the deficit is a serious 
problem and one that needs to be addressed.
    Senator Sarbanes. Is it serious enough to be categorized as 
a crisis?
    Secretary Snow. No, not the deficit inside the window 
because we are bringing it down to a level that is low by 
historical standards, but long term, the deficit reflected in 
Senator Conrad's charts is certainly something that seems to me 
to be a looming crisis anyway, to use President Clinton's 
phraseology on it.
    Senator Sarbanes. That trend line takes off in 5 years.
    Let me shift to the other crisis. I am concerned about 
these figures. This is the U.S. current account deficit. In the 
early 1980's we had a positive situation and then we started 
moving this way. But look at what has happened to our current 
account deficit over the last five or 6 years. It is 
incredible. We are now over $600 billion in the current account 
deficit, which of course reflects in large part what has 
happened with this rapidly deteriorating U.S. trade deficit. So 
we are now here. The figures are at record levels. Am I right 
in asserting that, that the figures on the trade deficit and 
the current account deficit are at record levels?
[GRAPHIC] [TIFF OMITTED] T1173.116


[GRAPHIC] [TIFF OMITTED] T1173.117


    Secretary Snow. Yes.
    Senator Sarbanes. Far beyond anything we have experienced 
in the past. Would that be a fair statement?
    Secretary Snow. Yes, Senator, as is our GDP.
    Senator Sarbanes. What am I to conclude from that?
    Secretary Snow. That there are a number of things that are 
growing.
    Senator Sarbanes. Including the deterioration in our net 
international investment position. Look at this chart. This is 
for 2003. It does not reflect 2004. 2004 is going to add 
another 600 billion to that. It is going to take us over $3 
trillion into a negative net international investment position. 
This is claims that people abroad, or governments abroad, are 
holding against us, correct?
[GRAPHIC] [TIFF OMITTED] T1173.118


    Secretary Snow. Certainly.
    Senator Sarbanes. In fact, have not the purchases of dollar 
assets in recent times been made primarily by the central banks 
in China and Japan?
    Secretary Snow. Yes, they have made substantial purchases 
of our debts.
    Senator Sarbanes. Do you think they are doing that in order 
to influence or impact the currency valuations and therefore to 
gain a trade advantage?
    Secretary Snow. No. I think they view the U.S. market as a 
good place to make investments.
    Senator Sarbanes. But not the private sector. There has 
been a shift from the private sector to the public sector, so 
these investment decisions now are being made by central 
bankers in China and Japan, correct?
    Secretary Snow. Certainly they have increased their 
holdings of U.S. treasuries.
    Chairman Gregg. Senator, I do not want to interfere with 
your line of questioning, but you are a bit over your time.
    Senator Sarbanes. All right. I will close, Mr. Chairman.
    Let me just make this point to you. I think they are 
manipulating the currency. You tell the Chinese to go to 
flexible exchange rates. All the experts tell us they cannot 
really do that right now without a serious banking crisis, and 
I cannot for the life of me understand why you do not shift 
your objective to getting them to reset the peg at least, which 
they could do without precipitating a banking crisis. You say 
flexible rates. All the experts say, ``Well, the Chinese cannot 
do that. They will have a banking crisis.'' But they can repeg 
and not have a banking crisis, and it seems to me that at least 
ought to be one administration objective.
    Chairman Gregg. Could you answer that question?
    Senator Sarbanes. Thank you, Mr. Chairman.
    Secretary Snow. Yes, Senator. We are in close and intense 
discussions with the Chinese. It is probably not best if I go 
into any detail about the nature of those discussions. I am 
encouraged by them even as I would like to see them move 
quicker. They are making progress on their financial 
institutions. They have indicated their commitment to move to 
greater flexibility, that is, a mean total flexibility, greater 
flexibility, which I think would accomplish the objective you 
are suggesting there.
    Chairman Gregg. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I would like to 
change the focus of some of the discussion here a little bit, 
and talk a little bit about your efforts to increase 
collections of those who are not supposedly paying their taxes. 
I have served in State legislature where proposals came in that 
said, ``We are going to improve our enforcement,'' and it never 
quite measures up. I have been here in the Congress where they 
said, ``Well, we are going to improve our enforcement,'' and 
never quite measures up.
    My question on the figures that you are giving us, where 
they can collect $255.2 billion less than what the taxpayer 
owes, I would like to know how you are figuring this out. 
Sometimes I think what they give us is a gross figure. They do 
not figure in the cost of collection. Lots of times you have to 
take it to court or whatever, you have to pay attorney fees, 
and take time and everything from your staff. You got to hire 
sometimes new employees and they do not get figured in. Can you 
shed a little bit of light on how you arrived at that figure?
    Secretary Snow. Senator, the figure you are talking about 
is this so-called tax gap figure?
    Senator Allard. Yes. You are estimating that you collect, 
the IRS collects $255 billion less than taxpayers owe.
    Secretary Snow. Right. Senator, I do not put a lot of 
confidence in these tax cap numbers. We know there is a big 
number out there. We know that we can do better, but I must say 
that the tax cap numbers are not intellectually very satisfying 
to me, as I look at them.
    Senator Allard. I am glad to hear you say that because I am 
having the same problems.
    Secretary Snow. I have talked about this with the IRS 
Commissioner, and there really is not, to be frank about it, 
any reliable estimate of the tax cap. We know it is big, we 
know it is sizable. It could be bigger, it could be smaller. I 
do not know. I am looking forward to getting the current study 
which is under way, updating this data, which I think is 17-, 
18-years-old. We really need better data, and I know Senator 
Conrad has an interest in that, the chairman does, you do, and 
as soon as we get this updated study I want to give it to you 
and make sure that it is available. But right now I think we 
are in a state of ignorance, frankly.
    Senator Allard. They are asking for more money to carry 
this out, and as I think as policymakers we need to make sure 
that there is some validity. I am glad to hear that you are 
going to try and update your figures, at least your methods of 
trying to do that.
    Secretary Snow. Right.
    Senator Allard. On tax simplification, you know there is a 
level there where it just does not pay to fuss with the 
taxpayer because the cost of collection is more than what it I 
worth. I have had constituents come to me and say, ``You know I 
had $45 I owed the IRS, and I paid it. Then they billed me 
again, and I paid it, then they billed me again and I paid it, 
because I did not figure it was worth messing around for 45 
bucks.'' But in a way it is not fair to the taxpayer. Do they 
make any kind of assumptions that, well, you know, ``If it is a 
low amount we will just keep hassling them until they finally 
break in. We do not care whether they are innocent or guilty.'' 
Would you respond to that?
    Secretary Snow. I think as with all laws--and laws need to 
be enforced--there is also a need to enforce them with a good 
deal of common sense, and one of our objectives for the IRS is 
that they enforce the law fairly and effectively, they go after 
real tax cheats, but they do so with a well-developed sense of 
good common sense as well, so that taxpayers are not harassed.
    Senator Allard. It seems to me that any proposal we have on 
tax simplification, we might look at simplification of 
enforcement, and kind of bring up some common sense proposal 
into it.
    I see I have some more time, so I want to talk to you a 
little bit about, or listen to you about what you are thinking 
about tax simplification. I would hope that does not include 
tax increases. I would hope that it is truly simplification. I 
want to hear from you what you think is most practical in 
today's environment.
    Secretary Snow. This was a subject of conversation with two 
of your form colleagues, the two Senators, who will be Connie 
Mack, who is the chairman, and John Breaux, who is the Vice 
Chairman of this panel. They have been asked by the President 
to look at this issue of simplification and fairness and 
growth. When you get to simplification, Senator, as you know, 
somebody who has lived in this world of taxes, simplification 
means getting at the things that create complexity and the 
things that create complexity are credits, preferences and 
deductions. And Senator Mack and Senator Breaux, and 
Congressman Frenzel, who is also on this panel, as well as the 
other panel members, but those particularly, understand the 
give and take of simplification because one person's 
simplification is the removal of somebody else's equity. But 
they have pledged to come forward with their best efforts to 
give me and ultimately the President the best thinking they can 
come up with on what a sensible simplification would look like.
    Beyond that I do not think I should try and foreshadow what 
they might do.
    Senator Allard. Thank you for your comment. I see my time 
has expired.
    Chairman Gregg. Thank you, Senator.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman.
    Welcome, Mr. Secretary. First of all I want to identify 
with a number of the remarks that Senator Sarbanes made, but 
with regard to the negotiations on adjustment of the currency, 
those numbers are serious and at some point cumulatively create 
huge risks in our financial markets, and at least my experience 
would say if we do not start seeing some change in our 
position, trade position and current account position, there 
will be tough times at some point that tend to happen in short 
bursts as opposed to something that you can see over a period 
of time.
    I actually want to ask some questions that are sort of 
definitional, and then I would like, if I have time, to get to 
will somebody be better off under Social Security reform as 
propositioned by the President?
    First of all, I do not think companies go bankrupt--I was 
watching the hearing--when they have unfunded liabilities or 
health benefits. They have a period of time to adjusts. Is that 
not correct, Mr. Secretary?
    Secretary Snow. Yes, Senator, but I was not talking about 
pension plans. I was saying that Social Security is going 
bankrupt in the same sense that a private company goes bankrupt 
when it cannot meet its obligations. That is the sense of the 
word I am using.
    Senator Corzine. But it is in the same context as there are 
obligations that are contractually put in place for pensions 
and health benefits, and we have it with regard to our 
entitlement projects, and that by one estimate 2042, and the 
other 2052. I think it is very confusing if not misleading to 
say that Social Security is bankrupt, and by any comparison 
with any other standard. And then when you tie it to Chapter 7 
and 11, there is no comparison since we can meet all our 
financial obligations up until 2042, just from a standpoint of 
definitions.
    Secretary Snow. I understand, Senator, but it is in 2042, 
call it what you want, the system can no longer meet its 
heretofore promised obligations.
    Senator Corzine. Unless we do something.
    Secretary Snow. Right. We need to do something.
    Senator Corzine. I think we all agree we need to do 
something. So bankrupt I think is a term that probably does not 
fit this current situation.
    On valuations of stock I heard a very interesting 
conversation about what drives stock markets. I do not know. 
Last time I took a finance course somebody told me discounted 
earnings flows over a long period of time are what people look 
at as what drives stock values as opposed to dividends and 
capital gains because it is a combination of all those things, 
and the earning power that people think. Have you seen the 
studies out that show that since we have cut the dividend rate 
that stocks that pay dividends have done more poorly than 
companies that have retained earnings? If you have not, I would 
be happy----
    Secretary Snow. No, I have not.
    Senator Corzine. I would be happy to just--this is under 
Davis Research, and I think actually there are a number of 
places. I would like to put in the record a Monday, January 
31st Wall Street Journal article that would point out that 
companies that have been paying dividends, increased their 
dividends, have done less well than companies that have 
retained earnings. I think there are some--all of us are going 
to talk about what is correlated to the power of earnings, but 
I think we have had 10 percent growth in earnings in the last 
couple of years, and it probably has something to do with what 
marginal comeback we have had in the stock market.
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    [GRAPHIC] [TIFF OMITTED] T1173.357
    

    [GRAPHIC] [TIFF OMITTED] T1173.358
    

    Senator Corzine. Another question I have, Mr. Secretary, 
over and over I hear about how small businesses have benefited 
from rate cuts, and I really think we ought to get the facts on 
the table because there is so much assertion that small 
businesses are the ones that are benefiting. According to the 
work that a number of analysts have done, and I think they have 
done this very specifically, only 436,000 of the tax filers 
with small business income, that is 1.3 percent of 32.8 million 
filers, actually were operating at the top tax rate. I suspect 
you will then translate that into who created jobs, is it those 
1.3 or is it the 32.8 million filers. But do you believe that 
the top tax rate is driving the job creation in small business?
    Secretary Snow. Yes. I think the tax cuts overall, 
including the expensing, taken cumulatively and in the 
aggregate have certainly helped job creation. And small 
businesses, what do they do? They create 7 jobs out of 10 or 
something.
    Senator Corzine. 32.8 million of filers are not operating 
at the top tax rate, and actually the numbers are not so 
impressive even at the second rate. I think the question was 
framed in the context of if you were dealing with a top tax 
rate relative to choices we had to make on strategic 
investments in education or strategic investments in research 
and development. I see the red light.
    Chairman Gregg. OK. You can continue that line of 
questioning.
    Secretary Snow. Senator, if you are asking me whether I 
think we should fail to make the tax cuts permanent, my answer 
is no. I think we should sustain the tax reductions because by 
doing so we avoid a tax increase, and tax increases I think 
would be not consistent with sustaining the sort of growth in 
the economy we want to see. Right now, as Senator Conrad and I 
discussed earlier, we are seeing the revenue line of the U.S. 
Government, the top line of the U.S. Government with the tax 
increases rise and improve, and revenues this year so far are 
up about 10 percent for the Federal Government, and I think the 
lower tax rates are helping get the economy stronger with more 
jobs, more profits, which is leading to higher tax revenues for 
the Government.
    Senator Corzine. Maybe Microsoft had something to do with 
that dividend and the repatriation of profits from overseas, 
but it is worth an analysis.
    I do have the request that I would love to see the Treasury 
put together numbers so that we could once and for all analyze 
whether the top tax rate is really applying to small business. 
And I know it has to include S-corps and all the other elements 
of it, but we hear that argument so much that it would be 
worthwhile having some definitive objective research on that 
made available.
    Thank you.
    Chairman Gregg. Thank you, Senator. Are there Senators 
who--did you have some second questions?
    Senator Domenici. Yes.
    Chairman Gregg. Why do you not go?
    Senator Domenici. After we finish with me we are done?
    Chairman Gregg. After we finish with you, we are going back 
to Senator Conrad and then if Senator Corzine wants to go 
again, we will do it.
    Senator Domenici. Mr. Secretary, I just want to spend my 
time on Social Security. If you do not mind, can we talk 
together about it? We are using this data, 2042, and some 
people use the word bankrupt and others say it is not bankrupt. 
What happens in 2042 if we do nothing, and assuming some 
reasonable path of growth and all the other things we say?
    Secretary Snow. Senator, in 2042, if nothing is done in the 
interim, according to the actuary of the Social Security 
system, the trust fund will have insufficient revenues to pay 
out the prior level of benefits and will only be able to pay 
out benefits at about 72 percent of the former level, 72 cents 
on the dollar of the former benefits that had been paid.
    Senator Domenici. So are we saying that if we do nothing, 
at that point in time everybody that is getting a check from 
Social Security will get reduced by 28 percent, and those who 
are waiting in line and not yet there, their expectation is 
rather bleak as to what their benefit is going to look like. Is 
that correct?
    Secretary Snow. Yes, they will take a big haircut on their 
benefits. That is right.
    Senator Domenici. Now, when we use the 2018 to 2020 number, 
what are we talking about?
    Secretary Snow. Senator, the 2018 number, which is a very 
important year, is the first year that the withdrawals from 
Social Security, the payments out are greater than the payments 
in, the inflow. The outflow exceeds the inflow for the first 
time, and that will continue in every year thereafter.
    Senator Domenici. OK. Now, Mr. Secretary, whatever you call 
it--bankrupt or the 2018 phenomenon--those are dates when 
Social Security, the program, there are signals of serious 
trouble, and then in 2042 there is big trouble because the 
checks are going to be dramatically reduced. Is that correct?
    Secretary Snow. Precisely. That is exactly what happens.
    Senator Domenici. Now, the question is: Should we try to 
fix it later or sooner? My question to you is: Will it be 
easier to fix it now for our seniors, or will it be easier to 
fix it later?
    Secretary Snow. Senator, I can quantify that. It is much 
easier to fix it now. If we look at just the arithmetic, fixing 
it now through--say you wanted to fix it through a benefit cut, 
or you wanted to fix it through a tax increase--I am not 
recommending either, but I am just giving you the arithmetic. 
Today it could be fixed with about a 3.5-percent change in 
either. If we wait out in the future there, 2042, it is double 
that. It takes a 6.5- or 6.6-percent change to fix it. So you 
would be adding a 6.5-percent tax in 2042 to fix it to the 6.4 
that you pay today--the 6.2 that you pay today. So you would be 
doubling the tax on the individual in 2042.
    Senator Domenici. Let's just stay with that. What we are 
saying is if we just wait around and the crisis occurs, the 
people paying in--that is our grandchildren and young workers--
they will have to pay almost twice what we are taking out of 
their payroll checks now to make this fund solvent.
    Secretary Snow. That is right, Senator.
    Senator Domenici. So out there in America, for the young 
people, they can expect that they will not get their checks in 
toto, they will be dramatically reduced, or they will take out 
of their paychecks twice what is being taken out now.
    Secretary Snow. That is right. They will have a huge tax 
increase.
    Senator Domenici. I assume that is what the young people 
understand. I have seen young people who get a payroll check 
for the first time, and they say--they come home, two of my 
daughters, and say, ``I thought I was in a low bracket. Look at 
how much they took out of my check.'' Well, it was the Social 
Security they were looking at. So that would be double what it 
is now, more or less.
    Secretary Snow. That is right, Senator. That is right.
    Senator Domenici. Now, when we speak of repairing this 
system sooner rather than later, we are talking about in the 
case of the President's notional fix, notional repair, taking a 
piece of that money that is going to into the fund and 
investing it. And let's just look at that by itself, just that. 
You are investing it. Can you give us, in some way that we 
would understand, how much more is generated that goes into 
these personal accounts than if the money was invested as it is 
now in Social Security, compounded? Do you have a chart showing 
that or can you give us that?
    Secretary Snow. Yes, Senator, I will be happy to supply 
that. I can give it to you sort of rough and ready. If you are 
an average wage earner born in 1985, 20 years old, you would be 
retiring in 2050. If the system could pay out to you in 2050 
what it promises, you would get $20,000. You would get almost 
$21,000. Unfortunately, the system can only afford to pay you 
$15,000. So that is that haircut I talked about.
    If that individual now took advantage, that 20-year-old 
took advantage of the opportunity to withdraw some of their 
money and put it into these personal accounts, by our estimate 
they would--and this is earning just the average sort of market 
return of a mixture of debt and equity--they would end up with 
$17,000. So rather than the $15,000 that the system could pay, 
they would get $17,000. And that comparison gets better with 
every cohort going out because the system becomes less and less 
and less capable of paying benefits over time.
    Chairman Gregg. Thank you, Senator.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Mr. Secretary, what are the estimates of economic growth 
that underlie the forecast that Social Security will not be 
able to meet its payments in 2042, according to the Social 
Security Administration, or 2052, according to CBO?
    Secretary Snow. Senator, I think the growth rates for GDP 
are something like 1.8, 1.9, something on that order.
    Senator Conrad. Yes, that is correct.
    Secretary Snow. Going forward.
    Senator Conrad. And what has been the economic growth rate 
over the last 75 years?
    Secretary Snow. It has been considerably higher than that 
because of the combination of productivity and population 
growth for the last 50 years. Population growth, demographic 
growth, has been much higher than the actuary sees for the next 
40 years.
    Senator Conrad. Let me just say that Senator Domenici has 
commented in the past on productivity growth. Something is 
happening with productivity growth that we do not fully 
understand. We have had much higher rates of productivity 
growth than were anticipated by anyone, I think it is fair to 
say.
    So one of the concerns I have about these projections in 
Social Security, first of all, they are 75 years. Second of 
all, they are really very pessimistic, 1.8-percent economic 
growth when we have had 3.4-percent economic growth in the 
previous 75 years. That is the first, I think, important fact 
to know.
    Second, Senator Domenici had suggested that some of us do 
not think you need to do Social Security, do Medicare first. I 
want to make clear my own position is I think we need to do 
both. I think we need to do both. The fact is the head of the 
General Accounting Office told us the shortfall in Medicare is 
8 times the shortfall in Social Security. So I urge the 
President to deal with Social Security and Medicare.
    Senator Domenici said, well, he has not heard any proposals 
on Medicare. I will give you four quick proposals on Medicare. 
No. 1, 5 percent of the people use 50 percent of the money. We 
ought to focus like a laser on that 5 percent by better 
coordinating their care. In the pilot projects we have run to 
do that, we have saved dramatically in expenses, we have 
reduced hospitalization substantially, and we haveten better 
health care outcomes. So that would be No. 1.
    No. 2, I think we ought to go back and look at the $10 
billion slush fund we provided the Secretary of HHS to sweeten 
the pot for private accounts.
    Third, I think we ought to look at the $40 billion we are 
giving private accounts over and above what traditional 
Medicare pays.
    Fourth, I think we ought to look at reimportation from 
Canada.
    Fifth, I think we ought to allow Medicare to negotiate 
lower drug prices. They are specifically precluded under the 
law from doing that.
    So if we want suggestions, I think it is--I welcome the 
Senator's call for that. I think that is exactly what we need. 
I think we need to have everybody come with their best ideas, 
and we need to work on Social Security and Medicare, and I 
think tax reform, too. There was a question about the tax gap. 
The tax gap that your IRS agency has developed, 2001, $300 
billion tax gap, the difference between what is owed and what 
is paid. Unfortunately, that is based on a modeling of economic 
behavior that is 17 or 18 years old, updated for 2001 figures. 
I think it badly understates the tax gaps. As a former tax 
administrator and the former chairman of the Multi-State Tax 
Commission, I have spent a good deal of time analyzing those 
numbers--with your people, by the way, Mr. Secretary--and I 
believe we will find in the new analysis that the tax gap is 
really much larger.
    And so when I say we need to bring revenue to the table--
and I know some of my colleagues immediately assume that is a 
tax increase--that is not necessarily the case, is it?
    Secretary Snow. No. I agree.
    Senator Conrad. If we could find a way to effectively 
capture part of that tax gap--and, by the way, that is why I 
think tax reform has got to be on the table here as well, 
because I do not think you are going to capture as much as we 
need to just by jiggering with the current system. The current 
system is a horse-and-buggy system that was devised largely in 
the 1930's, and we have to go back and do a much better job of 
improving the efficiency of the system.
    Secretary Snow. Senator, I think your former colleagues who 
are chairing this panel, the tax panel, share those sentiments 
entirely.
    Senator Conrad. Let me just conclude with--let me show 
that. This is where I have a profound disagreement on where you 
say this is all headed. This is your assertion of what is going 
to happen to the deficit in the coming 5 years, but you get 
there by leaving out a lot of things. It is sort of like a 
family having a budget and they say, gee, things are really 
going well, if we just leave out our mortgage payment and our 
car payment. But that is not the way it works with a family, 
and that is not the way it works with the U.S. Government. And 
you all have just left out a lot of things, like the war costs 
past September 30th of this year, like the need to fix the 
alternative minimum tax, a whole series of things that have 
just been left out.
    When we put those things back in, here is what we see as 
the pattern, somewhat of an improvement, but then when we get 
past the 5-year budget window and the full cost of the 
President's tax cuts come in, the situation further 
deteriorates. And, you know, in a way this does not even 
capture what is happening.
    So I would just say to my colleagues, I do not think I see 
anything that is very serious about dealing with this deficit. 
And for those who now say deficits do not matter, I think that 
is a preposterous position. Do you believe deficits matter, 
Secretary Snow?
    Secretary Snow. Absolutely, Senator. I think you and I have 
talked about that. They do matter. They make a big difference. 
Financial markets are watching this. We have to make sure that 
black line never materializes, and there would be serious 
consequences to pay if it did. So the administration knows, the 
President knows that these deficits are too large, that they 
matter, and we have to reduce them.
    Could I just offer one thought, though, on your 
observations on GDP growth and productivity growth and Social 
Security? Social Security is really not driven by GDP growth, I 
mean the problem there, because higher GDP growth translates 
into higher wages, and given the benefit formula, that 
translates into higher obligations, so you cannot grow your way 
of out the Social Security deficit problem given the formula or 
given the current rules of the road.
    Senator Conrad. Mr. Secretary, you and I would agree on 
that. That is why I do believe Social Security has got to be 
addressed as well as Medicare, as well as tax reform. It would 
help--I mean, obviously if you have higher rates of economic 
growth, that helps all of our challenges of meeting our long-
term budget obligations. And it is really those long-term 
budget obligations that are our central problem. I think you 
and I would agree on that.
    Secretary Snow. Absolutely.
    Senator Conrad. The real problem we are going to have, as 
the chairman has said, is how are you going to redeem those 
bonds. The Social Security Administration holds these bonds. 
They are backed by the full faith and credit of the United 
States. They are going to get paid. But how are they going to 
get paid? That really is the challenge before us.
    Secretary Snow. Exactly.
    Senator Conrad. Thank you.
    Chairman Gregg. Thank you.
    Do you have any additional questions, Senator Corzine?
    Senator Corzine. I will be very quick. Mr. Secretary, does 
the privatization formulation address that 30-percent gap? Does 
it provide for solvency 2042 and out?
    Secretary Snow. Senator, we call them personal accounts 
rather than private accounts because we really do not view what 
we are doing as privatizing Social Security. But the personal 
accounts, while not alone addressing the gap, are, I think, 
part of an overall solution. They are an integral----
    Senator Corzine. Just dealing with the solvency issue, do 
personal accounts accommodate the language? Do they deal with 
the solvency issue?
    Secretary Snow. The underlying purpose, as I understand it, 
of Social Security is the retirement security of the 
individuals who are in the system. And if that is the overall 
objective, which I think it has to be, then the personal 
accounts play a critical role in achieving the underlying 
objectives of Social Security.
    Senator Corzine. Financially?
    Secretary Snow. But alone they do not deal with the 
financial problem. They have to do it in concert with other 
things.
    Senator Corzine. What is the real rate of return and then 
the nominal rate of return that you use to get to this $3,000 
discount from the benefits that were talked about?
    Secretary Snow. I think it is a 3-percent real rate of 
return.
    Senator Corzine. A 3-percent real rate of return, if I have 
done my numbers right, will give you a bigger discount than 
$17,000 for your individual. But I would like to know 
specifically what it is, the rate of return that is built 
into----
    Secretary Snow. I am sorry.
    Senator Corzine. Both the break-even----
    Secretary Snow. The 3-percent is break-even; 4.5, I think, 
or 4.6 gives you the $17,000 I talked about. Three is the 
break-even.
    Senator Corzine. That is the 7.5 percent that you are using 
that is the average nominal yield over the extended period of 
time.
    Secretary Snow. Yes.
    Senator Corzine. To get back to the $20,000 mark, what 
would be the rate of return, the nominal rate of return that 
would be required?
    Secretary Snow. I think you need an equity rate of return, 
6.7 or something.
    Senator Corzine. Above the base.
    Secretary Snow. Yes, real.
    Senator Corzine. Something in the 11-percent----
    Secretary Snow. Nominal, yes.
    Senator Corzine. Right. I think these kinds of questions--
and, you know, I wish I could guarantee myself I was going to 
make 11-percent nominal rates of return over a historic period 
of time compounded. That is presuming that you would make that 
in this 50-year timeframe that you are talking about.
    Secretary Snow. Yes. The----
    Senator Corzine. Regardless of pattern or when you retire 
or----
    Secretary Snow. It is the average, yes, over the period.
    Senator Corzine. The question that I think is fair to ask 
is: Looking at different points in history, what is the 
probability of those kinds of returns, whether it is the 7.5 or 
11, applying to any cohort set of retirees? And any way you 
look at it, there is some risk factor that you have to assign 
to whether that is at all probable. You know, I think we all 
talk in certain terms. Those of us who are not particularly 
thrilled with personal accounts would say we are not--we are 
probably focusing too much on one element of risk. I think 
there is an ignoring of risk with regard to those kinds of 
returns actually coming to pass.
    Secretary Snow. Senator, the returns we are citing are the 
40-year averages for blended--you know this better than I do, 
but blended stocks and equities and a full equity and various 
ratios. But I think the 4.5, 4.6, with a fund over 50 years or 
40 years of bonds at 40 percent and equities at 60 percent 
produces that 4.6.
    Senator Corzine. If you go back and look at any given 
starting point, though, you get different patterns for each 
cohort that started work and then retired. It is just--I think 
too often we talk in certainties, and, frankly, I was surprised 
to hear you say, you know, you are going to come up $3,000 
short relative to what you would get under Social Security if 
we did some of that tinkering around that Senator Domenici was 
talking with you about, you know, got another Greenspanian 
commission to sit down behind closed doors and come out and 
give us the ability to say, well, let's tinker with this 
variable or that variable and get this resolved, which I think 
most people----
    Secretary Snow. I do not think tinkering--the problem, 
though, is that tinkering will not solve it. As I say, if today 
the system is out of kilter by 3.5 percent on benefits or 
taxes, it is out by 6.5 percent in 2042. Those are the 
actuary's numbers. That is a doubling of the taxes on 
individuals.
    Senator Corzine. If you wait--and I think all of us agree, 
from whatever perspective, that doing something now is a heck 
of a lot easier to solve this problem. Even your own example 
does that.
    Secretary Snow. Right. Senator, I think there is more to 
agree on here than disagree on. I think there is a sense that 
there is a real problem, that the sooner you act, the better. I 
think President Clinton--I like his formulation of the issue. 
It is ``a looming crisis.'' He said that in 1998. So it is 
coming in a little closer on us. If it was looming then, it is 
looming-plus right now.
    Senator Corzine. Thank you, Mr. Secretary.
    Chairman Gregg. I just do have to comment on this because I 
spent so much time on this issue and was there with President 
Clinton when he called this ``a looming crisis,'' and I had a 
bipartisan bill which did address this issue, and we did adjust 
benefits. We adjusted tax rates, and we created personal 
accounts. But the point, of course, here--and I think you, Mr. 
Secretary, put it in numerical terms, but I think it is 
important to put it in personal terms, which is that if you 
were to guarantee the benefit of Social Security as it exists 
today to a person who retires in the year 2042, that benefit, 
the $20,000 you are talking about in today's dollars, would 
cost the working American, our children and our grandchildren, 
a doubling of their tax burden, which would mean that their 
lifestyle would be radically reduced. Their ability to send 
kids to college, their ability to buy a house, their ability to 
buy a car, their ability to live a good lifestyle would be 
radically reduced by the need to support my generation which 
would be retired. And that is what this is about.
    Secretary Snow. That is right.
    Chairman Gregg. We as a generation, because we are the 
baby-boom generation which is so disproportionately larger than 
every other generation in the history of this country, have an 
obligation to fix the Social Security system before we hit it 
and put that burden on our children where they live a lower 
quality of life because they have to support us. And that is 
what this administration stepped up to the table on. I regret 
that members on the other side, especially in the House, are 
saying there is no problem, because there is a problem. Whether 
you call it ``looming,'' whether you call it ``crisis,'' 
whether you call it ``bankruptcy,'' our children are going to 
face the largest intergenerational tax increase since the drug 
plan, which was an inexcusable act, if we do not fix this 
situation for them.
    And so I at least congratulate the administration for 
stepping up to the issue. I hope we can reach consensus on it, 
and one legitimate way to do it is to use personal accounts to 
assure that at least our children have some asset which they 
own, which they will actually retire with, or which, should 
they unfortunately get hit by a truck before they retire, can 
pass to their children.
    So I congratulate you on creativity. Thank you for your 
time. You have been very generous with it.
    Secretary Snow. Thank you very much, Mr. Chairman.
    Chairman Gregg. We appreciate it.
    [The prepared statement of Secretary Snow follows:]

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    Chairman Gregg. The hearing is adjourned.
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                    TRANSPARENCY OF BUDGET MEASURES

                              ----------                              


                      WEDNESDAY, FEBRUARY 16, 2005

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Wayne Allard, 
presiding.
    Present: Senators Allard, Domenici, Ensign, Conrad, and 
Nelson.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Jim Hearn.
    Staff present: Mary Ann Naylor, Staff Director; and John 
Righter.

