[Senate Hearing 109-649]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 109-649
 
                  CONCURRENT RESOLUTION ON THE BUDGET

                            FISCAL YEAR 2007

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               ----------                              


         February 2, 2006--THE CBO BUDGET AND ECONOMIC OUTLOOK

   February 7, 2006--THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL

    February 15, 2006--UNDERSTANDING THE CAUSES OF AND SOLUTIONS TO 
                     ADDRESSING THE FEDERAL TAX GAP

  February 16, 2006--THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL 
                           (STATE DEPARTMENT)

 March 1, 2006--THE PRESIDENT'S BUDGETARY PROPOSALS FOR THE DEPARTMENT 
                      OF HEALTH AND HUMAN SERVICES

March 2, 2006--THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL FOR THE 
                         DEPARTMENT OF DEFENSE
                                     
                                     



           Printed for the use of the Committee on the Budget
          CONCURRENT RESOLUTION ON THE BUDGET FISCAL YEAR 2007

                                                        S. Hrg. 109-649

                  CONCURRENT RESOLUTION ON THE BUDGET

                          FOR FISCAL YEAR 2007

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

                                HEARINGS

                               before the

                        COMMITTEE ON THE BUDGET
                          UNITED STATES SENATE

                       ONE HUNDRED NINTH CONGRESS

                             SECOND SESSION

                               __________

         February 2, 2006--THE CBO BUDGET AND ECONOMIC OUTLOOK

   February 7, 2006--THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL

    February 15, 2006--UNDERSTANDING THE CAUSES OF AND SOLUTIONS TO 
                     ADDRESSING THE FEDERAL TAX GAP

  February 16, 2006--THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL 
                           (STATE DEPARTMENT)

 March 1, 2006--THE PRESIDENT'S BUDGETARY PROPOSALS FOR THE DEPARTMENT 
                      OF HEALTH AND HUMAN SERVICES

March 2, 2006--THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL FOR THE 
                         DEPARTMENT OF DEFENSE


                    U.S. GOVERNMENT PRINTING OFFICE
26-726                      WASHINGTON : 2006
_____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001

                                     
                                     



                                   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 2, 2006--The CBO Budget and Economic Outlook............     1

February 7, 2006--The President's Fiscal Year 2007 Budget 
  Proposal.......................................................    73

February 15, 2006--Understanding the Causes of and Solutions to 
  Addressing the Federal Tax Gap.................................   165

February 16, 2006--The President's Fiscal Year 2007 Budget 
  Proposal (State Department)....................................   273

March 1, 2006--The President's Budgetary Proposals for the 
  Department of Health and Human Services........................   385

March 2, 2006--The President's Fiscal Year 2007 Budget Proposal 
  for the Department of Defense..................................   463

                    STATEMENTS BY COMMITTEE MEMBERS

Chairman Gregg................................1, 73, 165, 273, 385, 463
Ranking Member Conrad.........................2, 75, 166, 274, 386, 464
Senator Bunning................................................104, 406
Senator Enzi................................71, 129, 269, 315, 438, 519
Senator Feingold.................................................   439
Senator Grassley.................................................   230
Senator Johnson................................................130, 441

                               WITNESSES

Hon. Joshua Bolten, the Director of the Office of Management and 
  Budget........................................................88, 125
Gordon England, Deputy Secretary, US Department of Defense.....479, 482
Hon. Mark W. Everson, Commissioner, Interanal Revenue Service..174, 177
Admiral Edmund P. Giambastiani, Jr., Vice Chairman, Joint Chiefs 
  of Staff, US Department of Defense.............................   487
Michael O. Leavitt, Hon., Secretary, Department of Health and 
  Human Services...............................................397, 427
Mr. Donald Marron, acting Director, Congressional Budget Office..19, 64
Nina Olsen, National Taxpayer Advocate, Taxpayer Advocate 
  Services.....................................................240, 243
Hon. Condoleeza Rice, Secretary, US Department of State........285, 288
Hon. David M. Walker, Comptroller General of the United States, 
  US Government Accountability Office..........................189, 191

                         QUESTIONS AND ANSWERS

    JOSH BOLTEN..................................................   138
    DAVID M. WALKER..............................................   270
    CONDOLEEZA RICE..............................................   317
    MICHAEL O. LEAVITT...........................................   444


                  THE CBO BUDGET AND ECONOMIC OUTLOOK

                              ----------                              


                       THURSDAY, FEBRUARY 2, 2006

                                       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, Crapo, Alexander, Conrad, 
Stabenow, and Menendez.
    Staff present: Scott B. Gudes, Majority Staff Director and 
Jim Hearn, director for federal programs and budget process.
    Mary Ann Naylor, Staff Director and John Righter, deputy 
staff director & commerce and housing credit.

             OPENING STATEMENT CHAIRMAN JUDD GREGG

    Chairman Gregg. Let me begin the hearing.
    We appreciate today having the opportunity to hear from Don 
Marron, who is the acting head of CBO. This is an opportunity 
to get CBO's estimate relative to the baseline, which is 
important. It is a technical concept, the baseline, but it 
substantively drives everything that we do around here. So this 
hearing is important on where we are going as a Government and 
how we are going to be able to approach the budgeting process 
in this coming year, because what CBO says, it is the memo that 
controls the meeting, as Henry Kissinger was fond of saying.
    So we look forward to hearing from Mr. Marron, who is doing 
an exemplary job, an excellent job. We appreciate his being 
thrown into the breach here and taking over so well.
    On other topics or the general topic of what is happening 
relative to the budget, I want to congratulate the House of 
Representatives for passing the reconciliation bill last night. 
It was a close vote, as it was here in the Senate, a tie vote 
in the Senate with the Vice President casting the vote that 
caused it to go over the top.
    This bill is the first time in 8 years that we have begun 
undertaking the process of addressing entitlement spending. 
Anybody who looks at the Federal budget these days, if they are 
honest, has to admit that the issue is entitlement spending. As 
Willie Sutton said, when they asked him why he robbed banks, he 
said, ``That is where the money is.'' Well, the money in the 
Federal Government is in the entitlement accounts. They have 
grown to about 60 percent of our spending, and the failure of 
the Congress to discipline those accounts and to put in place 
responsible policies in those areas has caused those accounts 
to continue to grow at a rapid pace. But, more importantly, 
with the looming issues of the baby-boom generation retiring, 
the demand on the Federal Government and, therefore, on the 
taxpayers of this country, who will be the baby boomers 
children and grandchildren, will be extraordinary.
    We have talked about this a lot, but approximately in the 
year 2035, three accounts--Social Security, Medicaid, and 
Medicare--will essentially absorb all the revenues of the 
Federal Government, assuming that the Federal Government stays 
at the historical level of revenues. And the practical 
implications of that are that there isn't going to be any money 
for anything else--national defense, education, environmental 
protection, or just general entitlement activity.
    So we have an obligation as a Government and as 
policymakers, but more importantly as baby boomers, to address 
this issue. We have no right as one generation to pass on to 
the next generation the problems which are going to confront it 
if we do not address the issue of entitlement reform, 
specifically in the areas of health care and pensions.
    And so I was also appreciative of the President raising the 
visibility on this issue by talking about it in terms of the 
baby-boomer responsibility in the State of the Union, and 
hopefully we can proceed from that point and actually get 
something constructive going here. It cannot be done unless it 
is done in a bipartisan manner. I know that the Senator from 
North Dakota is very interested in this issue, very concerned 
about this issue. We have different approaches, obviously, but 
that doesn't mean we shouldn't be able to sit down and try to 
work something out. And that is what I hope we can do, or at 
least begin the process of doing, and at least the 
reconciliation bill did show that we can put our toe in this 
water--and it was just our toe in the area of Medicaid--and try 
to do something constructive.
    So we look forward to hearing from you and getting your 
thoughts on what the baseline looks like. I have many questions 
about how we structure this baseline, but I do not want to 
absorb all the discussion here. And I will yield to the Senator 
from North Dakota for his thoughts, and then we would like to 
hear from you, Mr. Marron.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Thank you, Mr. Chairman. Thank you again 
for your courtesy in discussing the agenda of the committee for 
the year and the many courtesies extended by you and your staff 
to me and my staff. We continue to appreciate the extraordinary 
professionalism that you bring to this task and that your staff 
does as well.
    Chairman Gregg. Thank you, and the feeling is mutual 
obviously.
    Senator Conrad. And welcome to Mr. Marron. I think this is 
the first time you have had an opportunity to present before 
the committee, and we welcome you and look forward to a good 
working relationship with you as well. We had a very good 
meeting the other day in my office talking about some of these 
same concerns that the chairman has raised.
    Obviously, we do have a different perspective. My great 
concern is the explosion of deficits and debt. That is a 
combination of spending and revenue, and I believe we are going 
to have to work on both sides of the equation in order to 
achieve a result. And hopefully somewhere there is a principled 
compromise on which both sides could agree to avert this 
explosion of debt.
    Let me just go through----
    Chairman Gregg. Would you just yield for a second?
    Senator Conrad. Yes, I would be happy to.
    Chairman Gregg. I failed to recognize Senator Menendez, who 
has joined us and is part of the committee now, and we very 
much appreciate his choosing the Budget Committee to serve on. 
It is a place where you get a lot of arrows and very few kudos, 
and we thank you for being willing to take some arrows.
    [Laughter.]
    Senator Conrad. If I could, Mr. Chairman, extend my welcome 
as well. I was going to wait until we introduced Mr. Menendez 
to the committee, but this is an appropriate time to welcome 
him to the Senate Budget Committee. He comes from a 
distinguished career in the House of Representatives. This is a 
challenging post, and Senator Menendez and I have already 
talked about the work that we will have this year and on into 
the future.
    Let me just try to outline what I see as the significant 
concerns we face. This is the history over the last 5 years of 
what has happened to the budget deficit, and these are the 
largest budget deficits in dollar terms we have ever 
experienced. Last year, there was a bit of improvement, but 
then the outlook for this year, especially when you add back 
omitted costs, looks like we are headed back in the wrong 
direction.

[GRAPHIC] [TIFF OMITTED] T6726.001


    Let's go to the next slide, if we could.
    My greatest concern is that the growth of the debt is far 
greater than the deficits, and I find people are confused by 
this. I go around my State, and people assume--many people 
assume that the amount of the deficit is the amount by which 
the debt increases. And, of course, Mr. Marron, you know that 
is not the case. We are projecting now a deficit for 2006 of 
$364 billion, but we now estimate the debt will increase by 
$637 billion. Of course, the biggest difference between the two 
is Social Security money that is in surplus at the moment, but 
which will be all needed for the future, which is being used to 
pay for other things.

[GRAPHIC] [TIFF OMITTED] T6726.002


    Let's go to the next slide.
    This is a slide that I wish we could just imprint on 
members of the committee and our colleagues in the Congress, 
because this goes back to 1980 and it shows the relationship 
between spending and revenue. The red line is the spending 
line. The green line is the revenue line. And you can see back 
in the 1980's we were spending about 22 percent, some years 
even more than that, of gross domestic product in the Federal 
Government. During the 1990's, each and every year the spending 
came down as a share of gross domestic product. Now since the 
Bush administration came in, we have had a substantial move up. 
But I think it is important for people to know that roughly 90 
percent of the increase in discretionary spending is defense, 
homeland security, and rebuilding New York--spending priorities 
we all agreed were necessary.
    But look what happened to the revenue side of the equation. 
Revenue, when the President came in, was at a record high. He 
was quite correct in pointing out at the time that revenue was 
at a record high in terms of a share of our national income. 
But look at what has happened since. The revenue side of the 
equation fell dramatically.
    Some of our friends will say, well, when you cut taxes, you 
get more revenue. We cut taxes in a major way three times, and 
revenue kept falling. Now we have had an uptick, but we are 
still well short of where we were in the 1980's and 1990's, and 
the difference between what CBO and OMB are projecting in terms 
of spending and what they are projecting in terms of spending 
and revenue is this gap. And it is a big gap. And it is a gap 
that is occurring in many ways at the worst possible time--
before the baby boomers retire.

[GRAPHIC] [TIFF OMITTED] T6726.003


    Let's go to the next slide.
    There have been so many assertions that if you cut taxes 
you get more revenue. Let's just have a historical review here. 
The Federal Government in 2000 received $2 trillion in revenue, 
just a little over $2 trillion; 2001, right at $2 trillion. At 
that point we enacted substantial tax reductions. The next 
year, revenue fell to $1.85 trillion. We enacted more tax cuts. 
The next year revenue fell to $1.78 trillion. In 2004, we had a 
bit of an uptick but still well short of where we were back in 
2001. In 2005, a healthy increase, only now getting back to 
where we were in revenue way back in 2000.

[GRAPHIC] [TIFF OMITTED] T6726.004


    Let's go to the next slide.
    As we look at the CBO numbers, it is very important for 
people listening to understand the Congressional Budget Office 
is only able to tell us what they project deficits to be absent 
policy changes. But we know that policy changes are being 
recommended. For example, the President is saying make the tax 
cuts permanent. That costs $2 trillion. Alternative minimum tax 
reform, the old millionaires' tax--it is now becoming a middle-
class tax trap--costs $864 billion to fix. These are all over 
10 years. The President's defense buildup costs about $300 
billion; the funding for ongoing war costs, almost $400 
billion.
    Then we adjust for things that are one-time that should be 
removed. For example, we have taken out the effect of 
supplementals because we hope--we hope--those are one-time 
events. That takes out $827 billion, and the reconciliation 
conference report just passed in the House and previously 
passed in the Senate, that should save over 10 years $105 
billion. If you add the debt service that occurs as a result of 
these additions, you have $3 trillion of added debt.

[GRAPHIC] [TIFF OMITTED] T6726.005


    That is where we are headed with the policy changes that 
have been proposed. That gives us a very different long-term 
budget outlook than what the President is talking about. The 
President is talking about cutting the deficit in half, but he 
only gets there by leaving out things. When we add them back, 
here is what we see as the deficit outlook. And, of course, the 
President only has a 5-year budget horizon. The cost of his tax 
cuts absolutely explodes right beyond the 5-year budget 
horizon.

[GRAPHIC] [TIFF OMITTED] T6726.006


    Let's go to the next one.
    The President has said, back in 2001, ``My budget pays down 
a record amount of debt. We will pay off $2 trillion. That will 
be the largest debt reduction of any country ever.''
    Then he made a statement that I strongly agree with: 
``Future generations shouldn't be forced to pay back money that 
we have borrowed. We owe this kind of responsibility to our 
children and grandchildren.'' That is what the President said.

[GRAPHIC] [TIFF OMITTED] T6726.007


    Here is what is happening. When he made that statement, the 
debt of the country was $3 trillion less than it is now. It was 
below the bottom of this chart. Just in these 5 years, the debt 
has gone up by $3 trillion to $8.5 trillion, and every year of 
this budget proposal that has just been heralded here by my 
colleague, the debt is going to increase by $600 or $700 
billion each and every year. This is before the baby boomers 
retire.

[GRAPHIC] [TIFF OMITTED] T6726.008


    This to me is utterly unsustainable, and it does require 
our prompt action. I agree absolutely with the Senator: 
Entitlements on the spending side are the big enchilada. That 
is where the money is. But I think, in fairness and in truth, 
we are also going to have to deal with the revenue side of this 
equation. And lest somebody conclude that my first reaction is 
to increase taxes, let me assure my colleagues that is not my 
first reaction. My first reaction is to attack aggressively the 
tax gap, the difference between what is owed and what is being 
paid. That difference, the Revenue Service tells us, is over 
$300 billion a year. We have to do better than that.
    I thank the chairman for his patience, and I thank the 
witness for his presence.
    Chairman Gregg. Thank you, Senator.
    We would now like to hear from Mr. Marron.

 STATEMENT OF DONALD B. MARRON, ACTING DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Marron. Outstanding. Thank you. Is this on?
    Chairman Gregg. If the red light is on, it is.
    Mr. Marron. Excellent. Thank you, Chairman Gregg, Senator 
Conrad, members of the committee. It is a pleasure and exciting 
to be here today for my first appearance.
    Let me just say in my first month or so of being Acting 
Director, I haveten to work closely with your staffs and gotten 
to meet both of you and felt it has been very productive and 
look forward to continuing that.
    Both of you obviously are already familiar with our 
outlook, which we released last week, so I will try to keep my 
remarks short here.
    The key points that we have are:
    The deficit projection for 2006 increased a little bit from 
where we were last August. Most of that is due to Katrina, not 
a surprise.
    Some small improvements in the later years of our 
projection period, revenues slightly higher than we predicted 
previously, spending slightly lower. But I would characterize 
those changes as relatively small, and I would characterize the 
budget outlook as being roughly the same as what we reported 
last August.
    On the economic front, basically a solid economy for a 
variety of reasons. The economy has momentum and we expect 
solid growth this year, expect that to continue.
    And then a point that I want to emphasize and that 
reinforces some of the opening remarks of the members is that 
you can see in our projection the beginning of the challenges 
that are going to be posed by Social Security, Medicare, and 
Medicaid. And so it is in there. It is within the 10-year 
budget window that we are looking at.
    Turning to some details, as mentioned, our official budget 
projection of the deficit for 2006 in the Outlook is $337 
billion. We are not in the business of projecting what 
legislation might pass, and so as a result, we did not include 
the reconciliation bill in that number. If you include the 
reconciliation bill, that projection would become something in 
the neighborhood of $332 billion. That is up slightly from last 
year, but basically in the same ballpark relative to the 
overall size of the economy, 2.5 percent of GDP this year 
versus 2.6 percent last year.
    Again, we are in the business of projecting assuming 
current law, current policies. We cannot make predictions about 
what happens in the future. There are a few spending pressures 
that we see that are already sort of built in to what is going 
to happen: some additional spending on operations in Iraq and 
Afghanistan, and some spending that is likely to be necessary 
very soon on flood insurance. If you take those and add them 
in, for 2006 we would be looking for a deficit that is 
somewhere in the $355 billion range.
    If you could put up the first chart, please?
    Looking out over the rest of our projection--and the 
members have these charts in front of them as well--it is 
basically a race between the red line and the blue line as you 
look at the right side of this chart. Let me start with the red 
line, which is spending. It has a variety of components--
mandatory and discretionary primarily, along with interest--and 
the key thing to know is that, as CBO constructs its baseline, 
we are required to do so under certain rules.

[GRAPHIC] [TIFF OMITTED] T6726.017


    For mandatory programs, we basically take the mandatory 
programs as they are structured and assume that they continue 
regardless of whether or not they are scheduled to expire over 
this period. Over this period, the drivers of spending on 
mandatory include growth in the caseloads for those programs, 
particularly driven by the baby-boom generation, and for the 
health care-related ones, there is the increasing expectation 
that health care will continue to cost--the costs of health 
care will continue to rise more rapidly than the economy. Those 
two factors together cause mandatory spending to grow relative 
to GDP over our projection period.
    Now, you don't see that in our red line because of the way 
that we are required to structure our projection of 
discretionary spending. For discretionary spending, in essence 
what we do is take the budget authority that has been approved 
for fiscal year 2006, and we project it out into the future 
using our economic forecast of inflation rates. As you all 
know, in recent years discretionary spending has tended to grow 
much more rapidly than inflation alone, but for purposes of 
constructing this baseline, those are the rules that we have to 
follow. And what you see with the red line, where spending 
relative to GDP appears to go down over the projection period, 
that is in essence the story of the construction that we are 
doing for discretionary spending more than offsetting the 
underlying growth in the mandatory spending that we see going 
on in parallel.
    On the revenue side, the key thing I would point out is 
that given our current tax system, the natural state of affairs 
is for revenues to grow slightly faster than the economy. That 
is because of the structure of the regular tax system, because 
of the structure of the AMT, and also because increasingly with 
the baby-boom generation coming upon us, we are going to see 
some withdrawals from 401(k)'s and tax-deferred accounts that 
are going to provide some boost to revenues.
    So the natural tendency of revenues is to grow faster than 
the economy, but the big enchilada, which you can see in our 
forecast when we get out to 2011, is that under the rules under 
which we construct our baseline, we assume that the various tax 
provisions expire, and as a result, revenues increase 
dramatically in 2011 and 2012. And that essentially explains 
why the blue line of revenues rises up and gets slightly above 
the red line of outlays.
    Let me turn just to the economic outlook quickly. Again, we 
see a solid economy with momentum. There are reasons to believe 
that business investment needs to continue to be strong and 
will be strong this year and next year. Basically that is a 
story where the demand for products, the growth of demand for 
products in recent years has grown faster than the investment 
that businesses have been doing and that, therefore, in essence 
businesses have to do some additional extra investment to catch 
up.
    Rising wealth and rising incomes are helping to support 
spending by consumers, and there are some reasons to believe 
also that our situation on the trade front should improve 
somewhat. The dollar declined substantially from 2002 through 
2004, went up a little bit last year, but there is still 
basically some pent-up decline in the dollar that needs to flow 
through and is expected to flow through into somewhat better 
performance on the international side. You take all those 
together and our expectation is for solid growth, 3.6 percent 
real GDP growth this year, 3.4 percent next year.
    People worry a lot about housing. In our projection, we 
expect that the housing sector will indeed cool somewhat this 
year and next year. So we see housing investment lower this 
year than last, and we see it lower in 2007 than in 2006. So 
that degree of cooling is built into our projection.
    Then, again, in thinking about the longer-run challenges 
that we face on the budget front, it is important to recognize 
that another effect of the baby-boom generation aging is that 
the expected growth of the labor force, the pool of workers who 
produce things in our economy, that is expected to slow over 
time. And so that even as we see growth above 3 percent this 
year, next year, and for a few years after, in the later years 
of our forecasts we actually see economic growth slowing to 
about 2.6 percent. And so we are in a situation in which 
spending on mandatory programs is going to be rising faster and 
faster, and yet the size of the economy to support it is 
actually going to be growing slower and slower.
    Let me just emphasize quickly, as you all know, there are 
great uncertainties in the projections that we put together. It 
is extremely difficult to forecast all of the effects that will 
drive budget outcomes. If you take our projection in the spirit 
in which it is intended, which is as a projection, the key 
uncertainties are economic and technical factors. In the 
report, we have a very nice fan chart which tries to illustrate 
what the range of uncertainties are, and the basic story there 
is if you go out 5 years, say, to 2011, in that year we project 
a small deficit under the rules under which we construct our 
projection, but realistically it could be several percentage 
points of GDP either way. So there is a significant amount of 
uncertainty. We do our best to resolve that and eliminate it. 
But the reality is we live in an uncertain world.
    Then, second of all, our projection is not intended in any 
shape, way, manner, or form as a forecast, but it is sometimes 
interpreted that way. The key uncertainty for anyone who wishes 
to take our projection as a forecast, as was already pointed 
out, is policy uncertainty. Depending on what policies are 
adopted by the Congress and the administration, the outcomes 
could turn out quite different from what we project.
    Finally, if we could just go to the second of the two 
charts I had? There it is.
    I just want to emphasize a point I made earlier, which is 
you can now see within the window--the 10-year window that we 
are using for projecting the increasing pressures that are 
coming from the big three entitlement programs. So you can see 
that Social Security, Medicare, and Medicaid combined are going 
to place increasing pressures on the budget. Over this time 
period, these three rise by about 2 percentage points of GDP, 
from about 8.7 percent of GDP this year to about 10.8 percent 
in 2016, the final year of our projection. Most of this at the 
moment is being driven by the expectation that health care 
costs are going to continue to rise much more rapidly than the 
economy. You can only begin to see the transition in 
demographics. As you get beyond this window, the pressures from 
those programs become increasingly larger, and as you go out 
several decades, again, under the projections we make both in 
this report and in our long-term budget report, these three 
programs look to grow to be, say, 15 percent of GDP, which 
seems relative to where we have been historically something 
that would be unsustainable.

[GRAPHIC] [TIFF OMITTED] T6726.018


    With that, I am happy to take your questions.
    Chairman Gregg. Thank you. We appreciate that. And we 
especially appreciate your explaining that your baseline really 
is--it takes into account things that probably are not going to 
happen.
    Mr. Marron. Yes.
    Chairman Gregg. And you are forced to do that by law. For 
example, you have to continue Katrina spending as if we are 
going to do it forever. And you have to continue the war, the 
Iraq supplementals as if they were going to go on forever. And 
clearly those two events are not. They are both going to come 
down rather drastically here, as the chart that Senator Conrad 
held up made that point.
    But that is one of the things that bothers me, I guess, and 
the big area that we have this problem is in the area of how 
you are required to account for entitlements and revenues. You 
know, you have two different major rules on entitlements. If 
they sunset, you still have to consider them as going on. You 
have a different rule for discretionary, which you described. 
And then you have a different rule for revenues.
    Shouldn't we have homogenization here so that we have one 
rule that basically applies to all four categories so that 
there is consistency? In other words, if we are going to sunset 
revenues and we are going to presumably go back to the old law, 
then shouldn't we do the same for entitlements and actually 
have mechanisms to create that and make it happen so that we 
have a baseline that is consistent and treats these different 
accounts consistently?
    Mr. Marron. Well, that is a challenging question. I think 
it is important to keep in mind that whatever rules we choose, 
the goal--I think the goal cannot be to create baseline 
projections that look like forecasts because there will be, 
obviously, policy changes in the future.
    Chairman Gregg. We want to create as much accuracy as we 
can.
    Mr. Marron. We want to create--well, accuracy and, I guess, 
usefulness to you. I mean, in part I am afraid my answer is 
going to be to put the question back on you and your colleagues 
about what is the most constructive and useful way to present 
these data. And then I would distinguish the discretionary side 
where it is not entirely obvious to me what the rules are and 
what the alternative rules are one might use to project that 
out into the future. We went through various scenarios in our 
book of, you know, keeping it flat in nominal terms or growing 
it at the growth rate of GDP. At the moment, the rules are grow 
at inflation. I am not exactly sure of the best--if there is 
some specific way that would guide us to choose which of those 
makes the most sense.
    As for mandatory spending versus tax revenues, that raises 
a key issue, which you raised, which is if there is any 
symmetry. So we assume that tax things that expire truly 
expire; whereas, mandatory things that expire do not expire. 
That is clearly an asymmetry. It is clearly something to think 
about. I guess I would put back on you is that constructive for 
the process or is that not constructive.
    Chairman Gregg. Well, I appreciate that. I do not think it 
is constructive, and we will try to address it.
    But on another issue, today on the floor we have the 
reconciliation tax bill. The big battle, to the extent there is 
a big battle, has been waged around the issue of extending 
capital gains and dividend rates for 2 years. There appears to 
be support--I am not necessarily one of them--for doing an AMT 
patch, for doing State and local sales tax deductibility across 
the board, or across the aisle.
    I guess my question to you is, if you look at State and 
local deductibility, which essentially gives States which have 
a high tax burden a benefit, in other words, you are saying to 
a State that has a sales tax, you go ahead and raise it because 
your people are going to be able to deduct a percentage of it, 
so you can raise it to the extent the Federal income tax 
basically subsidizes it; whereas, States that do not have a 
sales tax, like mine--we do not have an income tax--end up, 
therefore, paying an unfair--getting treated unfairly in that 
exercise because they have nothing to deduct because their 
States are fiscally responsible and do not have those taxes. So 
you create an atmosphere where you are actually encouraging tax 
increases in States, and most of those are large States. 
Connecticut, Massachusetts, New Jersey, New York, Illinois, 
California all have major sales taxes.
    If you compare that tax from an effect on the economy to 
capital gains, where basically you are saying to people you go 
out and you invest and you reinvest and you realize your gains 
and then you reinvest and you create jobs, which one generates 
more economic activity, which in turn probably generates more 
revenue for the Federal Government: cap gains or sales tax 
deductibility--extending the cap gains rates or making sales 
tax deductible? Recognizing that both are essentially costing 
the same.
    Mr. Marron. So purely from an economic efficiency point of 
view in terms of economic activity, leaving aside any 
distributional considerations, reducing taxes on investment 
returns and on the returns to saving generally tend to be among 
the most pro-growth tax reductions that you can have. They 
encourage capital formation. Capital formation leads to a 
larger economy, higher wages, and economic growth as we go over 
time; whereas, the deduction for State and local taxes has 
exactly the two effects that you emphasized. The first is that, 
in essence, it reduces the cost to individual States to raising 
their taxes and, therefore, on balance encourages higher taxes 
at the State level. And then, second, given the different 
approaches that States take in this country to how they 
structure taxation, it provides that incentive in a way that 
sort of is not equal across the States and, therefore, it 
creates some--I guess you would say economic activity as a 
result faces different taxes at the margin across different 
States, which is not something that encourages efficiency.
    Chairman Gregg. I appreciate that answer, and I appreciate 
the forthrightness of it, and I agree with it. Basically we 
should not extend the deductibility of State and local sales 
taxes, in my opinion, because it does have an adverse and 
disproportionate benefit to States that have high--an adverse 
impact on States with low tax burdens, or at least that don't 
have sales tax burdens, and a disproportionately positive 
impact on States that have high tax burdens and have a sales 
tax.
    Another issue, and I am running out of time, but the Part D 
premium, the Part D drug benefit, the estimate is that it is 
now $45 billion over the original estimate. Is that correct? Or 
do you have a number on that? That is the estimate we have. And 
shouldn't we bring it back or have you assume that it is going 
to be brought back in line with the original estimate in order 
to properly budget for it?
    Mr. Marron. In our outlook we have a box that discusses 
Medicare Part D and tries to put some of the numbers in 
context. I believe the number we have at the moment is $42 
billion so that our current estimate--and I should emphasize 
what that is. Our current estimate of the spending from 
Medicare on prescription drugs is about $42 billion higher than 
we estimated in our original cost estimate. That increase 
reflects essentially three things:
    Some economic changes, basically inflation was higher over 
recent periods than we previously thought, and that flows 
through into some of the prices;
    Second of all, we have learned some more about how the 
program is going to operate. We learned something about how the 
rules are going to be implemented. A variety of those factors 
lead to the change;
    And that is what is built into our baseline, so we have no 
expectation of any possible future legislative change to the 
program. We have the program that is currently written.
    Chairman Gregg. But if we were to bring it back to its 
original proposals, we would reduce the rate of growth in that 
program by about $42 billion.
    Mr. Marron. If we brought it back to the original 
estimates, yes.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    Let me just go to a couple of questions to you because I 
know it is confusing to people out there listening, and I think 
it is confusing, frankly, to our own colleagues when they see 
CBO issue these estimates, because I don't think they have it 
firmly in mind what the chairman has said. That is, you are 
required by law to use existing policy, not what the policy 
proposals are that we are facing and that are likely to be 
adopted, but instead, existing policy. Isn't that correct?
    Mr. Marron. Absolutely.
    Senator Conrad. And you are required by law to do it that 
way, aren't you?
    Mr. Marron. Yes.
    Senator Conrad. So this is not any criticism--I want to 
make it clear--of the Congressional Budget Office. You are 
required to do it this way, and there is a good reason for 
that. But the problem is it is unlikely to match reality.
    Now, let's talk a minute about the policy proposals that 
are out there. Let me just ask you, the President said in his 
State of the Union, ``Make the tax cuts permanent.'' We see the 
10-year estimate of the cost of that proposal is $2 trillion of 
lost revenue. Do you agree with that? Is that roughly your 
understanding--

[GRAPHIC] [TIFF OMITTED] T6726.005


    Mr. Marron. Yes.
    Senator Conrad. An alternative minimum tax reform--and I 
know you say alternative minimum tax and right away people tune 
you out. But basically it is the old millionaires' tax that, 
unfortunately, is rapidly becoming a middle-class tax trap. 
There are going to be 20 million people affected this year if 
we do not do something.
    The 10-year cost of fixing that is $864 billion. Do you 
agree with that rough estimate?
    Mr. Marron. With the caveat that I think people may 
disagree on what constitutes a fix.
    Senator Conrad. A fix.
    Mr. Marron. And so we have a specific possibility, as we 
illustrated in our report, but obviously the actual fix, if one 
happens, may look different.
    Senator Conrad. And this estimate of what has been widely 
regarded as a fix, that is, to freeze this so more people are 
not swept into it, rough cost $860 billion over 10 years?
    Mr. Marron. Let me check my numbers.
    That sounds about right.
    Senator Conrad. The third issue is the President's ongoing 
defense buildup, and we have been given an estimated 10-year 
cost of roughly $300 billion. Do you believe that is roughly--
--
    Mr. Marron. I must admit that is not actually a calculation 
I have seen. I expect other people at CBO have.
    Senator Conrad. Let me just say that we face a tremendous 
stress on the military budget. I have just been advised by my 
Guard leaders and other Army leaders that the equipment in 
Iraq, much of it will just have to be left there because it is 
junk, and it is becoming junk because of the extreme heat, the 
adverse conditions, and, of course, the stress of combat. And 
this is going to pose substantial additional costs.
    Funding for ongoing war costs, I believe this is actually a 
CBO estimate, 10-year cost $380 billion. Do you agree that that 
is in the ballpark?
    Mr. Marron. Under a particular set of assumptions, yes.
    Senator Conrad. Now, we have backed out the 2006 
supplementals for the reason that Senator Gregg gave, and I 
think he is exactly right. Many of these supplementals for 
Katrina, for the war in Iraq, you are required to include those 
in future year estimates, but we have backed them out because 
we assume they are one-time costs. And when we back those out, 
that is a savings of $827 billion. Would you agree that that is 
roughly correct?
    Mr. Marron. Yes.
    Senator Conrad. And then the reconciliation conference 
report passed in the House--I know it is referred to as $39 
billion, but that is the 5-year effect; the 10-year effect, 
$105 billion. Do you agree with that?
    Mr. Marron. That looks about right.
    Chairman Gregg. It passed the Senate, too.
    Senator Conrad. And it passed the Senate.
    Chairman Gregg. I just want to make that point.
    Senator Conrad. Yes, it passed the Senate. The debt service 
related to all this, $481 billion. So we see the debt going up 
by $3 trillion over this next 10 years. Do you agree that that 
is roughly in the ballpark?
    Mr. Marron. Ballpark, if all these things come to pass.
    Senator Conrad. All of these elements. Well, that, I would 
say to my colleagues, is alarming to me because this is before 
the baby boomers fully retire. And if there is one place the 
chairman and I absolutely agree, it is this demographic change 
that is occurring is going to create a tsunami of debt, because 
the number of people eligible for Medicare and Social Security 
are going to double in very short order.
    Would you agree that the number of people eligible for 
Social Security and Medicare will double as the baby boomers 
retire?
    Mr. Marron. Yes.
    Senator Conrad. So if we are looking at the spending side 
of this equation, we have to focus there. Would you agree?
    Mr. Marron. Yes.
    Senator Conrad. And on the revenue side of the equation, 
the notion that tax cuts pay for themselves, my understanding 
is that CBO has found, using a wide variety of economic models, 
the tax cuts do not pay for themselves. Some of the models show 
positive effects on growth, but they are not large enough to 
offset the revenue loss. Is that an accurate characterization 
of what CBO has found?
    Mr. Marron. Yes. Pro-growth tax cuts, reducing marginal 
rates, things that are focused on savings and investment do 
help the economy grow. And, therefore, you get back something 
from macroeconomic behavior that a purely static estimate would 
not account for. But the scenarios we have considered do not 
come close to actually paying for themselves.
    Senator Conrad. Let me just say this by way of conclusion. 
I believe that we together have to take on this growth of the 
debt. I believe it is going to take a focus on the spending 
side, especially entitlements, and on the revenue side, and 
that the first place we ought to look for revenue is this 
massive tax gap.
    One final question, if I could on that. The tax gap--have 
you had a chance to look at the Internal Revenue Service 
estimates of the difference between what is owed and what is 
being paid per year?
    Mr. Marron. I know they exist. They are somewhere between 
$300 and $400 billion a year.
    Senator Conrad. The difference is $300 to $400 billion. 
That, my colleagues, I suggest, on the revenue side ought to be 
the first place we look.
    I thank the Chair.
    Chairman Gregg. I hope we can pursue that later, whether 
you have language which could accomplish that.
    Senator Crapo I guess was here first.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Marron, I wanted to pursue a little further the line of 
questioning that both the chairman and the ranking member have 
pursued with you, namely, the dynamic impact of tax cuts.
    As you have already indicated, certain types of tax cuts 
are pro-growth, stimulate the economy, stimulate the 
development of capital and wealth and development of jobs, and 
have the ability, therefore, to create a stronger and more 
dynamic environment in which greater revenue can be 
accomplished.
    Now, you indicated on the models that you have looked at 
that they did not return as much as they cost. Do you build any 
of those models into your projections, or have you just looked 
at them?
    Mr. Marron. For purposes of the baseline that we construct 
and that we have talked about here today, we do indeed account 
for dynamic effects. And so, for example, in our projections in 
2011 and 2012--in 2011, in particular, you see taxes rise 
significantly. And so as a result, in our projections we see 
that labor force participation goes down after that. And so 
there are some dynamic effects in the baseline.
    In the evaluation of legislation, which on the tax side I 
should emphasize is primarily done by the Joint Committee on 
Taxation, those effects are typically not accounted for.
    Senator Crapo. Do you get specifically into--say that 
again, what you just said? What is not accounted for?
    Mr. Marron. In evaluating legislative proposals on the tax 
side, which, again, is primarily done by our colleagues at JCT, 
they take into account some behavioral responses, so they are 
not purely static estimates, but they do not take into account 
possible macroeconomic effects of tax cuts.
    Senator Crapo. As you are evaluating the impact of tax 
relief, do you focus on the specific taxes that are being--
let's take, for example--and I think you are aware of the 
recent information that has come out on the capital gains tax 
cuts over the last 2 or 3 years and the impact of those cuts on 
revenue. Do you take that into account specifically as to the 
specific taxes that have been cut?
    Mr. Marron. There are really two related things there. In 
constructing our baseline, we definitely take account of the 
fact that if you change capital gains taxes, you change 
people's realization behavior roughly as you would expect. If 
the capital gains tax is lower, people are more willing to 
realize gains, and they also affect their timing. So we build 
that into the baseline. And then we also build into the 
baseline some macroeconomic effects from that, although, they 
are not that large given all the other taxes that we have.
    Senator Crapo. Well, what I am trying to get at--and I am 
using the capital gains tax information as the example here. I 
am trying to get at an understanding of just what it is that 
you are projecting and are not, because it appears that the 
projections of CBO, and others, when we passed the capital 
gains tax cut all were that there would be a net negative 
impact on the Treasury, on the budget in terms of revenue, and 
yet that the actual occurrence was dramatically different than 
that and that the net result was that there was a significant 
increase in revenue as a result of--and then the question is: 
Was it as a result of the tax relief, or was it as a result of 
something else?
    Mr. Marron. Specifically with capital gains, my 
understanding is the estimates that are prepared by the Joint 
Committee on Taxation do take account of the fact that people 
change their realization behavior. And so, for example, we saw 
capital gains tax rates come down significantly, and that 
essentially unlocks some gains that people had not wanted to 
realize, and that may--depending on the relative size of the 
change in taxes can give you either a plus or a minus on 
revenues.
    Senator Crapo. But our actual experience was that it was a 
dramatic increase in revenues, wasn't it?
    Mr. Marron. Yes, we have seen capital gains revenues on 
both the individual side and corporate side go up 
significantly. There is a confounding factor. There is 
something that happened at the same time which we are not able 
to fully yet measure, which is this dramatic increase in real 
estate prices. And so some of the recent increase in capital 
gains is clearly coming from that sector.
    Senator Crapo. And wouldn't some of that even have been a 
result of the increase in capital transactions generated by----
    Mr. Marron. Yes, and some of that may be the realization of 
capital gains on real estate that had been there for some time.
    Senator Crapo. The bottom line, though, is that the charts 
we were all using 3 years ago were saying that it was a net 
loss, and the reality that we are seeing now is that it was a 
very significant net gain. Is that not correct?
    Mr. Marron. It is true that the capital gains realizations 
have been very strong. Connecting that strength specifically to 
the tax reduction is a challenge because of the other things 
that have happened in the economy. And for that I would have to 
plead the need for more research.
    Senator Crapo. Are you saying that we do not have the 
ability to make those kinds of estimates in terms of the 
dynamic impacts?
    Mr. Marron. I think our colleagues at JCT, do their 
professional best to understand, given what happened in the 
past, to forecast capital gains realizations. We have a brief 
discussion in our outlook here about how forecasting capital 
gains is a particularly challenging part about constructing 
revenue projections. Just in the normal course of affairs, the 
actual realizations that occur could deviate wildly from what 
the best economic models predict.
    Senator Crapo. But you do not at CBO try to conduct that 
type of dynamic analysis?
    Mr. Marron. We do for purposes of constructing our 
baseline. This is one of the confusing nuances about how we do 
things. So in our baseline, which is our responsibility, we try 
to take into account exactly those effects. When it comes to 
score legislative changes, that is done by JCT. They take into 
account behavioral response, but they do not take into account 
macroeconomic effects.
    Senator Crapo. All right. I just have about a minute left, 
and I want to shift topics entirely here for a minute and talk 
about the growth in Medicare. I noticed that growth is 
projected to be in this--I don't know if these are your figures 
are not, but $339 billion in 2006 to $500 billion in 2011, and 
then over the next 10 years it grows to $744 billion.
    Do you know what percent of the growth in Medicare is 
attributable to the enactment of the prescription drug benefit?
    Mr. Marron. For 2006 alone, the addition of the drug 
benefit is responsible for about 50 percent of the growth in 
Medicare. That obviously gets smaller as you go out over time. 
This is the first year.
    Senator Crapo. And do you know what percent is attributable 
in these projections to the increased in the number of seniors 
retiring?
    Mr. Marron. I don't have particular numbers at hand for 
you, but I would say that the predominant driver is increased 
health care spending, so increased services and increased 
prices for those services. But there is also a portion of--
because of the transition to the baby boom, significant growth 
in the population in the program. I could get you specific 
numbers, but qualitatively it is primarily the rise in health 
care costs and then also some significant change from the 
caseloads.
    Senator Crapo. All right. One last question, and you may 
give the exact same answer to this, but do you have any idea 
what percent is attributable to the more intensive care that is 
being provided to seniors?
    Mr. Marron. I would include that in with the rise in health 
care costs, which is being driven, as I said, in part by prices 
and in part by increased utilization of various services.
    Senator Crapo. All right. Thank you.
    Chairman Gregg. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman. I want to thank 
you and the ranking Democrat for the welcome to the committee 
and for reassuring me I made such a great choice in seeking the 
committee. But it is a privilege to be here, and I look forward 
to working with our colleagues in crafting a sensible, 
responsible budget, and I look at that as a very serious 
exercise since I believe that budgets are a reflection of 
values. We do that every day in our lives in terms of our 
personal budgets. What we earn and what we spend in terms of 
providing a home, educating our children, providing for health 
care, the money that we tithe to our faith, the charitable 
contributions we may make--those are all expressions of values 
within a budget. And I think the national budget collectively 
on behalf of the Nation is also an expression of values, and so 
how we choose to use the collective resources of the Nation is 
an expression of our collective values. And in some respects I 
haven't agreed with the values that we have had over the last 
several years.
    I hope one of the values that we will be able to deal with 
today as we work on the Senate floor is rewarding work, those 
individuals who work very hard every day but find themselves in 
a set of circumstances where they are going to be subject to a 
tax even though their income may not have grown on the 
alternative minimum tax. That was never meant for 17 million 
middle-class families in our country, many from my home State 
of New Jersey. So I am looking forward to seeing that the 
Senate hopefully will act in a way that speaks to a value that 
rewards work.
    And I certainly share the concerns of Senator Conrad in 
this presentation. To me, one of the things that I thought we 
achieved several years ago is balancing budgets for the first 
time in a generation, creating record surpluses, low 
unemployment, low inflation, and moving to a Nation that was 
debt-free within 4 years. And now this mountain of debt that is 
being generated is just in my mind beyond the realm and 
comprehension of most Americans.
    When we talk about the type of figures that are being 
projected in the out-years, it certainly baffles them, as I 
think it might baffle any one of us. And that does not even 
deal with some of the concerns that I have that we have learned 
over the last year, that in addition to the rate of debt that 
we are accumulating, one of the things we learned, especially 
last year, is that sometimes the unexpected and the unthinkable 
will happen, and it certainly did last year. And that adds to 
our challenges and our readiness. So it is in that context that 
I look forward to the work of the committee.
    I would like to ask you, Director, about a couple of 
issues. One is the CBO acknowledges that the war costs may be 
understated in the next few years given that the baseline 
includes the $50 billion appropriated for 2006, a figure that 
is likely to be surpassed this year. Given the probability that 
we will be near the $90 billion range in 2006, and the 
possibility that we may be near these same funding levels at 
least for the next couple of years, could you provide a revised 
baseline and demonstrate the impact on the deficit if we were 
spending between $80 and $90 billion on the war effort through 
2008?
    Mr. Marron. Sir, we can clearly run scenarios based on 
different assumptions about what funding would be for Iraq and 
Afghanistan operations, absolutely. I wouldn't be able to 
characterize them as a baseline. The baseline is what the 
baseline is, but as an alternative set of projections, that is 
certainly possible to do.
    Senator Menendez. So if we asked you to do that, you could 
do that for us.
    Mr. Marron. Certainly.
    Senator Menendez. OK. We will ask you to do that, because I 
just find it very difficult to be including in supplementals, 
which in my understanding was supposed to be emergencies, that 
which you know that you are spending. We are obviously still 
engaged in Afghanistan and Iraq, and yet we continue to offer 
supplementals versus deal with the funding expectations that we 
need to provide for the engagement of our troops, their safety, 
and ultimately our mission.
    Let me ask you about the CBO projects that the budget 
reconciliation bill passed by the House yesterday results in 
about $5 billion in savings in 2006, $39 billion between 2006 
and 2010 and $99 billion from 2006 through 2015.
    It also projects the costs of extending the 2001 and 2003 
tax cuts would be about $346 billion if we extended it through 
2011, and a whopping $2 trillion if we extended it through 
2016.
    Given the arguments that the spending cuts will help reduce 
the deficit, can you compare the impact of each of these 
approaches that it has on the deficit? Isn't $99 billion in 
savings over 9 years a drop in the bucket compared to $2 
trillion in additional revenue loss?
    Mr. Marron. That is an easy one, so yes, roughly $100 
billion is about 1/20th of roughly $2 trillion.
    Senator Menendez. Let me ask you, with reference to the 
President's--I have been listening to the President's State of 
the Union speeches now for 5 years. We have heard numerous 
times from the President his intention to cut the deficit in 
half by 2009. If I am correct, he first made that pledge in 
2004. At that time the projected deficit for 2004 was $521 
billion, and the projected deficit for 2009 was $237 billion. 
So cutting the deficit in half was more of a projection than a 
promise.
    Is the President talking about actual dollar terms or is he 
talking about the deficit as a percentage of GDP? Which one is 
he talking about?
    Mr. Marron. Sir, I have seen news coverage and discussions 
that characterize it both ways, either in dollar terms or as a 
share of GDP.
    Senator Menendez. Well, it is hard to have it both ways, 
isn't it?
    Mr. Marron. They are both meaningful measures. You know, I 
have the luxury of being sort of a pointy-headed economist, and 
we like to divide through by GDP, so that tends to be the 
type--obviously, as you saw in my chart earlier, that tends to 
be the kind of numbers we focus on. But I would hesitate to 
characterize, you know, what the President's specific target 
was.
    Senator Menendez. I think most Americans would expect, when 
they hear that we are going to cut the deficit and the debt, 
they are talking about listening to actual dollar amounts. That 
is the reality in their lives. They don't get to do it as a 
percentage of GDP.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you very much, Senator.
    Senator Allard. Mr. Chairman, thank you. And at the risk of 
starting a war of charts, which I hope we can avoid, I just 
want to make a very brief point here because my good friend 
from North Dakota has tried to say that the growth package that 
was put forward by the President and passed by the Congress in 
2003 was not good public policy. The fact is that the facts 
point out differently, and so I have just four charts I want to 
briefly run through here that point that out.
    The first chart that we see here reflects basically that 
jobs have rebounded and that unemployment is falling.

[GRAPHIC] [TIFF OMITTED] T6726.021


    On the second chart that we have here, we have a chart that 
just quickly reflects the fact that gross domestic product is 
on a path of sustained growth and continuing in that direction. 
And the green line that we see on the chart is actually the 
point where the jobs growth package, a main portion of which 
was capital gains and growth stimulus, where we reduced taxes 
to stimulate the economy.

[GRAPHIC] [TIFF OMITTED] T6726.019


    Then on the third chart we have, look what has happened to 
Federal revenues rising. Despite projections that they would go 
down when the President's growth package was implemented, we 
see that the chart shows a pretty dramatic growth upwards.

[GRAPHIC] [TIFF OMITTED] T6726.020


    Then the fourth chart shows what is happening to household 
wealth, and it has reached record highs.

