[Senate Hearing 110-162]
[From the U.S. Government Publishing Office]


                                                S. HRG. 110-162. Vol. I 
 
                      CONCURRENT RESOLUTION ON THE 
                       BUDGET FOR FISCAL YEAR 2008 
=======================================================================

                                  HEARINGS

                                BEFORE THE 
                         COMMITTEE ON THE BUDGET 

                            UNITED STATES SENATE
 
                         ONE HUNDRED TENTH CONGRESS 
                                 FIRST SESSION 
                                     _______

                January 11, 2007-THE LONG-TERM BUDGET OUTLOOK 
             January 18, 2007-THE LONG-TERM ECONOMIC AND BUDGET 

                                 CHALLENGES
 
           January 23, 2007-THE GROWING TAX GAP AND STRATEGIES FOR 

                                 REDUCING IT
 
            January 25, 2007-THE CBO BUDGET AND ECONOMIC OUTLOOK
 
          January 30, 2007-DEFINING OUR LONG-TERM FISCAL CHALLENGES
 
            January 31, 2007-EXPLORING SOLUTIONS TO OUR LONG-TERM 

                                 FISCAL CHALLENGES
 



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                          COMMITTEE ON THE BUDGET 

                        KENT CONRAD, North Dakota, Chairman

PATTY MURRAY, Washington              JUDD GREGG, New Hampshire 
RON WYDEN, Oregon                     PETE V. DOMENICI, New Mexico 
RUSSELL D. FEINGOLD, Wisconsin        CHARLES E. GRASSLEY, Iowa 
ROBERT C. BYRD, West Virginia         WAYNE ALLARD, Colorado 
BILL NELSON, Florida                  MICHAEL ENZI, Wyoming 
DEBBIE STABENOW, Michigan             JEFF SESSIONS, Alabama 
ROBERT MENENDEZ, New Jersey           JIM BUNNING, Kentucky 
FRANK R. LAUTENBERG, New Jersey       MIKE CRAPO, Idaho 
BENJAMIN L. CARDIN, Maryland          JOHN ENSIGN, Neveda 
BERNARD SANDERS, Vermont              JOHN CORNYN, Texas 
SHELDON WHITEHOUSE, Rhode Island      LINDSEY O. GRAHAM, South Carolina 

                    MARY ANN NAYLOR, Majority Staff Director
 
                     SCOTT B. GUDES, Minority Staff Director
 




















                               C O N T E N T S 
                                 __________ 

                                  HEARINGS 

                                                                   Page 
January 11, 2007-The Long-term Budget Outlook .....................   1 
January 18, 2007-Long-term Economic and Budget Challenges .........  79 
January 23, 2007-The Growing Tax Gap and Strategies  
  for Reducing It ................................................. 131 
January 25, 2007-The CBO Budget and Economic Outlook .............. 209 
January 30, 2007-Defining Our Long-term Fiscal Challenges ......... 257 
January 31, 2007-Exploring Solution to Our Long-term 
  Fiscal Challenges ............................................... 337 

                       STATEMENTS BY COMMITTEE MEMBERS 
Chairman Conrad ............................. 1, 79, 131, 209, 257, 337
 
Ranking Member Gregg ........................ 9, 91, 138, 217, 264, 415
 
Senator Grassley ..................................................  69
 
Senator Allard .................................................... 127
 



                                WITNESSES 

Bernanke, Ben S., Hon.; Chairman, Board of Governors of the Federal 
  Reserve System ..............................................  93, 98 
Bixby, Robert L.; Executive Director, The Concord Coalition .. 347, 351 
Brostek, Michael; Director of Tax Issues, Government Accountability 
  Office ..................................................... 150, 153 
Butler, Stuart M., Dr.; Vice President for Domestic and Economic 
  Policy Studies, The Heritage Foundation .................... 401, 404 
Furman, Jason, Dr.; Director, The Hamilton Project at the The 
  Brookings Institute ........................................ 388, 392 
Greenstein, Robert; Founder and Executive Director, Center on 
  Budget and Policy Priorites ................................ 266, 271 
McIntyre, Robert S.; Director, Citizens for Tax Justice ...... 140, 143 
Minarik, Joseph J., Dr.; Sr. Vice President and Director of 
  Research, Committee for Economic Development ............... 377, 381 
Orszag, Peter R., Dr.; Director, Congressional Budget Office . 218, 222 
Reischauer, Robert D., Dr.; President, Urban Institute ....... 284, 287 
Satagaj, John; Sm. Business Legislative Counsel, Small Business 
  Tax Compliance & Fairness Coalition ........................ 177, 180
 
Steuerle, Eugene, Dr.; Senior Fellow, Urban Institute ........ 296, 299
 
Walker, David M., Hon.; Comptroller General of the 
   United States ............................................... 12, 23
 




                            QUESTIONS AND ANSWERS 
Questions and Answers .......................... 72, 128, 206, 253, 433
 

                 ADDITIONAL MATERIALS AND CHARTS SUBMITTED 

Testimony, charts, and graphics submitted  ......................... 64
 


















                       HEARING ON: LONG-TERM BUDGET OUTLOOK 
                                        ______ 

                             THURSDAY, JANUARY 11, 2007 

                                           U.S. SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:34 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Judd Gregg, chairman of 
the committee, presiding. 
   Present: Senators Gregg, Domenici, Grassley, Allard, Graham, 
Conrad, Murray, Cardin, Sanders, and Whitehouse. 
   Staff present: Scott Gudes, Majority Staff Director and Mary 
Naylor, Staff Director for the Minority. 
   Chairman GREGG. Let me call this hearing to order, which is-- 
I am sure some people are saying, what is he doing that for, he is 
not in charge anymore? They are saying, what is he doing that 
for? 
   Due to the vagaries of the Senate's arcane rules, I technically am 
still chairman, I guess. But that is obviously a technical point. I 
look forward to working with Chairman Conrad. We have had a 
very good, strong relationship. I very much appreciate his and his 
staff's extraordinarily cooperative and positive approach during my 
tenure as chairman. I intend, and our staff intends, to take the 
exact same approach and really use his example as our template 
as to how we will proceed. 
   So at this time I will yield to Senator Conrad as chairman and 
relinquish my chairmanship, even if it is only technical. 


                  OPENING STATEMENT OF SENATOR KENT CONRAD 

  Senator CONRAD [presiding]. I thank my colleague. I thank 
  Senator Gregg very much for the way he has conducted this committee. 
  Senator Gregg has been an exemplary chairman. He has conducted 
this committee professionally and with good humor and with fairness. 
He gives us all a good example of how committees should be 
chaired in the U.S. Senate. 
   He has also graced this committee with outstanding staff. We 
have had just a very good, very positive working relationship on 
this committee and we intend to continue it. 
   Senator Gregg and I have had lengthy discussions about the 
enormous fiscal challenges facing the country and our desire that 
we enter into a process to be able to address those issues and to 
do it this year. Obviously, whether or not that goes forward is at 
a higher pay grade than ours. It involves the President of the 
United States. It involves the leadership of both the House and the 
Senate. But I think it is fair to say that we are prepared to work 
in good faith to try to find solutions to these vexing long-term 
issues that, I believe, fundamentally threaten the long-term economic 
security of the country if they are not addressed. 
   Senator Gregg has repeatedly demonstrated that he is serious 
about this. So I very much look forward to the opportunity to work 
with him and others of our colleagues to try to address these issues. 
   I also want to take this moment to thank and welcome the new 
members of this committee. I see Senator Whitehouse is here. We 
are delighted to have you. 
   Sheldon, let me just say to you that when I started on this 
committee that is where I was. 
  Chairman GREGG. No, you were behind the screen. 
  Senator CONRAD. I was behind the screen. 
  I also want to welcome Senator Ben Cardin of Maryland, who 
served on the Ways and Means Committee and is deeply knowledgeable. 
We are delighted to have him as a member. Senator 
Sanders of Vermont as well. 
   I also should indicate that Senator Lautenberg, the former 
distinguished ranking member of this committee, has agreed to 
temporarily serve in Senator Johnson's spot pending Senator Johnson's 
recovery. 
   Let me say that all of our colleagues are hoping and praying for 
Senator Johnson's full and swift recovery. We have been delighted 
by the reports of recent days of Senator Johnson's progress and we 
eagerly await his return. But we so thank Senator Lautenberg for 
his willingness, as a former ranking member of this committee, to 
come back to temporarily serve in Senator Johnson's slot. 
   With that, I want to commend you, Mr. Walker. You are the 
head of the General Accounting Office. You could sit in your office 
and issue reports and nobody could fault you for that. But really 
these circumstances demand more and you are giving more. I want 
to publicly thank you. We do not have to agree on every single 
thing, every statement you have made. I have had a number of 
members of the press closely quizzing me in the last 24 hours, do 
I agree with this Walker statement, that Walker statement. That 
is not the point. I agree with the overall message that you are 
attempting to deliver to the Nation they we are on an unsustainable 
course and it has simply got to be changed. 
   Before I go further I want to again thank Senator Gregg for his 
assistance in organizing this hearing, because we could not have 
proceeded without him as he is still chairman of this committee in 
a formal sense. Again, I deeply appreciate the way he has cooperated so 
we could have this hearing. 
   Since 2001, the Nation has undergone a dramatic budget 
deterioration. We all know the pattern; record deficits. But more 
importantly, the debt is going up more rapidly than the size of the 
deficits. This is a point that I think is too often lost. Last year the 
deficit was $248 billion, but the debt increased by $546 billion. I 
think this is a point that has too often been lost. 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   We are facing a wall of debt. At the end of 2001 the gross debt  
of the country was $5.82 trillion. At the end of 2006 that had 
mushroomed to $8.5 trillion. And if we continue on the President's 
course we will have the debt soar to $11.6 trillion by 2011. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   The result is that increasingly we are borrowing these very large 
amounts of money from abroad. Fifty-two percent of our debt now 
is financed abroad. We have doubled foreign holdings of U.S. debt 
in just the last 5 years. We owe enormous sums of money to Japan, 
to China, to the United Kingdom. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