   OPENING STATEMENT OF ACTING CHAIRMAN SENATOR WAYNE ALLARD

    Senator Allard. I am going to go ahead and call the Budget 
Committee to order. We will have other members, I am sure, that 
will be attending this morning. We have some pretty stiff 
competition as far as testimony in front of the other 
committees, but I think we have the real expert here before us.
    Dr. Holtz-Eakin, I look forward to hearing your comments. 
And despite some of the competition, this does remain a very, 
very important hearing. We are going to be examining some of 
the fiscal demands of Government in the short term, and 
probably even more importantly in the long term, as they evolve 
over a number of decades, weighing the costs and the benefits 
of every dollar taxed and spent. And I think that is the role 
of this committee.
    I do not think we can underestimate the value of 
understanding the Nation's fiscal exposure, particularly when 
we look at such programs such as Medicare, which I think is 
very obvious. We have the other two big programs out there that 
we share concern with, that is, things like Medicaid and Social 
Security. But I anticipate we will focus most of our time on 
Medicare. But we also have other long-term liabilities out 
there that I am concerned about, and I think other members are 
concerned about, for example, the Pension Benefit Guaranty 
Corporation, and things like AFDIC and FDIC and other programs 
that I do not think some Members of Congress have thought too 
much about our future obligations, but potentially there are 
future exposures out there, and we need to at least give them 
some thought.
    I think each one of these trust funds--or programs, or 
trust funds in some cases, where we have these significant 
challenges and demands, I think we need to spend some time to 
study them, and I think that is what the chairman of the Budget 
Committee, Senator Gregg, had in mind when he set up this 
hearing. So we will try and focus on that, and I want to thank 
in advance Senator Conrad for his help in conducting this 
hearing with us this morning. This is a bipartisan effort this 
morning.
    With that, let me call on Senator Conrad for a few 
comments.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. First of all, I thank Senator Allard, who 
is acting as chairman for us this morning. I agree with you. I 
think this is very, very important because we are starting to 
talk now about our long-term obligations and the shortfall that 
we are experiencing in those long-term obligations.
    Let me just put this up. This was recently in Business 
Week. This is what they said: ``There are no good reasons for 
hiding the cost of all these endeavors or denying their 
consequences. New private retirement accounts could cost $1.5 
trillion from 2011 to 2015 and add $100 billion a year to the 
budget deficit for 20 years. Making tax cuts permanent could 
cost $2 trillion. Fixing the alternative minimum tax could cost 
an additional $500 billion. These are real numbers that should 
be included in any real budget. If President Bush believes the 
policies proposed are best for the Nation, then he should lead 
an honest dialog about how we should pay for them.''
    Mr. Chairman and Director Holtz-Eakin, I agree with that. I 
think we have a runaway train on our hands, not just in the 
short term, but more seriously, I think, in the long term.

[GRAPHIC] [TIFF OMITTED] T1173.138


    Let's go to the next chart. As I look at the budget and I 
see what is left out--full 10-year numbers are left out. We all 
know what that means because the tax cuts go up dramatically in 
cost the second five years. There is no funding included for 
the Iraq war beyond this next fiscal year; alternative minimum 
tax reform; Social Security privatization transition costs. I 
am told now that the cost of Social Security privatization 
costs over 20 years is approaching $5 trillion. And we have no 
discretionary spending policy details past fiscal year 2006. 
Highly unusual.

[GRAPHIC] [TIFF OMITTED] T1173.139


    Let me go to the next chart. When we put all these things 
back in, here is what we see. The President's budget shows the 
deficit improving, but when we put all the things back in that 
have been left out, we see the deficit improving slightly over 
the next 4 or 5 years, but then going back in the wrong 
direction. And all of this kind of hides our real long-term 
situation.
    The Comptroller General was here the other day and 
testified we have $43 trillion of obligations that have not 
been covered, of unfunded obligations, $43 trillion, most of 
that is for Medicare, $27 trillion for Medicare. Social 
Security was about one-eighth that amount.

[GRAPHIC] [TIFF OMITTED] T1173.140


    My own conclusion is we have to be addressing all of these 
things. We have to be addressing the imbalances in Medicare and 
Medicaid and Social Security. We have to address the budget 
deficits. All of that I think is going to require not only 
spending discipline, but fundamental tax reform.
    One other comment I would like to make because I think this 
is also critical to our understanding of the problem. The long-
term economic growth assumptions of the Social Security 
Administration are 1.8 percent a year. That is what they are 
forecasting the economic growth will be over the next 75 years. 
If we look at the previous 75 years, growth has averaged, as I 
understand it, about 3.4 percent. Now, the major difference is 
we have a dramatic reduction in new entrants to the work force. 
But that is really a very pessimistic outlook.
    I asked the Social Security Administration to tell us what 
would happen if productivity growth was 2.6 percent instead of 
1.6 percent. They told me that Social Security's funding 
shortfall would decline by more than half, from 1.8 percent of 
payroll to 0.82 percent of taxable payroll. If average 
productivity growth doubled to 3.2 percent, then Social 
Security's funding shortfall would decline 90 percent--90 
percent.
    So these estimates really matter, and it does strike me 
that they are extraordinarily pessimistic. It is one of the 
things I would like to talk to Dr. Holtz-Eakin about today.
    Notwithstanding any of that, we have still got a problem. 
We have still got a problem. The problem is the baby-boom 
generation that is going to dramatically increase the number of 
people eligible for these programs. As I have indicated, the 
Social Security problem of whatever dimension needs to be 
addressed. A far bigger problem is Medicare and, frankly, 
Medicaid is eating the States alive.
    So I am delighted we are having this hearing today, and I 
look forward to the testimony of Dr. Holtz-Eakin.
    Senator Allard. With that, Dr. Holtz-Eakin, welcome and we 
look forward to your comments.

   STATEMENT OF DOUGLAS HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you for the chance for the 
Congressional Budget Office to be here today. Mr. Chairman, 
Senator Conrad, we have some written testimony which I would 
like to submit for the record. It makes a few points, and it 
says that the Congress creates programs for their benefits, and 
it constructs budgets to reflect their costs. The focus of that 
testimony is that the key decision is to spend money and that 
that spending can be in many different forms. It can be in the 
form of mandatory programs, which last for a long time and 
which are currently the big numbers that attract everyone's 
attention. It can take the form of spending only under certain 
circumstances, as would be the case for a loan guarantee or an 
insurance program. Or it could be something that looks like a 
short duration but quite certain, such as annual 
appropriations.
    In each case, spending is a good measure of the cost of 
that program, and the spending should be presented as close as 
possible to its true economic cost, to level the playing field 
both across budgetary items and also between the public and the 
private sector so that a fair comparison of benefits and costs 
is possible in evaluating programs. I leave it to you to go 
through that testimony. I would be happy to answer any 
questions on it.
    Given the title of today's hearing, the transparency of 
budget measures, I wanted to focus my remarks on a slightly 
different topic, and that is, recently there has been, I think, 
a fair amount of well placed concern and attention placed on 
transparency in private sector accounting. In the private 
sector corporate accounting, there has been a lot of attention 
on better disclosure and presentation of the exact status of 
affairs. And in light of that, there is a temptation, I 
believe, to import into discussions of Federal Government 
finance the private sector model wholesale and in what I hope 
is--and in what I fear is a not--well thought out fashion. And 
my concerns come in two forms. The first is on principle. I 
think one should be cautious about importing this because there 
is no private firm that has the power to print money. Neither 
is there a private firm that has the power to tax. The Federal 
Government is a very different entity, and its most powerful 
asset is the sovereign power to tax. And thinking about 
presentation of budgets from a private sector standpoint can 
send you down to the wrong place.
    One of the pieces where I think that shows up the most is 
the notion of an unfunded liability. Let me spend a couple 
minutes talking about my reservations on this concept taken at 
face value.
    The first is, just so we are on the same page, how these 
are calculated. If you would take Medicare, for example, one 
would count up all the spending that is promised under Medicare 
where you count future years less than present years, discount 
them, and count them at less than dollar for dollar. But you 
add up all this spending over some horizon. You add up all the 
dedicated revenues over some horizon. And you look at the 
difference and label that an unfunded liability.
    What are the problems with that? Well, first, as I 
mentioned, is that at conceptual levels nothing is unfunded at 
the Federal level. There is always the power to raise taxes and 
fill that gap right up to the point of economic irrationality, 
at which point the taxes are so detrimental that you actually 
harm yourself. So I think it is unlike the private sector where 
an unfunded liability requires the infusion of new resources 
because the commitment is made and the funds are not in place. 
Here funds can be brought into place in a much different 
fashion.

[GRAPHIC] [TIFF OMITTED] T1173.140


    No. 2, I think we have to be careful with the word 
``liability.'' I noticed you used ``obligation.'' I think that 
is sensible. The firm liability of the U.S. Government is 
outstanding Treasury securities, backed by the full faith and 
credit of the United States. There is an enormous continuum of 
obligations, commitments, and promises to pay resources out in 
Federal programs, and some rise to a level of firmness that 
they should properly appear in the budget, and others do not, 
where it might be more appropriate to know about them, have 
some information, but not actually place them on the budget. 
One can think of areas such as implicit guarantees for future 
disasters where you would not want to actually put that on the 
budget, but you would want to be cognizant of the size versus 
very firm commitments where once they are made, a contract for 
a student loan, a contract for a long guarantee, it would be 
appropriate to put the recognition on the budget itself. So the 
notion of liability I think is slipperier than a lot of 
discussions make it seem.
    Then there are some practical difficulties, and I think the 
Medicare example is an important one for thinking about this in 
the Federal context. The first practical difficulty from a 
budget standpoint is that you lose some information in going to 
these unfunded liability kinds of measures. In the chart that I 
have distributed and that we have here, we have on the left 
side a replication of some work we did in 2003 on the long-term 
budget outlook. It shows the future spending under Medicare as 
a fraction of GDP between now and 2050, depending on how fast 
health care costs grow. The top line is growing at 2.5 percent 
faster than income per capita; the bottom line is 1 percent 
faster. So those are the numbers that we have in our long-term 
budget outlook.
    Senator Conrad. Mr. Chairman, might I just ask him to 
repeat that? Could you repeat, the 2.5 percent relates to what?
    Mr. Holtz-Eakin. We have historically had this, what I 
think of as a horse race between costs and resources--costs, 
spending per beneficiary, and resources, income per capita, GDP 
per capita. Historically, in the past three decades, costs have 
risen 2.5 percent faster per year than has income per capita. 
That gets the label ``excess cost growth,'' and the blue line 
shows the future of Medicare if one simply extrapolates that 
historical pattern with the new demography of getting older, 
and something which shows a sharp rise from a bit above 2 
percent of GDP now to just under 16 percent.
    The green line assumes a future where costs grow more 
slowly, 1 percent faster than income per capita, an assumption 
used by the Medicare trustees. The left panel shows two 
alternative futures. The right panel shows a series of present 
value calculations of the type that would be in an unfunded 
liability notion.
    Consistent with what I said earlier, I left out the taxes. 
It's the spending that matters. These are present values of 
spending. Blue bars on the right correspond to the fast cost 
growth on the left; green bars, the slower cost growth.
    From this, I think you can draw a couple of lessons. The 
first lesson is the bars on the right tell you nothing about 
how fast this problem hits, and so by definition, when you add 
things up over the future and you present them now, you give up 
the timing, which is actually central to budgetary planning, 
anticipating the importance of problems at different points in 
time. The left diagram gives you some timing.
    The second lesson that one could draw is these computations 
are very sensitive to discount rates. The middle bar in each 
pair is the 3.3 real interest rate that CBO uses for its long-
term projections at the moment. The actuaries use 3.0 for 
Social Security. I would argue by the standards of science 
those are the same number. We simply do not know. But you can 
see that there is a very big difference in the height of those 
bars. A slight change in the discount rate either down, to the 
left, or up, to the right, moves the numerical value 
tremendously.
    It is not the case that by bringing these numbers to the 
present there is a truth revealed. It is not about truth. It 
is, again, an estimate of the current cost of the obligation 
that has been incurred by this program. And they suffer the 
uncertainty that one would put in in any projection.
    Then, finally, if you just had those numbers, I do not 
think you would be able to discern readily whether you had the 
2.5 percent fast growth or the slower growth. So it would not 
necessarily be the case that by moving to this kind of a system 
one would increase transparency. Indeed, it might be harder to 
figure out what is behind the numbers. Looking at the left, you 
can see which grows fast and which grows slow.
    I think those are practical difficulties in moving 
wholesale toward this kind of a presentation for Federal 
budgeting and reasons why, given that Medicare, Medicaid, 
health programs are the big numbers that face us in the Federal 
budget, one would want to move cautiously in adopting this 
model for a whole variety of reasons.
    Then I will close by saying that I think it is obvious that 
more information about the future and the scope of the Federal 
budget is important, and more information is something that the 
CBO and many others would be happy to provide. The real issue 
is how to incorporate it into the formal budget process. You 
can imagine a range of possibilities where at the request of 
the Budget Committee we could provide a longer-term estimate or 
some alternative presentation. You could automatically provide 
such a presentation for mandatory programs, for example, build 
it into the process in that way so the information becomes 
available, but the current Federal budget process is unchanged. 
Or you could move a little more toward a formal incorporation 
by raising points of order, having some threshold for, ``Whoa, 
that is big,'' that would trigger a point of order and cause an 
automatic discussion of the size of a particular bill.
    Finally, one could--and I emphasize the trepidation with 
which I personally would go there--One could incorporate these 
kinds of numbers into the budget process in a formal and 
numerical fashion. I think given the practical difficulties of 
doing so, that would be a step that the Congress should only 
take with a great deal of caution and study.
    We are happy to be here today, and I look forward to 
answering your questions.
    Senator Allard. Well, thank you for your testimony.
    You know, this is one of the debates we have, the Members 
of Congress, is how far out should you project your estimates. 
I think generally the term applies, the further out you go, the 
more variables that get kicked in that are unpredictable, and 
how can you bring any kind of certainty to that process. I 
think sometimes we have a difficult time just figuring out what 
is going to happen within the same Congress, the first session 
to the second session.
    What kind of tools would you think we could use in trying 
to make some long-term projections?
    Mr. Holtz-Eakin. Well, the tools that we are using at the 
moment are to take current law programs, extrapolate them, and 
examine the sensitivity of those projections to alternative 
assumptions that are important. As Senator Conrad mentioned in 
his opening remarks, key uncertainties in the future of the 
Social Security program would include fertility, disability, 
mortality, and immigration on the demography side. And on the 
economics, what is the future of real wage growth as driven by 
productivity?
    So the tools that one can provide are both the best point 
estimate that an analyst can provide, but also some rough 
sensitivity analysis, in some cases formal sensitivity analysis 
that shows the bands of uncertainty from those sources. That 
would allow the Congress to see which solutions were robust to 
the uncertainties and which were not. And since we cannot know 
the future exactly, that is the kind of thing that you can 
bring to the decisionmaking.
    Senator Allard. One of the things that we have to struggle 
with is that this committee and your budget office have limited 
resources. And as we try and look at all these long-term 
obligations, it strikes me that it is going to outstrip our 
resources that we have, and perhaps maybe you can help us begin 
to set some priorities. What programs do you think we ought to 
be looking at now, what programs in the intermediate future and 
some that could be put out a little bit longer when we look at 
some of our long-term obligations?
    Mr. Holtz-Eakin. I think that you can divide, as our 
written statement did, the challenges into two rough areas. The 
first are the long-term costs of current programs, particularly 
in Medicare, Medicaid and Social Security, where regardless of 
the precise numbers, we know the shape of the future driven by 
demography in large part, and the spending lines point north to 
a degree that is unlikely to be sustainable.
    And then a second group of programs that merit attention 
but which are quite likely to be smaller in nature are those 
things that are associated with contingencies and uncertainty, 
things like the PBGC, where we do not--we know that the 
magnitude will not be comparable in scope to Medicare, but when 
it will arrive is very uncertain. And prudently knowing that it 
could arrive is an important part of the budget process.
    Senator Allard. So your suggestion then is that we look at 
those where we are looking at larger future obligations first, 
and I am gathering from your comments--I am just trying to 
simplify this--that because they are huger obligations, the 
sooner we begin to address those, then the easier it is going 
to be to solve those that are such huge ones; that if we put 
them off, then they almost get to be at the point where they 
are unsolvable. That is basically what you are saying.
    Mr. Holtz-Eakin. As a policy matter, the big mandatory 
programs are a key place for focus. As a budget presentation 
matter, we can work on all--I mean, I am happy to volunteer the 
staff to work on everything simultaneously.
    [Laughter.]
    Senator Allard. OK. We will move ahead. I call on Senator 
Conrad.
    Senator Conrad. Thank you, Mr. Chairman. Again, thank you, 
Director Holtz-Eakin, for being here. Thank you for that very 
thoughtful presentation. I learned something here this morning. 
Actually, I learned quite a bit. So that was important 
testimony.
    Explain for me, as you look ahead--let's remove ourselves 
from the language of whether it constitutes an unfunded 
liability or an unfunded obligation. To me the most important 
thing are the trend lines, where this is all headed.
    If you were to characterize, as you look--and not based on 
the rules that are put on you formally, because you can only do 
projections based on current law. That is the requirement that 
is put on you. But based on your judgment of--your analysis 
these numbers. You spend a lot of time doing it, as do the 
members of this committee. You look at the trend lines on 
Medicare. You look at the trend lines on Social Security. You 
look at the revenue situation. You know the demographics of the 
baby-boom generation.
    If you were to characterize our current circumstances in a 
budget sense--we have already got very large deficits; we have 
large demands on spending coming up; we have the President 
asking for substantial additional tax cuts--how would you 
characterize our long-term budget situation?
    Mr. Holtz-Eakin. I think our long-term budget situation is 
likely unsustainable. There is a long-term mismatch between the 
spending promised and the resources present to finance it, and 
the long-term spending promise could, in fact, be so large that 
one would not want to finance it as a matter of economic 
policy.
    Senator Conrad. Let's go to that statement, that the long-
term commitments that are being made by our Government are 
unsustainable, in your judgment, and as a matter of economics 
might be unwise to keep. Why?
    Mr. Holtz-Eakin. Again, nothing is for sure, but if one 
thinks of the upper end of the risks, Medicare and Medicaid 
over the next 50 years rising to 21.3 percent of GDP, Social 
Security rising to 6.3 percent, we are at 27.6 percent; 
whatever the needs in defense might be; and we have not touched 
many of the things that most people consider the Federal 
Government budget--education, highways, welfare----
    Senator Conrad. Let me stop you there and put that in 
perspective for people, because we have people listening and 
this percentage of GDP probably gets lost on them. What is 
typically the total spending by the Federal Government as a 
share of GDP?
    Mr. Holtz-Eakin. Twenty percent has been the post-war 
average, so the----
    Senator Conrad. About 20 percent.
    Mr. Holtz-Eakin. The numbers I mentioned, Medicare and 
Medicaid, take up all of that. And then you are layering on top 
of it additional spending that would take us above the post-war 
average to somewhere in the vicinity of 30 percent. The post-
war average on the tax side has been 18 percent of GDP. That 
strikes me as--it is certainly not a guarantee, but it is 
something that one would not want to sail into casually.
    Senator Conrad. Can we just repeat this? Because I think, 
you know, people listening, it is very important that they 
understand. Right now typically the Federal Government spends 
about 20 percent of gross domestic product.
    Mr. Holtz-Eakin. That is the post-war average.
    Senator Conrad. That is the post-war average. And what you 
are telling us here today is that there is a potential for 
Medicare and Medicaid alone to spend 20 percent of gross 
domestic product. Is that correct?
    Mr. Holtz-Eakin. That is a straight-line extrapolation of 
history. So something has to change in order for that not to 
occur.
    Senator Conrad. We are in a circumstance in which Medicare 
and Medicaid alone could consume what has typically been all of 
Federal spending. That would be no money for Social Security. 
That would be no money for national defense. That would be no 
money for parks or education or all of the other priorities of 
Government.
    Mr. Holtz-Eakin. That is right.
    Senator Conrad. And Social Security on that same trend line 
would be 6.5 percent of gross domestic product. Is that true?
    Mr. Holtz-Eakin. Yes.
    Senator Conrad. So just those, Medicare, Medicaid, Social 
Security, 26.6 percent of gross domestic product being consumed 
by the Federal Government when the post-war average is 20 
percent.
    Mr. Holtz-Eakin. Those are the numbers, and that is the 
risk that we face.
    Senator Conrad. Well, it again speaks to, to me, the need 
to address all of these things collectively.
    Senator Ensign. Senator, would you yield so I can ask a 
follow up question.
    Senator Allard. His time is just about up.
    Senator Ensign. Just to clarify and to add an additional 
number. What is the historical average of the rest of the 
budget as a percentage of GDP? In other words, you have Social 
Security which you just said in the future would account for 
about 30 percent, what would the total budget be as a 
percentage of GDP? You have just given us 26.5 percent just 
with Medicare, Medicare, and Social Security. Has historically 
everything else been 3.5 percent?
    Mr. Holtz-Eakin. Well, the history is less clean there 
because we have had this big shift over the post-war period. It 
used to be about two-thirds discretionary, one-third mandatory. 
Now we are at the other end of the spectrum. And so it is these 
big mandatory programs that we are talking about.
    How big can you let the discretionary programs get is, you 
know, much more controlled on an annual basis, but if you took 
a third of the budget, you are looking at 6 percent of GDP, 
roughly. That is right now.
    Senator Allard. I want to go back and give Senator Conrad 
an opportunity. You have 20 seconds left on your time, so if 
there is something you want to summarize?
    Senator Conrad. Thank you very much, Mr. Chairman, and 
thank you for the question, because I was going there myself, 
how does that all add up. And I think it just becomes very 
clear it does not add up.
    What I wanted to take you back to is the economic question. 
Why would it be harmful to the economy for the Federal 
Government to be consuming 30 percent of gross domestic 
product? What would be the adverse effect?
    Mr. Holtz-Eakin. It is hard to imagine that we could 
maintain some of the key broad pillars, I mean, not details but 
the big picture, pieces of the U.S. economic success have been 
broadly a reliance on private markets and small contained 
Government financed by relatively low and efficient taxes. We 
would have a much larger Government. It would take over a 
greater fraction of the economy. It would necessarily have to 
have higher taxes, and to the extent that they were levied in 
an inefficient fashion, that would have an economic cost. That 
is well documented. And it may be the case that in those 
circumstances there would be a temptation--and this is an 
unknowable part of the future--to accomplish policy goals in 
other ways, using regulations and mandates, and that interferes 
with the flexibility of the economy.
    So it is a future in which the overall scope of things 
becomes so large that it is hard to maintain the historic 
patterns that have been successful in the United States.
    Senator Allard. Thank you.
    Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman. That was a great 
line of questioning. I want to followup with it because I think 
that the importance of this cannot be overstated. What Senator 
Conrad and Senator Allard talked about underscores that, if we 
do not make changes sooner rather than later we will find 
ourselves in a difficult position. I mean, if we were at the 
point where our budget consensus, say 30, 33 percent of our 
gross domestic product, we would have to have the revenues to 
equal that. Historically that's obviously difficult when we 
have been around 18, 19 percent historically as far as a 
percentage of GDP for purposes of taxes. If we had to finance 
that, the tax rate would be outrageously high in this country. 
But if you just continue on the current course, there is no way 
you change it. It goes back to studying the historical truth of 
democratically elected governments collapse? They collapse 
because people realize that they can vote people into office 
who will give them what they want. We are at that critical 
breaking point, I think, and the longer we wait, the less 
chance there is of truly fixing the system.
    I want to talk about a couple of programs. Lets compare 
Social Security to Medicare and Medicaid. Social Security has 
unfunded liability that is small compared to Medicare and 
Medicaid. If we do not make changes to the new Medicare 
prescription drug benefit Part D right now, from what I 
understand, over the lifetime, we have huge unfunded 
liabilities. Do you know the number of the unfunded liability 
on just the prescription drug benefit over an equivalent 
timeframe?
    Mr. Holtz-Eakin. Given my reservations about these numbers, 
I want to just put big bracket----
    Senator Ensign. Just so we can compare apples with apples. 
You know, the numbers are what they are, but just so we can 
compare apples with apples.
    Mr. Holtz-Eakin. Drug spending is rising at about 8 percent 
per year at the end of our 10-year projection. The discount 
rate that one would apply to these kinds of calculations to do 
the unfunded is about 5-1/2 percent, treasuries plus inflation. 
That means that if you go over a long enough horizon, literally 
out to infinity, the cost of that bill is infinite because the 
costs are rising faster than the discount rate.
    So to give you a number I would have to make an arbitrary 
assumption about when drug costs would begin to slow down and 
how much. I would have to get them down to under 5-1/2 percent 
in order to give you a number, and I would have to pick a date. 
One of the reasons I am nervous about embedding numbers like 
this in the Federal budget is they are really arbitrary. I am 
terribly aware of how difficult some of these estimates are, 
but they are far less arbitrary than something like that.
    So it is a big number, I assure you. We could decide on how 
big a one you want.
    [Laughter.]
    Senator Ensign. I do not want a big one.
    [Laughter.]
    Senator Ensign. Just to further illustrate this, lets just 
go back to Social Security. We hear the year 2018 tossed out 
there, which is when the trust fund starts running into the 
red. As far as I am concerned, trust funds are phony and they 
are an accounting procedure. It is not like what most people 
really think of when they think about a trust fund where they 
actually have money in a savings account. We all know the kind 
of games that are played up here.
    If we do not do anything, and it has continued to grow--let 
us go out to 2018 and we have not touched Social Security, we 
have not made any changes to the system, we have not cut 
benefits, we have not done anything because the chances of 
cutting benefits, well let's jsut say we know the politics of 
this, so we have not increased the rate of return or anything 
like that. Lets go right to where the trust fund starts turning 
upside down.
    At that point, if we have not made any changes, what 
happens to the rest of the budget, Medicare, Medicaid, all of 
the discretionary spending? What happens to the rest of the 
budget at that point?
    Mr. Holtz-Eakin. First of all, the rest of the budget is 
growing rapidly, Medicaid and Medicare, and to honor the 
promises of Social Security you will have to find those 
resources in the rest of the budget. You will have to raise 
taxes. You will have to cut spending in the rest of the budget. 
You will have to go borrow more.
    In Social Security in isolation you might feasibly imagine 
that, but for the budgetary picture as a whole it is hard to 
imagine you could borrow that kind of money.
    Senator Ensign. At what point, how many years from now does 
that actually start becoming a reality? I gave you the 2018.
    Mr. Holtz-Eakin. 2010.
    Senator Ensign. 2010 is when that----
    Mr. Holtz-Eakin. 2010 the Social Security surplus peeks in 
our estimates, but somewhere around there, and then it begins 
to diminish and pressure in the unified budget will begin to 
become more apparent. And people have different dates at which 
it becomes a problem, but that is the starting point for the 
diminishing cash surplus into the remainder of the budget.
    Senator Ensign. Based on your experience on watching us up 
here on Capitol Hill and the proclivity to spending up here and 
not cutting spending, what is your best guess on what would 
happen to the rest of those programs? It would be borrowing, 
correct?
    Mr. Holtz-Eakin. An economist can give you two answers to 
anything, so the answers are as follows. One, people do things 
because of preferences, political or otherwise, and they do 
things because there are constraints. Even the United States 
cannot borrow infinitely large amounts of money every year and 
at some point the constraints will bind even if the Congress 
does not choose to change programs.
    Senator Ensign. Bottom line is we are in trouble in the 
future if we do not make changes?
    Mr. Holtz-Eakin. Yes.
    Senator Ensign. Thank you.
    Senator Allard. Let me call on Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    Hello again, doctor.
    Mr. Holtz-Eakin. Good morning.
    Senator Nelson. Several times. I am just going to ask a 
simple question. Years ago I came to the House of 
Representatives, elected in 1978, shortly after the Budget Act 
was put in place. And it was put in place for the purpose of 
basically bringing the deficit under control. At first there 
was some success in the late 1980's. I believe that the deficit 
was brought to somewhere close to 20 or 25 billion dollars. 
Then in the decade of the 1980's it ballooned and we had a 
different situation. Of course you know the history in the 
1990's. It was brought under control so that by the end of the 
decade of the 1990's the Federal budget achieved what we had 
been trying to achieve for 20 years, which was the budget came 
into balance, and then lo and behold, for a couple of years 
running we had a surplus.
    I guess my concern is that the budgetary process does not 
mean anything any more if we do not come forth with the subject 
of this hearing, the transparency, the adequate numbers. You 
can deal only with the numbers that you are given, but looking 
at one of Senator Conrad's charts here, that if all of these 
things are not included--and of course we are getting ready to 
vote on this right now, and it is going to pass overwhelmingly 
because who is not going to support to money to support our 
troops--and if all these other things are not in the budget, 
and I am asking you I think a philosophical question, why are 
we going through this exercise if what is in front of us really 
is not a reflection of the reality? Would you philosophize for 
us, make me feel any better about the budgetary process?