[GRAPHIC] [TIFF OMITTED] T6726.022


    Now, while those in opposition to those tax cuts have tried 
to make the point that it is bad public policy, in reality what 
we have seen happen is that that policy has been good for the 
economy.It has been good for the Federal Government because 
revenues have increased to the Federal Government, and it has 
actually helped American families. And so I for one think it 
was very good public policy, and I hope we can sustain that 
effort with policy toward a permanent tax cut. And I would 
agree with the chairman that capital gains was a vital part of 
that.
    One of the problems with estimating capital gains taxes is 
they have always been dramatically off, and in general, when we 
talk about cutting taxes to benefit the economy, it seems like 
the estimates that we get from the CBO have been off 
considerably.
    Let me take a couple of examples just to make that point. 
In 1992, President Clinton was elected into office, and around 
1993, we had what was characterized by many of us as the 
largest tax increase in the history of America at that 
particular point in time. The CBO projection in 1992 for the 
year 1993 up to 1996 had estimated a certain level of revenue. 
And when we applied these tax--when they applied the tax 
increases--and they were increases of up to 16 percent to 28 
percent, depending upon--that was just on the top tax rates. 
And the revenue that was generated from that was less than 1 
percent higher than the 1992 estimate.
    Now, when we get into the 2000 President's tax growth 
package earlier, the CBO had estimated that it was going to 
cost revenues to the Federal Government $27 billion. In 
reality, what it did, it increased revenues by $26 billion. 
There was a miscalculation of somewhere around $53 billion 
there.
    And when we look at--before I ask my question, and my 
question is going to be how can we improve the accuracy of 
revenues when we are talking about cutting tax policy, policy 
we retain of cutting taxes, particular economic growth taxes.
    By the way, on the chart of my good friend from North 
Dakota where he showed the economy coming down dramatically, 
revenues are up, we hadn't even applied the President's tax 
growth yet. We were still working under the policy of the 
previous administration, the Clinton administration. And so 
then when we see the Bush administration policy comes, we see 
the growth and what all of these charts here reflected.
    So, again, my question is: What is it that we can do to 
improve the accuracy of a tax cut's impact on the economy and 
revenues to the Federal Government?
    Mr. Marron. Again, I want to emphasize what I understand to 
be--as the new guy I may get this slightly wrong, but I want to 
emphasize my understanding of the roles and responsibilities. 
CBO is responsible for the baseline projection of revenues and 
spending. Among those would be capital gains. Our colleagues 
and friends at the Joint Committee on Taxation are responsible 
for the scoring of bills.
    And so to the extent that any of these issues arise with 
their scoring of the bills, I cannot speak to it directly.
    Senator Allard. I am not trying to--but you understand how 
they score bills, don't you?
    Mr. Marron. Yes, I understand why they do it.
    Senator Allard. What can we do to improve that, so we get a 
more accurate reflection of what is going to happen when you do 
things like cut capital gains?
    Mr. Marron. I have the standard economist answer, which is 
that one of the great challenges we face, particularly on 
capital gains, is how long is takes us to have data about what 
is happened recently. So if you think about it, capital gains 
often go to people with complicated tax returns. People with 
complicated tax returns often do not file until October of the 
year during which their taxes are due. It takes a while for the 
IRS to get the data together. And as a result, for people who 
are trying to study capital gains realizations and project them 
on behalf of the Congress we are actually operating--I forget 
the exact period. but we are operating with roughly a 2-year 
lag in which we are kind of guessing, to be honest. So it is 
hard to know exactly what is going on.
    I think unfortunately there is some irreducible uncertainty 
about capital gains realizations. They bounce around, for 
reasons that professional economists have not yet been able to 
fully ascertain.
    And then, perhaps to be more responsive to your question, I 
think it is always helpful and fruitful to revisit the 
techniques we use to forecast these things. And to the extent 
that there is room for improvement there--I cannot speak to it 
because I am not exactly sure how JCT does it, but to the 
extent that there is room for improvement----
    Senator Allard. I appreciate the last part of your 
response. I do think we need to look at it, and hopefully we 
can do something to make this more accurate.
    That is the whole point of my question. I think that, as 
policymakers, it serves us all if we can improve the accuracy 
so it truly reflects. It is a chronic problem with capital 
gains. Every time it is come through this Congress, it is 
been--revenues from reduction of capital gains has been badly 
underestimated. And I do think we need to look seriously at 
that.
    With your indulgence, and perhaps maybe the minority 
members' indulgence, I have another question on flood 
insurance. We are going to be increasing the debt limit on how 
much the National Flood Insurance Program can incur. I guess we 
do not know exactly where that number is going to be, but we 
are going to be increasing that up to $23 billion. In other 
words, they can incur these obligations on flood insurance up 
to that because of what is happened with Katrina.
    So you have this that is increasing. And then we have this 
other obligation of how we are going to pay for the current 
program, there is actually two aspects to it. And we have 
people that are exempted from having to pay flood insurance 
because they were there before the program was initiated.
    Do you have any ideas on how we can make this program more 
actuarially sound? And perhaps maybe you do not have any ideas 
but I think it would be helpful for those of us who happen to 
be on the Banking Committee to get some kind of written--me 
personally, I would be particularly interested in getting some 
kind of written response to that, what we can do to actuarially 
make our flood insurance program sustain itself without having 
to have a future obligation we are placing on it by increasing 
this debt limit, that we are looking at putting around probably 
somewhere around $23 billion.
    Mr. Marron. Sir, as you know, I had the opportunity to 
appear before the Banking Committee last week and talk a little 
bit about these issues. I would be happy to provide more detail 
on anything you have in mind.
    The key issue which you identify is there is a certain 
group of properties that are subsidized under the program. They 
pay premiums that are significantly less from what people 
believe would be actuarially fair, and particularly what FEMA 
estimates would be actuarially fair.
    To eliminate that by itself, the natural economist response 
would be to raise premiums, but that clearly raises issues 
about some of those people dropping their coverage and whether 
that is a desirable public policy outcome. Other ideas were 
brooded about at the hearing and we would be happy to followup 
with you.
    Senator Allard. I would appreciate taking a little time to 
discuss that with you.
    I thank the indulgence of the chairman and minority party.
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman. Thank you and 
welcome, Mr. Marron. It is good to see you, as a member of the 
Banking Committee as well, seeing you in front of both 
committees.
    Mr. Chairman, I feel like Yogi Berra when he said it is 
deja vu all over again. It seems that every year that I have 
been on the committee since 2001 we have heard about growing 
deficits. We have heard about what is happening in terms of the 
budget.
    When we look at the fact that now the projection from CBO, 
understanding that you have to project out with current 
policies, is going to be $1 trillion over the next 10 years for 
our children and our grandchildren. It is astounding.
    And when we figure in what Senator Conrad was talking 
about, with the costs of the war and Katrina and all of the 
other issues, we are talking more like $4 trillion, which is 
stunning when we look at these numbers.
    Mr. Chairman, we have a lot of work to do on this, as I 
know you know.
    I wanted to speak to the question of wages. We are always, 
I think, in a classic debate about supply and demand and where 
that balance is. I think some of my colleagues feel it should 
all be about supply side tax cuts, focusing on that. Others of 
us believing that it is about wages, money in people's pockets 
as well as being able to support investments and so on.
    And I certainly have to say that with my friend, Senator 
Allard, who just showed the charts on wealth, I assume that the 
only way we could get those kind of numbers would be to include 
equity in people's homes. Because certainly people are not 
feeling that somehow they are wealthier, certainly in my State, 
and in many other States across the country. They may have a 
home with more equity in it but they cannot sell the house. 
They have to live in the house. It does not pay the heating 
bill. It does not pay the gas bill. It does not send the kids 
to college.
    So where the rubber meets the road in Michigan it is a very 
different picture.
    But I wanted to just raise an interesting section on 121 of 
your report, just an interesting comment that I think is 
important to this debate. You talk about two of the most 
important types of income for projecting Federal revenue are 
wages and salaries and corporate profits. And you say wages and 
salaries are the most highly taxed component of income--wages 
and salaries--being subject to income tax and Social Security 
and Medicare and so on.
    And then you say consequently, CBO estimates that an 
additional dollar of corporate profits produces less revenue 
than an additional dollar of wages and salaries. Thus, higher 
projections for wages and salaries and correspondingly lower 
projections for profits result in higher projected budget 
received.
    And you go on to talk about that relationship to lowering 
the debt.
    I say that to followup on Senator Menendez's comment about 
valuing work. Valuing work. I mean, here we are talking about 
how the way that people are taxed the most in our country are 
through wages and salaries. Is the person working every day 
getting a paycheck? But then we go to this debate about capital 
gains possibly at the expense of the Alternative Minimum Tax 
hitting middle income people. And this seems to go certainly 
contrary to the picture of what is really happening if, in 
fact, the wages and salaries of Americans are the most highly 
taxed part of the revenue that is received for the Federal 
Government.
    And we are debating with the House of Representatives about 
whether 19 million people ought to get a tax increase right now 
because they bump up against the AMT ceiling versus giving 
another tax cut for people who earn their money off of 
investments.
    So I wonder if you might just speak for a moment about the 
importance of jobs or wages and salaries. I would argue that it 
is not only about revenue for the Federal Government, but that 
in my State, where we are losing jobs, we have lost one-third 
of our manufacturing jobs in the last 5 years, we are really 
fighting for our way of life in our country and it is about 
jobs.
    And we cannot just say this is about top down economics. It 
has to also be about somebody working, having wages, having 
money in their pocket to purchase things, to drive the economy 
as consumers.
    So I wonder if you might just speak--I guess I would not 
have a specific question for you other than to say that wages 
and salaries and people working are an important part of this 
equation; isn't that correct?
    Mr. Marron. Absolutely. Wages and salaries, clearly they 
are important for tax revenues. They are important for 
providing people with the money to live on and accomplish the 
things that they want to accomplish.
    I guess as an economist, the point I would emphasize is 
that the wages and salaries come from employers. And so you 
have to think about the balance of setting up an environment 
which makes employers as enthusiastic about hiring people as 
possible.
    From an individuals' point of view, a key determinant of 
how much you get paid obviously are your skill levels and your 
education. From the employer's point of view, the key 
determinant of how much they are willing to pay you is 
essentially how productive you can be for them. And over very 
long periods--not even very--over long periods what economists 
have found is that a key determinant of that is productivity 
growth. And then a key driver of productivity growth is capital 
accumulation.
    So that one channel actually for raising wages and salaries 
in the long run is to make sure that our companies invest, 
buildup capital, and therefore in the future are willing to pay 
high wages and salaries to their workers.
    I just want to emphasize lowering taxes for capital does 
not necessarily mean you are not helping workers.
    Senator Stabenow. I understand that. But doing that at the 
expense, as a tradeoff to lowering taxes on wages or salaries 
or doing other things such as lowering health care costs, 
protecting somebody's pension, lowering the cost to go to 
college, it all is a package. And we do not often enough, in my 
opinion, focus enough on that whole package.
    Let me just say, in conclusion, that in a global economy I 
think that debate changes from what you are saying. We have 
seen productivity go up and jobs go down and investments go 
overseas. The reality is in a global economy that our workers 
can and are more productive than they have ever been. But 
because of what is happening in the global economy, because we 
fund health care differently than any other country, because we 
do not enforce our trade laws on currency manipulation or 
counterfeit parts--and I will give you one example of $12 
billion counterfeit auto parts coming into this country. 
Illegal. Illegal. We have beefed up our laws, and yet we are 
doing nothing about it. And it is cost 200,000 jobs. People 
stealing our patents.
    I would just suggest that if we only say that this is about 
on the supply side, we have no guarantee that that capital is 
going to be in the United States unless we address the other 
pieces that unfortunately, because of the deficit right now and 
the tradeoffs that are being made, we are not addressing. We 
are not addressing. We would be a lot better off for jobs, that 
wages and salaries component that you are talking about for 
revenue for us, if we were to invest those dollars on the high-
end tax cuts back into paying for health care and helping 
manufacturers build to compete in the global economy to keep 
high wages here and invest in our people here at home.
    I would just say, Mr. Chairman, that I think part of all of 
this, as well, is when you talk about investing for the future 
and what employers want in a skilled work force, the $12 
billion we just cut in student loans goes contrary to anything 
that we ought to be doing, in my mind, to compete in the global 
economy.
    Thank you.
    Chairman Gregg. Thank you, Senator.
    I would point out that there was no reduction in student 
loans. In fact, what we did was reduce the rate of return, 
which was a windfall of significant proportions to the lenders. 
And then we took some of that money and we actually put it into 
expanding the benefits to students, through expanding the Pell 
grants. We took some of that money and moved it toward deficit 
reduction.
    Senator Stabenow. Mr. Chairman, if I might just insert one 
thing, and that is over $12 billion was shifted onto people who 
get student loans. We are already seeing a change in Michigan.
    Chairman Gregg. No, that is not true, Senator. As a 
practical matter, that is a representation that has been made 
that is totally inaccurate.
    The HELP Committee produced a bill which reduced the 
subsidy to the lender community, which if we had not done, 
quite honesty, would have dramatically--would have created a 
dramatic windfall to the lender community.
    We did keep a fixed loan rate, which was a mistake. We did 
not go to a variable loan rate, which would have benefited 
students.
    But I would point out that that was at the request of the 
Democratic side of the aisle. That those of us who wanted a 
variable rate, which would have allowed students to get a 
better deal even, were not able to get that through the 
Committee because of the opposition of Senator Kennedy.
    This representation that student loans have been cut is a 
canard.
    Senator Stabenow. I look forward to debating the results of 
the policy we passed, as it becomes apparent. Thank you.
    Chairman Gregg. So do I, because I think the numbers are 
pretty clear--
    Mr. Marron, the asbestos bill that is going to be coming to 
the floor, we have a reserve fund that this Committee put in 
place that is has some--that basically wants to keep this 
bill--is structured for the purpose of keeping the bill from 
costing the American taxpayer money. What is CBO's view of 
whether or not this bill is going to cost us money?
    Mr. Marron. The structure of the program, as I understand 
it, is to raise revenues in various ways and then to spin them 
out to beneficiaries who are stipulated under the bill 
language. The way that is going to be accounted for is that the 
money that comes into the fund are indeed treated as revenues 
to the Federal Government. And that, as a result, the money 
that goes out to pay claimants is treated as spending.
    So in an accounting sense, it is clearly going to be a 
spending and revenue program.
    If your question is how does--is your question how it 
operates over the long run and what its long-run prospects are?
    Chairman Gregg. My question is that if I am asked, as 
Chairman of the Budget Committee, whether or not the conditions 
of the reserve fund are met, which is that this will not be an 
obligation which falls onto the American taxpayer but will be 
paid for by the community which has agreed to absorb the 
responsibility, am I going to be able, as Chairman of this 
Committee, to say in good faith no, the American taxpayer will 
not have to pay the bill here.
    Mr. Marron. I think that--as written--the bill is intended 
to have a structure in which the administrator of the fund is 
supposed to stop paying claims if they believe that the claims 
will exceed the revenues that come into the program. And so, in 
principle, it is supposed to stop and not spend more money than 
it is going to receive.
    Whether that actually executes as written, I think will 
depend on kind of the discussions that happen at that point. 
That would be a projection of what policy changes might be in 
the future, but clearly we would understand that there is the 
possibility that there would be pressure to have the Federal 
Government step in.
    I am giving you an on the one hand/on the other hand 
answer.
    Chairman Gregg. It appears that way, yes. Unfortunately, 
whether I make a point of order is not an on the one hand/on 
the other hand issue.
    Senator Conrad. Can I make a point on this?
    Chairman Gregg. Yes, of course, jump in.
    Senator Conrad. If I could say, Mr. Chairman, my people 
have done a report that is now on my desk that I will be 
sharing with you hopefully later today. I have not had a chance 
to read it.
    I have asked for the conclusion--and this is with respect 
to the issue that you are raising. And my people have no ax to 
grind here. And they have reported to me that they believe, in 
nominal terms over the life of the program that this proposal 
is $150 billion underwater.
    Chairman Gregg. On top of the $150 billion that is----
    Senator Conrad. Yes. That the shortfall over the 50 year 
life is $150 billion. That is the nominal shortfall.
    Chairman Gregg. Let me see if I understand that. CBO has 
estimated--the general estimate is that this program is going 
to cost $140 billion?
    Senator Conrad. Correct.
    Chairman Gregg. So you are saying there is another $150 
billion on top of it?
    Senator Conrad. Correct. Over the life of the program, the 
net present value--net present value--shortfall is $50 billion.
    Mr. Marron, I think you have said on many occasions that 
the risks to this program all run toward the taxpayers--that 
they are heavily weighted in that direction. Is that not 
correct? CBO found that your estimates of the risks here run in 
the direction of taxpayers?
    Mr. Marron. We have our official numbers, official 
estimate. And then there were a variety of things that we were 
not able to price out and cost. Most of those seem to point 
toward higher costs than the range we have. There is at least 
one study that would be done that could point the other way. So 
there is some possibility of being lower.
    But again, we are in the business of scoring legislation as 
it is written. And as we understand as it is written, it is 
supposed to stop at $140 billion. But I am sympathetic to where 
you gentlemen are coming from, which is it is not entirely 
obvious that that would actually be what reality looks like.
    But from where we sit, I cannot say too much on that.
    Senator Conrad. I understand the strictures that you are 
under.
    I would just say to my colleague I asked this question of 
my staff, professional staff. They spent a lot of time 
analyzing this. They came back to me and they said they think 
this is way underwater.
    As I have looked at their work, and I have not read the 
whole analysis that they have just put on my desk I think 
yesterday or the day before, it really is striking. It really 
is striking.
    The assumption that the fund is ever going to stop, I think 
we have to do a reality check here. Is there any prospect, once 
this thing gets going, that it is going to be stopped? I think 
that is just--I know that you have to assume that it does stop. 
But the reality, all of us who are here, I think we all know 
what is going to happen. They are not going to stop.
    Chairman Gregg. Senator Stabenow, do you want to--I know 
this is an issue for your state.
    Senator Stabenow. It is. In an ideal world--yes, thank you.
    I am very concerned about the numbers, Mr. Chairman, as I 
mentioned to you. In an ideal world, this is an issue for us 
and our manufactures and I would like to see a trust fund that 
works. But there are a lot of issues that have been raised and 
the budget numbers are of concern to me. And so I am anxious to 
look at what Senator Conrad has been talking about before 
making a final decision myself.
    Chairman Gregg. We look forward to getting this information 
from you and your staff.
    On another question, to what extent are you factoring in 
oil costs? It appears we are in a world where $60 a barrel is, 
for the foreseeable future, the number, maybe even higher 
depending on demand coming out of Asia and what happens in 
places that are fairly unstable like Nigeria and Venezuela and, 
of course, the Arab nations such as Iraq and Iran.
    Mr. Marron. Our economic projection is built off of 
substantially higher oil prices than we have ever had before in 
one of our projections. It starts off in the neighborhood of 
the high 50's. I remember we locked down our economic forecast 
a bit over a month ago. Essentially it has prices at that level 
and then rising with inflation in the later years of the 
forecast. So we definitely have what traditionally has been 
viewed as high oil prices.
    In the intervening month, oil prices have gone up even 
further, and it is something clearly that we are keeping an eye 
on to see to what extent that may have some dampening effect on 
the economy.
    Chairman Gregg. As you know, one of the amazing things 
about the American economy and the American people are that we 
react and we are flexible. How do you factor this in to out-
year productivity, which is clearly going to have an impact? Do 
you presume we will innovate out of this? Or do you presume 
that you just pick a static number and go forward?
    Mr. Marron. This is not something that we factor in, in an 
incredibly detailed level, into the projections that we make. 
As you say, the economy has been very resilient and flexible in 
the past. It is absorbed various shocks in various areas. In 
terms of projecting longer run productivity growth, we 
essentially look at a snapshot of recent history and use that 
as our projection of what will happen in the future.
    Chairman Gregg. I do think this is a huge issue for us, 
because I do not think we have had this type of shock to our 
economy in a long time. I think we are just beginning to have 
the impact of it felt. Hopefully, we can innovate our way out, 
or at least through policy drive other sources of production.
    But in any event, it looks like this price for production, 
whether it comes from ethanol or whether it comes from some 
other nuclear--it still looks like the price is going to--we 
are going to have a new base on an economy that was built on 
$11 to $15 per barrel of oil, and it is got a base of $60 a 
barrel, and that changes a lot of things in an economy. And the 
changes will not be immediate maybe, but they will certainly 
have an impact over the long run, I would think, on 
productivity and on the development of wealth, the development 
of capital.
    I would be interested if you could have some of your 
thinkers take a look at that beyond the static approach and 
give us your reaction. If we are going to go out--and even if 
it is not oil--whatever it is. If we are going to pay for that 
unit of energy $60, what $60 translates into, whether it comes 
from some other source or not, as versus what has historically 
been probably $15. What is that sort of a quadrupling of the 
cost of that unit of energy do to our economy over the long 
run? And how--well, you do not answer this, this is our job. 
But when we have that number, how should we try to address it?
    Mr. Marron. I would be happy to.
    Chairman Gregg. Thank you. Senator Conrad.
    Senator Conrad. Mr. Chairman, let me just go back. My 
colleague from Colorado made a number of characterizations of 
charts that I put up. He said that with respect to revenue and 
the drop in revenue compared to where we were, that that 
happened before President Bush's policies took hold. That is 
just not the case. That is just factually not the case.

[GRAPHIC] [TIFF OMITTED] T6726.004


    In 2000 we had over $2 trillion of revenue. In 2001, the 
first year of the President's administration, we had almost $2 
trillion. In 2002, after the big tax cuts of 2001, revenue was 
down.
    More tax cuts in 2002. In 2003 revenues are down more.
    Then we had an uptick in 2004 but still way below where we 
were back in 2000. Much less revenue.
    Only now, 5 years later, are we back--and this is in dollar 
terms. If you look at this with inflation taken out, we have 
still not recovered.
    Now we are in the fifth year of the presidency. To say that 
his policies have not taken hold, I do not think it is 
factually correct.
    The Senator from Colorado talked about how good the economy 
has been. Let us look at a number of measures here. This is 
what has happened to real median household income. It has 
declined for four straight years. We believe the 2005 numbers 
will show a further decline. This is inflation adjusted 
household income. It has gone down every year. That is not the 
sign of a good economy.

[GRAPHIC] [TIFF OMITTED] T6726.009


    Let us compare what has happened in this economic recovery 
to the other major recoveries that have occurred since World 
War II. There have been nine business cycles, major recessions, 
since World War II. The red dotted line is what has happened to 
GDP growth coming out of those recessions. The black line is 
what has happened in this recovery. It is 25 percent weaker 
than the average of all of the other recovery since World War 
II. That is GDP growth.

[GRAPHIC] [TIFF OMITTED] T6726.010


    Let us look at business investment. Business investment is 
even worse. Again, the dotted red line is what we have seen in 
each of the other recoveries since World War II, the average. 
The black line is what we are seeing in business investment in 
this recovery. It is 50 percent lower than the average of all 
other recoveries since World War II.

[GRAPHIC] [TIFF OMITTED] T6726.011


    Job loss recovery. Again, the red dotted line is the 
average of all the recoveries, the major recoveries, since 
World War II. The black line is what we are getting in this 
recovery. We are 6.9 million private sector jobs short of the 
typical recovery.

[GRAPHIC] [TIFF OMITTED] T6726.012


    Something is wrong here. Something is wrong here. Something 
has fundamentally changed. I would argue it is what is 
happening with international competition.
    The result is, what the Senator did not want to talk about, 
is what has happened to the debt. The debt has skyrocketed. And 
the external debt of the United States has more than doubled. 
It took 224 years and 42 presidents to run up a trillion 
dollars of external debt. This president has doubled it in 5 
years, more than doubled it.

[GRAPHIC] [TIFF OMITTED] T6726.013


    Let me just show, finally, the other thing he did not want 
to talk about is what has happened to the debt. In 1998 to 
2001, we did not add any publicy-held debt in this country. Nor 
did we increase the debt limit. In fact, we were paying down 
debt.

[GRAPHIC] [TIFF OMITTED] T6726.014


    In 2002, we had to add $450 billion to the debt limit. In 
2003, $984 billion was added to the debt limit. In 2004, $800 
billion. Now in 2006 they want to add another almost $800 
billion.
    So, unfortunately, an awful lot of what is going on here is 
being put on the charge card and increasingly it is a charge 
card that is owed to foreigners.
    I would just ask, Mr. Marron, do you believe it is 
sustainable--sustainable to have this growth of debt held by 
foreign entities? We had 100 percent increase, more than 100 
percent, in 5 years.
    Mr. Marron. If I think about it in terms of the current 
account deficit and what would be sustainable on that front, 
which essentially translates into the debt as it builds, our 
analysis suggests that if the current account deficit were to 
hold at its current level in nominal dollar terms, and 
therefore decline over time as a share of the economy, that 
would probably return back to a sustainable level. But if it 
stays the same, relative to the size of the economy, over time 
that would be extremely difficult to sustain.
    Senator Conrad. I deeply believe that the combination of 
our trade deficit and our budget deficits, especially in light 
of the demographic time bomb that is coming at us, this is 
utterly unsustainable.
    I would just ask you, on the question of budget policy, do 
you believe, Mr. Director, that there is an imperative for us 
to act on these long-term imbalances in our budget accounts?
    Mr. Marron. Sir, the long-term situation would seem to be 
unsustainable, and I think I am well within the range of what 
CBO Directors and Acting Directors are allowed to do if I were 
to say that addressing those earlier rather than later is 
probably helpful for everyone involved.
    Senator Conrad. I know the Chairman believes that. I 
certainly believe it. The quicker we get at this, the better. 
And I hope that is the conclusion that comes from this hearing.
    Chairman Gregg. Thank you.
    I also think that is the conclusion that comes from this 
hearing, so that is a good place to stop.
    We appreciate your testimony and we thank you for your time 
and for your professionalism and the professionalism of your 
organization. It is very important to us as a Congress to have 
a fair arbiter out there, and you are it.
    Thank you.
    Mr. Marron. Thank you.
    [The prepared statement of Mr. Marron follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.025
    

    [GRAPHIC] [TIFF OMITTED] T6726.026
    

    [GRAPHIC] [TIFF OMITTED] T6726.027
    

    [GRAPHIC] [TIFF OMITTED] T6726.028
    

    [GRAPHIC] [TIFF OMITTED] T6726.029
    

    [GRAPHIC] [TIFF OMITTED] T6726.030
    

    [GRAPHIC] [TIFF OMITTED] T6726.031
    

    Senator Conrad. You have done a very good job.
    Chairman Gregg. The hearing is adjourned.
    [Whereupon, at 11:33 a.m., the committee was adjourned.]

                 PREPARED STATEMENTS SUBMITTED

[GRAPHIC] [TIFF OMITTED] T6726.032




            THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL

                              ----------                              


                       TUESDAY, FEBRUARY 7, 2006

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 3:03 p.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Domenici, Allard, Bunning, Cornyn, 
Alexander, Conrad, Murray, Wyden, Johnson, Byrd, Nelson, 
Stabenow, and Menendez.
    Staff present: Scott B. Gudes, Majority Staff Director and 
Dave Pappone, professional staff member.
    Mary Ann Naylor, Staff Director and John Righter, deputy 
staff director & commerce and housing credit.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will begin the hearing, and we certainly 
appreciate the Director of the Office of Management and Budget, 
Josh Bolten, being here today, someone whom I have great 
simpatico for because I think he is the only person in the city 
who upsets more people than I do just by showing up. Well, 
actually, Senator Bunning actually beats us both.
    [Laughter.]
    Chairman Gregg. Director Bolten has a very difficult job in 
a very complex and challenging time, which is putting together 
the budget of the United States. It is always hard to believe 
that a budget that spends $2.7 trillion is attacked for not 
spending enough. And yet that happens. And it is a complex 
budget in that it addresses today's problems, but it also has 
to address next year's problems and the year's after that.
    I want to thank the Director, speaking on behalf of the 
President--not me, but the Director representing the President, 
for having put in play what I consider to be the biggest public 
policy issue which we have as a Nation beyond the question of 
fighting terrorism, and that is the issue of how we deal with 
the retirement of the baby-boom generation, which we know is 
going to cost us an extraordinary amount of money as a Nation 
because the size of the generation is so huge, and the effects 
of that generation's demand on their children and their 
children's children relative to services for their retirement 
in the area of pensions and health care is going to overwhelm 
us.
    The estimates from the Comptroller's office, which is a 
fair arbiter on this issue, is that the unfunded liability of 
Medicare, Medicaid, and Social Security exceeds $47 trillion. 
That is over the actuarial life of those programs, 75 years. 
That is a hard number to comprehend, $47 trillion, but to try 
to put it in context, all the taxes raised in the United States 
since the beginning of our Government represent less than $47 
trillion. The entire net worth of this country--everybody's 
car, house, stock, assets--is only $43 trillion, I believe. So 
we actually have on the books a debt that exceeds our net worth 
as a Nation. And it is not going down.
    Last year, we put our toe in the water on this issue with a 
reconciliation bill which for the first time started to address 
mandated costs, which are health care and pensions. That 
passed, after a long, tortuous route, just a week or so ago, 
$40 billion over the next 5 years, a reduction in the rate of 
growth of the Government.
    It had in it good policy, especially on the issue of 
Medicaid. This committee does not have any jurisdiction over 
Social Security by law. But we do have jurisdiction over the 
issues of health care, and so I respect and thank the 
administration for being willing to step forward on the issue 
of Medicare this year. Last year, there was some reticence to 
do that. This year, the budget addresses it, using what I think 
are fairly reasonable proposals, especially in the context of 
the overall Medicare spending. You are asking for, I think, $35 
billion in a slowing of the rate of growth of Medicare. That 
means Medicare, instead of growing at 8.1 percent every year 
for the next 5 years, will grow at about 7.7 percent. And those 
reductions in the rate of growth are, as I understand it, a 
function of proposals that came forward from a bipartisan 
health care policy group, MedPAC, which is a highly respected 
organization and which should be listened to.
    So I respect the administration's proposals there. I also 
respect the fact the administration understands that we are 
fighting a war and we have to do whatever is necessary to give 
our troops the support to accomplish that effort.
    So we have a budget before us that obviously none of us 
really like in concept, but, in fact, it is something that we 
have to go forward with. We would rather not have a deficit 
projection of over $400 billion, but we understand, in light of 
what happened in Katrina and in light of the war we are 
fighting for our own survival as a Nation, that there are 
expenses we have to incur.
    But we also have a budget that at least sets us on a policy 
road to try and address what I consider to be our biggest 
public policy issue, which is the question of how we deal with 
the responsibility of paying for the next generation that is 
about to retire, the baby-boom generation.
    So I congratulate you for that, and I thank you for being 
willing to take the time to appear before this committee, and I 
will turn to the Senator from North Dakota for his thoughts, 
and an occasional chart, I am sure.
    [Laughter.]
    Chairman Gregg. Then we will hear from the Director.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. First of all, thank you, Mr. Chairman. 
Thank you for calling this hearing. Thank you, Mr. Director, 
for being here. It is always good to see you, and I enjoyed our 
visit the other day as well.
    I think you know pretty much my criticism of the budget is 
that it is really not coping or facing up to the fiscal 
imbalances that we face as a Nation. In fact, I think the 
President is doing an enormous disservice to the country by not 
putting before the American people how serious these long-term 
challenges really are.
    Let me just point out that these are the things left out of 
the President's budget. He does not have full 10-year numbers. 
He does not have Iraq war costs beyond 2007. He does not have 
the cost of fixing the alternative minimum tax. And he does not 
have spending policy details beyond fiscal year 2007, something 
that has typically been provided.

[GRAPHIC] [TIFF OMITTED] T6726.182


    Let's go to the next slide, if we could.
    The long-term war costs are substantially underfunded. The 
President has $120 billion in 2006 and 2007. The Congressional 
Budget Office says the additional outlays that are necessary 
are almost $300 billion.

[GRAPHIC] [TIFF OMITTED] T6726.183


    Let's go to the next.
    Probably the area that the President is, I think, doing the 
poorest job in alerting the American people as to the full 
costs of his proposal is in the area of extending his tax cuts 
and the other tax cut proposals that he has made. This dotted 
line is the 5 years of the budget. You can see the President's 
tax cut proposals explode beyond the 5-year budget window, and 
this pattern is very consistent, whether it is war costs or the 
tax cut or--let's go to the next slide--the alternative 
minimum--the cost of reforming the alternative minimum tax, the 
old millionaires' tax, it is now rapidly becoming a middle-
class tax trap. The President has no funding for AMT reform 
beyond fiscal year 2006. So he is not facing up to any of this 
cost. It is $1 trillion with debt service, 10-year cost. It is 
not in the President's budget. That is not a real budget.

[GRAPHIC] [TIFF OMITTED] T6726.184


[GRAPHIC] [TIFF OMITTED] T6726.185


    Let's go to the next.
    The President says, well, don't worry, we are going to cut 
the deficit in half over the next 5 years. That is this 
projection. But when you add back the things he has left out--
the full costs of the war, the need to fix the alternative 
minimum tax, the full cost of his tax cuts--this is the pattern 
that we see. And the deficit gets a little bit better between 
now and 5 years from now, but then it falls off the cliff.

[GRAPHIC] [TIFF OMITTED] T6726.186


    Let's go to the next.
    This is what the President said in 2001: ``My budget pays 
down a record amount of national debt. We will pay off $2 
trillion over the next decade. That will be the largest debt 
reduction of any country ever.''
    Then he said something I agree with very strongly: ``Future 
generations should not be forced to pay back money that we have 
borrowed. We owe this kind of responsibility to our children 
and grandchildren.'' The words were good. The performance has 
not been good.

[GRAPHIC] [TIFF OMITTED] T6726.187


    This is my final point. This is what has happened since the 
President took office on the debt. There is no paydown of debt 
going on here. The debt is exploding. At the end of his first 
year in office, the debt was $5.8 trillion. That has gone up. 
At the end of this year it will be $8.6 trillion, and our 
projections now say in the next 5 years, if the President's 
policies are followed, the debt will reach $12 trillion--a 
doubling of the national debt--a doubling--before the baby 
boomers retire. That to me is a course that just is not 
sustainable, and it should not be supported.

[GRAPHIC] [TIFF OMITTED] T6726.181


    I thank the Chair.
    Chairman Gregg. Thank you, Senator Conrad.
    We would like to hear from the Director now. Give us your 
thoughts, and then we will ask you some questions.

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

    Mr. Bolten. Mr. Chairman, Mr. Conrad, other distinguished 
members of the committee, the President's 2007 budget, which I 
transmitted to the Congress on the President's behalf on 
Monday, meets the priorities of the Nation and builds on the 
progress of the last 5 years.
    Before getting to the 2007 budget, I would like to take a 
moment to review the substantial accomplishments in spending 
restraint we were able to achieve together over the past year. 
We have put up on the screens for you, Mr. Chairman--and I 
thank you for the technology.
    Chairman Gregg. This is a very high-tech committee.
    Mr. Bolten. It is indeed, sir.

    [GRAPHIC] [TIFF OMITTED] T6726.188
    

    Last year's budget, the 2006 budget of the President's, had 
four major objectives:
    First, the President proposed to hold growth in overall 
discretionary spending below the rate of inflation.
    Second, he proposed an actual cut in the non-security 
portion of discretionary spending, the first such proposal 
since the Reagan administration.
    Third, he proposed major reductions or eliminations in 154 
Government programs that were not getting results or not 
fulfilling essential priorities.
    And, fourth, he proposed reforms in mandatory programs to 
produce $54 billion in savings over 5 years.
    The Congress substantially delivered on all four of these 
objectives, as the chart on your screen shows in the second 
column. I would like to thank you, Mr. Chairman, in particular, 
and the members of this committee for your leadership and 
dedication in helping achieve those goals that are reflected in 
the second column on the chart on the screen.
    When President Bush gave me guidance on what the 2007 
budget should look like, he directed me to build on last year's 
progress by focusing on national priorities and tightening our 
belt elsewhere. He told me to give our troops and those who 
defend our security what they need to fight and win the global 
war on terror. And he emphasized that the 2007 budget must 
support our pro-growth economic agenda.
    In particular, he said we should maintain our economic 
strength by extending the tax relief that has fueled our 
economic expansion and by aggressively restraining spending. 
Yesterday, I presented on the President's behalf a budget that 
does just that.
    In the past 5 years, our economy suffered a historic series 
of shocks, starting with the recession and the terror attacks 
of 2001 and continuing through the hurricanes of last summer. 
Those events had profound impacts on job creation and on the 
fiscal outlook.
    Despite these challenges, thanks to the productivity and 
hard work of the American people, our economy, as the chart on 
the screen now shows, is expanding at a healthy pace. In 2005, 
the economy grew by an estimated 3.5 percent--the third 
consecutive year of healthy growth. And as you can see on the 
chart, we project ongoing economic strength for the next 
several years. Economic expansion has produced more than 4.7 
million new jobs since May 2003, reduced the unemployment rate 
to 4.7 percent, and raised homeownership to all-time highs.

[GRAPHIC] [TIFF OMITTED] T6726.189


    This economic growth would not have been possible without 
the tax relief that you in the Congress passed and the 
President signed. The tax cuts--which were fully implemented in 
May 2003--have been critical to helping the economy recover 
from the recession and terrorist attacks of 2001--and then 
helping the economy to continue expanding despite the 
hurricanes and high energy prices of the past year.
    With the tax cuts fully implemented in 2003, the economy 
responded strongly and tax receipts rebounded. As you can see 
on this chart, receipts grew substantially in 2004. What that 
reflects is 5.5 percent growth between 2003 and 2004. In 2005, 
receipts jumped by a remarkable $274 billion, or 14.5 percent, 
the largest increase in 24 years. These recent gains in 
receipts confirm that a strong economy is the most important 
factor in reducing the deficit.

[GRAPHIC] [TIFF OMITTED] T6726.190


[GRAPHIC] [TIFF OMITTED] T6726.191


    The chart on the screen now shows our progress in bringing 
down the deficit. Since the President set a goal of cutting the 
deficit in half from its projected peak in 2004 of 4.5 percent 
of GDP, the deficit has come down markedly. The final 2004 
deficit was 3.6 percent of GDP, and fueled by the surge in 
receipts I just mentioned, the 2005 deficit fell further to 2.6 
percent of GDP.
    Although revenues are projected to continue to rise in 
2006, the deficit for the current fiscal year is now projected 
to come in at 3.2 percent of GDP, or in nominal terms, $423 
billion, which is more than previously expected. This is in 
significant part due to the unanticipated spending associated 
with the relief and recovery efforts from Hurricanes Katrina 
and Rita. While this increase in the deficit is unwelcome, at 
3.2 percent of GDP that projected deficit would be well within 
the historical range and smaller than the deficit in 11 of the 
last 25 years.
    More importantly, we project that if the policies in the 
President's budget are adopted, the deficit will return to its 
downward trajectory. We forecast a decline in the 2007 deficit 
to 2.6 percent of GDP. By 2009, the deficit is projected to be 
cut by more than half from its projected peak to just 1.4 
percent of GDP, well below the 40-year historical average of 
2.3 percent of GDP.
    In order to keep the deficit on this declining path, we 
must continue to do two things: first, keep the economy 
growing; and, second, restrain spending.
    First, the 2007 budget supports continued economic growth 
by proposing to make permanent the tax relief signed into law 
by the President in 2001 and 2003. Some have argued that we 
should let the tax relief expire. A tax increase is the wrong 
prescription, not only for the Nation's economic health, but 
for the Treasury's fiscal health as well.
    We are not an undertaxed society. By rejecting tax 
increases on families and small businesses, this budget will 
help keep the economy on a continuing course of job creation 
and strengthen the foundations for long-term growth.
    The second critical component of deficit reduction is a 
vigorous policy of spending restraint. Similar to last year, 
the 2007 budget again holds overall discretionary spending 
growth below the rate of inflation. That is reflected in the 
last column on the chart on the screen now. It again proposes a 
cut in non-security discretionary spending. It calls for major 
reductions in or total eliminations of 141 Federal programs, 
saving nearly $15 billion. And it continues our efforts to slow 
the growth in spending on mandatory programs, by proposing $65 
billion in savings over 5 years.

[GRAPHIC] [TIFF OMITTED] T6726.192


    These efforts to restrain the growth in mandatory spending 
are vital--not just for our near-term deficit reduction 
efforts, but especially for the long term. The chart on the 
screen now displays our long-term situation. Toward the end of 
the next decade, deficits stemming largely from entitlement 
programs such as Social Security and Medicare will begin to 
rise indefinitely. No plausible amount of spending cuts in 
discretionary programs or tax increases could possibly solve 
this problem.

[GRAPHIC] [TIFF OMITTED] T6726.193


    The President has shown a willingness to take on these 
future unfunded obligations and to propose long-term reforms. 
This year's budget proposes $36 billion in savings from 
Medicare and includes proposals that pave the way for 
additional reforms in the future. As with Social Security and 
Medicaid, we do not need to cut Medicare, but we do need to 
slow its growth. And this budget beings to do just that.
    In addition, the 2007 budget contains proposals to 
significantly improve the budgetary process. The budget 
proposes discretionary spending caps as well as restraints on 
new mandatory spending. The administration is also pleased that 
the congressional leadership is focused on the need for reform 
of earmarks in the budget process. One way we can address the 
excessive use of earmarks together is by Congress giving the 
President the line-item veto.
    The 2007 budget, Mr. Chairman, also continues our efforts 
to improve performance and make sure the taxpayers get the most 
for their money. Using the President's Management Agenda, OMB 
measures success not by good intentions or by dollars spent 
but, rather, by results achieved.
    As part of these efforts, OMB introduced just yesterday a 
new website called ExpectMore.gov. ExpectMore.gov allows 
taxpayers to review the OMB assessments of nearly 800 Federal 
programs. You can search the programs by rating, topic, or by a 
simple keyword. I urge you and your staffs to make use of this 
new resource.
    This management agenda, coupled with the restraint 
reflected in the President's 2007 budget, will help ensure that 
taxpayer dollars continue to be spent wisely, or not at all.
    Mr. Chairman, I would be happy to take your questions.
    Chairman Gregg. Thank you. Could you leave that chart up, 
that last chart you had, present trends are not sustainable?
    Picking up on that point, if you look at this chart--and 
your black line is historic revenues, obviously.
    Mr. Bolten. Yes. Historic revenues are about 18.2 percent 
of GDP.
    Chairman Gregg. It is fairly obvious that at some point in 
the not too distant future--within all of our lifetimes in this 
room, theoretically--we are going to have a cost of Government 
as a result of mandatory spending that exceeds the historic 
revenues of tax revenues, correct?
    Mr. Bolten. Correct. At some point, and on this chart----
    Chairman Gregg. About 2035.
    Mr. Bolten. About 2035, we would need to spend all of our 
revenues just to pay for the mandatory programs with money left 
for nothing else.
    Chairman Gregg. And that would mean we would have no money 
left for national defense, for building roads, for 
environmental protection, for education.
    Mr. Bolten. Correct.
    Chairman Gregg. Because those are mandatory programs. And 
so the way out of that is either, one, to raise the historic 
revenue obligation of people, which would mean dramatically 
increasing taxes on our children and grandchildren, right?
    Mr. Bolten. I suppose, although I don't think there is any 
precedent in history for tax rates at the level that would be 
necessary to actually close the gap.
    Chairman Gregg. So you essentially cannot tax your way out 
of this.
    Mr. Bolten. I do not believe so, and the damage to the 
economy would be enormous and would probably affect revenues in 
the long run.
    Chairman Gregg. So the way you need to address this is by 
reforming the programs that are going to basically drive this 
issue, which is the major entitlement programs of Social 
Security, Medicare, and Medicaid.
    Mr. Bolten. Absolutely, Mr. Chairman.
    Chairman Gregg. And your budget really does not do a whole 
lot in this area, but it does more than anybody else has 
attempted to do, so I congratulate you for that, which is $35 
billion in the Medicare accounts.
    Can you explain to us what the policy is behind that 
proposal, where it came from and why you think it is reasonable 
to make that type of change and what the base is? In other 
words, that $35 billion over 5 years compares to total Medicare 
spending of how much over 5 years?
    Mr. Bolten. I don't recall the total Medicare spending. One 
of my colleagues may be able to give that to us. But on the 10-
year window that we looked at, if the President's Medicare 
proposals were adopted, the rate of annual growth in Medicare 
spending would decline over the next 10 years from about 7.8 
percent per year to about 7.5 percent per year. So it is a 
relatively modest decrease in a very rapidly growing program.
    Most of the savings in the $36 billion that the 
administration has proposed--and that is a 5-year number, the 
$36 billion savings is.
    Chairman Gregg. So it works out to about $7 billion a year.
    Mr. Bolten. Roughly, over the 5 years, although it expands 
in the later years.
    Chairman Gregg. Right.
    Mr. Bolten. Most of the 5 year savings, that we would 
achieve in our proposals would come from a very modest 
reduction in the market basket by which the Medicare providers 
are given their annual update. The proposals that we carry in 
the reduction in the market basket were recommended by or build 
upon the themes of the independent MedPAC Commission, which, as 
you know, Mr. Chairman, is an independent Commission that is 
appointed by the Comptroller General of the United States and 
makes its own recommendations. The kinds of savings we are 
proposing----
    Chairman Gregg. On MedPAC, I think it is important to 
understand who the MedPAC group is, because this is where the 
essence of your proposal comes from. They are health care 
professionals and policy professionals. They are not in any way 
partisan. Is that correct?
    Mr. Bolten. No, and they have no connection to the 
executive branch that I am aware of.
    There are several other proposals within the Medicare $36 
billion that we have on the table. For example, we are 
proposing that clinical laboratory services be handed out on a 
competitive basis, which is not required to happen now. Most of 
those are relatively small in comparison to the market basket 
changes we are talking about.
    I should emphasize, in closing my response on this point, 
Mr. Chairman, that your initial point is just right. This is 
just a downpayment on the broader reform that needs to be 
undertaken in Medicare. This is a modest first step that I hope 
we can all agree on and then come together on more fundamental 
reform that is needed to really change the trajectory of that 
first chart you asked me to put back up.
    Chairman Gregg. Well, I think that is important to 
understand, and I think that chart there--for anybody who is 
involved in public policy and has an obligation to the next 
generation--and it is really our generation that has created 
the problem, the baby-boom generation. That chart there is a 
stunning statement of what we need to confront. And if we leave 
this job of public policy without having confronted that, we 
won't have done our job but, more importantly, we will have 
given our kids a very difficult hand to deal with in their 
future.
    At this point I yield to the Senator from North Dakota.
    Senator Conrad. Let me just that this is the point on which 
we agree. I agree with the chairman completely in terms of we 
are on a course that is not sustainable, and my deep regret is 
I think the President's budget does nothing to get us on a more 
sustainable course. In fact, as I examine the President's 
budget, I think he makes the situation a whole lot worse when 
you put in the things he has left out.
    Let me ask you this: What was the gross debt of the United 
States when the administration came into office?
    Mr. Bolten. I believe you had the figure on your chart, Mr. 
Conrad.
    Senator Conrad. Would you agree with that figure?
    Mr. Bolten. I don't have any basis to disagree with it. I 
always enjoy your charts.
    Senator Conrad. The debt was $5.8 trillion at the end of 
his first year. I do not hold him responsible, obviously, for 
the first year because other policies were in place. But since 
that time, he said we were going to have maximum paydown of the 
debt, but here is what has actually happened. Year over year, 
the debt just goes up, up, and up. And at the end of this year, 
can you tell us what you think the debt will be at the end of 
this year?
    Mr. Bolten. I don't have any reason to disagree with what 
is on your chart, Mr. Conrad.
    Senator Conrad. $8.6 trillion. We are just under $8.2 
trillion today and headed for $8.6 trillion at the end of this 
year. That is the projection. Maybe actually somewhat more than 
that.
    What is your projection for 2011?
    Mr. Bolten. $11.5 trillion is the projection we hold.
    Senator Conrad. We actually see the debt somewhat more than 
you are projecting by 2011. We think it is going to be $12 
trillion.
    But let's take your projection. The debt of the country 
will more than have doubled during this administration. In 
other words, it took 224 years to run up over $5 trillion of 
debt, and in the next 10 years--the 8 years of this 
administration included in that 10 years--the debt will more 
than double. Isn't that right?
    Mr. Bolten. When you combine the debt held by Government 
accounts and publicly held debt, yes.
    Senator Conrad. Well, to me that is----
    Chairman Gregg. Are you giving us a couple extra years in 
this administration, to 2011?
    [Laughter.]
    Senator Conrad. No, but, you know, this is their 5-year 
budget. It is not anybody else's. It is theirs. They are 
putting us on a course to run up the debt in this way.
    To me, it is just a failing grade. It is a failing grade. 
This administration proposes more spending and more tax cuts 
when we cannot pay our bills already. And the result is the 
debt is jumping very dramatically. This is what the debt is 
doing. Let's show that other chart.
    Increasingly, this debt is being bought by foreigners. When 
we hold a bond auction, increasingly the debt is being bought 
by these countries: Japan, now over $680 billion; China, over 
$250 billion. Have we got that other chart that shows how the 
debt is--yes, that one right there.
    This is debt held abroad. It took 224 years and 42 
Presidents to run up $1 trillion of debt held by foreigners. 
This President has more than doubled it in 5 years.
    Mr. Director, in your judgment, is this a sustainable 
pattern?
    Mr. Bolten. No, absolutely not, Mr. Conrad, and I am glad 
you are focusing on debt, on the long-term debt situation, 
because that is where our problem is. But the problem is not 
one of discretionary spending accounts. It is not one of being 
undertaxed. The problem and the reason why we have this 
exploding debt situation going out indefinitely into the future 
is a problem of the entitlement programs that I have been just 
been addressing with the chairman.
    Now, the President has put on the table measures to address 
the fundamental problems in our entitlements. He put on the 
table last year fundamental Social Security reform. We didn't 
get very far with it, but as the President said in his State of 
the Union, this problem is not going away, and the President 
is----
    Senator Conrad. Well, let me just ask you, on that 
proposal, did that increase the debt or reduce the debt?
    Mr. Bolten. Over the long term, that proposal would have 
put Social Security on an entirely sustainable basis.
    Senator Conrad. Well, you are talking a long term in which 
everybody is dead. In the foreseeable future, what that 
proposal did was add another $800 or $900 billion to the debt 
because it doesn't--you know, the President, he has a bad habit 
here. This administration has a bad habit. Every question, the 
answer is to borrow money. We are going to have tax cuts? We 
are borrowing the money from China and Japan to give tax cuts 
here. You need more money for defense? We borrow money from 
China and Japan.
    I tell you, that to me is not a way to strengthen the 
country. And when we talk about it is all on the spending side 
of the equation, that is not what the evidence reveals. This is 
going back to 1980. The red line is the spending line. The 
green line is the revenue line. The red line was coming down 
each and every year until this administration. Under this 
administration's watch, spending has jumped.
    On the revenue side of the equation, the revenue was going 
up until this administration, and the revenue side of the 
equation has collapsed. The result is massive deficits. This 
gap represents the difference between what we are spending and 
what we are raising. And under this administration, you keep 
spending more, but you are not raising the money to pay for the 
spending.
    Let me just conclude on this thought: instead of raising 
taxes as the first notion of how to get additional revenue, I 
wish we were more aggressively going after this tax gap, the 
difference between what is owed and what is being paid.
    Could you tell us, how big is that tax gap now a year in 
your estimate?
    Mr. Bolten. Mr. Conrad, you will be more familiar with the 
estimates than I because you follow them very closely. I know 
Commissioner Everson has presented some estimates that run into 
the hundreds of billions of dollars of money that we should be 
collecting in revenues and are not. We are making strenuous 
efforts to try to close that gap. We have put proposals into 
our budgets in the last several years to improve enforcement. A 
lot of it means, though, going after a fairly heavy dose of 
fraud that is going on in the Medicare and the Medicaid 
programs, in the earned income tax credit. We do need to dig in 
on all of those measures, and I am very encouraged by your 
interest in closing that gap because the administration shares 
that interest completely.
    Senator Conrad. Let me just say that the proposal from the 
administration is to collect about one in every 1,000 of those 
dollars. We have to do better than that.
    I thank the chairman.
    Chairman Gregg. Thank you.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. First of all, I 
would like to put a statement into the record.
    Chairman Gregg. Of course.
    [The prepared statement of Senator Bunning follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.037
    

    Senator Bunning. Josh, as released yesterday, in the budget 
for international affairs, the West Bank and Gaza are slated to 
receive $150 million. Is this funding going to be reviewed by 
the administration in light of the Hamas win in the recent 
Palestinian legislative council elections?
    Mr. Bolten. Yes, Senator. The budget was put to print 
before the elections were held. We are going to put a pause on 
that money, review it. Bear in mind that what is in the budget 
is 2007 money, so it would not----
    Senator Bunning. I understand.
    Mr. Bolten. So it would not be money that would be 
available for some time. So we do have time to make an 
assessment of the situation----
    Senator Bunning. We do, too, and that is why----
    Mr. Bolten. By ``we,'' I meant the administration and the 
Congress, and I imagine that that will be a subject of intense 
review. Under present circumstances, I would expect that 
Secretary Rice would want that to be reconsidered.
    Senator Bunning. Just reading and listening to what she has 
to say.
    Mr. Bolten. Yes.
    Senator Bunning. Also, the National Flood Insurance Program 
was created to generate enough revenue through premium dollars 
to prevent taxpayers from paying for disaster-related 
assistance due to flooding during an average flood loss year. 
Claim payments for flood damage from Hurricane Katrina will 
surpass any previous payments from the program at an estimated 
$23 billion. Under the current structure, assuming no major 
floods, it would take the program decades to repay the United 
States Treasury the necessary funds to pay off these claims.
    What changes would you suggest to improve the soundness of 
this program?
    Mr. Bolten. Senator, you are raising a very important issue 
that I think has been underappreciated in the context of the 
Katrina debate. It is an unsound system as it now stands. The 
Congress adopted last year $18 billion in borrowing authority 
for that program to meet its immediate needs. We need to go 
forward now in the next couple of weeks, I understand, to 
provide additional funds so that the Flood Insurance Program 
can pay off the legitimate claims that are now being made on 
it.
    The administration has sent forward proposals for 
fundamental reform in that program, which I anticipate will 
have to involve a reassessment of how we are calculating the 
premiums that people need to pay----
    Senator Bunning. We had a hearing today in----
    Mr. Bolten [continuing]. And what the Federal liabilities 
need to do.
    Senator Bunning. --Banking, so I know it is very important, 
but we have to have a pay-as-you-go program, and we are not 
getting it done.
    In 2004, CBO estimated that capital gains liabilities for 
2004-05 would be $98 billion, a $27 billion decrease from 
earlier projections made for those 2 years. When we look at 
CBO's most recent report, it shows payments from capital gains 
taxes for $151 billion for 2004 and 2005, significantly higher 
than CBO estimated this time last year. I understand that when 
Congress cut capital gains in 1997, actual 1997-98 capital 
gains revenue were about 11 percent higher than the original 
CBO estimates. Can you make a comment about this, please?
    Mr. Bolten. I can, Senator. What those data points reflect 
is that lowering the capital gains rate has had a very strong 
stimulative effect, not just on economic activity but also, it 
turns out, in our Federal revenues. One of the reasons why we 
had that spectacular increase in revenues in 2005, almost at 
15-percent increase in revenues, was because we had much 
stronger than expected capital gains receipts. That is good 
news for the economy and one way that the tax cuts that you and 
the President have put in place have done a good job not only 
in restoring economic health but fiscal health to our economy.
    Senator Bunning. Thank you very much. I yield 5 seconds.
    Chairman Gregg. Thank you. That is extremely generous.
    Senator Wyden.
    Senator Wyden. Thank you, Mr. Chairman.
    Mr. Bolten, welcome. Given the administration's interest in 
holding down the costs of entitlement programs, are you all 
willing to reconsider your opposition to lifting the 
restriction in Medicare so that Medicare can bargain to hold 
down the costs of medicine? It seems to me a particularly 
appropriate time for you all to re-examine this. We got 51 
votes in the Senate as of the last vote for this. As you know, 
there have been huge problems in rolling out this benefit in 
the first few months. Are you willing to work with us on a 
bipartisan basis to re-examine the administration's position 
with respect to bargaining power in Medicare?
    Mr. Bolten. I am going to let Secretary Leavitt engage in 
the detailed discussions with you, but when last I spoke to 
him, my understanding was that our assessment was that it would 
not, in fact, save the Medicare system money to allow the 
Medicare program itself to come in and buy the drugs.
    We are finding that the----
    Senator Wyden. That is just factually wrong. There is a CBO 
letter that says on single-source drugs alone, there would be 
savings.
    Mr. Bolten. I do not believe the administration agrees with 
that, but I will let Secretary Leavitt take it up with you 
directly. But something we are finding is that the Medicare 
Part D program is costing less than originally anticipated, and 
part of it is because of the competition that is occurring in 
the private sector, with the private sectors providers now 
engaged in delivering those services to our seniors. So that 
aspect of the program seems to be working pretty well.
    Senator Wyden. I am going to move on. Let's see what the 
costs are when people who are not automatically signed up start 
making these----
    Mr. Bolten. I should say the jury is still out on how well 
the costs are going to come down, but the initial signs are 
hopeful.
    Senator Wyden. The Bush budget proposal requires Bonneville 
Power to make additional payments to the Treasury if the 
agency's revenues from power sales exceed $500 million per 
year. Now, out in our region, folks really say this is sort of 
like Government loan-sharking. It would be requiring somebody 
to pay more in loan fees just because they are making more 
money.
    Now, my question is: Because the President says if you do 
not extend his expiring tax cuts, that is a tax increase. 
Wouldn't it be correct under that reasoning that the 
administration's budget proposal for Bonneville is a rate 
increase because you are not extending a current policy that 
keeps Bonneville's rates from going up in the future?
    Mr. Bolten. No, I don't think so. What the policy does is 
say that if--and I am sure, Senator--you and I have had a 
chance to talk about this in the past some, but what the policy 
does is say that the Bonneville rates within the customer area 
are substantially below those in the neighboring districts, 
that when Bonneville sells power into those other districts at 
prices that are well above its costs--I think into California 
it is about twice its costs right now--the additional revenue 
that comes in to Bonneville from that can be used, as it has 
been, to lower the rates even further for Bonneville customers, 
which is a good thing. We like to see low energy rates for 
everybody in the country. But what we are asking is, that when 
those revenues exceed $500 million a year, that the extra money 
be used to pay down Bonneville's Treasury debt, which we 
believe in the long run will enhance the soundness and 
stability of BPA and make it possible, with some ancillary 
proposals for BPA, to make investments in an infrastructure 
that in the long run will actually reduce the rates for 
Bonneville customers.
    I think this is a sound Government proposal that will not 
have any significant detrimental effects on Bonneville's 
customers even in the short run.
    Senator Wyden. You will find unanimous opposition in our 
region, Democrats and Republicans, to your views on that.
    One last question, if I might. Why are you all upending the 
most successful forestry law in decades? The Forest Service 
itself says that our county payments law, which is the law, of 
course, that replaces the money we used to get through Federal 
timber receipts, has brought together people who have never 
talked before--the timber industry, the environmentalists, 
local government.
    Your proposal would cut the revenue by more than 50 
percent. We are very concerned about the prospect of an 
ideological fight through these land sales. I would just like 
you to set out for the record, Why do you all want to, as the 
kids say, ``mess with success''?
    Mr. Bolten. Senator, the original program was designed to 
be a transitional program to assist those communities that were 
hard hit by the sudden drop-off in timber receipts. It has been 
successful in that regard.
    The administration believes that we can carry through that 
success with our proposal, which is to reauthorize the law, 
which does expire. Going back to our conversation about 
expiring and not expiring, this program was intended to expire. 
It does expire. The administration is proposing that it be 
continued at a phasing out rate of subsidy to these 
communities. We believe that this can be done responsibly and 
that it can be done on a revenue neutral basis if we make 
available Forest Service lands that are unwanted, isolated, 
unused, and so on. We think that this can all be done 
responsibly within a responsible budget, because all of the 
difficulties I have talked about with the chairman and Mr. 
Conrad and the other members suggests that we are in a 
constrained budget situation. We need to achieve savings where 
we can, and this is an area where we believe we can responsibly 
go forward with the program but do it on a revenue-neutral 
basis.
    Chairman Gregg. Senator Alexander.
    Senator Alexander. Thank you, Mr. Chairman.
    Director Bolten, thank you for coming. Senator Conrad was 
talking about bad habits. I wanted to congratulate you for 
encouraging us toward some good habits last year with the 
suggestion that we slightly restrain the growth of Medicaid and 
the suggestion this year that we slightly restrain the growth 
of Medicare. And I would urge for your consideration as a part 
of the management part of your job S. 489, which is a bill 
sponsored by Democrats and Republicans that would give States 
and local governments more ability to terminate outdated 
Federal court consent decrees so that as we change our policy 
and our rules, they are able to respond and set their own 
priorities.
    But it was after these hearings last year that I sat down 
with Senator Domenici and Senator Bingaman, and we said to 
ourselves if all we do over the next 10 years is spend our 
money on war, welfare, Medicare, Medicaid, disasters, and debt, 
we are not going to have an economy strong enough to pay for 
all those urgent needs. And we asked the National Academy of 
Sciences exactly what should we do to keep our edge in science 
and technology so we can keep our jobs from going overseas and 
so we can have the kind of weaponry we need to win the war 
against terrorism and the technology to deal with health care. 
And I am very pleased that the President is off to a good 
start, and in the Senate we now have 60 Senators--30 Democrats, 
30 Republicans--in support of the recommendations of the 
National Academies.
    I wondered if you would want to comment on the rationale 
for the good financial start for that initiative in this tight 
budget and the level of the President's ongoing commitment to 
this competitiveness issue.
    Mr. Bolten. Yes, Senator Alexander, thank you. And thank 
you for your and Senator Domenici's commitment to the 
competitiveness of this country and to the initiative that the 
President included in his State of the Union address and that 
is prominent in our budget. The conversations that the two of 
you have had directly with the President I know were 
substantial contributors to the final result.
    The President's proposal is recognizing that a critical 
part of maintaining our competitive edge in an increasingly 
competitive world is that we continue to lead in basic science, 
which is the underpinning of all of the major technological 
advances that have made this economy the envy of the world.
    To that end, the President's proposal is that over the next 
10 years we double funding to those successful agencies that 
are at the core of Government's basic science research--the 
National Science Foundation, the Department of Energy's Science 
Program, and NIST at the Commerce Department. So the 
President's budget proposal reflects progressively over time, 
over the next 10 years, a doubling of spending in those areas. 
We believe that that is money very well spent, particularly 
because these science programs, if they can avoid earmarks, are 
done on a competitive basis. And they do a very good job, when 
they are left with a free hand, of handing out money to the 
most promising scientific projects.
    Second, the initiative involves a permanent extension of 
the research and experimentation tax credit, which has been so 
important to private industry. And, third, the initiative 
involves an education element that you and Senator Domenici and 
others, including Norm Augustine, the Chairman of the National 
Academy of Sciences panel that you helped get underway and 
bring prominence to. This country is falling behind in math--
has fallen behind in math and science education for our 
children. The President's budget includes a $380 million 
investment in improving math and science education in the 
United States and ensuring that those who have an interest in 
math and science have an opportunity to pursue those interests 
in higher education.
    Senator Alexander. Thank you very much. I have one other 
short question. I believe I see in the budget that there is no 
funding to help States pay for the REAL ID legislation that we 
passed last year. This is a law to deal with border security 
that imposes a lot of responsibilities on States and State 
budgets. I think it tries to turn driver's license examiners 
into CIA agents. And it is going to be very expensive. The 
National Conference of State Legislatures suggests it will cost 
$100 million a year.
    Now, I believe that if we impose a mandate on the States, 
we ought to pay the bill. And I am wondering why in a $30-
billion-plus homeland security budget we do not include a 
sufficient amount of money, which is estimated at $100 million 
a year, to help the States pay to implement the REAL ID 
legislation. Senator Gregg got passed last year a 60-vote point 
of order for unfunded Federal mandates, and this violates the 
spirit of that.
    Mr. Bolten. Senator, I am not familiar with the details of 
the mandate on REAL ID that the legislation imposes or how we 
are proposing to fund that. I would like to come back to you 
for the record on it.