   This increase in debt is happening at the worst possible time, 
right on the brink of the retirement of the baby boom generation, 
a point that you, General Walker, have made repeatedly, that right 
now is in many ways the budget sweet spot. We have coming at 
us something we have not seen before and perhaps it is one reason 
our colleagues have a difficult time adjusting to it. It is this 
demographic tsunami of the baby boom generation and it is going to 
change everything, and that is not a projection. These people have 
been born. They are alive today. They are going to retire and they 
are going to be eligible for Social Security and Medicare, and we 
have to get ready. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   The number of Social Security beneficiaries is projected to climb 
to 82 million people by 2050. But we need to remember that Social 
Security is not the biggest budget challenge. Because of rising 
health care costs over the next 75 years, the shortfall in Medicare 
is seven times the projected shortfall in Social Security. And by the 
way, I believe it is far more likely to come true, that is the 
shortfall in Medicare, than the shortfall in Social Security. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


   The growing cost of Medicare and Medicaid is simply staggering. 
By 2050, if nothing changes, more than 20 percent of our gross domestic 
product will be spent on Medicare and Medicaid alone. That is about 
what all of Government costs us now. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   We do not just have an entitlement spending problem. We also 
have, I believe, a revenue problem. If all of the President's tax cuts 
are made permanent, the cost will explode at the very time the 
cash surpluses in Social Security and Medicare become deficits. In 
other words, the President's tax cuts will dramatically worsen an 
already deteriorating budget picture. 
   Now the good news is these problems are not insurmountable. 
The fact is, we could make a meaningful difference in these long-term 
projections if we took action here in the Congress and the President 
agreed. 
   I believe it is going to take a bipartisan effort. I believe neither 
party can do this acting alone. I think we have to work together 
and act together. It can and must be done, and the American people 
deserve nothing less. 
   The CHAIRMAN. 

               OPENING STATEMENT OF CHAIRMAN JUDD GREGG 

   Chairman GREGG. Mr. Chairman. I thank you, Mr. Chairman, 
and I look forward to working with you, and I want to echo your 
words relative to cooperation and very much appreciate the professional 
and constructive way that you worked with us over the years, and we 
look forward to doing the same. Also I appreciate your starting your 
tenure with this hearing because it highlights the issue. 
   I want to thank the Comptroller General for being with us. He has 
basically been the person who has sounded the alarm most effectively 
and whose numbers most of us have been using aggressively to carry the 
message which you have delivered to us. I appreciate your being here 
today to deliver it again. 
   To pick up where the chairman left off, this chart, I believe, 
summarizes the problem in the most concise way. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   They are numbers which were referred to by the chairman. Essentially 
by about the year 2025-three programs, three entitlement programs, 
Social Security, Medicare and Medicaid, will absorb the historical 
amount of spending which the Federal Government has done as a 
percentage of gross domestic product which is 20 percent. In other 
words, those three programs will cost as much as the Federal Government 
has historically cost the American people. 
   So it would mean at that point that you would either have to give up 
doing everything else the Federal Government does, such as national 
defense, which is the first priority of a Federal Government, or 
education or environmental protection. Or alternatively you would have 
to dramatically start to expand the taxes, because this share consumed 
by Social Security, Medicare, and Medicaid does not level off at 20 
percent, which is the historical norm for all Federal spending. It 
actually continues to go up. I think the number was cited by the 
chairman of 27 percent by 2032 of gross domestic product being 
absorbed. That, as you can see from that chart there, it just keeps 
going up. 
   So you have unchecked entitlement spending in the Federal 
Government as we head out into the next two decades. You can see that 
it is simply staggering. It is not sustainable. The point has been made 
that this is not an arbitrary number. This is not one of those 
projections which is suddenly thrown on the table by looking at tea 
leaves. The problem exists because the generation that is going to cost 
us this problem has already been born and is about to retire. We will 
double the size of the retired generation, the largest retirement 
generation in history, 80 million people will be retired versus about 
35 million today. The level of effort required to support that 
generation will simply stagger those Americans who are working during 
this period, and that will be our children and our grandchildren. 
   The way I have tried to describe it is that we need to pass on a 
government to our children that is affordable for them and still 
delivers the quality of services that a retired generation needs. And 
that means you have to balance this exercise between spending on 
benefits and revenues. 
   But you cannot anticipate, you cannot put the whole burden of this 
exercise on the next generation through raising revenues because you 
would simply wipe out our children's capacity to have the quality of 
life we had. We would have to raise their taxes so high that they 
would be unable to send their kids to college, buy their homes, and 
live a good lifestyle. So it has to be a balanced approach. 
   If you were trying to tax your way out of this problem, the tax 
burden would have would to rise to a level that essentially gives us 
the same tax burden that some of our neighbors in Europe have, which 
has led to, in my opinion, the diminution of their lifestyle, their 
productivity, and their ability to compete with us. So it is simply not 
an affordable event under the present fact pattern. 
   Now where the chairman and I depart paths here is how the 
President's tax cuts affect this exercise. If you look at revenues 
which we have received under the President's tax cut, we are today 
receiving more than the historical amount of revenues collected by the 
Federal Government. This year we are receiving about 18.5 percent of 
gross domestic product in revenues. Historically, the Federal 
Government has collected about 18.2 percent of gross domestic product 
in annual tax revenue. So actually the President's tax cuts are 
generating revenues that are equal to, essentially, our historical 
norm. 
   In fact, we now have a tax law that is even more progressive than 
the historical tax law. Today, 85 percent of revenues come from the top 
20 percent of taxpayers. Under the Clinton years, 82 percent of tax 
revenues came from the top 20 percent of taxpayers. 
The bottom 40 percent of taxpayers are getting back about twice today 
as they used to get back. They do not pay taxes. They are getting about 
twice as much because of the earned income tax credit as they did under 
the Clinton years. 
   So we have a more progressive law. We have a tax law which is 
generating more revenue than the historical norm. And if we were to 
repeal this tax law, in my opinion, that would be counter-productive. 
But if you repeal this tax law, you would see that the revenues would 
go well above 18.2 percent which is the historical norm. They would end 
up in the 23, 24, 25 percent range. 
   We have never had that type of a tax burden put on the American 
people by the Federal Government. It would stifle productivity, 
creativity, entrepreneurship and the creation of jobs, and I am not 
sure that is the way we want to go to solve this problem. 
   In fact it would not solve the problem because the entitlement 
growth would still be so staggering that you could not catch it up with 
tax revenues. 
   So the issue is huge, and it has to be approached in a balanced way 
which is that you are going to have to look at the benefit side, you 
are going to have to look at the revenue side, and you are going to 
have to face up to the reality that our generation has no right to pass 
on to our children this problem. 
   We are the Governors now. We are in charge of this nation. The baby 
boom generation is responsible for the leadership of this nation. If we 
pass on this issue, we will have done a total disservice to our 
children by having passed to them a problem which was our creation and 
our generation's responsibility to resolve. 
   So I very much appreciate the Comptroller General being here because 
most of these numbers are based off of his numbers. We look forward to 
his characterizing the problem for us again. And then I look forward to 
working with the chairman to try to come up with some process for 
actually addressing the problem. 
   Thank you, Mr. Chairman. 
   Senator CONRAD. Thank you, Chairman Gregg. 
   Again I want to thank the Comptroller General for coming back from 
Ohio early. He was there on the Fiscal Wake-Up Tour. I do not know if 
that is what it is called but I think that is what it is intended to 
do. We very much appreciate your coming back early so that you could be 
our first witness before this committee. 
   Welcome, General Walker. 