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[GRAPHIC] [TIFF OMITTED] T1173.139


    Mr. Holtz-Eakin. People rarely come to the Budget Director 
to feel better.
    [Laughter.]
    Senator Conrad. Or this committee.
    [Laughter.]
    Mr. Holtz-Eakin. And to ask an economist to philosophize is 
a really dangerous business.
    The purpose of the hearing I think is to ask the question, 
what should be in a congressional budget, how should it be 
entered, and how do you reflect the operations of the Federal 
Government?
    When there is a firm enough commitment it should be entered 
in the budget, there is no doubt about that. And budgets, I 
believe, should best be thought of in their plain vanilla 
English sense. They are planning documents. You budget for 
things. And you should plan for the things that are most 
important.
    Right now it is a different situation than it was 10 years 
ago. 10 years ago the hard work of the Congress put controls on 
discretionary spending. The peace dividend made it easier to do 
in the area of defense, and a revenue boom was a great bonus on 
top of it. We are 10 years way from that. We are 10 years 
closer to the retirement of the baby boom. We are unlikely to 
have a peace dividend in the near future, and the money in the 
Federal budget is not in the discretionary side.
    So to the extent that business needs to be done differently 
going forward, I think it essentially has to involve finding a 
way to budget for the mandatory programs that are the biggest 
part of the Federal budget, that are the rapidly growing 
threats to the future, and I do not have a magic presentation 
or panacea. I have some reservations about some things that I 
see people talking about. I would be happy to work with this 
committee, certainly, who are the people most cognizant of 
these issues in my experience.
    I do not know if that is good philosophy or not. I was not 
great at philosophy.
    Senator Nelson. Senator Conrad, you are so eloquent in all 
of this. Would you make me feel better?
    Senator Conrad. I wish I could. You know, I really think we 
are on a long-term course which the Director describes as 
unsustainable, and these things are real. There is no question 
about it. Alternative minimum tax is quickly becoming a middle 
class tax trap, 3 million people affected now. It is going to 
be 30 to 40 million people affected. We are going to have to 
deal with it, and it costs money to do. It is not in the 
budget.
    The war costs past September 30th of this year, the 
Congressional Budget Office tells us it is very substantial but 
it is not in the budget.
    The cost of going to Social Security individual accounts or 
personal accounts, whatever one wants to call them, private 
accounts, has an enormous cost, and it is not in the budget.
    I mean when we put the things back in the budget that the 
President is proposing it just further takes us into a swamp of 
red ink, and at the worst possible time, before the baby 
boomers start to retire. We know what is going to happen. We 
know that the number of people in this baby boom generation are 
going to double in very short order the number of people 
eligible for Social Security and Medicare, and we know that 
Medicare costs are going up before we even consider the new 
numbers. The costs of medical treatment are going up far in 
excess of inflation. Is that not the case, Director Holtz-
Eakin?
    Mr. Holtz-Eakin. Yes.
    Senator Conrad. So we are on a collision course. The more I 
come here the more I feel like I am in a sort of detached-from-
reality state in the Congress and in working with the 
administration, because we know these things. It is not even a 
close call. We know that none of this adds up, and yet we act 
as though nothing is happening and really nothing needs to be 
done.
    My own view is the work that we would have to do to put the 
country in a more secure position for the future is really 
quite stunning. To take on the challenge of the shortfalls in 
Medicare and Social Security and the existing budget deficits, 
coupled with the President's plan for even more tax cuts--none 
of it adds up. It does not even come close to adding up. And 
you know, I guess my most fervent wish would be that all of us, 
that the President say, OK, time out. Let us get everybody to 
bring forward their best ideas on how we deal with Medicare and 
Social Security and tax reform, because I think that has to be 
a piece of it, and I say that not as code words for a tax 
increase, I say to my colleagues. I say that because I truly 
believe our current tax system is hemorrhaging hundreds of 
billions of dollars a year that is owed that is not being paid.
    I used to be a tax administrator. I see the estimates of 
the IRS that say $300 billion in 2001 was the tax gap. I do not 
think they are anywhere close to how big the tax gap is. I 
think it is much bigger. They are working on studies now that I 
think will reveal that. I do not think just jiggering around 
with the current tax system is going to fix a significant 
proportion of that. We have tried. We have tried to do that 
before. Senator Allard has been a part of those efforts. I have 
been part of those efforts.
    But I think the agenda is really very, very significant, 
and yet we kind of are dealing with the edges of it, and the 
sooner we get on this much more ambitious agenda, the better 
for the country.
    Senator Allard. Your time is expiring here. I would like to 
keep it rotating around. We will have another time to speak. We 
allowed you to go over almost 4 minutes, so I would just like 
to keep it rotating around.
    Senator Nelson. May I make a concluding statement?
    Senator Allard. You may, as long as it does not go over a 
few seconds.
    [Laughter.]
    Senator Nelson. It seems to me that what I thought of as 
you were speaking is that we just cannot solve this problem in 
this era, this atmosphere of highly partisan charged, ``got 
ya'' politics, that it is just like Social Security. You cannot 
solve that in this atmosphere. And it has got to be a coming 
together, and the only thing that I can think is from my own 
experience when Ronald Reagan and Tip O'Neill got together in 
the early 1980's and said, ``We are going to do something about 
Social Security.'' And they had 6 months that they had to get 
it done because Social Security was going to run out of money 
for its payments, and they did it. And they did it with a 
bipartisan commission that said ``We are not going to play 
partisan politics.'' And they did it. I do not know how else we 
are going to solve this budgetary crisis until we get that kind 
of bipartisan atmosphere.
    Thank you.
    Senator Allard. Thank you.
    I would like to assume some of my time now on this. We talk 
about resources that are available, and in your preparation I 
think you had taken great pains and effort to distinguish 
between obligations and unfunded obligations. When you use the 
term ``unsustainable,'' are you not in a way talking about 
unfunded obligations?
    Mr. Holtz-Eakin. I use that term because I do not believe 
that if we attempted to fund them going to what is the ultimate 
resource, the U.S. economy, that we could do that by higher 
taxes without damaging that economy, that it would be a losing 
battle.
    Senator Allard. Another source out there that we have not 
talked about in this discussion, and maybe you want to take a 
little time to do that, is one thing we can do is restructure 
some of the programs in order that you do not incur the future 
cost. Would you care to mention how that resource may be used 
in trying to cut down on some of our future obligations?
    Mr. Holtz-Eakin. I think in the end it will be the 
prerogative of the Congress to decide how to restructure the 
programs, but I think the numbers----
    Senator Allard. Give us some ideas on some of the big ones.
    Mr. Holtz-Eakin. The numbers give you places to start. We 
know the big ones, Medicare and Medicaid. They are also the 
hardest of the mandatory programs because the underlying source 
of the increase is rising health care costs in the United 
States, not necessarily the structure of the programs alone, 
and that is not as well diagnosed as many other phenomenon. As 
a result, it is very difficult to pretend there is a list of 
solutions out there that one could pick off the menu and hand 
to the Congress. There I think progress will be incremental and 
involve lots of experimentation because necessarily we might 
spend more on health but we do not want to overspend.
    Social Security next in line in terms of magnitude, very 
different, a program that is well understood, a program that in 
the end involves raising money in one part of the economy, 
delivering it to another, perhaps at a different point in time. 
There is a large menu of potential solutions to the financing 
and the policy objectives, a place the Congress is discussing 
right now. Moving down the line, there is the whole list of 
policy options in the areas of defense and other defense 
policy, annual appropriations, and then smaller mandatory 
programs, whether they be insurance, where I think the 
important thing is to recognize that when the Federal 
Government engages in the large number of financial 
transactions that it does it transfers but does not eliminate 
risk, and when it carries that risk on the Federal budget, it 
is implicitly carrying it on behalf of the taxpayers who are 
ultimately going to have to foot that bill, making conscious 
budgetary recognition of all the risks that the Federal 
Government has collected and is holding for the taxpayer. It 
would be a step toward identifying which places were large and 
would be a way to go forward.
    In the work we have done for the Budget Committees, as an 
example of that, we have looked at the America West loan 
guarantee, which under current budgetary treatment appears to 
be a profit center for the Federal Government because it 
ignores the market risk, but if you put the risk in there 
appropriately the way markets recognize it, it swings from 
being a $45 million profit center to a $25 million loss. Things 
like that I think will be useful in letting the budget reflect 
the relative magnitude so that the policy decisions can be made 
better.
    Senator Allard. And I agree with our colleague from 
Florida, maybe some of this ought to be a bipartisan effort, 
but I think it serves reminding ourselves at this point in time 
that a third of this round figures is discretionary spending, 
which tends not to be as political as with the mandatory 
program which is two-thirds, and there is where we talk about 
the political part of it. And if we would take a position on 
spending on some of those programs, then the responsibility 
falls to the authorizing committee, not the appropriators to 
come up with some solutions as to how we can move these 
programs in a way in which our future obligations may not be 
quite as great, and that is a real challenge I think for the 
Congress.
    The only way that I see something like that happen is it 
does have to be a bipartisan effort because you have to have 
more than a majority to move forward on most of this, and so 
you have to rely on some support coming out of the minority 
party to get that accomplished. My hope is that we can come on 
these really important mandatory spending, or entitlements, in 
a way that we can look at it. I know that some members in the 
Senate, more so out of the Democrat side than Republican side, 
have said, Look, you know, there is not any problem with Social 
Security. But I hear my colleague here, and I certainly 
believe, and I think most of the American people believe that 
there is truly a problem with Social Security and that the 
sooner we deal with that problem the easier it is going to be 
to resolve it in a satisfactory way. As you had commented 
earlier, the longer you put that off it almost gets to a point 
where it is impossible to solve.
    Let me just kind of move on to another area, which I think 
has some potential sizable obligations on our Federal budget, 
but perhaps even more, it has some impact even on the 
marketplace, and that is what we call our Government sponsored 
enterprises. I serve on Banking Committee, for example, where 
we are looking at Fannie Mae and Freddie Mac, and those we see 
huge obligations, potential obligations out here, and that they 
are carrying a pretty sizable debt. I think somewhere around 
1.6 trillion, 1.7 trillion is the figure that gets tossed out 
there.
    What can we do legislatively to resolve this issue of 
implied obligation? We have not made a direct obligation to 
them, but everybody assumes that if something happens to Fannie 
Mae or Freddie Mac that that is going to be an obligation that 
the Government is going to pick up. What can we do 
legislatively to make it clear that those types of funds--and 
we can pick out several other examples, but I will just use 
those--what can we do legislatively to make sure that it is 
understood out there that it is not necessarily going to be--
that it is not a Federal future obligation?
    Mr. Holtz-Eakin. The implicit subsidy to the housing GSEs 
derives from an array of different features of the way they 
operate, the Presidential appointment of directors, the 
exemption from SEC registration requirements, the ability of 
banks to hold greater fractions of their securities as if the 
were treasuries, a line of credit at the U.S. Treasury. So 
there is a long list of things which contributes to this 
implicit subsidy. A process has begun and legislation could 
accelerate peeling back different aspects of those special and 
preferential treatments toward, and in the continuum of that, 
you get to a point where they are treated like any other 
private entity with comparable capital requirements, comparable 
registration requirements. That would sever it completely. Any 
movement in that direction would lessen this implicit 
guarantee.
    Senator Allard. You fall into almost kind of this concept 
``too big to fail,'' and it seems to me that perhaps maybe on 
those kind of things if the more competition you got in there 
so that your entities are not quite so large, that perhaps 
maybe that could be part of our solution. I wonder if you might 
address that thought.
    Mr. Holtz-Eakin. ``Too big to fail'' is a market 
perception.
    Senator Allard. It is.
    Mr. Holtz-Eakin. So you cannot control that directly. 
Indirectly you control it by more firmly putting in the same 
kind of regulatory environment that is meant to prevent 
failure, capital requirements, disclosure requirements, 
registration, all those things, so that the nature of the 
failure is one which is comparable in risk to other private 
entities, and then making sure that you are happy with the 
overall nature of the risks out there in the capital markets.
    Senator Allard. My time has expired. I will now recognize 
Senator Ensign--I am sorry--Senator Conrad, you had some time.
    Senator Conrad. Let me just, on the Government sponsored 
enterprise, signal this note of warning because I remember very 
well when I was doing in my younger days real estate projects, 
and North Dakota and many parts of the country did not have 
access to national credit markets. And the advent of Fannie Mae 
and Freddie Mac made a dramatic difference in the credit 
available for real estate development, both housing and 
apartments and commercial. It is very important we not throw 
out the baby with the bath water here because I can tell you 
the difference in interest rates because of access to a 
national market versus being locked into local and regional 
markets is very dramatic. It has had a very beneficial effect.
    Let me go to Medicare if I could because we have really 
identified that as the big enchilada in terms of our long-term 
obligations here. I just want to say for my colleagues, I 
really do think we need to have some kind of situation where we 
come together and everybody bring their best ideas.
    Let me give four that I would advocate to my colleagues, 
and ask them to ask their staffs to be thinking about these 
things. First of all on Medicare, 5 percent of the people use 
50 percent of the money, 5 percent use 50 percent. Is that 
roughly right, Dr. Holtz-Eakin?
    Mr. Holtz-Eakin. Yes.
    Senator Conrad. I think we ought to focus on that 5 percent 
like a laser, and we ought to better coordinate their care 
because we could, I believe, achieve substantial savings as 
well as get better health care outcomes if we put a case 
manager on every one of their cases, and here is why. We did a 
pilot study with 22,000 patients. We put a case manager, a 
nurse on each one of their cases to better coordinate their 
care, and we reduced hospitalization 20 percent, achieved 40 
percent savings and got better health care outcomes.
    Now, why is that such a powerful idea? Because what is 
happening in modern life is people have multiple doctors, they 
are going to multiple health care providers. They have a doctor 
at their home place, they have a doctor down at the lake or at 
the beach, they have a lung doctor, they have a heart doctor, 
and they are getting medicine at the pharmacy and they are 
getting medicine out of town, and they are getting medicine in 
mail order. The problem is there is no central point of 
coordination for many of these cases. The result is they are 
taking too many prescriptions, they are getting duplicate 
tests, and many of these things actually harm the patient.
    I'll just share a personal experience with my father-in-
law, who passed away. We went down and spread out his 
prescription drugs, taking 16 different prescription drugs. I 
got on the line with the doctor, and I started reading him the 
drugs he was taking. He said, ``Oh, my God, he shouldn't have 
been taking that for the last 3 years. He should not be taking 
that drug. That adversely interacts with the third drug you 
mentioned.'' And on and on it went. We found out 8 of the 16 
drugs he was taking he should not have been taking.
    I say that because that is exactly what they found with the 
22,000 patients. They found that many of them were taking 15 to 
16 prescription drugs, and half of them they should not have 
been taking. That led to all kinds of adverse interaction. It 
led to all kinds of hospitalization. In fact, that alone 
accounted for 20 percent of the hospitalization at enormous 
cost to Medicare and Medicaid.
    The second idea I would offer is negotiating lower drug 
prices in Medicare. We do it in the Veterans Administration. I 
think we have to seriously revisit that.
    The third idea I would offer is the $10 billion slush fund 
that the Health and Human Services Secretary has to sweeten the 
pot for private funds, private plans.
    The fourth idea I would offer is the amount that private 
plans are costing over and above traditional Medicare, that is 
$40 billion. I just do not think we can afford these things. I 
think on the prescription drug plan that we ought to go revisit 
it. I voted for it. I sided with the administration, to some 
consternation of some of my best friends. But honestly, when it 
is up to $720 billion, Mr. Chairman, I think it deserves us 
going back in and see where we could save money. I think we 
ought to be doing that everywhere. We have to revisit 
everything we are doing.
    Senator Allard. I thank you for your comments. I just want 
to take this up. I think it is more complicated than just 
having a case manager, frankly. I mean the State of Colorado 
from which I come, we have used case management as far as 
Medicaid is concerned. But those costs continue to grow. The 
real problem is that 5 percent that utilize 50 percent of the 
resources in Medicaid, for example, those are all at the end of 
the life cycle decisions that are very, very difficult for any 
kind of Government agency to make, and those almost comes back 
in onto the family and the provider to come and do that. And 
where we have in Colorado said we have case managers in those 
cases, this is being monitored, there still is some duplication 
of drugs, even though you have that oversight. It helps, but I 
think that the savings from that gets oversold, and there are 
some real tough decisions on how you manage a medical case 
toward the end of the life cycle, which, you know, I would hate 
to see Government involved in, and I do not think you want to 
get involved in it. The Governor of Colorado has tried to get 
involved in those discussions to a huge political detriment.
    So I think that we need to figure out some ways in which we 
can put the family and the family practitioner more in control 
of their own decisionmaking processes.
    My view sometimes is the fear of lawsuits and taken to 
court because somebody makes this kind of decision. Somebody 
who feels like they do not have any flexibility in their 
decisionmaking process really does not add an awful lot to 
that.
    Let me go ahead and call on Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    I think, Senator Conrad, you are exactly right though, and 
I said this about Medicare and Medicaid when Josh Bolten was 
here testifying, that I was disappointed that the 
administration did not propose more reform in its budget. I 
guess they are suggesting some reforms to Medicaid, but 
Medicare really is, between the two of those, a much bigger 
threat than Social Security. Social Security is a threat also. 
There is no question. There is a huge unfunded liability out 
there, but health care costs really, dwarf the Social Security 
problem that is looming out there in the future. I believe 
solutions have to be in a bipartisan fashion.
    There are some things that really are noncontroversial and 
which do not go to philosophy, pretty simple things. Requiring 
Medicare and Medicaid to move to best practices. The reason you 
need to start with those is because all insurance companies and 
everybody else follows what Medicare and Medicaid do. Each one 
of the specialties right now, have identified various disease 
types and what the best practices are to follow. What the best 
drugs are. What the best tests to run are. How exactly to 
follow up. Requiring best practices can result in fairly 
substantial savings. The estimates are up to 20 to 35 percent 
of health care costs with that single reform.
    Obviously, we disagree on tort reform. I have seen it right 
in my own State. Being right next door to California, which has 
had a very good medical liability reform law for a long time, 
and the difference between the liability costs in Las Vegas 
versus Los Angeles is just huge. A lot of our good doctors from 
Nevada are moving to California while, everybody else from 
California is moving to Nevada. The exception though is our 
doctors who are moving back to California because they can 
better afford to practice medicine there. We are losing a lot 
of really good specialists. We cannot get neurologists to take 
calls. There are all kinds of problems and the costs are 
skyrocketing. So I believe any kind of a system in the future, 
in order to get costs contained, needs medical liability 
reform. We also have to eliminate medical errors.
    Fundamentally, the other huge part of all of this is we 
have to devise a system where the patient is brought back into 
the accountability loop and understands cost. When you talked 
about case managers, today what has happened because of managed 
care and costs running out of control? Businesses said, hey, we 
need managed care. We need somebody to come in and control our 
costs. Managed care was originally supposed to be about 
managing care, now it is more about managing cost. The primary 
care physician used to be that case manager. They do not have 
time any more. It is about volume now. They have to try to see 
as many cases--Medicare's reimbursement is so pathetic, and 
because of the chances of being sued by the very low 
reimbursement, a lot of doctors are just saying, forget it. I 
am not going to even deal with those cases.
    We do not allow doctors to charge, on Medicare, wealthy 
people more, to allow doctors to spend more time with them. If 
we could have health savings accounts, a lot of administrative 
costs. There is so much money spent in administration today. 
HSA's puts a person back into the accountability loop. The 
money is actually being spent from their account and the 
patient sees their balance. The doctor could spend more time 
with them. Patients could negotiate prices. We could do those 
types things. There are lots of ideas like that that I believe 
in the future that we could all come together on.
    The question I wanted to ask, Dr. Holtz-Eakin, of you, has 
to do with the PBGC and the problems that are looming out there 
with so many pension plans. You know the ideas that have been 
put forward in Congress. Can you describe the problem to us? In 
the last year Congress passed a bill, and I was one of the few 
people who voted against it, that addressed pension under 
funding. Did that bill last year make the problem with the PBGC 
better or worse?
    Mr. Holtz-Eakin. The problem got worse because of the lower 
funding requirements for a couple of years. The problem comes 
in two pieces. One piece is the financial status, which is 
defined benefit pension plans are underfunded, broadly defined, 
and in some cases quite dramatically so. That is the broad 
underfunding issue.
    The PBGC's problem, as the guarantor of these is that you 
can divide the underfunding into some legacy problems which 
steel companies fit into that, and there is not much you can do 
about that, and there are a variety of plans that look like 
that, versus those which going forward could be funded 
adequately and which, given the right incentives, would provide 
an option for people to have a DB plan in the private sector.
    So the policy design issue is: can you segregate those 
policies aimed at the legacy and those which provide good 
incentives for DB plans going forward to fund themselves 
adequately? And if you raise, for example, a premium too high 
to cover the overall funding hole, you might make a DB plan so 
unattractive on a going forward basis that people would simply 
switch to defined contribution plans.
    It is one of these issues where you have to distinguish 
between the past and the future and it is hard to do.
    Senator Ensign. I mean I think most companies realize 
defined benefit plans are almost unsustainable into the long 
term. The rates of return are not what a lot of people have 
sold them.
    But I think that one of the points to make here, obviously 
is that the taxpayer is going to end up holding the bill on a 
lot of these.
    Mr. Holtz-Eakin. The narrow liability of the PBGC is quite 
clear, but the concern of course in the broader scope is if 
there was a larger than expected event which caused lots of 
plans to show up at the PBGC, that Congress would feel 
compelled to pick up more of the tab.
    Senator Ensign. Just a quick followup, and this is just 
clarification of this because I am now aware of this. Are the 
public employee pensions, are they guaranteed or backed up by 
PBGC? I do not know.
    Mr. Holtz-Eakin. No.
    Senator Ensign. OK. I just did not know. Thank you.
    Senator Allard. We are going to get ready to kind of wrap 
this up. I might check with Senator Conrad here on my right and 
see if he has any wrap up comments, then I will close the 
committee.
    Senator Conrad. First of all, I want to thank again 
Director Holtz-Eakin for being here, and thank Chairman Allard 
for filling in today and for conducting this hearing in a way 
that I think we had one of the best discussions we have had. I 
really do believe that this idea--and I would say to Senator 
Ensign, we have talked about more ideas here this morning about 
how to rein in some of these expenditures, than we have had a 
chance to talk about all year. I honestly believe if members 
had a chance to get together, bring their best ideas on saving 
money and improving care, it is amazing how many good ideas we 
would have.
    I think some of my colleagues would be surprised. They 
think, well, you are against tort reform. I am not against tort 
reform if it is done in a way that I think is fair. In fact I 
think it is going to be an essential component of this whole 
package. But I have heard more good ideas here this morning 
than I have had a chance to hear at any of our previous 
sessions.
    I very much hope that somehow we find a way to give a 
chance to every one of our colleagues to bring their best ideas 
and then implement them. I think we could make dramatic 
progress.
    I thank the Chair.
    Senator Allard. Thank you, Senator Conrad, for your 
comments and whatnot.
    I would also like to thank you, Dr. Holtz-Eakin, for making 
here to share your expertise with us. We appreciate your good 
work. I personally think that we are going to have plenty of 
opportunity in the future to have some more discussion on these 
because these are very, very difficult issues that we are 
coming to struggle with. It has taken some leadership. I think 
it has taken the President to bring up these issues so that 
they come before the Congress, and I think now that discussion 
opened, we are finding more and more members saying, look, let 
us look at the total package and let us look at all of these 
issues. I think that it is members like Senator Conrad, who is 
thoughtful and keeps coming up with some novel problems that we 
have out there, novel solutions, and participation from members 
on this committee.
    Hopefully, if we can get these out and begin to get them 
discussed, we can begin to address some of these solutions, 
which are not going to be easy, but they are important that we 
recognize them early on and begin to address them.
    With that I would like to thank my colleagues for 
participating this morning. I would like to thank the witness, 
and those who have been following this debate. Thank you very 
much.
    One other thing before I do adjourn the committee. We give 
to the end of the day for members to submit any additional 
questions that they may have to the staff, and then the staff 
will go ahead and process their responses. So I just ask the 
witness that if you get these additional questions, that you 
process them as fast as you possibly can, get them to the 
staff, and then we will be able to write up a full record on 
the committee proceedings.
    [The prepared statement of Mr. Holtz-Eakin follows:]

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    Senator Allard. With that, I want to go ahead and call the 
committee closed.
    [Whereupon, at 11:12 a.m., the committee was adjourned.]


   MEDICARE AND MEDICAID: RISING HEALTH CARE COSTS AND THE IMPACT ON 
                           FUTURE GENERATIONS

                              ----------                              


                      THURSDAY, FEBRUARY 17, 2005

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Bunning, Ensign, Alexander, 
Conrad, Nelson, Stabenow, and Corzine.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Don Dempsey and Dave Fisher.
    Staff present: Mary Ann Naylor, Staff Director; and Sue 
Nelson.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will start the hearing. We very much 
appreciate our witnesses joining us today.
    A lot of the testimony that we have heard so far in this 
committee about the issue of the fiscal solvency of our Nation 
and specifically our Government and how we address responsible 
management of our fiscal house has been tied to the question of 
health care. I think there is no debate any longer about the 
fact that health care is the single biggest driver of Federal 
expenditures for the foreseeable future. It is probably also 
the biggest driver of the costs of day-to-day life in this 
country as we head into the future.
    We have this aging generation, the baby-boom generation, 
which a lot of discussion has been focused on, and their needs 
in health care are going to increase exponentially as they head 
into the retirement years.
    We had Comptroller Walker testify that there is a huge 
amount of unfunded liability in this country, about $43 
trillion worth over the actuarial life of the various programs, 
of which the majority, about $27 trillion, is directly tied to 
health care costs.
    The President has begun to address this issue both from a 
policy standpoint and from a budget standpoint, and in the 
budget he has made proposals in the area of trying to address 
Medicaid costs. And this committee will hopefully also address 
those issues.
    But the big elephant in the room is Medicare and how we 
address the cost of Medicare and make health care available for 
seniors but also make it affordable for the young people who 
are working who have to pay the costs of the HI insurance.
    So we have asked the panel to join us today. The panel is 
made up of experts in the area of health care who have had a 
lot of experience with the Social Security funds and the 
management of the health care/Medicare system. And we look 
forward to getting their input on ideas that we as a Government 
could address to try to start to manage the health care issue 
not only from a standpoint of cost because cost is really the 
tail. The dog is delivery of service and how you make it--
continue to deliver quality but make it affordable.
    And so we are joined by Dr. Thomas Saving, who is a 
professor of economics at Texas A&M. He is a member of the 
Board of Directors of the Social Security and Medicare Trust 
Funds and has been instrumental in the development and the use 
of the infinite horizon to detail the financial difficulties 
facing Social Security and Medicare.
    We are also joined by Dr. Jeffrey Brown, who is assistant 
professor of finance at the University of Illinois on the 
Urbana-Champaign campus. Dr. Brown is assistant professor, as I 
mentioned, and he was a senior economist at the White House 
from 2001 to 2002, and I believe he has just been nominated to 
be a member of the Board of Trustees of the Social Security 
Trust Fund.
    And Lois Quam, who is the CEO of Ovations, a business unit 
of the UnitedHealth Group which provides health services to 
Americans age 50 and older, including insurance products for 
AARP and care options including Medicare supplement and 
hospital health insurance and plans, prescription drugs and 
discount programs.
    So it is a high-quality panel who I know are going to have 
a lot of good ideas to give us as we move forward in the budget 
and move forward in addressing this very critical issue of 
public policy.
    Senator Conrad.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Thank you, Mr. Chairman. We missed you 
yesterday.
    Chairman Gregg. Sorry I was not able to be here.
    Senator Conrad. Senator Allard carried on in exemplary 
fashion, and I thought we had really an outstanding session 
yesterday. I think we had more ideas on how we might save money 
for Medicare yesterday than almost any session that I have been 
at. And it just tells me that if we had an opportunity for 
everybody to come forward with their best ideas, we might make 
real progress.
    Yesterday, the testimony from the Director of the 
Congressional Budget office noted that in 2050, if nothing 
changes, and if we see the same trend lines hold, over 20 
percent of the gross domestic product of the United States will 
be spent on just two items: Medicare and Medicaid. It is pretty 
stunning when you just extrapolate out from where we are now 
and look at the increases that are projected as the baby-
boomers retire, more people are eligible for these programs, 
and health care costs continue to explode.
    Just to put it in some context, Federal spending since 
World War II has been at about 20 percent of gross domestic 
product. So to have just two items consume 21 percent of gross 
domestic product obviously is an unsustainable course.
    Let me put up this chart. In recent days, we have learned 
that the prescription drug benefit that was passed in 2003 is 
exploding in cost. When we passed it, we were told it would 
cost $400 billion. That estimate was later revised for the same 
period to be $534 billion. And now we are being told that for a 
different 10-year period it is going to cost $724 billion. So 
we have exploding costs with the most recent legislation that 
was passed for the Medicare program.

[GRAPHIC] [TIFF OMITTED] T1173.154


    Yesterday, Mr. Chairman, I said I really do think it is 
time for all of us to come forward with our best ideas on how 
to save money in Medicare. I have put up five ideas that I 
think could help us make a difference:

[GRAPHIC] [TIFF OMITTED] T1173.155


    Better coordinate care. Yesterday, I indicated 5 percent of 
the population uses 50 percent of the money. The most recent 
statistic is 6 percent use 51 percent of the money. I think we 
ought to focus like a laser on that population, and we will 
hear more about that in today's testimony.
    I think we ought to consider eliminating the $10 billion 
slush fund provided to the Health and Human Services Secretary 
to sweeten the pot for private plans.
    I think we ought to cut the $30 to $50 billion of 
expenditure that is the amount private plans are costing over 
and above traditional Medicare.
    I think we ought to allow the Health and Human Services 
Secretary to negotiate lower drug prices, just as the Veterans 
Administration is able to do very successfully.
    And I think we ought to allow the reimportation of 
prescription drugs. In Canada, my State borders Canada--drug 
prices are dramatically lower. There is no reason not to 
reimport those drugs manufactured in the United States that 
have gone to Canada, and have much lower prices. Let's bring 
them back and at least at some point be importing something 
that helps the economy.
    Those are ideas, Mr. Chairman, that I would like to put 
some focus on in the hearing today. I hope others will stress 
other ideas, because clearly we are on a course that is not 
sustainable.
    I thank the Chair.
    Chairman Gregg. Can I ask the Senator a question?
    Senator Conrad. Absolutely.
    Chairman Gregg. Because I am intrigued by his five 
proposals. I think it is constructive that he is willing to 
bring forward specific proposals. Can you explain the slush 
fund?
    Senator Conrad. You know, in the Medicare prescription drug 
bill----
    Chairman Gregg. Oh, this is Medicare? That is the money 
that was set aside in the Medicare fund. OK. I understand. You 
are talking about the drug fund then?
    Senator Conrad. Yes, right.
    Chairman Gregg. I thought it was the overall Medicare.
    Senator Conrad. No. And, you know, this was set aside to 
allow the Secretary of Health and Human Services to sweeten the 
pot for certain private plans.
    Chairman Gregg. Right, to keep their plans.
    Senator Conrad. No, that is another element of the 
legislation, to allow private sector businesses to keep their 
existing plans. I am talking now about the money that was given 
to the Secretary, money at his discretion to use to sweeten the 
pot for other private sector plans because they were concerned 
about regional differences.
    Chairman Gregg. Is that a 10-year number?
    Senator Conrad. Yes, and the $30 to $50 billion is a 10-
year number.
    Chairman Gregg. Thank you.
    Well, we will start with you, Dr. Saving. We would like to 
hear your thoughts, and then we will go down the line.