[GRAPHIC] [TIFF OMITTED] T6726.194


    The one thing I would say is that while the administration 
very much supports the notion that unfunded mandates ought not 
be imposed on the States when the Federal Government is not 
willing to put money behind them. There are already a lot of 
unfunded mandates in the law, and there is already in the law a 
lot of spending in the Federal budget that is a essential form 
of revenue sharing that goes out to the States. One of the 
things that the President directed me to look at, as we looked 
at the 2007 budget, is are we being sensible with all the 
dollars that are being sent out to the States, especially when 
State treasuries are in most cases in much better health now 
than they were a few years ago, largely a product of the 
improving economy the tax cuts you enacted helped trigger. The 
State treasuries are in the kind of situation where they ought 
to pick up more responsibility from the Federal Government. I 
don't know whether this is a good case for that particular 
situation on the REAL ID or not, but I think it is fair to say 
that overall in the budget, when the Federal Government is 
dealing with Federal responsibilities like fighting the global 
war on terror and responding to Hurricane Katrina and so on, 
that it is fair to expect the States to pick up a larger share 
of the burden.
    Chairman Gregg. Senator Murray.
    Senator Murray. Thank you very much, Mr. Chairman. I 
appreciate the opportunity to hear from Director Bolten on the 
President's 2007 budget request.
    I do have a number of concerns. I actually sent you a 
letter, January 31st, and I hope that I get a response on that, 
and a number of my questions. Let me just start by saying I 
would really have to concur with the remarks of our ranking 
member regarding this budget. This plan assumes the largest 
deficit in the history of the country, and yet it assumes over 
$1 trillion in new tax cuts. It does not show us the true costs 
of our commitments in Iraq, and really, from my point of view, 
really fails America's children in the cutbacks in education, 
and our poor, the citizens who are most vulnerable who count on 
Medicaid funding, and really our seniors, with the proposed 
cuts in Medicare, I really see it as a budget that kind of 
forces a huge burden on those who can least afford it.
    And there is one thing I can say about this budget, it is 
not a shared sacrifice budget, so I have a lot of real 
concerns. I know this year, here we are back. It is February 
already. We are still dealing with last year's budget and 
appropriations through the Budget Revenue Reconciliation and 
Debt Ceiling, we are being asked to still work on. I think we 
need to remember on this Budget Committee, that it starts with 
the budget process, and when we have an unrealistic budget, we 
end up 2 days before Christmas here unable to pass our 
appropriations bills.
    As ranking member on the Transportation, Treasury, Housing, 
Urban Development, Judiciary Branch--I think it is the one that 
oversees OMB as well, you know it well--we are going to be 
facing a very, very tough situation, and I will be working with 
Senator Bond, but I think it we do not invest in our 
transportation infrastructure, we are hurting our economy in 
the future, so I have more about that.
    But I did specifically want to ask you, Director Bolten, 
today about the VA budget, and wondered if you had talked with 
Secretary Nicholson, so we can prevent some of the budget 
shortfalls that we saw in 2005 and 2006. You may know that the 
GAO is doing an analysis on the VA's medical services budget 
modeling, and one of the initial major findings has been--and I 
want to read it to you--``VA's internal process for formulating 
the medical program's funding request was informed by but not 
driven by projected demand.'' How do you justify a VA budget 
request that is not based on demand of services? How do we send 
that message to our men and women in uniform?
    Mr. Bolten. Well, the budget, I believe, is based on 
projections of what we expect the demand to be. There was an 
error made last year, that you, among many members----
    Senator Murray. Has the budget modeling been revised then 
to reflect the----
    Mr. Bolten. Yes. I believe that that is an ongoing process 
of improving the budget modeling, but I believe that the errors 
that were in the modeling process last year that caused those 
errors have been corrected.
    Senator Murray. I would like to specifically see that, 
because that is one of the things we were deeply concerned 
about is that the VA budget has to be based on real numbers and 
not just guessing. We know that the model was not correct, so I 
would appreciate----
    Mr. Bolten. Sure. And my folks have worked hard with the 
folks at the VA to try to make sure that the modeling is 
better. You were among the many members that helped us put 
through a correction to an underestimate to how much demand 
there would be in the VA system.
    I should point out that this year's budget for the VA in 
health care is about a 9 percent increase.
    Senator Murray. Right. I saw that and I appreciate that, 
and I have had a chance to talk to many of the VSOs out there 
who appreciate that, but one of their biggest concerns is that 
a lot of that increase is based on fees and copays that are 
again proposed by the administration. In fact, Secretary 
Nicholson and his staff have made it really clear that part of 
the purpose of that is to keep 1.1 million vets from enrolling 
in the VA and prevent 200,000 vets from accessing care. That is 
part of their goal with those fees. Well, for one thing, none 
of our men and women who signed up to service were told that, 
``You will get health care services based on your income later 
in life.'' It was, ``You will serve our country and we will be 
there for you.''
    But there is another challenge here, and that is, having 
been around my State and holding a number of forums on the 
Medicare Prescription Drug, a lot of people who are calling 
about the Medicare program to Department of Health and Services 
are being asked, ``Are you a veteran?'' And if their answer is 
yes, they are saying, ``Well, do not do this prescription drug 
thing. Go to the VA.'' So it seems to me we kind of have two 
contradicting efforts here. We have Secretary Nicholson and his 
staff who are trying to lower the number of vets who are 
accessing VA through these copays and fees, and meanwhile over 
on the other side we have HHS who is telling everybody to go to 
the VA. How do you deal with that contradictory message?
    Mr. Bolten. I am not sure about the contradiction. The 
purpose of the fees is not to drive people out of the system, 
but rather to----
    Senator Murray. Actually, that has been made pretty clear 
from the VA, that one of the reasons that they are proposing 
these fees is to lower the access.
    Mr. Bolten. Well, if I can just back up for a second and 
say a word about the levels of VA medical care funding over the 
course of this administration. As the chart that has just been 
put up on the board shows, VA medical care funding has 
increased over the course of this administration.

[GRAPHIC] [TIFF OMITTED] T6726.195


    Senator Murray. Right.
    Mr. Bolten. In our current budget, what that will lead to 
is an almost 70 percent increase overall in the----
    Senator Murray. No surprise. The cost of health care has 
gone up. The number of veterans who are returning home from 
Iraq and Afghanistan has increased. The number of men and women 
who do not have health care at their employer any more, vets 
who are turning to--the aging population of veterans from 
Vietnam who are accessing the system. That does not surprise me 
the all. What does surprise me is based on what happened last 
year and the fact that the VA said, ``We looked at the wrong 
formula. We need to revise our formula.''
    I remain concerned that that formula has not been revised 
based on real demands, so that we are not faced with a 
situation 3 months from now, 6 months from now, a year from 
now, with the same underestimates, and we are turning back to 
our VA centers across this country, and they are saying to me 
today that there are still long lines, that vets are not 
getting their access. They are coming home from Iraq and 
Afghanistan and are not getting access to PTSD care, and 
numerous other issues that I can describe for the committee 
here, but I think it is critical that we go back and make sure 
we have real numbers based on real facts, and I am yet to be 
convinced that that is occurring. so I appreciate the increased 
cost, but if we do not get a handle on what the reality is out 
there, it still is not going to work.
    Chairman Gregg. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman.
    Thank you, Mr. Bolten, for your presentation. I would just 
say that I do not have any constituents who have come to me and 
ever complained because their taxes were too low. In fact, the 
response I have seen from the President's growth package is 
that the economy has grown, jobs have been created, revenues 
have gone up, and it is not unique just to this administration. 
The Kennedy administration put in place tax cuts so they could 
have more money for their programs, and the Reagan 
administration, and now we have seen it work in the Bush 
administration. These are all facts. You can go ahead and look 
at them, even reflected on Senator Conrad's chart if he had 
gone past the first 2 years there when we were still living 
under the Clinton policy.
    So I hope that we can do something to make these taxes 
permanent. My question to you is, I think the response to the 
economy would have even been greater if we had made those 
permanent. Have you done a study as to how much revenue we 
would have lost to the Federal Government by failing to make 
them permanent, just putting them out for just 5 years, in some 
cases even shorter? What amount of revenue would we have lost 
in the Federal Government from the stimulation of the package 
when we compared it to permanent versus temporary?
    Mr. Bolten. We have not, Senator Allard. One of the 
problems we face in this area is that economists and actuaries 
have difficulty agreeing on how to calculate the feedback 
stimulative effect of a tax cut on the economy. But we--and the 
budget numbers, as they now exist, and that often get cited, do 
not take account of that feedback effect at all.
    One thing we do know is that the feedback effect exists, 
that when taxes are cut, the economy grows, and revenues into 
the treasury grow. It is has just been so far impossible to get 
agreement among the economists and actuaries as to how big that 
effect is. I believe the effect is large, and I believe the 
effect is magnified, when on top of a tax increase, we threaten 
uncertainty in the system because that is the one thing that 
really throws businesses off. On top of losing the opportunity 
to keep some of their well-earned gains, what really throws 
them off is not knowing what the tax rates are going to be. So, 
certainty, as well as a low-tax environment, are two key 
elements that I believe are critical to economic growth.
    Senator Allard. I would like to move on. I did not realize 
you just put ``Expectmore.gov'' up. I have already been on it.
    Mr. Bolten. Really?
    Senator Allard. Yes. You have 189 programs that you have 
listed there have either been ``Ineffective'' or ``Results were 
not demonstrated.'' The ineffective is pretty clear to me. I 
think many have set-ups and goals and objectives, and for one 
reason or another, they are not able to reach those goals and 
objectives. But the group that went into ``results not 
demonstrated,'' is this a group that just absolutely refused to 
put in the right management policies to get us so we can 
evaluate that program? You have described it here as ``A rating 
of results not demonstrated indicates that a program has not 
been able to develop acceptable performance goals or collect 
data to determine whether it is performing.'' Most of them fall 
into that category. Only 27 are ineffective.
    I wondered if you could clarify a little bit about how you 
come up with these two different types of ratings?
    I think it is important to us, by the way, when we look at 
where we can get more efficiency in our programs, get more 
performance out of them. I think it is a great approach. Go 
ahead.
    Mr. Bolten. Thank you, Senator, and thank you for logging 
on to ``Expectmore.gov.'' The ``results not demonstrated'' 
category can mean a variety of things. In most cases it is not 
resistance from the program, but it is an unfamiliarity with 
having to set a goal of what the program is intended to 
achieve. Under the President's direction, my Deputy for 
Management, Clay Johnson, has been very aggressive in pushing 
all programs in Government to try to set some measure of 
accountability for what the money is being spent on, and then 
be able to make an assessment of, are you meeting that measure?
    And in a lot of cases it is understandably difficult to 
move to a system that actually measures accountability. That is 
what the ``Results not demonstrated'' usually shows. In some 
cases I expect that when we are able to establish measures of 
accountability, those programs may score pretty well. My guess 
is a lot of them will score pretty badly, and one of the 
reasons why there has been resistance to establishing measures 
of accountability is that they cannot be met.
    Senator Allard. I think from a policy standpoint it gives 
us some guidance, and kind of begins to focus us on those 
programs that perhaps maybe can justify why they do it, and 
during times when we are struggling to balance our budget, I 
think this is a helpful tool. So I want to commend your staff 
and you for working to put these out, because from a policy 
standpoint I think they are helpful.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman.
    Welcome, Mr. Bolten. We appreciate your being with us.
    Just to start, for the record, as we look at historically 
the decisions that are made in the last 5 years, I think it is 
important to note that 2001, when I came in as the President 
did, and I came in on the Budget Committee, we had the largest 
surpluses in the history of the country recorded. At that time 
we had two proposals in front of us, one by our ranking member, 
Senator Conrad, who suggested we divide that into thirds, take 
a third of it for tax cuts to stimulate the economy, a third to 
invest in education, health care and science, research, all of 
the things that Senator Alexander has talked about eloquently, 
and a third to prefund the liability to Social Security.
    When you look back at that now and what you have talked 
about in terms of Social Security, I think that proposal looks 
pretty doggone good. Instead, unfortunately, it was top-down 
tax cut and massive debt, turning the largest surplus in the 
country into the largest deficit. I hate to think what is 
coming for our kids and our grandkids.
    Let me talk specifically about this budget. The budget 
really is a values document, I believe. It is a lot of numbers, 
but it translates into things that affect real people, and it 
really reflects, just like our own checkbooks do, what our 
values and priorities are.
    When I look at what is happening in Michigan right now and 
the job loss, what is happening to manufacturing, which has 
built the middle class in this country, it is deeply disturbing 
to see what is not in this budget, in fact, the cuts that are 
made in things like the Manufacturing Extension Partnership, 
and the Advanced Technology Program, things that are important 
for us in terms of jobs, and the other areas that are very 
important for us to grow in.
    And, again, Senator Alexander talked about math and science 
and education, all of which I support. I supported the words of 
the President in terms of talking about education and 
competitiveness. But when we look at the budget, it does not 
match the words, and that is deeply concerning. In fact, the 
budget cuts education funding by $2.1 billion. It would cut it 
below the current year, below 2005, below 2004. In fact, it 
appears that it would be the biggest cut in the 26 years of the 
Department of Education since it was set up by President 
Carter.
    So you have small things, which I would support in focusing 
on math and science, but the big picture, when we talk about 
funding Leave No Child Behind, special education, the desire to 
eliminate vocational education, cut technology in schools and 
so on, I would just suggest the big picture on education does 
not reflect what you are talking about.
    Is it not true that in this budget you would cut $2.1 
billion out of education?
    Mr. Bolten. Senator, I am checking my book here. I believe 
that you are right, that there is a reduction in the spending 
in education from 2006 to 2007 of $2.1 billion. I would like to 
make a couple of points.
    First of all, the overall increase in education spending 
during the tenure of this President is about 30 percent, which 
I think over the course of any 6-year term is about as large as 
we have seen in the history of this country. So I do not think 
the President--if you want to judge the commitment to education 
by dollars spent, I do not think the President can actually be 
doubted on that count.
    Second, you mentioned that we need to put priority on those 
with the least economic means, the Title I kids, and the 
President has increased Title I funding as part of his No Child 
Left Behind proposals every year that he has been in office, 
very substantially over the first several years of NCLB. In 
this budget Title I funding increases by $200 million. You 
mentioned----
    Senator Stabenow. Mr. Bolten, if I might just say that 
Michigan, if we were fully funding education, Leave No Child 
Behind at the level that we voted for, that I voted for in this 
bipartisan bill, Michigan would this year, counting the last 5 
years, have $12.3 billion more. So the idea that there are 
small increases when there is a huge amount in standards and 
paperwork, and all that has been added to it, and the fact is, 
we passed something very different.
    I see my time is running out. Let me just raise one other 
issue, and that relates to health care, when you talk about 
health care cuts. Would you not agree that when hospital 
reimbursements are cut, they simply shift that over onto 
business? I mean we see right now that the biggest issue with 
our manufacturers, the biggest issue for our families, relates 
to health care. And when we see big cuts, or even small cuts as 
it relates to hospitals or doctors or home health and so on, 
would you not agree that this just means that we are going to 
see a shift over, and we are going to see private insurance 
rates go up? I mean that is how it works. The private sector 
picks it up when we are not funding the obligations from the 
public sector.
    Mr. Bolten. Are you referring to----
    Chairman Gregg. Senator----
    Mr. Bolten. I am sorry.
    Chairman Gregg. Why don't you answer this question, and 
then we are going to have to move on.
    Senator Stabenow. Sure.
    Mr. Bolten. I am going to assume, Senator, you are 
referring to the President's proposals on Medicare?
    Senator Stabenow. I am.
    Mr. Bolten. As I discussed with the Chairman at the outset, 
these are very moderate changes in projected growth in Medicare 
spending. If all of the President's proposals are adopted, the 
rate of increase in Medicare spending will decline from 7.8 
percent over the next 5 years to 7.5 percent.
    Second, will those costs--if there are higher than they 
were hoping for--or if there are lower than they were hoping 
for reimbursements going to hospitals and other providers, do 
those costs necessarily get passed on to the patient or to 
business? I do not think that is necessarily the case. One of 
the great accomplishments of this economy is the efficiencies 
that we have achieved in this economy in all sorts of areas. 
The one glaring exception that has been left behind is medical 
care, and in medical care we need to put in place the 
mechanisms that will ensure that we have an efficient medical 
system that can provide better service for the same amount of 
dollars as almost every business is required to do, and I think 
we can expect the same from providers in the Medicare system.
    Senator Stabenow. I agree, and I hope you are supporting 
Senator Snowe's and my Health IT bill. But let me just say that 
does not address the big issue in term of jobs in this country 
and manufacturers, which is to move health care off of the back 
of our employers and families and change the way we fund health 
care. This does not do that.
    Chairman Gregg. Thank you, Senator.
    Senator Domenici.
    Senator Domenici. Thank you, Mr. Chairman.
    Director Bolten, Thank you very much for testifying. I want 
to ask two questions for the record, and then I will get on to 
some observations.
    Would you furnish the committee, in detail, two things, 
one, the list of the programs that you contemplate eliminating 
or dramatically reducing, just a list of them?
    Mr. Bolten. Yes, we will.
    Senator Domenici. The reason I need to know, I need to know 
how many of them we have tried again and tried again. Second, 
there is a list of receipts like the Bonneville Power and the 
like, where you expect revenues by changes in formulas or the 
like. I would like a list of all of those kinds of things, and 
an indication whether they have been tried before, or how many 
times have they been submitted up here and not done. Even if it 
is only once, we would like to see them. Can you do that?
    Mr. Bolten. Right. We can do that, Senator. There is a 
chart at the back of the main budget volume that lists all of 
our revenue proposals, and what we will do, we will check off 
the ones that are repeats.
    Senator Domenici. Would you do that?
    Mr. Bolten. Which I gather is your interest.
    Senator Domenici. Yes. My interest is just to see, as we 
put the budget together, what can we expect. I think that is a 
rather relevant thing. You would too if you were in my shoes.
    Mr. Bolten. Yes, that is a fair question.
    Senator Domenici. Now I want to make a point. Hidden in 
this budget, in the State of the Union speech, is a little 
paragraph that I would like to share with those who are 
listening, and with you, to be something passed over quickly 
that I think may be the salvation of this country. That is a 
little statement that the President is going to appoint a 
bipartisan commission. I hope he does it quick. What is it 
going to be about? It is going to be about the health care 
costs that the United States has now promised its citizens 
under Medicare and Medicaid, the expectations versus what we 
can afford, versus what is going to happen to our fiscal 
policy.
    I do not think there is any question we need not waste any 
more time. We cannot pay for what we promised unless we decided 
to impose taxes so high that the country economy cannot work. 
So we either wait around till everything falls apart--that is 
an option. I had begun to think about it, and for a while I 
figured that is when it will happen, when health care falls 
apart, we will do something about it. When the pension system 
breaks, we will do something about it. I hoped that there could 
be another answer, that we might do it in a bipartisan way 
because there is no other way. Democrats cannot do it. 
Republicans cannot do it. We can stand up here and preach and 
blame the other guy, as is happening today. You did too much on 
Medicare. If you do more, you are hurting people. If you do 
nothing, you were irresponsible. It just depends who is in 
office. But nothing happens.
    So that might be your one--whoever put that in there--nice 
idea. I hope they are good people, and then I hope he follows 
them. We have had one before. The President kept the string on 
too tight and we did not get the results. I have had a chance 
to talk to him about this, the President. He is not going to do 
that. When he appoints the commission, he is going to take 
their recommendations. I hope it happens. No other chance, in 
my opinion, to save Medicare and Medicaid for the American 
people. Sounds bad.
    Second, I am not so sure we are going to know when it falls 
apart. I mentioned that a little bit ago. I am not sure. It may 
be falling apart around the seams right now, health care. I am 
not sure, but maybe.
    Now, having said that, your budget does a terrific job of 
prioritizing. The problem is when we put it together, all the 
things you did not prioritize by cutting or reducing are going 
to run into your priorities, and that is the tough part, 
because the President has done a terrific job with 
competitiveness. The Alexander-Bingaman-Domenici-Mikulski PACE 
Act or the President's so-called competitive initiative. You 
have funded it about 75 percent. That is terrific. Science, 
physics, R&D, research and development, all of those things we 
should have been doing, we are doing. Some terrific education 
programs to stimulate our ability to let our children develop 
their brains to the maximum.
    Then we will have American real brain power and free 
enterprise versus China, instead of America brain power 
depleted by our inability to teach our kids physics and math 
and science, competing with the Chinese. We will not make it 
that way. So those are great.
    But I am worried that when we are finished, because those 
are fit in your budget by reducing a lot of things that we will 
not have the courage to reduce, and we will not get the good 
things.
    So might I ask, will the President, in your opinion, stand 
firm on us getting these new initiatives in this appropriation 
process?
    Mr. Bolten. I believe he will, Senator, and I think the 
encouragement that you and Senator Alexander have given him on 
this issue has been critical. He shares your passion for 
achieving the requests that he has put into this budget.
    Senator Domenici. I am going to close by saying he 
mentioned some energy initiatives. I find them in the budget. I 
am very impressed.
    There is one area I am not so impressed with, and maybe 
Senator Byrd is going to speak of it, but in any event, I will 
just mention there is significant reductions in the fossil fuel 
research. Some of it is coal research. I think that I would 
like you, for the record, to explain in some detail what the 
justification was for the fossil fuel reductions, because you 
have some new initiatives in coal, but you got rid of some of 
the old ones, and I do not understand. You may be right, but I 
do not have an understanding. And I have to appropriate them 
now. Senator Byrd knows that. So I would like an explanation of 
that if you would, please.
    Mr. Bolten. I will provide that for the record.
    Senator Domenici. Thank you very much.
    Chairman Gregg. Thank you, Senator Domenici.
    Senator Byrd.
    Senator Byrd. Thank you, Director Bolten. Thank you for 
being our witness here today.
    The President's budget includes a nominal 2.8 percent 
increase in coal health and safety enforcement. This barely 
covers inflation.
    Since 2001 there are 217 fewer mine safety inspectors and 
support staff. That President's budget does not propose adding 
a single position to the Mine Safety and Health Administration. 
We have had this brought to our attention vividly in the last 
few weeks. In the wake of 19 coal miner deaths in just 37 days, 
where is the new money to hire additional mine safety 
inspectors and personnel?
    Mr. Bolten. Senator, the President's budget does have a 
modest increase, as you referenced, for the Mine Safety 
Organization. There have been increases throughout the course 
of this presidency, so that we are funding that organization at 
levels that are equal to or above what it has always been 
funded at, I think even accounting for inflation.
    But you are right, the recent events have highlighted the 
need for a reexamination. That need for reexamination has been 
highlighted at a time after our budget went to press, and it is 
an issue that I know Secretary Chao and others will be glad to 
work with you and other relevant Members of the Congress on as 
we prepare the 2007 appropriations. I know that it will be a 
substantial discussion in her Appropriations Subcommittee.
    Senator Byrd. I hope so. According to the President's 
budget request your proposed increase for MSHA is to cover the 
mandatory cost of living adjustment for current employees and 
increase in rent, but no new funding for new mine safety 
personnel. Will the President submit a supplemental request for 
additional personnel, core enforcement personnel?
    Mr. Bolten. I do not expect that, Senator. The request, I 
see in my notes here, is for $288 million, a 3.6 percent 
increase over the previous year. I do not expect a supplemental 
request to be submitted, but it is an issue that I think we can 
address in the overall budget situation without having to 
resort to a supplemental if the administration and the Congress 
agree that additional resources in the mine safety area are 
likely to be warranted, which I understand they well may.
    Senator Byrd. I think they are warranted. I think so. Don't 
you?
    Mr. Bolten. Senator, I do not know enough to know whether 
the funding levels at the Mine Safety and Health Administration 
were related to the problems we have experienced so far. My 
understanding had been that the safety record during the course 
of this administration has been pretty good under this Mine 
Safety Administration. The recent events suggest that there is 
a problem there. Whether the problem is with the Mine Safety 
and Health Administration though, I do not know, and before I 
made any indication that we would want to substantially plus up 
funding there, I would want to see a good case made as to how 
that funding might improve the situation.
    Senator Byrd. I think it probably does in considerable 
detail affect the Mine Safety and Health Administration. 19 
deaths in 37 days. That is not a very good record.
    According to the General Accounting Office, the Defense 
Department's accounting system is in disarray, costing 
taxpayers billions of dollars each year. The Pentagon's budget, 
including supplementals, exceeds one-half trillion dollars 
annually, and yet the Defense Department cannot pass a simple 
audit. I have been talking about this for years. Secretary 
Rumsfeld, I think we first talked about it a half dozen years 
ago, and he said he was going to see if he could not do 
something about it. I think he has tried. It is so big, I do 
not know how we will ever get our arms around it.
    The Pentagon's budget, as I say, is such that the Defense 
Department cannot pass a simple audit. When do you think the 
administration will make this a top priority issue? What is OMB 
doing to accelerate audit reforms at the Pentagon?
    Mr. Bolten. It is a priority, Senator. And I know that a 
number of our management experts have been working intensively 
over the last several years even, as you say, to try to improve 
the situation at DOD that does not create a sudden change in 
the way the Defense Department does business. The problem in 
their accounting structures has been present, I think, for 
probably almost as long as there has been a Defense Department. 
So it is an enormously complicated structure, an enormously 
complicated undertaking to try to bring them around to a 
situation in which they can pass an audit. It does remain a 
priority of this administration to move the Defense Department 
toward that goal.
    I mentioned earlier my Deputy Director for Management, Clay 
Johnson, is keenly focused on that, and is working with the 
folks at the Pentagon to try to make progress on that. We would 
welcome your assistance in making that come about, because it 
is certainly a goal that OMB would like to see achieved.
    Senator Byrd. Do you think w are making progress toward 
that end?
    Mr. Bolten. Yes, in certain sectors I believe we are making 
progress toward that end. There are much better measures of 
accountability that are now in place than were three or 4 years 
ago, but there is a long way to go. There is no sugar-coating 
the situation there, but I believe we are making progress, and 
I think everybody involved is committed to making progress more 
rapidly.
    Senator Byrd. How did we get so far behind? What happened?
    Mr. Bolten. Senator, I do not know.
    Chairman Gregg. Senator?
    Senator Byrd. Yes?
    Chairman Gregg. Can we come back to you for a second round?
    Senator Byrd. Yes.
    Chairman Gregg. Thank you.
    Senator Byrd. Thank you.
    Chairman Gregg. Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    Welcome. Mr. Bolten, I know you cannot know about 
everything in the budget, but I need to bring out one 
inconsistency with the administration here. The Department of 
Defense had approved the Navy request for $100 million for 
repairs from Hurricane Wilma relief funds for the critical 
infrastructure recovery at Key West Naval Air Station. The 
reason they had approved that is that it is now critical for 
the training of our pilots, because they will send a squadron 
down to Key West Naval Air Station, and then they have all that 
area out there over the Gulf of Mexico that is restricted space 
where they train.
    That request was refused by the OMB, so we have this 
conflict on the essential readiness of the carrier battle 
groups as they prepare to deploy. Key West was significantly 
damaged in Hurricane Wilma. These funds--and I can give you the 
breakdown. I have been down there, I have checked it out. 
Congress appropriated these recovery funds to ensure the 
readiness of our fleet, and we are going to have this insisting 
that that be allowed to be spent. So tell me about you want to 
deny it in the budget, and yet the funds are there in the 
relief bill. So how do we go about, in your opinion, getting 
this thing squared away?
    Mr. Bolten. Senator, I am not familiar with the details of 
it. I will commit to looking into it and come back to you.
    Senator Nelson. Well, the Navy is going to insist on this. 
OMB has thrown up the roadblock, in that it is not in the 
budget, and yet the funds were already appropriated in the 
Wilma hurricane relief funds. Let me just put it to you here, 
that I want to be notified as soon as the requested funds have 
been released to DOD. Is that a process that you would do?
    Mr. Bolten. That I personally would get involved in? No, 
not typically, Senator.
    Senator Nelson. But OMB?
    Mr. Bolten. Yes. OMB is the final stage before funds are 
released before anybody spends it, but my guess is that there 
is a story there that we will want to look into that may 
involve some details that I would want to inform you of before 
we reached any definite conclusions about whether what has 
happened so far is the right thing or not.
    Senator Nelson. OK. I will continue to converse with you on 
that.
    Mr. Bolten. Thank you, Senator.
    Senator Nelson. Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator. I am shocked to learn 
that OMB stood in the way of an agency doing something.
    Let me just check and see if Senator Conrad had any 
additional questions. Otherwise, we appreciate your 
attentiveness to this hearing.
    We thank you very much. We appreciate your answering all of 
the questions in such a forthright way, and we appreciate the 
work you do. It is a very hard job you have, and we are 
fortunate to have public servants of your ability and talent in 
this Nation. I am sure all my colleagues feel that way, whether 
they agree with you or not. I happen to agree with you.
    Thank you.
    Mr. Bolten. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Bolten follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.033
    

    [GRAPHIC] [TIFF OMITTED] T6726.034
    

    [GRAPHIC] [TIFF OMITTED] T6726.035
    

    [GRAPHIC] [TIFF OMITTED] T6726.036
    

    [Whereupon, at 4:33 p.m., the committee was adjourned.]

                 PREPARED STATEMENTS SUBMITTED

[GRAPHIC] [TIFF OMITTED] T6726.045


[GRAPHIC] [TIFF OMITTED] T6726.038


[GRAPHIC] [TIFF OMITTED] T6726.039


[GRAPHIC] [TIFF OMITTED] T6726.040


[GRAPHIC] [TIFF OMITTED] T6726.041


[GRAPHIC] [TIFF OMITTED] T6726.042


[GRAPHIC] [TIFF OMITTED] T6726.043


[GRAPHIC] [TIFF OMITTED] T6726.044


[GRAPHIC] [TIFF OMITTED] T6726.196


[GRAPHIC] [TIFF OMITTED] T6726.198


[GRAPHIC] [TIFF OMITTED] T6726.199


[GRAPHIC] [TIFF OMITTED] T6726.200


[GRAPHIC] [TIFF OMITTED] T6726.201


[GRAPHIC] [TIFF OMITTED] T6726.202


[GRAPHIC] [TIFF OMITTED] T6726.203


[GRAPHIC] [TIFF OMITTED] T6726.204


[GRAPHIC] [TIFF OMITTED] T6726.205


[GRAPHIC] [TIFF OMITTED] T6726.206


[GRAPHIC] [TIFF OMITTED] T6726.207


[GRAPHIC] [TIFF OMITTED] T6726.208


[GRAPHIC] [TIFF OMITTED] T6726.209


[GRAPHIC] [TIFF OMITTED] T6726.210


[GRAPHIC] [TIFF OMITTED] T6726.211


[GRAPHIC] [TIFF OMITTED] T6726.212


[GRAPHIC] [TIFF OMITTED] T6726.213


[GRAPHIC] [TIFF OMITTED] T6726.214


[GRAPHIC] [TIFF OMITTED] T6726.215


[GRAPHIC] [TIFF OMITTED] T6726.216


[GRAPHIC] [TIFF OMITTED] T6726.217


[GRAPHIC] [TIFF OMITTED] T6726.218


[GRAPHIC] [TIFF OMITTED] T6726.219


[GRAPHIC] [TIFF OMITTED] T6726.220


[GRAPHIC] [TIFF OMITTED] T6726.221


[GRAPHIC] [TIFF OMITTED] T6726.222


[GRAPHIC] [TIFF OMITTED] T6726.223


[GRAPHIC] [TIFF OMITTED] T6726.224




UNDERSTANDING THE CAUSES OF AND SOLUTIONS TO ADDRESSING THE FEDERAL TAX 
                                  GAP

                              ----------                              


                      WEDNESDAY, FEBRUARY 15, 2006

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:59 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Grassley, Sessions, Conrad, and 
Wyden.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Cheri Reidy, director for revenues and budget review.
    Mary Ann Naylor, Staff Director and Steve Bailey, sr. 
analyst for revenues.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. Let's get started a little early, which 
hopefully will set a precedent here, because our witnesses are 
here, and Senator Conrad is here. I know we will be joined by 
other people as we proceed forward.
    This hearing is to deal with the issue of what we call the 
Federal tax gap, the fact that there is a lot of taxes owed to 
the Federal Government which are not being collected. The IRS 
estimates a gap of $345 billion a year. That is a huge number, 
and the practical effect of not collecting those taxes is that 
other taxes end up being burdensome. The ability and 
flexibility of the Federal Government to do things that are 
necessary to improve the quality of life for Americans and to 
defend our Nation is limited. And we as a Nation need to make 
sure we are collecting what people owe simply to maintain the 
integrity of the Tax Code.
    We have always had a Tax Code which has been built on the 
concept of basically voluntary compliance. People recognize 
they owe a certain amount and they should pay it. Its success 
is unique to Western democracies. We have not had a history of 
avoidance, or fraud that has been systemic. It has occurred but 
has not been systemic.
    To the extent fraud occurrs, we should try to address it, 
improve on our collection capability, and make the Code more 
comprehensible so that we can effectively collect taxes which 
are owed so people can feel that the distribution of the tax 
burgen is just.
    But there is a lot we need to address to accomplish this 
goal. So we have an excellent panel today.
    The person who has been the greatest force here in the 
Congress in trying to address this issue has been my colleague, 
the Ranking Member on the Committee, Senator Conrad. This has 
been an issue that he has raised innumerable times, and I thank 
him for his vigilance on this and for raising the level of 
rhetoric. When someone becomes a champion for getting something 
done around here, that is the key of getting it done around 
here. And so, following his leadership, maybe we can get 
something done.
    So I yield to Senator Conrad on this issue that he has been 
so active and effective on.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. First of all, I want to thank the chairman, 
especially thank him for his kind, generous remarks this 
morning, but thank him as well for holding this hearing. I very 
much appreciate it.
    I really do believe this is one of the big ideas that we 
have to pursue in order to make progress on the deficit.

[GRAPHIC] [TIFF OMITTED] T6726.046


    Let me just run through a couple of things quickly which 
put it in perspective. We have the President now suggesting the 
deficit this year will be $423 billion. My own calculations are 
that that is somewhat high. I see a deficit this year of about 
$360 billion. But, still, that would give us four of the 
largest deficits we have had in history in dollar terms the 
last 4 years.
    Let's go to the next.

    [GRAPHIC] [TIFF OMITTED] T6726.047
    

    When we look at revenue as a share of GDP, here is what we 
have seen going back to 1955. There have been a lot of jigs and 
jags, but really the revenue side of the equation fell out from 
2001 to 2004. We have had some recovery here. But here is the 
point I want to make.
    If the tax gap, the difference between what is owed and 
what is being paid, is $350 billion a year or thereabouts, that 
represents about 2.5 percent of GDP. If we were collecting 
that, we would have collections as a share of GDP about right 
here, with no tax increase. No tax increase.
    The point I am trying to make to my colleagues is we 
clearly need more revenue to float this boat. We also have to 
be tough on spending, without question. We also have to reform 
long-term entitlements. But we also need more revenue. And the 
first place to look, rather than any tax increase, is to 
collect the taxes that are actually now owed. If we were doing 
that, we would have a very different budget situation.
    Let's go to the next chart.

    [GRAPHIC] [TIFF OMITTED] T6726.048
    

    This is the rough estimate that we have received from IRS 
that the gross tax gap is approaching $350 billion a year. 
Hopefully we can get to a newer estimate because I think that 
is pretty conservative, based on my own judgment.

[GRAPHIC] [TIFF OMITTED] T6726.049


    Let me just put it in perspective. This is the projected 
deficit for the year, $423 billion. Here is the amount of the 
gross tax gap, $345 billion. Again, I think this deficit number 
is somewhat overstated. My own judgment is the deficit will be 
about $360 billion this year. If we are actually able to 
collect all this revenue that is owed, we would come close to 
eliminating the deficit. And I understand the difficulties with 
collecting it all. The question is: How can we make serious 
progress, not just through enforcement but through tax reform? 
Because I think we have to now seriously consider fundamental 
tax reform as part of the mission.
    The point I really want to make is that this is critically 
important to solving our budget problems. This is a component 
of what we could do to really close the gap, and we could do it 
without increasing taxes, but increasing the collection of 
taxes that are now due and owed.
    And with that I want to again thank the chairman very much 
for holding this hearing.
    Chairman Gregg. Thank you, and I appreciate your suggesting 
that we have this hearing. I think it is a critical issue.
    Of course, the Budget Committee only has the capacity to 
set a budget out which projects where we are going to and how 
we are going to get there. But it doesn't have the authority to 
actually institute action in these areas. That lies with a 
different authorizing committee. In the area of tax policy, 
that is clearly the Finance Committee, and I notice we are 
joined by the chairman. Does Chairman Grassley have anything he 
wishes to add?
    Senator Grassley. Not at this point, Mr. Chairman. I am 
just around to see what the Budget Committee thinks I ought to 
do a better job of doing.
    [Laughter.]
    Chairman Gregg. Well, the Budget Committee is always 
interested in having the chairman here.
    Mr. Everson, we would love to hear from you. We are joined 
today by two witnesses in the first panel: of course, the 
Commissioner of the Internal Revenue Service, Mr. Everson; and 
the Comptroller General, David Walker.
    Mr. Everson.

   STATEMENT OF HON. MARK W. EVERSON, COMMISSIONER, INTERNAL 
                        REVENUE SERVICE

    Mr. Everson. Thank you, Mr. Chairman, Senator Conrad, and I 
will say Chairman Grassley, because if I leave that out, it 
would probably be at my peril, given the frequency with which I 
am before Finance.
    I am pleased to be here today to discuss the tax gap. I 
understand it has been at least some years since an IRS 
Commissioner has come before the Budget Committee. Given the 
fact that the IRS is responsible for collecting substantially 
all of the over $2 trillion that comes into Government coffers 
each year, I commend you for putting tax compliance on your 
agenda. If we can improve tax compliance and reduce the tax 
gap, it will make all of our jobs easier and reduce the burden 
of debt being shifted to future generations.
    I also want to thank the committee for the important role 
you played last year in ensuring that the IRS received adequate 
resources for our enforcement activities. I am hopeful that you 
will do the same as pertains to the President's 2007 budget 
request.
    Simply stated, the tax gap is the difference between the 
tax that taxpayers should pay and what is actually paid on a 
timely basis. Overall, our Nation enjoys a very high compliance 
rate, certainly among the best in the world. The vast majority 
of Americans pay their taxes honestly and accurately, and they 
have every right to expect that their neighbors and competitors 
do the same. Not only are the dollars at stake important, but 
so is the sense of fairness. As President Kennedy stated in 
1961, ``Large continued avoidance of tax on the part of some 
has a steadily demoralizing effect on the compliance of 
others.''
    Unfortunately, our research indicates that in tax year 
2001, there was a gross tax gap of $345 billion and a 
noncompliance rate of about 16.5 percent. Noncompliance takes 
three forms: nonfiling, underreporting, and underpayment. As 
this chart indicates, the bulk of the tax gap, over 80 percent, 
relates to underreporting of income, not nonfiling or 
underpayment. The research which we have just completed for tax 
year 2001 further indicates that the largest piece of the 
underreporting component of the gap relates to individual 
income tax, almost $200 billion a year. And of this, over half 
is underreported business income.
    In attacking the tax gap, I would like to make four points.
    First, we are doing a great deal to restore the enforcement 
functions of the IRS. This chart shows the growth of 
enforcement revenues achieved over the last several years. 
Enforcement revenues are the direct moneys we bring in from our 
collection activities, audits, and document matching program. 
Enforcement revenues do not include the indirect behavioral 
impact of our enforcement activities. But enforcement revenues 
alone have increased from $33.8 billion in fiscal year 2001 to 
over $47 billion last year. I believe the credibility of our 
enforcement activities has been restored. Still, we need to do 
more, and we will.
    As I indicated moments ago, I very much appreciate the 
support this committee has given for securing adequate funding 
for the IRS. Appropriate funding is essential to reducing the 
tax gap.
    Two, we are using the conclusions from our research to 
update our audit models. The tax gap research will help us do a 
better job of selecting cases for review. Our enforcement 
operations will be more efficient and more productive.
    Three, the President's budget proposal contains several 
legislative proposals which will help close the tax gap. These 
are generally in the area of increased third-party reporting. 
This chart depicts the fact that noncompliance is greatest 
where there is little or no third-party reporting.
    Four, we continue to work to improve taxpayer service. 
Helping taxpayers understand their obligation and facilitating 
their participation in the system no doubt supports compliance. 
But I would emphasize that the most important thing we could do 
to better serve taxpayers would be to simplify the Tax Code. 
Complexity obscures understanding.
    The last point I would like to make is that while we are 
moving aggressively to reduce the tax gap and can close a 
significant portion of the gap over a period of years, I say 
here, ``no one should think...''--maybe I should revise that 
for Senator Conrad--that we can totally eliminate the gap. That 
would take draconian measures and make the Government too 
intrusive. We need to strike the right balance.
    Thank you.
    [The prepared statement of Mr. Everson follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.095
    

    [GRAPHIC] [TIFF OMITTED] T6726.096
    

    [GRAPHIC] [TIFF OMITTED] T6726.097
    

    [GRAPHIC] [TIFF OMITTED] T6726.098
    

    [GRAPHIC] [TIFF OMITTED] T6726.099
    

    [GRAPHIC] [TIFF OMITTED] T6726.100
    

    [GRAPHIC] [TIFF OMITTED] T6726.101
    

    [GRAPHIC] [TIFF OMITTED] T6726.102
    

    [GRAPHIC] [TIFF OMITTED] T6726.103
    

    [GRAPHIC] [TIFF OMITTED] T6726.104
    

    [GRAPHIC] [TIFF OMITTED] T6726.105
    

    [GRAPHIC] [TIFF OMITTED] T6726.106
    

    Chairman Gregg. Thank you, Mr. Everson.
    Mr. Walker.

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

    Mr. Walker. Mr. Chairman, Senator Conrad, Chairman 
Grassley, thank you for being here to talk about the tax gap. I 
would respectfully request that my entire statement be included 
in the record.
    Chairman Gregg. Of course.
    Mr. Walker. I will move to summarize the highlights.
    Let me note at the outset that I, too, would like to 
commend this committee for being concerned with this issue. I 
would also like to note for the record that the Senate Finance 
Committee held a hearing on this exact subject last year, at 
which both the Commissioner and I had the opportunity to 
testify. I hope and expect that the Senate Finance Committee 
will be taking action in a number of related areas in the 
future.
    With regard to the tax gap, let me make five major points, 
and I have some slides that have been made available to you 
that I will show so the audience can see.
    GAO's long-term budget simulations show that over the long 
term we face large and growing structural deficits due 
primarily to known demographic trends, rising health care 
costs, and lower Federal revenues as a percentage of the 
economy. Figure 1 and Figure 2, the first two slides that are 
on pages 4 and 5 of my testimony, exhibit this large and 
growing structural imbalance. I am happy to answer questions 
about the differences between 1 and 2 in the Q&A section if you 
so desire.
    Continuing on this imprudent and unsustainable fiscal path 
will gradually erode, if not suddenly damage, our economy, our 
standard of living, and ultimately our national security. 
Reducing the current tax gap would contribute to our fiscal 
sustainability while simultaneously improving fairness for 
those citizens who fully and timely meet their tax obligations.
    Second, underreporting of income by businesses and 
individuals accounted for most of the $345 billion tax gap for 
2001, with individual income tax underreporting alone 
accounting for $197 billion. Corporate income tax and 
employment tax underreporting accounted for $84 billion, and 
that is noted on Table 1 on page 7, or the third slide that you 
have.
    Third, given the persistence and size of the tax gap, we 
need not only to consider options that have previously been 
proposed, but also explore new administrative and legislative 
approaches to reducing the tax gap. Even modest progress would 
yield significant revenue. Each 1-percent reduction would 
likely yield nearly $3 billion per year. Reducing the tax gap 
will be a challenging effort. Long-term progress will require 
attacking the gap on multiple fronts and involving multiple 
strategies over a sustained period of time. These strategies 
could include and in some cases should include such efforts as 
to regularly obtain data on the extent of and reasons for 
noncompliance; simplifying the Tax Code--I would agree that is 
No. 1; providing quality services to taxpayers, which I know 
the IRS has been focused on in recent years; enhancing 
enforcement of tax laws by utilizing such enforcement tools as 
tax withholding, additional information reporting, enhanced 
penalties where they have been eroded over time due to 
inflation, better leveraging technology, and maximizing 
resource allocation based upon the areas that are likely to 
generate the best value and, therefore, close most of the tax 
gap.
    With regard to tax expenditures, which are noted on Figures 
3 and 4 on pages 13 and 14 of my testimony, this notes the 
significant increase in the number of tax expenditures over the 
past two decades. We lose $700 to $800 billion a year in tax 
revenues due to tax expenditures. They represent in many cases 
back-door spending.
    It is important that we have appropriate visibility on 
these tax expenditures in order to make them part of the 
overall equation on assuring that we can ultimately pay our 
current bills and deliver on our future promises over time.
    And, last, Figure 5, which is on page 17 of my testimony, 
summarizes selected information with regard to individual tax 
underreporting as it relates to areas where information returns 
are not provided and withholding is not required. In this 
regard, some examples of additional information reporting or 
withholding actions which might make sense going forward would 
be: requiring tax withholding and more and better information 
return reporting on payments that are made to independent 
contractors; requiring information return reporting on certain 
payments made to corporations; and requiring more data on 
information returns dealing with capital gain income.
    In summary, our Nation's fiscal imbalance and related 
challenges have created a situation where we are on an 
imprudent and unsustainable path that needs to be addressed. 
While our long-term imbalance cannot be corrected solely by 
addressing the tax gap, and while we should have zero tolerance 
for people who don't pay their fair share, the tax gap will 
never be zero. Nonetheless, it could help tremendously in 
closing the gap over the longer term. We will, however, need to 
take other steps, and we stand ready to work with the Congress 
in trying to address this and other issues of mutual interest 
and concern.
    Thank you very much.
    [The prepared statement of Mr. Walker follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.071
    