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

   General WALKER. Thank you, Chairman Conrad, Chairman Gregg, other 
members of the Senate Budget Committee. Let me apologize in advance for 
my voice. I do not feel as bad as a sound, thank God, but I do have a 
challenge with my voice. 
   As you pointed out, I have just come back this morning from what was 
the sixteenth Fiscal Wake-Up Tour outside Washington, DC, which was 
held in Columbus, Ohio. We had probably 300 to 500 citizens there last 
night. We had members of the Concord Coalition, fellows from the 
Brookings Institution and the Heritage Foundation, former Senator John 
Glenn, OMB director Rob Portman and myself. 
   Many of the numbers that I will use today were in graphics I used 
last evening. And let me say that the American people are smart enough 
to get this. If you state the facts, if you speak the truth, if you 
help them understand where we have been, where we are, and where we are 
headed, what the consequences are to our country, our children and our 
grandchildren, they will enable people to act without losing their 
jobs. 
   In fact, what the Fiscal Wake-Up Tour is all about is to try to help 
till the ground and prepare the way for elected officials, who will 
ultimately have to make the tough choices, to be able to do so without 
losing their jobs. 
   I am going to lay out a picture this morning that is not a pretty 
one. It is also getting worse with the passage of time. It is fair to 
say that we have made some progress on our short range deficits in the 
last few years. And that is good. It is better to have smaller deficits 
than bigger deficits. But our financial condition is worse than 
advertised. We are on an imprudent and unsustainable long-term fiscal 
path. While the short-term deficits have improved in recent years, the 
long term is getting worse every second, of every minute, of every day, 
and the time for action is now. 
   If I can, let me show you a few graphics. I understand that each of 
you have your own copies of these available if you have difficulty in 
seeing the screen. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   This represents our historical Federal deficits as a percentage of 
the economy. So inflation is taken out. The red represents the 
on-budget deficit, excluding the Social Security surplus primarily. The 
blue represents the off-budget surplus, primarily Social Security. 
The black line represents the unified deficit; the combination of the 
two. 
   You will see that ran larger deficits as a percentage of the economy 
in the 1980's. But we got something for it. We bankrupted the Soviet 
Union. We won the cold war. And we declared a peace dividend. 
   Then in the early 1990's the Congress got serious, imposed a number 
of budgetary constraints. We had strong economic growth. 
A variety of things came together and we went from significant deficits 
to surpluses. We even went to on-budget surpluses. We actually started 
paying down the debt. People were actually concerned that we may pay 
off all the Federal debt. Oh my God, would that be terrible. Obviously, 
I am being facetious here. People actually were concerned about thought 
that that was going to be a problem. Needless to say, that problem did 
not come to pass. 
   We took a big turn in the wrong direction, but as I said before, 
things have not better in the short term over the last several years. 
But do not focus on this because this is not the problem. 
   By the way, there are plenty of people out there that say, do not 
worry about the deficits. We have had larger deficits as a percentage 
of the economy. That is like flying a plane or driving a car looking in 
the rearview mirror. What is important is not where we have been. What 
is important is where we are heading. And by setting goals to say we 
want to achieve a certain level in 5 years, while it is good to make 
progress, that is not adequate. It is like heading to the Grand Canyon 
at 100 miles an hour and your goal is to slow the car to 50 by the time 
you get to the edge. Quite frankly, that is not going to get the job 
done. So our problem is the long term. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Part of the problem is we have three numbers for the Federal 
deficit, which in and of itself confuses people. These are not three 
sets of books, but there are three different numbers for the deficit. 
And unfortunately, the press tends to only focus on the smallest one. 
Last year we ran a unified budget deficit of $248 billion. As you know, 
you have to draw nine zeros to the right of the 248. You do not really 
appreciate it till you write it out. 
   But we spent every dime of the Social Security surplus, as we have 
in most years. So the on-budget deficit was $434 billion. We have not 
been in a recession since November of 2001. We had among the highest 
GDP growth rates of any country on earth last year and yet we are 
running deficits of that size. Most of that deficit did not have 
anything to do with Iraq and Afghanistan, although they currently do 
not help. And we had a net operating cost on an accrual basis for 
financial reporting of $450 billion. 
   All of these were down from the prior year but they are still 
imprudently high. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Here is the real problem. As has been shown, whether you go baseline 
extended or whether you assume that discretionary spending grows with 
the economy and all tax cuts are extended, the math just does not work. 
You have already seen this graph. I am going to move on the next one 
because it is clear. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   In January of 2001 I testified before the Senate and this was our 
long-range fiscal simulation in January of 2001. We had fiscal 
sustainability for 40-plus years in January of 2001. Now this 
simulation was based upon assumptions, as all simulations are. Some 
proved valid, some did not. But let me show you where you are today on 
two scenarios. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   No. 1, this is CBO baseline extended, which assumes that all of the 
tax cuts expire, which assumes that discretionary spending grows by the 
rate of inflation for the next 10 years. You can see, even on that 
basis, we have a long-range problem because if the bar is above the 
line that is a deficit. 
   Let me show you the next one. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   This one assumes that all tax cuts are extended, something is done 
about the AMT, and that discretionary spending, which includes national 
defense, homeland security, judicial system, education, transportation, 
environment, grows by the rate of the economy. 
   Under this scenario the fiscal simulation blows up in the 2040's. So 
we have gone from fiscal sustainability for 40-plus years to the model 
blowing up in 40-plus years. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   As has been shown, this is primarily but not exclusively, due to the 
explosive growth in Medicare, Medicaid, and Social Security. It is not 
the only problem. But entitlements are clearly the biggest problem. 
   Now these are in trillions, tens of trillions. So you would have to 
write 12 zeros to the right of these numbers if they were rounded to 
the tens of trillions. 
   In 2000, the United States had major reported liabilities social 
insurance commitments, and unfunded promises in current dollar terms 
for Social Security, Medicare and other major items totaled about $20 
trillion. Last year that total had risen to $50 trillion--in 6 years, a 
147 percent increase primarily due to Medicare. 
   Medicare prescription drugs did not exist in 2000. It is about an $8 
trillion obligation. Medicare prescription drugs alone added more 
unfunded commitments to the U.S. Government than all of Social 
Security. Medicare was already underfunded $15 trillion to $20 trillion 
when the Medicare prescription drug bill was passed. 
We cannot afford the doughnut, much less to fill the doughnut hole with 
jelly. 