  STATEMENT OF THOMAS R. SAVING, DIRECTOR, PRIVATE ENTERPRISE 
                        RESEARCH CENTER

    Mr. Saving. Mr. Chairman, thank you for having me here, and 
I am really going to concentrate my discussion here on the 
long-run costs of Medicare, and we can deal with questions 
later on.
    Chairman Gregg. Can you pull the microphone a little closer 
to you and make sure it is on?
    Mr. Saving. A little closer? All right. And maybe get the 
height of it adjusted to my lower center of gravity.
    Today, Medicare is the second largest entitlement, program 
behind Social Security. In 2004, Medicare accounted for 13 
percent of the Federal budget, 2.6 percent of gross domestic 
product and required general revenue transfers equal to 10.7 
percent of Federal income tax revenues. The program provides 
health care and insurance for the retired and disabled 
population, the same population served by Social Security. The 
2003 Medicare Modernization Act made Medicare's health 
insurance coverage more comprehensive, with the addition of a 
prescription drug benefit. It did other things also to general 
Medicare, but that is beside the point here. Making the 
coverage more comprehensive has also made the program more 
costly. By 2024, total Medicare spending is expected to exceed 
Social Security spending, and the differential will continue to 
escalate thereafter.
    Here I want to discuss several ways to address the current 
and future status of Medicare as it pertains to the Federal 
budget. So I am going to concentrate a lot on the Federal 
budget. As a trustee of the Social Security and Medicare Trust 
Funds, I will highlight a few of the measures I believe shed 
light on Medicare's financial position.
    Before getting to the estimates of the total cost of 
Medicare, I want to review a couple of the characteristics of 
Medicare that will cause it to become larger than Social 
Security in just 20 years and become 50 percent larger by the 
middle of this century. And while both Social Security and 
Medicare share the same demographics, the similarity ends 
there.
    Social Security's revenue and expenses, without 
consideration of the demographic issues, rise at roughly the 
same pace as the Nation's gross domestic product. Its future 
deficits are the result of two--or three things, actually: the 
baby-boom generation's retirement, falling fertility rates, and 
increasing life span.
    Medicare faces these same demographic issues, plus the fact 
that the population's demand for health care, something that 
you alluded to already, Mr. Chairman, is growing faster than 
the Nation's gross domestic product and has been for a century, 
so that nothing has changed there. Since 1960, per capita 
health care expenditures have grown 3 percentage points faster 
than per capita gross domestic product. But Medicare Part A 
Hospital Insurance tax revenues rise only as fast as gross 
domestic product. This means that even if there were no 
demographic issues at all, Medicare would face future deficits. 
Other components of the Medicare program face a similar fiscal 
situation. Supplementary Medical Insurance, SMI, comprised of 
Parts B and D, prescription drugs, are financed through premium 
payments. They provide approximately 25 percent of the program. 
The rest of it, 75 percent, are general revenue transfers. The 
premium payments are expected to rise about 25 percent of 
expenditures, so they are going to grow as fast as expenditures 
and, thus, they are actually going to grow faster than gross 
domestic product. But because 75 percent of these expenditures 
are financed by general revenue transfers, an ever larger 
proportion of general Government revenue will be required to 
fund SMI, that is, Parts B and D of Medicare.
    Because the revenue for Part A is not linked to GDP growth, 
the day will come when premium payments for SMI--that is, both 
prescription drugs and what used to be physician things--will 
actually exceed the tax revenues for Part A. In 2003, the tax 
revenues were more than 5 times total Medicare premiums. In 
2005, when the prescription drug benefit becomes fully 
operational, the HI tax revenues will still be 3.5 times 
premium revenues. But by 2055, the premium revenues will exceed 
the HI tax revenues.
    Now, in producing the Trustees Report estimates of future 
expenditures, we assume that by 2029 Medicare expenditure 
growth will have fallen from its current level of approximately 
2 percentage points faster than per capita gross domestic 
product to 1 percentage point faster. And then when we end the 
75-year horizon, we gradually let the growth of health care 
fall to exactly the same as the growth of gross domestic 
product. Both of these assumptions may be conservative as there 
appears to be little evidence that health care expenditures 
will not continue to grow at more than our ultimate assumed 
rate of 1 percentage point above per capita gross domestic 
product.
    Now, Medicare's financial status can be summarized in two 
ways: one of them in terms of the present value of future 
unfunded liabilities, which people are familiar with, often the 
75-year horizon, sometimes a longer horizon; and, second, in 
the past of future budget transfer required to cover future 
shortfalls. And I think that may be more appropriate in regard 
to this committee, but I am going to address both of those.
    The first of these represents how much the system owes, and 
the second represents how much the general tax revenue must be 
tapped to meet these obligations. Medicare is fundamentally a 
generation transfer system; current taxpayers pay for the 
benefits of current retirees. And the fundamental economics of 
such a system is that the debt that we owe the current 
generation is going to have to be paid by the future 
generation. And I want to separate that debt, the way we do it 
in the Trustees Report, into the three principal programs of 
Medicare. Part A, Hospital Insurance, the debt owed to the 
current generation, that is, everybody who is working now and 
currently retired, if we pay them the benefits that are in the 
bill at the moment and we only charge them the tax rate, which 
is the HI tax rate, the unfunded liability for the current 
generation is $14.2 trillion.
    Now, in a system that worked, that is, in a system that was 
in equilibrium, the next generation would pay--would have a 
surplus because they would enter the system--they will start 
working tomorrow. They will pay taxes for 45 years before they 
ever collect any benefits, so they should contribute something 
to paying off this debt? Rather than contributing anything, 
what are they going to do? They are actually going to generate 
$7.8 trillion more in debt. So that the total unfunded 
liability for just the Hospital Insurance part of Medicare is 
$22.1 trillion.
    Now let's move to Medicare Part B, which, along with the 
prescription drug benefit, Part D, of course, comprises 
Supplementary medical Insurance. Unlike Part A, which is meant 
to be financed with HI taxes, Part B is set up to be financed 
with general revenue transfers of 75 percent. And we know that 
that is going to make for a rising cost. So the difference 
between the premium income that we expect to accrue over the 
whole period and expenditures for the current generation is 
$8.8 trillion.
    Now, the next generation is going to cost us another $14.4 
trillion, so the unfunded liability, the present value of the 
unfunded liability for Medicare Part B is $23.3 trillion, and 
this comes right out of last year's 2004 Trustees Report.
    Now, let's consider the newest addition to Medicare, Part 
D, prescription drug benefits. Again, this operates exactly the 
way SMI does. It has premium payments, which are roughly going 
to cover 25 percent of expenditures. The unfunded liability for 
Part D for the current generation is $6.2 trillion. The next 
generation, rather than contributing anything to paying that 
off, is going to add another $10.3 trillion to it. So the total 
unfunded Part D liability is $16.6 trillion.
    All three of these together, we owe the current generation 
$29.2 trillion. Now, David Walker talked about $27 trillion, 
which is the 75-year unfunded liability, and this is the 
current generation's unfunded liability. The two numbers are 
similar, but they have a different meaning. The future 
generation is going to add $32.5 trillion to this obligation. 
The total Medicare unfunded liability as it now stands is $61.6 
trillion.
    I am going to put it in perspective for you. Assuming that 
Federal income tax revenues were to remain at the 50-year 
average of 10.9 percent, roughly, of gross domestic product--
now, they were lower this year; they were only like 8.7 percent 
because we are still coming out of the recession. But if they 
were to do that, the present value of all future Federal income 
tax revenues is $99.3 trillion. The unfunded liability here is 
$61.6 trillion. It is 62 percent of all future Federal income 
tax revenues.
    If you pass legislation today binding on all future 
Congresses that set aside 62 percent of all Federal income tax 
revenues, starting tomorrow to eternity, that is what it would 
take to cover this liability. You would have to give up almost 
two-thirds of all Federal income tax revenues. This year you 
spent 10 percent on Medicare, so that means roughly 50 percent 
additional of all Federal income tax revenues would have to be 
set aside from now to eternity to cover the debt. So the funds 
have--that means that--and what I would really like to say, 
again, bear in mind that you cannot just spend the money and 
send us some bonds, send CMS some bonds that we will later on 
cash. I mean, this means you really would invest the 62 percent 
of Federal income tax revenues in real resources in the economy 
because that is what would in the future generate the revenue 
and the resources and the output that it would take to provide 
these benefits that we are promising.
    As a final note--and this comes back to the 75-year 
horizon, the numbers that David Walker talked about--that 
number is $27.7 trillion, but that is only the 75-year number. 
And even erasing that would take for the next 75 years your 
setting aside 43 percent of all Federal income tax revenues. 
And then at the end of the 75 years, you would have these huge 
debts that you would still have to pay off. So these are very 
significant numbers.
    Now, another way of understanding these future funding 
problems is just look at the cash-flows. They can be 
denominated in a number of different ways. I like to denominate 
them in terms of Federal income tax revenues, again, because I 
think that is meaningful. I am not convinced that the way we do 
it in the Trustees Report where we denominate these things in 
terms of gross domestic product is very meaningful to most 
people. They do not understand what gross domestic product is, 
and it is clear from a budget perspective that Federal income 
tax revenues are a clear budget item, income, and what you want 
to know is how much of that income do we have to transfer to 
these programs.
    They may seem like a manageable amount. We are going to 
show a deficit--the Hospital Insurance portion showed for the 
first time in many years a deficit last year, in 2004, and that 
is going to grow at an accelerating pace over the next 25 
years. Part D, prescription drug benefit, will begin in earnest 
next year and will rapidly grow in its requirements on the 
budget. The transfers required to pay the current law benefits 
given current law taxes and premiums will grow from their 
current level to almost 19 percent of Federal income taxes in 
2015. Now, remember, they were 10 percent this last year, in 
2004. They are going to double by 2015. They are going to 
triple by 2025 to a third of all Federal income tax revenues. 
And they are going to require over 90 percent of Federal income 
tax revenues by 2075. It is hard to imagine transfers of this 
magnitude being made, but the only real alternative is for 
individual members of society to ultimately provide more of the 
funding for their own retirement health care. How we are going 
to do that and, second, somehow make markets so that people 
care about what it costs--and one of our fundamental problems 
is they do not.
    As I pointed out above, the trustees have adopted the 
assumption that health care costs per capita will grow at a 
rate equal to GDP per capita growth plus 1 percentage point. 
And that implies alone that health care expenditures will rise 
from the current level of 15 percent of gross domestic product 
to 38 percent by 2075. But, actually, of course, they have been 
historically growing much more rapidly than that. And if they 
were to grow plus 1.5 or 2 percentage points, then they are 
going to account for 55 or 79 percent of GDP, and they are 
going to account for huge proportions, if we are paying for 
them the way we are now. Federal income tax rates would have to 
be way over 50, 60 percent, rather than 11 percent of gross 
domestic product.
    Now, numerous factors contribute to health care growing 
faster than the rest of consumption. Regardless of the cause, 
it seems reforms are inevitable given that 45 percent of all 
health care spending today is paid for by taxpayers through 
Federal, State, and local government funds. Now, that same 45 
percent sounds like a number that we have to report to you, but 
that is State and local. I will get to that number right now.
    Beginning with the 2005 Medicare Trustees Report, as you 
know, the Medicare Modernization Act requires the Board of 
Trustees to test whether the difference between program outlays 
and dedicated financing sources, consisting of payroll taxes, 
share of income taxes, and premium payments, reach 45 percent 
of total Medicare expenditures. If this critical level is 
expected to be attained within 7 years of the projection, then 
we have to say there is excess general funding and we have to 
let the White House know that, and they have to come to 
Congress with something. In the 2004 Trustees Report, we 
reported that the critical difference is expected to reach the 
45-percent level in 2012. That is just 1 year short of the 7-
year requirement. If our 2005 Trustees Report for which we do 
not have the final numbers at this time--is consistent with 
that, that means that this year when we issue the report, we 
would be issuing an excess general funding warning to the 
executive branch.
    To conclude, since I am past my time here, as my fellow 
trustee John Palmer and I have noted several years in the 
summary of the combined Medicare and Social Security reports, 
Medicare's financing problems occur sooner than Social 
Security's, and the solutions to its problems are more 
difficult. The more difficult part is important. This past year 
Part A, Hospital Insurance, spending was in excess of tax 
revenues. The others will be increasing general revenue 
transfers with each passing year. The pace of this increase 
will accelerate when the full Part D prescription drug benefit 
takes effect. The demands Medicare places on the rest of the 
Federal budget will force Congress to consider some difficult 
choices of who should bear the burden of retirement health care 
spending. As the debate over Social Security has highlighted 
the generational consequence of financing elderly entitlements, 
the generational burden represented by Medicare amplifies the 
need for serious consideration of reform.
    Thank you.
    [The prepared statement of Mr. Saving follows:]

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    Chairman Gregg. I would like to say thank you, Doctor, but 
to tell you the truth, you just made me sort of sick.
    [Laughter.]
    Chairman Gregg. Thank you. Those were startling and 
sobering numbers, to say the least.
    Dr. Brown?

 STATEMENT OF JEFFREY R. BROWN, PH.D., ASSISTANT PROFESSOR OF 
      FINANCE, UNIVERSITY OF ILLINOIS AT URBANA-CHAMPAIGN

    Mr. Brown. Chairman Gregg, Ranking Member Conrad, and 
members of the committee, thank you for the opportunity to 
speak before you today about the implications of an aging 
population for the Medicaid program.
    As you know, in just 3 years the leading edge of the baby-
boom generation is going to start claiming Social Security 
benefits. In just 6 years, they are going to start claiming 
Medicare. In the years to follow, millions of them will find 
that, due to declining health, they are in need of long-term 
care services, including nursing homes. As a result of the 
substantial costs of paying for long-term care, many of them 
will end up relying on Medicaid to finance their own care after 
their own financial resources have been exhausted.
    While my written testimony focuses primarily on Medicaid, I 
do want to take just a moment to put Medicaid's cost growth 
into this broader context which Dr. Saving has just told us 
about, which is the context of overall growth in entitlement 
spending.
    Today, spending on Social Security, Medicare, and Medicaid 
combined is about 8.5 percent of GDP. Just 25 years from now, 
about the time that I am looking to retire, these three 
programs alone will be close to 16 percent of GDP. The farther 
into the future that one looks, the larger these programs 
become.
    As Senator Conrad already mentioned, total spending today 
by the entire Federal Government is about 20 percent of the 
economy. Looking ahead about 75 years, absent significant 
change to the structure of these programs, Social Security, 
Medicare, and Medicaid alone will account for 25 percent of 
this Nation's output.
    Now, this is obviously before we have set aside a single 
penny to support national defense, homeland security, 
environmental protection, or educating our children. It is also 
before any State and local government has raised money to 
support programs at their level. And then, of course, one must 
also keep in mind the obvious fact that future generations are 
still going to need money to live on, to start careers, to buy 
homes, to educate their children, and save for their own 
retirement.
    So to sustain these entitlement programs strictly on a pay-
as-you-go basis in the future decades will require substantial 
increases in tax burdens. And, unfortunately, large tax 
increases can in turn basically serve as a drag on future 
economic growth, which can, therefore, exacerbate the problem.
    So it is clear, as all of you know, that the time to begin 
thinking about the long-term prospects for these programs is 
now because the sooner that we begin to face these issues, the 
more choices we have available to us.
    I would like to specifically turn to Medicaid now. As you 
know, Medicaid is a very important source of health care 
financing for about 46 million individuals today. This includes 
children, pregnant women, individuals with disabilities or who 
are blind, as well as the elderly. And obviously this program 
plays a very important role in the lives of its beneficiaries, 
providing health care to people who otherwise might not be able 
to receive the care they need.
    Unfortunately, the financial burden of Medicaid, which is 
shared by both the Federal and the State governments, is large 
and it is growing. This year, for example, it is expected that 
the Federal Government will spend approximately $190 billion on 
Medicaid. If you include both Federal and State spending on 
Medicaid, it is well north of $300 billion.
    As large as this level of spending is, it is the trend in 
spending that is perhaps even more noteworthy. Over the last 10 
years, at a time when the economy grew by about 60 percent, 
Medicaid expenditures more than doubled. CBO and OMB 
projections are both that Medicaid expenditures are going to 
continue to grow faster than the economy for the foreseeable 
future, and the role that aging of the population plays in this 
is relatively straightforward. It is attributable to three 
basic facts: first, America is growing older; second, older 
Americans spend disproportionately more on health care, 
particularly long-term care services such as nursing homes; 
and, third, because Medicaid today is the single largest source 
of payment for nursing home and other long-term care 
expenditures in the U.S. It currently covers about 40 percent 
of nursing home expenditures. And, therefore, Medicaid 
expenditures are anticipated to rise.
    Under reasonable assumptions, by the time today's 
kindergartners reach age 65, Medicaid spending at both the 
Federal and State level will consume about $5 out of every $100 
produced by the economy.
    Now, to better understand these trends, I want to focus 
just a bit on the interplay between long-term care and Medicaid 
in the United States. As I already mentioned, Medicaid covers a 
wide range of beneficiaries, but from the perspective of a 
budget and the perspective of the economic impact, not all 
Medicaid beneficiaries are created equal. What I mean by that 
is roughly one-half of Medicaid beneficiaries today are 
children, and yet children only account for about $1 out of 
every $8 of Medicaid spending.
    In contrast, the aged currently represent just a little 
over 10 percent of Medicaid enrollees, but account for over 
one-quarter of all expenditures. And long-term care is a major 
reason for this.
    Medicare, which Dr. Saving referred to, pays the lion's 
share of acute medical spending for the elderly, but it has 
very limited coverage of long-term care. In addition, there is 
very little private insurance coverage in the U.S. for long-
term care. Last year, it was estimated that only about 4 
percent of total long-term care expenditures were covered by 
private insurance. This is in very sharp contrast to the market 
for acute care. And also in contrast is the fact that the 
Medicaid program, as I mentioned, is the single largest source 
of financing for long-term care. It is about 40 percent of 
nursing homes, 35 percent of all long-term care.
    It is also worth noting, by the way, that this leaves about 
one-third of long-term care expenditures currently paid for out 
of pocket by individuals.
    But in regards to Medicaid, this suggests that, absent 
significant policy changes in the way we finance long-term 
care, rising long-term care expenditures in the aging 
population will certainly lead to rapidly rising Medicaid 
outlays in the years to come.
    In my written testimony, I go into more depth about some of 
the other factors that influence this process, in particular, 
changes in life expectancy, changes in the disability rates 
among the elderly, as well as factors like changes in family 
structure that influence the degree to which there are informal 
substitutes available for formal care. While these issues are 
complex and, therefore, make it difficult to pin down a very 
precise estimate of future costs, nearly every plausible 
scenario suggests that Medicaid expenditures are going to 
continue to grow faster than the economy in the coming decades.
    Looking into the future, one interesting question is to 
what extent some of the future costs of paying for long-term 
care can essentially be off-loaded onto the private sector 
through encouraging private long-term care insurance markets. I 
discuss this issue in more depth in my written testimony and 
would be happy to take questions. But, in particular, I focus 
on the fact that among the many possible explanations for why 
the private market is so small, the Medicaid program itself 
turns out to be one that is quite relevant. Specifically, 
Medicaid serves as a disincentive for people to purchase 
private insurance policies for reasons that I am happy to go 
into during the questions and answers. And as a result, it is 
unlikely, absent some sort of significant reform to the way we 
think about Medicaid, that private insurance markets are going 
to save the day for us.
    So just to conclude, let me just say that we all know that 
Americans are living longer. This is great news for each of us 
as individuals. But we have to recognize that the existing 
financial structure of the entitlement programs in the U.S., 
particularly those that are serving the elderly, are going to 
place an ever increasing burden on future generations.
    If we continue to try to finance all of these programs on a 
pay-as-you-go basis, we are not going to have many good 
alternatives. We can either impose an ever increasing tax 
burden on future generations; we can start scaling back 
benefits for the elderly; or we can basically reduce or even 
eliminate all non-entitlement spending. The best and possibly 
the only alternative to those scenarios are to try to find ways 
today to increase national savings. By increasing national 
savings, essentially what we are doing is reducing our current 
consumption in order to set aside resources to invest in the 
economy, to grow the economy, and hopefully provide the 
resources for the future from which to pay these rising costs.
    I would be happy to take questions. Thank you for the 
opportunity to speak to you.
    [The prepared statement of Mr. Brown follows:]

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    Chairman Gregg. Thank you, Dr. Brown.
    Ms. Quam.

STATEMENT OF LOIS E. QUAM, CHIEF EXECUTIVE OFFICER, OVATIONS, A 
                   UNITEDHEALTH GROUP COMPANY

    Ms. Quam. Chairman Gregg, Senator Conrad, and distinguished 
members of the committee, thank you for the opportunity to 
appear before you today. I am Lois Quam. I am chief executive 
of Ovations, which is the largest company providing services to 
the Medicare program. We are headquartered in Minnesota, and we 
are unique in that we participate in the Medicare program 
nationally, operating in both urban and rural areas, and we 
participate in the traditional fee-for-service program as well 
as Medicare Advantage and programs for the chronically ill.
    The discontent about the growth and costs, which my fellow 
panel members have so eloquently spoken of, is igniting today's 
discussion and can and must be addressed. As the chairman 
indicated, it is not only an issue for Government, but it an 
issue for all of us.
    Our discussions about solutions have followed predictable 
but somewhat frustrating patterns: calls for increased public 
subsidies, calls for cuts to public programs. As for the first, 
we cannot spend our way through this because cost increases 
outstrip our economic capacity. As for the second, cuts in this 
arena simply shift costs to others--families, providers, State 
taxpayers--rather than actually cutting or eliminating 
services.
    So as business people, our job is to try to find practical 
and sustainable solutions. I wanted to offer the committee four 
ways that we may be able to do something else, and that is to 
powerfully shift to a strategy of not cutting our spending, but 
a strategy of using our current resources more successfully.
    The first idea I would like to put before you is to improve 
services to those who are chronically ill. As Senator Conrad 
indicated in his opening remarks, people who are chronically 
ill use most of the Medicare budget and Medicaid budget. Five 
percent use slightly over half of those budgets. These are very 
sick people, and despite the immense amount of resources we put 
forward to care for them, they still suffer greatly.
    We need to expand effective ways to care for them and 
invent new ways to improve their care and maintain their health 
because that also reduces our use of resources.
    We, through our Evercare program, have been providing 
services in this area to the Federal Government since 1987, to 
many States, and to the British National Health Service since 
2002. This sophisticated set of tools that we bring really 
comes down to a straightforward approach to do three things:
    The first is we try to keep this very sick group of people 
as healthy as possible so they do not need to go to the 
hospital.
    Second, we try to prevent those crises, like a broken hip 
or a case of the flu, that send them to the hospital for long 
stays.
    And, third, when they become sick, we move heaven and earth 
to try to treat them where they live versus having to send them 
to the hospital.
    Our results have been good. The independent Federal 
evaluation of Evercare found that we reduced hospitalizations 
by half while achieving a 97-percent satisfaction rate among 
patients and their families, and a 20-percent reduction in the 
use of medication. In one Texas county, from 2000 to 2002, we 
saved $123 million through this approach.
    The MMA provided some important expansions in this area in 
the special needs plans and in the chronic care improvement 
program, but there is great potential to do more, and I wanted 
to suggest three things:
    The first is moving these chronic care programs from the 
edge of Medicare to its center, to focusing in this area.
    The second, to focus on patients' burden of illness, not 
simply on discrete diagnoses.
    And the third, to focus on the dual-eligible population, 
those people who have both Medicare and Medicaid coverage. They 
often get lost between those two programs, and there is an 
opportunity to improve their lives and save resources by 
focusing on them solely.
    Second, I wanted to suggest that we look more diligently 
for ways to increase the productivity in American health care. 
If American health care productivity were simply on par with 
the rest of the American economy, we would not be having this 
discussion today. We would have the resources that we need to 
meet the challenges of Medicare and Medicaid. So how can 
productivity be improved? In our experience, it can be improved 
by improving the way that work and patient care is organized. 
We have seen dramatic increases in productivity by changing the 
way that we ask our work force and our caregivers to work.
    Second, by using technologies to support better ways of 
working. We have invested over a billion and a half dollars in 
new technologies to make these changes in ways of working 
stick.
    Third, we can use rapid learning models to get better 
results. In essence, learning quickly from things that don't 
work well. In Evercare, after every patient ends up in the 
hospital, we have a case conference where we don't say, ``the 
flu is going through and it is inevitable that this is going to 
happen.'' We say, ``what could we have done differently to 
prevent it from happening?'' And what does that tell us about 
how we need to change the way we work? And then how can we 
instill that in our practice?
    While productivity cannot be legislated, legislation can 
establish a framework for productivity: reward structures tied 
to preferred outcomes, incentives to invest in productivity 
tools like technology, and improved regulatory processes and 
standards.
    I want to make clear that technology is not an end in and 
of itself but simply a tool. And, in fact, if the underlying 
ways of working are not improved, technology can, in fact, 
increase spending and productivity. It is a tool to institute 
and make stick better ways of working. Surely American health 
care, where so many of our best and brightest go to work, can 
be on par in productivity with the rest of our economy.
    Third, we should look at ways of developing a national 
focus on evidence-based health insurance packages. This would 
encourage that best treatments are covered and that damaging or 
ineffective treatments are not covered. It would use science as 
its base. We need to invest in more research, and the MMA took 
an important step to do that. But lots of research is available 
which is not used. And we would support an empowered, 
independent entity akin to the IOM that could develop evidence-
based benefit packages that public purchasers and private 
purchasers such as ourselves could use. There may also be an 
interesting role for tax incentives here.
    Finally, I would urge us all to look at ways to apply both 
the strengths of both the private sector and government to this 
important problem. So often the health care debate is 
counterproductive, focused on whether government or companies 
can do a better job. As chief executive of one of the nation's 
largest health care companies, I would be the first to 
acknowledge the importance and benefits of government. This 
debate does not need to be an either/or, but it can be 
effectively a debate about how to get the best out of both 
sectors. Each have strengths, each have weaknesses, which makes 
them complementary. Government does a great job of offering 
consistent programs nationally, providing security over time, 
concentrating resources on vulnerable populations, providing 
standard operating rules, to name a few.
    Companies do a great job of adapting services locally, 
innovating rapidly, quickly deploying skilled staff, and 
inventing new ways of working, to name but a few.
    I would urge a shift from the debate between the two to 
take on the real challenge of bringing about the best in each.
    We have reached a state in health care where a new approach 
truly is required. Cost increases outstrip our ability to 
afford them, not only in the Federal budget but in State 
capitals and boardrooms and at dinner tables. It is time now to 
focus on a way to better use the existing resources that we 
have. There are ways to do that: improving care for the 
chronically ill, investing in productivity tools, translating 
research into practice, and using the practical and immense 
skills of both Government and companies to do that.
    These efforts in a way have been at the periphery of our 
efforts in Medicare and Medicaid. They need to become its 
focus.
    Thank you very much.
    [The prepared statement of Ms. Quam follows:]