    [GRAPHIC] [TIFF OMITTED] T6726.072
    

    [GRAPHIC] [TIFF OMITTED] T6726.073
    

    [GRAPHIC] [TIFF OMITTED] T6726.074
    

    [GRAPHIC] [TIFF OMITTED] T6726.075
    

    [GRAPHIC] [TIFF OMITTED] T6726.076
    

    [GRAPHIC] [TIFF OMITTED] T6726.077
    

    [GRAPHIC] [TIFF OMITTED] T6726.078
    

    [GRAPHIC] [TIFF OMITTED] T6726.079
    

    [GRAPHIC] [TIFF OMITTED] T6726.080
    

    [GRAPHIC] [TIFF OMITTED] T6726.081
    

    [GRAPHIC] [TIFF OMITTED] T6726.082
    

    [GRAPHIC] [TIFF OMITTED] T6726.083
    

    [GRAPHIC] [TIFF OMITTED] T6726.084
    

    [GRAPHIC] [TIFF OMITTED] T6726.085
    

    [GRAPHIC] [TIFF OMITTED] T6726.086
    

    [GRAPHIC] [TIFF OMITTED] T6726.087
    

    [GRAPHIC] [TIFF OMITTED] T6726.088
    

    [GRAPHIC] [TIFF OMITTED] T6726.089
    

    [GRAPHIC] [TIFF OMITTED] T6726.090
    

    [GRAPHIC] [TIFF OMITTED] T6726.091
    

    [GRAPHIC] [TIFF OMITTED] T6726.092
    

    [GRAPHIC] [TIFF OMITTED] T6726.093
    

    [GRAPHIC] [TIFF OMITTED] T6726.094
    

    Chairman Gregg. Thank you, Mr. Walker, and thank you for 
the really excellent information and data that you have given 
the Congress, especially in the area of the out-year 
unsustainability of our present programmatic activity and the 
entitlement accounts. Anybody who looks at your numbers on 
entitlement accounts recognizes we have to do something, and it 
is our obligation as policymakers to do it sooner rather than 
later. So we thank you for that because you are viewed as a 
fair arbiter of those numbers.
    Commissioner Everson, last year the budget had in it 
basically what amounted to a reserve fund which was available 
to the Appropriations Committee to assist in funding further 
increases in enforcement for the IRS. I think it worked out to 
about $446 million when it was all done.
    The administration has asked for another $137 million for 
that type of a plussing up of your enforcement activity, again, 
as a special budgetary item within the budget. So it is a 
unique vehicle to use, quite honestly, to get to this 
enforcement.
    To what extent do those dollars assist you? And if we would 
put in more than $137 million, would we get a return of--you 
know, what is the return on those dollars? Is it 1:1 or 2:1 or 
10:1? Hopefully 10,000:1.
    Mr. Everson. Let me first state, as I indicated a moment 
ago, I very much appreciate what you did last year. It was 
essential to our continued rebuilding of our enforcement 
activities. And I hope that you support every dollar requested 
in the budget, as well as the program integrity cap.
    I am taking the same approach I took last year. I am asking 
for every penny of the President's budget request but not for a 
penny more. I don't----
    Chairman Gregg. Let's stop there. What I want to know is: 
How much did we get for the money we put in last year? And if 
we exceeded the President's request, would we get more back? I 
mean, I don't mind putting more in----
    Mr. Everson. I am going to answer that. I am going to 
answer that. So I am not asking for more than the President has 
requested.
    Chairman Gregg. I understand that.
    Mr. Everson. That is the first thing I am going to say and 
I am going to get that out of the way.
    Obviously, when we invest in enforcement moneys for the 
IRS, we get a return. If you take a look at our budget, our 
total budget is about $10.6 billion. So, roughly speaking--
let's go back to the enforcement revenues--the enforcement 
revenues alone last year were $47 billion. So use that as an 
order-of-magnitude comparison. That is the direct moneys you 
got back against the whole budget. The enforcement piece we are 
talking about is approaching $7 billion in terms of how we 
allocate within our budget what is enforcement. But the other 
moneys play an important role, too--modernizing our systems--
the whole thing is important.
    Now, when you make a marginal investment, the return on 
that marginal investment depends. If you are doing document 
matching, it is very cheap. You might get a very high return--
10:1, 15:1. If you are doing high-end complex audits, the 
return is lower, but it is still a multiple of one after you 
have trained the people. So it is a good investment.
    Again, though, the big point here is that this is only the 
direct return that I am speaking about. I am not talking about 
some concept that I would consider dynamic--or you might 
consider dynamic scoring--which is to say when we audit Senator 
Conrad and whether or not we find more money----
    Senator Conrad. You wouldn't get a dime.
    [Laughter.]
    Mr. Everson. You may think twice about something that you 
might do on your return. That is not in these concepts. And, 
clearly, there is an important behavioral impact.
    So, yes, you get a positive return. If you give us more 
money, yes, you will get a multiple of that.
    Chairman Gregg. Well, let's say we were to take this 
number, 137, the President has asked for and double it. Could 
we presume that our return on that would be 5 times, 10 times? 
I mean, how would we--in other words, if we were going to 
offset that with receipts that we would score in our baseline, 
what would be the number that we should be considering putting 
in as a result? And when do we get to a diminishing return 
event?
    Mr. Everson. I don't think you will get to a diminishing 
return for some time. This gets to the basic question of how 
much can you reduce that tax gap. The way I view it is you can 
clearly reduce it by $50 or $100 billion without changing the 
way the Government interacts with its citizenry. And I don't 
know precisely where that point is. But at some point, you will 
be more intrusive. You will get more allegations of strong-arm 
tactics and excess. But I believe you can make progress with 
investment and with the statutory reforms. I have seen in the 
press that some have pooh-poohed these, but I think that they 
are the most significant reforms that we have asked for in two 
decades, since the 1986 act when Congress said, ``Going 
forward, if you are going to get an exemption for somebody, you 
have to put down the Social Security number, not just the 
name.'' Well, the next year, 5 million dependents vanished.
    What we are trying to do here is attack this also with 
statutory proposals, so I wouldn't want you to lose sight of 
those.
    Chairman Gregg. Well, of course, this committee does not 
have jurisdiction over statutory proposals. That is Senator 
Grassley's. But we do have the ability to set up this fund.
    Mr. Everson. Yes.
    Chairman Gregg. And give the money to the Appropriations 
Committee, which we did last year, which in turn generates 
additional revenues, which in turn allows us to score higher 
revenues, which in turn gives us a different budget scenario. 
So it is critical to us to know how those dynamics all work 
together, and I think you have answered that question for us.
    Mr. Everson. I would say one thing. My understanding is 
that part of the problem here is the revenue side does not 
score. That is my understanding.
    Chairman Gregg. Well, we understand that, too, but at some 
point we have to start being logical about this. If we put an 
extra $500 million into your enforcement mechanisms, we have to 
talk to CBO about giving us some score for that, because, 
clearly, there is a return for that money.
    Senator Conrad.
    Senator Conrad. Let me just pursue, if I could, with you, 
Mr. Everson and General Walker--first of all, I want to thank 
you both. I think your testimony has been excellent, I think it 
has been honest, and I think we begin to get a sense of how big 
this is, this $350 billion revenue gap here.
    I hear you saying, Commissioner Everson, in your judgment 
we could close that by $50 to $100 billion without affecting 
the interaction between the agency and taxpayers in some 
negative way.
    Let me first say I believe--and I have gone over in some 
detail how the estimates were made. I believe that it is likely 
the estimates are understated. And I understand how the 
estimates were made. I don't fault you for how the estimates 
were made. You are in some sense locked into building off a 
base that is quite old because, as I understand it, this update 
to 2001 is based off a file that is substantially earlier than 
that. And so with what I have seen happen in the accounting 
community in terms of aggressive approaches to tax avoidance, I 
believe that there is a strong likelihood that the estimates 
are understated.
    Could you share, Commissioner Everson, your sense on that 
issue?
    Mr. Everson. Sure. Can we go to the tax gap map?
    If you look at the way we have color-coded this map, we 
have three colors. Now, this is not some sort of national 
security warning system, but maybe it is a fiscal warning 
system.
    Green represents actual amounts--that is to say the 
underpayment piece, which when I file my return and I indicate 
that I owe $7,000 but I don't send the check in. That is a 
good, hard number.
    The blue numbers are the estimates that have been updated 
from this national research program that we did using the 
46,000 2001 audits so we think those numbers are very good. 
Also, the nonfiling piece is a very good estimate because we 
used census data and our own records to try and get our arms 
around what we think has not come in.
    Now, what is less reliable and gets to the issue that you 
just mentioned, are the pieces in yellow, and the biggest piece 
in yellow relates to corporate returns.
    The reason we didn't update this piece is because we still 
have significant research to do here. We started with the 
individuals because that is where historically the biggest 
piece of the problem is. In terms of corporate audits, 
especially the larger corporate entities, we have a very high 
audit coverage. For businesses with assets of over $250 
million, our audit rate is over 40 percent. So we are doing a 
lot in that area, anyway.
    I take your point, though, and I agree with it, but what I 
would say is, even if the tax gap for corporations is 
understated by half--that is to say, it is $60 billion instead 
of $30 billion--it still doesn't change the picture that 
dramatically. And I would not allocate our resources any 
differently because we already give, as Senator Grassley knows, 
a great deal of focus to corporations and high-income 
individuals.
    Senator Conrad. Let me just say that I have had the 
opportunity to talk to a number of big firms on Wall Street who 
have taken a look at this issue, and they have told me they 
have reviewed the analysis, had people with great expertise, 
and they think we may be understating this by $50, perhaps even 
$100 billion a year. Do you think that is out of the question?
    Mr. Everson. I would not venture a guess as to the amount. 
I would say, however, that one of my principal concerns is the 
issue of corporate compliance, particularly with increasing 
globalization. And what we have done is we have enhanced our 
contacts with other taxing jurisdictions.
    I was at a meeting--it took almost 2 years to set this up, 
believe it or not--where for the first time we have included 
the Chinese and the Indians in some of our discussions in 
anticipation of the reversal of capital flows.
    We are doing more here. We set up something called the 
Joint International Tax Shelter Information Center about a year 
and a half ago. It is a joint center involving the Brits, the 
Australians, and the Canadians, where we share information 
along with our exchange agreements, totally in accordance with 
treaties. We have found numerous instances of tax arbitragers 
who set up deals so that there is a tear line between our 
system and the U.K. system, and they don't end up paying taxes 
either place. And that is not----
    Senator Conrad. May I just say----
    Mr. Everson [continuing]. What was intended.
    Senator Conrad. When I was a State tax commissioner, in one 
case alone I found a major company doing business in my State 
had an operation in the Cayman Islands. They showed no profits 
on very extensive operations in the United States. They showed 
hundreds of millions of dollars of profits in the Cayman 
Islands with one employee. And I always said that was the most 
efficient person in the world. That person was really 
productive. And that person didn't even work full-time for the 
company. That individual was an agent for many companies.
    I showed on the floor of the Senate last week a five-story 
building in the Cayman Islands that is the home to 12,500 
companies. It is amazing how much you can get done in a 
situation like that on avoiding taxes legitimately due here, 
and what they were doing is through the use of transfer 
pricing, showing their profits in the Cayman Islands where 
there are no taxes, avoiding their legitimate taxes here, and I 
collected a lot of money from companies playing this game when 
I was the State tax commissioner.
    Mr. Everson. I know David wants to say something, but let 
me just make one final point on this subject. The root cause of 
the problem here is the divergence between the incentives to 
increase book earnings on the one hand and to drive share 
prices and to minimize taxable earnings on the other.
    I would recommend to you a very interesting article in the 
Sunday Business Section of the New York Times from about 10 
days ago that talks about this problem and the fact that all of 
this is obscured to the investor and public community.
    Mr. Walker. As you know, among other things I am a 
certified public accountant, and I practiced in the private 
sector for a number of years. I believe that the world has 
changed dramatically, especially in the corporate sector, since 
the baseline for these estimates were created.
    We need to understand that corporations do not have duties 
of loyalty to countries. They have duties of loyalty to their 
shareholders. They will do everything that they can legally do 
to avoid and minimize taxes. In today's world, through transfer 
pricing, through basing of corporate headquarters, there are 
lots of things that can be done in order to minimize tax 
burdens. Some of this deals with being able to make sure the 
IRS has enough people with the right kind of skills and 
knowledge to be able to effectively address these issues, 
because they are very sophisticated transactions.
    Part of it is the Congress looking at a substance over form 
doctrine to determine what does it take in order for somebody 
to legitimately say that they are headquartered in for example, 
the Cayman Islands, when, in fact, a vast majority of their 
operations and revenues occur in the United States. Their 
executives are based in the United States and many spend most 
of their time in the United States.
    And so, it will take both administrative actions as well as 
a potential legislative actions that the Senate Finance 
Committee will have to take a look at.
    Chairman Gregg. And we will turn to the Senate Finance 
Committee chairman.
    Senator Grassley. To what extent are the numbers on here 
money that is going to come into the Federal Treasury once, if 
you have found that these people were cheating, or to what 
extent is that going to repeat from year to year? Like, for 
instance, if you close the gap on self-employment tax at $39 
billion, would that $39 billion come in this year, next year, 
and next year?
    Mr. Everson. The first point I would make about that, is 
that there is a reason there is an arrow in between those two. 
That amount is largely derivative of the underreported business 
income. In other words, you have obscured the income; 
therefore, that has just sort of an automatic effect on the 
self-employment tax that the Schedule C filer is not putting in 
there.
    These are annual figures. This is what is not coming in 
every year. If we go to the enforcement----
    Senator Grassley. Well, if you found a taxpayer cheating 
and they started paying their taxes, then these numbers would 
say this would come in year after year?
    Mr. Everson. That is right. What we have to do here is two 
things: we need to reduce that gross gap, which is to get 
better behavior up front, and we need to continue to make the 
IRS more efficient and effective in terms of what we actually 
bring in. That is how you get to the $290 billion number that 
is in there. It is the 345 less an estimate back in 2001 of 
about 55 that we would bring in through enforcement revenue and 
late payments.
    Obviously that 55 number is now better because we have 
increased the enforcement revenue. So you want to attack it 
from both sides: bring down the overall gross gap and increase 
our recoveries.
    Senator Grassley. Now, questions that even if we did in 
these areas would be probably a small amount of revenue 
compared to the tax gap, but I want to ask your views on a 
couple things that my committee has been working on. One would 
be what I call the battle of appraisers, legitimate valuation 
disputes. We took some steps to deal with this a couple of 
years ago by giving more straightforward rules on car donations 
and intellectual property. In a bill that just passed the 
Senate, we have some additional steps regarding reforms of 
appraisal and who can appraise as well as trying to deal with 
other problems, such as clothing donations and facade 
easements, and valuation is part of this determination.
    Give me your view on this matter in general as to how big 
of a problem that is, and your thoughts are important. You 
might want to give some detail in writing. I recognize that, 
just as we have found, it may be many targeted reforms that are 
needed to deal with this overall problem. In other words, I 
wish there was one magic bullet about everything you have on 
here. But I think we are going to have to do like how do you 
eat 10,000 marshmallows one at a time.
    [Laughter.]
    Mr. Everson. First, let me say I think that you and I are 
in lockstep agreement that the tax-exempt sector is extremely 
important, not just for reasons of protecting the integrity of 
the sector itself, but beyond that, for protecting the revenue 
base of the country. If we allow individuals and businesses to 
masquerade as charities or tax-exempt entities, over time we 
will erode the revenue base.
    You are correct, though, Mr. Chairman, in saying that the 
costs of those abuses as indicated here our study are 
relatively small. But just as your committee has been 
aggressively looking at this issue, I think what we have to do 
is stop abuses in charities before they really get going and 
get larger.
    So I think you are on the right track here to make sure we 
address this.
    Senator Grassley. OK. Then on another issue that may be 
small, but may be very big, too, because I don't know that we 
know for sure, the Taxpayer Advocate recently came out with 
this proposal on reporting for stocks about what the basis is. 
How big of a problem do you see the issue of basis in the tax 
gap? In other words, how much would it help if we had a better 
basis reporting? And what are your thoughts on the Taxpayer 
Advocate's proposal that has been put forth in this area?
    Mr. Everson. Certainly. If you look at this chart it sort 
of spreads those numbers in a different way in terms of what is 
in the underreporting piece. The capital gains understatement 
that we determined in the study was only about $11 billion. And 
I say ``only'' because that was a surprise compared to what 
some academics and others had thought it might be. And so, as 
you can see here, the noncompliance rate to be about 12 
percent. So I would caution to say that this, at least on the 
basis of our research, does not appear to be as big a problem 
as some had thought it to be.
    Now, of course, different years you would bring different 
results. In year 2001, stock prices were going down. You might 
haveten a different answer in earlier years in which the 
valuations were different.
    But we have not included a proposal focusing on the tax 
basis issue in the President's budget. We have included five 
proposals largely touching on increased reporting to get after 
these, but we have not targeted this particular issue at this 
time.
    Senator Grassley. Before you go, General--but does what you 
just told me deal with the issue of how do you determine basis?
    Mr. Everson. Sure, because what they are doing, we are 
doing the audits here. We get good third-party reporting on the 
transaction in the sense that the sale is reported and the 
proceeds are reported to us. So it is only the basis that is at 
issue here.
    Senator Grassley. OK. General Walker.
    Mr. Walker. As you know, Mr. Chairman, this is something 
that we recommended at the hearing that you conducted on the 
tax gap last year. There were several specific areas where we 
felt that additional information reporting and potential 
additional withholding would be appropriate, and this was one. 
I would also respectfully suggest that $11 billion is a lot of 
money.
    Furthermore, if we look at what is happening with regard to 
investment patterns, it is not just stocks and bonds. There is 
a tremendous amount of investment going on in real estate. The 
capital gains aspects of real estate for investment properties 
has exploded within the last few years. And so I think if we 
are doing these estimates based upon conditions that existed in 
the 1980's, I think it is a different ball game today than the 
1980's.
    Mr. Everson. The estimates are not based on the conditions 
of the 1980's. The 1980's issue really gets to Senator Conrad's 
point about the corporations. That is where you get the $30 
billion on the corporation side. The individual side is fresh 
research. Just to clarify this.
    Senator Grassley. Thank you, Mr. Chairman.
    Chairman Gregg. Mr. Everson, just to clarify, these numbers 
don't really include things like dishonest transactions, such 
as the drug industry and things like that?
    Mr. Everson. By ``drug industry,'' do you mean illegal 
drugs?
    Chairman Gregg. I am talking about illegal drugs, yes.
    [Laughter.]
    Mr. Everson. I think I know what you are saying, and that 
is correct.
    Chairman Gregg. And illegal gambling.
    Mr. Everson. Illegal sources.
    Chairman Gregg. This number, 340 or 420, whatever it is, 
does not even take into account that. This is just 
underreported or----
    Mr. Everson. Legal source.
    Chairman Gregg [continuing]. Those taxable events that we 
should be able to find.
    Mr. Everson. That is right.
    Chairman Gregg. Senator Sessions.
    Senator Sessions. This is an excellent hearing. I am 
delighted to be with you, and I am one who believes that people 
should pay their taxes. They should be as low as we can 
possibly make them, but they ought to pay them. I try to pay 
mine. Most Americans try to pay theirs. And when somebody 
doesn't pay their taxes, they are cheating all of us. If you 
are competing against a business who doesn't pay their taxes, 
it is hard for you to compete when you are doing the right 
thing every day. So I think it is very, very important, and as 
a Federal prosecutor who worked with IRS agents a lot, Mr. 
Everson, I found that they were far more reasonable than most 
of the people they were investigating.
    [Laughter.]
    Senator Sessions. A lot of them were crooks. A lot of them 
used political pressure to get around paying taxes they owed 
and should have paid. But I do think we had this spasm before 
Senator Grassley took over to control the IRS, whatever they 
thought they were doing, and I am concerned we might have gone 
too far. We want this system to be a voluntary compliance 
system. People ought to pay their taxes, and if they are not, 
they ought to expect to be investigated at some point and 
possibly disciplined, if that is the appropriate thing.
    I saw the deal in Italy a number of years ago on ``60 
Minutes,'' and they were raising the taxes to, I think, 95 
percent because nobody was paying them. And so they just kept 
raising them up, and it becomes absurd, of course. Nobody is 
going to pay 95 percent of what they make. So everybody cheats. 
If we can keep it simple and low, I think that is the better 
approach.
    Perhaps you stated it, but I would ask both of you, out of 
this $345 billion estimate over a period of, say, 2 or 3 years, 
if we can commence a series of good reforms, how much of it 
could we recapture?
    Mr. Everson. What I indicated earlier, Senator, was that I 
think that over a period of time you can collect somewhere 
between $50 and $100 billion without changing the dynamic 
between the IRS and the people.
    What we have said is that between now and 2009 we want to 
get the compliance rate from 83.5 percent to 85 percent, which 
gets you about $30 billion in improved compliance. That is a 
combination of things. It is increasing up those enforcement 
revenues further and driving down the noncompliance overall.
    Now, that is relatively modest, but I think what we need to 
do here is gain the experience of reinvigorating the IRS. We 
need to get that tax reform done; that will really help. And we 
need to build off of the legislative proposals for some 
increased reporting, because, again, where there is a third-
party reporting there is greater compliance, and the idea here 
is not to be too burdensome. That is why we have asked credit 
card issuers to report to us gross receipts for a business and 
government entities to report to us the payments for goods and 
services. If we do things like that, I think we can make some 
real headway here.
    Senator Sessions. Mr. Walker, do you have any thoughts on 
how much we could reasonably expect if we took a series of 
appropriate steps, whatever they may be?
    Mr. Walker. First, you should do what can you achieve 
through additional enforcement activities and additional 
communication activities to enhance voluntary compliance and 
you try to provide reasonable assurance that individuals are 
complying with the law and paying their fair share.
    When the Commissioner says $50 to $100 billion, I don't 
know if that is incremental to the $55 billion.
    Mr. Everson. That is a net improvement from----
    Mr. Walker. OK.
    Mr. Everson. From the 345, we figured we brought in 55. I 
am saying you can get another 50 to 100 on top of that 55.
    Mr. Walker. That is helpful.
    Mr. Everson. Some of this is the result of increased 
collection and some is the result of behavioral change.
    Mr. Walker. Right. I understand. He is in a better position 
to give you an estimate on that. I will tell you this, Senator: 
I do not believe that you are going to make dramatic progress 
on the 345 billion unless you get tax simplification and unless 
you end up getting additional information returns in selected 
areas and additional withholding in selected areas. I am happy 
to be more specific if you want.
    Mr. Sessions. Well, my time is up. But, Mr. Chairman, as we 
do tax reform and, Senator Grassley, as we do tax reform, 
perhaps we need to ask the people who are collecting the taxes 
while we are doing it, if we wrote it in a simple, clear way, 
it would be easier to audit, it would be easier for people to--
there wouldn't be the gray areas they might justify not paying 
because it would be more clear, and we may get a better 
compliance rate.
    Chairman Gregg. Thank you, Senator. Obviously that is a 
bigger issue than this committee has a role in, although we can 
clearly be interested in it, as we are. But the things that we 
can impact are the issue of enforcement, because we can fund 
that through the appropriations process with specific language 
in the budget.
    Are there other things, Mr. Commissioner, that the budget 
could do in the way it was written which would assist you in 
collecting and addressing this tax gap?
    Mr. Everson. In terms of the jurisdiction of this 
committee, I think you have put your finger on the issues. 
There is a short-term issue of the President's request, and 
then there is the overall issue of scoring, which goes back and 
forth and has taken different tacks at different times. So I 
think those are two.
    And I echo General Walker's views here, that these are 
significant proposals on the reporting, and I hope that you as 
individual Senators will champion these proposals. They will be 
quite controversial in some communities, principally in small 
business, and some in the banking community will say that the 
credit card issuers may be reluctant to take these steps. So 
you can say this is important from an overall budgetary point 
of view.
    Chairman Gregg. Your one chart--and I appreciate your 
outlining where we can be most helpful, but that one chart on 
individual income tax underreporting gap, which shows the vast 
majority of the money is lack of transparency, is a startling 
chart.
    Mr. Everson. Yes.
    Chairman Gregg. Especially since we are not talking about 
illegal activity here. I mean, if we were talking about illegal 
activity, that would be an understandable number. But since it 
is not illegal activity, one presumes we ought to be able to 
get transparency on it some way.
    Mr. Everson. And if I could make just one point on this, 
because it is important. Most Americans are subject to this 
reporting already. There are about 235 million W-2s that are 
issued each year for about 150 million employees. There is not 
only reporting but, of course, as everybody is aware, 
withholding.
    What we are proposing here is relatively modest but I would 
say quite significant to get some information reporting, say, 
on gross receipts for businesses.
    Chairman Gregg. Mr. Walker, you made a comment that we also 
need to address tax expenditures. Can you define the type of 
tax expenditure you are talking about? Are these like targeted 
tax expenditures? Would these be the same things as an earmark? 
Is that what you are talking about? Or are you talking about 
something that is more broadly determined to be a tax 
expenditure such as the deductibility of mortgage interest?
    Mr. Walker. Mr. Chairman, I will talk to you about this on 
an informational basis because all Senators would be 
interested, but it is not necessarily within the jurisdiction 
of this committee.
    What I am talking about is that ultimately what we have to 
do in order to get our fiscal house in order is that we need to 
do something about the tax gap to make sure that people are 
paying their fair share. We need to do something to constrain 
spending, including reforming entitlement programs. Ultimately 
we will also need to make sure that we have enough revenues to 
be able to pay our current bills and deliver on our future 
promises.
    In doing that, one of the things that is largely off the 
radar screen is the revenue side. We spend $700 to $800 billion 
in deductions, exclusions, exemptions, credits and other types 
of tax preference activities. Some have an economic policy 
impact. Some are for social policy reasons. But they are not 
part of the budget process. They are not part of the 
appropriations process. They are not adequately disclosed in 
the financial statements of the U.S. Government. And yet they 
are $700 to $800 billion a year and growing rapidly. The No. 1 
item is the fact that no individuals in America--pay income tax 
or payroll tax on the value of employer-provided and -paid 
health care, no matter how much money they make, no matter how 
wealthy they are, and no matter how generous their health care 
package might be.
    And so just as you talked before about if you end up 
investing more money in enforcement, that is likely to generate 
revenues, I think we need to think about how we can make sure 
that what is happening on the revenue side, whether it is a 
plus or a minus, comes on the radar screen. Right now it is 
largely off.
    Chairman Gregg. I appreciate that. You are getting into the 
broader concept of tax expenditure when you talk about that. I 
thought you might be talking about a more targeted event, which 
this committee might actually be drawn into that fight, because 
this committee is going to be drawn into the fight of earmarks 
by it being set up as a point of order, it appears. Although it 
won't be going through this committee, it appears it is being 
done by a separate working group somewhere in some back room. 
But it is clearly going to be a point of order, which means 
this committee is going to be involved in that.
    What we are going to do here, since Senator Wyden just 
arrived, we are going to go to Senator Conrad for his second 5 
minutes, then Senator Grassley, then to Senator Wyden.
    Senator Conrad. First of all, let me say my own belief is 
that the tax gap is larger, perhaps significantly so, than the 
estimates. I say that not just based on some feeling, but based 
on our analysis of how this determination was made, and also 
what I have been told by very sophisticated financial firms on 
Wall Street who tell me they see the other side of these 
transactions. They think there is big leakage. They think there 
is significant underreporting on basis by both corporations and 
individuals that is very hard to detect.
    So, first of all, I believe that the tax gap is larger. A 
lot of this is behavioral change. Nobody knows this better than 
General Walker, who used to be in the accounting profession, 
and a very distinguished career there, I might add, with an 
outstanding company which at the time was the gold standard, I 
found in my transactions, absolutely superb people. And there 
has been a change, it is undeniable, in the corporate culture, 
because some of these firms, accounting firms, established very 
aggressive accounting practices after these base estimates were 
made, after the base periods. And so you have had--and I have 
people who I worked with very closely over many years telling 
me, Kent, there has just been a dramatic change in the ethic--
in the ethic--and that because of competition, firms became 
much more aggressive, accounting firms, in helping people and 
companies avoid what they legitimately owe. I believe that is 
the case.
    Could I get a reaction from the two of you on that basic 
proposition?
    Mr. Everson. I think I have covered the point on the 
estimates, and we are going to use the estimates as well as we 
can. And I don't think that changes really how I would do my 
job. There is real money on the table here. We know where the 
larger issues are. And so we are going to do the best we can, 
and we are going to continue to get better estimates, as the 
GAO and others have suggested, as best we can.
    Your point is exactly correct. Our system depends upon not 
being overly intrusive compared to other countries. It depends 
on the integrity of tax practitioners, and there is no doubt, I 
would suggest to you, that over the course of decades, the role 
of professionals has changed.
    I was also at that fine firm that you referenced for 6 
years starting in 1976. And the role of the accountant in that 
era was to make sure that your client adhered to professional 
standards and followed the law. That role migrated to value 
creation and risk management, and this migration has 
compromised the image of both accountants and attorneys, whose 
roles have changed. And that is why in our 5-year strategic 
plan we made one of our four enforcement priorities to assure 
that attorneys, accountants, and other tax practitioners adhere 
to professional standards and follow the law. And we have done 
a lot in this respect. We have increased the size of our Office 
of Professional Responsibility and have a former prosecutor 
doing that work. As Chairman Grassley knows, there have been 
important criminal proceedings that have taken place in this 
area. And I think that the message that this hasten out of 
hand, hasten through.
    Senator Conrad. General Walker.
    Mr. Walker. Senator, I practiced public accounting from 
1973 to 1979 and from 1989 to 1998 with some of the largest and 
best-known firms in the world. It was a fundamental change in 
business and in the accounting profession between those two 
time periods.
    As I said before, corporations do not have duties of 
loyalty to countries. They have duties of loyalty to 
shareholders, and they will do everything that they can in 
order to maximize revenue and minimize expense legally. In 
addition to that, when attorneys and CPAs are representing 
clients in tax planning, they are not independent. They are 
there to try to help their client minimize their tax burden--
legally, of course.
    There has been an explosion of products and techniques to 
try to legally avoid and minimize tax burdens. In today's 
world, where more and more economic activity is crossing 
borders, part of that is the use of sophisticated transfer 
pricing techniques where specialized practices have been 
created, headed by Ph.D. economists and a variety of other 
individuals.
    You have the example that you gave where people will in 
form set up their headquarters in certain tax-advantaged 
locations, but in substance they are not really there. That 
didn't really occur to a great extent in the 1970's, but it 
occurs quite frequently today.
    Senator Conrad. It has changed. It has changed 
dramatically. I have people that I dealt with in the accounting 
profession over many years. Your former firm is the absolute 
gold standard. I found deeply honorable people very, very 
troubled by what occurred.
    Let me go quickly to two other things. Obviously, more 
reporting, more withholding would make a significant 
difference. Let me go, because my time has really expired, to 
the question of tax reform, because my own conviction is, yes, 
we can make progress probably on the order of what, Mr. 
Commissioner, you are suggesting. But for us really to make 
dramatic progress would probably require tax reform that would 
involve simplification and also a system that is just more 
transparent by its nature.
    A final comment on that question?
    Mr. Walker. I think Senator Sessions said it well. 
Ultimately if you want to minimize the tax gap, you are going 
to have to reform the overall tax system to make it as simple 
as possible and, therefore, broadening the base, having much 
fewer exemptions, deductions, and exclusions. You need to keep 
it as simple as possible, enhance the transparency associated 
with income of all different types from all different parties, 
and thereby try to minimize the tax rate that would apply to a 
much broader base and a much simplified tax structure.
    Over the long term, the Congress, in addition to 
streamlining and simplifying the income tax system, may also 
have to consider whether and to what extent it wants to have 
our tax structure more consumption based, because we are the 
only major industrialized country in the world that doesn't 
derive a significant percentage of its revenue through a 
consumption type approach. After all the distribution of wealth 
and income in the United States is fundamentally different 
today than it was in the early 1900's when we created the 
income tax.
    Mr. Everson. I would simply add that I think tax 
simplification is absolutely essential. As I indicated in the 
oral statement, complexity obscures understanding. And so it 
hurts the taxpayer who desires to be compliant, and it also is 
a tool of taxpayers who seek to obscure their true activities 
from us as tax administrators.
    Mr. Walker. And if I can quickly say, Senator, I have for a 
number of years prepared my tax return by hand, and I am a CPA. 
It is mind-numbingly complex. Even for an individual who wants 
to pay every dime that they owe, it is tough to be sure that 
you have done it right. It is unbelievably----
    Senator Conrad. Can I just say, as a former tax 
commissioner, I would be happy to review your return and make 
sure you are paying----
    [Laughter.]
    Mr. Everson. I will say this. If he has a problem and in 
any way we have mishandled it, David, just call me personally.
    Senator Conrad. Can I just conclude by saying I would ask 
for both of you, if you could provide to us in writing your 
recommendations on what we could do to really make progress, 
whether they are on the tax reform side or the administrative 
side, your recommendations to us.
    Mr. Everson. The Administration proposed, in its Fiscal 
Year 2007 Budget Request, five new legislative changes to 
reduce the tax gap and re-proposed four legislative changes to 
improve tax administration efficiency. In addition, the 
Administration noted that it would strudy the standards used to 
distinguish between employees and independent contractors for 
purposes of withholding and paying federal employment taxes. 
The nine legislative proposals are:

                      Closing the Tax Gap

      1. Clarify the circumstances in which employee leasing 
companies and their clients can be held jointly liable for 
federal employment taxes. This proposal would facilitate the 
effective use of third party employee leasing companies by 
small businesses to pay employment taxes. In addition to 
clarifying joint liability, it would also provide standards for 
holding employee leasing companies solely liable for such 
taxes, if they meet specified requirements.  
    2. Increase information reporting on paypment card 
transactions. In order to improve compliance, annual reporting 
to the IRS would be required for aggregate payment card 
reimbursements made to certain businesses in a calendar year.  
    3. Expand information reporting to certain payments made by 
Federal, State, and local governments to procure property and 
services. This proposal would improve tax compliance of those 
taxpayers who do business with government agencies.  
    4. Amend Collection Due Process procedures for employment 
tax liabilities. For Collection Due Process purposes, this 
proposal would align the treatment of levies to collect 
employment taxes with the treatment of levies to collect 
Federal taxes from State tax refunds. The proposal would 
curtail delinquent employers' ability to pyramid myltiple 
periods of unpaid employment tax liabilities. Taxpayers would 
retain the ability to seek managerial appeal and to participate 
in the formal Collection Appeals Process.  
    5. Expand to non-income tax returns the requirement that 
paid return preparers identify themselves on such returns and 
expand the related penalty provision. This proposal would 
address the growing problem of return preparers who assist in 
the preparation and submission of improper excise, employment 
tax, and other non-income tax returns and related documents.

                  Improving Tax Administration

      1. Implement administrative reforms to improve the 
efficiency of IRS operations such as (a) adopt measures to 
reduce frivolous submissions made solely to delay or impede tax 
administration; (b) allow the IRS to terminate installment 
agreement if the taxpayer is not paying as agreed; and (c) 
streamline jurisdictionover collection due process cases in the 
Tax Court.  
    2. Initiate cost savings measures such as: (a) Reduce 
transaction costs by changing the way the Treasury Department's 
Financial Management Services is reimbursed for offsetting 
collections, and (b) expand IRS' authority to require 
electronic filing.  
    3. Authorize the IRS to access employment date in HHS' 
National Directory of New Hires for tax administration 
purposes, including data matching, verification of taxpayer 
claims during return processing, preparation of substitute 
returns for non-compliant taxpayers, and identification of levy 
sources.  
    4. Extend IRS' authority to fund undercover operations, 
which expires on December 31, 2006, to permit the IRS to fund 
certain necessary and reasonable expenses of undercover 
operations, including international and domestic money 
laundering and narcotics operations.
    These legislative proposals strategically target areas 
where (1) research reveals the existence of significant 
compliance problems, (2) the compliance benefit is properly 
balanced against the burden placed on taxpayers, and (3) the 
changes support the Administrations's broader focus on 
identifying legislative and administrative changes to reduce 
the tax gap. The enactment of these proposals would position 
the IRS for improved service and enforcement effectiveness and 
productivity.
    The FY 2006 appropriation for the IRS earmarked $6,382 
million (post rescission) specifically for tax enforcement and 
included an increase of $442 million (post rescission) for 
enchanced enforcement programs, for a total of $6,842 million. 
The Appropriators were able to accommodate this increase as 
part of a program intergrity cap adjustment proposed by the 
Administration in the FY 2006 Budget, and adopted as part of 
the Budget Resolution. This enhancement is a critical component 
of our efforts to reduce the tax gap.
    In the FY 2007 request, the Administration is again 
proposing a program intergrity cap adjustment for IRS 
enforcement. The amount for FY 2007, $137 million, is the 
amount needed to pay cost increases associated with the FY 2006 
enforcement base (the FY 2006 cap adjustment of $442 million is 
now part of the ``base'' and would be included within the 
capped amounts when the Subcommittees receive their 302(b) 
allocations.) The $137 million is necessary to perserve the 
intergrity of the program increase provided in the FY 2006 
budget.

    Mr. Everson. I don't speak to tax policy, as Chairman 
Grassley knows, but we will certainly give you what we can in 
terms of pulling this all together.
    Chairman Gregg. Senator Grassley.
    Senator Grassley. I have a statement I want to put in the 
record, an opening statement.
    [The prepared statement of Senator Grassley follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.107
    

    [GRAPHIC] [TIFF OMITTED] T6726.108
    

    Senator Grassley. I want to bring up something that 
probably would amount to no more than a few hundred million 
dollars that you have on the tax gap there, but probably a few 
hundred million that you may not collect the way we are going 
now, and make a suggestion to you, Commissioner. And that is in 
regard to the interplay between the alternative minimum tax and 
the incentive stock options.
    You know, the idea of our tax law is to encourage people to 
hold their stock to get preferential tax treatment in a very 
legal way, but then we had the dotcom bubble burst of 2001 so 
people received a lot of stock options. They drop in value. 
They don't have it. They have to pay the tax on, you know, what 
is not really income. So I believe that we have a lot of that 
in this tax gap.
    And I have had people in my State come to me about this, 
and probably for every one in my State, there are 50 people in 
California having a problem, maybe Massachusetts, too. But I 
believe the right solution here for the IRS would be to 
exercise its expansive authority that it was given in the 1998 
IRS restructuring bill to provide offers in compromise for the 
purpose of effective tax administration. I think that these 
cases fit well within the type of people Congress is trying to 
assist, people who have honestly paid their taxes for years but 
because the law is working at cross purposes, they are between 
a rock and a hard place. And, unfortunately, the IRS and 
Treasury, I believe, have been overly narrow in construing the 
authority given them in this provision passed in 1998.
    So I have been pushing for quite some time to get the IRS 
and the Treasury to move more open-mindedly on this matter and 
would like to note that I particularly appreciate the Taxpayer 
Advocate's assistance in trying to help some of my 
constituents.
    So I am only asking--I am not asking you to explain right 
now, but if you would make this a priority, because I believe 
it is a way of bringing in some income, that maybe because you 
cannot get blood out of a turnip, you may get nothing.
    Mr. Everson. Certainly, Senator, we will take a look at it 
again. This is a complicated issue because if people exercise 
the options and then hold onto the stock and the stock value 
decreases, they may have a personal economic hardship, and then 
they can come in to us under the offer in compromise program if 
they don't have the money. But sometimes they are asking for a 
blanket exemption, which we tend to feel might require a 
statutory review.
    So we will certainly take a look at it, of course.
    Senator Grassley. OK. And then just for the benefit of the 
Budget Committee, I would say that Senator Baucus and I have 
made the tax gap a very major effort of ours over the last 
couple years, working very closely with the Commissioner trying 
to take care of some of these industries that are promoting tax 
shelters, a lot of them that leave the poor taxpayer owing the 
Government a lot of money and thought they were getting honest 
advice that just was not very good advice.
    But in addition, Senator Baucus and I asked the Joint Tax 
Committee to study, and they came out a year ago with a report. 
Some of it, as the General has suggested, just changing tax 
laws to bring in more revenue, not from people cheating on it 
necessarily, and some of these are very controversial: repeal 
of the mortgage interest deduction for home equity loans, 
subject State and local workers to Medicare tax, apply the 
payroll tax to most fringe benefits, allowing the offshore 
activities of U.S. companies to be exempt from U.S. taxes, 
examples of things that are very difficult to deal with and 
very popular with taxpayers.
    Then they had another part of it that dealt with the tax 
gap, in other words, people cheating, and we are trying to zero 
in on those efforts, and efforts that are not there, some 
things that our respective staffs are coming up with.
    And then, last, sometime last year we held a hearing on 
leakage of the payroll tax system, in other words, how it 
basically impacts upon solvency of Social Security. And, again, 
some of those are very controversial, probably would be real 
easy to handle in the context of overall Social Security reform 
because they deal with small business, maybe more difficult to 
deal with the case in isolation, although I am not saying that 
they shouldn't be dealt with in isolation, but, you know--well, 
I guess I have said what I wanted to say.
    Thank you, Mr. Chairman.
    Mr. Walker. Can I comment real quick, Mr. Chairman, on 
this?
    Senator Grassley, I realize that there are two dimensions, 
as you properly pointed out, with regard to this revenue issue, 
one of which is what can be done to try to reduce the tax gap--
you will never eliminate it--and the other is what type of 
broader tax reforms might be necessary. And they are very 
different things.
    Candidly, based upon any reasonable set of assumptions 
given where we are at and where we are headed fiscally, in 
addition to minimizing the tax gap--and I think things can and 
should be done through additional information returns and 
withholding and targeted enforcement activities--there is no 
question that you are going to have to make some tough choices 
in order to generate enough revenues to be able to pay our 
current bills and deliver on our future promises. And it is 
going to require real tough choices that are not going to be 
popular.
    Frankly, one of the things that I am trying to do is to try 
to help pave the way for people to understand that, because 
realistically, elected officials cannot get too far ahead of 
their constituents, and their constituents need to understand 
where we are and where we are headed and what the consequences 
are for their kids and for our country if we don't start 
dealing with some of these things.
    Senator Grassley. The only think I would add to what you 
said is that the other side of the equation is the extent to 
which Congress over the last 4 years, maybe unrealistically, 
overpromised, and promises that cannot be kept as well, maybe 
not badly intentioned at the time, but how unrealistic they are 
right now, that you couldn't close the gap just on the revenue 
side.
    Mr. Walker. Absolutely. The current liabilities and 
unfunded commitments of the United States, which includes 
unfunded promises for Social Security and Medicare--just those 
two, not Medicaid--are $46 trillion in current dollar terms, up 
from $20 trillion 5 years ago, and growing every second of 
every day.
    Chairman Gregg. A startling number.
    Senator Wyden.
    Senator Wyden. Gentlemen, thank you, and thank you for your 
service, and both of you have been very helpful to me.
    I have introduced the Fair Flat Tax Act, S. 1927, and in 
the legislation--I am going to hold it up--is a one-page 1040 
form. I filled it out myself. It took about half an hour, and 
that in and of itself is kind of a revolution for a member of 
the Senate Finance Committee to actually be able to do their 
own taxes. And a reporter called yesterday and said he did his 
in 15 minutes using my form.
    It is pretty straightforward. You take your income from all 
your sources, subtract your deductions, add your credits, and 
send it off to Mr. Everson and say to the IRS, ``I'm done. Have 
a nice day.'' The end.
    What I find so baffling is I have a one-page 1040 form, the 
President's Commission that reported this fall, their proposal, 
colleagues, is maybe six, seven lines longer, but for purposes 
of Government work, they are pretty darn close. What are the 
problems in terms of actually getting this done?
    I pressed Secretary Snow on this a week ago. I just for the 
life of me can't understand why an effort can't be begun 
immediately to jump-start this tax reform. I have one approach. 
The President has another. A Democrat is saying that the 
Republicans have some good ideas.
    What is the problem here? Why can't this be well underway?
    Mr. Everson. I, again, as you can appreciate, do not speak 
for the administration on tax policy. I have said consistently, 
including before the tax panel last March, that I believe 
reform is essential. As I indicated actually before you came 
in, Senator, simplification is one of the most important 
answers in terms of reducing the tax gap, which is the subject 
of today's hearing. So I am a strong advocate of moving forward 
with reform.
    Senator Wyden. But specifically on the idea of taking what 
I have and what the administration's proposal has--and others, 
by the way, have good ideas as well--wouldn't that make sense 
doing that now?
    Mr. Everson. I think that Treasury is looking at the reform 
panel ideas, and I am sure that as they do that, they are 
cognizant of what else is also out there, including your 
proposal.
    Senator Wyden. You are being very diplomatic. When I tried 
to get them to put this on deadline or anything resembling some 
sense of urgency, it just wasn't there.
    Mr. Everson. It is in my self-interest to be diplomatic.
    Senator Wyden. Yes, it is.
    [Laughter.]
    Senator Wyden. Mr. Walker, you are a good man. Any thoughts 
on this?
    Mr. Walker. From a policy standpoint, it absolutely makes 
sense. From the standpoint of trying to close the tax gap, it 
absolutely makes sense.
    There are a lot of people, Senator, vested in the status 
quo. Not everybody is for transparency. Not everybody is for 
broadening the base because they have their special preferences 
and an interest in maintaining their special preferences. And 
my view is it is also a matter of what other priorities exist 
at any given point in time as to where decisionmakers are going 
to allocate their time and political capital.
    The sooner, the better, from the standpoint of streamlining 
and simplifying the Tax Code, not only from the standpoint of 
the tax gap, but in order to minimize tax burdens and enhance 
economic growth and efficiency.
    Senator Wyden. There are plenty of interests that will 
oppose this, you are right. But unlike Social Security, there 
are not going to be any rallies outside a Member of Congress' 
office saying, ``I love the Internal Revenue Code.''
    I am going to do everything I can with colleagues on a 
bipartisan basis to see what I can do to goad both political 
parties into getting into this.
    Gentlemen, in your view, how much of the underreporting and 
underpayment of taxes is due to genuine confusion--genuine 
confusion--due to complexity, and how much is due to cheating? 
Give me just a ballpark figure because I know, Mr. Everson, 
there are a lot of issues with respect to how that is 
calculated. But give me a ballpark assessment of how much you 
think is confusion, how much you think is people trying to cut 
corners.
    Because willful noncompliance has to do with the motivation 
of the taxpayer at the time he or she filed his or her tax 
return, it is virtually impossible to know for certain how much 
of the tax gap is due to genuine confusion as opposed to 
cheating. While our auditors may be able to identify what 
appear to be obvious cases of willfulness or simple mistakes, 
in the vast majority of cases, the motivation of the taxpayer 
is not at all clear. Moreover, it is not realistic to rely on 
taxpayers themeselves to indicate whether they deliberately 
tried to understate their tax liability. Finally, many taxpayer 
mistakes arise from not doing something that should have done, 
which could be caused by anything from innocent carelessness to 
willful evasion. It is not difficult for an auditor to note 
what was not done, but it is often virtually impossible to be 
certain about why.
    That fact that reporting accuracy is much worse in the 
absence of third-party information reporting and withholding 
suggests that, with respect to income reporting, many taxpayers 
exploit their opportunities to be noncompliant. It also suggest 
that information reporting makes it easier for honest taxpayers 
to comply. More significantly, the growing complexity of the 
tax law is a primary driver of the tax gap, creating both 
genuine confusion and opportunities for those who wish to 
exploit the tax law.
    Mr. Everson. I would decline to do that, Senator. While we 
directionally are trying to work on that issue through our 
research, we don't have precise conclusions at this point even 
to give a ballpark. What I would suggest to you, though, is 
that there is no doubt that confusion is a very real 
contributor here.
    Look at something like the EITC or look at some of the 
other credits that are out there. Complexity is quite 
significant and a great challenge to individuals as they try to 
navigate educational credits, of which there are a number.
    Senator Wyden. I still think it is important for you all to 
give us a ballpark estimate of what this problem is all about. 
I understand it is difficult. But I would like to ask you, as 
one member of the Finance Committee and someone on this 
committee as well, to get back to us with even a ballpark 
figure, because to just say, well, we cannot give that.
    Mr. Everson. Well, I will talk to our research people to 
see whether they can do that.
    Senator Wyden. Right.
    Mr. Everson. I must tell you that, they are pretty reticent 
to say something that they don't feel is substantiated.
    Senator Wyden. I understand, but I think we owe it to our 
constituents to get a general sense so that we know what it is 
we are tackling.
    One more question for you, Mr. Everson. What is it going to 
take to make those yellow boxes blue? My understanding is that 
the yellow boxes are the areas where we are not making the kind 
of progress we need in terms of the audits.
    Mr. Everson. Yes.
    Senator Wyden. Can you give us a deadline when those yellow 
boxes will be blue so that people will see that there are 
modernized criteria with respect to how taxes are determined?
    Mr. Everson. We are looking now at the continuation of our 
research programs. One thing we have done this year is work on 
S corporations. S corporations have exploded over the last two 
decades in terms of being used as pass-through entities. They 
don't even show up on that yellow piece there, if you will. But 
that is where we are looking now.
    As I indicated, I think before you came in, if you look at 
what we do in terms of the corporation side, which is the 
biggest piece of the yellow, our coverages there are 
significantly higher by a factor of 10fold or more than what 
they are on the individual side. That is why we have not gone 
forward to do research per se on that issue.
    I would say to you that as we look at this program, we will 
probably be more inclined to circle back and update the 2001 
figures on the individual side and probably do more on the C 
corporations.
    Senator Wyden. Now, the administration's budget expands 
third-party reporting of income for additional transactions as 
part of its proposal to close the gap. They propose 
specifically expanding third-party reporting to include 
Government payments for goods and services as well as debit and 
credit card reimbursements paid to merchants. But the proposal 
for expanded third-party reporting does not include third-party 
reporting of investment income.
    I find it very troubling. What I did with my tax reform 
proposal was build on what Ronald Reagan said in 1986, that, 
marginal rates are a big deal, they send a powerful message 
with respect to growth and opportunity, but we ought to treat 
all income the same, which is, of course, what was done in 
1986.
    And so I want to continue to try to build on the philosophy 
that Ronald Reagan laid out and would simply ask, Why aren't 
you applying the same rules to investment income that apply to 
wage, interest, and other income?
    Mr. Everson. I guess my answer to that, Senator, is the 
five proposals we have made as well as the commitment we have 
made to look at the definition of employee versus independent 
contractor, which is really going to cause a firestorm. That 
definition has been locked in since 1978, and since then the 
employment model has really changed with many more independent 
contractors. I do consider them a very significant set of 
proposals. If we can work and get these done, then, of course, 
we ought to look at what other issues need to be included.
    What we have not done in our proposals, by the way, is send 
specific language over to Finance or Ways and Means. We have 
said we want to do this and then will work with you on the 
details. So we are open to discussing what needs to be done 
here, but I do view it as very important that we are again 
tackling this issue substantially for the first time in 20 
years.
    Senator Wyden. I share your view, and I think it is helpful 
that you are. I just am concerned that right out of the box 
again we are going to set up a double standard in this country. 
And colleagues have heard me talk about that we have two 
standards in America: one for people who work for wages and 
another for folks who make their money from investments. I am 
not interested in soaking anybody. I believe in markets. I 
believe in creating wealth. But when the cops on the street 
gets a raise, they pay 25 percent of their income to the 
Government in taxes, pay Social Security payroll taxes on top 
of it, and the person who makes their money on capital gains 
and investments pays 15 percent and no Social Security payroll 
tax, looks at this budget and says, Hah, down in Washington, 
D.C., they are talking about closing the tax gap, I hear all 
about that, but we got one set of rules that apply to me and we 
got another set of rules that apply to the investor.
    Mr. Everson. I would point out, as you know, there is very 
good reporting in the dividends and interest areas already, and 
that is why the noncompliance rate is very low there.
    Chairman Gregg. Senator Sessions.
    Senator Sessions. Quickly, I would ask Mr. Everson, if we 
had tax simplification, would that not help your auditors and 
reduce the time that they spend and help them be able to focus 
more on the abuses?
    Mr. Everson. Absolutely, sir.
    Senator Sessions. Could you suspend CPAs and attorneys, 
short of some criminal or ethical prosecution, for 
irresponsible advice or lack of professionalism? And would that 
be something you could accomplish with far less litigation than 
might otherwise be the case?
    Mr. Everson. We have strengthened professional 
accountability over the last several years through doubling the 
size of our Office of Professional Responsibility. There is 
something called Circular 230, which is standards that govern 
the conduct of attorneys and accountants who practice before 
us. We have included for the first time a provision that says 
said if you get an opinion from an attorney that you are doing 
the right thing, then you get out of paying penalties if the 
Service audits you and says that transaction does not work. We 
have said now how those opinions have to be developed for 
shelter transactions. That is a very important step.
    We continue to monitor this area and look to do more, but, 
again, the leverage of making sure the practitioners are 
responsible is also essential and keeps us from having to, if 
you will, have more auditors. We have to have integrity in the 
attorneys and the accountants.
    Senator Sessions. Well, most accountants I think really do 
try to do the right thing, and when they sign their name on 
there, they expect you to know that they have done professional 
diligence. Would you not both agree on that?
    Mr. Everson. Yes, that is absolutely correct, and the steps 
we have taken, including the steps you have taken in the 
Congress--for example, the JOBS Act, which provides tougher 
standards and penalties for people who go awry of the 
standards--are important. And the other thing we are asking 
with one of the five proposals, gets to preparer standards on 
the non-income tax type reporting. So that is in the mix. We 
are trying to do more there, and we are asking for you to pass 
some new law on that issue.
    Senator Sessions. Mr. Walker, would you like to comment as 
a CPA yourself?
    Mr. Walker. I would agree that simplification would do a 
lot to take enforcement pressure off of the IRS and help them 
target much more. I also agree that a vast majority of CPAs, 
and I am sure attorneys as well, try to do their job to the 
best of their ability and in compliance with the laws and 
regulations as they understand them, although I think we have 
to keep in mind we live in a gray world.
    Mr. Everson. Let me make one final point. Practitioners 
come to me all the time and say, ``We applaud what you are 
doing, going after the bad practitioners,'' because it is a 
competitive disadvantage when somebody in your State is saying, 
``I can get you a better deal with the IRS'' when they really 
are just, you know, smoking something.
    [Laughter.]
    Mr. Everson. That is the drug business we were talking 
about.
    Chairman Gregg. You are implying that to deal with the IRS 
you should be smoking something.
    [Laughter.]
    Senator Sessions. I dealt with a good lawyer when I was 
United States Attorney, and he came to me and he said, ``Tell 
me what the law is. I am telling my client they have to pay 
taxes on this. The competitive businesses down the street are 
not paying taxes on it. They think I am costing them money. 
What is the law? What should we do?'' It was a fair question, I 
thought. I am not sure that he ever got a clear answer.
    With regard to your allocation, Mr. Everson, of the 
resources you get in total, are you satisfied that you have the 
resources in the right areas? I do notice that your customer 
service seems to be working. Complaints are down, and audits 
are beginning to go back up. Those are good things. Are you 
confident as Congress mandates money in certain ones of these 
accounts, whether it is audits or compliance or those things, 
are we requiring expenditures and organizations of your office 
that make you less efficient than you would like to be? And can 
we help?
    Mr. Everson. Broadly speaking, let me say this. We have 
three strategic objectives for the IRS: one is to continue to 
improve service to taxpayers; the second is to significantly 
enhance enforcement of the law; and the third is to modernize 
the IRS.
    This only works if we support all three in a balanced 
manner, and that includes the funding. So it would be a bad 
cocktail to give us more money for enforcement but to cut 
services or the IT infrastructure, because they all have to 
work together. And it is important to leave, I believe, the 
latitude to the Government managers--there are only two 
appointees in the whole agency--to take those funds and use 
them wisely.
    So I do worry that we are in a bad space. We are in the 
TTHUD Subcommittee on Appropriations. And if you look at the 
President's request, HUD is down by 2 percent and 
Transportation by something like 9 percent. I looked at the 
Federal Page the day after the budget came out. If you look at 
the non-Homeland, non-DOD domestic discretionary budget, it is 
a tough corner of the budget to be in.
    So, yes, I ask you to do what the President asks and 
provide us the funds that we have requested and let us be free 
to spend them as wisely as we can.
    If I could make one final pitch: please do your job on 
time. We are a big operational agency, and when you give us 
moneys or write language into the appropriations process 2 or 3 
months into the year saying don't do this or do that, then it 
is very hard for us, particularly with the curb we have on our 
spending, to implement some of those provisions.
    Chairman Gregg. Thank you. Let me thank you very much for 
your time. You have given us a lot of time today.
    Senator Conrad. Might I have a minute?
    Chairman Gregg. Yes.
    Senator Conrad. Two quick things, and I would say this to 
the Commissioner. My own brother called me. My brother prepares 
returns for people. He used to be the head of the Office of 
Management and Budget in our State. And he said in the office 
in Bismarck, the IRS office, it is on the second floor of a 
building, of a bank building. Forms are not available on the 
first floor by some agreement with the bank. And when you call 
to see if forms are available, he was unable to get through 
repeatedly in Bismarck, North Dakota. And if you could check on 
that and if we could do something to----
    We appreciate that your brother pointed out this issue. 
There is an IRS office on the third floor of the same building 
in which the bank is located. We did some checking with the 
bank and determined that it does not appear that the bank ever 
distributed tax forms in its lobby. We recently placed a new 
sign on the first floor of the building. This sign indicates 
the location and hours of available tax assistance and also 
indicates that Tax Forms are available in the IRS office.
    In addition, IRS forms and publications are available in 
downtown Bismarck at the Veteran Library on North 5th Street. 
Forms also can be downloaded for free from IRS.gov and they are 
available free by calling 1-800-TAX-Form.
    Mr. Everson. Certainly.
    Senator Conrad. You know, when my brother calls--my brother 
in 19 years has never called me about any governmental matter. 
But he said, you know, ``Kent, it just not good service to 
taxpayers in the capital city of our State.''
    Mr. Everson. Certainly.
    Senator Conrad. One final thing I would say. When I was tax 
commissioner, an accountant came to me one of the first days I 
was in office and brought me his list of clients with a 
recommendation that I audit them.
    [Laughter.]
    Senator Conrad. I thought that was a rather curious thing.
    Chairman Gregg. It would be helpful, if you can do this--
and maybe you can't do this, but the administration asked for 
$137 million of additional funding, set up in this special 
mechanism that basically gets you additional funding on top of 
whatever TTHUD can do for you. If you can give us an estimate 
of what that would represent in broad terms, in additional 
receipts as a result of better enforcement, that would be very 
useful to us, to maybe even go beyond $137 million.
    The $137 million you mention represents funds that provide 
for the pay raise and non-pay inflation associated with 
maintaining the enforcement base and building from Fiscal Year 
2006 hiring. As these funds are intended to maintain the 
enforcement base, we measure that not in terms of additional 
receipts but rather the potential for lost revenue without the 
increase. As I reported last year, our FY 2006 initiative will 
yield a $4 to $1 enforcement revenue return per year once fully 
implemented. In addition, the increased enforcement presence 
will have a deterrent effect on those who are tempted to abuse 
the tax law. To clairify, if Congress does not provide the 
additional $137 million to maintain its FY 2006 enforcement 
build, the Federal Government would lose approximately $4 for 
every $1 reduced and the deterrent effect of the unfunded 
enforcement activities. If Congress provided additonal funding 
for enforcement activities in which the additonal funds were 
invested.
    Mr. Everson. Yes, sir.
    Chairman Gregg. Thank you, and I appreciate very much your 
time, and I appreciate your service. Both of you do 
extraordinary work for our Nation, and we thank you for using 
your talents on behalf of the American people.
    Mr. Everson. Thank you.
    Mr. Walker. Thank you.
    Chairman Gregg. Our next witness is going to be Nina Olson, 
who is the Tax Advocate.
    Ms. Olson, we appreciate you taking time to come today. We 
appreciate your job as Tax Advocate and we look forward to your 
thoughts. You have obviously listened to the Commissioner and 
the General. Give us your thoughts.