   This figure shows the Social Security surplus. The budget will start 
to suffer withdrawal pains in 2009 because starting in 2009 the Social 
Security surplus will start to decline. In 2017 the Social Security 
surplus will be gone and therefore we will have to redeem these bonds. 
That means raise taxes, cut other spending, or borrow more from foreign 
players. 
   By the way, before I summarize, if you take that $50 trillion 
number, let me benchmark that for you because frankly it is too big for 
anybody to relate to. Fifty trillion dollars is 95 percent of the total 
net worth of every American, up from 91 percent last year. Fifty 
trillion dollars is $440,000 per American household. 
   The median household income in America is less than $47,000. That is 
like having an implicit debt or mortgage equal to over nine times your 
annual income. And like a mortgage, it will be paid out over a number 
of years. But unlike a mortgage, there is no house to back this debt. 
It is only your citizenship and your ability to earn and the 
opportunity that one is given by being a citizen of the United States 
to reach one's full potential. 
   In summary, our financial condition is worse than advertised. We are 
on an imprudent and unsustainable long-term fiscal path. We cannot grow 
our way out of this problem. Anyone who says we can grow our way out of 
this problem has not studied economic history and probably is not very 
proficient at math. The numbers do not come close to working under 
reasonable assumptions. 
   Yes, we want to maximize economic growth. Yes, we want to minimize 
tax burdens. But in the final analysis you have to have enough revenue 
to pay your current bills and deliver on your promises for the future. 
   We need to enhance truth and transparency in our financial reporting 
and budgeting processes. We need to reimpose meaningful budget controls 
on both sides of the ledger and impose those controls not just on 
discretionary spending but also impose mandatory reconsideration 
triggers for mandatory spending both that done directly and that done 
indirectly through tax preferences. We need to reengineer and 
reprioritize the base of the Federal Government because it is based on 
the 1940's through the 1970's and most of Government is not necessarily 
generating positive results that can be identified. 