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    Chairman Gregg. Thank you, Ms. Quam, and I thank the entire 
panel for a truly excellent presentation, which gives us a lot 
to think about. What I appreciate is it gives us some 
substantive ideas to pursue.
    Just to quickly summarize, as I understand it, what Dr. 
Saving is saying is that we are heading toward one heck of a 
train wreck, but that there are things that we could do that 
would slow the potential there, and the area of making people 
more cost-sensitive in their purchasing was one item I heard 
him suggest. And then Dr. Brown was talking about maybe 
creating incentives for savings which pre-fund some of this 
liability. And then Ms. Quam has outlined a number of 
interesting initiatives which would be sort the hands-on, how-
to-do-it-better answers.
    This committee deals in the big numbers. Finance deals in 
the specifics, usually, on this. And I hope that we can get 
your specifics over to Finance. But dealing with the big-number 
question, I guess I would like to start with the Medicaid issue 
because the President has addressed that in his budget. He did 
not address Medicare in his budget. I happen to think we should 
address Medicare, but I may be a voice in the wilderness on 
that one. And I have to produce a budget. So I am looking for 
votes.
    So to get to the point of Medicaid, Dr. Brown, maybe you 
could talk about this a little bit. What the President, as I 
understand it, is basically suggesting is that we try to slow 
the rate of growth of Medicaid from about 41 percent over 5 
years down to about 34 percent over 5 years. The way he 
suggested that it be done is that we address a number of 
different elements: first, the issue of better handling the 
spend-down problem; second, the issue of giving States much 
more flexibility with the dollars they receive; and, third, the 
issue of making sure that Medicaid is spent on health care 
versus on general fund operations within the States.
    The first year of his proposal, as I understand it, 
basically represents a reduction in rate of growth of about--
well, about half a billion dollars, $500 million, on a spending 
base of over $190 billion. So it would seem to me to be--those 
types of restraints would seem to me to be attainable. Do you 
think that they are attainable?
    Mr. Brown. I think the specific cost savings that are built 
into the President's budget are achievable. It is important, 
though, to distinguish between policy changes that lower the 
level of spending, a one-time reduction in the level of 
spending that then might last forever, versus things that 
actually change the rate of growth.
    Chairman Gregg. Which, of course, goes to your second 
point. I would be interested in your second point. But you feel 
on the first point that we could make those types of numbers?
    Mr. Brown. I do not have any reason to believe that we 
cannot. I will put it that way.
    Chairman Gregg. So on your second point, what are the 
systemic issues which we should put in place to pre-fund the 
liability, as you mentioned earlier, and other ideas you have 
in that area?
    Mr. Brown. Sure. Let me address the issue of pre-funding 
specifically, and this is something that is an issue that cuts 
across any number of entitlement programs, be they Social 
Security, Medicare, or Medicaid. When I am thinking about pre-
funding in a Medicaid context, there is a sense in which that 
is most appropriate for some of the longer-term sort of long-
term care type of issues that directly affect the elderly.
    There is a sense in which it is more difficult to think 
about pre-funding that piece of Medicaid which is specific to, 
say, providing acute health care for children and so forth. But 
in the context of thinking about the elderly, which is the part 
of the program which I am most familiar with, one of the things 
that distinguishes long-term care is that almost anyone in this 
country has a risk of needing long-term care services in their 
lifetime and they tend to happen late in life. If you look at a 
group of 65-year-old individuals alive today, for example, 
roughly a third to even 40 percent of them can expect to spend 
some time in long-term care during their lifetime, women more 
so than men. And the average age of entry into, say, a nursing 
home is in their early 80's. So this is a type of cost which is 
a substantial, large risk, and is for most young people today 
far off into the future. In that sense, it is the perfect type 
of program to be thinking about how do we get people to set 
aside money today in a way that pre-funds their future 
expenditures.
    Achieving this is, unfortunately, difficult. I am happy to 
go into more detail if you want. The rules of the existing 
Medicaid program that require that people spend down their 
resources means that Medicaid is not necessarily a very good 
insurance policy for people in the sense that it does not allow 
them to protect their wealth. But, on the other hand, it is 
sufficient to sort of crowd out most of the income distribution 
from wanting to buy private long-term care insurance policies 
today. And so it is a little bit of a catch-22 from a policy 
standpoint in that we are providing a publicly provided means-
tested program for people who do not have the resources to pay 
for care themselves. It might not be a great form of insurance, 
and yet it is enough to crowd out what might arguably be better 
forms of insurance.
    That is a tough problem, that is a very tough problem to 
deal with. But I think in general what we need to be thinking 
about, not only with regard to Medicaid but with all of these 
programs, is how do we set up a system so that rather than 
continuing to pay for these on a pay-as-you-go basis, we find 
ways of encouraging national savings more broadly.
    Let me just say one other thing, and then I will take 
followup questions if you would like.
    When we think about the role of national savings, it is not 
necessarily important that that national savings be earmarked 
for any one particular use. If you think about it, the real 
trust fund in this economy is the economy itself. And the role 
of national savings is to provide resources that the economy 
can invest, grows the economy even larger, so that hopefully 
economic growth can try to keep up or possibly outpace some of 
the growth in expenditures. And as long as we do additional 
saving today--and that can be done through Social Security, 
through the pension system, through some of these programs that 
have been proposed to encourage savings among children, things 
like that. That helps grow the economy and provide the 
resources that we can then draw on in the future to help pay 
for some of these costs.
    Chairman Gregg. Thank you. I have a lot of followup 
thoughts and questions, but my time has expired, so I will turn 
to Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Dr. Saving, what are the economic growth estimates that 
underlie the projections that you gave us?
    Mr. Saving. Well, really we are assuming productivity 
growth, but they have actually very little to do with this 
because if you think about the growth in gross domestic product 
and if health care has been consistently growing faster than 
gross domestic product, increasing the rate of growth of gross 
domestic product is not going to help you because health care 
is simply going to grow that much faster. So you cannot--in a 
sense, to the extent that the amount of health care that people 
want to consume is related to their income, and if we give them 
more income, if they want to consume even more health care, 
then we actually worsen this deficit that we are talking about.
    Senator Conrad. But, understand, we are the Budget 
Committee, and on the Budget Committee economic growth matters 
a lot.
    Mr. Saving. Oh, yes. No question about it.
    Senator Conrad. Economic growth determines how big the pool 
of resources are that we are going to have to draw from to 
sustain all of these programs. So this is a relevant question, 
and I assume that the underlying forecast that you are using is 
what the Social Security Administration is using, what the 
Congressional Budget Office is using, which is about 1.8 
percent a year.
    That is their estimate for the next 75 years, 1.8 percent a 
year. I contrast that with what has happened over the previous 
75 years, which is roughly 3.4 percent, and it seems to be a 
very pessimistic outlook for economic growth.
    Now, the reason for that pessinism is they see new entrants 
to the work force combined with productivity as the underlying 
factors that determine economic growth, and they see a dramatic 
reduction in new entrants to the work force with productivity 
basically humming along at 1.6 percent.
    But one of the things I want to caution my colleagues about 
is the notion of solving Social Security for all time. Most 
plans have been focused on 75 years, and I tell you, I have 
grave doubts about these projections. The truth is we were told 
4 years ago that we were going to have $5.6 trillion of 
surpluses over the next 10 years. That proved to be wrong. That 
proved to be totally off the mark. So I want to just enter a 
note of caution, about these 75-year projections. I have grave 
doubts about them. They are very pessimistic forecasts. With 
that said, we still have a problem, and the problem is the size 
of the baby-boom generation.
    I would like to go to Ms. Quam for a moment, if I could. 
You laid out three very specific areas where we might make 
progress. Just for the record, I assume that each of these 
areas would also help us on the Medicaid side of the budget.
    Ms. Quam. Yes, they are as powerful on the Medicaid side of 
the budget as they are on the Medicare side.
    Senator Conrad. You talked at some length about the 
chronically ill and the fact that just a small percentage of 
the people are using most of the resources. It seems to me that 
tells us we ought to focus like a laser on the chronically ill.
    You also mentioned something about productivity in health 
care, and you made a statement that caught my attention. You 
indicated that if productivity in health care were the same as 
it is in other elements of the private sector, we would not 
have a shortage of resources. Could you just go a little 
further in describing what you meant by that?
    Ms. Quam. Yes. When you look at the productivity of the 
American economy by sector, the health care portion of the 
economy has lagged in terms of productivity, that is, it has 
cost more to provide services. There have not been the gains in 
productivity in terms of output per worker or other ways that 
you can measure that as there have been in the rest of the 
economy. And that is part of the reason why we experience much 
higher costs.
    If we were able to get health care working on the level of 
productivity as the rest of the economy, we would have an 
enormous freeing of resources you which we could address these 
questions. You will find pockets within health care that 
function very productively, and they can provide us with best 
practices, clues about ways of spreading that across the whole. 
But, in fact, that is our challenge. And to me it says that 
that challenge is surmountable because surely it is not 
inherent that it has to operate in so much less productive a 
manner.
    Senator Conrad. What are the key reasons that there is less 
productivity, in your judgment? Obviously, you have spent some 
time trying to understand this with respect to your own 
company. What is your assessment of why productivity has 
lagged?
    Ms. Quam. Well, I think there are many. I think one relates 
right back to the discussion around the chronically ill. The 
focus has not been on those areas where we can make most of a 
difference. Since most of the spending is in this area, and 
since, in fact, despite this level of spending, this group has 
fairly poor outcomes, there is a huge opportunity to do better.
    Second, relating to my point around evidence-based benefit 
packages, we actually know a lot about what works in medicine 
and what does not. We need to know a lot more. We need much 
more research. But there is a vast amount of time between when 
a research finding comes out and when it is generally applied 
in practice. And during that period of time, we pay for lots of 
things that are ineffective or even harmful for people. So 
establishing frameworks and incentives to be able to make 
changes more quickly that are productive is at the heart of 
what we need to do to improve productivity.
    Senator Conrad. Thank you. My time is up.
    Chairman Gregg. Senator Alexander.
    Senator Alexander. Thank you very much, Mr. Chairman.
    I have a question about Medicaid, and I want to ask for 
your help, the help of the panel. And trying to follow the 
example of Senator Conrad, I actually brought a chart to help.
    Let me try to put this into perspective. Twenty-five years 
ago, when I was Governor of Tennessee, I came to see President 
Reagan, and I asked him to make a swap. I said let's swap 
Medicaid and elementary and secondary education. We States will 
take all the responsibility for K-12, you take Medicaid. And he 
liked the idea, but nobody else did.
    And then all during the time I was Governor--and we have a 
former Governor who is chairman--I had to work through the 
problem of trying to keep health care spending under control so 
we could fund universities such as the ones that two of you are 
associated with.
    Now, here is what happens with Medicaid. The Federal 
Government sets the eligibility rules, tells the States these 
are the core areas you must fund, and sends some money. And so 
what had traditionally happened is that State spending on such 
things as Texas A&M and the University of Illinois and the 
University of Tennessee goes up at the rate of 5.5 percent. 
That is the blue lines through here. But State spending on 
Medicaid goes up 15 percent.
    Now, there was a blip on that when the welfare law was 
passed in the mid-1990's, but now we are back to the same 
thing. And so when I left the Governor's office in 1987, we 
were spending 51 cents out of every State tax dollar on 
education and 15 cents on health care. Today it is 40 cents on 
education and 31 cents on health care, and one of the results 
of that is we will not continue to have great research 
universities like Texas A&M and the University of Illinois if 
States cannot properly fund them.
    Here is my question: I support the idea of saying we have 
to reduce the amount that we increase, Federal spending on 
Medicaid. But when we send that problem back to the States, 
they are likely to have to increase spending on Medicaid, and 
it is already more than they are increasing spending on 
everything else. And why is that? It is because we set the 
eligibility requirements up here and they cannot change them, 
and the second thing that happens is the Federal courts get 
involved and they do not let the States make changes.
    In Tennessee, the Governor is trying to reduce an optional 
program, and a Federal judge just decided the Governor cannot 
do that. And the legislature may have to go into recess just to 
wait for the Federal judge to decide what to do. The same thing 
happened in Arkansas. The same thing happened in Mississippi.
    So my question is this, and I am really asking for help 
from the chairman and the ranking member: If we are going to 
tell the States that you must continue to spend more on 
Medicaid than every other thing based on these eligibility 
requirements we have set here, but we are going to cause you to 
have to make even greater reductions in growth, then how are we 
going to make sure they can do it? Can we write some language 
either into the reconciliation act or into other legislation 
that requires the Federal Government to give States more 
flexibility and makes it less likely that the courts will 
interfere with their decisions? That is my question.
    Mr. Saving. I would respond first by saying that the issue 
that you raised, Senator Alexander, about flexibility is 
extremely important. The only way that you can get things to be 
better is for people to try experiments. Those experiments have 
to be done on a small scale. You are not going to have a 
national experiment, and I would take welfare reform as a case 
in point; that if it were not possible for individual states, 
like Wisconsin, to experiment with things and to show you that 
something worked, and the things that do not work, of course, 
will not be adopted, but they have to have flexibility. Without 
flexibility, with a national uniform program, you are not going 
to have change. And you want States to experiment. When 
programs do not work, we will abandon them because that is the 
way business operates.
    Senator Alexander. But, Dr. Saving, just to hone in on my 
point, we have a Democratic Governor in Tennessee who has 
decided that if we keep growing Medicaid at the rate it is 
growing, we will not have a University of Tennessee or a K 
through 12 or a city park or anything else. And so he has 
decided that he wants to take 323,000 people off the rolls. 
These are optional programs. The Federal Government does not 
require that these people be served, and the Federal court is 
stopping him. The Federal court is stopping him.
    Now, how can the Federal Government, how can we blithely 
pass a law up here and say, ``OK, you spend less money,'' and 
then the State does not have the capacity to do that? What 
could we write into the law that would stop that and also 
encourage the Federal agencies that administer the program to 
give the Governors more flexibility?
    Mr. Saving. I would like to be able to respond to that, 
but, unfortunately, that is outside my--that is your expertise, 
Senator. It is outside mine, I think, in terms of how you might 
keep the Federal courts out of, with the flexibility, but it is 
clear that we have given it in the welfare program. We gave 
variances so that States could try experiments. Now, that is an 
experiment that, clearly, we might allow a State to try because 
that, in a sense, is within the law, but I merely meant, within 
the current law, allowing States to deviate from those 
experimentally to see if there was a way to reduce expenditures 
that worked and that did not harm the participants, and that is 
what we are looking for here.
    It may be the case, of course, some of those will come 
under, as a lot of the welfare reform things in Wisconsin did, 
and have to get by those issues. And how you get that 
legislation that takes the courts out of it is beyond my 
expertise.
    Chairman Gregg. Senator Alexander's time is up, but go 
ahead.
    Ms. Quam. Thank you, Mr. Chairman.
    Senator Alexander, it surely is not in the national 
interests to have this situation where we cannot invest in 
education. And if Medicaid reduces spending, of course, in many 
ways, it gets shifted then to county levels or health care 
providers. So our challenge is to figure out how Medicaid can 
cost less, and I want to just offer you four ideas, if I could.
    The first is, is providing integrated programs for the dual 
eligibles. These folks, right now, get lost between Medicare 
and Medicaid. In Arizona, for example, for over a decade, we 
provided services for both Medicare and Medicaid. We have to 
have separate programs, separate administrations, separate 
everything to care for the same person, and it is not nearly as 
effective, and it is much more costly to do.
    Second, connected with that, if States could invest in 
areas where these dual eligibles that they are principally 
responsible for that gets savings to the Medicare program and 
gets that recognized, that would help. We often talk with 
States that are considering investing in case management 
programs for these people. And the cost of those programs is 
borne by the State. The result of those programs are savings 
and reduced hospitalizations, and those savings and reduced 
hospitalizations go to the Federal Government. So, again, they 
are lost sort of between these programs. It is not an 
integrated view.
    Third, it would be possible to authorize waivers. The 
waiver process now is very time consuming and diminishes the 
flexibility States have to respond to these situations. There 
has been some Federal legislation that has preauthorized 
waivers under model circumstances. They have been very small. 
That could be done more broadly.
    And then, finally, I think there is an opportunity to 
recognize some benefits of an improved regulatory process. The 
regulatory process has both quite lengthy delays which do not 
correspond well to State budget pressures. And, second, it 
would be useful I think at times to consider whether all of the 
regulations are worth it in terms of the lost opportunities for 
savings. Sometimes, obviously, we need regulations, but 
sometimes those are not looked at together. And put to that 
test, it may be able to come to something more effective.
    Senator Alexander. Thank you, Mr. Chairman.
    Thank you, Ms. Quam.
    Chairman Gregg. Thank you for those excellent thoughts. I 
wish this committee had legislative authority over Medicaid 
because I would like to institute those. But there are a number 
of Finance members on this committee.
    Senator Nelson.
    Senator Nelson. Continuing on Medicaid. Right now, in 
Florida, they are currently discussing a change that would 
require Medicaid beneficiaries to shop for private coverage. 
Now, I would like, Dr. Brown, your opinion. That has a certain 
appeal to it, but what is your opinion about how could such a 
system care for those with severe cognitive problems such as 
Alzheimer's or mental illness?
    Mr. Brown. I am not familiar with the details of what is 
being done in Florida, but, in general, I think it is certainly 
worth experimenting with ways of involving the private sector, 
but one needs to be very careful about what we economists call 
the issue of adverse selection or what might be called cream-
skimming or cherry-picking have you, which is the notion that, 
if it is going to be done, it needs to be done in such a way to 
where the private sector is not just picking up the good risks 
and, essentially, leaving the more difficult, more expensive 
population sector because that is just going to sort of shift 
those costs around.
    As I said, I do not know the details of the Florida 
program, so I am not sure to what extent they have been 
successful at doing that. But as Dr. Saving said, one of the 
nice things about experimentation at the State level is that we 
can hopefully learn from those types of experiments, and 
hopefully only expand the ones that actually work.
    Senator Nelson. Going back to Senator Conrad's chart, where 
he was pointing out the increasing cost of the Medicare 
prescription drug benefit, any one of you, what would be your 
opinion of the cost savings that would occur as a result of us 
changing the law where the Secretary of HHS would be allowed to 
negotiate on behalf of beneficiaries in order to arrive at a 
price for the prescription drugs through Medicare?
    Mr. Saving. I am not a big fan of these negotiations, and I 
will say why, and I am not sure I can answer the question of 
what the savings will be. We have done an extensive study of 
what seniors paid for prescription drugs before the 
prescription drug bill came into effect. And the individuals 
who paid for the drugs entirely themselves actually got lower 
prices than any of the negotiated prices that we have seen, and 
we were using Medicare data for this.
    So the more you care about what it costs, the more you 
shop. When you shop, you get lower prices, and since these 
prices were lower than the negotiated prices, it comes back to 
the issue that to the extent that the bill covers prescription 
drugs and gives people co-pays, then they are not paying for 
it. And when they stop paying for it all, they stop shopping. 
And when they stop shopping--you know our strongest thing about 
finding out about prices and about overcharges is if 
individuals care what it costs because then they will shop. 
They will spend some of their time.
    As I like to say, when we were talking about up-coding and 
a big issue in Medicare, and we had to have investigators go 
into doctor's offices, to find out if they are up-coding, I 
said, ``There is a reason we do not have to do that in a 
grocery store. Nobody is looking at the counter because the 
customer is looking at every item that gets rung up to see if 
they are being up-coded.'' We have to somehow make the 
individuals care what it costs to help us.
    Senator Nelson. My question was not about shopping. My 
question is about negotiating in bulk purchases just like the 
VA Administration.
    Mr. Saving. Yes, I understand, and my point was that people 
who shop get lower prices. Our issue is how much will it help? 
And it may help. I do not know the answer to that question, 
though, because I have not investigated it.
    Senator Nelson. Well, do you have an opinion with regard to 
the VA? They negotiate in bulk purchases. Does that tell us 
anything that would apply to the Medicare model?
    Mr. Saving. Well, you would expect that they should be able 
to negotiate similar prices. My point was that people who paid 
for the drugs themselves actually got lower prices, still lower 
prices by shopping. The problem with the bill is it relieves 
people from having to pay for it all. So then you are in a 
situation where they will wind up paying more, and then the VA 
program might well help.
    Senator Nelson. And comparing apples to apples, in the VA 
system, does your answer that you just said apply to the VA, 
that they go out and shop, and that is why they get lower 
prices?
    Mr. Saving. They shop in bulk, yes, for these. They get 
bids, and individuals shop individually, but they wound up with 
lower prices than the VA did.
    Senator Nelson. Thank you, Mr. Chairman.
    Mr. Saving. Sorry.
    Chairman Gregg. Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    First of all, I would like to put an opening statement in 
the record.
    [The prepared statement of Senator Bunning follows:]
    Senator Bunning. There are a couple of things I would like 
anybody that knows the answer can come up with it. The 
President has proposed in his Medicaid proposal closing some 
loopholes that States use. The budget proposes curbing the use 
of intergovernmental transfers States have used to avoid the 
legal-determined match rate for Medicaid. Through several 
accounting measures, Government providers of health care, such 
as county-run nursing home or a municipal hospital, returns a 
portion of their Federal Medicaid dollars back to the States. 
The State then recycles these funds to draw down additional 
Federal dollars or for other purposes. The budget proposes to 
match only those funds kept by providers as payment for 
services. It says that there will be about a $5-billion savings 
over 5 years and about a $12-billion savings over 10 years.
    Is this a problem in a lot of States or do you know that?
    Mr. Brown. Again, my expertise in this is more in terms of 
the budgetary impacts of long-term care financing and so forth. 
So my knowledge of this sort of is----
    Senator Bunning. You do not know of any States----
    Mr. Brown [continuing]. Is limited to what I have seen the 
HHS Secretary----
    Senator Bunning. Ms. Quam?
    Ms. Quam. Yes, Senator. As Senator Alexander referenced, 
many States have seen incredible pressure on their budget 
through Medicaid, and they have gone to great lengths to then 
try to find ways to get a larger Federal contribution.
    Senator Bunning. So they are doing it, and it is a practice 
that might, if we could eliminate it, save some Federal 
dollars? We want to make sure that all the States are, if there 
is a share that they are getting and that is an actual share of 
cost, like Kentucky gets 70 percent from the Federal Government 
and pays 30 percent of all programs under Medicaid. I just want 
to bring Kentucky in specifically because Senator Alexander 
brought up the fact that a Federal judge has ruled in a 
specific way.
    In Kentucky, there are currently 27 optional services 
provided under Medicaid. There are only 13 core programs that 
we must cover. According to the judge in Tennessee, those 
optional programs are not optional. In other words, they are 
challenging us and the judge is challenging Tennessee that they 
must cover what has been paid for because it was optionally 
paid for by Tennessee.
    Would the Federal Government be better off not having 
optional programs or letting the State decide what is optional 
and what is not?
    Ms. Quam. Senator, I think the challenge we have now is 
that health care costs have gotten sort of too high for every 
part----
    Senator Bunning. That is true.
    Ms. Quam [continuing]. The Federal budget, the State 
budgets, corporations, families. And so we are going to have to 
really put a great deal of focus on how we get more for the 
current money we spend. And shifting, in some ways, has become 
less of an option as the costs have gotten so high, that if 
costs shift from Federal to State, States have difficulty, and 
then if they shift to local, then the local areas have 
difficulty, that we really have reached something of a stage or 
a dilemma where we are going to have to look at how do we get 
more value out of the whole.
    Senator Bunning. The productivity thing interests me 
because of all of the areas that we have in the economy, you 
would think that medicine would be one of the most susceptible 
to new productivity because of the technologies not only in the 
way we use it, but other things, as far as drug development and 
things like that. Is that----
    Mr. Brown. I just want to make a comment about the 
productivity point, which is productivity in health care is a 
very difficult thing to measure, and let me just give you an 
example. Suppose that a pharmaceutical company develops a new 
drug for treating cancer, to take an example. It may be the 
case that this actually increases overall health care spending 
in the U.S. The sense in which we get benefits from that is 
that people are living longer, have better quality of life 
after being diagnosed and things like that.
    And if you really want to think about health care 
productivity, you need to take into account those health 
benefits that people are receiving. So the question I often ask 
my students, when I am teaching in class, is would you rather 
have 2005 health care at 2005 prices or would you rather have 
1980 health care at 1980 prices? Of course, the usual answer 
is, well, we want 2005 health care at 1980 prices. That is not 
an option on the table.
    But the point is, is that health care is better today than 
it was 25 years ago. We are getting something for our money. 
The question that I think we need to ask, and it gets at the 
heart of this productivity question, but it is a very difficult 
thing to measure, is on each new drug, on each new investment, 
from a public standpoint, are we getting what we pay for?
    We know that there are incremental benefits. We know there 
are incremental costs, and the question is which is larger?
    In going back to Dr. Saving's point, one of the 
difficulties about health care in the United States is because 
consumers, by and large, are not facing the full price of their 
decisions, private insurers or Medicare or whatever is picking 
up part of the costs----
    Senator Bunning. Third-party payers.
    Mr. Brown. That is right. You know, I go to the doctor, and 
all I need to think about, when there is a prescription, is, is 
it worth $10 to me because that is my co-pay. And if I get $11 
worth of benefits from that, I am going to do it, even if it 
costs society $100 to provide that prescription.
    There are two concepts here. One is I think we need to be 
careful about how we talk about productivity. I think some of 
the productivity gains may be greater than what traditional 
productivity measures have suggested.
    And, second, is I think it underscores the point that we 
need to find ways to get on the margin for people to have to 
think a little bit harder about whether the cost-benefit is 
worth it.
    Mr. Saving. There is another issue here that affects the 
way we measure productivity. If you were a private firm 
developing in a private market a new knee replacement, you 
would be asking yourself what people would be willing to pay 
for this knee replacement. And if it were a $100,000-knee 
replacement, how many people would buy it, and what is it going 
to cost to produce it? And if not many people would buy it, but 
here you only say, if Medicare is willing to pay for it, it is 
free to everybody who takes it. And you have a whole different 
market. So the technologies that get developed in the private 
sector, you just would not have developed it because, in any 
other industry, it would not have worked.
    And that helps productivity in those industries look 
better. Now, that does not mean that someone like me, an old 
person whose parts are wearing out, is not much better off 
because everyone else is subsidizing the system to do things 
which do not enhance productivity in the way we usually measure 
it. And I think therein lies a problem, and when we try to deal 
with this, we are encouraging these kinds of technological 
change. And they do contribute greatly to the rate of growth of 
health care costs.
    Senator Bunning. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you. Thank you for those interesting 
responses.
    Senator Corzine.
    Senator Corzine. Thank you, Mr. Chairman, and I appreciate 
you holding this hearing. I think this is focused on maybe one 
of the most important topics we have. It is certainly going to 
dominate our----
    Chairman Gregg. Especially for those who might be Governor.
    Senator Corzine. Yes. I am sort of trying to go to school 
on a few of you here.
    [Laughter.]
    Senator Corzine. If I might be a little bit editorial 
before I get into a serious question. Dr. Saving, did I read in 
your remarks that you said Medicare's financing problems occur 
sooner than Social Security and the solution to its problems is 
more difficult?
    Mr. Saving. Well, to the extent that it is already in--you 
say HI is already in deficit last year.
    Senator Corzine. Right.
    Mr. Saving. So, in that sense, yes.
    Senator Corzine. And did I hear you say that whatever the 
indefinite infinity unfunded cost is something like $62 
trillion----
    Mr. Saving. Exactly, yes.
    Senator Corzine [continuing]. Depending on, I presume, 
Social Security. We are having a debate about what crises and 
problems are, and I would just like to have that for 
background. And for a failed economic student at the University 
of Illinois, I am glad that Dr. Brown is here.
    I would want to argue----
    Mr. Saving. You are going to get revenge on him?
    [Laughter.]
    Senator Corzine. I was going to suggest that since we take 
a survey of young people in the country or at least I hear 
somebody says anecdotally that they think the likelihood of 
them getting their Social Security payments is about as likely 
as seeing a UFO, do you really believe that people are thinking 
about spending down their assets so that they can get Medicaid 
for their long-term care? Do you think that that really is a 
decision that is going on when people are making savings 
decisions when they are 25 years old?
    Mr. Brown. I, actually, use that survey in my class, and my 
class confirms it, that they are somewhat pessimistic about 
getting Social Security in the future.
    Senator Corzine. I guess they would be a little skeptical 
about getting Medicaid in the long term.
    Mr. Brown. Yes, I think it is fair to say that young people 
today are not thinking a whole lot about long-term care needs. 
What is more troubling is that when you look at 65-year-olds 
today, who have a fair amount of information out there, for 
those who are interested in looking, about the probability of 
needing long-term care. They have had family members and 
acquaintances that need long-term care. Among those that buy 
long-term care insurance, the average age is around sixty-five. 
But even at that age, there does not seem to be a tremendous 
amount of activity on the part of seniors to save.
    Senator Corzine. I think you and I probably have the same 
view, that there is a real savings problem in the country----
    Mr. Brown. Oh, absolutely.
    Senator Corzine [continuing]. On a whole host of issues 
that underlie how we get to resolving some of these issues. It 
was interesting that Chairman Greenspan yesterday used the term 
``forced savings,'' when he was talking about private accounts 
and Social Security. And somehow or another, on all of these 
various issues, we just do not have enough savings to take care 
of the demographic problem, whether it is through governmental 
programs or through a private program, so that there is a major 
shift of something that has to happen under any kind of 
category.
    Ms. Quams, you start on this discussion about capping 
Medicaid. We can hold down costs on Medicare, but the costs do 
not go away, I do not think. I think we create a feel-good 
situation here in Washington because we controlled our budgets, 
but the last time I checked, at a hospital in New Jersey, they 
have a responsibility to take in people who come in with no 
insurance, and then they give out the care, if I am not 
mistaken, and then it is just a big charity care.
    Can you walk us through? These problems do not go away just 
because we capped them or we say they do not exist. I do 
appreciate that there are specific challenges or specific 
steps. We can take on productivity and all of the other things. 
I think they are worthy of discussion. But we have a problem. 
There are sick people.
    And I was also curious why you did not talk about 
catastrophic insurance, all of you, since that 5 percent is 
dominating 50 percent of the cost. Are there not directions 
that we can go in that area that maybe help solve some of this 
problem in conjunction with the other issues?
    Ms. Quam. Senator Corzine, you are correct. We have an 
overall problem. And where it all eventually gets shifted to is 
families. And as we have done some analysis and look at 
different family income and look at by county, so you look at 
average family income in a county, average housing costs, 
health care costs, other kinds of things, you see very quickly 
that this combination of costs, health care costs has increase 
in a dramatic way for families. That is very significant.
    And your point on local providers of health care is exactly 
right. Hospitals are required to care for these people if 
Medicaid does not pay. And I think it is interesting to note 
that Arizona was the last State that put a Medicaid program in 
place. They did it in the eighties. And what finally propelled 
them to do it was that the local health care system was 
collapsing under the weight of caring for patients for which 
they were not reimbursed.
    Medicaid pays for 40 percent of all deliveries in the 
United States. It is an essential part of what we do. So I 
think we have reached a point where, in some ways, there is not 
anyone to shift to that can bear it, that we have to seriously 
look at ways of controlling costs and, in particular, look at 
those people with these high expenditures because there is an 
opportunity to do better for them and to lower costs.
    Mr. Brown. I just wanted to make one point that it is 
certainly true that for a given level of expenditure, if you 
just reduce Federal Medicaid spending, that has got to show up 
somewhere else. Somebody has to bear that cost.
    I think what we really need to be spending a lot of time 
speaking about is to what extent the structure of Medicare or 
the structure of Medicaid or the structure of how we pay for 
health care, in general, leads to additional increases in 
health care costs that might not be efficient from a social 
point of view.
    I am not about to make a policy recommendation on this, 
like in the future, one might need to ask really difficult 
questions like just because a particular new procedure or a new 
drug is approved by the FDA, does that mean it automatically 
ought to be something that the public sector pays for?
    There are all sorts of issues involved in terms of thinking 
about what is the proper role for what the Government ought to 
pay for using tax revenue, which we know has distorting effects 
on the economy, as opposed to things that ought to be left to 
the private sector. It is a big issue, a lot of research speaks 
to this, and it is broader than we can get in here today. But I 
think it is important not to forget that these programs can 
influence the level of spending and not just how it is divided 
up.
    Chairman Gregg. Thank you very much.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    Chairman Gregg. I want to thank you for chairing yesterday.
    Senator Allard. Well, thank you. We had a good discussion I 
think yesterday, and we were talking the very same subject I 
think you are kind of talking about now. And my staff informs 
me that we continue to talk about the 5 percent that consumes 
50 percent of the resources, and that is a very tough issue, 
and it is a difficult issue. And, bottom line, I think we have 
to rely on the patient-doctor relationship to come up with the 
right answers, in many cases. And somehow or the other, we 
haveto facilitate this so that the doctor and patient feels 
some responsibility in the decisionmaking process.
    You had just made a comment here about in Medicare, about 
the taxpayer should not be required to pay maybe for some 
procedures or some drugs. I believe we still have, in current 
law, and, Mr. Chairman, you are more knowledgeable on this, but 
I think we have in current law now a provision that a physician 
who is taking Medicare patients cannot take private pay in 
addition to that. And as a result of that, I think they feel 
really constrained, and it is difficult for them to say, well, 
you know, maybe there is a procedure out here, the Federal tax 
dollars should not pay for it, but if you are a wealthy 
individual, you can pay for it, and you can go ahead and do it. 
I do not think that option is there.
    Do you think that that provision creates some special 
problems as far as our health care policy is concerned and 
perhaps maybe it is something that ought to be looked at?
    Mr. Brown. I think all of these issues need to be looked 
at, and it is tough. I mean, at some level, what we, as a 
country, just need to decide is how much health care do we want 
and how are we going to pay for it?
    The fact that health care expenditures are growing faster 
than the economy is not necessarily a bad thing if that is what 
we want to spend our money on. I think the issue that you are 
referring to is one which what people are concerned about is 
that we get into a situation where, if you are poor, here is 
the set of drugs you can buy, and if you are wealthy, here is 
the set of drugs you can buy, and there are concerns about 
equity and so forth.
    But what I was trying to get out more was the issue of, as 
Dr. Saving was referring to with his knee replacement example 
suppose there is already a perfectly good knee replacement 
technology out there, and then someone is trying to decide 
whether to develop one that is slightly better. When we think 
about the net social gains to having this new knee replacement, 
it may be relatively small, but positive.
    But because this is all paid for by public dollars, it is 
very much in that company's interests to do it. It can be very 
profitable for them. Once we have all these third-party payers 
in here, it takes away a lot of the market forces that would 
typically serve as a control on those costs. And my point is, 
simply, and again I am not recommending this, I am just saying 
these are the types of issues we need to ask ourselves, is to 
what extent should new drugs or new procedures or new 
technologies be required to pass some sort of a social cost-
benefit test before the public sector pays for them? These are 
difficult questions. I am not even sure how one would implement 
that, but, I mean, those are the types of things I think we are 
going to have to think about.
    Mr. Saving. In that same vein, what are the incentives for 
I will say the need for someone to develop a cheaper knee 
replacement? And when there is no reason for them, the 
customers do not care what it costs, and what is the benefit of 
the cheaper--and that is the thing that, as productivity, Lois 
talked about productivity, productivity is better in the 
private sector because developing the cheaper way to do it is 
how you transfer the customers to yourself.
    As we know, as we look, and a member of my board is the 
chairman of Radiological Oncology at M.D. Anderson, one of the 
top cancer hospitals, and when I speak to her, I like to say, 
``I just dream of the day when I drive to Houston, and I see a 
big sign, but for M.D. Anderson, and the biggest thing on the 
sign is the price. And you are telling me come to M.D. 
Anderson. It is $99 a day, everything included.'' I thought she 
was going to fall off her chair when I told her that. But that 
is what we see for LASIK surgery, that is what we see for 
plastic surgery. The notion of the price matters to people.
    And until we can make it matter to people, and the real 
issue is, as Jeff said, if you make it matter to people, do you 
take away the top tier, the Rolls-Royce of care, from everyone 
else? And do we have to have a system in which everyone is 
entitled to the Rolls-Royce of care? And those are very tough 
questions. That is what makes Medicare reform so difficult.
    Senator Allard. I appreciate your comments, both of you, 
and I do think that we need to figure out ways of trying to 
make it more competitive out there. I agree with that approach. 
But the fact remains it is very obvious that we have a problem 
with Social Security that needs to be dealt with immediately. 
We have a big problem with Medicare that we need to think about 
at some point in the future. We have a big problem with 
Medicare, all of our entitlements, as a matter of fact, but 
particularly those three programs that we have to begin to deal 
with. And I think what we are struggling with and what we have 
to get some insight in is on solutions.
    Most problems in medicine, if you make the diagnosis, the 
treatment is easy. This is one of those problems in politics, 
where you make the diagnosis, the treatment gets very complex, 
and is not so easy. And I am looking forward to hearing from 
you in the future about any suggestions on what we may do to 
bring some efficiencies to the program to make it so that we 
can begin to reduce the huge exponential growth that is 
happening in all of the entitlement programs, as we go out into 
the future.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you.
    Dr. Allard?
    [Laughter.]
    Senator Allard. A little veterinarian medicine thrown in.
    Mr. Saving. Just send everybody to the vet, and we would 
have no problem at all.
    [Laughter.]
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Well, thank you, Mr. Chairman. I would 
just, on that note, indicate if everyone went to their vet for 
their prescription drugs, they would get the same medicine at 
about half the price. So that is one way to--maybe we ought to 
do that. We ought to be doing it.
    Senator Allard. Well, we do not have as many lawsuits.
    [Laughter.]
    Senator Stabenow. Thank you all very much. This is such an 
important topic. And thank you, Mr. Chairman, for holding this 
hearing. I have many thoughts and comments. I think this is the 
most important issue, both from a moral standpoint and fiscal 
standpoint, that we have to deal with, as well as for 
businesses and family members.
    On a personal note, just to bring this back to a human 
factor, I think the reality to the question of how much health 
care do we want is we all want health care for our families, 
and we all want to make sure our families are taken care of, 
that we are taken care of, that we can afford medicine, that we 
can get what we need. And our challenge is to figure out how to 
do that in a cost-effective way without telling someone they 
cannot get what they need for their families.
    I have a question, but I first want to put this in context. 
Other countries, other industrialized countries, spend about 9 
percent of GDP on health care. We spend 15. This goes to the 
point that Ms. Quam talked about, which I think is so critical 
at this point. It is not that we are not spending money, but it 
is a question of how effectively are we spending dollars and 
what way. And I would urge us to look at the context of looking 
at all of health care and not just Medicaid and Medicare, which 
are our immediate responsibilities, because, according to CBO, 
Medicare and Medicaid, average spending growth on a per-capita 
basis in the last 4 years was lower than the private insurance, 
was lower than private insurance.
    So we have to make sure we are looking at all of this so 
that we can address it and not just moving the deck chairs 
around on the Titanic. We need to be addressing it, as you 
said, Ms. Quam. And I would reinforce what Senator Conrad said. 
We have 5 percent of the public that is chronically ill, using 
50 percent of the dollars. Evidence-based health care would say 
we should be focusing in that area, and there are a number of 
other issues that deal with evidence-based care that we need to 
address.
    I, also, would just make the point that if we cut Medicaid 
and Medicare, our business community now understands that that 
rolls over into uncompensated care, which rolls back onto them. 
So, in Michigan, last year, we had over a billion dollars in 
uncompensated care folks walking into the emergency room sicker 
than they should be or getting care they could have gotten in a 
doctor's office or preventative care, if they are treated, as 
they should be, and then my private businesses see their health 
insurance rates go up.
    So it is all connected, and the question is how do we more 
effectively do this and deal with tough choices. And I would 
suggest there are a number of tough choices beyond whether or 
not we buy new equipment. We have prescription drug prices on 
the blockbuster drugs going up 10 times faster than the rate of 
inflation. A tough choice would be maybe we ought to do 
something about that, in terms of accountability. So there a 
number of choices.
    I would like to ask Dr. Saving, though, on the issue of 
prescription drugs and on pricing, you have indicated that the 
prescription drug benefit will ``rapidly grow in its 
requirement on the budget.'' I am assuming that your statistics 
are assuming current drug prices; is that your assumption?
    Mr. Saving. Well, we are making assumptions about what is 
going to happen to pharmaceutical prices, so----
    Senator Stabenow. You are assuming that they would be going 
up as a part of that?
    Mr. Saving. Is that they are going to rise at historic 
rates, and we taper them down. So we make assumptions about 
what is going to happen to pharmaceutical prices. And one of 
the things that Jeff Brown mentioned, are things about levels 
and rates of change. A lot of the things we have discussed 
today have to do with the level of expenditures and do not 
really affect how fast they are growing. And those have very 
small effects in total because you only simply reduce something 
now, but it grows just as fast. The issue is a lot of this is 
about how fast these things are growing and not----
    Senator Stabenow. Right, which, of course, they are 
exploding the prices.
    Mr. Saving. That is the issue. That is right.
    Senator Stabenow. Yes. Let me just ask, though, when you 
talk about shopping around, one of the challenges I think for 
us in health care and in prescription drugs is that it is not 
like buying an automobile. I come from Michigan. We want 
everyone to buy one, and we want it to be made in Michigan. And 
it is not like buying a pair of tennis shoes or something else 
where you can say, ``You know, I would really like a new pair, 
but I will wait a year.''
    My sister-in-law was diagnosed last year with breast 
cancer. Her doctor gave her a prescription for medications. She 
could not say, ``I will wait until next year. I cannot afford 
this.''
    So we have a different way which we approach this because 
the marketplace is different. And so I would ask you, when we 
look at this, if we shop around, and if I am walking in by 
myself to a pharmacy right now without an insurance plan to 
negotiate for me, I pay the highest retail prices in the world, 
but if I have somebody who negotiates for me, I do not.
    We have the VA, as an example. Zocor right now, a veteran 
will pay 66 cents for a pill. If I walk in by myself or my 
relatives who are veterans walking by themselves, they will pay 
$3.77 for a pill. Why would we not want to give Medicare the 
ability to negotiate 66 cents for a pill for others, rather 
than telling folks to go shop on their own, when it is 
something that they have to have?
    Mr. Saving. Well, I am not here to suggest how you might 
change things, although I have suggestions for that, but that 
is not my role here. But the research that we did looked at 
what bulk buyer are paying and what individuals paid who are 
paying for it themselves. As a matter of fact, when I presented 
this on the Hill somewhere--I think it was over on the House 
side--there was a woman in the audience who had just had breast 
cancer, and she was taking Tamoxifen, and she was going to have 
to take it the rest of her life. And she said, You know what 
you are saying is exactly right. I searched--because she was 
going to pay for it herself--she searched, and the prices 
ranged from something like $140 to $60, and so she went to the 
$60 pharmacy. Now, if she paid a $10 co-pay, she would have 
stopped at the first pharmacy she went to and taken the drug. 
It might have been the $140 one. And the difference is her 
shopping for the drugs, since she was paying for it. And it was 
as if I had had her in the audience. It was wonderful to have 
someone like that when you are giving a talk. I was not 
expecting her to be there, but she leapt up and said, ``That is 
exactly right.''
    I am not suggesting that we give people the authority to do 
this. I am requiring it. For that to be the price, it may be 
some what difficult to make sure that everyone pays that price 
because it may be a higher price than some people would 
actually be able to get the drug for. So we have to be very 
careful of the----
    Senator Stabenow. No question that folks should shop 
around. I am just suggesting it is a limited shopping if you do 
not have somebody negotiating for you, and that is why I have 
introduced legislation that I hope my colleagues will support 
to allow, as our former Secretary Tommy Thompson said, he 
wished he had had the authority to be able to negotiate group 
prices, and I think that is a part of bringing prices down. But 
you raised one other point, and I know my time is up, but I am 
going to ask to pursue this just for a second on Tamoxifen as 
an example.
    Part of shopping around and getting the best price is to be 
able to do what we can do for any other product, which is go 
across the border and safely purchase Tamoxifen. Again, in 
Michigan, I can go to Windsor, across the bridge, it is $60; in 
Michigan, it is $360 for a month's supply. Have you looked at 
issues on reimportation. And if you are talking about shopping 
around and the ultimate competition to be able to bring prices 
down would be to give our pharmacists the same ability to shop 
for people that we have for other products. And we have a very 
strong bipartisan group advocating this right now, but that is 
certainly is a part of shopping around, and I wondered if you 
had looked at that.
    Mr. Saving. No, we have not done research. I understand 
some of the economics of this issue and why the drug prices are 
different, meaning that certain foreign countries have 
suggested that if they do not get the price that they want to 
the pharmaceutical companies, they will allow other companies 
to simply make the product, and that has a longer-run issue, in 
terms of drug development. And this is a real issue that, say, 
you want to have the new exotic drugs, and if you were to 
control the prices of them, no one will develop again.
    So I am not taking a position on this in one way or the 
other. I am simply saying here are the arguments on both sides 
of the issue.
    Senator Stabenow. In Canada, for instance, they negotiate 
prices.
    Chairman Gregg. Senator----
    Senator Stabenow. Thank you, Mr. Chairman.
    Chairman Gregg. Well, we want to thank the panel. You have 
certainly put on the table a lot of very interesting ideas and, 
obviously, some statistics which are fairly staggering and have 
significant implications for us as a society and for the 
Government, specifically. So we do thank you, and this 
concludes this hearing.
    We will have, on March 1st, the Deputy Secretary of 
Defense. It will be a first for this committee to have that 
opportunity to talk to the Defense Department about a fairly 
large budget that they have, something I know the ranking 
member has been interested in having.
    So we look forward to that testimony, but we very much 
appreciate your testimony. I am hopeful, quite honestly, that 
some of the ideas that you have put on the table, which have 
been very creative, will find resonance with the proper 
authorizing committee, and we will certainly try to energize 
that.
    Senator Conrad. Thank you all.
    [Whereupon, at 11:43 a.m., the committee was adjourned.]