    STATEMENT OF NINA E. OLSON, NATIONAL TAXPAYER ADVOCATE, 
                   TAXPAYER ADVOCATE SERVICE

    Ms. Olson. Mr. Chairman, Senator Conrad, and members of the 
Committee, thank you for inviting me here today to testify 
about the tax gap.
    The tax gap is a serious problem because it deprives our 
Government of much-needed revenue and imposes excessive burdens 
on compliant taxpayers. The average individual tax return is 
effectively assessed a surtax of more than $2,200 each year to 
subsidize noncompliance by others. That is simply unacceptable.
    The starting point for addressing the tax gap is solid 
research about the causes of noncompliance. The IRS needs more 
information to determine the best allocation of its resources 
after taking into account both the direct and indirect effects 
of its activities on tax revenue. Not all forms of taxpayer 
service and not all enforcement measures have the same affect 
on compliance.
    For example, if the IRS is given additional funds to combat 
noncompliance, will the IRS get the biggest bang for its buck 
by spending the funds on strengthening enforcement or on 
improving taxpayer service? If the answer is enforcement, 
should IRS continue to target corporate tax shelters or should 
it move more aggressively against the cash economy? If the 
answer is that funds are better spent on taxpayer service, 
should the IRS expand existing taxpayer services or should it 
develop new services that take advantage of the latest 
improvements in technology?
    Unfortunately, the IRS has little reliable research to help 
guide its choices. Simply put, we need more extensive research 
to make optimal fully informed resource allocation decisions. 
We do not know the return on investment of taxpayer service 
moneys because the IRS does not measure it.
    I want to stress that not all the tax gap is attributable 
to deliberate cheating. The sheer complexity of our 1.5 million 
word Internal Revenue Code leads to significant inadvertent 
error, particularly on the part of small-business owners and 
low and middle income taxpayers who have limited resources yet 
are expected to comply with particularly complex requirements.
    As the IRS works to reduce the tax gap, its choices should 
reflect the central role that taxpayer service, particularly 
taxpayer assistance, outreach and education, plays in achieving 
long-term compliance.
    Congress also has an important role to play here. If you 
adopt fundamental tax reform that puts a premium on 
simplification, inadvertent errors will decline. In my 2005 
annual report to Congress I outlined six common sense 
principles for tax reform. And if you are able to construct a 
tax system that reduces what I call opportunities for 
noncompliance that will go even further to reducing the tax 
gap.
    Data released yesterday show that the most significant 
source of the tax gap is economic transactions that go 
unreported to the IRS, what I call the cash economy. Consider 
this: where payments are subject to tax withholding, compliance 
is almost 100 percent. Where payments are subject to Form 1099 
or other third-party information reporting to the IRS, 
compliance is about 96 percent. But where economic transactions 
are invisible to the IRS the compliance rate drops 
dramatically, perhaps to around 50 percent, although no one 
knows for sure.
    These data tell us what most people would intuitively 
expect. When a taxpayer believes IRS knows he has received a 
payment, the taxpayer will surely comply. When a taxpayer 
thinks the IRS has no clue he has received a payment, the 
likelihood he will comply plummets.
    If we are then to successfully address the tax gap I 
believe that Congress must examine ways to expand such 
reporting. In some cases the burden of requiring third-party 
information reporting will outweigh the benefits. But the tax 
gap is composed of many different types of taxes, types of 
noncompliance, and types of taxpayers. There is no one silver 
bullet that will eradicate all components of the tax gap once 
and for all. So we should begin by identifying various 
categories of transactions that currently are not subject to 
information reporting and consider on a case-by-case basis 
whether the benefits of requiring reporting outweigh the 
burdens such a requirement would impose.
    In the meantime there are many steps Congress or the IRS 
can take right now that would chip away at the tax gap. In my 
2005 annual report to Congress I made a number of 
administrative and legislative recommendations that are 
summarized at the end of my written statement. For example, 
some self-employed taxpayers who really do want to comply fall 
behind on their tax payments and simply cannot save enough 
money during the year to make quarterly payments. Thus, the IRS 
should encourage self-employed taxpayers to sign up for 
automatic monthly payments of estimated tax from their bank 
accounts like they pay their car payments or their mortgages. 
We already have a system capable of receiving regular payments. 
We need to do more to promote it.
    Under current law an individual taxpayer can escape 
information reporting by incorporating. For Form 1099-
Miscellaneous information reporting purposes there should be no 
distinction between taxpayers providing the same services for 
compensation merely because one taxpayer is incorporated and 
another has not. Therefore, we recommend that many corporate 
taxpayers be subject to 1099 Miscellaneous reporting 
requirements to the same extent that unincorporated businesses 
are today.
    My report also contains recommendations to promote 
voluntary withholding agreements, to require backup withholding 
on payments to taxpayers with a demonstrated history of 
noncompliance, and to develop local compliance initiatives 
tailored to the unique economies of different regions of the 
country.
    We also recommend that Congress require brokers on a going 
forward basis report to taxpayers and the IRS the cost basis of 
publicly traded stocks and mutual funds when these shares are 
sold.
    In conclusion, I am pleased that the IRS is making the tax 
gap a priority. I am pleased to see strong Congressional 
interest in this issue, and I am hopeful that we will make 
strides to collect more of what is due, yet with minimal burden 
on the taxpayer.
    Thank you.
    [The prepared statement of Ms. Olson follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.050
    

    [GRAPHIC] [TIFF OMITTED] T6726.051
    

    [GRAPHIC] [TIFF OMITTED] T6726.052
    

    [GRAPHIC] [TIFF OMITTED] T6726.053
    

    [GRAPHIC] [TIFF OMITTED] T6726.054
    

    [GRAPHIC] [TIFF OMITTED] T6726.055
    

    [GRAPHIC] [TIFF OMITTED] T6726.056
    

    [GRAPHIC] [TIFF OMITTED] T6726.057
    

    [GRAPHIC] [TIFF OMITTED] T6726.058
    

    [GRAPHIC] [TIFF OMITTED] T6726.059
    

    [GRAPHIC] [TIFF OMITTED] T6726.060
    

    [GRAPHIC] [TIFF OMITTED] T6726.061
    

    [GRAPHIC] [TIFF OMITTED] T6726.062
    

    [GRAPHIC] [TIFF OMITTED] T6726.063
    

    [GRAPHIC] [TIFF OMITTED] T6726.064
    

    [GRAPHIC] [TIFF OMITTED] T6726.065
    

    [GRAPHIC] [TIFF OMITTED] T6726.066
    

    [GRAPHIC] [TIFF OMITTED] T6726.067
    

    [GRAPHIC] [TIFF OMITTED] T6726.068
    

    [GRAPHIC] [TIFF OMITTED] T6726.069
    

    [GRAPHIC] [TIFF OMITTED] T6726.070
    

    Chairman Gregg. Thank you very much. I appreciate that 
statement.
    A lot of what you talked about, of course, is not within 
the jurisdiction of this Committee but just pursuing some of it 
just for my own edification and because it is part of the 
process of resolving this, you are basically saying that we 
could do some minimal things in the area of reporting--well, 
not minimal but some things in the area of reporting which are 
doable--let us put it that way rather than minimal--such as 
requiring--I like this idea of basis being reported 
prospectively.
    The Commissioner talked about having credit cards reported. 
Is that included?
    Ms. Olson. That is not in our report, although I do not 
particularly have any objections to that myself.
    Chairman Gregg. Would that accomplish some of the goals?
    Ms. Olson. I think it would. I think that the $11 billion 
that shows up in this new tax gap estimate for capital gains is 
about double what the IRS originally estimated the last time 
they estimated it, and is more than the tax gap attributable to 
the Earned Income Tax Credit which we throw a lot of resources 
at.
    So I think that $11 billion dollars is really interesting 
in terms of where you might want to pay attention.
    I think the unreporting of--the not reporting payments to 
small corporations--our recommendation was corporations with 50 
or fewer shareholders--goes to a trend I am seeing where 
Schedule C sole proprietor taxpayers are converting to the 
corporate format for legitimate non-tax reasons, limited 
liability, those sorts of concerns. And S Corporations and 
small corporations are the forum of choice. And they are really 
operating as independent contractors but in the corporate 
format.
    So we are losing a lot of information there that we could 
just very simply and inexpensively document match to see 
whether those payments are showing up on the S Corporation's 
gross receipts.
    I think that is where is some real money is. And again, 
when people think we are going to get that information they 
report it. It makes them nervous. And as I have often said, I 
like a society of nervous taxpayers because that changes their 
behavior.
    Chairman Gregg. On that theme of making people nervous, if 
we were to take $137 million the Administration has asked for 
and doubled it as an available resource for the purposes of 
enforcement, do you think that would make enough people nervous 
so we would generate significantly more revenues?
    Ms. Olson. The one concern I have about that is that the 
IRS has done a lot of hiring in the last couple of years 
because of Congress's support for building the enforcement 
side. And when you have a lot of new trainees you have problems 
with the kind of audits that you are able to give them to work 
on.
    And so although you might not max out on the IRS's ability 
if it had fully trained auditors, that many auditors or that 
many collection people, they will not be fully trained over a 
period of time. You might max out on what kind of work we can 
actually give them in a particular area.
    Chairman Gregg. But you have to start training them some 
time. You are never going to get to the point of being able to 
do a complex tax shelter deal unless you put people in the 
pipeline so that four or 5 years from now can do it.
    Ms. Olson. I believe that what we need to have is over a 
period of years this hiring initiative so that each year we are 
bringing on more people and being adequately able to train them 
and having them at various levels.
    Chairman Gregg. Does the IRS need some sort of differential 
in pay, such as we did with the FBI, in order to get talented 
people into the technology area?
    Ms. Olson. That is a very interesting comment. I think that 
is very true. I think that my biggest concern right now--it is 
not my biggest concern but a great concern I have is on the 
business systems modernization. I believe that we really do 
need to support that initiative.
    So many times in the cases that my office gets, and our 
cases are increasing. They increased 17 percent last year on 
and year-to-date they are increasing 11 percent, taxpayers that 
are having significant hardships in their dealings with the 
IRS.
    When we go out to the IRS and ask, can we fix this problem, 
so many times the answer is we cannot fix it systemically 
because of our systems. And so there is a real taxpayer service 
and problem-generating aspect to our systems, that they are 
just so far behind where they need to be. They create work and 
they create problems for the IRS. And our employees are 
spending time on those problems that are being generated just 
by our systems and not by enforcement actions.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman. And thank you for 
being here as a witness. It is important to the work of the 
Committee and the work of the Congress.
    Let me just say what we have heard there this morning is 
the gross tax gap is roughly $350 billion a year. I believe 
that that is probably a conservative estimate based on the 
analysis that we have done.
    And we have heard from the Commissioner that he believes he 
could collect an additional $50 billion to $100 billion a year 
if we took the appropriate steps. And he focused on reporting 
and withholding.
    You have indicated today that in your analysis of where 
there is under-reporting taxes to the Revenue Service that in 
those areas where there is withholding there is almost 100 
percent compliance. In those areas where there is reporting 
there is almost 96 percent compliance. But where there is not 
reporting, where there is not transparency, compliance falls to 
perhaps 50 percent.
    Interestingly enough, I was talking to a major Wall Street 
firm with significant research capabilities. They had almost 
the identical estimate that they gave to me some months ago in 
a conversation I had. That where there is not reporting they 
believe, from observing the other side of transactions, that 
compliance is way off.
    So if we were to engage in more transparency--because after 
all the vast majority of people, as your testimony indicated, 
the vast majority of people do have those requirements. Is not 
that the case?
    Ms. Olson. Right. That is correct.
    Senator Conrad. What percentage of the people have 
reporting requirements now? What percentage of taxpayers? Has 
your work revealed what that would look like?
    Ms. Olson. Commissioner Everson said this morning that we 
get 235 million W-2s and there are 150 million employees. We 
get about 130 million individual returns a year. I do not have 
the answer to your questions exactly but we can go back and ask 
IRS to comment.
    Senator Conrad. Let me just say in business school we 
always talked about the 80/20 rule: 80 percent of your problem 
is with 20 percent of your clientele. If that rule applies 
here, and there are many variants on it, maybe it is 85/15. But 
the point is a fraction of your clientele--or in this case 
taxpayers--is the bulk of your problem.
    Do you believe that is the case here?
    Ms. Olson. I think that is. And then I think that within 
that fraction there are many different reasons why they are 
noncompliant. We have spent a lot of time over the past 3 years 
focusing on the cash economy and the problems of self-employed 
individuals. I prepared returns for a living for 27 years and 
was a tax lawyer representing taxpayers in controversies. So I 
did not do the planning side. I got them when they had problems 
already and tried to get them out.
    And so much of the time the non-reporting, the 
underreporting, was not because they did not want to be 
compliant. It was because they just could not save or because 
their neighbor was also cheating and they felt that they cannot 
compete, they have to get away with that kind of cheating.
    And that has really led me to thinking about how do you 
change norms of behavior? And that goes to long-term 
compliance. This is the issue Senator Grassley was concerned 
about, that you get one fix 1 year. How do you convert people 
from noncompliant people to compliant taxpayers?
    Senator Conrad. Let me just tell you when I was Tax 
Commissioner I had a program that I declared a period in which 
people could come in who had been tax cheating and I would 
suspend penalties. I would charge them interest but I would 
suspend penalties. It was amazing what we got.
    I remember one man had not paid any income taxes to our 
State since the Korean War. I had one man come in who was a 
priest. He had not paid taxes in 22 years. He came in and he 
cried. He said you know, this has bothered me every year around 
filing time. He said I have been so anxious about getting 
caught. I have been so upset. And he said I did not do it for a 
few years and then it kind of got to be a habit. And then I was 
afraid if I would report what the penalties would be and it 
would swamp me financially.
    I know there is a real resistance to declaring that kind of 
thing.
    But I must say I told him I made a deal with our 
legislature. You give me $1 million--in North Dakota that's a 
lot of money--and I will give you a 10-to-one return. We got 
substantially in excess of that.
    And we started it by indicating OK, we are going into a new 
regime here. This deal of paying your taxes every other year, 
which some people had in their heads, that is over. We are 
going to get you--you can come and, come clean, just pay the 
interest on what you owe and we will start fresh. But from now 
on there is not going to be any of this.
    And it was amazing the kind of response we had.
    And it was behavior changing. We had people who after that 
filed every year. It makes quite a difference when you have 
people who are not paying at all all of a sudden start to pay 
into the system like the vast majority of people do.
    Ms. Olson. Congress has authorized a program called the 
Offer in Compromise Program. And how it is administered is that 
taxpayers can come in and say if they have a tax debt that they 
cannot afford to pay the full amount of the tax, the penalties, 
and the interest. And the penalties and interest are often more 
than the tax after a period of years. We have 10 years to 
collect.
    And we look at what, on the basis of their financial 
condition, they can afford to pay. We say you have to pay that.
    Part of the deal though, because it is a deal, is that they 
have to agree to be a complaint for 5 years with all tax laws. 
And if they violate that agreement then the debt in full is 
reinstated and we get to go forward with collection action.
    I have always thought that that was a very important 
program for people who just have things that go wrong or they 
make bad business decisions. You want to be careful in 
administering this program. But that promise to be compliant 
for 5 years means that if somebody really is compliant for 5 
years, his behavior is really changed for the long-term.
    Now disturbingly, the number of offers that we haveten over 
the last few years has declined significently. I think that 
people are concerned about the way the IRS is administering 
this program. And I have tried to say to the IRS this is an 
important program. It turns people who are noncompliant into 
compliant. And it does not undermine your other enforcement 
initiatives. They are actually mutually strong messages.
    Senator Conrad. That is a good point.
    I again want to very much thank the Chairman for holding 
this hearing. I want to thank the witnesses that we have had 
here today.
    I think there is a growing level of information that 
supports the notion. This really is an area that needs to be 
addressed, that we could make meaningful progress at closing 
the budget deficit by aggressive approach on the tax gap, the 
difference between what is owed and what is being paid.
    At $350 billion a year, that just cannot be left 
unattended.
    Chairman Gregg. I thank the Senator for bringing this 
matter forward and being aggressive on it. And I know he is 
going to remain aggressive on it, as I hope I can. And to the 
extent this Committee can do something about it, we intend to.
    We also appreciate your testimony, Ms. Olson. I think your 
approach is very common sense, which is good. I hope somebody 
at the IRS will listen to you and maybe you can track down Mr. 
Everson in the hallway here.
    Ms. Olson. He is my boss.
    Chairman Gregg. Because I do think the ideas you are 
putting forward make a lot of sense, which is to make sure that 
we put in place the mechanisms for getting more reporting and, 
as a result, getting more compliance.
    So thank you. We appreciate your testimony.
    The Committee is adjourned.
    [Whereupon, at 11:48 a.m., the Committee was adjourned.]

    PREPARED STATEMENTS

    [GRAPHIC] [TIFF OMITTED] T6726.109
    

    [GRAPHIC] [TIFF OMITTED] T6726.225
    

    [GRAPHIC] [TIFF OMITTED] T6726.226
    

    [GRAPHIC] [TIFF OMITTED] T6726.227
    



            THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL

                              ----------                              


                      THURSDAY, FEBRUARY 16, 2006

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 9:57 a.m., in 
room SR-325, Russell Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Conrad, and Murray.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Maureen O'Neill, professional staff member.
    Mary Ann Naylor, Staff Director and Rock Cheung, jr. 
analyst for science and international affairs, webmaster.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will convene the hearing a little early, 
which is nice. We appreciate the Secretary being here early. We 
know she has a very busy schedule and we hope to accommodate 
that schedule.
    It is a pleasure to have the Secretary of State here. She 
is an exceptional representative for our Nation around the 
world. She has done an incredibly strong job of making 
America's views known throughout the world and effectively 
advocating our policies, and we appreciate her taking the time 
to come address the Budget Committee.
    It is ironic that we are meeting in this room. The last 
time that I was to have a hearing in this room was on September 
11, 2001 and the First Lady, Mrs. Bush, was supposed to be here 
to talk about education with the HELP Committee, and of course 
we know what happened. That is a day which clearly no one will 
ever forget and we should not forget. Much of what the 
secretary and her team does is about that day and how we 
continue to respond to the threat, which remains regrettably 
very viable out there.
    We have heard from our enemies that they intend to continue 
to try to attack us and kill Americans and destroy our culture. 
And part of our response to that is to have a strong State 
Department which can carry our message around the world of 
freedom, democracy and market-oriented approaches to the 
economies of the world.
    So this Committee, which has the jurisdiction of setting 
the numbers, deems it a pleasure to have the Secretary here to 
talk about how the State Department--the type of resources the 
State Department needs and how we can be of assistance in 
making sure you get the resources you need.
    With that I will yield to Senator Conrad.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Thank you, Mr. Chairman, and again thank 
you for holding this important hearing. And welcome, Secretary 
Rice. It is good to see a fellow Stanford alum here. I had a 
much less distinguished career there than you did.
    Chairman Gregg. That is true of most of the schools.
    Senator Conrad. That is true.
    Chairman Gregg. He and I went to the same high school.
    Senator Conrad. So we very much appreciate your service to 
the country. We know this is an incredibly challenging time for 
our Nation and for many parts of the world.
    With that said, this Committee is responsible for budget 
decisions and allocating resources. This is going to be a 
difficult and challenging year.
    Let me just say, I have already heard more from my 
constituents about this budget than any budget in the 19 years 
I have been in the Senate and serving on this Committee.
    I am going to go through in a moment what I am hearing 
about. But let me just first put up a slide that talks about 
the overall priorities of the budget. What we see here is in 
international affairs, which you have preeminent responsibility 
for, is getting the biggest increase--9.4 percent over the 
baseline. Defense, 3.4 percent, Homeland Security a little less 
than 3 percent. Other domestic spending down almost 5 percent. 
Let's go to the next slide, if we can, because these are the 
kinds of things I am hearing about and it is important for you 
to hear it as well. And I know you are not responsible for 
putting together budgets and you are not responsible for 
domestic priorities, but I think it is important for you to 
know the kinds of feedback that we are getting.

[GRAPHIC] [TIFF OMITTED] T6726.110


[GRAPHIC] [TIFF OMITTED] T6726.111


    Let me just say in my State, Byrne Justice Grants are for 
local law enforcement. The President's budget eliminates those. 
He eliminates the money for Safe and Drug-Free Schools. These 
first two are especially sensitive in my State at this time 
because we are facing an epidemic of methamphetamines, is the 
worst illegal drug I have ever seen. It is absolutely 
destroying families in my State.
    He eliminates funding in the budget for vocational 
education, also something very much valued in my State.
    Rural health care is cut 83 percent in this budget.
    The COPS Program, which has put some 200 police officers on 
the street in my State, is cut 78 percent.
    The Essential Air Service, which is critically important to 
the transportation needs of my State, cut more than 50 percent.
    Amtrak cut 30 percent, which will endanger passenger rail 
service to my State.
    And the RUS electrification loans, which are almost 
religion in my State, cut 29 percent.
    You can see that these priorities create real conflict. And 
I can tell you this budget submission is unpopular in the 
constituency that I serve.

[GRAPHIC] [TIFF OMITTED] T6726.112


    Let us go to the next one. I have shown this to my 
colleagues many times. As we look ahead we see the deficits 
with some small improvement over the next few years, but then 
getting much worse if the President's policies are adopted.

[GRAPHIC] [TIFF OMITTED] T6726.113


    And the debt of the country, and this is an area that I 
hope is of direct concern to you, the debt of the country 
growing very dramatically--$5.8 trillion at the end of the 
President's first year. Now at the end of this year, $8.6 
trillion. Our projections are that, in the next 5 years, it 
will reach $12 trillion.
    And more than that, increasingly, we are relying on 
foreigners to finance this debt. In 5 years we have doubled the 
amount of debt held by foreigners. Doubled.

[GRAPHIC] [TIFF OMITTED] T6726.114


    These are the countries that we now owe money. Japan we owe 
almost $700 billion. China, more than $250 billion, and on it 
goes.
    This is of increasing concern in terms of our vulnerability 
to others making decisions about our financing. If these people 
pulled away from financing our debt, most economists tell us 
interest rates would rise significantly in this country, which 
would create economic slowdown.

[GRAPHIC] [TIFF OMITTED] T6726.115


    The Comptroller General said this on February 15th in a 
hearing in this Committee ``Continuing on this unsustainable 
fiscal path will gradually erode, if not suddenly damage, our 
economy, our standard of living, and ultimately our national 
security.''
    That is really the final point I want to make because it 
goes right to the heart of what makes a strong country. If we 
are not financially strong, we cannot be militarily strong.
    And so the question of how we arrange the priorities of the 
country in the work of this Committee is critically important 
and we welcome your insights.
    Chairman Gregg. Thank you, Senator Conrad. Madam Secretary, 
we would be happy to hear whatever you wish to tell us.

STATEMENT OF HON. CONDOLEEZZA RICE, SECRETARY, U.S. DEPARTMENT 
                            OF STATE

    Secretary Rice. Thank you very much. Thank you, Senator 
Gregg. Thank you, Senator Conrad and members of the Committee.
    I have a longer statement which I would like to enter into 
the record but I will not subject us to a reading of that 
statement so that we can have full time for a discussion and 
for questions.
    I would like, in lieu of reading the statement, to make 
just a few points and then, of course, to take your questions.
    It has been a little over a year since I was confirmed as 
Secretary of State and it has been a very eventful year. It is 
a time of great and historic change. It is a time when the 
United States and its friends are meeting multiple challenges 
across the globe.
    If I could start where you began, Senator Gregg, September 
11th really was a crack in time. It changed our security 
priorities. It changed our thinking about what makes a secure 
America when we were attacked in that brutal way on that 
September day.
    The challenge for the United States is, of course, to use 
all of our means of national power, our military power, our 
economic power, our diplomatic strength, our influence around 
the world, of course to defeat the terrorist threat that so 
brutally attacked us, but recognize that we are not going to be 
able to have a permanent peace to pass on to other generations. 
I think we recognize also that the degree to which we can leave 
a world that is more democratic, more free, more prosperous, 
where there are not failed states of the kind that Afghanistan 
became which led directly to terrorist training camps in which 
people trained to attack us from, the more that we recognize 
that the incapacity of states to govern, to control their 
borders, to fight terrorists themselves endangers us.
    The President's budget is a budget that is in support of 
those national security goals. And I have said to my 
colleagues, to your colleagues on Senate Foreign Relations 
Committee yesterday, that I think we should think of our 
assistance programs as national security spending because 
without a robust effort by the Department of State, on the 
diplomatic side, on the foreign assistance side, and on 
bringing well-governed democratic states alongside us, we will 
not be able to protect ourselves in the long term.
    This budget therefore is a budget that is in support of the 
tremendous democratic transition that is going on in the world 
in places like Iraq, where clearly there is a struggle for the 
creation of a stable and democratic Iraq. But the struggle that 
they are embarked on is far preferable to the false stability 
of the dictatorship of Saddam Hussein who threatened us all, 
threatened his neighbors and caused two wars in the region.
    Afghanistan, as I said before, was a failed state that 
directly produced Al Qaeda and its attacks. Of course, 
countries like Jordan and Pakistan that are in the front lines 
of the fight on terrorism are with us. And we have seen, in 
places like the Palestinian Territories, that democratic 
processes are always not very predictable.
    At some point I can speak to the issue of the election that 
brought Hamas to power. Obviously, this will have an effect on 
American assistance. We have made very clear that we cannot 
fund a Palestinian government unless that government is devoted 
to Israel's right to exist, to denouncing terror and to indeed 
disarmament.
    This budget also recognizes that we have other major 
challenges. In the areas of proliferation of weapons of mass 
distraction and prevention of that. I announced yesterday that 
we will be asking, in a supplemental request, for an additional 
$75 million for democracy programs in Iran. Perhaps one of the 
biggest problems that we face is the policy of the Iranian 
regime, which is a policy of destabilization of the world's 
most volatile and vulnerable region. It is not just Iran's 
nuclear program but also their support for terrorism around the 
world. They are, in effect, the central banker for terrorism 
around the world. They are also, of course, going 180 degrees 
away from the way that this region should be going in terms of 
human rights and democracy for their own people.
    We have worked very hard to create a coalition of states 
that will confront Iran's aggressive policies, particularly its 
nuclear program. We have had some success and we are now in the 
U.N. Security Council to address that problem.
    I think it is worth noting that we will not be able to 
address the Iranian nuclear program and problem in a vacuum. It 
is Iran's regional policies that really are concerning as we 
watch them with their sidekick Syria destabilizing places like 
Lebanon and the Palestinian Territories and indeed, even in 
southern Iraq.
    So there is recognition of those matters in this budget.
    There is also recognition of America's desire to continue 
to be a compassionate nation. We have led the world, of course, 
when there have been humanitarian disasters, when there has 
been a need to deal with the world's most vulnerable 
populations through refugee assistance or food assistance. And 
that is represented in this budget.
    And finally, and this is to speak, in part, to Senator 
Conrad's concern. We are, Senator, very aware of the pressures 
on this budget. And we are very aware of the pressures on the 
American people and the American taxpayers' dollars to fund the 
significant program that we need to secure ourselves through 
diplomatic means.
    As a result, we have launched a number of reform 
initiatives to try and make certain that we are better stewards 
of the American people's taxpayer dollars, that we are not 
engaging in duplicative activities, that we are engaging in 
activities that are effective.
    I would just cite two of those reforms, which we have put 
under the title of transformational diplomacy. On the one hand, 
I have asked for and received a plan for global repositioning 
of our diplomatic presence. It seemed to me that almost 15 
years after the end of the cold war are still rather heavy in 
parts of the world where we traditionally had large presences, 
in Europe for instance, and rather light in places that are 
really growing in influence: Brazil, China, India, other places 
in Latin America and indeed in Africa.
    We have to put our people increasingly in very difficult 
hardship posts where they cannot take family with them, so I 
want to make sure that our people are well treated. To meet 
these changes, we are moving our diplomats around. So far we 
have repositioned 100 people and I have asked for further 
repositioning plans to do more of this.
    I am asking in this budget that we create 285 new 
positions, for transformational posts, very important security 
measures that we must take, and also for work that we need to 
do to improve our capabilities in critical language skills. We 
are just simply very short of people who can use Arabic or 
Farsi effectively in the places that we really are meeting the 
threats.
    The other aspect of transformational diplomacy is that we 
are working very hard for foreign assistance reform. We believe 
that we must realign better the somewhat 80 percent of the 
foreign assistance budget that resides in USAID and State so 
that we are certain that we are meeting the objectives, 
addressing the concerns and the needs of the world's most 
vulnerable people. But we are also building State capacity to 
address those concerns. We do not want our foreign assistance 
program to be a kind of permanent dependency for countries. We 
really want them to be able to take on their own problems. If 
you fund countries that are corrupt, if you fund countries that 
are unreformed, then there are going to be permanently 
dependent because they cannot govern wisely.
    So through foreign assistance reform we hope to be able to 
use the precious dollars that we receive better, to make sure 
that we are not duplicating efforts, and to make sure that we 
are spending on the highest priority items.
    I have proposed creating a Director of Foreign Assistance 
reporting directly to me who would also be the USAID 
Administrator so that we can get synergies between our various 
programs.
    Finally we are requesting for the Millennium Challenge 
account $3 billion this year. I know that there have been 
questions about how rapidly the Millennium Challenge program 
hasten up and running. I can go through some of the numbers 
later. But let me say that I think this is really, in many 
ways, the President's flagship program, to change the way that 
recipient countries think about their responsibilities as they 
receive our foreign assistance dollars. These countries are 
states that are governing wisely, that are investing in their 
people, that are fighting and rooting out corruption and that 
we think are the lead edge of responsible sovereign states that 
can not only do better for their people but be contributing 
states to a safer and more secure world.
    Thank you very much.
    [The prepared statement of Secretary Rice follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.120
    

    [GRAPHIC] [TIFF OMITTED] T6726.121
    

    [GRAPHIC] [TIFF OMITTED] T6726.122
    

    [GRAPHIC] [TIFF OMITTED] T6726.123
    

    [GRAPHIC] [TIFF OMITTED] T6726.124
    

    [GRAPHIC] [TIFF OMITTED] T6726.125
    

    [GRAPHIC] [TIFF OMITTED] T6726.126
    

    [GRAPHIC] [TIFF OMITTED] T6726.127
    

    [GRAPHIC] [TIFF OMITTED] T6726.128
    

    [GRAPHIC] [TIFF OMITTED] T6726.129
    

    [GRAPHIC] [TIFF OMITTED] T6726.130
    

    [GRAPHIC] [TIFF OMITTED] T6726.131
    

    [GRAPHIC] [TIFF OMITTED] T6726.132
    

    [GRAPHIC] [TIFF OMITTED] T6726.133
    

    [GRAPHIC] [TIFF OMITTED] T6726.134
    

    [GRAPHIC] [TIFF OMITTED] T6726.135
    

    Chairman Gregg. Thank you, Madame Secretary.
    That was really an excellent summary for us of where the 
State Department is and what you are trying to do. And I 
especially congratulate you on this effort, this 
transformational effort, to try to move people to where the 
problems are, which is something when I was chairing the State 
Department appropriating committee I worked on. There was some 
progress. But obviously your commitment to this is great. And 
we want to be supportive of that.
    You are in an ironic situation in that you are one of the 
few secretaries who comes before this Committee who has had 
significant increases in your budget. I guess our question to 
you is are there efficiencies which we could look at? Are there 
things that we should be thinking about that would allow us to 
get more additional dollars, more additional activity for the 
dollars we are putting in? There is concern about the 
Millennium Challenge and the way that has been started up.
    Can you just sort of give us an overview of how you think 
the Department can most effectively use the dollars we are 
giving you and whether or not the dollars we are giving you are 
enough, considering the fact that you are getting a significant 
increase?
    Secretary Rice. Thank you, Senator Gregg. I really do not 
take for granted or take lightly the sacrifice that is being 
made on behalf of the programs that we run. I know that there 
is a lot of pressure on this budget.
    I would just first go back to one point before I address 
the question of what the Department can do.
    We are now in a phase of our diplomacy in which we have 
gone through two wars in Iraq and Afghanistan. We have gone 
through the largest terrorist attack on American soil. And we 
are literally, I think, in the midst of a big historic 
transformation to a world that, if we do our work correctly, 
will be more democratic, more free, and have states that will 
be allies in the war on terrorism, not states that will be 
fueling the war on terrorism. We are in the midst of trying to 
beat back concerns about the proliferation of weapons of mass 
destruction because heaven help us if weapons of mass 
distraction ever fall into the hands of terrorists, let alone 
into the hands of rogue states.
    We are trying to meet the challenges of helping front-line 
states that are taking enormous risk in the war on terrorism, 
like Jordan and like Pakistan. We are in the midst of trying to 
help the people of Iraq and Afghanistan rebuild on the ruins on 
these dictatorships that were supportive of terrorism.
    And around the world we are trying to use our diplomacy to 
further the cause of freedom and liberty and responsible states 
and to engage our long-term allies as real partners in doing 
that.
    I would note that we have been very fortunate, for 
instance, to have the whole world really united against Iran, 
not just the United States. That takes work and it takes 
diplomatic effort.
    The Millennium Challenge, as I said, gives us a particular 
kind of tool to encourage responsible behavior by states. I can 
tell you that countries want to participate. They want to make 
the case for why they ought to be a Millennium Challenge 
country. They will tell you what they are doing to fight 
corruption and what they are doing to invest in their people. I 
think these are all dollars well spent so that we can leave a 
foundation for a more peaceful and secure world, much as our 
predecessors left the foundation for a Europe that became 
whole, free and at peace and a Europe where no one can any 
longer imagine a war between the great powers.
    That is the challenge that we have in a volatile region 
like the Middle East.
    We will do our part to make sure that the dollars are well 
spent. It is why I think that we have to continue with our 
global repositioning. It is not going to be enough to come to 
the Committee and ask for more positions, and heaven knows we 
need more positions around the world, in places like Baghdad, 
like Islamabad, in many of our Latin American posts and in our 
posts in China and India. If you just look at the importance of 
those countries and the growth in populations in some of those 
countries, we are not meeting the diplomatic needs that we need 
to meet. However, with some combination of new resources and 
reprogrammed resources, I think can help us meet those needs.
    I have also asked Henrietta Fore, who is the Management 
Under Secretary, to work harder on our rightsizing initiative 
and to work on questions of what we might be able to do to 
merge functions between various parts of the foreign policy 
community, to see if we can do with more regionalization of 
some of our efforts. Maybe every embassy does not have to have 
every thing. Maybe we can do things on a more regional basis.
    So I promise you, we are going to be looking to squeeze out 
every dollar that we can. But right now the demand outstrips 
the supply of even significant increases that we have had 
because I think we have recognized the challenges before us.
    Chairman Gregg. Thank you.
    Yesterday I listened to some of the questions you were 
asked at the Foreign Relations Committee yesterday. And I 
thought some of them may have more to do with campaigns for the 
presidency maybe than what your answers were.
    But independent of that, the bottom-line question was, I 
thought, what is going to happen in Iraq? And when are we going 
to get out of there And so let me ask you that question.
    Secretary Rice. Well, the Iraqis are now engaged in the 
final stages of their political journey to actually create a 
permanent government. It is very hard to realize that it has 
only been a year since they have had their national elections 
and they now are in the process of creating a permanent 
government and creating a constitution. It is very hard because 
this is a country that has always resolved its problems by 
repression of groups, even repressions of majorities like the 
Shia or by dictatorship of the kind that Saddam Hussein 
imposed.
    However now they have to do this by politics and by 
compromise. I think they are doing really rather well at it and 
I think you will see the formation of a national unity 
government.
    Our support for them has been twofold. The Congress was 
generous in reconstruction funding for Iraq, which has been 
subject to some problems due to security. But I think the 
reconstruction program has had a real effect. We have been able 
to modernize large portions of the Iraqi infrastructure. For 
instance, we are delivering water and sewage in much larger 
numbers to many more Iraqis than in the past. We are continuing 
to work on the oil and the electricity infrastructure.
    The Iraqi security forces are about 227,000 strong now. And 
to be fair, we made a mistake earlier on. We relied on numbers, 
not quality. These are, according to those who train them, 
quality forces that are now the Iraqi security forces. They are 
taking their own territory, holding their own territory, and 
now beginning to create the circumstances under which these 
provinces can really be rebuilt.
    That, Senator is the way that I think about the course 
ahead for Iraq. Now our part in that is to continue to support 
them and to continue to support them so that they can have a 
secure basis on which to become democratic and prosperous.
    But I do not believe that we ought to think that this is 
only a job for American military forces. As Iraqi security 
forces stand up in their security task, there is no doubt in my 
mind that American security forces will be less and less needed 
and less and less relevant to the task.
    Indeed, I think it is why General Casey recommended to the 
President that we go from 17 brigades to 15 brigades, one now 
in Kuwait as a rapid reaction force. I think you will see more 
of that because Iraqi forces are stepping up, because the 
political process is progressing, because Sunnis are now 
heavily engaged in the political process and insurgents have 
less reason to be in the insurgency and Sunnis have more reason 
to be in the political process.
    So I know that it sometimes looks like a complicated place 
but it is a place that is making progress along the political 
front and ultimately that is how you defeat an insurgency. If 
we leave early, if we do not remain committed, then we risk 
leaving an Iraq that is going to be a force of instability and 
terrorism in the region. If we do this job well, imagine the 
impact of an Iraq that is fighting terrorism, that is 
democratically governed, that is a friend of the United States 
and that can anchor a different kind of Middle East, a Middle 
East which desperately is in need of change because any region 
that produces an ideology of hatred so great that people fly 
airplanes into our buildings is in desperate need of change.
    I think that the future of a better Middle East is one 
where Iraq is an anchor. That is why the United States is so 
important to that cause.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Madam Secretary, did I hear you right when 
you said that water and sewer has improved in Iraq?
    Secretary Rice. Yes, you did. We have increased the 
capacity for clean water for several million Iraqis and 4 
million Iraqis have better sewage than before the war.

[GRAPHIC] [TIFF OMITTED] T6726.116


    Senator Conrad. Let me just ask you--this is from the New 
York Times from February 9th, and this was testimony by the 
Special Inspector General for Iraq Reconstruction before the 
Foreign Relations Committee. In that story, the lead paragraph 
is, ``Virtually every measure of the performance of Iraq's oil, 
electricity, water and sewage sectors has fallen below 
preinvasion levels'' even though we have spent $16 billion of 
American taxpayer money on Iraq reconstruction. Specifically on 
percentage of drinking water before the war, according to the 
Inspector General, 50 percent had it before the war. Now only 
32 percent do.
    On percentage with sewage service, 24 percent before the 
war, only 20 percent now.
    So who are we to believe?
    Secretary Rice. Let me give you the numbers. I have worked 
with the Inspector General and I actually went over his 
briefing before he gave that briefing. He came and gave the 
same briefing to me.
    On potable water, millions of persons served prewar 5.5, 
2005 average 8.6. We hope by the end state, that 12.5 will be 
the case.
    Sewage, in millions of persons served, prewar about 0.5 
average, in 2005, five. So the numbers have been going up on 
water and sewage.
    The problems, you are absolutely right, Senator, have been 
on oil and electricity.
    Senator Conrad. Wait, wait, wait. This is the Inspector 
General's testimony before the Foreign Relations Committee. He 
says yes, oil is down. Daily crude oil production down from 2.6 
million barrels to 2.1. Daily heating oil production down from 
5,000 tons to 1,700.
    But he says specifically drinking water, 50 percent had it 
before the invasion. Now only 32 percent do. Percentage with 
sewage service, 24 percent had it before the war and now only 
20 percent do.
    Secretary Rice. I think this may be an issue of whether we 
are talking about delivery or capacity. We have increased the 
capacity for clean water for several million Iraqis and for 4 
million Iraqis in sewage.
    Senator Conrad. Can I say to you though, what matters to 
people is getting it. And what the Inspector General said very 
clearly is that in virtually every measure the performance of 
Iraq's oil, electricity, water and sewage sectors has fallen 
below preinvasion levels. We can improve capacity and that is 
great. But at the end of the day what matters to people is that 
they get it.
    Secretary Rice. That is true, Senator, but without improved 
capacity more Iraqis are not going to get it.
    You are right, we have concentrated on improving the 
capacity to deliver these services. The reason that we now have 
moved from rather large scale reconstruction projects, as I say 
reconstruction with a large R, to smaller scale more local 
reconstruction projects is to make certain that there is also 
better delivery for Iraqis.
    Senator Conrad. Let me stop you there, if I can, because in 
this article it goes on to say in one sense focusing on the 
plummeting performance numbers misses the point. The real 
question is whether the Iraqi security forces will ever be able 
to protect the infrastructure from insurgent attack.
    That leads me to this question. This is an article that 
appeared in the Washington Times on December 3rd saying that 
``Funds may be lacking for ample Iraqi army... The U.S. general 
in charge of shaping an Iraqi army raised the prospect 
yesterday that the new Baghdad government will not have 
sufficient money'' to fund the army envisioned by our 
Administration.

[GRAPHIC] [TIFF OMITTED] T6726.117


    Let me ask you this because this is a budget committee. As 
much as we are interested in foreign relations here--and I 
think every Senator is--our primary responsibility to our 
colleagues is budget matters. These things raise two questions 
in my mind that are directly budget related.
    We have the Inspector General saying things are getting 
worse there across a broad metric of delivering services to 
people, even though we have provided a lot of money. In fact, I 
think we have approved downsizing of expectations. It says, in 
this story, it was striking given that $30 billion of American 
taxpayer money has already been dedicated to the task.
    So the American people have been very generous already. And 
they are saying in this article that, according to the 
Inspector General and other witnesses before the Committee, 
they need more than $56 billion for reconstruction.
    What of that amount do you think the American taxpayers 
will be asked to finance?
    Secretary Rice. Senator, let me say first that the 
taxpayers' dollars that we have spent have modernized aspects 
of the Iraqi infrastructure. For instance, creating more 
capacity will allow us to deliver more. The first is to create 
more capacity.
    Then you can deliver services. What we are now really 
focusing on is how to make that delivery work, which is why I 
think you will see, both in our budget request and in what will 
be a supplemental request, that the focus is actually not on 
large funding for reconstruction projects. Rather, we are 
focusing on funding for provincial reconstruction efforts that 
will be more decentralized, but will allow us to work with 
local governments to deliver services. It will focus more on 
creating capacity in the Iraqi ministries so that they can also 
deliver services. In effect, we have given them a real boost in 
the infrastructure itself, in helping to modernize it, helping 
to create its capacity.
    We are now going to have to work with others, and there are 
pledges from other countries that have not yet been paid, not 
yet been actually handed over to the Iraqis for infrastructure, 
that I think we will use it to help them to continue the 
infrastructure modernization.
    You will not see large numbers in our budget requests for 
further infrastructure projects. What you will see is funding 
for maintenance. You will see that we want to spend down the 
remaining money in the Iraq Reconstruction Fund (IRF-2). We 
have committed that money. Finally, we want to have provincial 
reconstruction efforts that will allow us to help the Iraqis to 
deliver services.
    Senator Conrad. Let me just say you need to mark me down as 
a skeptic. According to the Inspector General, he says by 
virtually every measure things are going in the wrong 
direction, not the right direction with respect to delivering 
services to people there. And they say the $56 billion is not 
going to be enough. This is the testimony before the Foreign 
Relations Committee.
    I tell you, I am very concerned that we are going to be 
asked for a boatload of additional funding. And as I have 
pointed out, things that are terribly important to my 
constituents, including essential air service being cut more 
than half, Rural Utility Service being cut 30 percent. There is 
an enormous challenge in the Middle East. We also face big 
challenges in our own Midwest.
    And I would say to you that this trajectory does not look 
good to me. And this notion that there is going to be a 
tremendous need for additional money, including for the Iraqi 
army, and we seem to be the ones that keep ponying up. We have 
to find a way to share this burden because I can tell you, 
patience is wearing thin.
    Secretary Rice. Thank you, Senator.
    I agree that we need to find a way to share the burden. In 
fact, we do have a significant amount of money that has been 
pledged to Iraqis that has not yet been appropriated to them. 
We need to work to get people to pay those pledges. Some of 
that money is for exactly the kinds of projects and you are 
talking about.
    But I want to be very clear, the United States has about 
$2.9 billion remaining in the IRF. We intend to spend that, 
continue the spending on infrastructure of that money. We 
intend to use that money in smaller scale projects that will 
allow for more rapid delivery.
    Our focus in this supplemental and in this budget is on 
making the Iraqis more capable of delivering their own services 
by working at the local level with provincial teams and working 
at the national level with ministry teams to make better use of 
the infrastructure that we have helped to provide.
    However, there are still problems.
    Senator Conrad. Could you say that again? Could you just 
educate us here? When you say in the IRF, is that a term of 
art?
    Secretary Rice. I am sorry. That was in the Iraqi 
Reconstruction Fund. Sorry.
    Senator Conrad. It is referred to in that way?
    Secretary Rice. Yes, that is where the money was 
appropriated by the U.S. Congress.
    Senator Conrad. The thing that is so striking to me, I have 
had my staff every 30 days provide me with an update about how 
things are going with these matters. And every month I get 
these reports and things are not getting better. That is what 
is so striking to me.
    And now we have the Inspector General coming up here and 
testifying that in almost every one of these areas things 
haveten worse since before the war, and that the estimates of 
the cost are going up, up and away. And now they say there may 
not be the funds for the Iraqi army that we want to turn the 
responsibility for security over to.
    What is your anticipation there? Are they going to have the 
funds necessary to stand up an army that can provide security?
    Secretary Rice. Senator, I think the Iraqis and the new 
Iraqi government recognizes that one of their first 
responsibilities is going to be to provide security themselves. 
Yes, theoretically, you could end up with not enough money for 
the Army. But that is what budgeting is about and that is what 
programming is about. The Iraqis are going to have to budget 
and program hopefully with some help from others in the 
international community, as well, to be able to meet their 
security needs.
    They have two problems right now that we are helping them 
work on. One is that while it is true that oil revenue has been 
down because even though oil production and export was at 
prewar levels in the summer, there have been insurgent attacks 
against the pipelines making much more difficult the export of 
oil, which is a huge source of revenue for the Iraqis.
    We are working to try and improve that situation so that 
oil production and oil export can go back up.
    The other piece of that is that the Iraqis are working to 
eliminate some of the subsidies that are a huge drag on their 
budget. They also have a number of debt relief pledges that 
when they have an IMF program, can be met.
    So there are sources of revenue for the Iraqi government. 
It is a matter of their budgeting and programming that they are 
going to have to meet to cover their security needs.
    I would expect that that is going to be a very important 
conversation with the new government.
    Senator Conrad. My time has expired. I must say that I am 
increasingly skeptical when I look at the data that I am 
receiving about what is happening with the infrastructure of 
Iraq by virtually every measure.
    I was just handed another review--down, down, down. I will 
tell you, I think we have a huge problem on our hands here. If 
they do not have the funds to stand up the Army necessary to 
provide security to their people, it makes me extremely 
concerned about what will be asked of our people. I thank you.
    Chairman Gregg. Thank you. Senator Sessions, do you have a 
questions? We have about seven-and-a-half minutes left on this 
vote.
    Senator Sessions. I will try to be brief.
    First, I would like to compliment you, Madame Secretary, on 
your commitment to review and transform the State Department. 
As a member of the Armed Services committee, the Defense 
Department is intensely reviewing its investments and how it 
spends its money, what its priorities are, what the future will 
look like, and trying to configure that department to meet 
those challenges.
    The State Department does not have weapons systems and 
things of that nature. But likewise, I think it is healthy that 
you are challenging, asking people where you really need 
embassies, where you need to have people stationed.
    And you may get push back from Congress or from people who 
prefer to be stationed in Germany than some Third World 
country. But you have to make those decisions. And I hope that 
if you do that you ask for support from this Congress. I think 
you will get it.
    I am also pleased that you are requesting funds for 
democracy in Iran. It was not too long ago that I met an 
Iranian who fled Iran and he was so sincere. It just really 
brought tears to your eyes to talk about his love for his 
country and the difficulties that they have, his belief that so 
many of the people there want a better life, they want freedom. 
And I think that is a policy we should encourage.
    And I think the President, by saying this openly and 
appealing to the people of Iraq, we are not hostile to them but 
we want them to simply have a better life, a freer life, that 
it is the right thing.
    You have been asked about the Iraq war and the 
reconstruction effort. Fundamentally I guess--I would ask you 
this way.
    The State Department's responsibilities now include the 
infrastructure and the political progress in Iraq in trying to 
work with the new government of Iraq and assist them and 
encourage them to do things that would be in the long-term best 
interest of that country. The military is challenged and 
oftentimes have to carry the load, but they are executing 
policies that are consistent with the State Department 
policies; is that correct?
    Secretary Rice. Yes, absolutely.
    Senator Sessions. In other words, this is a sovereign, 
Iraq, now. We relate to Iraq through the State Department, our 
Ambassador, not by a military force that operates on its own 
will throughout that country; is that correct?
    Secretary Rice. Absolutely, Senator. What happens is that, 
first of all, we have found in a number of parts of the world, 
and Iraq is one and Afghanistan is another, that the strong 
integration of our military and political efforts, our military 
and diplomatic personnel, has to really be achieved. So you 
will not see a closer working relationship than between 
Ambassador Khalilzad and General Casey. They are joined at the 
hip. You rarely see one without the other these days.
    That gives us the ability to deal with the Iraqi government 
in a way that unifies what we need to do to continue to defeat 
the insurgency, with what we are trying to do to build the new 
Iraqi state.
    You need to vote. I will stop there.
    Senator Sessions. Thank you.
    I would just say that Secretary Rumsfeld was complimentary 
of the relationship. But as Chairman John Warner mentioned in 
our last hearing with the Secretary, that we talk about 
jointness within the military. We need a jointness within 
State, Commerce, Defense and within DOD as we deal with these 
complex issues. And I hope that you will work toward that.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Madame Secretary.
    We have a vote on. You have been very generous with your 
time. I do not think you should have to sit here and wait for 
Senators to arrive after the vote. So we are going to adjourn 
the hearing and we appreciate the input.
    More importantly, we appreciate the job you do for this 
country. You are an exceptionally good spokesperson and manager 
of the diplomatic affairs of our Nation and we are very 
fortunate to have you as a public servant. Thank you.
    Secretary Rice. Thank you very much, Senator.
    Chairman Gregg. The hearing is adjourned.
    [Whereupon, at 10:45 a.m., the hearing was concluded.]

    PREPARED STATEMENTS

    [GRAPHIC] [TIFF OMITTED] T6726.118
    

    [GRAPHIC] [TIFF OMITTED] T6726.119
    

    [GRAPHIC] [TIFF OMITTED] T6726.228
    

    [GRAPHIC] [TIFF OMITTED] T6726.229
    

    [GRAPHIC] [TIFF OMITTED] T6726.230
    

    [GRAPHIC] [TIFF OMITTED] T6726.231
    

    [GRAPHIC] [TIFF OMITTED] T6726.232
    

    [GRAPHIC] [TIFF OMITTED] T6726.233
    

    [GRAPHIC] [TIFF OMITTED] T6726.234
    

    [GRAPHIC] [TIFF OMITTED] T6726.235
    

    [GRAPHIC] [TIFF OMITTED] T6726.236
    

    [GRAPHIC] [TIFF OMITTED] T6726.237
    

    [GRAPHIC] [TIFF OMITTED] T6726.238
    

    [GRAPHIC] [TIFF OMITTED] T6726.239
    

    [GRAPHIC] [TIFF OMITTED] T6726.240
    

    [GRAPHIC] [TIFF OMITTED] T6726.241
    

    [GRAPHIC] [TIFF OMITTED] T6726.242
    

    [GRAPHIC] [TIFF OMITTED] T6726.243
    

    [GRAPHIC] [TIFF OMITTED] T6726.244
    

    [GRAPHIC] [TIFF OMITTED] T6726.245
    

    [GRAPHIC] [TIFF OMITTED] T6726.246
    

    [GRAPHIC] [TIFF OMITTED] T6726.247
    

    [GRAPHIC] [TIFF OMITTED] T6726.248
    

    [GRAPHIC] [TIFF OMITTED] T6726.249
    

    [GRAPHIC] [TIFF OMITTED] T6726.250
    

    [GRAPHIC] [TIFF OMITTED] T6726.251
    

    [GRAPHIC] [TIFF OMITTED] T6726.252
    

    [GRAPHIC] [TIFF OMITTED] T6726.253
    

    [GRAPHIC] [TIFF OMITTED] T6726.254
    

    [GRAPHIC] [TIFF OMITTED] T6726.255
    

    [GRAPHIC] [TIFF OMITTED] T6726.256
    

    [GRAPHIC] [TIFF OMITTED] T6726.257
    

    [GRAPHIC] [TIFF OMITTED] T6726.258
    

    [GRAPHIC] [TIFF OMITTED] T6726.259
    

    [GRAPHIC] [TIFF OMITTED] T6726.260
    

    [GRAPHIC] [TIFF OMITTED] T6726.261
    

    [GRAPHIC] [TIFF OMITTED] T6726.262
    

    [GRAPHIC] [TIFF OMITTED] T6726.263
    

    [GRAPHIC] [TIFF OMITTED] T6726.264
    

    [GRAPHIC] [TIFF OMITTED] T6726.265
    

    [GRAPHIC] [TIFF OMITTED] T6726.266
    

    [GRAPHIC] [TIFF OMITTED] T6726.267
    

    [GRAPHIC] [TIFF OMITTED] T6726.268
    

    [GRAPHIC] [TIFF OMITTED] T6726.269
    

    [GRAPHIC] [TIFF OMITTED] T6726.270
    

    [GRAPHIC] [TIFF OMITTED] T6726.271
    

    [GRAPHIC] [TIFF OMITTED] T6726.272
    

    [GRAPHIC] [TIFF OMITTED] T6726.273
    

    [GRAPHIC] [TIFF OMITTED] T6726.274
    

    [GRAPHIC] [TIFF OMITTED] T6726.275
    

    [GRAPHIC] [TIFF OMITTED] T6726.276
    

    [GRAPHIC] [TIFF OMITTED] T6726.277
    

    [GRAPHIC] [TIFF OMITTED] T6726.278
    

    [GRAPHIC] [TIFF OMITTED] T6726.279
    

    [GRAPHIC] [TIFF OMITTED] T6726.280
    

    [GRAPHIC] [TIFF OMITTED] T6726.281
    

    [GRAPHIC] [TIFF OMITTED] T6726.282
    

    [GRAPHIC] [TIFF OMITTED] T6726.283
    

    [GRAPHIC] [TIFF OMITTED] T6726.284
    

    [GRAPHIC] [TIFF OMITTED] T6726.285
    

    [GRAPHIC] [TIFF OMITTED] T6726.286
    

    [GRAPHIC] [TIFF OMITTED] T6726.287
    

    [GRAPHIC] [TIFF OMITTED] T6726.288
    

    [GRAPHIC] [TIFF OMITTED] T6726.289
    

    [GRAPHIC] [TIFF OMITTED] T6726.290
    

    [GRAPHIC] [TIFF OMITTED] T6726.291
    

    [GRAPHIC] [TIFF OMITTED] T6726.292
    

    [GRAPHIC] [TIFF OMITTED] T6726.293
    

    [GRAPHIC] [TIFF OMITTED] T6726.294
    



 THE PRESIDENT'S BUDGETARY PROPOSALS FOR THE DEPARTMENT OF HEALTH AND 
                             HUMAN SERVICES

                              ----------                              


                        WEDNESDAY, MARCH 1, 2006

                                       U.S. Senate,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:22 a.m., in 
room SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, 
chairman of the committee, presiding.
    Present: Senators Gregg, Bunning, Ensign, Conrad, Murray, 
Nelson, and Stabenow.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Dave Fisher, health policy director.21Mary Ann Naylor, Staff 
Director and Sarah Kuehl, analyst for social security, 
transportation and medicare.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will convene the hearing. I apologize to 
the Secretary. The understanding was that we were going to have 
a vote at 10 and then we were not going to have a vote at 10, 
so we have been in the practice of running back and forth to 
the floor.
    The Secretary obviously has a huge portfolio relative to 
the responsibilities of the Federal Government, and some of it 
is the day-to-day activity of maintaining the health and 
welfare of the Nation, and some of it involves significant 
issues of how we protect ourselves from the threats of a 
biological attack or potential influenza outbreak or some other 
major disease event. And equally important to that is the 
portfolio of the senior citizens' Medicare and Medicaid 
accounts, which we know are going to be under huge pressure as 
we move into the out-years.
    This committee has spent a lot of time focusing on that 
issue, trying to put in context what we are looking at in the 
out-years, and I respect and congratulate the administration 
for bringing forward a budget which attempts to address in a 
small way the Medicare issue. And last year, of course, we made 
some progress on the Medicaid issue as a result of the hard 
work of the Secretary.
    Whether we are going to make progress on the Medicare issue 
this year is very much an issue, and that is something I want 
to hear from the Secretary, how he thinks we can--what his road 
map is for accomplishing that.
    And so we look forward to your testimony. Obviously, most 
of your Department has been given a budget which is very 
constricted, and the non-defense discretionary accounts under 
the President's proposal essentially are flat funded, and those 
would almost all affect accounts within your jurisdiction. But, 
of course, the entitlement accounts, like Medicare, are not and 
they are exploding. And there is a genuine bipartisan effort 
here in the Congress in support of the President's efforts to 
try to get us ready for the potential of a pandemic flu 
outbreak, and that obviously has been budgeted for.
    So we look forward to your testimony, and thank you for 
taking the time to come here, and now I will yield to the 
Senator from North Dakota.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. Thank you, Mr. Chairman, and thank you for 
calling this hearing, and thank you, Mr. Secretary, for being 
here. I apologize as well for the unpredictability of the 
Senate. I have high regard for you both personally and 
professionally, as I have expressed to you, both publicly and 
privately.
    I do not have high regard for this budget, and let me just 
run through some of what I see are the serious deficiencies of 
this budget.

[GRAPHIC] [TIFF OMITTED] T6726.296


    We heard from the administration the deficit is going to be 
cut in half over the next 5 years, but they only get there by 
leaving out things: war costs, the costs of fixing the 
alternative minimum tax, and the full cost of the tax cuts 
beyond the next 5 years. When you put all those things back in, 
this is our projection of where the deficit heads, and we do 
not think that is a healthy direction. The growth of the debt 
is even more alarming. As you know, the debt is growing much 
more rapidly than the deficit. This year the President says the 
deficit is going to be in the $400 billion range, which I think 
somewhat overstates the deficit for this year. But the debt 
will go up, according to our calculation, $630 billion this 
year, and every year for the next 5 years under the President's 
budget proposal we see the debt increasing $600 billion or more 
each and every year.

[GRAPHIC] [TIFF OMITTED] T6726.297


    You understand this challenge very well. As we look at the 
unfunded liabilities of the country, Medicare is by far the 
biggest. This is the 75-year shortfall in Medicare, $29.6 
trillion. It is more than 7 times the projected shortfall in 
Social Security. And, by the way, I think the projected 
shortfall in Social Security is somewhat overstated for 
technical reasons I will not go into, but I do believe the 
shortfall in Medicare is very real. And it is the thing that is 
going to swamp the boat.
    Let's go to the next chart.

    [GRAPHIC] [TIFF OMITTED] T6726.298
    

    Then I look at the specifics of the President's budget, and 
for 2007 through 2016, he proposes $154 billion in savings from 
Medicare and Medicaid. But during that same period, he proposes 
tax cuts of $1.7 trillion, more than 10 times as much. Frankly, 
I do not think these proposed tax cuts are affordable given the 
fact we cannot pay our bills now and given the priorities of 
the American people.
    Let's go to the next chart.

    [GRAPHIC] [TIFF OMITTED] T6726.299
    

    This is a statement, Mr. Secretary, you made that I very 
much agree with: ``We had to make hard choices--hard choices 
about very well intentioned programs.'' I agree that these are 
hard choices. I do not agree with the choices that have been 
made because I do not see any justification for having 10 times 
as much tax cuts as we are having in terms of spending savings.
    Let's go to the next slide if we could.

    [GRAPHIC] [TIFF OMITTED] T6726.300
    

    Then we get to an issue of priorities. In the President's 
budget, he would cut rural health care programs $133 million. 
During this same year, tax cuts, the cost of the tax cuts going 
to those who earn over $1 million a year is over $41 billion. 
You know, I think we are going to have to go to the wealthiest 
among us and say, you know, everybody has to sacrifice here. We 
are at war. We are piling up debt at a record rate. We have to 
get everybody here pulling the wagon. We cannot be saying to 
those who are the wealthiest among us, ``You get a pass.''
    Let's go to the next slide.