   We have to reform entitlement programs. We have to reengineer and 
constrain spending. And we have to engage in comprehensive tax reform 
that hopefully will generate more revenues in an economically efficient 
manner. 
   We are going to have to do all three because the numbers do not come 
close to working if you just focus on one or two of the three. 
And the longer you wait, the bigger the gap you are going to have to 
close. And the longer you wait, the less transition time you have. 
And the longer you wait, the more people who are vested in the status 
quo. 
   So the time to act is now, not just for the country but also for our 
kids and our grandkids. 
   Thank you. 
   [The prepared statement of Mr. Walker follows:] 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Senator CONRAD. General Walker, thank you for that really 
outstanding testimony. This is precisely why we wanted to have you as 
the first witness before this committee, to lay out clearly and 
concisely and in a compelling way the seriousness of the challenge 
confronting us. 
   Let me go back to a couple of the statements you made. Yesterday or 
perhaps the day before I read in one of the major newspapers, the 
Washington Post, they had a little sidebar story in which they said, 
the deficit is only 1.8 percent of GDP and economists say that that is 
sustainable indefinitely. True or not true? 
   Misleading or not misleading? How would you characterize that? If 
you were to write the story trying to advise people of our fiscal 
condition, how would you characterize it? 
   General WALKER. It is accurate but misleading. We probably can 
sustain a deficit of less than 2 percent of GDP for a number of years. 
But that is not where we are headed. Where we are headed is to deficits 
of multiple times 2 percent of GDP. As both of you have noted, Chairman 
Conrad and Chairman Gregg, we are headed to the point where Social 
Security, Medicare, and Medicaid alone will consume all of the 
historical Federal revenues as a percentage of the economy. 
   And that does not count interest on the Federal debt. The fastest-- 
growing cost in the Federal budget today is interest on the Federal 
debt. It went up from 7 percent of the budget in 2005 to 9 percent in 
2009. And we have relatively modest interest rates. 
   When, not if, foreign investors decide, as a matter of mere prudence 
and diversification, that they are not going to continue buying as much 
U.S. debt, then interest rates will rise and that will start a 
compounding effect. So what is important is that we act so to mitigate 
the impact and to help avoid their seeking to hold less of our debt. We 
can. We must. I think we will, hopefully, with bipartisan leadership. 
   Senator CONRAD. General Walker, you have outlined here what the risk 
is to the economy, that increasingly we are financing this debt abroad. 
Fifty-two percent is the latest figure I have, 52 percent of our debt 
is now financed abroad. We have doubled the amount of our borrowing 
from foreign countries in the last 5 years-doubled. We borrowed 65 
percent of all of the money that was borrowed by countries in the world 
last year. 
   So to me it is clearly an unsustainable course now. And that is 
before the baby boomers retire. How much more serious does it become as 
the baby boomers become eligible for these programs? 
   General WALKER. It becomes clearly unsustainable. Basically what is 
going on right now is we have a national credit card. But unlike most 
credit cards it does not have a credit limit. And so we are continuing 
to charge our national credit card, compounding interest. But we are 
expecting our kids and our grandkids to pay it off. 
   We have four deficits today that relate to your point: (1) a budget 
deficit which we have talked about, (2) a balance of payments deficit 
of which the trade deficit is a subset, (3) a savings deficit. In 2005 
for the first time since 1933, which was not a good year for America, 
Americans spent more money than they took home last year. 
   And (4) the worst deficit of all is the leadership deficit. That is 
what we have to address on a bipartisan basis because Social Security, 
Medicare, and Medicaid represent a tsunami of spending. And, unlike 
most tsunamis, this one never recedes. It is a permanent change in the 
landscape. 
   What is going on now is as if we are on the beach and we are saying, 
let us just focus on the short-term. We are making progress on the 
short-term, but right on the horizon we can see this tsunami building. 
We need to recognize reality and start to act to deal with that. 
   Senator CONRAD. Final question from me. General Walker, Senator 
Gregg and I and others have been talking about a structure that would 
be a bipartisan effort to devise a plan to address our long-term fiscal 
imbalances, including but not limited to Medicare and Social Security, 
also looking at the structural deficit, and ask the group--Republicans 
and Democrats equally divided--to come back with a plan that would 
require a super-majority vote here to pass. 
   Would you endorse such an effort? Do you think it is important that 
we make that attempt in this year? 
   General WALKER. I think it is important to figure out mechanisms 
that will allow the Congress to be able to deal with this issue sooner 
rather than later. Realistically those mechanisms must involve the both 
executive and the legislative branches. They must be bipartisan in 
nature. At least the recommended package, I would respectfully suggest, 
should be subjected to a super-majority vote of the members who 
comprise this group. 
   Senator CONRAD. And it would. 
   General WALKER. Whether or not you should require a super-majority 
vote once it gets to the Congress is a different issue. I think you 
clearly need a super-majority vote on something that comes to the 
Congress but I think it is a different issue as to whether or not you 
should require a super-majority vote once it gets to the Congress. 
Obviously you have to be concerned to make sure that the President is 
not going to veto the package because then you would have to have a 
super-majority vote. All the more reason why you have to have the 
President engaged in this. Expedited consideration I think would 
clearly be a desirable feature; no doubt about that. 
   So without knowing the details, I think that to the extent that you 
could put together something without a commission, that is desirable. 
But we have to figure out how to get it done and how to get it done 
sooner rather than later in a bipartisan manner. 
   Senator CONRAD. I thank you for that and I want to make clear that 
it would require a super-majority of the group that would be given the 
responsibility to come up with a plan. It would involve the White 
House. The President would have members of this working group.  
   The reason for both a super-majority from the group and a 
super-majority when you come back is if it is on an expedited basis and 
you are restricting members' right to amend, which is the most 
fundamental right of a Senator, people are not going to give up that 
without the assurance that there is going to be a tough hurdle here to 
pass. That is the reality that we confront here. 
   I just think what you say is absolutely the case. The sooner we get 
at this the better. Those things we cannot agree on will have to wait. 
   Senator Gregg. 
   General WALKER. Senator, if I may just add something quickly, sir. I 
understand what you are saying about why you are proposing a 
super-majority vote of this body and the other body. Obviously, one of 
the possible tradeoffs for your consideration is limited amendments and 
not requiring a super-majority vote. That is something I would 
respectfully suggest you may want to think about. 
   The other thing is the scope. Does it include all of the elements 
that I talked about? I think it is important that it include all of the 
elements that I talked about: more transparency in financial reporting 
and the budget process, strong budget controls on both sides of the 
ledger, discretionary and mandatory spending including entitlements, 
and tax preferences. I think it is really important that all of these 
items be on the table in order to be able to get to the point where we 
can really do something meaningful and where you can achieve the vote 
requirement. 
   Senator CONRAD. Thank you. Senator Gregg. 
   Senator DOMENICI. Senator Gregg, I wonder if you would yield 30 
seconds so I can ask the chairman a question. 
   Chairman GREGG. I am sure the chairman will allow it at this time. 
   Senator DOMENICI. I just wondered, so the whole public will know, 
you keep using and we all keep using the word it. We have to do it. 
What is it? 
   Senator CONRAD. It is to address these long-term entitlement 
challenges, these long-term fiscal imbalances, but not limited to 
Medicare and Social Security, but including the imbalances between 
projected revenue and expenditures so that we are getting at not only 
the long-term entitlements but the structural deficits that we have 
going into this process as well, with everything on the table. 
   Senator DOMENICI. Senator, I just want to try one more time because 
I think if it was as easy as you say we would just do it. The problem 
is when you put this budget together or this instrument that solved the 
problem of the world toward America, what are we going to have to do to 
Social Security? What are we going to have to do to Medicare? We are 
talking about fixing it. When we look at there at Americans we say we 
are not going to be able to afford Medicare in its current form. So 
what is going to happen? Generally, what do we have to do? 
   Senator CONRAD. I would just say to the Senator, we cannot give the 
results of the exercise before we have started the exercise. We cannot 
give an answer to what the solutions are until we devise a process to 
have a proposal brought back before the Congress. 
   So I do not think you can say what the conclusions are until we 
begin and engage in the process. And do it together and do it in a very 
serious way. 
   Chairman GREGG. Just to followup on that, I think the issue here is 
to set up a procedure that drives policy. But the key to the procedure 
is that it be unquestionably bipartisan, that nobody feels they are 
being gamed, that the American people feel that when the procedure is 
concluded and the policy is proposed that it has been reached in a way 
that is totally fair. That means you have to have the presidency in the 
room and you have to have the Congress in the room. 
   The situation that we have now is that we have a divided government 
where that type of fairness is inherent in the process if everybody's 
in the room and the structure is such that you have super majorities 
for reporting and for passage. 
   So I think the opportunity is here and let us hope somebody takes 
advantage of it. 
   Senator DOMENICI. Thank you. 
   Chairman GREGG. If I could pursue some of the thoughts you had, 
Mr. General, to get a little bit into the weeds here, historically we 
have had 18.2 percent of gross domestic product in tax revenue. For the 
last few years we have had 20 percent in spending. If we are on this 
path of entitlement spending, we are looking at 28, 29, 30 percent 
spending, which is not sustainable. We all know that. 
   The question becomes at some point-we are going to have to make a 
decision where these lines should appropriately cross. In other words, 
the only way you are going to solve the out year imbalance of liability 
and revenue is to pick a number which is sustainable and which 
maintains a strong economy for expenditures and revenues that is the 
same. I mean, that is just the way it is. 
   So I guess my question to you is do have an idea, do you have a 
thought of what is a number where those lines cross that the economy 
maintains its strength, that you do not undermine the economy by having 
too large a government to support? 
   General WALKER. I understand. 
   Chairman GREGG. Looking in the historical terms of somewhere, I 
presume, between 18.2 percent and--
   General WALKER. Let me try to provide you meaningful information 
here. 
   First, I believe that the imbalance is requires you to address all 
three issues that I mentioned. You are going to have to get most of the 