            THE PRESIDENT'S FISCAL YEAR 2006 DEFENSE BUDGET

                              ----------                              


                         TUESDAY, MARCH 1, 2005

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:03 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Allard, Sessions, Bunning, Ensign, 
Alexander, Conrad, Feingold, and Stabenow.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Mike Lofgren.
    Staff present: Mary Ann Naylor, Staff Director; and Jamie 
Moran.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will begin this hearing. We are joined 
today by Dr. Wolfowitz and General Pace and Ms. Jonas, and we 
are very fortunate to have these three individuals join us 
today. They lead the Defense Department, along with Secretary 
Rumsfeld, and have done an extraordinary job there. I believe 
this is a new precedent in that we have not heard too often 
from the Defense Department at the Budget Committee, and we 
very much appreciate Secretary Wolfowitz taking the time to 
come here today and bring with him his senior team.
    This is important for us to have the Defense Department's 
input onto the budget. Obviously, the Defense accounts 
represent the most significant item in discretionary spending. 
It represents in a $2.5 trillion budget approximately 20 
percent of the entire budget of the United States, and one that 
is clearly critical to where we are going as a Nation and how 
we maintain our independence and strength as a Nation.
    I want to begin by thanking the men and women who serve 
this Nation and who work with you in the Defense Department. We 
have seen a display of extraordinary courage, ability, talent 
and intelligence in the way they have executed their duties in 
Iraq and Afghanistan and around the globe generally, but 
obviously in those two extremely intense environments. We are 
all very proud of them and we are very thankful for what they 
have done because it has been exceptional work. And their 
success is considerable. The elections in Iraq I think stunned 
the world because it showed that democracy could work and that 
there was a desire for it. And they came about because men and 
women on the ground in American uniforms made sure that they 
were able to pursue an election there. We should take great 
pride in that result.
    The recent actions in Syria and in Palestine also reflect 
that the awakening of the voices of democracy is occurring in 
the Middle East and it is in large part because of the 
commitment, the efforts of our soldiers in that region, making 
sure that people who seek freedom have the ability to pursue it 
without being stifled by radical terrorists or individuals who 
are despotic in their approach. So we admire what you have 
done, or I do, and I think I speak for most Americans, and we 
thank you.
    The budget of the Defense Department, as I mentioned, is 
significant, and it is one that needs to be addressed in an 
open forum like this. I know many of my colleagues will have a 
lot of questions. My questions primarily will focus on how we 
are going to sustain our commitment to the Defense initiative 
as we restructure the force structure in order to meet the new 
threat of terrorism or the threat which now unfortunately we 
are deep into fighting. It is not that new any longer. But what 
is it going to cost us in the outyears? We know what it is 
going to cost next year. We can project what it is going to 
cost for maybe 2 years, but what is the long-term cost and 
where should we be reallocating resources and how should we do 
that? And how do we treat the issues beyond the Defense 
Department, which the Defense Department is pursuing or being 
drawn into, such as public diplomacy and nation building, for 
lack of a better word, protecting democracies, fledgling 
democracies? How do we deal with that and what is the cost as 
we move forward? Where will we adjust in other areas, which 
obviously there has been a lot of discussion about, and there 
are some major reports coming forward.
    So we look forward to your testimony today. We thank you 
for taking the time to appear before us. We appreciate the 
courtesy you are showing us by being here today.
    With that, I will yield to the ranking member of the 
committee, Senator Conrad, for his thoughts.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Thank you, Mr. Chairman. I want to join the 
chairman in first of all thanking you, Secretary Wolfowitz and 
General Pace and Ms. Jonas for being here today. It is very 
important for the deliberations of this committee to have a 
defense panel before us, and we appreciate very much your 
taking the time to come and make a presentation here.
    I also want to join the chairman in, through you, thanking 
the men and women in uniform. I think every American is 
intensely proud of how you have conducted yourselves at a time 
of great stress. I believe my State has the highest proportion 
of guard troops in Iraq. We are proud of each and every one of 
them, and we recognize their sacrifice and their service, and 
again through you, we want to express to them this Nation's 
undying gratitude. Whether one agrees with every element of the 
policy of the United States really should not have a place with 
respect to how we regard the men and women who meet the call of 
this Nation. That is an extraordinary thing that people do to 
answer this Nation's call at the time of need.
    I would just like to put a few things in perspective in my 
opening remarks, and then we will get to questions. And I want 
to thank the chairman as well for holding this hearing.
    I put up this chart just to put in perspective where we are 
in constant dollars terms, the Defense budget of the country 
over an extended period of time. What this chart shows is going 
back to 1950, coming off of the Korean War and the peak of the 
time of the Vietnam War which was between four and five hundred 
billion in constant dollars. Then the Reagan defense buildup, 
which was just about 500 billion in constant dollars, and now 
this buildup which appears to be, if my eyesight is correct, 
the highest in real terms since the Korean War. So we have a 
trajectory here that I think we all understand. It is a result 
of the war in Iraq, the war in Afghanistan. It is a result of 
the war on terror. Those are the things that are pushing up 
this Defense budget. Defense is where most of the increase in 
discretionary spending has occurred. In fact, 91 percent of the 
increase in discretionary spending is a result of the increases 
in Defense, Homeland Security and the other responses to 
September 11th, the rebuilding of New York, the airline 
bailout, et cetera. So the vast majority of the increase in 
spending that has occurred is in just those three areas.

[GRAPHIC] [TIFF OMITTED] T1173.218


    If we go to the next slide, I think the administration has 
been less than forthright with respect to what these costs 
would be. This is an interview with George Stephanopoulos in 
January of 2003 with the Secretary of Defense. And the 
interviewer asked this question: ``What should the public know 
right now about what a war with Iraq would look like and what 
the cost would be?'' Secretary Rumsfeld: ``The Office of 
Management and Budget estimated it to be something under $50 
billion.'' Interviewer: ``Outside estimates say up to $300 
billion.'' The Secretary: ``Baloney.''

[GRAPHIC] [TIFF OMITTED] T1173.219


    Let us go to the next slide. These are just the 
supplementals that we have had since that time. The 
supplemental in 2003 was 79 billion. We had a total of 
supplementals in 2004 of 112 billion, and now this year $82 
billion. You add that all up and we are approaching the $300 
billion that was described as baloney.

[GRAPHIC] [TIFF OMITTED] T1173.220


    Whatever the description, the harsh reality is this has 
cost us a lot, and it is going to cost us a lot more. As I look 
at the budget, I do not see the President providing for these 
costs anywhere close to what most objective observers say the 
cost is going to be. We have the supplemental now of $82 
billion. The Congressional Budget Office says that the expected 
cost is over $380 billion. If I were to fault the 
administration, I would fault them for not really sharing with 
us in a clear way what the costs are going to be. I know people 
say it is hard to estimate the cost. Well, that is what a 
budget is about, and it is like a family saying it is hard to 
estimate what our utility bill is going to be, so we just leave 
that out of the family budget, or it is hard to estimate how 
much we are going to eat out so we are going to leave that out 
of the budget.

[GRAPHIC] [TIFF OMITTED] T1173.221


    We know the right answer is not zero past September 30th of 
this year, and yet that is where we are with the budget. So I 
would urge the administration to put in the budget what they 
think the real costs are going to be.
    Let me go to the next slide. This is a quote again from the 
Secretary in February 12th of 2004 before the Defense 
Appropriations Committee, and he said, ``We have instituted 
realistic budgeting so that the Department now looks to 
emergency supplementals for unknown costs of fighting wars and 
not to sustain readiness as had been the practice previously.''

[GRAPHIC] [TIFF OMITTED] T1173.222


    But when we look at this budget, when we look at these 
supplementals, we see something other than that assertion. We 
see $5 billion for Army modular force restructuring, $2 billion 
for aid to foreign militaries, $100 million for a Jordan 
Special Operations Training Center, $300 million for recruiting 
and retention, and as much as $3 billion of core Army 
operations and maintenance costs.
    I would say to you, Mr. Secretary, and through you to the 
Secretary of Defense, from a budgetary standpoint I think it is 
critically important that we have these ongoing expenses 
included in the budget itself, not in supplementals, because 
that will lead us down a road that is even more unsustainable 
than our current course.
    With that I look very much forward to your testimony. Mr. 
Secretary, you reminded me this morning we first met in 
Indonesia almost 20 years ago, and I was very impressed by you 
then. As I have expressed to you before publicly, we appreciate 
all of those who come forward and serve this Nation, and I say 
that to General Pace as well. I have high regard for Ms. Jonas, 
thank you as well.
    Chairman Gregg. Thank you, Senator Conrad.
    Dr. Wolfowitz, we would be happy to hear your thoughts.

 STATEMENT OF PAUL WOLFOWITZ, DEPUTY SECRETARY, DEPARTMENT OF 
 DEFENSE, ACCOMPANIED BY GENERAL PETER PACE, VICE CHAIRMAN OF 
  THE JOINT CHIEFS OF STAFF, DEPARTMENT OF DEFENSE; AND TINA 
 JONAS, UNDER SECRETARY OF DEFENSE/COMPTROLLER, DEPARTMENT OF 
                            DEFENSE

    Mr. Wolfowitz. Mr. Chairman, thank you. Senator Conrad, 
thank you.
    We understand the enormous responsibility this committee 
has to try to look at the overall financing of the Federal 
budget. We appreciate that we are a very big part of, as you 
said, of the discretionary part of that budget, and most 
importantly we appreciate that the incredible men and women who 
serve this country so nobly and so well, that both of you have 
praised appropriately. And I think we cannot praise them 
enough, could not do what they do without the support that 
comes from the U.S. Congress through the budgetary process. We 
know that we need that support and we are privileged to come 
here and be able to try to explain what we are doing to this 
important committee. Given the many difficult choices with 
which you are faced, I appreciate this opportunity.
    As both of you have referred to, we are a Nation at war. On 
September 11th, 2001, terrorists attacked the United States in 
a way that American territory had never been attacked before, 
claiming lives on a scale that could only be compared with the 
attack at Pearl Harbor 60 years earlier. Along with our 
national loss, September 11th revealed another stunning threat, 
the possibility of far more terrible attacks including those 
using weapons of mass destruction. Indeed, soon after September 
11th the Congress itself was attacked with military grade 
anthrax.
    Given the nature of terrorist networks and the secrecy with 
which they operate, no one can say for certain why this country 
has not been attacked in the last 3 years. What we can say with 
confidence is that the reason we have not been attacked is not 
because the terrorists have not been trying, we know that they 
have. But we can also say with confidence that many plots and 
attempted attacks, both here and abroad, have been thwarted 
through the continuing efforts of the United States and some 90 
nations who are cooperating with us in the war on terror. The 
facets of this international cooperation are many and varied. 
They are not purely military.
    In fact, from our standpoint, this war involves all 
elements of American national power, including military force, 
but not solely or in most cases even primarily military force. 
Indeed the various instruments of our national power, including 
intelligence, law enforcement, diplomacy, and I would add 
particularly as we watch dramatic events unfolding in places 
like Lebanon, the power of the idea of freedom for which this 
country stands served to reinforce one another. But there is no 
question that the contribution of the U.S. military has been 
indispensable to much of the success that we have achieved so 
far.
    While our efforts are far from complete, we can point to 
certain significant milestones. For example, terrorists have 
lost their ability to train thousands of potential terrorists 
in camps that previously existed in Afghanistan and in northern 
Iraq. And while bin Laden and his top lieutenant, Ayman al-
Zawahiri, are still on the loose, more than three-quarters of 
al Qaeda's senior leaders have been detained, captured or 
killed, and thousands of lesser members of that organization 
since September 11th. Bin Laden's access to resources and his 
ability to communicate with his confederates has been 
significantly constrained. And in the terror war which bin 
Laden Abu Musab al-Zarqawi is waging against democracy in Iraq, 
al Qaeda is losing badly.
    In just the last 3 years, in regions some people previously 
judged immune to the democratic spirit, there has been an 
extraordinary movement toward representative Government, what 
President Bush has rightly called the ultimate weapon against 
the terrorists' bleak vision of death and despair.
    Thanks in no small part to the efforts and the sacrifices 
of American men and women in uniform, some 50 million people in 
Afghanistan and Iraq, almost all of the Muslims, are now 
themselves helping to advance the cause of freedom in the 
Muslim world.
    But Afghans and Iraqis are not alone. There seems to be a 
larger movement of democratic forces at work, and it has been 
due in great measure to the courage and commitment of brave and 
committed citizens of Muslim countries themselves, in many 
cases without any involvement of U.S. military force.
    Last September in the country where I first met Senator 
Conrad--it is hard to believe it was 20 years ago, Senator, you 
do not look that old; I hope I do not--Indonesia, the country 
with the largest Muslim population in the world, held it second 
successive free and fair election of a president, a milestone 
often considered a landmark on the road to democracy.
    In January the Palestinian Authority held an historic 
election that has produced new leadership that may finally 
deliver for the Palestinian people the state they have long 
deserved.
    In Lebanon tens of thousands of people have come out to 
demonstrate in the wake of the assassination of former Prime 
Minister Rafiq Hariri. As we saw just yesterday, the Syrian-
backed government in Lebanon resigned under popular pressure.
    And of course citizens were a powerful driving force for 
freedom in Afghanistan and in Iraq.
    While the U.S. military is not the only national instrument 
the has contributed to these important goals, its indispensable 
role is unquestionably the most expensive. It is expensive in 
terms of the resources that it demands of the American 
taxpayer, and it is expensive particularly in terms of the 
sacrifices that it demands of our men and women in uniform, 
including those who have made the ultimate sacrifice for our 
freedom and security.
    This Defense budget is first and foremost about them and 
about their future, and about ours as Americans.
    It is in this context, Mr. Chairman, that the President has 
requested $419.3 billion in discretionary budget authority for 
the Department of Defense, representing a 4.8 percent increase 
over fiscal year 2005. Combined with a supplemental, this 
request provides sufficient funding to sustain the President's 
pledges to defeat global terrorism, to restructure America's 
armed forces and global defense posture, to develop and field 
advanced war fighting capabilities, and most of all to provide 
for the personnel needs of our forces.
    Before I discuss the 2006 budget request, I would like to 
say a few words about the supplemental. The President has 
pledged that our troops will have what they need to fight and 
win this war. The President's recent request for an additional 
$74.9 billion in fiscal year 2005 supplemental appropriations, 
on top of the $25 billion that was appropriated last August, 
keeps that solemn pledge.
    Of critical importance, this supplemental will provide 
significant resources to address wear and tear on our military 
equipment, to create a larger more combat-capable Army and 
Marine Corps, and to train and equip Iraqi and Afghan security 
forces to empower them to take the fight to the extremists and 
help them take control of their future. Let me briefly address 
each of those three topics.
    First, as far as resetting the force is concerned: a high 
operating tempo is causing significant wear and tear on some of 
our war-fighting equipment. The supplemental includes $11.9 
billion to reset or recapitalize the force, which is essential 
to ensuring military readiness. I think those are some of the 
costs that Senator Conrad referred to, and we believe they are 
war related costs.
    Our commitment is to keep military units at full combat 
strength, and provide them with the equipment they need to be 
ready when we need them.
    Second, very importantly, when it comes to restructuring 
ground forces, the Department has made a major commitment to 
restructuring the U.S. Army, adding $35 billion over the 7-
years of the fiscal year 2005 to 2011 future years Defense 
plan, on top of $13 billion that was already in the Army 
baseline budget.
    Restructuring will increase the number of Army brigades and 
convert them into independent brigade combat teams that can 
conduct operations on their own. Let me take just a moment to 
explain in a bit more detail what we mean when we talk about 
that conversion. We use regularly the term ``Army modularity.'' 
We all think we know what it means, but it is a kind of obscure 
phrase that I think obscures the exciting implications of 
what's going on.
    Because what the Army is undertaking is actually a 
remarkable and fundamental transformation in the way that it 
organizes and thinks about deploying forces, and it will make a 
huge difference in the strain that is placed on forces and the 
strain that is placed on families through deployments.
    The Department has made a major commitment to this type of 
restructuring for its ground forces, which is designed to add 
more deployable units, create a larger rotational base, and 
increase flexibility, thus relieving the strain on the total 
force by creating more deployable units.
    The Active Army, for example, will expand from 33 maneuver 
brigades in fiscal year 2003 to 43 brigade combat teams in 
fiscal year 2007. The chart that has been put up actually shows 
you how that increase of 10 deployable brigade combat teams, if 
notional, for deployment of 15 active brigades, increases the 
amount of time that any individual brigade spends at home by 50 
percent. That is a very big difference, has a very big impact 
on morale and on families.
    In addition the current Army plan would restructure the 
Army National Guard to reach 34 trained and ready brigade 
combat teams by fiscal year 2010, up from the current 15. The 
most significant consequence of these two expansions is that 
for any required level of overseas force deployment, active 
brigades will deploy much less often and reserve maneuver 
brigades will be mobilized much less frequently.
    Right now as we speak, the Army's Third Infantry Division, 
the first to complete the transformation going from three 
brigades to four independently deployable units has just 
completed its redeployment to Iraq. It is putting this new 
concept into practice. The Third Infantry division relieved the 
First Calvary Division which will undergo the same 
transformation now when it returns to Fort Hood. The result of 
that change in the Third Infantry Division is that we needed 
one less National Guard brigade to fill what otherwise would 
have been a hole.
    The recent history of the Third Infantry Division explains 
why we are funding Army transformation in fiscal year 2005 and 
fiscal year 2006 from supplemental funds. As the Third Infantry 
Division redeployed from Iraq some 15 months ago, we 
simultaneously reset it from the wear and tear of combat and 
transformed it from three brigades to four.
    Let me emphasize beginning in fiscal year 2007 we will 
request funding for restructuring I the baseline Army budget. 
By then we expect both the rotational strain on our troops to 
be less, and our understanding of the costs of transformation 
to be more exact.
    But for this year and next year supplemental funding is 
critical because it addresses two urgent requirements. First it 
rapidly expands the operating size and combat power of the 
Army, making our forces more effective in the global war on 
terror and making their deployment more sustainable. And 
second, by creating a larger number of more capable brigades 
available for rotation, it significantly reduces the strain on 
our military units and troops.
    Third and very important, the supplemental also funds the 
vital strategic goal of training and equipping indigenous 
military and security forces in Iraq and Afghanistan. Building 
the capabilities of these countries' forces is essential to the 
long-term security and stability of both nations, and will 
enable them to become more self-sufficient and less reliant on 
U.S. and other coalition forces. I urge full funding of our 
request and creation of an Iraq Security Forces Fund and 
Afghanistan Security Forces Fund to provide the resources 
needed to train those forces so that they can take control of 
their own security needs and take the burden off of our troops.
    Members of Iraq's security forces were critical 
participants in January's choice for freedom. Several bravely 
gave their lives to shield Iraqi voters from suicide bombers 
and insurgents. Their performance on the January 30th election 
day is visible and tangible evidence of the returns we are 
getting from our substantial investment in those forces.
    In a recent call with General Casey, he told us that since 
the election Iraqi security forces have grown more confident, 
and volunteers have grown in numbers. The Iraqi people have 
become more confident of an Army made up of Iraqi patriots who 
are their husbands, their daughters and their sons, and some 
1,400 Iraqi police and soldiers have died since Iraq's 
liberation.
    Mr. Chairman, let me say a brief word also about the 
requesting in the supplemental for tsunami relief. Let me also 
emphasize that our ability to come to the aid of hundreds of 
thousands of people who were made homeless by that incredible 
disaster, that made it possible I think to save tens of 
thousands of lives, would not have been possible without the 
investment the American taxpayer has made over many years in 
those capabilities. We estimate conservatively just the 
equipment alone, the ships and the helicopters, represented a 
$28 billion investment in military equipment that no other 
country could have provided. It was an honor and a privilege to 
be able to do that, and I think it was not only a great 
humanitarian success, but I also think it has helped advance 
America's position in many parts of that region.
    We have requested funds in the supplemental to cover those 
expenses. We have an enormous stake to make sure that the 
subsequent recovery efforts build on the success we have 
already achieved. The benefits of that assistance will focus 
principally on Indonesia, which, as I believe Senator Conrad 
pointed out, has the largest Muslim population of any country 
in the world, and it does so at a time when Indonesia is 
emerging as a democracy, seeking to join the community of free 
nations.
    A recent poll in that country indicates that strong 
positive change in public opinion after people saw how 
Americans, especially American military men and women, labored 
to bring life-saving water, food and other supplies. I was 
privileged to visit with young sailors on board the U.S.S. 
Lincoln, as did several Members of Congress. They were 
incredibly eager and enthusiastic volunteers whose tireless and 
selfless efforts were truly inspiring.
    We now have the opportunity--and the supplemental will 
enable that--to build on their wonderful work by helping 
Indonesia strengthen its democratic institutions and rebuild 
its vital infrastructure. It is certainly in our national 
interest to do so.
    Mr. Chairman, we have had to make some difficult choices in 
this budget, particularly to find the resources to fund Army 
modularity in fiscal year 2007 and beyond. We recognize that 
the fiscal year 2006 budget is sizable by historical standards, 
but I believe it is a sustainable defense burden, especially in 
light of the stakes involved. Americans can be ensured, 
however, that we are balancing this budget request with some 
difficult choices among competing needs. We need Congress's 
support of those tough choices.
    To get the best out of America's investment in defense the 
budget reflects continuing work to restructure our forces, to 
restructure our global defense posture, and to restructure our 
basing here at home. We believe those are all smart choices 
that will help to achieve more combat power in the future 
without a commensurate increase in troops or funding.
    Beyond concepts like Army modularity, something equally 
remarkable is taking place in the way in which we base our 
forces. We are changing fundamentally the character of our 
global stationing, and at the same time we are going through a 
major effort to realign our basing posture here at home so that 
it supports the essentially expeditionary character of most of 
our forces. In addition we think this realignment of our base 
structure will support the new requirements for homeland 
defense.
    There are two key initiatives regarding base structure that 
I would like to mention. The President's global posture 
restructuring will bring home 70,000 U.S. military personnel 
and approximately 100,000 dependents back to the United States, 
and relocate those forces and equipment that remain overseas. 
Second, the 2005 Base Realignment and Closure Commission will 
take this return from overseas into account in deciding how to 
streamline and restructure the Department's installations here 
in the United States.
    In addition, all of our services are taking efforts to 
rebalance the distribution of military specialties between the 
active and reserve components, so that for those military 
specialties that are in high demand, we will not constantly 
have to go to the reserves as we have had to for certain ones, 
particularly, notably, civil affairs.
    Mr. Chairman, the fiscal year 2006 budget funds a balance 
combination of programs to develop and field the capabilities 
most needed by America's military. It provides for our most 
valuable asset, our people, by maintaining the President's 
commitment to take care of our military men and women and their 
families. It includes a 3.1 percent increase in military base 
pay. It includes an increase in funding to ensure continuing 
good health care, and it will fund by fiscal year 2009 the 
elimination of all inadequate housing units worldwide.
    Mr. Chairman, American soldiers, sailors, airmen, Marines 
and Coast Guardsmen, as well as their civilian colleagues 
serving in the global war on terror have performed 
magnificently. They have done everything that has been asked of 
them and more. As of February 28th, more than 1,600 Americans 
have given their lives in Afghanistan and Iraq, and thousands 
more have been wounded to protect our freedom and encourage 
liberty's advance for people once enslaved by brutal tyrannies.
    They could not have pursued this noble cause without the 
strong support of Congress. On behalf of those brave Americans 
who serve and have served us so well, I would like to thank the 
members of this committee and the entire Congress for that 
continued bipartisan support.
    We can point to some truly significant gains, some of which 
I mentioned earlier, but we must not allow ourselves to become 
complacent just because this country had not been attacked in 
the last 3 years. As I said earlier, we know that the 
terrorists are still actively plotting, and we must maintain 
strong pressure on them, and if possible, intensify it.
    As just one example, I would note that in the regions that 
straddle the Pakistan-Afghan border, as we speak here today 
Pakistani armed forces, supported by active American operations 
on the Afghan side of the border, are putting intense pressure 
on al Qaeda leadership, hiding in northwest Pakistan.
    But while capturing and killing terrorists is critically 
important, this struggle is not just about those activities 
alone. As the President said in his inaugural address, and I 
quote, ``The best hope for peace in our world is the expansion 
of freedom in all the world.'' That means reaching out to 
mainstream Muslims who want freedom and democracy and 
prosperity. That is what the terrorists fear. That is why they 
fight to impose on their fellow Muslims a medieval, intolerant, 
tyrannical way of life.
    That is the fear that prompted members of the Taliban to 
threaten voters in the Afghan elections. That is the fear of 
freedom and self-determination that caused Osama bin Laden to 
declare that Iraqis who voted in the elections would be 
infidels and apostates.
    But we know that despite those threat, the Iraqi people 
exercised their new-found freedom and voted anyway. It is a 
story of enormous courage by 8-1/2 million individual Iraqis, 
every one of whom knew they were taking a personal risk when 
they marked their finger with that bright purple ink, telling 
everyone including the terrorists where they stood.
    There are many stories of heroism from that day, including 
the stories of two separate Iraqi policemen who tackled suicide 
bombers and gave their lives to protect voters. But one of the 
ones that impressed me the most was one told to me the next day 
by Brigadier General Carter Ham, who commands our forces up in 
Mosul.
    He described a polling station in a Sunni-Arab neighborhood 
of that city, a city that suffered some of the most brutal 
intimidation in the last few months. Nobody had voted for the 
first 2 hours, but a crowd of several hundred people had 
gathered at a distance to watch. Finally, around 9 o'clock in 
the morning after the polls had been open, as I say, for 2 
hours, one old woman in her late 60's, early 70's stepped 
forward and said, ``I have waited all my life for this 
opportunity. I am not going to miss it.'' She stepped into the 
polling place and the crowd followed her. The will to fight for 
freedom does not diminish with age or infirmity.
    It is difficult to imagine people anywhere in the world 
showing more courage and determination to vote in the face of 
intimidation.
    But as impressive as that result is, as impressive as the 
results in Afghanistan or some of the seeds of freedom that are 
sprouting elsewhere in the Middle East, Iraqis and everyone 
still face a difficult road to defeat the terrorist threat, to 
defeat tyrannical intimidation, and to achieve stability, much 
less freedom and democracy. But our investment in training 
Iraqis to defend themselves is beginning to pay off, and it 
will continue to do so, especially as their growing capability 
translates into less stress on our troops, which is one of our 
key goals.
    Mr. Chairman, just to conclude, our investments in many 
fronts of the global war on terror have given us some important 
returns, but we must remain resolved and patient, for there is 
much yet to do. This problem of terrorism grew up over a period 
of 20 or 30 years if not longer. It is not going to go away in 
two or three. We may recall how long we waged the cold war and 
how long it took to rebuild Western Europe, but in both cases 
we know how the story ended. We know that seemingly impossible 
challenges can be achieved when the American people and their 
allies are resolved to stand firm for freedom, and freedom is 
perhaps the most powerful force in the world.
    It has been the glue of the world's strongest alliances. It 
has been the solvent that has dissolved tyrannical rule. The 
same values that held the western alliance together over four 
decades of often contentious debate during the cold war have 
brought some 40 countries into the coalition effort in 
Afghanistan, more than 30 countries with us into Iraq, and some 
80 or 90 countries into the larger coalition against global 
terrorism. The longing for freedom that penetrated even the 
Iron Curtain brought about the peaceful end to the cold war, 
and that same universal desire for liberty among Muslims as 
well as non-Muslims will be our strongest weapon in fighting 
fanaticism today.
    Mr. Chairman, this budget addresses our country's need to 
fight the war on terror, to support our men and women in 
uniform, and to meet the threats of the 21st century. It 
reflects difficult choices to ensure sufficient funding for our 
most pressing requirements. Those difficult choices and our 
proposed transformation of the business of defense underscores 
our resolve to be wise in spending taxpayer dollars.
    This committee has provided our country strong leadership 
in providing for the national defense, and ensuring the 
taxpayer dollars are wisely spent. We appreciate that support 
and we look forward to continuing our work with you to achieve 
both of those critical goals.
    Thank you very much.
    Chairman Gregg. Thank you, Mr. Secretary, for that very 
strong statement on purposes of our military and how it has 
brought freedom really to millions of people and allowed 
elections to occur in Afghanistan and Iraq, which have led, I 
believe, to the elections in Palestine being successful and the 
recent Lebanon situation, which has reflected a movement toward 
democracy. So I congratulate you.
    This committee deals with numbers, and although the 
philosophy you have presented is one I would love to pursue, 
because I think it needs to be echoed, let me stay with the 
purposes of this committee which is numbers.
    The ranking member, Senator Conrad, has mentioned the fact 
that the budget did not, as presented by the President, did not 
have in it any allocation for the expenditures which we might 
incur relative to the war in Iraq. It had in it a core defense 
budget, as you mentioned, of $419 billion as being the request. 
You have obviously presented a supplemental this year. There 
are prior supplementals before this year. It is logical that 
next year we will need to expend money in Iraq and in 
Afghanistan, which will be above the core defense budget. It 
would be my expectation that as part of our budget process, we 
would put in place a reserve fund for the purposes of funding 
that. I expect it would be in the same range as we put in last 
year, although the budget did not pass last year, which was $50 
billion.
    The reason I think it is important to pursue it in a 
reserve fund form and the reason I think you are correct in 
bringing up the issue of how you paid for the war in Iraq and 
Afghanistan through the supplemental process, as versus through 
the core process is that these are not expenditures which are 
going to go on forever. In fact, we hope that they are 
expenditures which will be shortened in their time horizon 
rather than infinite in their time horizon, and in fact, 
hopefully no more than two or three more years of significant 
expense, maybe even less if we are fortunate.
    Therefore, I do not believe that these dollars that we are 
expending in Iraq and Afghanistan should be built into the 
defense base, and I think it would be a major budgeting error 
to do that because it would inappropriately inflate the defense 
base. So they should come forward as supplementals, but I also 
think that our budget should reflect the fact that we expect 
that, and therefore, I do anticipate that we will put in, as I 
said, a reserve fund. I have spoken with people within the 
administration who I do not believe resist this idea. I think 
they probably think it is a reasonable approach, and I would be 
interested in whether you even have an opinion on this or 
whether you think it is our responsibility to just go forward 
and do what we think is right.
    Mr. Wolfowitz. Let me say we certainly want to work with 
you to provide as much clarity as we can about expenditures. I 
agree emphatically with what you have just said about why these 
emergency expenditures that are not predictable should not be 
built into the base budget. In fact I believe we made an effort 
to do exactly that in the first year of Operation Enduring 
Freedom, and I think the Congress turned it down on the ground 
that this would be an unallocated--in some people's words--
slush fund.
    I think when you have emergency expenditures of this kind 
that really are unpredictable, it is wise to do it through 
supplemental. At the same time we can absolutely predict there 
will be a supplemental budget request next year. I do not know 
what the size is. I hope as you do that it may turn out to be a 
lot smaller than what we need this year, but I would be a fool 
to predict that. I think, therefore, making some kind of a 
provision in your overall budgeting for the fact that there's 
going to be a requirement for U.S. Fiscal resources over and 
above the $418 billion that we are requesting makes common 
sense. I think you did it last year or tried to do it last 
year.
    The one thing I would add in addition is the reason we came 
forward with a supplemental request for 2005 early in this 
process this year was precisely so that people would see--as 
you know, often there has been a tendency, for various reasons, 
to delay it and delay it. We are kind of happy as the Defense 
Department to get that number out there early, and I think the 
administration as a whole was happy to get it out there early 
so that Congress understands at this point what we estimate is 
going to be the full cost for fiscal year 2005, but we really 
cannot predict fiscal year 2006.
    Chairman Gregg. I expect we will set up a reserve fund and 
it will be approximately in the range of last year, and I take 
it from your answer that you do not have any great reservations 
about that approach.
    The number 419 is a significant number, but in the context 
of being at war it is probably not a significant number 
relative to the rest of the national budget, the national 
budget being a $2.5 trillion budget. We are at war. Senator 
Conrad put up some numbers which reflected this in real terms 
relative to the number in other periods in our history, but I 
suspect that if we went back historically the percentage of the 
budget that is being committed to fight this war is 
significantly less than percentage of the budget that was 
certainly committed to fight World War II when we were attacked 
at Pearl Harbor as we were attacked this time in New York and 
here in Washington. And I suspect that it is significantly less 
than when we were at war in Korea, and probably in Vietnam, and 
during the defense buildup of the Reagan years it may have even 
been less then when we were not in a formal war, though 
obviously our intention was to dismantle the Soviet Union by 
making it clear to them that they could not compete with a free 
society.
    So I would be interested in putting those numbers in a 
framework of what they represent rather relative to defense 
spending at a time of war if you have those numbers.
    Mr. Wolfowitz. Ms. Jonas may have more detail. I know 
roughly just in terms of the measure of percent of GDP, which--
or defense burden, or what it represents for the average 
taxpayer, if there is such a thing as an average taxpayer. We 
are at about 3.3 percent of GDP which I think is about half or 
less than half of the cold war peak. My impression--I guess I 
do not want to guess.
    What was it in World War II, Tina? Do you know?
    Ms. Jonas. I do not have that percentage, but I do have, in 
terms of Federal spending, we are 18 percent--this budget would 
make us 18 percent of Federal spending. But 1960 we were 51.4 
percent of Federal spending so it has dropped a little bit. I 
have the number here. In 1960 DOD outlays were 8.2 percent of 
GDP, so we are down significantly.
    Mr. Wolfowitz. We will get you the full historical data, 
not for the record.
[GRAPHIC] [TIFF OMITTED] T1173.207