    [GRAPHIC] [TIFF OMITTED] T6726.301
    

    This hospital administrator back home says, ``We cannot 
absorb cuts of this magnitude without reducing access to needed 
services and negatively impacting the health of our 
communities.'' This is from the head of Mercy Hospital in 
Valley City, North Dakota. Valley City is a town close to where 
we were when you were with me in Fargo, and this is the 
consistent message I am getting back from back home.

[GRAPHIC] [TIFF OMITTED] T6726.302


    Let me go to my last slide because this goes to the 
question of what do we do about all this. This to me is the 
most compelling statistic: 6 percent of Medicare beneficiaries 
account for roughly 51 percent of program costs. I think 
collectively we have to focus like a laser on that fact--6 
percent of Medicare beneficiaries are using over half of the 
Medicare budget. This to me is the major opportunity to both 
save money and get better health care outcomes, because I do 
not think we are doing a good job of coordinating the care. The 
result is these people are taking many, too many prescription 
drugs, many of which work against each other. They are being 
subjected to all kinds of duplicate testing. And these factors 
actually make their health worse and cost the taxpayers massive 
amounts of money. Of course, it costs the patients massive 
amounts of money, too.
    So I hope that in this hearing today we are able to have a 
conversation about what could we do that would be effective at 
saving money here and improving health care outcomes. And then, 
Mr. Secretary, I just want to say I am going to try to focus on 
avian flu and what the plans are there and what we need to do 
to get ready, because I am convinced the risk is enormous, and 
you and I have had a long conversation on this matter before to 
talk about the strategy for how we get ready to combat a 
pandemic, whether it was avian flu or caused by some other 
virus.
    I thank the Chair. I thank the Secretary.
    Chairman Gregg. Thank you, Senator, and we welcome you, 
Secretary. We also welcome Vince back, Vince Ventimiglia, who 
has been a friend and a tremendous asset to the Senate for many 
years, and now I know is the same for your office, and has 
written most of the major health legislation that has come out 
of the Senate over the last 6 years.
    So we would like to hear what you have to say.

     STATEMENT OF HON. MICHAEL O. LEAVITT, SECRETARY, U.S. 
            DEPARTMENT OF HEALTH AND HUMAN SERVICES

    Secretary Leavitt. Well, thank you, Mr. Chairman and 
Senators. Thank you very much for having me here. I am here to 
speak of a budget that is a large budget, $700 billion. You 
well know that it is broken into two general pieces. There is 
the entitlement budget and then there is the discretionary 
budget. The discretionary budget is about $75.5 billion of that 
nearly $700 billion. The balance of it is the entitlement 
budget.
    The discretionary budget that I will present to you today 
is roughly down $1.5 billion. This is a deficit reduction 
budget. As Senator Conrad pointed out, there are hard decisions 
that have to be made in this kind of a context, and today I am 
here to talk with you about how I went about making the 
decisions I made. There will be areas on which we have 
disagreement, where you would have made different choices than 
I did. My purpose is simply to tell you the basis on which I 
made my suggestions.
    But I do want to speak for a moment about the same subject 
that you have raised, both of you, and that is the entitlement 
budget. This is of grave concern to me. It is to the President. 
You have expressed it in trillions of dollars. A trillion is a 
startling number on its face. I have begun to focus on this in 
a different way, and that is, what is the percentage of the 
gross domestic product that these expenditures make up?
    As you are aware, we recently put out a report indicating 
that health care in total is now over 16 percent of the gross 
domestic product. By 2015, we are projecting it will be 20 
percent. But an even more startling statistic than that is that 
Medicare alone today is 3.3 percent of the gross domestic 
product. If you project forward, by 2040 it becomes 8.14 
percent of the gross domestic product. If you go into the same 
range where you were looking into the 70-, 75-year range, it 
becomes 14 percent of the gross domestic product. Once you get 
to that point----
    Senator Conrad. Medicare alone?
    Secretary Leavitt. Medicare alone. Medicare alone.
    Now, I have to confess that when I get to that point, I am 
discouragingly amused by those numbers because no economy in 
the world will be viable at that point. And so for us to 
project that far is a mathematic exercise because we will have 
been eliminated from the competition economically. And the 
capacity to sustain it simply will not be there. So we need to 
act, and I want to be clearly and firmly on record. This budget 
does present some modest ideas on how to get started. The 
President has been speaking about the need for bipartisan 
action, and I hope we will get a chance to talk about that some 
today.
    This is a Budget Committee. You deal in the strategy of the 
budget and, therefore, I think it would be helpful for you to 
know how I have approached this strategically. There are new 
initiatives that are proposed in the budget. A good example of 
that would be the Health IT budget. These tend to be things 
that I believe will help us find efficiencies and that will 
help stave off costs in the future.
    Another example of that would be the HIV/AIDS treatment and 
testing program--again, new initiatives you will find. You will 
find some Presidential initiatives that continue to be funded 
here. For example, the President's community health centers 
initiative is a good example, his faith-based initiatives. 
Again, these are commitments that he has made that we have 
continued to press forward on. You will see a substantial 
commitment to bioterrorism and pandemic funding, subjects that 
I know are of interest to this committee.
    I have found dollars in this budget to fund those new 
initiatives or initiatives that I think are highly efficient 
initiatives by looking for funds that are one-time and moving 
them into that category, looking for programs that are being 
addressed by a multiple of agencies and eliminating those 
duplications.
    I have looked for funds that are carryover that I could 
move into those areas, and there are a number of programs in 
the budget that we propose be eliminated or cut or reduced 
before that were not, and I have gone back and included those.
    I have also then said to my colleagues who were helping 
prepare the budget, I want to lay out a series of principles, 
and I want you to take every investment that we make and I want 
you to lay it against those principles, and it might be helpful 
for you to know what my principles are. You will obviously have 
identified your own.
    I am looking for investments that are targeted. We do a lot 
of general investment in Federal budgets. I am interested in 
looking for places where the specific need is. We are brilliant 
at proportionate distribution. We are not as good at finding 
targeted benefit, and so I hope you will see that reflected 
here, targeted benefit.
    I am a big believer in prevention. Health care in general, 
we have to redefine health care not to mean treatment. It needs 
to be prevention giving equal rigor to just treatment. And so 
prevention you will see emphasized.
    You will see an emphasis in actually delivering services as 
opposed to infrastructure. This is a deficit reduction budget. 
We all know infrastructure is important, but you will see me 
opting and tilting toward treatment of people as opposed to 
building the infrastructure where I had to choose between two.
    You will see a bias on my part toward consumer choice. You 
will see a bias on my part toward markets because I believe 
they find greater efficiency. You will see a clear inclination 
on my part to invest in new technology, recognizing that there 
are a lot of research projects that may have run their course, 
and we ought to be investing in new opportunities as opposed to 
those things we have been perhaps investing in a long time that 
are not producing benefit.
    HHS is a huge Department. There are many silos, and so you 
are going to find a bias on my part toward things that cover 
the entire Department. I have tried to find ways--things where 
there are two different agencies or operating division that 
may, in fact, be investing in the same thing, I have tried to 
bring those together. What that means is that sometimes it 
looks like there is a reduction, when in reality I have just 
brought them together. You will see that I have tried to bias 
our investment toward the things that I can demonstrate are 
being efficient. So those are the principles.
    Now, you will also, as I indicated, you will see an 
inclination on our part to invest on a risk basis as opposed to 
simply a proportionate basis. Those are the principles.
    Now, we undoubtedly will have disagreements on how to apply 
those principles, and you will have your own, and we are now 
presenting this budget for the legislative branch to go ahead 
and exercise its priorities. But I am delighted to be here 
today to defend my own judgments and be helpful in the 
conversation. So thank you, Mr. Chairman.
    Chairman Gregg. Thank you, and I agree with your approach, 
by the way, especially this concept of picking issues you can 
solve versus trying to do a broad-brush approach.
    But on the grounds of being helpful--we are going to start 
the clock here. On the grounds of being helpful, this is the 
problem: I want to do a $35 billion adjustment in Medicare. I 
think it needs to be put in the context of what it represents. 
I think Medicare over the next 5 years will spend something 
like $2.2 trillion. The rate of growth of Medicare is somewhere 
in the vicinity of 48 percent over that period; that if we were 
to do $35 billion in savings in Medicare and the rate of 
growth, that would reduce the rate of growth to 45 percent or 
something like that; that it is really--the proposals that the 
White House has put forward came out of the MedPAC study, as I 
understand it, primarily, which was an independent group of 
health professionals, do not have a partisan axe to grind, are 
not part of the administration, and essentially said these are 
places we can save some money that make sense. It is primarily 
changing the market basket for hospitals. And the failure, of 
course, to move forward in this area means that we are just 
allowing the cliff to come closer, and without any plan for how 
we are going to get over the cliff, get past it.
    So the baby-boom generation is not going away. It is here, 
and it is going to retire, and it is going to double the size 
of the retirement community. And as Senator Conrad has pointed 
out in his numbers and as we have tremendous testimony in that 
creates a $26 trillion unfunded liability, you mentioned that 
goes up to 14 percent of GDP, which is a number that is not 
comprehensible or even viable in any scenario. It would 
basically wipe out our children and their capacity to have a 
decent lifestyle.
    So the question becomes: How do we do this? How do we 
actually put in place $35 billion--which is a lot of money but 
in the context of the overall spending on Medicare, it still 
means Medicare would be growing at 45 percent. It still means 
it would be spending $2.2 trillion plus over the next 5 years. 
So how do we do that? Because I have wandered around the halls 
talking to my colleagues, and I do not sense that on the other 
side of the aisle there is any support for it. And, of course, 
on our side of the aisle, moving into an election year, the 
response is, ``Well, can't we put this off?''
    So give me the road map that gives me 51 votes to pass this 
concept of reducing Medicare by--reducing the rate of growth of 
Medicare from 48 percent down to 45 percent.
    Secretary Leavitt. Senator, let me break my thoughts into 
two parts.
    The first is we ought not to have this conversation without 
acknowledging that underlying all of our worry here is the fact 
that Americans are not living very healthy lives right now, and 
that it is, in fact, driving our health care costs through the 
roof. Senator Conrad used a chart that showed a small 
percentage eating up a big piece. Some of that is end-of-life 
issues, but a big part of it is people who suffer from chronic 
illness. Roughly 75 percent of all of the expenditures in our 
health care general come from people who have chronic illness. 
That has substantially increased over the last number of years. 
Those are diseases that are to some extent preventable and to a 
large extent manageable, and in my judgment, has to become, as 
was indicated earlier, part of our focus on how can we inspire 
Americans to live healthier lives, because we are paying a 
price. They are paying a price in--they are paying the physical 
pain. We are all paying the fiscal pain. And we will. So that 
has to be a big part of it.
    But let's deal with Medicare as a program for just a moment 
and how we go about navigating the treacherous political waters 
that are involved in this dilemma.
    I would just offer this observation: I think it is unlikely 
that any one Congress is going to act in a way as to be bold 
enough to fix this problem with a silver bullet. It is not 
likely. It is also my judgment that it is difficult to get 
legislative bodies or political bodies in general to deal with 
these issues, and that we may need to set up a construct that 
over time holds the discipline for that to occur. The 
President's budget proposes or suggests that we use a hard 
trigger, that is to say, that if, in fact, 45 percent of the 
revenue--45 percent of the proceeds going to fund Medicare come 
from general revenues, anything above that would trigger 
reductions in the program or would require some kind of action 
on the part of Congress to deal with it.
    I think ultimately that is the road map, Mr. Chairman, and 
a lot of refinement will have to be made to that, but this is a 
first step of a series of small actions that would need to be 
required if we were to achieve it.
    Chairman Gregg. Thank you. I will come back. I have 
additional questions, obviously, but my time has expired, and I 
will turn to the Senator from North Dakota.
    Senator Conrad. Thank you, Mr. Chairman.
    In my questioning, I am going to really try to focus on 
avian flu because I am extremely concerned about the threat to 
our country. I told the Secretary, as he came in, that I have 
just been reading this book. The Secretary tells me he has read 
it twice cover to cover. I have read about half, and half is 
enough to make your hair stand on end. This is about the 1918 
flu epidemic and how devastating it was worldwide. Nobody 
really knows how many people died. Some estimates are as high 
as 100 million people died.
    We know that there is an enormous risk with avian flu, and 
whether it is avian flu or some other pandemic, it leaves us 
with the same questions; that is, are we doing everything we 
can do to prepare for this threat?

[GRAPHIC] [TIFF OMITTED] T6726.303


    Let me put this up. This is a Washington Post--I am sure 
you read, Mr. Secretary, this editorial from February 13th. And 
I would direct your attention to the last full paragraph, and 
it says, ``Given the overwhelming challenges of preparation as 
well as the uncertainties surrounding antivirals, it would make 
the most sense to focus on a vaccine. But although meetings 
among international scientists will be held this summer in the 
hopes they will exchange information and speed up research, 
officials at the Department of Health and Human Services agree 
they still don't have `visibility' about what everyone is 
doing.'' In other words, there is not much coordination.
    ``Furthermore''--and this is what I would like you to 
respond to specifically--``some U.S. companies say that they 
remain confused about this country's vaccine development 
program which lacks a timeline, leadership, and clear 
incentives for the private sector.''
    Mr. Secretary, is there a timeline? And where is the 
leadership? And what are the clear incentives for the private 
sector to produce a vaccine?
    Secretary Leavitt. I have met on a number of occasions now 
directly with the heads of all of the producers of vaccines in 
the United States. The President has met with them as well. 
They made clear to us that they need three things in order to 
proceed with the development of vaccines. The first is 
protection from the liability that historically has been there 
when a vaccine was developed in a rapid fashion.
    Senator Conrad. OK. Let's take them each in turn. Have we 
done that?
    Secretary Leavitt. Yes, we have.
    Senator Conrad. OK.
    Secretary Leavitt. We have done so.
    Senator Conrad. OK. So they got--that is No. 1. No. 2?
    Secretary Leavitt. The second is that they need to have 
some certainty that there will be a market if they produce the 
vaccine. The answer to that is yes, we would be the market if 
such a vaccine were needed.
    Senator Conrad. And what has been done to make certain that 
they understand that that is the case?
    Secretary Leavitt. Well, we are now in the process and will 
within a matter of days or a couple of weeks announce a series 
of contracts that we have negotiated after response to requests 
for proposals that will drive forward not just the development 
of new facilities, but also the development of new technologies 
in the cell-based manufacturing realm. We are quite optimistic. 
Because we are still in procurement, I cannot be more specific 
than that, but I can tell you that in a very short time we will 
have deployed the resources, the first phase of the resources 
that Congress appropriated just a little under 2 months ago, 
not just in the area of vaccine, new cell-based vaccine and 
facilities, but also adjuvant technologies and also rapid 
diagnostics.
    Senator Conrad. And, Mr. Secretary, will you keep the 
committee informed as to your progress on that point?
    Secretary Leavitt. Indeed I will. In fact, I will be 
issuing within 2 weeks a full report to the Congress and to the 
American people on our progress on our comprehensive plan for 
pandemic preparedness, and I will periodically do that. The 
vaccines are one part of a comprehensive plan. I am currently 
involved now in 50 State summits. By the end of this week, I 
will have done 18, and we have virtually every other State now 
scheduled or in active conversation. And by the end of April, 
we will have accomplished that.
    Senator Conrad. And what is the third point? You mentioned 
there are three things that pharmaceutical makers have said are 
necessary: point No. 1 was protection from liability; second 
was certainty of market. The third?
    Secretary Leavitt. Regulatory streamlining. They made clear 
that if we go through the normal process of approvals through 
the FDA of facilities, that it will elongate the process in a 
way that would be defeating to our ambition. And so I am 
working directly with the Food and Drug Administration. They 
are going to be using a streamlined and--not short-cut, but a 
streamlined process where we are essentially approving as they 
are developed, as opposed to waiting until they are developed 
and then approving.
    Senator Conrad. And is there any action required by the 
Congress to accomplish regulatory streamlining?
    Secretary Leavitt. No. We got the authorities in the 
defense authorization budget that appropriated the money, as 
well as where needed. We can proceed and we are proceeding, and 
I think you will find when the report is issued that we are 
making rapid and aggressive progress.
    Senator Conrad. Do you have a timeline with respect to 
vaccine development?
    Secretary Leavitt. Well, yes, we do. I can tell you that it 
will likely be 3 to 5 years--now that is a timeframe, but what 
we are essentially doing, Senator, is we are involved in co-
venturing with the pharmaceutical manufacturers or the vaccine 
manufacturers a series of new technologies. It is possible that 
one of those will break through. We are not just counting on 
one. We are counting on multiple strategies. We have multiple 
strategies we are working at the same time.
    Senator Conrad. What do we do if the pandemic hits before 
that 3- to 5-year period?
    Secretary Leavitt. Let me provide you some insight or at 
least offer some insights on vaccines as a strategic component 
of our plan.
    Any way you look at it, if we have a pandemic virus that 
begins to transmit from person to person, we are likely to be 
through--we will most certainly be the first 6 months without a 
vaccine because it takes that long, even in our most ambitious 
plans, to identify the virus and be able to develop a vaccine, 
go through the testing element and get it manufactured. So 
let's assume that it happened in a remote village in Thailand 
today. It would likely be 30 days, maybe 45 days before it came 
to the shores of the United States. At that point it would 
begin to move. We would be in full alert by that time and have 
implemented our National Response Plan and will have identified 
samples and have gone to the process of identifying the 
vaccine.
    Any way you look at it, we are going to be 6 months before 
we have the capacity to start providing those vaccines, and we 
will undoubtedly have been through the first wave of the 
pandemic, and we will be dependent upon good public health 
measures to protect us, and that is why the other components of 
the plan are so important.
    Chairman Gregg. Thank you.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman. I would like an 
opening statement to be put into the record, if it is all 
right.
    Chairman Gregg. Of course.
    Senator Bunning. Thank you.
    [The prepared statement of Senator Bunning follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.151
    

    Senator Bunning. Your budget that you have proposed for HHS 
includes a reduction in mandatory spending of $2.5 billion in 
fiscal year 2007, $35 billion over 5 years. The budget also 
includes some legislative and administrative changes that would 
save about $13 billion in Medicaid over the same period of 
time. That is a $48 billion savings. I want you to tell me why 
the administration feels these changes are so important this 
year, especially, not last year or the year before, why are we 
doing it this year?
    Secretary Leavitt. Well, Senator, this has to be a long-
term strategy because what we are doing this year is only an 
increment of what ultimately has to be done to keep these 
programs sustainable. When you compile the impact of Medicaid 
and Medicare together, we are seeing growth rates that are 
simply unsustainable in the long term. And, frankly, they are 
not as efficient.
    Now, we believe that we will see substantial improvement 
based on authorities that were granted in the statutes in the 
Deficit Reduction Act. We think we will begin to see States 
innovate and that many changes will be made that will improve 
Medicaid as a program and allow us to begin serving more people 
with basic health care.
    Senator Bunning. For more efficient spending of our money 
for that?
    Secretary Leavitt. That is correct. I also am optimistic 
that we will see our capacity to assist more people with basic 
health care as opposed to having relatively fewer people have 
unlimited care increase. And that is a basic strategic change 
that I believe is beginning in Medicaid.
    Senator Bunning. You have also proposed in your budget to 
allow States to use drug formularies in their Medicaid programs 
like in the private sector. What kind of change do you think 
this will have on the States' Medicaid programs and 
beneficiaries? In other words, are we really going to allow the 
States themselves that do get waivers, particularly--Kentucky 
just got a waiver. Will that really impact the cost not only 
for the Federal Government but for the State government, 
because we are going to run about a $750 million deficit in 
Kentucky unless we do something very dramatic.
    Secretary Leavitt. Senator, the States have needed to have 
the same tools that any private sector manager of benefits 
would have, and one of those would be formularies, the ability 
to use generic drugs where necessary or to find a class of 
drugs where there may be more than one alternative, one being 
much cheaper. When we are providing prescription drugs to a 
large population, having that management tool is an absolute 
necessity.
    Senator Bunning. You as the Secretary of Health and Human 
Services, how do you get the message out that when you reduce 
the growth in a program, it is not a cut?
    Secretary Leavitt. I repeat----
    Senator Bunning. In other words, if you are reducing the 
growth in Medicaid and Medicare over a period of time from 48 
to 45 percent, how do you get that message out when other 
people are trying to pound and say that we are actually cutting 
the program?
    Secretary Leavitt. Well, I have found the phrase useful to 
express the fact that we are allowing it to grow at a slower 
rate.
    Senator Bunning. Who is listening?
    Secretary Leavitt. Well, you and I are.
    Senator Bunning. Well, I know that, but who else? The 
American people, are they listening? Or can you get that 
message out so that people understand if we don't do something 
by 2030 or 2035, three programs, mandatory programs, are going 
to take up 75 percent of the total budget of the United States 
of America?
    Secretary Leavitt. Well, not only are the Governors 
listening, they are speaking. They know that this is true, and 
it is beginning to crowd out in their States many of the other 
important duties that they undertake, such as education and 
public safety. They have led the charge to this committee and 
to others to say we need the tools. What we want is to be able 
to provide coverage, to provide assistance to a larger group of 
people. And we can do that and be able to make the program more 
efficient if we have the flexibility.
    Now, I believe Congress has made a historic step in the 
Deficit Reduction Act in providing a whole series of tools. We 
are working with States and propose even more tools that would 
allow States that capacity. Medicaid is thought of as one 
program. The reality is it serves a whole series of different 
groups of people. The dilemma has been we have tried to use one 
approach to cover everyone. We will be far better if we can 
acknowledge that Medicaid does serve people who are aged and 
who are disabled and children who are in protected classes, and 
they have very specific needs. It also serves a lot of people 
who just need help buying insurance, and the needs of one group 
are different than the other. And what has been important is to 
provide States with the capacity to meet those needs with 
specific tailored approaches.
    Now, a big step was taken by the Congress with the Deficit 
Reduction Act. It has given States a new set of tools, and I 
believe that those tools will have a profoundly important role 
in being able to help us meet the needs of those groups in a 
better way.
    Senator Bunning. Thank you. My time has expired.
    Chairman Gregg. Senator Stabenow.
    Senator Stabenow. Thank you, Mr. Chairman. And welcome, 
Secretary Leavitt. It is a pleasure to see you again, and while 
I have concerns about the budget, I have great admiration for 
you and have enjoyed working with you in your different hats 
that you have come before us with.
    Secretary Leavitt. Thank you, Senator.
    Senator Stabenow. First, a couple of comments and then a 
question. When we look at Medicare cuts in the budget, 
hospitals, nursing homes, home health providers and so on, in 
terms of reimbursement cuts, what we see in the State of 
Michigan, with major manufacturers, major employers providing 
private insurance, is a cost shift. I don't see that saving 
money. I think there are things that we can do to save money as 
you talk about managing, whether it is chronic diseases or 
dealing with Health IT that I want to ask you about, but just 
for the record, Mr. Chairman, I do not see where we save 
dollars by cutting reimbursements that mean people end up 
either in emergency rooms sicker than they should be, getting 
treated, and then the cost is given to employers who see their 
rates go up, or hospitals who raise rates because their 
reimbursements are less through Medicare.
    So this has become a huge issue for our major employers in 
the country and certainly in Michigan when we look at the cost 
shifting that is going on.
    What I believe saves money--and I know you do as well from 
what you have talked about before--are initiatives like Health 
IT. And I am pleased that we were able to pass the legislation 
dealing with interoperability.
    But my question deals with where do we go from here, 
because when we look at the budget, we see $116 million in for 
the Office of--it appears that there is about $53 million in 
for small grants, which is not going to do much. I mean, that 
is what? A couple of hospitals, maybe. I do not know. But it is 
not very much in terms of getting us where we need to go, and 
yet David Brailer's office has testified that hundreds of 
billions--hundreds of billions of dollars can be saved by doing 
what you have spoken about, what I have spoken about.
    Senator Olympia Snowe and I have legislation that would 
allow some flexibility by using Medicare trust fund dollars to 
be used to purchase hardware, software, training, which we know 
will save the Federal Government, Medicare, Medicaid, as well 
as the private sector dollars. Tax incentives for physicians to 
be able to have accelerated depreciation to purchase the 
hardware, software, and so on.
    Could you speak to how you see us moving ahead on something 
that is clearly a bipartisan initiative? We have leaders in 
both parties speaking out, the President, yourself, and yet I 
do not see the movement in this budget that allows us to get 
there quickly and in the context of what we are talking about 
in terms of savings that has to occur in these programs. I do 
not understand why we are not moving more quickly, and 
certainly we would welcome your support for the legislation 
that Senator Snowe and I have introduced.
    Secretary Leavitt. Thank you, Senator. Could I answer your 
question in the context of the first subject you raised, which 
was physician reimbursements and how that in and of itself does 
not ``save money.'' It, in your suggestion, moves it from one 
account to the other.
    This is a prime example of how we have to change the entire 
way we think about health care and reimbursements. If we had 
Health IT in place where we were able to measure the impact of 
health care as opposed to the number of procedures, if we were 
able to pay physicians on the basis of performance and 
improvement in health, we would be able to have a rational way 
of seeing that trend turn down. What is lacking at this point 
is a way to collect that data in a consistent and clear way.
    Health IT is a critical part of that. There are two parts 
of Health IT. The first is adopting, that is to say, how do we 
get computers in every office and have everyone able to use 
them, and then the second is interoperability, the ability for 
those systems to work together so we have a consistent way of 
doing it.
    One of the worries is that if we are not fueling people 
buying systems that are not compatible, then, in fact, what we 
are doing is essentially investing our way into a state of 
incompatibility.
    Now, we are working hard on both of those accounts. They 
have to happen at the same time. I can tell you that by the end 
of this year we have four significant breakthrough projects 
that will begin to move us on a pathway of standards. One will 
be doing away with the medical clipboard as we know it. When 
you walk into a doctor's office, they always ask you to fill 
out your information again and again. We are creating a set of 
standards where every system that is now on the market could 
essentially have one system so that you could go into a 
doctor's office, present yourself, and some way that you would 
identify, and all of that information would be available. That 
will be a big step forward, and we believe that by the end of 
this year, those standards will be available.
    Another area is in chronic disease management. I indicated 
earlier to Senator Conrad that 75 percent of all expenditures 
are in the area of chronic disease. Many of those diseases now 
are able to be monitored by devices that are external to a 
doctor's office or a hospital. It is, again, Health IT. But 
that will allow us to do that in a more efficient way.
    Those are the kinds of things we are doing, and by the end 
of this year, we will have not just one but four breakthrough 
projects that are paving the way for this level of 
interoperability. At the same time we have to be working on 
adoption, as you have suggested.
    Senator Stabenow. Well, and, Mr. Secretary, I appreciate 
what you are working on. I know there are already, in fact, 
standards within the Department, and interoperability, I 
support doing that. But creating standards does not put the PC 
in front of the person that checks you in at the doctor's 
office or create the dollars to buy the information software 
that is already out there. There is amazing software, as you 
know, that is out there right now that could be used.
    I would just suggest that we have talked about pay for 
performance, but the first thing is pay for use. They have to 
be able to get the equipment, and when we look back at this 
whole question of what is being cut, we are talking about 
reducing hospital reimbursements, home health, nursing homes, 
on and on, and then we are saying, by the way, we want you to 
go out and invest in hardware and software and train people. I 
do not see that as compatible when we talk about compatibility. 
And if we--it takes time to get these systems in place, and if 
we wait until every T is crossed and I is dotted on standards, 
we are losing time, critical time that could be put into saving 
money the right way, rather than cutting access to health care 
for people.
    And so I would urge you to look at what we have suggested, 
which is not general fund dollars, but a way for us to jump-
start this and move it down the line.
    I know that we started our own systems in the Senate before 
they were interoperable. We still do not have all of the 
systems interoperable, and yet everybody got up and going, got 
on e-mail, got their websites set up, and we are connected in 
some ways. And we have built from there. You can also go 
backward on interoperability, as I understand it, so that it 
does not have to be waiting until the perfect standards are in 
place.
    In this time when we are cutting and using strategies that 
take away resources and, I would say, take away health care, 
Health IT is a very important way to do something that is 
positive, bipartisan, and doable. But I think we can be moving 
much more quickly than we are.
    Thank you, Mr. Chairman.
    Chairman Gregg. Thank you, Senator.
    Senator Ensign.
    Senator Ensign. Thank you, Mr. Chairman.
    Mr. Secretary, I would like to followup on some of the 
issues that Senator Stabenow raised. Specifically, I would like 
to address the issue of health information technology. I am 
going to be holding a hearing in my Commerce Subcommittee on 
technology, innovation and competitiveness on this very issue. 
We held a hearing on the issue in July and I believe another 
hearing is warranted. I would appreciate it if you could come 
and testify at the hearing because we do not have the time to 
delve into the topic of health information technology in detail 
today. I know that you have issued several requests for 
proposals to accelerate the adoption of health information 
technology. I would like to invite you and some of the 
organizations who have been awarded contracts as a result of 
the RFPs to testify before my subcommittee. The hearing will 
provide Senators with an update on where health information 
technology stands today. Everyone I have talked with believes 
that health information technology will reduce duplication and 
cut down on administrative costs such as transcription and 
billing. Clearly, information technology has enormous potential 
to reduce medical errors, improve quality of care and lower 
health care costs.
    I was recently in a car accident. If I would have had an 
electronic health record the physician who treated me would 
have instantly been able to obtain personal and medical 
information about me to determine how best to treat me. 
Instead, I was required to provide personal and medical 
information to the physician while I was in a neck brace lying 
on a stretcher. It is much easier to have that type of 
information readily available on an electronic health record. 
Electronic health records can also help ensure that physicians 
have the information they need to make appropriate clinical 
decisions.
    I would like to discuss interoperability. We need to 
develop interoperability standards to support electronic data 
exchange. Physicians and other health care professionals are 
hesitant to invest in information technology systems. Frankly, 
they do not want to invest ina system that will not be able to 
exchange information with anyone else. Currently, there are 
health care systems that have developed their own 
interoperability standards with their own network of doctors. 
This is happening today. I have had several meetings in the 
last several months with groups that have developed 
interoperable systems. We need to rapidly increase these 
efforts.
    I agree with putting out tax credits and perhaps we should 
allow full expensing to encourage health information 
technology. There are a lot of barriers to the adoption of 
information systems in health care. The interoperability piece 
is absolutely going to be key.
    I would also like you to comment on the area of best 
practices. I believe we need to develop and encourage the use 
of best practices so that doctors and patients have the 
information they need to make appropriate clinical decisions. 
However, this has not been a big focus of health information 
technology. It seems to me that health information technology 
is how we drive best practices. Only about half of the doctors 
in the nation are utilizing best practices. The use of best 
practices is very common in business, but we are still not 
using best practices in medicine. I believe we will see 
dramatic results when through the use of best practices.
    Could you please comment on how we can drive best practices 
into private health insurance programs and large government 
programs such as the Medicare and Medicaid programs? I would 
alos be interested to learn what types of savings could result 
from the full implemetation of health information tecnology as 
well as the savings that could be achieved through the use of 
best practices.
    Secretary Leavitt. Let me say to both you and Senator 
Stabenow, I am as impatient on this as you are. This is 
something that needs to happen. Interoperability is critical to 
this. There are remarkable systems that you can go through and 
name the systems--Kaiser Permanente, Intermountain Health Care, 
Cleveland Clinic. I mean, you can go all the way through the 
country and find centers of excellence where they have--the 
Veterans Administration. They have brilliant systems where they 
can track their entire health record, but they cannot talk to 
each other. And that is what we have to solve, is a way to 
bring them together.
    Now, how do we achieve interoperability? I would suggest 
there are three alternative paths. The first is for the Federal 
Government to step up and say this is the way it is going to 
be. This is the interoperable standard. You will meet this. 
Well, that fails--it almost always fails and is not a good 
path.
    The second option I call the last vendor standing. We will 
just let everybody fight it out until they have one standing. 
Well, that does not work because there are lots of different 
ways to get to the same path.
    The third way is messy and it is hard and it is 
frustrating, but it is the only way, and it is a collaboration, 
and in my mind, it ought to be led by Government. And that is 
exactly what we are doing. We have established the American 
Health Information Community. For the first time, we have 
brought together the Department of Defense, the Department of 
Veterans Affairs, all of the HHS entities, the States, the 
private sector, the communities, and we are saying to the world 
we are going to adopt as Government, which makes up 46 percent 
of all the dollars paid, we are going to adopt a set of 
standards, and we want the world to know that.
    But we want them to be the right standards, so we are going 
to collaboratively develop them, and then you need to know we 
are going to adopt them.
    Well, when you are 46 percent of the market, you are going 
to move the market. And we believe that in a very short period 
of time--I indicated at least four breakthrough projects--the 
market will begin to move, and we will start to see 
interoperability.
    Frankly, the world does not lack computers. It lacks 
interoperability. And once we have achieved that--now, I don't 
think we ought to be waiting until we have perfect 
interoperability. I for one would be delighted if I could say 
to my health provider, ``Send my lab results to me 
electronically, and let it fit into a record that I will 
create.'' That would be not the perfect step, but it would be a 
very important step. I was talking with a colleague of mine who 
went to the doctor. She took her children to the doctor, and 
she had to be away from work for a day. I said, ``How did it 
go?'' She said, ``Well, it went fine, but I spent the first 
half a day being a medical courier. I had to go to three 
speciality doctors. I had to pick up brown envelopes with tests 
in them. Then I had to take them over to a specialist so they 
could read it.''
    There is no reason that has to be that way. They could, 
with the click of a mouse, send those in electronic form. And 
they should not need to do that. And those are the kinds of 
policy changes that will get us steps forward.
    I will confess to you that this is not happening as fast as 
I would like it to, but it is a big, cumbersome, and 
complicated problem. But I believe we are on the right path.
    Senator Ensign. Mr. Chairman, Secretary Leavitt did not 
comment on the area of best practices. Mr. Secretary--could you 
please address best practices?
    Secretary Leavitt. Well, you can get lots of estimates on 
what kind of efficiency this would create. Many believe it is 
as much as 30 percent. When you are talking about 30 percent of 
$1.9 trillion, that is a lot of money. Now, others say it is 
less than that but still significant. There is no question in 
my mind that money is part of it, but it is not the only 
reason.
    What is the savings to my colleague of not having to take a 
day off of work? That is big. What is the value of having a 
best practice that will save my life because I did not get a 
hospital infection or an adverse drug effect. Those are huge 
savings that are not reflected in that 30 percent.
    Senator Ensign. Mr. Chairman, the reason that we are 
focused on the money aspect of best practices is because we are 
beginning to work on the budget. Even if we did not save any 
money through the use of best practices it would be worth 
implementing best practices it simply because of all of the 
other side benefits. I think that best practices is absolutely 
one of the most important areas that we can focus on as far as 
our health care system and as far as our budget is concerned. 
Best practices certainly have the potential to curb health care 
costs. At the same time, best practices will ensure that 
Americans have access to evidence-based health care when they 
need it the most. This is exactly why this Congress needs to be 
focused on doing everything that we can to bring best practices 
to fruition as quickly as we possible.
    So I thank you, Mr. Chairman.
    Chairman Gregg. Thank you. We just need to apply it to 
veterinarians.
    Senator Murray.
    Senator Murray. OK. I don't think I will touch that.
    Thank you very much, Mr. Secretary, for being here to talk 
about the budget for Medicare and Medicaid, and I agree with 
Senator Stabenow's original comments where she started out 
talking about just reducing the dollar amount we spent here 
does not necessarily save us a lot of money unless we focus on 
really prevention and programs like preventive health block 
grants and maternal and child health program, HCAP, those kind 
of programs that are preventive, that keep people from coming 
in and using costly health care dollars. So it concerns me that 
those programs are cut in our budget.
    But I want to focus my questions today on what is happening 
in the reality of us shifting costs in terms of saving money, 
and specifically let me talk about the VA, because as all of us 
know, we went through a very difficult situation last year 
where the VA finally told us after months of saying that there 
are long lines, people are not getting access to care, we have 
a crisis, that they indeed were short well over $1 billion in 
VA health care. And we had to come up with additional dollars 
to face that last year.
    Well, what I am hearing now--and we had a VA Committee 
hearing yesterday--is that a number of States, because of the 
shifting burden to them to care for the Medicaid population, 
looking for ways to save money, are working to treat veterans 
who qualify for Medicaid, shifting them back to the VA. And it 
was shared with us that an analysis was conducted by Missouri's 
auditor in 2004. It found that Missouri could save $5.5 million 
if veterans who received benefits through Medicaid had instead 
received care from the VA.
    Missouri is not the only State doing this. My home State of 
Washington recently identified veterans who enrolled in public 
assistance programs and introduced 2,000 veterans back to the 
VA system, saved my State $4 million, but that cost is shifted 
back to us. And it makes me very concerned because 5 percent of 
Medicaid recipients are veterans today. We have an obligation 
to care for them. But we have not budgeted for that. That will 
have a huge budget implication back at us, and I am curious if 
you are aware of this trend and whether you expect it to 
continue.
    Secretary Leavitt. I have to confess, Senator, that is the 
first I have heard that. I am not surprised that States are 
looking to the Veterans Administration to cover those who are 
eligible. That does not surprise me. But I am not aware of the 
trend that you have spoken of, and it is worthy of 
investigation.
    Senator Murray. Well, it is an important one because it 
comes back and hits us, and we have to make sure that we have 
the dollars for the VA. I don't think any of us want to be 
sitting there in July saying we are $1 billion short again. But 
I think we need to be aware that that is what happens.
    And a second similar shift, a number of seniors are telling 
me that when they call Medicare to ask about the Part D drug 
benefit, they are being told--asked, in particular, if they are 
a veteran, and if they are, telling them, well, don't sign up 
for Part D, go into the veteran system--which then, by the way, 
covers all their health care and they deserve that and we 
should not turn them away. But it is shifting that cost from 
Medicare to the VA, and again, it has a budgetary implication.
    So I did not know if you were aware that people are being 
told that.
    Secretary Leavitt. We have been working to help people get 
prescription drug coverage by whatever means possible, and I 
will tell you that I have been in, I think, 44 States talking 
with seniors about the Medicare Part D. And routinely people 
will say, ``I am a veteran, and I am happy with that system.'' 
And so as a matter of course, people who are eligible----
    Senator Murray. Sure. I did not have a problem with it. It 
has a budget impact because it is not just their prescription 
drugs. If it a senior just looking for prescription drugs, they 
shift to the VA, and it covers their entire health care. They 
cannot just go in and ask for a prescription. They then get all 
of their health care there. It is a cost. It is one that we owe 
to our veterans. But it is going to have tremendous budget 
implications, and I think we--it makes me very worried about 
our veterans budget again, as I was concerned last year with 
these shifts from Medicaid and Medicare moving back onto our 
veterans system and us not providing the resources for it.
    So just saying we are going to reduce Medicaid costs does 
not necessarily save money. I just want us all to be aware of 
that, and we are going to have huge implications from that.
    And my time is short, but I did want to just mention that I 
appreciated you being out in my State recently working with my 
Governor to come up with additional--I think it was $15 million 
for our dual-eligibles. It is, as you know, a huge challenge 
across the country as the prescription drug plan is going into 
effect. The dual-eligibles are rightfully--really, it is a very 
disconcerting problem that has an impact on our physicians, on 
our senior citizen homes, on our pharmacists themselves. And I 
appreciate you coming out with the announcement to help our 
State with this co-payment issue for dual-eligibles.
    But I did want to find out from you, this is not new money, 
it is my understanding. It is simply a recalculation of the 
State's clawback. I just want to make sure my State is not 
going to end up at the end of the day with this bill sitting in 
their lap, and if you cannot provide me with the information 
today, if you could give me a detailed answer on that, I would 
really appreciate it.
    Secretary Leavitt. I am actually able to give you a fairly 
detailed answer on this. The good news on the prescription drug 
benefit is that enrollment continues to go up dramatically and 
the costs are going down, and they are going down because the 
competitive nature of the market now has driven them down. And 
one of the benefits of that is that we have been able to reduce 
the amount of money that the States have to reimburse the 
Federal Government. And in the case of the State of Washington, 
it was a little over $14 million.
    That announcement came at a very good time because your 
Governor was interested in being able to cover the $1 and the 
$3 co-pay. Some States have chosen to do that. Washington State 
was not one who had. And so the Governor went to the 
legislature and proposed it, and I understand that authorities 
have been granted, and she is now able to use that $14 million.
    It is important, as I have communicated to her, that she 
recognize that is a one-time proposition. We do not know what 
will happen next year. We like to think that they will continue 
to go down, but----
    Senator Murray. And you have the flexibility within the 
law, just so I understand, to be able to say we are not going 
take the clawback?
    Secretary Leavitt. It was a recalculation of the clawback. 
It was just a recalculation. Because of the cost savings, the 
amount that they would need to pay was $14 million less.
    Senator Murray. So it is not an additional cost to the 
Federal Government?
    Secretary Leavitt. It is not. Nor is it--let me restate it 
for clarity. The State of Washington had budgeted----
    Senator Murray. And other States, I am understanding.
    Secretary Leavitt. Right. When the Medicare Modernization 
Act was passed, it took the dual-eligibles and moved them from 
Medicaid over to Medicare. That would have been a substantial 
savings to the State because they would no longer carry that 
responsibility. And so Congress concluded that the financial 
benefit to the States should be phased in and started with 90 
percent of the first year of the cost of that would need to be 
repaid, and some people have called that the clawback.
    Senator Murray. Yes.
    Secretary Leavitt. Each year that reduces by a certain 
amount, 5 percent a year until it gets to 75 percent. That was 
calculated, and the amount--let me just say it was this big--
    [indicating] for the State of Washington.
    When we recalculated it, seeing the new savings that were 
involved because the costs of the drugs were less, instead of 
being this much that they needed to pay back, it was this 
much--
    [indicating]. And the savings that they no longer needed to 
pay to the Federal Government was the $14 million.
    Senator Murray. But you are saying that was 1 year only?
    Secretary Leavitt. I am saying that would be 1 year.
    Senator Murray. All right.
    Secretary Leavitt. Actually, that might repeat because--it 
very well could repeat because the savings will be--you know, 
one would like to think they will be permanent. We do not know. 
The market may continue to drive them down, and it may be even 
more. But the point is the $14 million was coincidental to the 
fact that she needed $14 million. It was a stroke of good 
fortune, and it solved a problem, and they will need to wrestle 
with a permanent solution. But it may, in fact, be permanent, 
because the actual amount they will have to repay will go down 
5 percent every year. So I guess now that I think about it, it 
would very likely be at least dependable, maybe not permanent.
    Senator Murray. Sure. All right. Thank you, Mr. Chairman.
    Chairman Gregg. Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman.
    Mr. Secretary, thank you for your public service, and thank 
you for your service as EPA Administrator as well as Secretary.
    About the time that you were coming in as Secretary--it has 
been a couple of years, hasn't it?
    Secretary Leavitt. A year. Time flies.
    Senator Nelson. Well, then, just before you came in, we had 
had a little dust-up in Florida with some harassment of senior 
citizens cracking down on their importation of a minimal supply 
of prescriptions from Canada, either by the Internet or by 
mail. This was before you came in as Secretary, and I had 
assurances from the head of the Food and Drug Administration 
that since they have a lot on their plate, what they were not 
intending to do was to harass senior citizens, and that they 
were not going to implement a program whereby the confiscation 
of these prescriptions were occurring, where there was a 90-day 
supply or less of the prescriptions ordered by mail or by the 
Internet. And so we have gone along the last couple of years 
under that policy.
    Lo and behold, starting about November, apparently that 
policy has changed. And I have been getting complaints from all 
over Florida, and especially so in the last couple of weeks, to 
the tune of 130 complaints. And what that would indicate is 
there are a lot of people out there, because when I get a 
complaint, it is usually the tip of the iceberg and there is a 
lot underneath. A hundred and thirty complaints is fairly 
sizable, that suddenly their prescriptions had been 
confiscated.
    Now, of course, one of the things that comes to mind, first 
of all, I have raised a lot of sand about this because this was 
the policy of Food and Drug, which is under your 
administration, but I am also concerned, Is there any linkage 
between trying to drive citizens, senior citizens, out of 
purchasing where they can get them at half the dollar value of 
the retail price, by driving them out of getting them from 
Canada into the prescription drug benefit Part D.
    And so I want to ask you that for the record, if you could 
clarify what are your policies.
    Secretary Leavitt. Senator, I can give you some insight on 
this. I have done some investigation myself.
    The Food and Drug Administration has worked in a 
cooperative way with the Customs Service, and generally what 
happens, if there is an event involving a prescription drug, it 
is referred to the FDA by the Customs Service. The FDA frankly 
has been spending some time, but for the most part focused on 
other things, but the Customs Service in the last year has been 
given independent authority and developed independent of the 
FDA the capacity to deal with these matters and, you know, not 
always required to check with the FDA on the implementation of 
such a policy or, for that matter, the adjudication of that 
kind of a matter.
    What you are seeing is a substantial increase in activity 
by the Customs Service, and as I understand it, what they do is 
send to the recipient of the drugs a letter saying: We have 
these. It is not in accordance with the law. Would you like us 
to refer this to the FDA for testing?
    The recipient then has an opportunity to do that, and the 
FDA then receives it, and the FDA then is able to determine 
whether or not it is appropriate or not.
    So I want to make three points. The first is what you are 
seeing is an increase in activity by the Customs Service.
    Senator Nelson. Indeed, and that has been confirmed, to the 
point 7 times greater what it has been in the last couple of 
years.
    Secretary Leavitt. The second point is, whether one agrees 
with it or not, it is the law.
    And the third point is I wanted to just give you some sense 
of why there is concern about this. We have a rather well-
protected distribution system of drugs and, for that matter, 
food in this country. I have been concerned about drug 
counterfeiting. The FDA recently, as an example, found a 
website called ``Canadian Generics.'' It had the Canadian flag. 
It had all kinds of motion to it. I think it may even have the 
Canadian anthem, for all I know, but it was all focused on 
Canadian generics.
    Our investigators bought drugs from this site. We tracked 
the transaction. It turns out the website was actually managed 
in Belize. It turns out that the ISP was in China. It turns out 
the check we sent them was cashed in the Virgin Islands. And 
the postmark on the drugs came from Dallas, Texas.
    When we tested the drugs--there were a series of them that 
we ordered--every single one of the drugs had active 
ingredients that were dramatically different than represented. 
In some cases, it was half. In other cases, it was twice. In 
one case, we had a syringe that was brilliantly counterfeited. 
You could not tell the package from the original one that would 
be developed by a manufacturer. But instead of the solution in 
the syringe being according to specifications, it was tap 
water.
    The point is that there is a danger here, and there is a 
need for buyers to beware and to be very careful about who it 
is they are buying drugs from. It is currently the policy of 
the United States to protect the distribution system of our 
drugs in that way.
    Now, again, I wanted to tell you that in the context of I 
think the increased activity that you are seeing is a function, 
as you have confirmed, of the Customs Service. That is the role 
FDA plays and why we are being quite concerned about 
counterfeiting. The World Health Organization indicates that it 
is now a $35 billion industry. Law enforcement people tell me 
that if you take a trunkload of capsules of crack cocaine and 
you set it side by side a trunkload of phony Viagra, you will 
get a lot more money out of the phony Viagra than you would the 
crack cocaine, and the penalties for getting caught are 
substantially less.
    So we are seeing a substantial amount of increase in the 
level of trafficking in counterfeit drugs, and so the 
intensified concern on behalf of the Customs Service is not 
just in enforcing the law. There is a legitimate public harm 
that could, in fact, occur here.
    Senator Nelson. I understand that, and you need to 
understand the flip side of this, that we want you to go after 
all of the counterfeit, and that is what the law is for. There 
are certain established procedures that the Food and Drug 
Administration over the course of the last year, because of its 
policies, seeing that a small supply of prescriptions to 
seniors coming from reputable pharmacies in Canada, that the 
possibility of harm is de minimis and they know it, and given 
the fact that the FDA has so much on its plate, then it was not 
going to cause the confiscation of seniors' drugs. And the flip 
side you need to hear from us as we, the legislative branch, 
advise to you, the executive branch, and hold you accountable 
is that there are seniors out there that are having difficulty 
making ends meet. They cannot afford the retail price of drugs. 
They either are confused and have not signed up because of the 
multiplicity of plans, or where they try to sign up, they find 
that the cost is way more than they could get the drugs. And 
rather than having to sacrifice on other necessities, since 
they have to have their prescriptions, they buy them where they 
can get them at half the retail price.
    Now, that is the side that you need to hear in the 
implementation of the policy. So I take it that your final 
answer then is you see no causal connection with trying to 
force seniors into prescription drug Part D Medicare.
    Secretary Leavitt. Senator, we have had no change in 
policy, and I can tell you that I know of no causal connection 
between those. I do think your points are sound ones, and that 
is, we need to help seniors have access to the prescription 
drugs that they need. We need to work hard to make certain that 
they know about the benefits of the prescription drug benefit. 
We also need to do our best to inform them of the difficulties 
that can come in having drugs that are not pure and not well 
protected.
    You know, I acknowledge that there is this ongoing policy 
debate about what our law is, but I do want to assure you there 
has been no change in policy.
    Chairman Gregg. Thank you.
    We doubled the spending on NIH by 2003. We have taken a few 
years basically to pause that spending so they could absorb it 
and effectively use it, which I think was appropriate.
    I notice this budget once again essentially freezes NIH 
funding. Is the demand for research being adequately met by NIH 
at this time?
    Secretary Leavitt. Well, Senator, you appropriately--this 
is a flat proposal on our part. It ought to be recognized that 
there is a $30 billion investment here, and we are working to 
find ways in which we can use that money better. One example is 
that we are pressing hard on having trans-institute investment. 
Instead of just having institutes invest on their own, this is 
a good example of what I talked about going across agencies and 
breaking out of silos.
    For example, the genetics and environment initiative that 
you will see represented here, that will benefit all 27 
Institutes. Dr. Zerhouni has what he calls his road map where 
they are identifying high-priority basic science that does not 
need to be done in every single one of the institutes. I 
frankly felt pretty good about keeping NIH level-funded in a 
deficit reduction budget.
    Now, I know that we would all be happier if we had 
resources to do otherwise, but I feel good about the commitment 
that we have made, and I feel good about the strategy that we 
are deploying to make certain that those important initiatives 
keep going forward.
    Chairman Gregg. Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman.
    I would like to go back to the avian flu question. I don't 
know if you saw the February 17th opinion piece in Newsday. 
This is what they said. The headline was ``The Next Disaster.'' 
It said, ``The U.S. Government has done little of consequence 
to prepare for the possible rise of the epidemic. Congress has 
allocated $280 million for flu surveillance, but none of it has 
been spent. Now it is too late to use the money effectively. 
President Bush has set a goal of creating 81 million courses of 
Tamiflu, but the United States has a current stockpile of only 
4.3 million courses of Tamiflu. And it is unclear how quickly 
pharmaceutical companies can produce more. The real hope lies 
in the development of new, more effective bird vaccines. Crash 
programs are underway in Asia and the United States, but there 
is little, if any, coordination among them. Bird flu may not 
become a pandemic, but Washington must be prepared for it and 
devote more money and greater urgency to preventing it, and 
time is running out.''
    Can you tell us how much is in this budget to confront a 
potential pandemic?
    Secretary Leavitt. In total, the President has requested 
$7.1 billion. The Congress has funded thus far $3.3 billion of 
it. We have embarked on a multi-strategy comprehensive plan, 
and I would be happy to go through each piece of it. I would 
like to point out----
    Senator Conrad. But how much money is in this budget?
    Secretary Leavitt. Well, in this budget we have $2.3 
billion, and there is an ongoing $350 million.
    Senator Conrad. $2.3 billion.
    Secretary Leavitt. When you combine the $3.3 that Congress 
allocated in the last budget period and this $2.3 billion plus 
$350 million, and then we will undoubtedly be making a request 
for the third year, that will get you to the $7.1 billion that 
the President has requested.
    Senator Conrad. Let me ask you this: Is $2.3 billion all 
that you can use to prepare for this, or could more be done?
    Secretary Leavitt. Senator, there is always more, but we 
believe that the $7.1 billion provides a comprehensive approach 
and, frankly, will have put us on a crusade to create vaccines, 
to put stockpiles of antivirals in place, to create 
technologies that do not exist today to work with a monitoring 
network around the world and around the United States, and to 
bring to a level of readiness never before achieved in the 
United States for any kind of a medical disaster. We see this 
as not just having value in the context of a pandemic, but for 
any medical emergency, be it bioterrorism, a nuclear attack, or 
in some kind of natural disaster. We believe that this is 
combined with the almost $7 billion that has been spent on 
surge capacity since 2002, this is a rigorous and quite 
aggressive campaign to prepare.
    Senator Conrad. Let me just say this to you: that my 
reading of this book on what happened in 1918 is that an awful 
lot of well-meaning people did not respond aggressively enough. 
And I am very concerned that we are headed in that direction 
again.
    When I hear you say 3 to 5 years on the vaccine front, that 
sounds like a long time to me. And in any event, we would have 
to face 6 months of the scourge before we would be ready to 
respond.
    Is there anything that could be done to shorten those time 
periods?
    Secretary Leavitt. That is a question that has been posed 
to every vaccine manufacturer and every scientist I could find, 
and I am persuaded, Senator, that simply the nature of the 
process of building and manufacturing vaccines requires that 
period. When you make a vaccine, it needs to be tested. You are 
putting into the arm of people a virus or some component of a 
virus that has an impact on their body, and we have learned 
from sad experience that if we are not doing it in a safe way, 
it is possible to cause harm. And that is the major component.
    Now, we do have manufacturing deficits right now. We do not 
have the capacity in this country. That is, frankly, the 
subject of 20 years of neglect. One of the good things that 
will come from this is that we will not only create the 
capacity to generate vaccines in a pandemic, we will also take 
care of the problem we have on vaccines for the annual flu.
    But any way you look at it, we are going to have to do two 
things: more capacity and new technology. You cannot get to the 
300 million courses that we aspire to get to in 6 months using 
eggs. We have to use cells, and that capacity does not exist. 
When that editorial was written, we were 47 days into our 
funding cycle. We are already issuing substantial procurements 
in that period of time. I don't know how it could be done 
faster.
    Senator Conrad. Let's go back to this question. Is there a 
way through more investment to be prepared for this capacity 
need sooner than the 3- to 5-year time period?
    Secretary Leavitt. That is precisely the question we have 
issued to the entire vaccine world. We did not give them 3 to 5 
years. We said: Come to us with your ideas. Show us how you can 
create a vaccine and technology in the shortest amount of time 
possible.
    They are responding in a competitive marketplace. We have 
multiple providers who have stepped forward with good ideas and 
smart people. We have asked them not to do anything short of 
putting their best people, and, frankly, that has been a--we 
have had to offer the kind of co-investment that we are making 
in order to incent them to do that.
    Senator Conrad. And how much is that co-investment?
    Secretary Leavitt. Well over $1 billion of the 3.3 this 
year.
    Senator Conrad. And let me just go back to this, my final 
question. If we wanted to do more to speed this process, are 
there things we could do?
    Secretary Leavitt. Senator, I am persuaded that there are 
five components to readiness. The first is having antivirals in 
sufficient proportion. We will be at 20 million courses of 
antivirals by the end of this year. We have stepped that up 
substantially. We are working with the States to create their 
stockpiles and means of distribution.
    The second is vaccines. We----
    Senator Conrad. If I could just stop you, No. 1 is when you 
say antivirals, you are talking there about Tamiflu and----
    Secretary Leavitt. Tamiflu and other antivirals----
    Senator Conrad. Relenza?
    Secretary Leavitt. Primarily Tamiflu. You and I have had 
conversations----
    Senator Conrad. Yes.
    Secretary Leavitt [continuing]. About Tamiflu and its 
limits, but it is a very important part of our plan.
    The third part is in monitoring. We are developing with the 
world a monitoring network. Now, I need to tell you that I have 
personal doubts about whether or not you are going to be able 
to find the spark when it happens. It is a big world, and there 
are lots of people, as we are seeing. It has now spread over--
well, we have seen it in 20-plus more countries over the course 
of the last 2 months. This morning it is being reflected in 
cats in Africa and in new countries. I mean, it is spreading 
across the world. I do not believe that there is any reason to 
believe we will not see wild birds in the United States with 
the virus.
    Senator Conrad. It is just a matter of time.
    Secretary Leavitt. It is just a matter of time, maybe very 
soon. It is not inconceivable that we could see a domestic 
flock. Neither of those would be emergencies or crises or 
things that we have not seen before. We can deal with that. 
What becomes a pandemic is when we see person-to-person 
transmission.
    Now, any way you look at this, the first 6 months of a 
pandemic we are dependent upon basic public health, social 
distancing, every business having a plan, every school, every 
church, every county, every tribe having a plan.
    Senator Conrad. And we do not have that, do we?
    Secretary Leavitt. When it comes to a pandemic, we are 
overdue and we are underprepared. But we are moving with 
dispatch, perhaps at greater speed and with greater opportunity 
to do something about this than any generation in humankind has 
had before.
    Now, that is exactly the reason why I am going personally 
to 50 States with Governors, holding pandemic summits, not just 
to talk to public health people but to talk well beyond public 
health, to school principals, to superintendents, to college 
presidents, to corporate planners. We are talking with 
community leaders. We are talking with faith-based 
organizations.
    Senator Conrad. Can I just say to you, Mr. Secretary, with 
great respect, when I read the reactions of public health 
people, what they are telling me and what they are saying 
publicly is that the response is woefully inadequate, that we 
do not have the resources, that if it comes down to it, if we 
have a pandemic, the medical essentials are going to be in 
grossly short supply.
    Ventilators--if there is one thing I have heard 
consistently, it is that we are going to immediately have a 
crisis with ventilators; that we are going to have a crisis 
with hospital space; that we are going to have a crisis with 
public health providers. And, I mean, this is what I get back 
from them, that we are not prepared. And when I talk to people 
in business, their response is, ``We are not prepared.'' And I 
have great respect for you. I think we have to do more. I think 
we have to have a more ambitious plan than we have that I see 
so far.
    Secretary Leavitt. Senator, is there time for me to give 
you a response.
    Senator Conrad. Certainly. You can always respond.
    Secretary Leavitt. I am spending a very high percentage of 
my time--I know you do not doubt that. This concerns me 
greatly. I spent weeks walking through medical shelters during 
Katrina. I saw people who had come from every State to help 
their fellow citizens in distress. I learned a couple of 
lessons from that. One is sometimes we have to think about the 
unthinkable, and what you are suggesting, I agree with.
    Second is that a pandemic is different than any disaster 
that we prepare for. It is different than an earthquake, it is 
different than a hurricane, it is different than a bioterrorism 
event--in two ways: The first is it happens everywhere at the 
same time. It will happen in Seattle and Santa Fe and Sarasota 
and Syracuse at the same time.
    I saw in the paper recently a public health official, like 
one that you referenced, saying, ``Look, what the Federal 
Government does not understand is that we count on them for 
ventilators when we have any kind of a problem like an 
earthquake or a bioterrorism event, and we are all going to 
come there at the same time.''
    Senator Conrad. I just read that very----
    Secretary Leavitt. That is exactly what we do get, and the 
reason I am going from State to State to say to them any 
community that fails to prepared on the basis of the 
expectation that the Federal Government will be able to step in 
at the last minute and throw them a lifeline will be sadly 
mistaken.
    Yes, we have an obligation at the National Government, and 
we are responding to it. We are developing vaccines; we are 
developing antivirals. We are working to develop stockpiles. We 
are going out to the States. We are working on our border 
issues. We are exercising at the Cabinet level. We are working 
internationally. All of those things are roles that the 
National Government has to play, and we are playing them.
    But communities need to prepare. We have to be a voice, a 
warning that we will not have the capacity to respond to every 
community if it is happening at one time. If they need 
ventilators, we will have some, but it will not be nearly 
enough to go to every community. And maybe they ought to be 
thinking about whether they need ventilators or a new swimming 
pool. If they are concerned about preparation, public health is 
a public responsibility of local government, not because we do 
not want to respond, not because we have not got the wallet for 
it, but because you cannot manage a pandemic in that 
atmosphere. There are too many places. We will be responding to 
as many as 5,000 different communities at the same time.
    This is an important principle in the management of a 
pandemic. The foundation is local preparedness.
    Senator Conrad. Let me just conclude by saying I agree with 
that. I also believe deeply that the Federal Government has a 
leadership role. I think you believe that as well. And I must 
say as I look at this and I look at $2 billion to confront 
something that could be the disaster of our lives, could be the 
disaster of our time, I just do not think it is enough. I do 
not think it represents the kind of commitment that we need to 
make in light of the potential danger. This potential danger is 
so extraordinary, and we need to--I think we need to do much 
more.
    Chairman Gregg. Mr. Secretary, we appreciate your time. I 
want to followup on that briefly. You know, as former chairman 
of the HELP Committee and as chairman here, I have been 
intimately involved in this. And I do not want to leave this 
hearing with the sense that you folks have not been doing an 
extraordinary amount to try to prepare, both in this and the 
area of bioterrorism.
    This $7 billion that you have asked for is outside the 
budget. I mean, it is an emergency funding. You have asked for 
another 2.3, I think, outside the budget. It will come to you. 
And the issue I have sensed, looking at it on fairly close 
analysis, is--as you pointed out earlier, the first issue is 
how you get people to start producing vaccine. The vaccine 
industry in this country basically was destroyed by the legal 
community. And so I drafted language--actually, Vince drafted 
the language, I think. But we drafted language which Senator 
Frist has been a strong supporter of, and we put it in and we 
have hopefully taken care of that legal issue. But we still do 
not have a vaccine production capability in this country of any 
capacity, and I know you are working to get that up to speed. 
Because we understand that when this happens, every country is 
going to need vaccine. There is going to be a unique situation. 
Every country is going to need vaccine, and the country that 
produces it is going to keep their own, and so we have to have 
a domestic vaccine capability, and I know you are--and we put 
this $5 billion in the pipeline for bioterrorism, and now we 
have $7 billion in the pipeline for avian flu. That is a lot of 
money on the table that hopefully the marketplace will respond 
to, and I know you are working to make sure they do.
    So it is not an issue in the area of vaccine; it is not an 
issue of having the money or the Federal Government commitment. 
It is the issue of not having the structure; it is not having 
the infrastructure and building that infrastructure is 
something we are committed to. And I think the Federal 
Government has done yeoman labor here to try to make the 
playing field attractive and force the action to occur. And so 
I congratulate you for that.
    The secondary issue is just the nuts and bolt of addressing 
a pandemic or bioterrorism event. It involves things like 
stockpiling ventilators, but other things, you know, masks, 
syringes, gloves--none of which are made in the United States 
any longer in any significant amount. So we have to buy them 
from somewhere, and I have been putting a lot of pressure. We 
had Dr. Gerberding earlier in another forum, and I asked her: 
When are we going to have our stockpiles up to speed? And do we 
have a timeframe for it? And she said yes, we do, we will have 
the adequate stockpiles by June--and she said she would confirm 
this, and I would like you to confirm it--of syringes, of 
masks, and of the other what you would call mundane activities 
of dealing with people who are sick. So we are moving in that 
area.
    And then we have the issue of quarantine, which I 
understand you are aggressively pursuing. So there is a lot 
going on in this area, and the commitment of resources is huge. 
Are we moving as quickly as we want? No, but I don't think it 
is so much a lack of commitment on your part--in fact, just the 
opposite. I think the part of the administration has been huge, 
and it has been a bipartisan support here. Obviously Senator 
Harkin has played a major role. But it is really a fact that we 
don't have infrastructure and we don't have production 
capability. And we have never really thought through how you 
quarantine 20 percent of a population, how you do it and how 
you handle a bed surge of that size.
    So it is not something you can just wave a wand at and 
solve, and so I just--well, first off, I want to make sure that 
Dr. Gerberding was right, that we are going to have this stuff 
stockpiled by June. And, second, I do want to say that I 
appreciate the huge amount of attention and energy that is 
being put into this and into the bioterrorism effort. And I 
understand that it comes down to getting the antitoxins and the 
antivirals and the vaccine industry up to speed to accomplish 
it.
    Secretary Leavitt. Senator, I want to say if there is a 
bioterrorism event or an earthquake or a hurricane or a nuclear 
event, we have the capacity to take to a spot stockpile, and we 
can deliver it anywhere in the country in a very short period 
of time. But I don't want to in any way mislead you or anybody 
else. If we have a pandemic and we are having to deal with, as 
a country, 5,000 different communities, it is unrealistic to 
think that we are going to be able to serve them out of 
national stockpiles other than, say, antivirals. We will have 
sufficient, between what we have in our----
    Chairman Gregg. If I can stop you there, my understanding 
was that we were--our game plan was to stockpile for a 
pandemic, with the capacity to handle mundane activity of 
dealing with sick people, specifically syringes, masks, gloves, 
you know, so that we----
    Secretary Leavitt. All that will be in it, and we will be 
able to deliver it to a certain point. But this is a different 
kind of emergency than what we are accustomed to dealing with, 
and for that matter--well, let me pose it differently.
    I was in Florida at a pandemic summit, and we were having 
this conversation with the Governor of Florida, Governor Bush. 
He said, ``How long do these last?'' Well, that is the second 
difference. Not only do they happen everywhere at once, they 
last a year or a year and a half. They come in waves. He said, 
``In a year, a year and a half?'' He said, ``I have had two 
hurricanes down here--eight hurricanes in the last 2 years.''
    So we have the potential of having a hurricane in the 
middle of a pandemic. There is no reason to think that a 
bioterrorist event couldn't occur during the middle of a 
pandemic.
    So for us to empty our stockpiles out with the idea that no 
other event could occur may put the Federal Government in a 
position where we are not able to respond to the things we are 
uniquely prepared to respond to.
    I go back to the fact that we need help here in being able 
to communicate the urgency of State and local governments, of 
every business, of every school, of every college, thinking 
through what their own needs are going to be.
    Chairman Gregg. I think everybody appreciates that point. 
Having a State plan is critical, and I know you have asserted 
and demanded State plans everywhere. But I guess I 
misunderstood, because my understanding was that we were--that 
part of this $7 billion was basically the capacity to stockpile 
nationally, obviously spread across the country, the everyday 
needs that we would not be able to import for medical care. I 
am not talking vaccine here. I am talking, you know, what we 
just--the things we just----
    Secretary Leavitt. I think there is $212 million going into 
increasing stockpiles of consumable medical. That is a lot of 
gauze masks and a considerable number of ventilators. But if 
you try to stretch that over 5,000 communities----
    Chairman Gregg. Well, OK.
    Secretary Leavitt. Now, antivirals, that is a different 
proposition. We are working with the States. The challenge 
there is not having them. It is distributing them. It is having 
the capacity to put pills in the palms of people's hands at the 
right--within 24 to 48 hours. I think this is an important 
conversation because if you have been left with the impression 
that in our stockpile is the capacity to respond to every 
community, every village, every city, every hospital's needs 
for consumables, I do not think we are there.
    Chairman Gregg. Well, I guess I must have misunderstood, 
but that was the impression I had. So we will followup on it.
    Secretary Leavitt. Yes.
    Chairman Gregg. Thank you.
    Secretary Leavitt. Thank you.
    Chairman Gregg. We appreciate your time, appreciate your 
effort, and appreciate your service.
    Secretary Leavitt. Thank you.
    [The prepared statement of Secretary Leavitt follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.136
    