money through entitlement reform. That has to be No. 1. 
   Second, you can and should get money from spending restructuring and 
constraint outside of entitlement reform. 
   And third, you are going to have to get more revenues hopefully 
through fundamental tax reform which, among other things, would broaden 
the base, try to keep rates as low as possible. 
   My personal view is you are going to need additional revenues; 18.2 
percent of GDP will not get the job done even if you end up restructing 
entitlementa and constrain spending . The gap is just too great. It is 
going to have to be more than 18.2 percent. 
   I believe that you need to try to keep it as low as you can for 
three reasons. No. 1, to maximize economic growth. No. 2, to maximize 
disposable income. And No. 3, to maximize our competitive advantage 
compared to Europe. 
   Europe's tax levels are about 10 plus percent higher than ours when 
you compare Federal, State and local. They have much higher 
unemployment rates. They have slower growth rates and much higher 
employment rates. We need to learn from that. 
   Now, where will we end up? Is it 20 percent of GDP? Is it 22 percent 
of GDP? What the exact number is I cannot tell you. But it is more than 
18.2 percent and it is below 25 percent. 
   Chairman GREGG. What I most appreciate is the lead in to it where 
you outline the issues, the spending restraint and the benefit reform 
and some sort of revenue reform. 
   When you are talking revenue reform, there has been proposals out 
there that we should maybe have a dedicated stream of revenue from a 
consumption tax. Have you ever thought of that? And what is your 
reaction to that? 
   General WALKER. There is absolutely, positively no question you are 
going to need more revenues for health care. If there is one thing that 
can bankrupt America, it is health care. 
   Frankly, you could reform Social Security and exceed the 
expectations of every generation of Americans without additional 
revenue. You may have to have additional revenue to get a political 
deal, but you do not need it to make it work. You are going to need it 
for health care. 
   In health care, candidly, I think there are four things we are 
ultimately going to have to shoot for in health care and it is going to 
take us probably 10 to 20 years to get to where we need to be in 
installments. 
   We are going to have to limit the percentage of the Federal budget 
that is dedicated to health care. If you do not do that, that is the 
ultimate put option on our children and grandchildren. Every other 
industrialized nation does that in some way. We ration health care 
today, we just do not ration it rationally. 
   Second, we need to try to move toward providing basic and essential 
health care coverage for everybody. Basic and essential. Inoculations 
against infectious diseases, wellness services, protection against 
financial ruin due to unexpected catastrophic illness where you are not 
using heroic measures, and ability to purchase more insurance if you 
want. Right now we spend 50 percent more of our economy on health care 
than any country on earth. We have the largest uninsured population. 
   By the way, the third element is quality. We need to achieve above 
average health care outcomes. Today, we are below average for an 
industrialized nation on health care outcomes. We have lower average 
life expectancy, higher than average infant mortality, and way higher 
than average medical error rates. Finally, increase personal 
responsibility and accountability for one's own health and wellness 
activities. 
   I believe that we can do this but it requires fundamentally 
rethinking Medicare and fundamentally rethinking what our future will 
look like 20-plus years from now and then taking installment steps to 
get there over years. 
   We are not going to be able to move from plan A to plan B overnight. 
It will have to be done in installments over a number of years. But 
this kind of system, quite frankly, I think could be affordable and 
sustainable. But where we are at now, no way. 
  Chairman GREGG. Thank you for that explanation. That was very cogent, 
to say the least. 
   Senator CONRAD. Senator Murray. 
   Senator MURRAY. Thank you very much, Mr. Chairman. 
   First of all, let me congratulate you on your leadership on this 
committee. I am glad you are the chair. 
   And Senator Gregg, I want to thank you for your tremendous respect 
of all of us on this committee under your leadership over the last 
several years, and look forward to working with you. 
   Mr. Chairman, I am interested in the process you have outlined for 
all of us to try and work our way forward under a very, very difficult 
scenario that General Walker has set out for us. And I want to thank 
you for being here today, and putting all of this in perspective as we 
move forward under very, very difficult--dismal I might say--budget 
situation that we have been left with after deficit spending for a 
number of years. 
   I think we know that unsustainable budget deficits have become the 
norm and we have to look at the long-term picture and make some very 
difficult and strategic decisions. And it cannot be done alone. We need 
to all work together to accomplish that. 
   Let me go from the macro down to a question I had because this 
situation that you have presented to us in this hearing comes within 
the timing of the President addressing us last night on his plan on his 
military efforts in Iraq. That will be debated outside of this 
committee, I am certain. We all have our opinions on that. 
   But I wanted to ask you, particularly in terms of the budget, about 
the realistic estimate of the long and short-term costs of the war in 
Iraq. Do you think Congress has a clear understanding of the cost 
estimates of the war? And are we budgeting for it in a way that is 
sustainable in the long term? 
   General WALKER. No, I do not think Congress has as good of an 
understanding of the cost of the war as it should have. 
   No. 2, I have serious concerns about some of the past numbers that 
have been associated with it and the numbers that we are hearing with 
regard to the most recent proposal. For example, I have heard that 
there will be a request for $5.6 billion associated with a surge of 
21,500 troops. 
   Well, the average total annual compensation for a member of the 
active duty military is close to $120,000, fully loaded, with benefits 
and everything. It is about $1.2 billion per 10,000 troops. If you 
multiply that by 2.15, you do not get anywhere close to $5.6 billion. 
   Plus, on top of that, most of those people are already getting paid. 
Yes, you have to pay war zone supplementals, you have to get them there 
and back, you have to properly equip them-but that is less than the 
total dollar amount I cited. 
   But I honestly have to tell you, I think the defense budget is a 
serious problem. There is a tremendous amount of waste going on. And I 
think that it is important that as much of the defense budget get into 
the base as possible so that it can be subject to Congressional 
scrutiny and oversight. 
   Only time will tell how much longer we will be in Iraq and how much 
it will cost us. I do not think anybody knows that but God today. 
   Senator MURRAY. There is a number of different scenarios out there 
and the long-term budget projections that you are looking at today, 
what scenario were you basing those long-term projections-- 
   General WALKER. CBO. We do not try to compete with CBO. We start 
with the CBO baseline and, as you know, they must assume, that whatever 
funding was provided for Iraq will continue. 
   And then what we do longer-term, Senator Murray, is we do not 
segment out Iraq or Afghanistan or the global war on terrorism. We 
basically make an assumption as to what is total discretionary spending 
going to be as a size of the economy? After the 1st 10 years it grows 
with the economy, we assume? So we do not get down to that level of 
detail long-term. 
   Senator MURRAY. Just as a quick followup, the CBO estimated that the 
care of the veterans from Iraq before the recent plan from the 
President is going to cost about $1 billion per year over the next 10 
years. Have you looked at that and put that into your long-term? 
   General WALKER. I will be happy to provide something for the record, 
but the real question is how is it included in the CBO baseline? We are 
piggybacking on CBO. I will check it and provide something for the 
record. 
   General WALKER. GAO's long-term simulations do not make any 
assumptions about the path of any specific program within the ''other'' 
category shown in the figures. This ''other'' category includes both 
discretionary spending and mandatory programs other than Social 
Security, Medicare, Medicaid (and of course net interest). Under the 
''Baseline Extended'' scenario we use the CBO baseline for the first 10 
years. This baseline assumes that discretionary spending in the 
aggregate grows with inflation. After the first 10 years we keep the 
level of spending in this category constant as a share of GDP. Under 
the alternative scenario we assume that spending in this category grows 
with the economy for the first 10 years and the longer-term. 
   Senator MURRAY. I do think, Mr. Chairman, that is something we are 
going to have to look closely at and monitor as well, as we do this. 
   General WALKER. If I may add, Senator Murray too, and I think this 
is important, one of the reasons that the Defense Department budget is 
out of control is because of health care. It is one of many. And 
Congress passed expansion of TriCare benefits for defense. 
   I sent letters up to the Hill talking about that was going to just 
enable employees to exercise a huge put option on our kids and our 
grandkids, and that is exactly what is going on. 
   Senator CONRAD. Senator Domenici. 
   Senator DOMENICI. Thank you very much, Mr. Chairman. 
   Mr. Walker, thank you so much for coming up. Over time I kind of 
wondered what your role was vis-a-vis this effort we are doing and that 
started back when we were not getting along too well. But I want to say 
to you that I think you are a big help. We have our own, they have 
their own, we have you. You have many other jobs besides this, but I 
think that you are very helpful. 
   Let me say first, as we all listen, that when we talk about having 
to do something with a long-term program such as Medicare, Medicaid, 
Social Security, it is not-fellow Americans, it is not that what we 
have to do is easy, or we would just do it. 
   The truth of the matter is that something has to change. Normally, 
when we look at that, we do not want to tell the American people that 
the program that saves America changes these programs so that over time 
they do not cost as much. That means something will change in the 
program that it will be different 10 years from now or 15 than it is 
now. We might as well say the truth: it will be less, probably less 
benefits. 
   That is why I was hinting when I was talking to you, not that you 
ever hide from it, Mr. Chairman. But when we speak of doing something 
to it, what we mean is doing something to the programs that people 
currently want because they are getting them. They like them and they 
fight for them. And we are just sitting here and saying to them well, 
they will keep on coming. 
   You keep telling us but when will it stop? And then we get people 
saying it is not going to matter, we are going to be able to take care 
of it. And then we are up here as budgeteers saying oh, but we have to 
make some changes. And in the middle of this line, good faith Senators 
are trying to figure out some formulation that would put this in a 
position where we could call upon ourselves in a meaningful way. 
   Nobody wants to be part of a program of trying to fix these programs 
when it is not going to fix them. That is a total, total political 
waste, so you will not do it. So it has to be something that will work; 
right? 
   And people have to feel like it will work when they join it. And I 
am not sure that people want to risk that much of their political 
strength. But they are going to have to. 
   I want to laud this Chairman and this ranking member and say if they 
can begin  to put this together, they will go down much more in history 