[GRAPHIC] [TIFF OMITTED] T1173.208


    Chairman Gregg. The point I was obviously trying to make 
was that, yes, we are spending a lot on defense, but we are at 
war, and in the context of other times that we have been at 
war, actually our defense spending is small compared to those 
periods.
    Senator Conrad.
    Mr. Wolfowitz. One other point, Mr. Chairman, too. I think 
compared to the potential cost to this country if terrorism is 
successful--we had a inkling of that on September 11th--the 
potential expense of that. We are not doing this mainly to--
most of all it is a matter of protecting lives and security, 
but just the monetary costs alone of terrorism are enormous.
    Chairman Gregg. Thank you.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Let me say first of all the speaking for me, I intend to 
fully support the President's request for Defense, as I have 
throughout this period. We are at war. I think it is very 
important that we stand shoulder to shoulder. I think it is 
very important that we signal our adversaries that we are 
united in support of our men and women in uniform, and I think 
that it is just critically important that we send that message. 
I can assure you that on our side of the aisle, we will fully 
support the resources the President has requested.
    I also told the President, when I had an opportunity to fly 
to North Dakota with him right after the speech on the state of 
the union, that I thought when he talked about the enduring 
values of this country, freedom, liberty, that is really the 
moral strength of America, and that is the signal that we 
should send the rest of the world.
    I think I mentioned to you, Mr. Secretary, that I graduated 
from high school from an American military base in Libya, old 
Wheelus Air Force Base. A family I lived with was the Vice 
President of Mobil Oil in Libya at the time. His name was 
Wendall Smith. So it was an interesting growing up. Sometime I 
would love to sit down with you and share perspectives on what 
is happening in that part of the world and the challenge that 
we face there.
    But we face a challenge on this committee of trying to make 
all this add up, and frankly, as I look at the overall budget, 
I do not see any of it adding up, and that is a big problem. We 
have record deficits. We are headed for the retirement of the 
baby boom generation. And the pressure on all of these spending 
priorities is going to be intense and only get more so.
    Let me just go to this. This struck me, this exchange with 
the Secretary of Defense on February 7th in a press briefing on 
the President's budget. And let me just go over with you what 
was said in this briefing. The reporter asked the Secretary: 
``The budget shows that Army spending is going down by $300 
million in the fiscal year.'' The Secretary interrupted and 
said, ``Which as you know is not the case.'' The reporter said, 
``Well, that's what I see.'' The Secretary said, ``Yeah, I 
should have mentioned that. The only way you can look at this 
budget is to look at the supplementals with it, and it would be 
a misunderstanding of the situation to come to the conclusion 
that you pretended you had come to, but of course you did not, 
being as knowledgeable as you are.'' The reporter: ``Well, are 
you hiding? Are they in fact hiding non-combat costs in the 
supplemental?'' The Secretary: ``No, of course not. No, that 
would be wrong''--laughter--``and we wouldn't do that.''
    You know the problem that I see looking at this budget--and 
again I want to make clear I support the overall resources 
being requested--but I have to tell you I am very, very 
concerned about not having anything in the budget for past 
September 30th of this year for conducting this war. We all 
know that there are going to be expenses. To the extent we know 
them, we ought to budget for them.
    I applaud to chairman for indicating he is going to put up 
a reserve fund, because it is just a mistake, I believe, not to 
tell the American people, not to tell Congress the expenses 
that we anticipate associated with these conflicts. You know we 
can take--but we need you to make your best estimates, and I 
know it is hard, I know it is difficult to estimate, but it is 
impossible to put together a budget unless we make good faith 
estimates of what costs are going to be, and to say there are 
not going to be any costs, to suggest in a budget there are not 
going to be is just wrong. We know it is not the case.
    So I would ask you what your reflection is on this 
interchange with the Secretary and the reporter on whether or 
not the Army budget is being reduced. How would you have 
answered those questions?
    Mr. Wolfowitz. We know that the Army budget is going to--
the Army resourcing in fiscal year 2006 is going to include a 
substantial amount for resetting the force and modularity, and 
I think I made that clear in my testimony. It covers 
expenditures that have I would say two characteristics to them. 
A lot, No. 1, they are unpredictable, and No. 2, a lot of them 
are combat related and we can get into how many angels dance on 
the head of a pin as to whether--certainly repairing equipment 
that has gone through extra wear and tear because of the very 
substantial increases in usage in Iraq is combat-related, but 
also the kind of resetting that we are doing in the Third 
Infantry Division on the schedule we are doing it is because we 
are at war. We could do it in a much more leisurely way if we 
were not. And these really are--that is the second point, 
Senator, these really are genuinely unpredictable.
    General Pace may be able to help me on this, but General 
Shoemaker and Acting Secretary Brownlee, they first came to the 
Secretary of Defense with this whole idea of Army modularity--
when was it, Peter? Was it the fall of last year or a little 
earlier?
    General Pace. About that, sir, maybe just a little bit 
earlier.
    Mr. Wolfowitz. That was brand new. It was projected in the 
neighborhood of several billion dollars. I do not want to give 
an exact number because my memory will betray me here. That was 
a brand new expenditure that had not been anticipated that is, 
as I say, is related to making the Army more sustainable for 
the war.
    By the time we got around to putting together this year's 
supplemental just a few months later, that Army estimate had 
nearly tripled for a variety of reasons. So we really are 
dealing with something that is unpredictable, but I can predict 
for you with confidence that there will be a substantial 
request to fund Army modularity and reset in fiscal year 2006 
in a supplemental appropriation. So if you want to take a 
realistic estimate of fiscal year 2006 Army resources, that 
would have to be part of it. And we are not trying to hide that 
fact. We just cannot predict it.
    General Pace. If I might add, sir, when the Army thought 
bout how they would use the money that was coming to them to 
reset the force, had a choice of resetting to the old Army or 
moving forward to what was a new concept of modularity. Using 
the money then in a supplemental to buy the new Army, not the 
old one, and as a budget is laid out then, in fiscal year 2007 
and beyond, the expenditure to reset the remaining part of the 
Army will in fact be on budget. But since this budget process 
had begun and the concept of how to modularize came up about 
midway through the 2006 budget process, the perturbations that 
would have taken place seemed to make it prudent for the Army 
to use the supplemental money that was available for resetting 
to being modularization, and then to put the rest in budget 
beginning in fiscal year 2007.
    Mr. Wolfowitz. Let me just mention on the perturbations 
General Pace refers to, I mean we have gone through an enormous 
amount of reallocating budget priorities in fiscal year 2007 
and beyond with in the Army and between the Army and other 
services, and it has led to decisions which I am sure you have 
read about, about scaling back procurement of aircraft, scaling 
back procurement of ships, efficiencies across the Department 
in various areas, and those involve a lot of painful decisions, 
a lot of moving pieces around. Trying to do that for this 
budget that we are presenting now with a dollar request for the 
Army that is uncertain, I think frankly would have thrown the 
whole budget process into chaos rather than help it.
    Senator Conrad. Let me just say in conclusion, I appreciate 
all you say. Also, we have the same problem here. I mean we 
have got competition for scarce resources. And frankly, it is 
not acceptable, I think, to come here and say, well, it is hard 
to predict. All of the budgets are hard to predict. That is 
what budgeting is, is making a projection. The one thing we 
know for sure is not the right answer is zero, and so I just 
push back and say to you it would be very useful for this 
committee, very useful for the Congress, if you provide 
estimates that are as good as you can make them about what the 
costs are going to be.
    Chairman Gregg. I have to agree with Senator Conrad. If you 
can give us an approximation, we will budget it, because we are 
committed to making sure you have the resources you need, and 
it might actually be helpful to you folks in the end.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. I would like to 
put my opening statement into the record with your permission.
    Chairman Gregg. Absolutely.
    [The prepared statement of Senator Bunning follows:]