    [GRAPHIC] [TIFF OMITTED] T6726.137
    

    [GRAPHIC] [TIFF OMITTED] T6726.138
    

    [GRAPHIC] [TIFF OMITTED] T6726.139
    

    [GRAPHIC] [TIFF OMITTED] T6726.140
    

    [GRAPHIC] [TIFF OMITTED] T6726.141
    

    [GRAPHIC] [TIFF OMITTED] T6726.142
    

    [GRAPHIC] [TIFF OMITTED] T6726.143
    

    [GRAPHIC] [TIFF OMITTED] T6726.144
    

    [GRAPHIC] [TIFF OMITTED] T6726.145
    

    [Whereupon, at 12:01 p.m., the committee was adjourned.]

    PREPARED STATEMENTS

    [GRAPHIC] [TIFF OMITTED] T6726.146
    

    [GRAPHIC] [TIFF OMITTED] T6726.147
    

    [GRAPHIC] [TIFF OMITTED] T6726.148
    

    [GRAPHIC] [TIFF OMITTED] T6726.149
    

    [GRAPHIC] [TIFF OMITTED] T6726.150
    

    ANSWERS TO QUESTIONS SUBMITTED

    [GRAPHIC] [TIFF OMITTED] T6726.304
    

    [GRAPHIC] [TIFF OMITTED] T6726.305
    

    [GRAPHIC] [TIFF OMITTED] T6726.306
    

    [GRAPHIC] [TIFF OMITTED] T6726.307
    

    [GRAPHIC] [TIFF OMITTED] T6726.308
    

    [GRAPHIC] [TIFF OMITTED] T6726.309
    

    [GRAPHIC] [TIFF OMITTED] T6726.310
    

    [GRAPHIC] [TIFF OMITTED] T6726.311
    

    [GRAPHIC] [TIFF OMITTED] T6726.312
    

    [GRAPHIC] [TIFF OMITTED] T6726.313
    

    [GRAPHIC] [TIFF OMITTED] T6726.314
    

    [GRAPHIC] [TIFF OMITTED] T6726.315
    

    [GRAPHIC] [TIFF OMITTED] T6726.316
    

    [GRAPHIC] [TIFF OMITTED] T6726.317
    

    [GRAPHIC] [TIFF OMITTED] T6726.318
    

    [GRAPHIC] [TIFF OMITTED] T6726.319
    

    [GRAPHIC] [TIFF OMITTED] T6726.320
    

    [GRAPHIC] [TIFF OMITTED] T6726.321
    

    [GRAPHIC] [TIFF OMITTED] T6726.322
    



THE PRESIDENT'S FISCAL YEAR 2007 BUDGET PROPOSAL FOR THE DEPARTMENT OF 
                                DEFENSE

                              ----------                              


                        THURSDAY, MARCH 2, 2006

                                       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, Alexander, 
Conrad, and Nelson.
    Staff present: Scott B. Gudes, Majority Staff Director; and 
Mike Lofgren, professional staff member.
    Mary Ann Naylor, Staff Director and Jamie Morin, analyst 
for national security.

            OPENING STATEMENT OF CHAIRMAN JUDD GREGG

    Chairman Gregg. We will call the hearing to order. We very 
much appreciate Secretary England and Admiral Giambastiani and 
Ms. Jonas coming up today to talk to us about the defense 
budget. They are obviously a high-powered group representing 
very well the Pentagon and serving our country well and we 
appreciate their service to our nation. We appreciate the 
difficult task they have, especially with the pressures 
presently on the Department of Defense and the many men and 
women we have in the field defending us across the globe, but 
especially in Iraq and in Afghanistan. We obviously thank them 
for their extraordinary service.
    The issue, of course, on the budget is one that is 
difficult. Could we pull up that chart, please? The 
discretionary side of the Federal budget is basically half non-
defense and half defense. For the last 2 years, we have 
essentially frozen non-defense spending and the President has 
actually asked for a decrease in non-defense discretionary 
spending this coming year. Defense, on the other hand, has 
received extremely robust support as a result of the attack of 
9/11 and the war that we are involved in, primarily, but also 
because we recognize that in the late 1990's, there was much 
too much of a draw-down in defense.
    But this chart here reflects the rate of growth of defense 
from 2000, when the core budget was at $292 billion, to 2007, 
when the core budget was up to $460 billion. In addition, on 
top of that, there has been what I call a, well, let us call it 
a shadow budget of emergency spending for defense, which has 
basically been outside the budget process and, as a result, has 
therefore not been subject to any fiscal discipline because 
there have been emergencies and it has represented fairly 
significant spending, primarily focused on fighting the war in 
Iraq and Afghanistan.
    And the question which our committee has is how long can we 
sustain this and at what levels can it be sustained, and I 
think there are serious issues here. Also, whether or not it is 
appropriate to have this ancillary budget moving along for the 
Defense Department which is essentially outside the 
Congressional budgeting process in that it is all done by 
emergency and therefore not subject to any significant 
discipline as the basic budget is.
    The other question which I have, which I know somebody will 
address, is what is the core? What is it being used for? How is 
it--it has grown so large, what is its main thrust? If you look 
at the cost of fighting the war, the actual on-the-ground cost 
in Iraq is about $6 billion a month and the on-the-ground cost 
in Afghanistan is, I think, about $1.5 billion a month. That 
adds up to $85 billion, approximately, a year, and so the 
question becomes, to what extent is the core supporting that 
versus emergency funding and to what extent should the core 
support that?
    So those are some of the questions I have. We have a bit of 
a conundrum, to put it simply. We are confronted with an 
extremely stringent budget on the discretionary side in the 
area of non-defense spending, but on the defense side, there 
appears to be very little control. As a result, we have 
questions about whether there is some way to put projections 
which are more predictable into the process and which are going 
to be affordable as we move into the out years in the defense 
accounts.
    That all being said, there is absolute commitment by this 
Congress and certainly the administration to support our people 
in the field with whatever they need. That is critical. That is 
obviously why the budget has gone up so much in many areas, but 
we do have issues and questions regarding areas outside the 
actual fighting of the war.
    So we look forward to your testimony and your thoughts and 
ideas as to how we address this, and we don't really have a 
whole lot of thoughts and ideas. That is why we are asking for 
your input on it.
    I will now yield to the Senator from North Dakota.

        OPENING STATEMENT OF RANKING MEMBER KENT CONRAD

    Senator Conrad. First of all, I want to thank the Chairman, 
first of all, thank him for holding this hearing; second of 
all, thank him for the excellent questions that he has just 
posed because this has to be faced up to.
    Let me just start with the first chart that tries to put in 
context where we are in comparison to previous conflicts in 
terms of defense spending. This chart is expressed in constant 
2006 dollars, so we are comparing apples to apples. You can see 
going back to the Korean War, we are over $500 billion a year 
in terms of expenditure expressed in 2006 dollars. The Vietnam 
War was well below $500 billion a year. The Reagan defense 
buildup got to about $500 billion a year. And then we went into 
a long trough of reduced spending because of the cold war 
dividend, the end of the cold war peace dividend that was 
through several administrations. And now, the very dramatic 
ramp-up because of the attack of 9/11 and the conflicts in 
Afghanistan and Iraq.

[GRAPHIC] [TIFF OMITTED] T6726.152


    Where we are now, we can see we have actually reached a 
high compared to previous conflicts. We are above where we were 
in Korea. We are above where we were in Vietnam in constant 
dollars, so let us go to the next one.

[GRAPHIC] [TIFF OMITTED] T6726.153


    I think we all recall that at the time we entered into 
Iraq, that there were people in the White House who said it was 
going to cost $100 to $200 billion, and administration 
officials including the Vice President discounted that, said it 
wasn't accurate. The Secretary of Defense discounted it. Here 
is one exchange that occurred on a talk show. George 
Stephanopoulos asked, ``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.'' 
Stephanopoulos, ``Outside estimates say up to $300 billion.'' 
The Secretary of Defense said, ``Baloney.''

[GRAPHIC] [TIFF OMITTED] T6726.154


    Well, so much for baloney. We are now at $397 billion and 
counting. The Secretary of Defense suggested it was going to be 
$50 billion. That is what is known as being wrong by a country 
mile. So here the supplemental in 2003, $63 billion; 2004, $65 
billion; 2005, $101 billion; 2006, $118 billion; 2007, $50 
billion so far and counting. Let us go to the next one.

[GRAPHIC] [TIFF OMITTED] T6726.155


    In this budget the President has provided in 2006 and 2007 
$120 billion. The numbers from CBO for 2007 to 2016 say we had 
better be counting on almost $300 billion. We have to have full 
disclosure here. It is pretty hard to budget if we are not 
being given the full facts and if we are not being given 
serious estimates of what the costs are going to be. Let us go 
to the next one.

[GRAPHIC] [TIFF OMITTED] T6726.156


    Again, to put in context, the United States now spending 
$552 billion a year on defense. That is more than the next 39 
nations combined. Now, I think there are serious questions 
about this analysis, I would be the first to say. I am not sure 
how you compare us to China, for example. It maintains a bigger 
army than we do, pay them virtually nothing. So just a cost 
comparison may not be fully revealing, but I think we do need 
to understand roughly where we are. Let us go to the next one.

[GRAPHIC] [TIFF OMITTED] T6726.157


    This also has to be understood and that is the skyrocketing 
debt of the country. If this doesn't sober up people, I don't 
know what will. I am about ready to wonder what is going on in 
our country with respect to our leadership when nobody seems to 
give a fig what happens to the debt of the country. The debt is 
absolutely skyrocketing. The President said he was going to 
have maximum pay-down of the debt. There is no pay-down of the 
debt. The debt has gone up, up and away every year. The debt 
has gone up over $3 trillion in 5 years, and if the President's 
plan is adopted, it is going to go up another $3 trillion and 
reach $12 trillion by 2012, and all of this at the worst 
possible time, before the baby boomers retire. If you think 
there are tough budget choices happening now, we haven't seen 
anything yet. We have not seen anything yet, because this is an 
utterly unsustainable course.

[GRAPHIC] [TIFF OMITTED] T6726.158


    We had the Comptroller General here before the Senate 
Budget Committee last month. Here is what he said. ``Continuing 
on this unsustainable fiscal path will gradually erode, if not 
suddenly damage, our economy, our standard of living, and 
ultimately our national security.'' I think the Comptroller 
General is telling the truth. Collectively, we have a 
responsibility to face up to this, and that means every part of 
the budget has to be scrutinized and has to be disciplined.
    With that said, I want to say and I want to make very 
clear, this committee will support--the Congress will support 
every dollar that is needed for national security and we will 
stand shoulder-to-shoulder with the President in providing for 
our men and women in uniform and for the defense expenditures 
that are required to protect this nation. That is an absolute 
commitment from this Senator, and I believe the overwhelming 
sentiments.
    With that said, we have a major challenge, and Senator 
Gregg said it well. If we are going to budget, we have to have 
people being frank with us about what the real costs are. This 
continuing submission of supplementals that are unpredictable 
when, in fact, we know that the costs are going to be--we have 
known every year that the costs were going to be far more than 
what was being put in the budget.
    So with that, I again thank the Chairman. I think this is a 
very important hearing, and I thank the witnesses. I thank you 
for being here. I thank you for your service to the nation. I 
also ask you to help us begin to grapple with this exploding 
national debt, because it is a matter of national security.
    Chairman Gregg. Thank you.
    Secretary England and other panel members, however you wish 
to proceed.

STATEMENT OF GORDON ENGLAND, DEPUTY SECRETARY, U.S. DEPARTMENT 
   OF DEFENSE; ACCOMPANIED BY TINA JONAS, COMPTROLLER, U.S. 
                     DEPARTMENT OF DEFENSE

    Mr. England. Mr. Chairman, if I can start, and Senator 
Conrad, thanks. I do want to thank you for the opportunity to 
be here today. This is my first opportunity to appear before 
the committee and it is an important dialog. Admiral 
Giambastiani, who is the Vice Chairman of the Joint Chiefs of 
Staff, and Tina Jonas, who is our Comptroller, are with me 
today who worked in preparing the budgets. I mean, we do a lot 
of the detail work. Hopefully, today we can have a constructive 
dialog and we look forward to it and we appreciate the 
opportunity. I thank you for the opportunity to be here today.
    This is a critical time for our nation and I appreciate 
both the comments in terms of your words of encouragement to 
support our men and women in uniform because obviously it is 
essential. We have these magnificent people who are the cloth 
of our nation who literally put their lives and limbs on the 
line every day to preserve our freedom and liberty and it is 
important that we support them in every single way we can and I 
appreciate your comments in that regard.
    Regarding the budget, one comment I will make is in fiscal 
year 2007, we are asking for $439.3 billion and also a $50 
billion allowance in terms of a supplemental tied to that, and 
that is a lot of money and is 7 percent above last year, so it 
is a lot of money and we recognize and understand that. 
However, I don't believe, frankly, that we are crowding out the 
rest of the Federal Government. I worry about it going the 
other way, frankly.
    If you look at it in terms of the GDP, we are actually a 
much smaller percentage now than we were in the past. I mean, 
we are now, this year, including this supplemental, about 3.7 
percent of GDP, and so Mr. Conrad, you are right. The numbers 
are large, but in terms of what the country can afford for its 
national defense, and we were spending 4.6 percent during the 
Gulf War, 9 percent during Vietnam, between 11 and 12 at the 
height of our involvement in Korea, and, of course, it was 
gigantic during World War II. So the percentage today, it is a 
lot of money but it is not a huge percentage in terms of the 
insurance and the freedom and liberty that we enjoy with our 
men and women in uniform.
    This is a more expensive force, there is no question about 
it. It is an all-volunteer force. That is a more expensive 
force. On the other hand, it is a much more capable force and 
we ask them to do much more than we have asked them to do in 
the past.
    There are a number of threats. First of all, we are all 
familiar with this long war against the terrorists and that is 
an ongoing war we have today, but we also have other threats 
that we need to be aware of and we need to budget for, we need 
to deter and be prepared to defeat. We have hostile states or 
non-state actors that could acquire and use weapons of mass 
destruction, and we are familiar with those today, and they can 
use those to devastating effect. Guarding against this threat 
and preparing for the possible consequences of WMD require new 
technologies and skills as well as enhanced 
counterproliferation efforts. We also have a possibility of a 
major emerging power could choose a hostile course. Therefore, 
it is important that we shape the force to discourage a pure 
military competitor and be able to defeat such a military, if 
necessary, in the future.
    Meeting these challenges requires fostering cooperation 
with emerging powers while hedging against possible surprise 
while maintaining our military superiority. So traditional 
state-based threats are still a concern to the nation. They are 
being kept at bay precisely because the Nation has been so well 
prepared, and this is a case, frankly, if thanking this 
committee and the other committees and the American people for 
letting us do that, and it has worked. It has worked for this 
nation now for many years.
    Now, all of these challenges have a bearing on the security 
of the homeland, so detecting, deterring, and defeating threats 
far from shore, in our judgment, is the very best and likely 
the only way to keep America safe. But the Department of 
Defense is also prepared in working to defend America closer to 
home, and we continue to provide support to other agencies of 
the U.S. Government for our homeland security missions.
    So in short, our nation today faces far more diverse 
challenges and far greater uncertainty about the future global 
security environment than perhaps we ever have in the past. So 
it is, indeed, a dangerous time for America. It is expensive. 
But on the other hand, that is the first obligation of 
government, is to provide for the common security of the 
nation. I can assure you that myself and Admiral Giambastiani, 
Tina Jonas, the Secretary, and all my colleagues in the 
Department of Defense, we understand this is indeed the 
taxpayers' money. We understand it is their money that they 
allow us through you to spend on the security and we work very, 
very hard to spend this money appropriately and correctly. So 
we understand this is the taxpayers' money and you have our 
pledge that we will do everything we can to manage this money 
appropriately for the American people.
    I will comment, I appreciate both of you being here today 
and your comments because at the end of the day, the war we are 
in, and particularly this war against the terrorists, is a war 
of will. This is a war of will and commitment and resolve. The 
cold war lasted for 40 years. This will be another long but 
totally different kind of war. But just like the cold war, it 
was many administrations and many Congresses where we had 
bipartisan support in terms of funding to protect and defend a 
nation and it is going to require the same sort of effort.
    I mean, this is, first and foremost, a war of will, 
determination, and commitment that we will prevail over a very, 
very long period of time and it will take a bipartisan effort. 
While parties may disagree on lots of other issues, this is one 
issue where they absolutely need to come to consensus. 
Otherwise, we will not be able to prevail in this long war. So 
I appreciate your bipartisan support and your comments here 
today and we do look forward to your questions, to a 
constructive dialog. We understand it is indeed a lot of money.
    I would like to ask Admiral Giambastiani if he would just 
make a few comments, and then we will get down to questions. 
Thank you very much.
    [The prepared statement of Mr. England follows:]

    [GRAPHIC] [TIFF OMITTED] T6726.163
    

    [GRAPHIC] [TIFF OMITTED] T6726.164
    

    [GRAPHIC] [TIFF OMITTED] T6726.165
    

    [GRAPHIC] [TIFF OMITTED] T6726.166
    

    [GRAPHIC] [TIFF OMITTED] T6726.167
    

    STATEMENT OF ADMIRAL EDMUND P. GIAMBASTIANI, JR., VICE 
  CHAIRMAN, JOINT CHIEFS OF STAFF, U.S. DEPARTMENT OF DEFENSE

    Admiral Giambastiani. Thank you, Mr. Secretary, Chairman 
Gregg, Senator Conrad, Senator Alexander. Thank you for the 
opportunity to represent our men and women in uniform today 
before you. I am pleased and proud to appear here with Deputy 
Secretary Gordon England and also Comptroller Tina Jonas. The 
three of us have worked together very closely over the last 7 
months since I have returned to the Pentagon from 3 years as a 
combatant commander and I look forward to working with them as 
we discuss the 2007 President's budget that is presented to you 
today.
    I would like to make three brief points, if I could. First, 
I would like to thank each of you and the Members of Congress 
for your strong support of our men and women in uniform, to 
continue that support in the midst of this long war that 
Secretary England has talked about against extremists and 
terrorists, one where the enemy is attempting to destroy the 
resolve of the American people.
    We have carefully examined our requirements against 
available resources. We believe from the military perspective 
that the President's budget allocation of this $439.3 billion 
maintains that support at the right level. I look forward to 
discussing in more detail the capabilities this budget will 
deliver to our troops.
    While this is a considerable sum of money, as you all have 
pointed out, we recognize that it is less than we have 
historically spent during wartime as a percentage of our 
national wealth. I am, along with Secretary England, fully 
committed to ensuring that the taxpayers' money is well spent.
    Second point, we come today having just completed a several 
year long processes of fundamental importance to the 
Department. These include, one, the Quadrennial Defense Review, 
which we have just submitted to the Congress; the second, and 
required by law, the Chairman of the Joint Chiefs of Staff 
assessment our ability to execute the National Military 
Strategy; and finally, of course, the President's fiscal year 
2007 budget development.
    In all of these processes that we have gone through to 
submit these papers, we have had unprecedented collaboration 
and dialog amongst the senior civilian and military leaders of 
the Defense Department, and not just those in the Pentagon, 
frankly, but also our commanders in the field represented by 
our combatant commanders. We have literally spent thousands of 
man hours listening, questioning, analyzing, and learning as we 
have worked together. In fact, this is an unprecedented amount 
of time, in my experience in all the budgets we have presented 
in my 36 years in the service, that I have ever seen us spend, 
civilian and military, putting these papers, studies, reviews 
together.
    Based on this, I can tell you categorically that our armed 
forces are fully capable of executing every portion of the 
National Military Strategy and that this budget supports 
prosecuting the war on terror, it supports accelerating 
transformation, it supports enhancing joint warfighting, and 
finally, improving the quality of life and service of our 
troops and our families.
    The final point I would like to make, as long as we fight 
this long war against a ruthless enemy, we are doing it with an 
all-volunteer force. I have seen both sides of this military, 
in a conscript force and in an all-volunteer status. In fact, I 
was a recruiter at the beginning of the all-volunteer force. 
Congress brought that decision forward to us, frankly, with the 
military and the Defense Department resisting moving to an all-
volunteer force. It is more capable, it is more expensive, but 
there are none of us in the senior leadership who would ever go 
back to a conscript force.
    I think this is significant and we need to ensure this 
commitment is fully recognized, rewarded, and valued. I know 
that all of you value our service members' service, sacrifice, 
and commitment, and again, we thank each of you for your 
support.
    Because this is the first war we have fought with an all-
volunteer force, attraction and retention of quality people are 
more important than they have been in our previous history. The 
fact that it will be a long war amplifies this consideration. 
Although we are now on new ground in some respects, experience 
teaches us that we attract individuals, but we retain entire 
families in our military. A keystone of attracting and 
retaining the best America has to offer is maintaining a superb 
health care system, a system that Congress authorized for 
service members and their families back in 1995.
    As you know, the cost of that benefit has increased 
substantially since 1995. Let me give you a couple of figures. 
The cost has doubled in the last 5 years, from 2001 to 2006. It 
has gone from $19 billion to $37 billion, and it is projected 
to increase to $64 billion in 2015. Despite this increase, 
there have been no premium changes since 1995 when Congress 
instituted this program. It is a superb health care program by 
the response from our folks within the Defense Department, but 
in particular in what we Joint Chiefs care about is our 
uniformed members and their families.
    The Joint Chiefs have discussed this in length and in 
detail. We believe the legislation you passed in 1995 was 
superb and is superb today, and we want to see it sustained 
going forward with this health care program. Because of that, 
and based on our belief that the cost to the individual was 
reasonable in 1995, we recommend that you re-norm the 2006 cost 
shares to the 1995 level. That will allow us to maintain this 
superb health benefit for our families and ensure that it is 
there 20 years from now.
    Some very important points to underscore about this 
recommendation that are included in the President's budget. 
First of all, it doesn't affect any active duty members. The 
second thing is it applies to retirees under 65 only. And 
finally, it maintains the catastrophic cap of $1,000 for active 
duty families and $3,000 for retirees. So fundamentally, our 
recommendation is to take the benefit enacted in 1995 and 
update it in a fiscal sense to 2006.
    Thank you again for the opportunity to testify today and to 
represent our men and women in uniform and we are ready to 
answer your questions, sir.
    Chairman Gregg. Thank you, Admiral. Did you say you have 
been wearing the uniform for 36 years?
    Admiral Giambastiani. Yes, I have been wearing the uniform 
for 40--four years at the Naval Academy.
    Chairman Gregg. Thank you. That is extraordinary service.
    Can we go back to that chart? The essence of the budget 
question is this. How do we, in the context of the overall 
spending of the Federal Government, and accepting your 
argument, which I do accept, that our commitment to the 
national defense as a percentage of gross national product is 
not historically high, even though the numbers are historically 
high, how do we get out of this process of budgeting by 
emergency, which basically means we are not budgeting at all. 
We simply give you an open-ended check subject to your sending 
up a supplemental, and the issue is this. If you look at those 
emergencies that have come up and you look at what the spend-
out is in Iraq and Afghanistan, which is about $85 billion a 
year right now, we are actually exceeding a spend-out on the 
on-the-ground costs in Iraq and Afghanistan.
    A lot of this supplemental has been base activity, not a 
lot, but, for example, in the supplemental that was just sent 
to us, we have $3.5 billion for repositioning the Army under 
the new modular approach, which isn't an emergency. I mean, 
that is a decision that should have been in the context of the 
core budget. It does seem to me that we have been at this now 
long enough so that there should not be a necessity for these 
major supplementals to come up here, but it should be sent up 
as part of the budget.
    Are we essentially saying, by sending these supplementals, 
that the core budget is not being used to fight this war in 
Afghanistan and Iraq and that the war in Iraq and Afghanistan 
is being fought by emergency supplementals? If we are not 
saying that, then why are we sending up emergency 
supplementals? Shouldn't we be putting it into the core budget? 
Shouldn't the budget that was sent up to be an accurate 
reflection of what we are going to spend for this year not have 
been $434 billion, but shouldn't it have been $550 billion, 
because you know these numbers are coming at you. They are 
pretty predictable right now. You have been in Iraq long enough 
to know what the number is for next year for sure. Maybe you 
don't know what the number is for 3 years from now. I certainly 
hope it is going to be a lot less, but why this process of 
running two sets of books?
    Mr. England. Mr. Chairman, if I could just comment, first 
of all, I guess I need to say what Secretary Rumsfeld said at a 
hearing, and that is it is above my pay grade how we do this. 
This is, frankly, worked out by the Appropriations Committees' 
leadership, OMB, and the President in terms of how to do this 
and the base budget and the supplemental.
    Now, look, you could do it either way. Frankly, the 
supplemental is much later data. I mean, in the supplemental, 
it is not only the costs of the war in terms of the number of 
troops and what we have on the ground, so we know what that is 
at a later time in the budget when we turn it in. It is much 
more precise data for you in the supplemental.
    We also replace equipment that is damaged or worn out or 
destroyed as a consequence of the war, and that is included in 
the supplemental. So these are not numbers that are easily 
predicted. In the supplemental, we do have significant support 
for the numbers because we know--we are a lot closer to what 
those numbers are when the supplemental is submitted as opposed 
to trying to estimate well in advance.
    As you know, like today, we are doing the 2008 budget. I 
mean, if we were trying to plan that far ahead for Afghanistan 
and Iraq, it would be very difficult to do that. So my own 
judgment is we have more accurate numbers the way we are doing 
it now, but the decision in terms of what categories and this 
process is really worked out at a much higher level, and so----
    Chairman Gregg. Well, why are you putting in these 
supplementals things which are not related to Iraq that are 
core questions of how the Army is structured, for example?
    Mr. England. Well, in some cases, like for the modular 
Army, an agreement was reached that we would have it in a 
supplemental until 2007, so this time, in 2006, you will see 
dollars in there for the modular Army in the supplemental, but 
in 2007, they are in the base budget. So we are transitioning 
to the base budget where we do have definitive numbers, and we 
went through a transition in that particular case.
    Admiral Giambastiani. If I could, Senator Gregg, just to 
followup on this modularity question, one of the reasons why it 
was put into the supplemental was to accelerate the modularity. 
I just returned from Iraq a couple of weeks ago and I was in 
Tal Afer up north in Iraq, where the Third Armored Cavalry 
Regiment was being relieved by the First Armored Division First 
Brigade Combat Team. That First Brigade Combat Team is the last 
Army brigade that will go over that hasn't had any of the 
modularity put into it, and the reason why the Army has been 
able to accelerate it is because on very short notice, this 
modularity money was put in over the last 2 years into the 
supplemental. So I would tell you that we are doing this on the 
fly and the Congress has really helped us out there.
    Chairman Gregg. I appreciate that, but it just seems to me 
that it is being done in a way that essentially prejudices the 
rest of the budget, because it means the defense budget, what 
you send up here for a defense budget has no relevance to the 
real budget because you are 15, 20 percent off of what you are 
actually spending every year, which goes to a larger 
philosophical issue, which is this.
    The defense budget is very large and you are fighting a war 
on terrorism with it. Now, a large percentage of the defense 
budget doesn't appear to be directed at the war on terrorism. 
It is directed at what you have referred to, I believe, as the 
pure military threat, which is understandable, I guess, 
although if you take the ten nations after America that spend 
money on national defense and combine their national defense 
costs, I think it is less than what we spent. But let us assume 
that there is a rising pure military threat, and I presume you 
are referring to China but don't want to use that term. So you 
have a core budget directed at trying to make sure that we are 
strategically strong enough to deal with a pure military 
threat.
    If we are fighting terrorism, the fight on terrorism 
doesn't appear to me to be purely a military exercise. A large 
percentage of the terrorism effort has to be intelligence. A 
large percentage of the terrorism exercise has to be nation 
building, which is not necessarily a good role for the 
military, but it is what you have been drawn into in Iraq and 
Afghanistan. A large percentage of the fight on terrorism has 
to be defending our domestic homeland and protecting our 
borders.
    And yet when you look at this budget the way it is coming 
at us, the military is absorbing the vast amount of the 
structure of the fight on terrorism, and we are actually 
starving or treating as step-children things like the Coast 
Guard and the Border Patrol, who basically protect the borders. 
We are treating as step-children the effort at nation building, 
or we are doing it indirectly through the Defense Department, 
which isn't the best vehicle to do it through. And the question 
of intelligence, I don't think we can get into, but it has been 
a robust commitment to intelligence, but certainly there is 
still, compared to what the commitment is to the Defense 
Department, it is not anywhere near the significance of the 
rate of growth, and that is because you are on the front line 
in the hot war, so to say, in Iraq and in Afghanistan.
    And so I guess, and this probably isn't something you can 
answer, but I guess my question is, are we allocating these 
resources for fighting terrorism correctly amongst the various 
responsibilities in light of the fact that this isn't your 
typical war? This is a different undertaking. This is an 
undertaking where you have to know who your enemy is before he 
attacks you because by the time he attacks you, it is too late. 
This is a war where you have to say to the nations that are in 
the Middle East, listen, democracy works and we are going to 
show you how it works because we are going to help you rebuild 
and be democracies. And this is a war that says, we have to 
know who is coming in and out of this country because that is 
where the threat is.
    Mr. England. If I could just make a comment, Mr. Chairman. 
First of all, the level of spending, I want to followup a 
little here for the Vice Chairman, because he talked about 
medical. We spent--in our base budget, we have $39 billion is 
our medical bill. That is $2 billion more than the entire 
defense spending for Germany--$2 billion more than the entire 
country of Germany. And by the way, here is an opportunity, and 
here is where we ask your support, because frankly, we haven't 
been able to control some of these costs in the past.
    Here is an opportunity for the Congress to help us on this. 
I mean, here is a case where literally we can save $11.2 
billion and we don't jeopardize any single person active, 
nobody over 65. We find ourselves in the situation where in 
this medical arena, our premiums are so low and our benefits so 
significant that companies, when people leave the military and 
go to work for a company, the company pays them cash, some 
companies, not to take their medical but to stay on our 
program, and municipalities and States. They will not even let 
their people take their medical coverage. They are required to 
take the medical coverage on DOD. So slowly, every retired 
person from the U.S. military is staying on our health care 
program and it is one reason it is going up significantly.
    So if we can just literally adjust our rates for inflation, 
we help ourselves and this committee significantly. So there 
are some things that we can help change, perhaps, the pattern 
in the future which are, frankly, very painless to do. So we 
encourage you to help us in that regard.
    Chairman Gregg. We can certainly put language in. 
Obviously, we are not the authorizing committee, but we can say 
we are assuming in this budget that your recommendation in this 
area will be pursued. I have no problem with that.
    Mr. England. Good, and I appreciate it, because we have not 
been successful in the past. I mean, these benefits have 
basically been handed to us to some extent by the Congress and 
we end up paying this very large bill, so here is an 
opportunity to help us in the other direction and I sincerely 
appreciate your comment, Mr. Chairman.
    The comment about the whole fight against terrorism, we 
have just completed the Quadrennial Defense Review that was 
directed by the Congress. We spent a whole year working 
extraordinarily hard at this in terms of the strategic 
direction of the Nation and the Department specifically as we 
see future threats to America. And we went back and adjusted 
the 2007 budget to the extent we could. So the 2007 budget has 
a number of changes as we transition and transform the force 
for both the war on terror and the conventional threats in the 
future.
    My assessment is that we worked very hard to do the very 
best assessment we can as we go forward, and we have put more 
money in our special forces, a lot of moneys in the 
intelligence side of this business. We have done a lot of work 
to restructure for exactly the reasons you have stated.
    I also will tell you, I agree with you completely. The 
Department of Defense cannot win this war. This is beyond just 
the Department of Defense. I mean, this will take the entire 
Federal Government and all aspects of Federal power to win this 
long war. And in fact, in the Quadrennial Defense Review, our 
view is it not only takes all aspects of national power, but 
all aspects of international power, our friends and allies, 
because these are international threats to the peace and 
security and freedom and liberty.
    So we have in our budgets going forward, and in 2007, we 
made adjustments just for language skills, cultural skills, 
reshaping the kind of force we have. It is all now starting to 
show up in our budgets and some of that is in the 2007 budget 
that you will be looking at this year.
    Chairman Gregg. Admiral Giambastiani.
    Admiral Giambastiani. Chairman, I might mention a couple of 
other comments here. One of the things that Senator Conrad put 
up was a chart from the International Institute for Strategic 
Studies, the lists of expenditures of other countries. What is 
fascinating is there is no section in the IISS that talks about 
extremists, terrorists, and all of these threats that are non-
nation states. And so how do you calculate that and who is out 
there calculating it?
    As a matter of fact, I am making an intervention with them 
to see when they are going to start putting that into what they 
call traditionally today their military balance. I have been 
looking at that for the last 17 years. I did a fellowship back 
in 1990 and 1991 where I spent a lot of time looking at that. 
But I would just tell you, there is no comparable section in 
there that talks about these extremist groups that are going 
after weapons of mass destruction, that are looking for 
biological weapons. If a small group has a nuclear weapon and 
it only costs them a small amount of money, that is very bad.
    So what we have done in this Quadrennial Defense Review 
that the Deputy has talked about is we have looked at 
asymmetric threats. We have looked at non-traditional warfare, 
irregular warfare, the intelligence it takes to help the 
overall community so that the military and the Defense 
Department can do its share to respond to these threats. How 
can we, for example, increase the number of capabilities we 
have to render safe nuclear weapons if we find them? How do you 
deal with biological threats in our chemical-biological defense 
program, and there is a whole section, frankly, in here, page 
52 and 53 in the QDR, that talks about things just like that 
and the weapons of mass destruction area in the render safe 
place, in the dealings with rogue states with nuclear weapons.
    So what I would tell you is that we have spent a 
significant amount of time trying to look at how we can not 
only deal with the conventional side of the military, which is 
what we were designed to do, clearly, in the past, but also how 
we can increase the amount of intelligence we have--we call it 
intelligence, surveillance, and reconnaissance, for example, in 
the use of unmanned vehicles--not just satellites, but increase 
our human capability, increase our foreign language capability, 
and increase our ability to do what we call find and fix 
targets, not just finish them. The military is very good at No. 
3. It has to be better at the find and the fix, and so does our 
entire intelligence community.
    So a lot of what this Quadrennial Defense Review has done 
is to give us a substantial vector change to try to go after 
these irregular, asymmetric threats, recognizing again that not 
just the military in the United States can do it. This is a 
coalition event. This is an allied event. And it is an 
interagency non-governmental event.
    Chairman Gregg. Thank you.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman, and I think you 
are asking very important questions. In some ways, this is a 
bit of a frustrating exercise perhaps for both of us because 
the three of you aren't responsible for the things that cause 
us to have these questions.
    I must say, I feel there has been some ``hide the ball'' 
going on here by the administration. I think the evidence is 
pretty clear for that. They tell us early on the war is going 
to cost $50 billion. Now it has cost $397 billion. Every year, 
they come up with these big supplementals. Last year, they 
asked for $120 billion of supplementals for the year that we 
are in now. So actually, they first asked for $50 billion. Now 
they come and ask for another $70 billion, so that is $120 
billion. Now we are being told it is only going to be a $50 
billion supplemental for next year, and you will excuse us if 
we are pretty skeptical about that.
    It seems unlikely to this Senator, and perhaps to the 
Chairman, as well, that that $50 billion is really what you 
anticipate, because just doing the math, it would suggest that 
the cost of the conflict in Afghanistan and Iraq is going to 
somehow going to dramatically be reduced in 2007.
    Secretary England, I am going to say to you, I have great 
respect for you. I was somebody who is behind the scenes and 
publicly strongly supported your elevation to this position. 
Admiral Giambastiani, I very much enjoyed our visit yesterday 
and have great respect for you and your service to our country. 
Ms. Jonas, I have always been impressed by you.
    But that isn't the point. The point is, we have to be 
straight with our colleagues about what things are going to 
cost. That is our responsibility. And it doesn't look like 
people are being straight with us about what the costs are 
going to be for 2007, that there is this continuing kind of 
``hide the ball'' about what things are going to cost.
    I would just say to you, Secretary England, do you really 
believe that the $50 billion that is in the budget is all that 
is going to be asked for in 2007, or is it more likely that the 
administration is going to come right back like they did this 
year and ask for another big chunk of change?
    Mr. England. Senator, my understanding is that the $50 
billion is not to be a projection of our needs for next year. 
My understanding, and again, this was a decision by OMB and, I 
believe, the appropriators and leadership, but my understanding 
is that the $50 billion really followed the action by the 
Congress, that is, the Congress put in $50 billion the prior 
year as a transition funds and that this was a follow-on to the 
Congressional initiative to put the $50 billion in. So I don't 
believe this was--I am quite confident this is not an estimate 
of future expenditures. It is to have a vehicle in the budget 
so that we can continue to execute the war while we then 
prepare detailed supplementals.
    I, frankly, would disagree that anyone is hiding the ball. 
In the supplemental, you will find a lot of detail in terms of 
very specific costs, and in my judgment, very traceable----
    Senator Conrad. Well, wait, wait, wait. Come on, now. Let 
us be straight. You have just said that this isn't a prediction 
of what next year's spending is going to be. That is what a 
budget is. You know that full well. The purpose of a budget is 
to state what the cost is going to be, and this isn't a 
statement of what the cost is going to be. It is hiding the 
ball. I don't know how you can say it is not hiding the ball. 
Last year, they said $50 billion and then they come and ask for 
another $70 billion right away.
    Mr. England. But Senator----
    Senator Conrad. And next year, they say it is going to be 
$50 billion and you and I both know they are going to be coming 
and asking for a lot more money.
    Mr. England. But the dilemma, Mr. Conrad, is trying to 
estimate costs when you don't have a basis to estimate. I mean, 
we do not know what the war will cost us next year. Hopefully, 
we will have less troops. Hopefully, we will have less 
equipment destroyed. There will be more Iraqi military stood 
up. So it is an unpredictable environment.
    Again, I guess you could do this either way. The decision, 
like we said, is above my pay grade. You could do this either 
way, but it does seem to me that the Congress gets a much 
better base in which to act than if we just literally tried to, 
quote, guess numbers in the future, and it would be largely 
guessing numbers in the future. So this way, we do give you a 
defined budget and a defined supplemental. But again, it is 
above my pay grade how to do this.
    It would seem to me, however, that you get much better data 
through the supplementals than if we tried to estimate that far 
ahead, because again, we are preparing today the 2008 budget. 
It would be very hard to predict what those expenditures would 
be in that period of time when we are actually executing a 2008 
budget. I mean, there is the tyranny of the budget. There is a 
long period of time in preparation before you get to execution.
    Senator Conrad. I just say to you, hope is not a plan. A 
budget is supposed to be a plan. A budget is supposed to be our 
best estimate of what things are going to cost, and I would 
respectfully say to you, I don't believe this is a best 
estimate of what it is going to cost, and that to me is hiding 
the ball. I don't think it serves anyone well.
    Mr. England. Well, again, the $50 billion, my understanding 
is not an estimate of the future. It was literally to follow 
the Congressional----
    Senator Conrad. I know, but we are just going over the same 
ground. Mr. Secretary, the purpose of a budget is to estimate 
what we are going to spend, and what we have before us, 
frankly, I don't think is a serious estimate of what we are 
going to spend, and it has proved to be the case repeatedly. I 
mean, we started this when the war began and the Secretary said 
it was baloney that this thing would cost $300 billion. We are 
over $300 billion now. So, you know, it is important--our 
responsibility to our colleagues is to try to have a best 
estimate of what things are really going to cost. That is what 
a budget is about.
    Chairman Gregg. Would you yield?
    Senator Conrad. Yes, I would be happy to yield.
    Chairman Gregg. To try to put this in a number context, it 
does not appear that any part of the core, which is this year 
$434 billion and next year estimated to be $460 billion, is 
anticipated to be used for on-the-ground expenditures in Iraq 
or Afghanistan. And if you take the average of the last 4 
years, it is about $90 billion supplementals to do the on-the-
ground expenditure in Iraq and Afghanistan.
    So I guess my question, which is a follow-on to Senator 
Conrad's question, is why aren't you folks telling us, we 
aren't going to spend any of the core on the on-the-ground 
expenditure in Afghanistan or Iraq. We have an average 
expenditure of $90 billion over the last 4 years for on-the-
ground expenditures. So, therefore, it is reasonable to presume 
that we are going to get a supplemental in that range.
    Mr. England. Well, again, above my pay grade, Mr. Chairman, 
but I can tell you, my view is if we came in and just said, we 
need $90 billion and we were literally looking ahead 2 years 
and sort of guessing the future, I don't believe that would be 
supported by the Congress and I don't believe that you can--the 
next thing, then, everyone wouldn't have a great deal of 
support for that number. I don't believe you can do that. We do 
not have enough clairvoyance to look that far ahead and give 
you firm estimates for numbers.
    So the choice is, we give you very firm numbers in terms of 
the supplementals or we try to go way ahead and predict them, 
and again, we could do it either way, but the decision was to 
do it this way, and again, we are the implementors of those 
decisions made by OMB and the Appropriation Committee and the 
leadership of the Congress and the President. There are 
different ways to do it. That was the way that was decided and 
that is the way we have prepared the budget, sir.
    Senator Conrad. I would like to ask one other question, if 
I could----
    Chairman Gregg. I apologize.
    Senator Conrad. Why don't you go around, or go ahead and I 
will catch it on the second round.
    Senator Alexander. Please go ahead, Senator Conrad.
    Senator Conrad. I will go off that subject. I hope that it 
gets expressed up the line, the frustration that we have, 
because----
    Mr. England. We understand.
    Senator Conrad. You know, we do try to present our 
colleagues with a realistic estimate of what things are going 
to cost, and if people don't share with us realistic estimates, 
we can't do our job.
    Let me just raise a question that I raised with the Admiral 
yesterday. I tried to give a heads-up that I would ask this 
question, because I think it is a serious concern. This is from 
the Washington Times of December 3. Funds may be lacking for 
ample Iraqi army, and it goes on to talk about the U.S. general 
in charge of shaping an Iraqi army raised the prospect 
yesterday the new Baghdad government will not have sufficient 
money to fund the army envisioned by our administration. The 
President has said repeatedly that we will stand down as the 
Iraqi army stands up, and the question that is being raised is 
will the Iraqi nation state have sufficient funding to be 
standing up an army? Have you had a chance to look into that, 
Admiral, or Secretary England, either one?