than any of the other things that we are talking about that Government 
has to do. 
   I, myself, haveten so frustrated, Mr. Walker and Mr. Chairman, that 
I am planning to put together a bill with Senator Feinstein, and it is 
almost finished, and I will bring it to you all, which would set up the 
commission which would do this business for us and report to the public 
and to Congress on how to solve the problem. Sooner or later we are 
going to have to do that. Somebody is going to have to set it together 
and put it together and move on with it. 
   I have a brief summary that I would have given and I would like to 
put it in the record, Mr. Chairman, at this point. 
   And with that, thank you for giving me time. Mr. Walker, thanks 
again for your public service. It is admirable and we need it. 
   GENERAL WALKER. Thank you. If I can, Mr. Chairman, I think we have to 
be realistic. Senator Domenici, as you properly point out, we are 
talking about real tough choices here. Real tough choices, dealing with 
benefits, dealing with other spending, dealing with tax policy. 
   Realistically, whether you go the approach that you are talking 
about, Senator Conrad, or whether you go with the approach that you are 
talking about, Senator Domenici--one does not involve a commission and 
the other one does--I would respectfully suggest that you are not going 
to solve the problem in one fell swoop. 
   But I do think you could do several things as the first installment. 
Start by poroviding, additional transparency in a financial reporting 
and the budget. Second, impose tough budget controls to stop or slow 
the bleeding. In terms of sbstantive installment could do 3 things: 
First, a comprehensive Social Security reform that is not 
preprogrammed to have to come back. That is easily doable. 
   Second, round one of tax reform. 
   And third, round one of health care reform focused on Medicare and 
Medicaid. Those things, I believe, would mean a meaningful down 
payment, would provide more transparency and a structure in place to 
help you going forward, would be a credibility enhancer with the 
American people and a confidence builder for the Congress. 
   Senator CONRAD. Mr. Walker, let me just say that I think you have 
described very ably and very succinctly what would be realistic goals 
for this kind of effort. 
   Let me say to my colleague, Senator Domenici, who has been such an 
important force on this committee for so long, as chairman, as ranking 
member, as senior member, the notion of a commission, we decided that 
it would be better if it were all members, people that have skin in the 
game, rather than asking outside experts who ultimately are not 
accountable. Because it has to pass here. And we need the people who 
have responsibility here, and I include the White House. I want to make 
very clear that if the White House is not on board with his effort, 
there is no sense even beginning. Because ultimately the President has 
to agree to sign or to veto. 
   So everybody has to be on board. And Senator Domenici is exactly 
right. This is not easy. This is going to be excruciatingly 
difficult. But if we fail to act, kick this can down the road, that 
only makes the ultimate solution more draconian. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Mr. Walker, I applaud your remarks on the health care system. If 
there is one thing that can bankrupt America, it is health care. And 
you have identified a lot of the problems that our health care system 
is burdened with. 
   My view is that our health care system is ridiculous and that it 
would be disgraceful for the U.S. Congress to seek to cut health care 
spending without taking as hard a look as we can add at the reforms 
that are necessary to drive the costs down not with the tough budget 
knife but by actually making the system work better and be more 
efficient. 
   I think it is probably the most inefficient system in the world. 
Many years ago in Rhode Island, I led a reform of the workers 
compensation system. And we put discipline to that process by hiring 
actuaries who prices the reform legislation as it went. And we could 
not put that thing through until they had signed off on yes, this will 
save the money that you have said it will. 
   It is an imperfect discipline but it was a good discipline. I am 
wondering if your office is interested in and capable of providing that 
kind of discipline and support to a health care reform effort in this 
body? 
   General WALKER. First, Senator, we are here to support the Congress 
in any way that you think would be helpful. Obviously, most of our 
work, as you probably know, is focused on supporting the committees 
because those are the entities that end up moving legislation, holding 
hearings, et cetera. In addition, we do not want to compete with our 
sister agency, the Congressional Budget Office, which you know is the 
official scorekeeper for the Congress. 
   But I will tell you this, one of the things that you touch on is the 
need better metrics and for more disclosure of not just the 1year, the 
5-year and the even 10-year cost of proposals. We need a sense as to 
what the longer-term implications of any major policy or proposal would 
be. 
   One of the things I think we have to do, for example, Medicare 
prescription drugs. As you may recall, and I know you were not in this 
body then but I am sure you read the papers then. 
   Senator WHITEHOUSE. It is a thrill to arrive with this kind of 
problem looking at us. 
   General WALKER. You have a challenge and there is an opportunity. 
   Let me take that as an example because it goes to your point. 
Congress decided that it could spend several hundred billion dollars 
over 10 years on Medicare Part D when we had a surplus. When the bill 
passed we had a deficit. There were differences between what CBO said 
it was going to cost and what the actuary at Medicare said it was going 
to cost, but the actuary was not able to disclose his numbers. More 
importantly, there was never any discussion of the discounted present 
value dollar cost; not until three and a half months after the bill 
passed--and it was $8 trillion. 
   For big-ticket spending and tax items we need to have good numbers 
and those numbers need to go beyond on the short term to help us get a 
sense for affordability and sustainability over the long term. 
   And so yes, we are willing to help in any way we can. At the same 
point in time, we do not want to duplicate the efforts of our sister 
agency. 
  Senator WHITEHOUSE. The other question I have, as I said, the budget 
knife can be pretty unwieldy. If you want to cut your transportation 
budget in half you do not go out and cut your car in half. That takes 
you to zero transportation. You have to be a little bit more 
sophisticated about it and understand the underlying system. 
   My experience as an attorney general, particularly in education, was 
that very often we were saving money at the $7,000 per pupil level, say 
in a middle school, and losing so many kids through that school that 
then turned up at $100,000 per kid in the training school, and whose 
trajectory of life was dramatically compromised by their failure in 
middle school. 
   I have always surmised that the cost of losing them at that age and 
of their ceasing to be productive citizens and creating enormous law 
enforcement and other costs, was enormous. But I have never seen a 
calculation of that or a looking forward consequences analysis of where 
a failure to invest creates enormous costs later on, as opposed to 
simply cutting as you go. 
   General WALKER. I have not seen that either. I can go back and see 
if we have done anything on that in the past. 
   I do think this, Washington tends to suffer from two maladies: 
myopia, or nearsightedness, and tunnel vision where you are just 
looking narrowly at one issue at a time. One of the things we have to 
do, which you are touching on, we need to look longer range, and we 
need to understand the collateral effects of things that we do or we do 
not do. 
   Education, frankly, is a problem in and of itself because we are not 
even top 20 in the world in math and science. And yet we have to 
compete based on brain power in a more advanced economy. So there are a 
number of issues there I think that are worth exploring. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Senator CONRAD. Thank you, Senator. 
   Senator ALLARD. 
   Senator ALLARD. Mr. Chairman, thank you. 
   I just want to raise a word of caution as far as talking about 
things like infant mortality, disease occurrence, and hospital 
associated accidents or however you want to delineate them. Because 
many times the World Health Organization builds these off of records 
that are kept within the country. 
   And so you take a country like Mexico, who does not record births, 
does not record marriages, does not record deaths. These figures are 
not as accurate as what we have in this country, where we require 
physicians and health care professionals to report adverse reactions in 
hospitals. Infant deaths are recorded. We have had a birth certificate, 
a death certificate, where all of this is documented for the public 
record. 
   I do think that when we make comparisons with other countries that 
we can get some misleading figures there and I think we need to keep 
that in mind when we are working with those figures. 
   The thing I would like to bring up is that I agree with everything 
that has been said. We have a complicated problem. I think we have put 
this problem off to the point now where we cannot tax our way out of 
it. You cannot simply cut spending. It is going to take a group of 
things that has to happen. And I think that we need to put together a 
group of experts who can recommend to us what groups of things need to 
happen in order to make sure that our entitlement programs can survive. 
You mentioned the health care sector. As deep a trouble as it is, that 
is new information and I appreciate you bringing that to our attention 
this morning. 
   One of the things that we struggle with, obviously, is what is the 
proper level of taxes in order to get the economy to grow? Obviously 
you cannot tax 100 percent of production or you are not going to get 
any revenues because nobody is going to produce. Similarily, you cannot 
have zero taxes because you will not have any revenue. 
   But somewhere in between there is a magic level. And that will vary, 
depending on tax levels and what kind of taxes you are talking about. I 
think this is part of your discussion on tax reform. 
   What tax reform do you think might be easiest to manage by the 
Congress? Answer that question first and then I will bring up another 
one. 
   General WALKER. First, I think you have several issues. One, how 
much of the economy do taxes represent? You are correct in saying you 
want to keep that as low as possible in order to maximize economic 
growth, maximize disposable income, and maintain our competitive 
advantage compared to Europe. 
   Then you have to decide how are you going to go about raising that 
revenue? And then you get into how much are you going to rely on 
individuals? How much are you going to rely on corporations? How much 
are you going to rely on income taxes? How much are you going to rely 
on payroll taxes? How much are you going to rely on consumption taxes 
or other excise taxes? And then how are you going to allocate the 
burden within those groups? How progressive is it going to be, et 
cetera. 
   A few preliminary thoughts. We want to maintain a competitive 
advantage as compared to Europe. We want to minimize tax burdens while 
dealing with our fiscal imbalance. So that means we are going to need 
more revenues. 
   Corporations do not have duties of loyalty to countries. They have 
duties of loyalty to their shareholders. You must be competitive in 
your tax structure vis-a-vis corporations because they have the ability 
and an incentive to do business elsewhere if you do not. 
   As to individuals: obviously, you want to be fair and equitable with 
regard to the tax burdens there. But most Americans are not looking to 
be citizens of someplace else. Most other citizens are looking to be 
citizens of America. We have to keep that in mind. 
   I think that our tax system today is so mind numbingly complex it is 
virtually impossible for persons in good faith who itemize to do their 