    [GRAPHIC] [TIFF OMITTED] T1173.194
    

    Senator Bunning. Secretary, I have before me your request 
for $81.9 billion in supplemental spending, and in it there is 
a section called International Affairs, $5.6 billion being 
spent. I want to know how you can justify that $200 million--I 
am just going the pick one out--in economic and military aid to 
Jordan, when Jordan was on the other side, fighting against us 
in the first Gulf War. My son happened to be in that war, and 
flying over Kuwait at the time, and we could not get Jordan's 
cooperation to stop the supplies coming in from Jordan. Now I 
want to know why, not only that, but then there is $200 million 
in aid to Pakistani, or to the PLO, I would suggest, 
humanitarian aid. I can understand that one a little better.
    But these are items that are normally done in the 
appropriation process in Foreign Affairs. Why would they be in 
a supplemental?
    Mr. Wolfowitz. There are two different numbers that come 
out almost the same. That is why there is a certain confusion 
on our side.
    Senator some of this is State Department budget request, 
including things like construction of more secure embassies and 
so forth, and you would have to get a State Department witness 
here for that. But let me just say two things----
    Senator Bunning. The big number would be $658 million for 
construction of a U.S. embassy in Baghdad. That would normally 
come under normal funding in the State Department request.
    Mr. Wolfowitz. Well, I don't think they anticipated when 
they put in their fiscal year 2005 budget request 12 months ago 
what the security needs would be for that embassy. But let me 
just say that there is one large number in there, and that was 
what caused the confusion. It is not the $5.6 billion you 
mentioned. There is $5.7 billion requested for training Iraqi 
and Afghan security forces, and----
    Senator Bunning. Well, I understand that.
    Mr. Wolfowitz. You understand that, OK.
    Senator Bunning. I was there watching them being trained at 
the time when we thought there were 250,000 of them being 
trained. That is what we were told. And, unfortunately, they 
cut and ran during certain attacks, and we finally found out 
that there were about 125,000 or less that we could depend on. 
And I understand us trying to buildup that force. In fact, 
General Petraeus is a good friend.
    Mr. Wolfowitz. A constituent, I think. From a defense 
perspective, I would just like to comment on Jordan and 
Pakistan. You are right that Jordan was an unfriendly neutral 
during the first Gulf War in 1991. But things have changed 
enormously, and they really stood up and supported us at 
considerable risk to themselves because they are right on the 
border. There is a very large Iraqi--there was a very large 
Saddam Hussein intelligence presence in Jordan, and yet they 
allowed us to base forces and many things that were helpful.
    And in the case of Pakistan, again, I am not about to 
defend everything that government does, but as I mentioned in 
my testimony, their cooperation in pushing into northwest 
Pakistan and putting pressure on al Qaeda leadership in 
northwest Pakistan I believe is helping us in the global fight 
on terrorism. And President Musharraf has taken some enormous 
risks to be on our side. In fact, there have been two attempts 
on his life. I think support----
    Senator Bunning. I understand Pakistan better than I do 
some of the others.
    Mr. Wolfowitz. OK. I cannot go line by line with you, but--
--
    Senator Bunning. Well, that is what we have to do.
    Mr. Wolfowitz. I understand that, and I think for the State 
Department--I will do my best on the defense pieces, but----
    Senator Bunning. OK. I am going to do something that is 
usually done here a lot more. This is a parochial interest in 
Kentucky. You have withdrawn defense money for the construction 
and procurement of the destruction of chemical weapons at the 
Bluegrass Army Depot and at Pueblo, Colorado. Instead, $33 
million is requested for further research. Do you know how long 
we have been researching the destruction of those weapons? We 
have a treaty to get rid of them by 2012, and even the money we 
appropriated in the last DOD budgets over the last 1, 2, 3 
years, you want to use it for other purposes now. That is what 
you have requested in this year's DOD budget.
    Now, go down to Richmond, Kentucky, and Lexington, 
Kentucky, and tell those people that those 50,000 rockets that 
have nerve gas, that are corroding, that you are not going to 
be able to get rid of them in time to meet the treaty 
obligations. Thirty-three million dollars is peanuts in a 
defense budget.
    Now, why would you do that?
    Mr. Wolfowitz. Senator, I don't want to--on the why, we 
were confronted with, as I think you know, enormously 
escalating costs for this whole program. The budget does 
contain $1.4 billion for this fiscal year and $6.3 billion over 
the course of the defense program. I talked with a couple of 
your colleagues about that decision, and we are certainly 
prepared to look at whether changes can be made. We understand 
the priority that has to be put into getting rid of this stuff, 
but we also have a problem of costs that are just going through 
the roof.
    Senator Bunning. I would invite you to come with me to the 
Bluegrass Army Depot and walk through it.
    Mr. Wolfowitz. I would be happy to do that, sir.
    Senator Bunning. And you would understand how urgent it is 
to get rid of those things.
    Mr. Wolfowitz. OK.
    Senator Bunning. Properly.
    Mr. Wolfowitz. Let's do that.
    Senator Bunning. Thank you.
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Thank you, and welcome, Deputy Secretary. 
I appreciate your being here. And, General Pace and Ms. Jonas, 
thank you for your service as well.
    First, a comment, and then a couple of questions in a 
different direction. I would share, first of all, the 
sentiments of Senator Conrad speaking about the fact that we 
join together, Democrats and Republicans, in supporting our 
troops and making sure that they have the resources that they 
need. That will not be a debate, I do not believe, before this 
committee, and that is something that we all stand here ready 
to do.
    The challenge for us goes to the question of funding the 
wars and whether or not it is in the budget or not in the 
budget, and as has been said, we know that proceeding it is not 
zero. And so I would just echo, Mr. Chairman, that we need to 
have, whether it is a reserve fund that is adequately addressed 
in terms of the dollars or whether it is in the regular budget. 
We know it is not zero. And it seems to me the supplemental 
should be used to make adjustments, not be a part of the 
regular budgeting process. So I hope in some way as a part of 
the Budget Committee that we will be addressing that so that 
this is a more real and a more honest reflection of the costs.
    We talk a lot about the sacrifice our men and women make in 
the military, and I certainly agree with all that has been 
said. Deputy Secretary, you said that our men and women have 
done everything that has been asked of them and more. I would 
like to speak about what we are doing for them.
    My husband and I have had an opportunity to visit the men 
and women at Walter Reed. He is former Air Force and 
International Guard, by the way. I am very proud of that. And I 
have also had the opportunity to have a number of men and women 
from the Guard and Reserve come here to the Hill and visit with 
me and so on, and we have worked with them.
    And I am very concerned right now that for the men and 
women that we have been visiting with that have received 
medical care for injuries while serving in the war on 
terrorism, that without exception--without exception--the Army 
has made mistakes in the proper allocation of their pay. And it 
has been extremely difficult for them to resolve these issues, 
and this is of great concern to me. And I am sure it is--
hopefully it is with you as well, that we are asking them to 
serve, they are coming back, they have injuries, and then we 
are dealing with bureaucracy and the inability to be able to 
have them receive the pay that they have earned.
    Just this month, the Government Accounting Office released 
a report that I am sure you are aware of that found that the 
Army cannot ``provide reasonable assurance that injured and ill 
reserve component soldiers receive the pay and benefits to 
which they are entitled without interruption.''
    This is just not acceptable, and I would hope that you 
would view it as not acceptable as well, that when we are 
asking men and women to serve, to fight for the freedoms that 
you have eloquently spoken about today, that they are not able 
to be assured that something as basic as their pay will be 
taken care of when they are injured in the line of duty. And I 
would like to know what funds are in the budget, this budget. 
What funds are you allocating to resolve these pay issues? And 
what plans do you have to fix this problem?
    Mr. Wolfowitz. Those are very important questions, and I 
appreciate your asking them, and let me make one aside before I 
go to the heart of it, because Senator Conrad said correctly--
and I applaud him--that it is very important for our 
adversaries to understand that we are united. And I just wanted 
to add it is also very important for our men and women in 
uniform to understand that.
    I think I continue to be amazed, in many, many visits with 
our wounded troops, at the incredible spirit and morale they 
have in facing what, as you obviously have observed, are huge 
new challenges in life. And a huge part of what keeps them 
going is the knowledge that the country regards them as heroes.
    Now, I am about to talk about material issues, which are 
very important, but that spiritual morale issue is--it is 
pretty difficult to exaggerate how important that is. So I just 
wanted to mention that.
    I share very strongly your concern. I spend a lot of time 
with wounded soldiers, and I hear about some of these problems. 
And I cannot help saying that, you know, they get the absolute 
best, 21st century medical care, and then they have to deal 
with a bureaucracy that is inherited from earlier times.
    Some of it is, I think, bureaucratic rules that probably 
date back to World War II when we had hundreds of thousands of 
severely injured soldiers for whom very little could be done, 
as opposed to now when the number is much smaller and the 
possibilities of re-employment and rehabilitation are 
incredible. In fact, on the good-news side, there is an Air 
Force lieutenant colonel who has lost his leg above the knee, 
not a combat injury, but he spends a lot of time at Walter Reed 
himself. He is the first pilot in Air Force history to be 
requalified on jets after losing his above the knee.
    There are a lot of miracles even in the bureaucracy of that 
kind, but we need to do a lot better. That is the reason why we 
recently opened something called the Military Severely Injured 
Joint Support Operation Center. I think we need a shorter name 
for it, but this is a 24/7 family and wounded service member 
support center where people can call in 24 hours a day to get 
what we hope will be the right answers to what the rules 
permit, and also to alert us, if it looks as though the rules 
are not written the right way.
    Sometimes it is a matter, unfortunately, that they will go 
to someone who misinforms them about what their rights are and 
they don't know where to go next or they accept that as the 
right answer, and that should not happen. So we want people who 
are absolutely the best trained, who know exactly what is 
possible, who also can alert us if what is possible is not good 
enough.
    One of the most concerning problems to me right now is the 
one you alluded to, that if someone is medically retired, there 
is an unfortunate and I think inexcusable gap between the time 
they go off active duty pay and go onto VA benefit pay. And, in 
fact, I have talked to Jim Nicholson personally about the fact 
that we need to get together between our two Departments and 
find a way so that that burden is not borne by the serviceman, 
that somehow we manage to deal with it between our two 
Departments.
    I wish I could put a deadline on when we solve it. As far 
as I am concerned, I wish we had solved it last month. But we 
are putting a lot of energy into it.
    I think the general principle here is that because of the 
nature of modern war, the burdens of war are not distributed 
evenly at all across the population. It is a much smaller 
number of people that go into combat, that bear the costs of 
combat. I think that puts a greater obligation on the rest of 
us to make sure that those who are wounded, the families who 
survive members who were killed, make sure that those people 
who bear the inordinate burden are adequately supported by the 
rest of us.
    I feel very strongly about it. I appreciate your interest. 
And I am quite certain that where money is needed to deal with 
that, the Congress will be supportive. I hope also where new 
legislation is required, I am sure the Congress will be 
supportive as well.
    I would make one last observation, and that is, we need to 
be a little bit careful I think sometimes about taking a 
benefit that we want to go to those people who have suffered in 
combat and extending it to the entire population of active and 
retired military personnel. You very quickly sort of price 
yourself out of the ability to do anything. I think the point I 
just made is that the exceptional burdens are borne by 
relatively few people, and that really should make it possible 
to make the resources that we need to meet those needs.
    Chairman Gregg. Thank you, Senator.
    Senator Stabenow. Well, thank you, and if I might just 
conclude and just indicate that my specific question regarding 
funds allocated to resolve the pay issues I would appreciate a 
followup on to know if there are specific dollars in here, and 
just say that we have got a lot of work to do on this front 
because we do have men and women with tremendous patriotism and 
love for this country who have, in fact, put their lives on the 
line and are coming back now. And when I look at the kinds of 
requests I have gotten in my office on just basic things in 
terms of pay, it is just not acceptable and it needs to be a 
very high priority. And I appreciate your comments about that. 
But this needs to be a high priority if we expect people to 
believe and trust what we are saying in terms of fulfilling our 
commitments when they are certainly fulfilling theirs.
    Mr. Wolfowitz. I agree with you, Senator. I take it very 
personally. I know General Pace does, too. Do you want to add 
to this, Peter.
    General Pace. I know the light is red, Mr. Chairman. Please 
forgive me.
    Chairman Gregg. Go ahead, General.
    General Pace. But I would be remiss if I did not add my 
sincere thanks on behalf of all of us who wear the uniform, not 
only from the funding standpoint but the fact that so many 
members of this committee and of Congress go out and visit the 
troops, that you visit the hospitals, that you have them in 
your offices, that you have them in your homes. That sends a 
huge message to all of us, especially those who are overseas 
serving right now, that this Congress cares. And, Senator, you 
are right. It is not acceptable that any of our service members 
have pay problems, and we owe them better than that, and we 
will work on that.
    Chairman Gregg. Senator Alexander.
    Senator Alexander. Thank you, Mr. Chairman.
    Thanks to each of you for being here and thank you for your 
service. I would like to get an update about armor on vehicles 
in the combat zone in Iraq. One of our Tennessee guardsman from 
the 278th Cavalry Division last December got pretty famous 
asking the question of the Secretary of Defense, and the 
question went along the lines of why was he and his colleagues 
having to scrounge through junkyards--I believe those were 
roughly the words--in order to properly arm their vehicles.
    That struck a chord with a lot of people in Tennessee. We 
prize and honor all of our service men and women, but the 278th 
is our largest National Guard unit. There are 3,000 of them. 
They had just arrived in Iraq. There are three deputy sheriffs 
from my home county and the school superintendent from Athens 
and the mayor of Lexington. So we know them all, and they are 
all in our community, and their lives have been interrupted for 
18 months, which they are proud to do.
    You have been good about keeping me updated about the 
progress you have been making toward making sure that they have 
armor for those vehicles. So my specific question is this: I 
have been told that by 2005 June, June of this year, just a few 
months away, that all of the vehicles in the combat zone will 
have Level 1 or 2 armor. And I wonder if we are still on that 
track and if you could describe for me what that means and tell 
me what I should be saying to families of those 3,000 guardsmen 
about the level of armor on vehicles in the combat zone in 
Iraq.
    General Pace. Senator, thank you. I can respond to that. 
And you are correct, by the summer of 2005 we will have all our 
vehicles with the Level 1, Level 2 armor. You have through 
funding allowed us to ramp up from building, for example, 35 
up-armored Humvees per month to 450 per month now, going to 550 
a month in about a month and a half from now. You have given us 
the money we need to give every single soldier, sailor, airman, 
marine, U.S. Government civilian complete SAPI-protected body 
armor. We were able to ramp up the focus on Level 3 armor, 
which, as you know, is armor which is produced here but put on 
over there, so that by the middle of February, February 15th, 
General Casey, the command on the ground over there, was able 
to announce that no vehicles would leave and travel throughout 
Iraq unless they were properly armored. So he had gotten to the 
point where he could ensure that he could put out that kind of 
an order. Of the 35,000 wheeled vehicles that are in Iraq right 
now, 28,000 are currently protected by armor; the other 7,000 
are being worked on.
    So the whole program and the billions of dollars that 
Congress has allocated and the focus of effort to include 
taking sailors who are welders on ships and getting them over 
to Kuwait to help put on this armor has had a tremendous 
impact.
    Senator Alexander. General, that is a very good answer and 
an adequate answer for me. But if I were explaining in plain 
English to families in Tennessee what does Level 1 and Level 2 
armor mean on a vehicle, what would you suggest I say? How do I 
explain that so they will understand it?
    General Pace. You can tell Mom Pace that her son, Peter, 
will be protected from rifle fire in the vehicle that he is 
traveling in and that some of the explosive devices, he will be 
protected from that as well.
    The difference between Level 1 and Level 2 is only where it 
is put on. Level 1 is made here in the United States, and it is 
made a part of the vehicle when it is being produced. Level 2 
is the exact same armor shipped to the theater and then put on 
in-theater. It would be like putting a stereo in your car 
either bought in the factory when it is delivered to you or 
taking the same stereo and putting it in when you get the car.
    Senator Alexander. And no Level 3, which was improvising, 
which was finding scrap metal and using it to make a vehicle 
that was not properly armored better armored. Is that correct?
    General Pace. Level 3 in the way it has been describes 
makes it sounds like the Beverly Hillbillies, which it is not. 
It was very good, protective armor, but, in fact, it was metal 
that was available in-theater that had been in-theater for 
other reasons and was used to properly armor vehicles to the 
metal protection of rifles.
    What was not part of Level 3 was ballistic glass protection 
that is part of Level 1 and Level 2. That is correct, sir.
    Senator Alexander. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Feingold.
    Senator Feingold. Thanks, Mr. Chairman. Mr. Secretary, good 
to see you again.
    There are Wisconsin Guard and Reserve units returning from 
Iraq without any of their equipment, including the Army Reserve 
652nd Engineer Company from Ellsworth, Wisconsin, and the 
Wisconsin Army National Guard's 264th Engineer Group out of 
Chippewa Falls, Wisconsin. There is no way for these and many 
other Guard and Reserve units throughout the country in similar 
situations to train and maintain their readiness or be ready 
for state missions without their equipment. So this is also 
going to have a corrosive effect on morale and retention if we 
treat these brave citizen soldiers as second class.
    The supplemental includes $5.4 billion for refurbishing and 
replacing equipment, but there are estimates out there that it 
will take much more than that. How much of the regular fiscal 
year 2006 budget and how much from the fiscal year 2005 
supplemental is going directly to the National Guard and the 
Reserve for reset costs? And will that cover the need to make 
sure that readiness is maintained?
    Mr. Wolfowitz. In the budget, in the supplemental request, 
we include funding for returning Guard and Reserve units to be 
reset to war fighting standard, which I believe would cover the 
Guard units that you are describing, although I would want to 
check and give you an answer for the record to be sure about 
that. And I think--Tina, how much is that sum?
    Ms. Jonas. We have about $3.3 billion in the supplemental 
for reset activities. Also, the modularity piece in the 
baseline budget in the outyears, if the Army continues with 
their plan, would cover some of those units.
    Senator Feingold. I would like to send a letter to you, if 
I could, a question to just kind of nail this down a little 
more specifically so I can give the kind of reassurance that 
you at least were beginning to give me here that this will be 
taken care of.
    General Pace. Senator, I may be able to help just a little 
bit, if I may; that is, part of the reason that they are coming 
home without their equipment is that to save taxpayer dollars, 
rather than have Unit A go over with the same gear that is 
there, Unit B is leaving their equipment behind. When they come 
back to the States, then we have to redistribute. That does not 
overcome the fact that as we started out into this with our 
Guard and Reserve, the plan for the Guard and Reserve had been 
to go as part of World War III, so to speak, to be available to 
fight at month six or month nine, so the levels to which they 
had been provided equipment were lower than the rest of the 
Army.
    That clearly has changed in the way we are using our Guard 
and Reserve. They are fabulous soldiers. They are doing a great 
job. And we will get the exact number for you, but I know there 
is $16 billion total in the supplemental for procurement and 
resetting the force, and the Army's intention, I know for a 
fact, is that as they reset the active Army, they will reset 
the Reserve so that it will have 43 active brigades and 34 
Guard and Reserve brigades that are ready to go to combat 
tomorrow for the country, sir.
    Senator Feingold. I appreciate it, General. I will follow 
this closely, but I certainly sense your sincere desire to make 
sure there is no gap here.
    The Defense Appropriations Act for Fiscal Year 2005 
included a sense of the Senate that said that ongoing costs for 
operations in Iraq and Afghanistan should be included in the 
President's annual budget submission. Section 9012 of that same 
bill required the President to provide Congress by January 1 of 
this year with a detailed report on estimated costs for ongoing 
operations and reconstruction costs for Iraq and Afghanistan 
for fiscal year 2006 through fiscal year 2011.
    Where is this report, Mr. Secretary?
    Mr. Wolfowitz. We are working now with OMB and with the NSC 
to try to find the correct way ahead on that report. It is 
still not possible to accurately estimate the cost for military 
operations in fiscal year 2006, much less over the following 5 
years. So there is a challenge here. I mean, we can make 
guesses, but the guesses would be really unsubstantiated.
    We are working with NSC and OMB to try to answer that 
requirement.
    Senator Feingold. When will we get the report?
    Mr. Wolfowitz. As soon as we can figure out how to answer 
it, sir.
    Senator Feingold. Estimate, please?
    Mr. Wolfowitz. I don't have one. I am sorry.
    Senator Feingold. Weeks?
    Mr. Wolfowitz. I just don't know.
    Senator Feingold. Years?
    Mr. Wolfowitz. Obviously sooner than that.
    Senator Feingold. It is a congressionally mandated report, 
I would note for the record.
    I am also concerned that the reliance on supplemental 
spending bills is forcing the services to raid accounts to 
cover the incremental costs of ongoing operations and, thus, 
hurting readiness. How much money has been reprogrammed already 
to cover costs in fiscal year 2005?
    Mr. Wolfowitz. Tina, do you know?
    Ms. Jonas. Sir, we could certainly provide the exact number 
of the record, but I would say that with our fiscal year 2006 
budget, our operation and maintenance accounts are up $11 
billion over the fiscal year 2005 enacted level. The readiness-
related amounts are up $4 billion. So we understand the 
concerns of the Congress with respect to readiness and agree 
that that is an important thing for the military.
    Senator Feingold. Thank you, Mr. Chairman. Thank you, Mr. 
Secretary.
    General Pace. If I might add, sir, the bridge $25 billion 
that you made available to us made it possible to really reduce 
any O&M movement into the current year. So that was very, very 
helpful to have that going into this year, sir.
    Chairman Gregg. Thank you.
    Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I for one want to 
take time right at the start here to compliment our men and 
women of the armed forces. I just think they are doing a 
tremendous job. I visited with them before they went over to 
Iraq and Afghanistan, visited them in those countries 
personally, and I have visited with them when they have come 
back. And I think we can be very proud of our young people who 
have stepped forward to meet the causes of freedom. And I 
realize that it is a stress on their families and their spouses 
as well, but I think we can be particularly proud of the whole 
unit--the family, the spouses, and the men and women who have 
served in the armed forces.
    I would also say this about this administration: I think 
you have been responsible. I have witnesses in previous 
conflicts and war where we have tried to run the war out of the 
Pentagon or you try and run a war based on politics. And I 
think this administration has tried to be very sensitive to the 
professional men and women in the military and listened to the 
commanders in the field. And I think that that is as 
responsible as you can be.
    Now, you cannot come up--I can understand why you cannot 
come up with a sound budget, you know, specific figures on a 
budget. You know, war is unpredictable. I think we all have to 
recognize that. And, you know, there has been some 
unpredictable things in this budget. But the important thing is 
that we have responded when those unpredictable things have 
occurred, and I think it has been through the professional 
advice of those people that are in the field. They have come 
back with recommendations. It is then worked through, and 
finally we have come up with a solution.
    So I do think that this has been a rather responsible 
budget in many ways. There are some areas obviously where we 
raise questions. But I don't think the administration can take 
all the blame because I think in being responsible and 
consulting with the professionals, we have dealt with four 
amendments on the floor of the Senate, for example, and in the 
House from the other side that have said, well, you are not 
doing enough, we need more after 9/11, we need more for our 
Reserves and National Guard, and we need more for our ground 
troops, we need more for our retirees, we need more for 
education after they graduate, we need more recruits, we need 
more intelligence, and more and more and more. But I think the 
bottom line is that you have been responsible.
    Now, I have a lot of concern like the chairman does about 
how we define emergency spending. I want to compliment the 
chairman for thinking about how you are going to put in a 
reserve fund. But even with the reserve fund, I don't know how 
you meet all the unpredictabilities that will happen when you 
are in conflict. And so my question, as we get to this budget, 
and particularly when you get to the supplemental, how much of 
this supplemental is a one-time expenditure? I think that is 
the key question. If it is not a one-time expenditure, then 
perhaps we ought to build this into the base so we can project 
for future expenses. But if it is a one-time expenditure, then 
I don't think we want to unnecessarily build this into the base 
and obligate ourselves into an expanding base when it is a one-
time expenditure. I would like to know--and maybe you cannot 
give that to me today, but I would like to know how much of 
this supplemental is a one-time expenditure.
    Mr. Wolfowitz. I think, if I understand the way you use the 
word, I think everything that we are putting in the 
supplemental and anticipating next year's supplemental are one-
time expenditures. I know precisely we want to avoid the 
phenomenon you describe where we artificially inflate the base, 
and then you spend a long time arguing that number down because 
people say, you are decreasing your budget from last year, and 
we try to say, no, that was a one-time expenditure; it needs to 
come out. I think it is important to identify these 
expenditures, which does not mean they will not be repeated. If 
we are still--at some point we may still have forces--we will 
certainly have forces in Iraq in fiscal year 2006, for example. 
So spending some money this year for those forces I would 
consider a one-time expenditures, but we are going to have 
another one-time expenditure next year.
    It is when we get to the point where there is some 
stability and some predictability to it that then you can build 
it into your base budget.
    Senator Allard. Your hope is that what you are asking for 
in the supplemental, you may have to repeat a little bit of 
those requests in future years but at some point in time that 
is going to phaseout. If it does not phaseout, it is going to 
be built into the base. Have I got that right?
    Mr. Wolfowitz. That is right, and we certainly expect at 
some point, and it is an unpredictable point----
    Senator Allard. I want to move on a little bit here, and I 
am sorry to interrupt you on this, but I also want to followup 
on some of the concerns that were expressed by Senator Bunning 
from Kentucky. He also alluded to the plant that we have in 
Colorado, the problems, and that has to do with the Department 
of Defense's chemical weapons demilitarization program. Now the 
Department of Defense has decided to delay construction of 
disposal sites in Pueblo as well as Bluegrass in Kentucky.
    My question is, is the Department considering its decision 
to suspend all construction activities at the disposal sites in 
Colorado and Kentucky? Do you know that?
    Mr. Wolfowitz. We are taking another look at that whole 
decision to see whether there is maybe a different way, but 
there is no question that the costs, as I said, were going 
through the roof and we need to do something about that.
    Senator Allard. I think you need to review costs. But here 
is what has happened. The Army has gone and sat down, at least 
in Colorado, with the leaders of the community and said, here 
is some technology we think is reasonable that can be done, and 
now all of a sudden after working this out you have backed off, 
or the Army has backed off. So then this adds to the confusion 
of the project, adds to delays, and part of the delay is that 
you are asking for more studies. We have already done three 
studies on transportation issues out of there.
    I do not understand why you include part of your restudying 
transportation issues related to that when you have already 
done three studies on that. We have in fact passed legislation 
that says transportation is off the table. The legislation says 
that if it is going to go across State lines that it has to 
have the agreement of the Governor as well as the President--
has to go to the Presidential level, and none of that has 
happened. So as far as I can tell it is off the table and yet 
we are still going ahead and have these included in the 
studies.
    So it seems to me that some of the costs that have gone 
here is because of the faults in the demilitarization program 
itself and it not being focused and moving forward like it 
should. I would hope that you would sit down, because 
Condoleezza Rice--I asked her this same question about how it 
was going to impact our relationship with other countries when 
we do not comply with demilitarization agreements. It is a 
chemical convention agreement treaty--why we did not comply 
with that.
    Her response was, I think, very straightforward and 
unequivocal, that such a failure would damage our credibility 
overseas and hinder our efforts to hold other nations 
accountable when we do not meet our deadlines when we have 
eight sites and we are only meeting the deadline on six of 
them. So I do think that whole program needs to be reviewed.
    I also think that the people of Pueblo and Bluegrass have 
been misled, assuming that you have put everything together and 
then all of a sudden we are back to a study. I think that the 
whole program, something needs to be done and we need to move 
forward, and what is happening now is we are just having 
further delays, we are going to lose confidence with our allies 
and our friends overseas because we are not meeting deadlines, 
and we need to move forward in my view. I think some of the 
costs that we are experiencing is because we have had these 
delays. Maybe you would like to have some response, Doctor, or 
maybe Ms. Jonas, your staff person, would want to respond to 
that.
    Mr. Wolfowitz. Let me just say I think we do need to take a 
look at it. I think of the parameters that has to be in there 
though is how to contain costs, in addition to all the others. 
That is what led to the current budget proposal. I acknowledge 
there are some issues there that we really do need to look at, 
and would be happy to work with you and with Senator Bunning 
and other concerned members.
    Senator Allard. I hope that we can. We have been working 
with those that are underneath you. I hope they have been 
consulting with you. But we do need to get something moving 
here. I want to make that point.
    Thank you, Mr. Chairman.
    Mr. Wolfowitz. If I may, Mr. Chairman, I think it is 
important at least to say for the record that the costs we 
carry for the cost of the war to date, for Operation Noble 
Eagle, which is defense of the United States, Operation 
Enduring Freedom, which is Afghanistan, and Operation Iraqi 
Freedom, all three put together to date is $172 billion. You 
can get to different numbers depending on whether you look at 
money that is spent or money that has been authorized. Of that 
$172 billion, $110 billion is for Operation Iraqi Freedom.
    I think those are, Senator Conrad, different from your 
numbers and I would be happy to talk with you and see whose 
numbers are right, or maybe there is a third set. But I thought 
it was important to put those in the record.
    Chairman Gregg. I think Senator Conrad's numbers are 
accurate as a statement of what the supplemental requests have 
been over this period--a percentage of those supplementals went 
to items that are not included in the three wars, that we are 
pursuing. So that is where the differenence probably occurs.
    Mr. Wolfowitz. I think so.
    Chairman Gregg. Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    Mr. Secretary, I would like to address, the recent 
supplemental submitted by the Administration. One of the 
reasons that some of us on this committee have had a problem 
with the way that this supplemental has been put together is 
because of our experience up here on the Hill. My question 
focuses on how Congress has used offsets in the past for 
supplementals. Sometimes you have offsets for regular 
appropriations bills. There are real offsets and then there are 
phony offsets.
    What I mean by a phony offset is this: DoD puts in a 
request for this year, including money that cannot be spent 
this year, or maybe even for next year. Then somebody on 
Capitol Hill decides, because that money is not going to be 
spent this year, we will rescind supplemental money and use 
that as an offset to make it look like regular appropriations 
bills are deficit neutral, when it really is not. So Congress 
can increase overall spending by using phony offsets.
    I can understand the 2005 and somewhat the 2006 numbers in 
the supplemental because of what Secretary Rumsfeld explained 
last week to the Armed Services Committee about the budgeting 
process. I understand the difficulty in the budgeting process 
because of how long it takes to put a budget together, and how 
long it takes to go through the whole process, and that the 
supplemental is much faster. So I understand that a 
supplemental request in the short term, 2005 maybe and even 
2006 expenditures. Which amounts to about $62.5 billion of the 
total supplemental request.
    But after that the supplemental has $14 billion in 2007, 
almost $4 billion in 2008, $1.3 billion and it goes a little 
bit down each year from that.
    I guess the question is, why those are put into a 
supplemental. Supplementals are supposed to be for emergencies. 
That is why they are designated emergency as such.
    Ms. Jonas. Senator, I appreciate your concern with regard 
to the spending. The procurement funds are multi-year funds, 
but I am told that we expect that all the procurement funds 
would be on contract by the end of the fiscal year. The funds 
for the Iraqi security force, I believe, are multi-year, and 
that is to allow the military to have some flexibility with 
their training. So I understand the concern there. But what I 
am told on the procurement funds, about $16.1 billion in the 
supplemental would be able to be on contract by the end of the 
year.
    Senator Ensign. But the money is still not spent. It is 
going to be out there. It is not an outlay.
    Mr. Wolfowitz. But it is a commitment you have to make in 
this fiscal year. Can we get back to you for the record if 
there is money that is not committed by the end of this fiscal 
year, which sounds like it may be----
    Senator Ensign. Do you understand the fear that I have? It 
is that the unspent money will later be used by somebody to 
increase the overall budget number, to increase the deficit. 
They will say, ``but this money was put out there in the 
supplemental but now it really was not spent this year so we 
can use that number,'' because even if it might be committed in 
contracts they will say, ``Congress can now use that number 
since it was not an outlay.'' And Congress will use that as an 
offset and we will have to later reappropriate that money. We 
spent it twice.
    Mr. Wolfowitz. I do understand your question. Let us give 
you a detailed answer for the record. The FY 2005 emergency 
supplement request for contingency operations is specifically 
for incremental costs above the baseline funding needed for the 
ongoing global war on terrorism. The supplemental request does 
not in any way add to the baseline funding requirement in a 
future year. Regarding multiyear funding, only items that are 
executable for obligation in FY 2005 were considered, and those 
must be able to produce deliveries prior to FY 2006 funded 
deliveries. Assuming approval of normal periods of availability 
for procurement appropriations, normal outlays will occur over 
the period of deliveries. In this respect, the supplemental 
funding request only supports items needed due to the emergency 
nature of ongoing operations, and there is no artificial 
expansion of a future year funding requirement base.
    Senator Ensign. Thank you.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you. We appreciate your time, Mr. 
Secretary. Senator Conrad did have one final question and then 
we are going to let you go.
    Senator Conrad. This goes to the question that was asked 
previously about the armoring of vehicles. General Pace, you 
gave a review there. I do not know what it related to; perhaps 
Humvees, other vehicles as well.
    But here is the question that I have. It relates to the 
medium and heavy trucks that are in Iraq. These are the oldest 
trucks in the inventory. We were advised there were 9,000 of 
the M-939 class and the M-915 class in January in Iraq but that 
only 10 of them had level two armor. At that point the DoD had 
not even let a contract to design more robust kits, and the 
best that these trucks had were level three armor. I will tell 
you, my units that are in Iraq refer to level three armor as 
hillbilly armor. This is how they describe it in their e-mails 
to us.
    These older vehicles are concentrated in the Guard and 
Reserve. I have got a lot of my guys who are driving these 
trucks, and they are very concerned about the lack of armor. 
Can you tell me if those numbers that I have just used are 
correct, and if not, how they are not correct? We were told in 
January, 9,000 trucks in the theater, in Iraq specifically, and 
only 10 of them had level two armor.
    General Pace. Senator, I will get for you for the record a 
very detailed description of each vehicle, how many, and by 
when they will have what level of armor. For today, if I may, I 
will tell you that as of 15 February no vehicle traveling on 
the roads in Iraq is allowed to be out there without level one, 
two, or three armor, and that the difference between one and 
two is where the armor was put on. And the difference between 
one, two, and three is that one and two have ballistic 
protection for the windshields themselves.
    Senator Conrad. But let me just be clear on what you have 
said here now because I hear that differently than what I heard 
before. What I hear you saying now is that as of February 15 no 
vehicles are on the road unless they have got one, two, or 
three.
    General Pace. That is correct. In answer to the Senators 
question, by June of this year, June, July of this year, it is 
projected that all vehicles will have one or two. But as of 
now, all those traveling on the roads have one, two or three. 
Of the 35,000 vehicles that are there, 28,000 have one, two or 
three, which leaves 7,000 still to go. Then all those that have 
level three need to be replaced.
    Senator Conrad. From what I hear, that would still leave 
the possibility that there are literally thousands of these 
trucks that do not have one or two.
    General Pace. Sir, I will get you the specific answer so we 
are not talking past each other.
    Senator Conrad. That do not have one or two. I want to be 
very clear now. That there are thousands of these trucks that 
do not have one or two level armor.
    General Pace. I do not know that it is thousands. I do know 
that there are a number that have level three right now, and 
that by this summer all of those are to be replaced. I will get 
you the specifics.
    Senator Conrad. If you can get me the disposition of these, 
because we have got, disproportionally, Guard and Reserve 
driving these trucks. I was told in January there were 9,000 in 
Iraq and only 10 of them had one or two level armor.
    General Pace. I will get you the details, sir.
    Senator Conrad. Thank you.
    Chairman Gregg. Thank you. We want to thank you very much 
for participating in this hearing and making yourselves 
available to the Budget Committee. We appreciate it. We hope it 
will be a precedent that has been set that will continue. We 
appreciate your excellent presentation today. Thank you for 
your service to the country.
    Mr. Wolfowitz. Thank you again and all of your colleagues 
for the support you give to our military. Thank you.
    [The prepared statement of Mr. Wolfowitz follows:]

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    Chairman Gregg. Thank you, Mr. Secretary.
    The meeting is adjourned.
    [Whereupon, at 11:47 a.m., the Committee was adjourned.]

Responses to Questions submitted by Senator Domenici to General 
                      Pace for the Record

Question: Can you discuss the current strategic approach 
pursued by the Department to address the persistent rocket, 
artillery and mortar threat that continues to kill and injure 
our troops in Iraq?

Answer: The Chief of Staff of the Army initiated a Countering 
Rockets, Artillerly and Motors (C-RAM) effort in May 2004. The 
Army is aggressively fielding 2 Intergrated Area Defense 
Intercept systems to 1 Point Defense, Sensing and Warning is 
based upon successful demonstration late last year. The 
demonstration system comprised the Ranger's Lightweight Counter 
Mortar Radar with the Navy Close In Weapons System (CIWS is a 
20 mm Phalanx gun system). The DepSecDef requested fielding 
acceleration options. Those options are in development.

Additionally, a Joint Staff directed, Army led Intergrated Air 
and Missile Defense Capabilities Assessment (IAMD CBA) 
currently underway includes C-RAM capabilities. The functional 
solutions analysis poortion of the IAMD CBA will examine all 
potential material approaches and provide an evaluation of the 
operational effectiveness, operational suitability and 
estimated costs of alternative systems to meet this mission 
capability.

 Responses to Questions submitted by Senator Nelson to General 
                      Pace for the Record

Question: Section 153 of Title 10, US Code requires the 
Chairman of the Joint Chiefs of Staff to submit a ``risk 
assessment'' each year. If the Chairman's assessment in any 
year is that a risk is ``significant,'' the Secretary must 
include a plan for mitigating that risk. Why has the Chairman's 
risk assessment not cleared the Pentagon and arrived on the 
Hill as required?

Answer: Title 10 requires the Chairman's annual risk assessment 
to be submitted through the Secretary of Defense. It was 
approved by Gen Myers on 4 March and is currently with OSD for 
development of mitigation options given the characterization of 
risk. Title 10 requires that the Secretary forward the 
Chairman's risk assessment and the Secretary's comments/
mitigation plan with the Department's budget justification 
materials, which OSD say will be in late March.

Question: Given the pace and scope of operations around the 
world; the extension, and arguably over-extension of our ground 
forces as they are currently configured; and the strategic 
uncertainty of conditions in many areas around the world like 
the North and Southwest Pacific, do you think it is 
strategically prudent to reduce our Nation's aircraft carrier 
capability at this time?

Answer: Crisis response and deterrence through global presence 
are the prinicipal aspects of the carrier fleet's contribution 
to our national defense strategy. Using innovative joint 
solutions such as global force management, global posture 
realignment initiatives and use of rotational expeditionary 
forces and the Navy Fleet Response Plan, risk associated with 
the reduction of our Nation's aircraft carrier numbers can be 
mitigated.

With regard to the North and Southwest Pacific, current global 
posture realignment initiatives are examining ways to increase 
our ability to project military forces rapidly, at long ranges, 
by establishing a network of forward operating sites and 
cooperative security locations.

Determining the approriate size of the carrier force has long 
been a topic of debate in force-structure planning. As the 
strategic environment changes, DOD will continue to assess the 
force structure necessary to execute the missions of the 
National Military Strategy.

Question: The Navy has based its willingness to cut a carrier--
in order to satisfy the Department's late breaking requirement 
for a budget reduction--on initial results of experimentation 
with the ``Fleet Response Plan.'' I recall that the Air Force 
essentially experimented with the Aerospace Expeditionary Force 
concept for about two years before deploying it throughout the 
force. In your judgment, is a single experiment with a new 
operating approach sufficient to base a reduction of this 
magnitude in our carrier force?

Answer: The Fleet Response Plan (FRP) was designed and 
implemented prior to the Service determination to reduce the 
carrier fleet by one. FRP realigns fleet maintenance and 
training cycles to increase the number of months a group is 
available and ready to deploy in support of global 
contingencies. FRP, by design, does not appreciably increase 
the Navy's capability to provide routine forward deployed 
global Carrier Strike Group presence; however, the increased 
availability provided since the implementation of FRP has 
postured the Navy to rapidly respond to emergent world events 
with the deployment of up to eight Carrier Strike Groups (CSG). 
Reducing the carrier fleet by one will have a small incremental 
impact on the Navy's ability to meet Global Naval Force 
Presence Policy and will slightly reduce the overall number of 
carriers available for contingency operations. However, FRP has 
shown great promise as a more effective way to manage our Naval 
Forces and will contribute to the mitigation of the risk 
associated with this carrier force reduction.

Question: All Atlantic Fleet nuclear aircraft carriers are 
currently stationed at one port in Norfolk. In your view, what 
is the strategic risk associated with vulnerable concentrartion 
of valuable ships in a single port? Would it be more prudent to 
have the flexibility to station our nuclear aircraft carriers 
at other locations on the East Coast? How would this impact 
stationing and construction decisions in the near-term?

Answer: At a national level, it would be prudent to mitigate 
strategic risk associated with carrier stationing by having the 
ability to station carriers in multiple locations. The ongoing 
BRAC process will look specifically at the risks and costs of 
the current and future carrier basing plans and will develop 
recommendations on basing locations for all of our strategic 
assets.

Question: At presence there are two nuclear-ready carrier ports 
on the West Coast, but only one on the East Coast. All of our 
Atlantic Fleet nuclear carriers are homeported in one place. 
How does the strategic situation justify two ports on the West 
Coast and only one on the East Coast?

Answer: At a national level, it would be prudent to mitigate 
strategic risk associated with carrier stationing by having the 
ability to station carriers in multiple locations. The ongoing 
BRAC process will look specifically at the risks and costs of 
the current and future carrier basing plans and will develop 
recommendations on basing locations for all of our strategic 
assets.

Question: Admiral Clark told the Armed Services Committee 
recently that the Environmental Impact Statement process and 
MILCON necessary to make Naval Station Mayport CVN-ready will 
take up to 6 years. What is your assessment of the strategic 
risk of having only one carrier port on the East Coast through 
2011?

Answer: At a national level, it would be prudent to mitigate 
strategic risk associated with carrier stationing by having the 
ability to station carriers in multiple locations. The ongoing 
BRAC process will look specifically at the risks and costs of 
the current and future carrier basing plans and will develop 
recommendations on basing locations for all of our strategic 
assets.

Question: General Pace, current Defense Department policy 
offsets the Survivor Benefit Plan (SBP) benefits purchased by 
100 percent disabled retired Service member by DIC payments 
also due to the survivors of retirees and Service members 
killed on active duty. My staff and I could find no other 
purchased benefits program that is allowed to refuse to pay its 
benefits based on the receipt of another benefit. From my 
experience as Florida insurance commissioner I can tell you 
that this would be a breech of contract in the private sector. 
How do you justify this offset?

Answer: The Survivor Benefits Plan (SBP) is currently the law 
of the land. This is an excellent topic to be discussed with 
the Congress and with the Executive Branch.

  Responses to Questions submitted by Senator Feingold to Dr. 
                    Wolfowitz for the Record

Question: The Defense Department had the unfortunate 
distinction of, once again, doinating the GAO's list of high-
risk areas open to waste, fraud, and mismanagement. Of 
particular concern to me since coming to the Senate in 1993 are 
the chronic problems with DOD's financial management system. 
The President's FY06 Budget Request still rates the Pentagon's 
financial management as poor. We are spending half a trillion 
dollars a year on defense yet the Department of Defense still 
cannot submit auditable financial records. Is it still your 
goal to obtain an opinion on DOD's consolidated financial 
statements by FY2007? Is that a realistic goal? What are you 
doing to make sure you meet this goal? What are the top 
challenges you must overcome to meet your goal? If you intend 
to revise the FY2007 deadline, please provide details.

Answer: We have concluded that an unqualified audit opinion 
(clean audit opinion) on the DoD's consolidated financial 
statements is not achievable by FY 2007, unless we spend an 
extraordinary amount of resources to achieve it through 
unsustainable methods. Hence, our goal is to create sustainable 
auditability without incurring extraordinary annual costs. We 
are making progress toward that goal by aligning our business 
transformation activities, thus creating more transparent 
material and financial processes in support of warfighter 
requirements.

    However, the Department continues to make progress toward a 
clean audit opinion through both improved business processes 
and business systems modernization. Our progress includes:

Six unqualified and one qualified audit opinion on the 
Department's subordinate FY2004 financial statements.
BMMP is transitioning from an architecture phase to an 
implementation phase. Systems efforts are being prioritized to 
deliver measurable capabilites that will be affirmed by 
auditable financial statements.
Instituting stronger program governance over the Business 
Management Modernization Program (BMMP) through the creation of 
a Defense Business Systems Management Committee chaired by the 
Deputy Secretary of Defense.
Developing a plan to use the Marine Corps as a test case for 
achieving an unqualified audit opinion for an entire Service. 
Our focus on the Marine Corps audit, as an interim deliverable, 
is intended to help us better understand how to overcome the 
critical barriers to a clean opinion across the other Services 
without the duplicative costs that would result from learning 
those lessons simultaneously. We will use the lessons learned 
from this to build more predictable audit plans and 
expectations for the other Services.

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