[GRAPHIC] [TIFF OMITTED] T6726.160


    Mr. England. I can say this, Senator, that we have been 
very sensitive that the Iraqi army can stand up an army that 
can do the job they need to do and also is affordable by the 
Iraqis, and the Iraqis do not need an army like the United 
States of America. I mean, they need an army to provide for 
security and stability in their country. So it is a different 
kind of army than we have, frankly, and we are training the 
army and, frankly, equipping the army now to be able to do 
those jobs rather than us do those jobs in Iraq. So I can tell 
you it is sensitive. I can't tell you the detail. I can just 
tell you from a policy, philosophy point of view, we do want 
them to stand up an army that is obviously sustainable by them 
over a long period of time.
    Senator Conrad. But you must have estimates of whether or 
not they really have the financial capability to provide for 
the kind of army that is necessary to do the job that we 
envision for them.
    Mr. England. Mr. Conrad, I would have to get back to you. 
Perhaps Tina Jonas or the Admiral. I just don't have those 
estimates. But we would be pleased--I would be pleased to get 
back with you on that subject and meet with you in your office. 
I just don't have those numbers----
    Senator Conrad. I just think this is a centrally important 
question to our strategy. When the Admiral and Ms. Jonas were 
in my office yesterday, I alerted them that I would ask this 
question, because it seems to me for the purposes of our 
planning, we have to know, do the Iraqis really have the 
resources to have an army to stand up? That becomes a pretty 
central question.
    Mr. England. Tina, can you----
    Ms. Jonas. Mr. Conrad, I don't have the precise number in 
front of me, but the Iraqis are providing--paying for the 
salaries of the army that is being stood up. As you know, we 
are asking for additional funds in the supplemental, about $5.9 
billion between Iraq and Afghanistan, to continue to train and 
equip them. But I will say, and Admiral Giambastiani may want 
to talk to certain aspects of the capability, this is a concern 
of the Secretary, and as the Deputy Secretary just mentioned, 
we are very conscious of the fact that we should not be 
building something that they cannot sustain.
    Admiral Giambastiani. I think the only thing I could add, 
Senator Conrad, to what the Deputy and the Comptroller have 
said to you is, No. 1, General Dempsey, as both a NATO 
commander and as a U.S. commander, has spent substantial time 
since he has taken over as the multinational training head to 
work with the ministry responsible, MOD, and now with the MOI, 
the Ministry of Interior, to look at the needs long-term for 
the government. Because the government is in transition, 
clearly, and because they are still building ministries, there 
is still much work to be done.
    But the point is that we are looking for a sustainable 
Iraqi solution and we are looking for a sustainable Afghan 
solution in both cases. And if that takes help from coalition 
and allied members, which it has--for example, large numbers of 
tanks have come in from Hungary, large numbers of small arms 
and weapons and ammunition have come in from a number of NATO 
allies, and these are all important parts of equipping. I did 
that for part of my time in my last job as a NATO Supreme 
Allied Commander.
    And what I would say to you is that working with these 
ministries, the attempt of these estimates, if you will, is for 
them to sustain it and not build something they can't sustain, 
as the Deputy has said.
    Chairman Gregg. Senator Alexander, thank you for your 
generosity in time.
    Senator Alexander. Thank you, Mr. Chairman.
    Mr. Secretary, Admiral, Ms. Jonas, thank you for being 
here. I want to shift the subject a little bit.
    A few weeks ago, in Nashville, I sat down for a couple of 
hours with our Adjutant General, Gus Hargett, and the Commander 
of the Tennessee forces that have been in the National Guard in 
Afghanistan--the 278th unit, which has had 3,000 Tennesseeans 
in Iraq, and the 844th engineering unit. It was a very 
interesting visit. Ten thousand of our 13,000 National 
Guardsmen and women have been in Iraq or Afghanistan. Much of 
the equipment used by the Guard units, specifically the 278th 
and the 844th engineering unit, was left in Iraq following 
their return. It is now being used by the units that replaced 
them. That makes sense. Other Guard units across the country 
are in the same situation. Undoubtedly, many of the Governors 
who were here this week talked with you about that.
    So my question is about the funding and the pace of 
replacing the equipment of the National Guard units, and I 
would specifically like to know how much money is allocated in 
this budget to replace this equipment, and what is the time 
line for spending it, and what does that level of funding and 
pace of spending say about the use of the Guard in Iraq and 
Afghanistan in the future years?
    Ms. Jonas. Senator, thank you for the question. I would 
just like to point out that over the program plan that we have 
in this budget, which is from year 2007 to 2011, we have added 
$21 billion for Guard equipment. On average, we are spending--
we are going to be doubling--over that program period, we will 
have doubled what we spent during the 1990's. We were spending, 
on average, $12 billion during the 1990's for Guard equipment, 
so we will have doubled that, and that is in the baseline 
budget.
    In addition, we are requesting, I believe it is $1.7 
billion in the supplemental for Guard equipment. So I think 
there is a recognition that that is very important and we put 
some emphasis on it, sir.
    Senator Alexander. Would it be possible for you to tell me 
how much of that is in this year's budget?
    Ms. Jonas. Yes. I am sorry. The amount that we are spending 
for the Army and Air Guard in the 2007 budget is $23.1 billion.
    Senator Alexander. And are your plans definite enough for 
spending to be able to say how much of that would be allocated 
to the 278th and the 844th engineering unit for this next year?
    Ms. Jonas. OK. We would have to get back to you for----
    Senator Alexander. No, that would be fine, but, I mean, 
could you--that would be a big help to them.
    Ms. Jonas. Sure.
    Senator Alexander. Following that, your request reduces the 
planned number of National Guard combat brigades from 34 to 28. 
How much does this save over the period of, say, the 4-year 
period you just described or any period you might choose, and 
is most of that personnel or is most of that equipment or how 
do you divide that?
    Ms. Jonas. Admiral Giambastiani might want to talk to the 
restructuring of the Guard.
    Admiral Giambastiani. Let me just discuss the restructuring 
for a second. What is important to remember is that we are 
looking at fully equipping all of these National Guard brigade 
combat teams. That has never happened in the history of the 
National Guard, that we have----
    Senator Alexander. The 28 that we will end up with?
    Admiral Giambastiani. Twenty-eight, 34, 32, whatever number 
you pick and whatever we have had in the past, we have never 
fully equipped, to my knowledge, any of these brigade combat 
teams, and the intent here within the baseline budget is to 
fully equip 28 brigade combat teams, retain the total number 
that we have today of brigades. These are not just brigade 
combat teams, but support brigades, which is 34, whatever 
number you take. The total is 106 between the combat teams and 
the support brigades, and retain 106, transition a number of 
these into engineering and other support units which we feel 
will be better postured and structured to support homeland 
defense, contingency operations, national disasters, and the 
rest. But we will have a much more capable brigade combat team 
force where we don't have to take people from one unit to 
another to send them forward and the rest.
    Now, your question is--one of the questions you asked, I 
don't have an exact number, but do you save money over the 
people or over the equipment if you take down the number of 
brigade combat teams, and the answer is it is mainly in the 
equipment because most of these brigades would be heavy brigade 
combat teams which require lots of armored personnel carriers, 
tanks, and other things which are very expensive, comparatively 
speaking, than trucks are, engineering equipment, and other 
things like that. So the cost differentials are really in the 
equipping of the heavy brigade combat teams, Senator.
    Senator Alexander. Thank you. That is very helpful. I 
assume that in all of this, you are working with the States and 
the Governors to try to make sure that the equipment you 
replace fits into what they perceive their needs are for 
homeland security and disaster relief, things they may be 
called upon to do?
    Admiral Giambastiani. Yes, sir. The Department and the Army 
has made a commitment to equip all of these brigades properly. 
That is very, very substantial. You know, a number of the Guard 
leaders have been skeptical of this in the past, and frankly, 
you have a very solid commitment and the amount of money that 
is in there, the $21-plus billion that are in our program, is 
unprecedented and is really quite--to the Guard leaders, their 
eyes----
    Senator Alexander. So you are telling me we are going to 
have 28 combat brigade units that will be better equipped than 
they ever have been before?
    Admiral Giambastiani. Yes, sir, both manned, equipped, and 
trained, all three of those.
    Senator Alexander. And that would suggest to me that they, 
while none of us can predict the future, that they would be 
prepared to serve in the same kind of role again that they were 
called upon to serve in Iraq and Afghanistan----
    Admiral Giambastiani. Yes, sir.
    Senator Alexander [continuing]. If that need ever arose?
    Admiral Giambastiani. What I would tell you is, that our 
reserve force within the military has always been what we call 
a strategic reserve. So if we need brigade combat teams, for 
example, in the combat support, we have always built in some 
time to get them properly trained and sent over and the rest. 
Well, we have had to use them as an operational reserve here 
during Operation Iraqi Freedom, Operation Enduring Freedom. In 
fact, we have had upwards of 39 percent of our deployed forces 
have been Reserve component, both National Guard and Reserve. 
Today, it is actually running at a little less than 20 percent.
    But the point is that we need to have them structured as 
not only a strategic reserve, but as an operational reserve in 
the future, and in order to do that, the Department has to step 
up and properly man, train, and equip them, and that is the 
purpose of the program.
    Senator Alexander. That is very helpful. Thank you. And if 
you could get back to me at your convenience with any details 
you have about those units I asked about.
    Thank you, Mr. Chairman.
    Chairman Gregg. Senator Allard.
    Senator Allard. Thank you, Mr. Chairman. I would like to 
pursue just a little different line of questioning here.
    About 12 years ago, the Congress passed legislation that 
dealt with the issue of government procedures and results. It 
is called the Government Procedures and Results Act. That 
program under the administration is referred to as PART, and I 
have pulled down off the Internet--the White House has an 
Internet where these programs are listed and there are a number 
of departments, frankly, that have not done a very good job. 
But the Department of Defense, you have four program areas in 
which your ratings were, results were not demonstrated.

             RESPONSE TO SENATOR ALLARD'S QUESTION

    The Department of Defense Training and Education Programs-
Other Training and Education consists of three disparate 
programs: Off-Duty Voluntary Education; Junior Reserve 
Officer's Training Corps; and Civilian Education and Training.
    During last year's PART development cycle it was determined 
late in the process that these programs would be included and, 
frankly, these programs were improperly combined and the 
metrics selected failed to properly measure the effectiveness 
of these programs. This was recognized by OMB, but a grade of 
``not demonstrated'' was assigned to the programs in order to 
permit the Department to properly re-evaluate them. In 
coordination with OMB, we have divided these programs into 
three separate areas and are actively working with OMB to 
successfully evaluate them during this year's PART cycle.
    Funding reductions based on the results of the FY 2005 PART 
asessment would be premature, particularly at a time when costs 
for pursuing higher education opportunities are escalating 
around the country. Study after study has proven that the 
Voluntary Education program is a key recruitment and retention 
tool that impacts positively on militaru job performance, 
mission accomplishment, and disciplinary issues. DoD has 
reacted to this dynamic by changing policy to require fewer 
out-of-pocket expenditures on the part of our Service members. 
Reduction of funding for this program would have a negative 
impact on troop morale at a time that would be inopportune for 
continued readiness.

    Now, if the program is listed on here, it is either rated 
as ineffective or results not demonstrated, and when they list 
it as results not demonstrated, what it means--a rating of 
results not demonstrated indicates that a program has not been 
able to develop acceptable performance goals or collect data to 
determine whether it is performing.
    You only have four, which is good, but my question to you 
is can you elaborate on how you are using this and if you can 
address these four programs specifically, I think it would be 
helpful to me and the committee so that we know how these are 
performing. Those four programs, one is the defense 
communications infrastructure. The other one is defense small 
business innovative research, technology transfer. The other 
one is Department of Defense training and education programs, 
other training and education. And the fourth is the Marine 
Corps expeditionary warfare.

    The Marine Corps is taking steps to define specific long-
term performance measures for Marine Corps Expeditionary 
Operations. Below is the history of that effort:

          a. PART is a component of the President's Management 
Agenda to evaluate the entire Federal Government every 5 years. 
In 2005 it included the USMC.
          b. PART consists of responses to a series of stock 
strategic planning, program management, and program 
accountability questions and associated cost, schedule, and 
performance data. Two questions pertain to a limited number of 
long-term performance measures.
          c. The USMC submitted responses to all questions and 
data requested and also provided the USMC Expeditionary 
Manuever Warfare Capability List (ECL) containing a substantial 
number of goals and measures. OMB deemed this list to be too 
comprehensive and requested instead the USMC provide a subset 
of priority long-term performance measures.
          d. There was no approved short list of long-term 
performance measures used to describe the USMC at that time. 
This resulted in the USMC PART getting a ``Results Not 
Demonstrated'' rating by OMB.
          e. The USMC has requested a PART Abbreviated 
Reassessment for 2006 to address this. The Marine Corps Combat 
Development Command (MCCDC) has been tasked to develop a short 
list (approx 4) specific long-term performance measures for 
evaluating Marine Corps Expeditionary Warfare. Draft measures 
are due to OMB 14 April and final measures 23 June 2006.

    The ECL contains 230 pages of desired capabilities (or 
goals) for near-term 2005-2011, mid-term 2012-2018, and far-
term 2019+ time frames in the key warfighting functions of 
Joint and Multinational Enabling, Strategic Agility, 
Operational Reach, Tactical Flexibility, and Support and 
Sustainment. These include a substantial number of long-term 
measures that could be tracked. The Deputy Commandant, Programs 
and Resources (DC, P&R) tasked the DC, MCCDC to develop a 
short-list of measures that focus on outcomes and meaningfully 
reflect the purpose of the USMC that can be tracked. The USMC 
requested 2006 PART Abbreviated Reassessment will address this.

    I wondered if any of you, by chance, would be prepared to 
elaborate on these four programs in the Department of Defense 
that are not meeting the standards as far as that Act is 
concerned.
    Mr. England. Senator, if I can just try here, I can't speak 
specifically about each of the four programs, but the last--
what I do is I try to review a whole set of metrics across the 
Department, both for the Government Procedures and Results Act, 
then we have the President's scoreboard we have and we have our 
own measures and metrics. We have a large complex department. A 
lot of it has not performed well in the past.

        Additional Information submitted by Mr. England

    OMB's Program Assessment Rating Tool (PART) review 
completed in February 2006 rated the DoD Small Business 
Innovation Research and Small Business Technology Transfer 
(SBIR/STTR) program as ``results not demonstrated''. This is 
one of four DoD programs to receive such a rating.
    The Department is taking several actions to address the 
issues raised by OMB's PART review. First, we are tracking 
company commercialization records and utilizing a 
commercialization assessment in our proposal selction process. 
Our tracking will reduce the likelihood of funding companies 
that repeatedly fail to commercialize their technologies. 
Second, we are taking steps to help successful awardees 
transition more SBIR/STTR derived technologies. Section 9 of 
the Small Business Act prescribes fixed percentages of the 
extramural budget for research development, test and evaluation 
be expended for the SBIR/STTR programs. Therefore, the 
Department cannot reduce funding for SBIR/STTR. Lastly, the 
Department is also participating in OMB's on-going PART 
assessment of the Federal government-wide SBIR/STTR.
    The SBIR/STTR programs have long been a source of high-
value technology for the warfighter. For example, Small Arms 
Protective Inserts (SAPI) plates and hand-held speech 
translation devices, both widely in use in critical operations 
in Iraq, Afghanistan, and around the world, were initially 
developed through SBIR. The Department is committed to ensuring 
the SBIR/STTR programs improve and remain valuable sources of 
technology for the warfighter.

    Senator Allard. Well, I understand all that----
    Mr. England. But my comment is, in almost every case, our 
trend lines were up. That is, we were doing better in almost 
all categories, and so I was encouraged, because we do track 
these and manage all the programs now----
    Senator Allard. I think it has improved gradually, I just 
have these four programs and I think it is important. The 
President has suggested in those programs where they don't meet 
these standards, he is reducing their funding by 3.6 percent, 
and the rest of the programs that have done well, he has 
increased them by 1 percent. You may not be able to give me the 
specifics on these four programs, but I think the committee and 
I would appreciate, if you haven't, review them a little bit 
and give us a little more detail on these.

      Response to Senator Allard's request for information

    The Administration has used the Program Assessment Rating 
Tool (PART) to assess 70 percent, or $309 billion, of DoD FY 
2007 resources requested in the budget, and 5 percent, or $16 
billion, are in programs rated Results Not Demonstrated (RND). 
A RND rating does not necessarily mean that a program is not 
performing; it means there is not sufficient performance 
information available to assess whether the program has 
achieved its goals.

    Only 4 of the 32 DoD PART programs are rated RND. Those 
four programs are:
        (1) Communications Infrastructure
        (2) Marine Corps Expeditionary Warfare
        (3) DoD Training and Education Programs; Other Training 
and Education
        (4) Small Business Innovation Research/Technology 
Transfer

    The first three programs were rated RND because they did 
not have program-wide metrics that adequately measure program 
performance. To address this issue the Department is developing 
performance measures for these programs that will meet the PART 
standard. For example, the PART on the Other Training and 
Education program assessed three dissimilar programs; 
therefore, standard metrics do not demonstrate and assess the 
programs accurately. The Department is seeking to divide this 
program into three separate PARTs to allow a more focused 
assessment.

    The fourth program, Small Business Innovation Research, 
needs to improve its allocation processes. Toward this end DoD 
is tightening eligibility requirements for programs to 
participate in the Small Business Innovation Research program.

    Mr. England. No, we will. We will get back to you 
specifically. I will comment, it is an excellent question on 
the four areas. In the Quadrennial Defense Review, Senator, we 
made a specific effort in the Quadrennial Defense Review to 
address the way that the Department is managed and the 
processes in the Department to make sure that we run everything 
effectively, and so we are, as a consequence of the QDR, we are 
putting out road maps in terms of how we improve the 
fundamental processes in the Department so that in all these 
areas of measuring and metrics, we will be able to show 
continuous improvement.
    So it is an excellent question and it is a very sensitive 
area to us to make sure that we continuously improve the way we 
are running the Department. And as the year progresses, I mean, 
I would be pleased to get with you or have you come meet with 
us and just discuss what we are doing in the Department to 
improve our business process, because frankly, there is a lot 
of room for improvement and we understand that.

       ADDITIONAL INFORMATION SUBMITTED FROM MR. ENGLAND

    The Department has made significant progress towards 
improving our business practices. I would like to highlight a 
few actions being taken within the DoD to transform our 
business operations:

      1. First we have estasblished strong governance and 
senior executive involvement through the establishment of the 
Defense Business Systems Management Committee (DBSMC).
        a. I chair the committee, with the USD(AT&L) as vice-
chair;
        b. Members include USD(C), USD(P&R), ASD(NII), the 
Servic Secretaries, and Directors of the major Defense 
Agencies.
      2. In September 2005, we established DoD business process 
standards and systems that are focused on improving our end-to-
end integration and financial transparency. These formed the 
basis for the establishment and implementation of the Business 
Enterprise Architecture (BEA) and our Enterprise Transition 
Plan (ETP).
      3. I have established four Investment Review Boards (IRB) 
that collectively review every defense business system as an 
investment annually and review all system development or 
modernization programs greater than $1M prior to the obligation 
of funds.
      4. I have directed the establishment of a new defense 
agency, the Defense Business Transformation Agency (BTA0, that 
is charged with consolidating all OSD enterprise level effort 
on business transformation under a single agency. The BTA will 
become our Center of Excellence for transformational best 
practives and continuous process improvement.
      5. On March 15, 2006, we submitted to Congress our first 
update to the ETP and BEA. We have met the majority of our 
planned performance milestones, both at the DoD Enterprise 
level and within the Services.

    Senator Allard. During this last break, I had an 
opportunity to go and visit a number of our defense companies. 
They specialize in satellites, getting the satellites up in the 
air as well as missile defense. As you know, a good deal of the 
satellites that we put out in space has to do with 
communications.
    Mr. England. Yes.
    Senator Allard. It is vital, and I think it is vital for 
your efforts to build this jointness between the various 
branches of government, or of the armed services. The message 
that I left with the companies is that one area that they have 
been notorious about is not sticking with their budgets and not 
being able to stick with the time lines when they bring these 
proposals into the Department of Defense. I explained to them, 
you know, when you don't meet those--if you don't make an 
attempt to stick with time lines, you only attempt to keep your 
agreements, we lose support of the Congress for these, and I am 
a strong supporter of the armed services programs. So that is 
kind of what I told them. I notice on here the defense 
communications infrastructure is on one of those lists, and so 
I hope that I can get a little more detail back on that.
    While I am on the satellites and our space programs, I have 
also noticed that--and I think space, by the way, is very, very 
important. If we don't have our space assets operating, all 
branches of government are impacted. Now, it happens to be 
under the jurisdiction of the Air Force. The Air Force had 
combined their space programs with their strategic command and 
I have heard rumors that the current general of U.S. Space 
Command, who is retiring, his replacement may not be a four-
star general. It may be something less, and I have written a 
letter to Secretary Rumsfeld on this.
    I think these programs are so vital that we need to make 
sure we have the best leadership and people that have the 
experience, because these are complicated, difficult, and I am 
hoping that maybe you can respond to the rumors and what we 
picked up that there may be an attempt to downgrade this 
position and there may not be as much emphasis on space 
communications as we would hope there would be.
    Admiral Giambastiani. Senator Allard, with regard to the 
commander of the Space Command in the Air Force, I think you 
have just been given bad information, to be frank with you.
    Senator Allard. All right. Very good. And my understanding, 
do they have--someone called the office and said that they 
thought they had somebody lined up that would be a four-star or 
working on somebody----
    Admiral Giambastiani. Sir----
    Senator Allard. You can't comment on that?
    Admiral Giambastiani. I will just tell you that the process 
is working and I think you have been given bad information.
    Senator Allard. OK, very good. I am glad to hear that, all 
right.
    The other issue I wanted to bring up, there is some 
discussion among members of the Senate about a 2-year budget. 
What is your attitude about a 2-year budget in light of the 
fact that we are having a hard time making projections to this 
committee on military spending and we keep finding we are 
having to go into supplemental spending? I am one that supports 
the idea of a 2-year budget, but hearing the comments that are 
going on here from the Chairman and the Ranking Member on this 
committee, the thought struck me is how would the Defense 
Department deal with a 2-year budget and if it is an idea that 
appeals to you or not. I would like to hear a comment on that?
    Mr. England. Tina, why don't you try first.
    Ms. Jonas. Sir, an interesting point that you raise, and 
one thing we have done within the Department at the Secretary's 
urging is to try to reduce the churn and amount of staff time 
we spend on developing budgets, and so we have gone to what we 
call an on-year and an off-year process for current year and 
out-year budgeting, and that has had some--we were in an off-
year this year within the Department and we will do an on-year 
next year.
    You know, we would adjust. If the Congress decided it was 
the best thing to do, I am sure the Department would adjust. I 
do agree that we spent an awful lot of staff hours in the 
Department deciding resource decisions, so anything we can do 
to simplify and streamline the process is a good thing to do.
    We will have every year, probably, some requirement to 
adjust the budget during the year of execution, and we do that 
in a couple of different ways. One way we do it is through a 
mid-year review, which you are familiar with. OMB does that, as 
well. And we send up reprogrammings if we need to make 
adjustments for fact of life. So that is one way that we deal 
with the year of execution.
    A second way is if we have to ask for a supplemental, and 
we have had plenty of discussion on supplementals here this 
morning, so I don't need to belabor that. But we would have 
fuel, for example. In this supplemental that you will see, it 
is not strictly war-related. There is some adjustment because 
of the price of fuel. That is just a fact of life adjustment we 
would always have to make.
    So it is an interesting idea, sir. I would obviously defer 
to the Congress as to what they think is the best for them.
    Senator Allard. OK. Mr. Chairman, my time has expired. I 
had one more question. I am wondering if I may pursue that. It 
has to do with National Guard.
    Chairman Gregg. Yes.
    Senator Allard. NATO has taken this policy where each 
country in NATO is going to specialize in a certain type of 
endeavor as a part of it. They look at the whole NATO aspect 
and then each unit. And so in National Guard and our National 
Reserves, I am under the impression that we are working at 
trying to get various units or brigades to specialize in 
certain areas and then take those units and then fully manpower 
them in those areas and also give them equipment they need, and 
by doing this, what we do is we avoid duplication and 
unnecessary costs as far as the National Guard program. Is this 
approach being followed in the National Guard and Reserves, and 
are we seeing cost savings as a result of that?
    Admiral Giambastiani. Senator, first, if I could just 
address the NATO side to make sure that we all have what I 
consider to be the correct information, as a former NATO 
commander, along with Jim Jones, we have a certain number of 
countries within NATO that we have what we call full-service 
militaries. Some of the smaller countries are working on very--
it is not a particularly great term, but niche capabilities, 
special operations, others where they are particularly good at 
them.
    Senator Allard. Yes, that is what I am referring to.
    Admiral Giambastiani. Exactly, and there are a number of 
countries that, in fact, are specializing in those so that they 
can be very good in certain things. You take the Czechs, for 
example, they have chemical and biological outfits. The 
Norwegians have fighters, but they have special forces. They 
have mountain training. And we spent a lot of time with the 
centers of excellence throughout NATO. So the answer is yes, 
but there are certain militaries that are full-service 
militaries within NATO.
    With regard to the National Guard, what I would tell you is 
I pulled out two sheets here just to let you know. Besides 
infantry, if you will, armor, these heavy brigade combat teams, 
light brigades, and the rest, besides the 28 brigade combat 
teams we are talking about, you have combat aviation brigades 
where we are going, theater aviation brigades, fires, 
battlefield surveillance brigades, combat support brigades, 
they are called maneuver enhancement, sustainment brigades, air 
defense artillery, engineer, military police, chemical, 
military intelligence, signal, explosive ordinance disposal, 
quartermaster, medical, and the rest. Obviously, there is a 
sizable number of these.
    Just to give you the breakout for use, as I said, 28 
brigade combat teams in the Army National Guard. There are none 
in the Army Reserve. Inside the multi-functional support of 
that list I gave you, the Army National Guard will have 44 and 
the Army Reserve will have 11, for a total of 55 there. And 
then for what we call functional support brigades, they are 
directly functional single-source specialties, there will be 34 
in the National Guard and 47 in the Army Reserve.
    Senator Allard. So there is some effort----
    Admiral Giambastiani. Yes.
    Senator Allard [continuing]. Moving forward so we avoid 
this costly duplication that happens among the Guards.
    Admiral Giambastiani. Yes, sir, and I think you will find 
that the Army's plan here is a sensible one as they have tried 
to work with all of the Adjutants General, as they have 
explained to the Governors, and as they have tried to bring 
forward that has some relevance to not only supporting our 
forces forward when we need to bring them up and support with 
combat service and service support, but frankly, also provide 
us homeland defense capability, provide us national disaster 
and contingency response.
    Senator Allard. So you are working with Northern Command in 
that regard, I suppose?
    Admiral Giambastiani. Yes, sir.
    Senator Allard. OK. Was that addressed in the Quadrennial 
Review?
    Admiral Giambastiani. Yes, sir. You will find a number of 
sections where we talk about these types of capabilities and 
our increase in support of homeland defense, for example, and 
how we are restructuring overseas.
    Senator Allard. Thank you, Mr. Chairman.
    Admiral Giambastiani. Yes, sir.
    Chairman Gregg. Senator Nelson.
    Senator Nelson. Thank you, Mr. Chairman. Mr. Chairman, I 
have three subjects that I want to touch on and I will try to 
make it brief, depending on the comments of the two gentlemen, 
and I don't mean to leave out the lady but I want to 
specifically address my comments to the Secretary and to the 
Admiral.
    First of all, I want to thank you, Admiral. You, after many 
conversations with me and others, weighed in at an appropriate 
time with a letter from Secretary Rumsfeld, to use his words, 
that oil and gas rigs in the Eastern Gulf of Mexico, east of 
the military mission line, would be, his word, ``incompatible'' 
with the testing and training mission of the Department of 
Defense. That was a timely letter because as Senator Martinez 
and I have approached this, trying to look out for the 
interests of the Defense Department, given the fact that the 
Chairman of the Energy Committee is coming forth with a plan to 
drill in four million new acres in the Eastern Gulf, I want to 
thank you. Oh, well there is the Chairman of the Energy 
Committee right here. I didn't see him.
    Your letter was most timely and I appreciate that as it is 
under consideration in Senator Dominici's committee right now. 
So thank you for alerting us to that, and Senator Martinez and 
I have drawn the lines in a plan that we have offered and 
hopefully we will have some ability to discuss it and try to 
work it out with Senator Domenici. But thank you for your clear 
statement of it being one of the largest testing and training 
areas and how important it is to the defense preparedness of 
our nation.
    I want to mention two other items. We have, Mr. Secretary, 
an inconsistency in our policy with regard to widows and 
orphans. Widows and orphans are a cost of war, and that has 
been an established policy ever since Abraham Lincoln so 
declared it. Congress changed the law to automatically enroll 
the survivors of those lost while on active duty. But because 
of an offset against disabled and indemnity compensation, many 
of those enrollees end up receiving nothing from the survivors' 
benefit plan.
    There are those of us who have tried to eliminate that 
offset, and in fact, in an amendment that I offered last fall, 
the Senate voted 92 to six to eliminate that offset, and then 
when it got into conference, it was stripped out. That cost is 
estimated to be $9 billion over 10 years, and it is a cost of 
war to help those widows and orphans and I wish you all would 
take another look at that, because the administration has 
opposed the elimination of that offset. I don't think that that 
is right and I don't think it is fair.
    Now let me ask you, Mr. Secretary, on the third question. 
As you know, we have been going round and round on the 12 
carrier minimum in the midst of a war. I just simply, the QDR 
has come down. It is in law now that we have to have 12 
carriers. The QDR is saying that you want 11 carriers. Could 
you try to give some rationale why, in the middle of a war, 
especially with the evidence of China's naval buildup, for a 
budgetary decision is it not penny-wise and pound foolish to 
eliminate one of the carriers when, in fact, if you ever had to 
reverse that it takes $10 billion and over 7 years to build a 
new one? Would you share with us your thoughts?
    Mr. England. Senator, I will.
    The QDR examined that earlier decision by the Department of 
the Navy and also concurred that the 12th carrier was not 
needed. First, that 12th carrier is not in very good condition. 
In fact, today it has no airplanes because of years and years 
of being a reserve carrier and not having the planned 
maintenance, et cetera. So it would take years and years to 
bring it up to par.
    But the main reason is that if you look at our carrier 
fleet, our new carriers will sustain 1,000 sorties a day. It 
used to be down in less than a 100 if you go back in time. So 
today I believe we do like 330. We are going to go to about 630 
sorties and eventually 1,000 sorties a day off of a carrier. In 
addition, our airplanes, much longer range, much more capable. 
And with precision weapons, along with our airplanes, our 
sustainment power of particularly our nuclear carriers is much 
more than our conventional carriers. If you put all this 
together, we just have a vast amount of tactical air power.
    In fact, in the QDR we looked at the whole tactical air 
situation because of the Navy, Marine Corps and Air Force, 
because there is this just a terrific capability now that we 
have. If anything, we are vastly overmatched.
    When you look at all of that, we just do not need the 
carrier. It is something that may be nice to have but we do not 
need it. If you go back to the Vietnam war we had, I believe, 
like 30 different sorties, 30 different attacks against the 
Tran Quan Bridge. And it took 30-some airplanes each time. And 
we did not take that bridge out after 1,000 attacks against the 
bridge until we had our first precision weapons that took the 
bridge out. Now all of our airplanes have precision weapons. We 
take that out in one strike.
    As a matter of fact one B-52 with precision weapons can 
take out 90 different targets.
    So it is a question of the capability has improved to the 
point that we just do not need that number of carriers anymore. 
And that was the conclusion of the military and the civilians 
and the Department of Defense as part of the Quadrennial 
Defense Review.
    Senator Nelson. As you know, it is no surprise to you that 
there is a difference of opinion with regard to that. But let 
us assume that at the end of the day that your position 
prevails and that there are less than 12. Maybe there is 11, 
maybe there is 10. In a few years it could well be 10 because 
the one that is being built now is being considerably delayed. 
So it could be that we are down to 10.
    But assuming that is the case. When you were Secretary of 
the Navy and in front of the Armed Services Committee on 
another policy decision, in light of Pearl Harbor, the eggs in 
one basket theory. Instead of all the carriers being in one 
port, Norfolk, you as well as the CNO had expressed that you 
ought to disperse those assets on the Atlantic coast of the 
United States.
    Would you care to offer any update on that statement that 
you had made last year?
    Mr. England. No, my judgment is still the situation, 
Senator. That is that the Kennedy should be retired and a 
nuclear carrier should be in Florida to replace the Kennedy to 
get some dispersion. That would give us two carrier ports on 
the East Coast and the West Coast. And I believe that is still 
the plan of the Department of the Navy to do that, to have a 
replacement carrier in Florida, a nuclear carrier, which would 
be advantageous just in terms of dispersion.
    The concern there was always weapons of mass destruction. 
Even though carriers are at sea, the maintenance facilities, et 
cetera, are all still there and the crews, et cetera. So having 
some dispersion would be of value to the Department of the 
Navy. So I would say that is still a legitimate conclusion, 
Senator.
    Senator Nelson. Admiral, do you concur?
    Admiral Giambastiani. Sir, I have not dealt with the port 
location issue personally. I have discussed this in some detail 
with the Secretary or with the CNO, and I would just tell you 
that having dispersion of all of those assets, I can remember 
one Christmas, it is the only time I have ever seen it where we 
had five nuclear carriers all sitting next to one another. And 
that is not something we would like to routinely do.
    Senator Nelson. Thank you. Thank you, gentlemen. Thank you 
for your public service.
    Mr. England. Thank you, Senator. Good to see you again, 
sir.
    Senator Nelson. Thank you. Thank you, Mr. Chairman.
    Chairman Gregg. Senator Domenici.
    Senator Domenici. Mr. Secretary, I came principally just to 
thank you for all of your hard work. It seems to me you are on 
double duty these days. And you still look pretty good.
    Mr. England. Thank you.
    Senator Domenici. You are holding up fairly well.
    Mr. England. For a man my age.
    Senator Domenici. You do not want to compare ages. That 
would probably put me in a position of outdoing you.
    I guess I am getting a little concerned, more concerned 
each year, about our failure to include the full supplemental, 
the full expectation of the Iraq war in the budget. I 
understand this year again you are going to use the $50 billion 
fiction because the rational apparently is that is what we have 
been doing.
    How long do you think we are going to keep on doing this?
    Mr. England. Senator, the $50 billion, again my 
understanding is it is not an estimate. It is only a--it 
basically does what the Congress did the previous year, which 
is put the $50 billion in terms of along with the budget.
    Senator Domenici. I say it is a fiction. We just pick it 
out. It is not realistic. It is not showing us what the Defense 
Department is actually costing. We are sort of assuming that 
the war is a separate entity, and how much longer does that 
have to go on until it becomes part of the regular budget? We 
should assume that it is part of what we are going to pay. 
Another 2 years?
    Do you understand what I am talking about?
    Mr. England. I understand Senator. We earlier had the 
discussion, I comment then that this is really above my pay 
grade. This is a decision by the Appropriation Committee and 
the leadership of the Congress and the OMB and the President to 
have the supplementals. And you can either put it in the budget 
or in a supplemental.
    Frankly, my view is you get much better numbers and much 
better support in the supplemental because otherwise we are 
today preparing the 2008 budget. We would literally have to 
``guess'' ahead. There is this tyranny of the budget process. 
It takes a long time.
    So we are preparing the 2008 budget. We would have to look 
ahead literally several years and try to predict and literally 
guess those numbers, which be very, very hard to do that we 
could not support them at that time.
    So it is a decision as to which way to go. It could go 
either way. But frankly, my judgment is there is better numbers 
in the Congress with the supplemental but that is obviously a 
judgmental decision.
    Senator Domenici. Just one last question that has to do 
with whether we are meeting our quota with reference to the 
volunteers signing up for our military. We had a couple of 
questions in here that I am not going to read back on. But 
could the Admiral or one of you talk to me just for a moment? I 
am sure it has been asked. But where are we?
    I read one thing in the newspaper and then I hear something 
from the military. Could we get something official from you 
all?
    Mr. England. Sure. The Admiral has the numbers but I can 
tell you. For the last 8 months we have met all of our 
recruiting goals for all of our services. Do you have the 
specific numbers there, Admiral?
    Admiral Giambastiani. I do. And Senator, what I would like 
to do you is what I am going to give you is that tally as of 
the end of January. We expect the official tally to come out 
for the month of February here within a couple of days. But all 
indications are that we have made goal in February also. That 
is what I understand. Those are draft remarks.
    But what I will tell you is the U.S. Army has made it, as 
the Secretary mentioned, for the last 8 months in a row. The 
Navy has made it for the last 11 months in a row. The Marine 
Corps for 16 and the Air Force for 16.
    And obviously along with that we are at unprecedented 
retention rates across our services. Every one of them. In 
fact, all services are greater than 100 percent retention, 
which is pretty remarkable.
    And then on the National Guard side, the Army National 
Guard through the end of January has made it 4 months in a row 
and was at 109 percent in January. The Army Reserve has made it 
5 months in a row and was at 100 percent. The Marine Corps has 
made it 11 months in a row and was at 100 percent in January. 
The Air Force Reserve was at 100 percent and has made it 12 
months in a row.
    The only one that has missed in January was the Navy 
Reserve. And frankly, there are some goal adjustments that are 
going on inside the Navy with regard to the Reserve, I 
understand.
    So that is what I can give you for official totals. And we 
will give you a roll up of that here, if you would like.
    Senator Domenici. Would you also, for the record, tell us 
what kind of bonuses and/or changes have been made in an effort 
to meet these goals, say over the last year?
    Admiral Giambastiani. Yes, sir. We will give that to you 
for the record.

              ADDITONAL INFORMATION FOR THE RECORD

    Through the continued support of the Congress, we are 
fortunate to have a wide range of incentives to offer as we 
aggressibely compete in a challenging recruiting environment to 
recruit the best and the brightest into our ranks and retain 
those that we already have.
    The Department has three primary enlistment incentives-
enlistment bonuses, the Montgomery GI Bill (MGIB) College Funds 
(Kickers), and a College Loan Repayment Program. The Services, 
based on their needs, offer these incentives to encourage 
enlistmens into critical or hard-to-fill specialities and to 
fill seasonal needs.
    Enlistments bonuses are cash incentives designed to induce 
people to enlist and serve in military occupations experiencing 
personnel shortages. The legislative maximum for enlistment 
bonuses is $40,000 for the Active Components and $20,000 for 
the Reserve Components (based on increases enacted in NDAA 
'06). Bonuses are generally paid for skills that are 
understaffed, arduous (such as combat arms), and those that 
require a high degree of technological skills. Additionally, 
enlistment bonuses are used to even-flow the new recruits into 
the Service training bases by encouraging entry onto active 
duty during traditionally difficult accession months.
    The Montgomery GI Bill (MGIB) and College Funds are 
valuable tools in our professional recruiter kit bags. The MGIB 
is offered to most personnel who enter the Service for the 
first time. Service members may receive up to 36 months of 
benefits for approved programs of education or training. Those 
enrolled in the MGIB have their pay reduced by $100 per month 
for 12 months, or $1,200. This money is not refundable.
    The current monthly MGIB benefit for an individual serving 
at least 36 months on active duty and enrolling full-time in an 
approved program in $1034 per month for up to 36 months 
providing a potential total benefit of $37,224. This rate is 
reduced for less than full-time educational enrollment and for 
less than a three-year active-duty commitment. Funding for this 
benefit comes from the Department of Veterans' Affair budget.
    In addition to the basic MGIB benefit, the Services may 
offer an increased benefit, call a ``kicker,'' for enlistment 
in certain critical or hard-to-fill skills. This kicker plus 
the basic MGIB benefit are commonly referred to as the Service 
College Funds. The statutory limit for the kicker is $950 per 
month and is currently offered by the Army, Navy and Marine 
Corps. The Services contribute an actuarially determined amount 
to the DOD Education Benefit Fund for each individual accessed 
with a college fund.
    The Reserve Components offer the MGIB Selected Reserve (SR) 
program as well. Their program is actually a recruiting and a 
retention incentive since it is not limited to only personnel 
service in their first term of service. The requirement for the 
MGIB-SR program is for an individual commit to a six-year term 
of service. The member is then eligible to receive an 
educational benefit of up to $292 per month for 36 months. The 
monthly benefit is based on class load and the amount is 
adjusted annually based on the Consumer Price Index. The 
cuurent maximum benefit for this program is $10,512. The member 
is not required to contribute financially to this program. 
Additionally, all of the Reserve Component Services are 
authorized to offer a kicker (discretionary, based on Service 
needs/skills requited) up to $350 per month.
    The last in the major triad of incentives legislated and 
offered is the College Loan Repayment Program (LRP). The LRP 
allows the Services to repay certain Federally guaranteed 
educational loans for enlistments in military specialties 
designated by the Service Secretary. Only loans existing prior 
to entrance onto active duty are eligible. Currently, the Army, 
Navy and Air Force offer LRPs. The Active Army and Navy will 
repay loans up to $65,000, while the Air Force limits the LRP 
to $10,000. The Marine Corps does not use this incentive in 
either their active or reserve recruiting programs. The Reserve 
Components (less the US Army and Navy) use this program as 
well, however the level of repayment is less than that in the 
active programs. New recruits that enlist under the LRP option 
are ineligible for enrollment in the MGIB.
    Our retention programs are strong and successful in both in 
Active and Reserve compnents. Service men and women are staying 
in because they are proud of what they are doing in Iraq and 
Afghanistan and want to see it through. Here again, the 
Congress has better enabled us to keep the best of our Service 
members by enabling us to offer them first-rate bonuses that 
show them our high regard for their past and future service. 
These are discretionary programs, which like the enlistment 
bonuses, are used based on the needs of the individual 
Services. Both the Active Component retention bonus is $90k 
(increased from $60k in NDAA 06). The maximum allowable 
retention bonus for the Reserve Component is up to $15k (based 
on needs of the Service, length of reenlistment and number of 
prior reenlistment bonuses for that individual). Additionally, 
for critical job specialities (e.g. Special Forces) a Critical 
Skills Retention Bonus (CSRB) Program is provided where the 
Services may pay (based on needs, skills, etc) up to $200k (for 
the Active Component) and up to $100k (for the Reserve 
Component) over the career of the individual.
    In addition to the increased level of enlistment and 
reenlistment bonuses enacted in NDAA 06, this legislation also 
had other components, which are helping in the recruiting 
efforts of the Services. It increased the maximum age for 
enlistment to 42 and also authorized the Army a referral bonus 
program. In this program, a serving member of the Army will be 
paid $1,000 upon the successful completion of initial training 
for any person that he or she refers.
    The programs detailed above are vitally important to the 
success of our progessional recruiting and retention personnel 
across the Armed Forces. We are confident that with the 
continued support of the Congress on robust programs such as 
these, the personnel required to successfully prosecute the War 
on Terrorism will be there.

    Mr. England. I can tell you, Senator, just for the record 
though, in this budget there is close to $2 million, $1.9 
billion, for bonuses and incentives are included in the fiscal 
year 2007 budget. And we will give you breakdown of those 
specifics.

            ADDITIONAL INFORMATION FROM MR. ENGLAND

    The Department has three primary active-duty enlistment 
incentive-enlistment bonuses, the Montgomery GI Bill (MGIB) 
College Funds (kickers), and a Loan Repayment Program. The 
Services offer these incentive to encourage enslitments into 
cvritical or hard-to-fill specialites. For Fiscal Year (FY) 
2007, the Services have budgeted $431 million for these 
purposes.
    The National Defense Authorization Act (NDAA) for FY 2006 
raised the limit that may be paid to a new recruit for an 
enlistment bonus from $20,000 to $40,000. The Army and Navy are 
using this increased authority to target those especially 
difficult skills formerly contrained by the $20,000 limit. The 
NDAA also authorized the Army to provide a $1,000 referral 
bonus to Soldiers who refer an applicant for enlistment. The 
Army alreadly has over 1,000 leads from referrals and sees this 
new program growing daily.
    Thanks to Congressional support, most bonus authorities for 
Reserve componenets have been increased over the past year in 
an effort to bolster our recruiting efforts, and the components 
are using these increased bonuses and incentives to recruit 
quality Service members. In the education benefits arena the 
basic MGIB allowance received its annual increase, now at $297/
month, and the new chapter 1607 benefits for Reservists who 
were mobilized are being implemented-significantly increasing 
the education benefit allowance. In the area of recruiting 
incentives, Reserve component enlistment and affiliation 
bonuses more than doubled to $20,000 for six year contracts, 
and prior service enlistment bonuses also increased to $15,000 
for six year contracts. Additionally, in an effort to resolve 
some junior grade officer shortages, the officer accession 
bonus was increased to $10,000. To help ensure that we retain 
these quality members, reenlisment bonuses have been increased 
to $15,000 for a six year commitment. Also, the critical skills 
retention bonus was expanded to include Reserve component 
members with skills that are critically short. This expanded 
authority allows us to pay up to $100,000 over the course of 
the Reservist's career. These benefits, along with innovative 
programs, are proving to be extremely helpful in turning around 
Reserve component recruiting in a difficult environment.

    Senator Domenici. Thank you very much. Thank you, Mr. 
Chairman.
    Chairman Gregg. Thank you.
    Do you have a projection for how many troops will be in 
Iraq over the next 12 months?
    Admiral Giambastiani. I guess the way I would answer that 
is that it is condition based as we continue to stand up the 
Iraqi security forces. And by Iraqi security forces I mean both 
Iraqi army and Iraqi police forces, since the Defense 
Department is now running the police training for the last 3 
months or so.
    The numbers are about 232,000 I believe today, Iraqi 
security forces. And those numbers are going up substantially. 
And as they come up and continue to take over battle space, 
which has been happening routinely. Just a month ago the Iraqis 
took over about the size of Kentucky where they have the lead.
    Just to give you an idea, yesterday morning I was on a 
video teleconference with General Casey and General Chiarelli. 
This was the Secretary of Defense, the Chairman and myself. And 
we were getting a briefing from him. General Chiarelli has now 
been in theater for about 6 weeks. He had left for a year, had 
served as the Baghdad area U.S. Commander and came back.
    And when he left there were only three Iraqi security force 
battalions, Iraqi army battalions that actually owned battle 
space. Today the number is well over 40 and going up very 
rapidly.
    So from his perspective how those forces are growing is 
substantial. I just remind you that we also have two less 
brigade combat teams right now than we did 6 months ago. One of 
them is in Kuwait on what we call a prepared to deploy order if 
we need it, but it is a reserve. This is significant. And we 
fully expect that as the political situation continues to 
mature hopefully within Iraq, and as the security forces 
continue to build, General Chiarelli felt very, very pleased at 
the performance of the Iraqi army in particular because of 
their very good performance security-wise here as a result of 
the destruction of the Golden Dome up in Samarra.
    So what I am saying to you sir is it is condition-based but 
the Iraqi forces are making great progress. They have 
accelerated their fielding. And they are performing 
exceptionally well based on our experience. But again, it is 
condition based.
    Chairman Gregg. That being the case, it sounds like you are 
saying you are not going to be adding more force?
    Admiral Giambastiani. I do not expect us to add forces. But 
of course when we have elections, when we have parliamentary 
things, as certain things come up we do get requests from the 
commanders on the ground and we will move forces, for example, 
from Kuwait into Iraq or somewhere else.
    Chairman Gregg. Assuming that we are not adding more force, 
and assuming that there is a chance we may be drawing down 
force, is it safe for us to assume that the average cost over 
the last 4 years would be a number that might be a reasonable 
number for the next supplemental year, next year's 
supplementals?
    Admiral Giambastiani. I cannot estimate the costs. What I 
am telling you is that from a security force standpoint, 
dealing with the numbers.
    Chairman Gregg. What I am saying is we have historical cost 
for maintaining this level of force, which hopefully we will 
actually be drawing down as we stand up force. That historical 
cost appears to be about $90 billion supplemental request.
    Is it reasonable to assume that that is what the 
supplemental will be next year? Or in that range, assuming 
historical factors?
    Mr. England. Senator, I think obviously if you assume 
historical factors you come out with that number. The unknowns 
are a lot of what is in the supplemental is also the repair and 
replacement, the resetting of the force. And until we actually 
complete this activity, we do not know what that end cost is 
for resetting and the repair of the equipment.
    So there is this unknown that is always out there in terms 
of----
    Chairman Gregg. I accept the fact that there is an unknown. 
But I also accept the fact that zero is the wrong number, which 
was the number you sent up last year. So we put $50 billion in. 
And it appears to be the wrong number.
    And so I am trying to figure out what is a number that, 
assuming all of these unknowns, is still a reasonable number 
within the context of the history of the costs. And it seems to 
me that $90 billion is probably a number that is somewhere in 
the ballpark. it is lower than last year or this year and 
higher than the prior years. Just a thought.
    In any event, we have to address it. If we do not get 
guidance from you, we still have to address it. So I am just 
trying to get a sense.
    Admiral Giambastiani. Chairman Gregg, if I could just 
mention one thing. We send over every 90 days, as required by 
Congress, a report to Congress on the stability and security in 
Iraq. There is an unclassified section which is called 
Measuring Security and Stability. And then there is a 
classified supplement that specifically talks about the Iraqi 
security forces and makes some projections.
    Deputy Secretary England has signed out that document here 
just on the 17th of February. And we sent it over. We presented 
it to all four of the Armed Services and Defense Appropriations 
Committees, in addition to the Intelligence Committees of the 
House and the Senate. And in there it talks about some 
projections of where we see the Iraqi security forces being.
    So that happens to be only one component of it, but you 
will see that it talks about the projections that we are giving 
and the buildup from where we are today of 232,000 forces to a 
number that is substantially larger than that.
    Chairman Gregg. Which is obviously very good news.
    Admiral Giambastiani. Yes, sir.
    Chairman Gregg. We certainly hope that you accomplish that. 
And one presumes that leads to lower troop levels on our part.
    Admiral Giambastiani. Yes, sir. And that is what I am 
trying to pass on, sir.
    Chairman Gregg. I am trying to say that we have reached the 
high water mark. So we ought to be able to pick an average of 
the high water mark, which are the last 4 years, and be fairly 
close to where you hopefully will be next year.
    Senator Conrad.
    Senator Conrad. I just want to associate myself with the 
remarks of the Chairman and the remarks of the former chairman, 
Senator Domenici.
    I think we have been engaged in a fiction on budgeting. 
When you talk about Congress doing the $50 billion last year, 
that was in response to the Administration saying nothing. They 
said you do not need to add any money. At least that was what 
was in their budget.
    So the frustration that you are witnessing here is there is 
a feeling here that we have not been quite leveled with on what 
the costs are and what they are going to be. And there is a lot 
of reason for us to feel that way.
    Let me just ask a final question, if I can. This is what we 
are spending on fighters, $11.1 billion, long-range bombers 
$740 million. And in that context, the proposal in the budget 
is to retire 20 percent of our bomber fleet, to reduce the 
number of B-52s from 93 to 56 when we are a decade away from 
the next generation of long-range strike planes being 
available. I just want to say to you it strikes some of us as 
unwise to reduce the bomber fleet that dramatically.
    These B-52s, as was part of your own testimony here this 
morning, have extraordinary capability. I think, Secretary 
England, you referenced that one B-52 can carry enough armament 
to take out 90 targets.
    I found it surprises constituents when they find out we 
only have 93 B-52s in the active inventory. We have one more 
that is at NASA, for a total of 94. And they are talking about 
going to 56, when we are more than 10 years away from the next 
generation of long-range bomber being available.
    So I just want to send that message, that some of us are 
not going to be supportive of that kind of dramatic drawdown of 
the B-52 force without some replacement in our sights.
    With that I want to again thank the witnesses. I want to 
thank you, Secretary England. Thank you for your service to the 
Nation.
    I certainly want to thank the Admiral, as well. I very much 
appreciate it. I did not have the chance, I told you my wife is 
Italian. I did not tell you, she is one of those people that 
ran away from home and joined the Navy and had a great career 
and is enormously proud of serving in the United States Navy, 
and also very proud of her Italian heritage.
    Admiral Giambastiani. I am proud of her being Navy and I am 
glad to see that I was as smart as she was.
    Senator Conrad. And to Ms. Jonas, as well, we have high 
regard for your professionalism.
    Mr. England. Can I take just 30 seconds on the bomber 
issue?
    Senator Conrad. Certainly, absolutely.
    Mr. England. This is an issue that I think we agreed on, in 
terms of the importance of bombers. As a matter of fact, we 
said we need to start working on the next generation bomber, 
which is in the QDR. So that was one of the efforts of the QDR. 
And we have money in the budget to do that, by the way, to 
actually start the next bomber.
    The B-52s are literally venerable old work horses and they 
have been upgraded and they do a wonderful job. But some of the 
B-52s are not venerable work horses. They are worn out old work 
horses and they are really not of value to us and they are past 
the point of being useful.
    So this was really an effort to the very best----
    Senator Conrad. Can I stop you on that point? Because I do 
not think that is true. We have--Minot Air Force Base in North 
Dakota is home to the Attrition Reserve. Those planes, to my 
knowledge, have all been upgraded. All of the planes have been 
treated the same, even though some are in the Attrition 
Reserve. All of them have had been given upgrades.
    Is that not correct?
    Mr. England. Senator, I will get back with you. My 
understanding though, as I recall the discussion, and the 
Admiral may recall some of this, I believe there is 18 that do 
not fly at all.
    Senator Conrad. No, I will tell you, that is bad 
information. We have talked about bad information here. All of 
the planes are flown. All of the planes have been upgraded.
    That is alarming to me when you say these things that I 
know are not right. Those planes have been upgraded. Those 
planes fly. And we have been very careful to do that. This 
Committee has been very aggressive to make certain that was 
done.
    Mr. England. The Admiral is about to correct me on this 
subject, sir.
    Admiral Giambastiani. I normally do not correct my boss----
    Mr. England. Please do.
    Admiral Giambastiani [continuing]. But in this case I will 
publicly help him out here.
    We understand completely what you have said. They are 
called Attrition Reserve aircraft because we do not normally 
have them in a line unit. But obviously, as you well know, we 
take those Attrition Reserve aircraft, we have upgraded them. 
We have put them in a line unit for a short period of time, 
flown them, make sure they are upgraded.
    The reason is that if you do not do that, you cannot have 
them ready for service if you need them.
    We have looked at the bomber force. We all, most of us 
within the Defense Department, at least for example me as the 
Vice Chairman and I will speak for myself, are a very strong 
proponent of the bomber force. I think I am the only Navy 
admiral I know of that has actually flown a two-and-a-half hour 
mission in a B-2, for example.
    What I would tell you as that in the beginning in 
Afghanistan, we had Air Force bombers and Navy tactical 
aviation off of carriers. We did not really have other things 
flying, other then of course tankers and AWACS and all of those 
big aircraft that we are flying which were so important to our 
effort.
    But the Secretary is dead on. There is a very strong 
commitment to a follow-on bomber force. And in the next 
President's budget and in our future year defense program that 
we will present after this year of deliberation, you will see 
more on this bomber force and where we are going. We will put 
lots more granularity into it.
    Senator Conrad. I appreciate that.
    I just am concerned about the bathtub effect that is being 
created here. I think it is unwise in terms of the national 
security. And this will be something Congress will want to 
review.
    Admiral Giambastiani. Yes, sir.
    Chairman Gregg. Again, I want to join my colleagues in 
thanking you for your service. Thank you for taking the time to 
come up and testify before the Committee. It is very useful for 
us, obviously, and we appreciate all that you do. But we 
especially appreciate all that the men and women who are on the 
front lines in this war are doing.
    Mr. England. Mr. Chairman, thank you very much. Mr. Conrad, 
thank you. It is a pleasure being with you today. Thank you 
very much, sir.
    Chairman Gregg. The hearing is adjourned.
    [Whereupon, at 11:54 a.m., the committee was adjourned.]

    PREPARED STATEMENTS

    [GRAPHIC] [TIFF OMITTED] T6726.161
    

    [GRAPHIC] [TIFF OMITTED] T6726.162
    

    Answers to Questions submitted from Senator Ron Wyden by 
Mr. Gordon England

        The President's Fiscal Year 2007 Budget Proposal

    Question #1

    A Pentagon audit identified $263 million in unjustified 
charges from Kellogg, Brown and Root (KRB) as part of its bill 
for a no-bid contract to deliver fuel in Iraq. However, the 
Army recently announced that it is going to pay almost all of 
these excessive charges.

    The Army says that they have to pay these disputed charges 
because they fall within the terms of the contract. When $253 
million worth of questionable and unsupported charges are still 
technically within the bounds of a contract, it indicates to me 
that the Army isn't reading the fine print before signing 
contracts.

    Is the Pentagon instituting any reforms to ensure that this 
kind of sweetheart contract doesn't happen again?

    Answer

    The RIO I contract was a cost plus award fee contract of 
the type described in FAR 16.405-2. Under the contract, the 
contractor's costs are reimbursed and the contractor earns a 2% 
base fee and an award fee, which can range from 0 to 5%. The 
award fee is not a ``performance bonus'' but is an earned fee 
based on criteria set out in the award fee plan in the 
contract.

    No unsupported costs were paid. The contractor either 
provided support for costs or withdrew the costs from the 
proposal. The contracting officer found most questioned costs, 
which KBRS actually had incurred in executing the mission, 
should be reimbursed. However, he excluded just over half of 
those costs from the amount used to calculate the award fees 
paid to KBRS; refused to reimburse some $3.8 milion in costs; 
and did not pay a claim for $5.4m in interest. In addition, he 
excluded the entire amount of the $28.5m claim submitted on 
Task Order 4 from the amount used to calculate the base and the 
award fees.

    The award fee determining official also considered the 
issues identified in the DCAA audits in making his fee 
determinations. The results was that KBRS also earned a lower 
percentage of the available pool. Award fees ranged from 4% to 
68% of the maximum 5% award fee. All fees were awarded in 
accordance with the award fee plan set out in the contract, 
which placed more emphasis on timely mission accomplishment 
than on cost control and paperwork.

                                 