taxes and know they have done it corretly. Many Americans pay more in 
payroll taxes than they do income taxes. That is a fact. And yet we are 
using some of the payroll taxes to pay operating expenses of the 
Government. We have to keep that in mind. 
   I think we need to do several things. We need to broaden the tax 
base, reduce and eliminate a number of tax preferences to keep rates as 
low as possible to be able to help assure equity, consistency, and 
economic efficiency. We are also going to need to consider some type of 
a consumption tax that may or may not be dedicated because income and 
wealth in this country is distributed fundamentally differently today 
than it was in the early 1900's, when income taxes came into effect. 
   The $345 billion tax gap would be a good place to start--with more 
information returns, more withholding, more targeted IRS enforcement. 
But you are not going to solve the tax gap until you do comprehensive 
tax reform with simplification. 
   Lastly on simplication, I have paid AMT several times now. I think 
that is a massive bait and switch surtax. I think you would be much 
better off to build it into the rates and just be honest with people. 
If you want to have a surtax on the really wealthy, then have a surtax 
on the really wealthy. But the idea of AMT, where you in good faith 
fill out your tax return and think you are done and then all of a 
sudden you have to go do this other one--all it is is a surtax. You 
would be better have a streamlined and simplified income tax that 
builds it into the rates. And then if you want to have a surtax, target 
it. 
   Those are a few thoughts. 
   Senator ALLARD. Mr. Chairman, my time is run over but for the 
committee's benefit I would like to ask for a clarification, if I may 
have the time. 
   Senator CONRAD. Sure. 
   Senator ALLARD. You talked about consumption tax. I have read tax 
policy experts who will say that a flat tax and a sales tax are both 
consumptive taxes, depending on how they are structured. So when you 
talk about a consumption tax, which one are you referring to? 
   General WALKER. It depends on how they are structured. You could 
have an income tax that does not tax savings and does not tax certain 
items that do not represent consumption and pretty much get a 
consumption-based tax, if you will. So there is different ways you can 
get there. 
   The last thing that I would mention, let me give you one example of 
something that really needs to be on the table. The single largest tax 
preference in the budget or probably in the Government today is the 
fact that no American, no matter how much money they make, no matter 
how wealthy they are, pays a dime of income or payroll taxes on the 
value of employer-provided and paid health care, even if they have a 
very lucrative health care package. That is approaching $200 billion a 
year. 
   And it is part of the problem with health care cost explosion 
because it disassociates people from the cost of health care. And that 
is something that the Mack-Breaux Commission put on the table. 
   The good news is there is lots of good work that has been done on 
entitlement reform and taxes. You do not have to reinvent the wheel. 
You can pull from work that has already been done and come up with 
something that hopefully addresses the elements we talked about. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   Senator CONRAD. I thank the Senator from Colorado for his good 
questioning. 
   Senator CARDIN. Again, Senator Cardin, you were not here when I 
welcomed the new members to this committee. We are delighted that you 
and Senator Whitehouse are here. Senator Sanders was here earlier. 
   We very much appreciate your coming and replacing a former No. 2 
person on our side on this committee, Senator Sarbanes, who was an 
essentially valuable member of this committee. We anticipate that you 
will make significant contributions here, as well. 
   Senator CARDIN. Mr. Chairman, I thank you very much for these 
comments. Serving in the other body, I served on only one committee so 
it was very much expected I would make those hearings. In this body 
they put me on a lot of committees. 
   So I apologize for the fact that Secretary Rice is before the 
Foreign Relations Committee and that has divided my time today. 
   I want to thank you very much for holding this hearing. I had a 
chance to work with you, Mr. Walker, when I was in the House, and I 
always found your information to be extremely helpful, particularly 
your projections regarding areas that we need to address. 
   Today we are talking about the long-term budget outlook. Let me just 
caution you, as you were talking about the Alternative Minimum Tax--and 
I agree with you on AMT. Remember, we got the AMT because Congress 
wanted to simplify, broaden, and reduce rates. 
   So let us be careful as to how we move forward because our actions 
may very well not produce the results that we anticipate. Our tax code 
is the most complicated it has ever been and we have gone through I do 
not know how many tax simplifications. So we should be very cautious 
about that. 
   The other point I want to make is that as we look at ways of solving 
the budget dilemma that we are in, and I know that Congress will 
examine entitlement spending, let us remember that it was not too many 
years ago that the projections for our budget were pretty good. 
   I remember some of the documents that you prepared for the Ways and 
Means Committee as to how we got this reversal, particularly your 
analysis of the 2001 and 2003 tax cuts and the effect our budget 
situation if those provisions are made permanent. 
   You already mentioned earlier the impact of the medicare 
prescription drug law has. 
   As we look for ways of dealing with our budget problems today, let 
us be mindful of how we got here so that we do not repeat the mistakes 
we have made in the past. 
   Medicare and Medicaid are clearly a challenge for the Federal budget. 
There is no question about that. I do not how we deal with that if we 
address the overall issue of health care in this country. How do you 
get a handle on the Federal Government's costs health care unless you 
address the lack of affordable health insurance, the rising cost of 
long-term care, and as you point out, a more responsible approach to 
Medicare prescription drug coverage? 
   I do not know whether you have done any projections in this or not, 
or whether you have any views on that, but it seems to me that we will 
not benefit taxpayers or consumers if we just attempt attempt to rein 
in Medicare and Medicaid but do little about the entire health care 
system itself. 
   General WALKER. My personal view is, Senator, that while there are a 
number of things that we can and should do in the short term to try to 
moderate health care costs, including moving to national practice 
standards,--something that would help to reduce costs, improve quality, 
and reduce litigation risk, among other things,--that ultimately we are 
going to have to engage in comprehensive health care reform in 
installments. Medicaid is really not just health care. It is also 
long-term care. About two-thirds of Medicaid now is long-term care. 
That is really a hybrid. It is really life maintenance. It is really 
not health care. 
   So I think that ultimately we are going to have to engage in much 
broader reforms, but we are going to have to do it in installments. We 
are also going to have to do something about our savings rate. And I 
would respectfully suggest for your consideration one of the things 
that we might want to think about for Social Security is to reform 
Social Security to make it solvent, sustainable and secure 
indefinitely, keeping it as a defined benefit program for a variety of 
reasons and adding a supplemental individual account on top with 
mandatory personal savings through payroll deduction--money put into a 
real trust fund with real investments, with real fiduciary 
responsibilities where people go to jail if they violate that 
responsibility. 
   I think that combination could help us not just with Social 
Security, but also with long-term care; it could help us with our 
savings rate; it could help us with a number of things. And I think 
that could be done in a way that would be broadly supported. 
   Senator CARDIN. Some of us have looked at that option for Social 
Security and support trying to provide supplemental accounts. The 
difficulty, of course, is that there is a budget score associated with 
these accouonts. 
   General WALKER. Actually, you can because what I am talking about is 
you reform Social Security--and we can talk about that if you want, how 
to do that--to where you make it solvent, sustainable and secure. And 
then you have individuals, through payroll deduction, have 2 percent of 
their pay go into an individual account. It is their money, not our 
money. It is not a budget item. 
   Senator CARDIN. But if you take it out of the Social Security 
system, you are compounding--
   General WALKER. I am not taking it out. It is not a carve-out. But 
Congress is probably poised to increase the minimum wage. 
   Senator CARDIN. I think it is an intriguing suggestion, but as you 
pointed out, payroll taxes are rather oppressive already for a large 
number of Americans. 
   General WALKER. It is. It is a regressive tax and I think one needs 
to be concerned with that. But here is the difference, this is not a 
tax increase. This is your money. 
   The other thing is this would provide for a very substantial 
preretirement death benefit that one does not get in Social Security 
today, et cetera, et cetera. 
   Senator CARDIN. I want to continue this, Mr. Chairman, but this is 
not the right time. I would just urge that for lower-wage workers, 
supplemental accounts are not feasible unless someone puts money on the 
table in addition to the worker. But we can debate that issue at a 
different point. 
   Thank you, Mr. Chairman. 
   Senator CONRAD. Let me just say I, for one, I like this basic 
construct. I think it has to be part of an overall tax reform plan 
because we are using payroll taxes to fund operating expenses. If you 
were doing this in the private sector, if you were taking retirement 
funds of employees, and using it to pay operating expenses, you would 
be on your way to a Federal institution. It would not be Congress, it 
would not be the White House. You would be headed for the big house. 
That is a violation of Federal law. 
   We have just an incredible mismatch here in terms of our funding 
mechanisms and the outgo. 
   I would like to go for just a minute back to the health care issue 
because that really is the 800 pound gorilla, and that is what has the 
potential to swamp the boat around here unless we address it. And I 
agreed you entirely. I do not think we can solve this in one fell 
swoop. I think it is going to take a series of bite-sized chunks over 
time. Frankly, I do not think we know enough at this moment to solve 
the long-term problem of Medicare. But we have to make progress. 
   One thing I have talked about repeatedly on this committee is the 
fact that about 5 percent of Medicare beneficiaries use half of the 
money. It is not quite that, is about 6 percent use half of the money 
currently. But it has been in that range, 5 percent or 6 percent use 
half the money. Now my business school training says you focus like a 
laser on that kind of fact. 
   Can you help us understand, we know that these are the chronically 
ill, people with multiple conditions. Have you had a chance to study 
this? And have you had any sense of how we might make progress with 
respect to that population? 
   General WALKER. Clearly, there is an opportunity to use more case 
management approaches, which is what you are talking about. A very high 
percentage of the cost for Medicare relates to a fairly small 
percentage of those that are covered by Medicare. And in the private 
sector typically, and even frankly in the public sector with regard to 
some governments, you typically have a much more aggressive case 
management which is not just to control cost but it is also to try to 
assure quality. For examplel, if you are taking too many prescriptions 
that can actually be a detriment, for example, to the individual 
involved. 
   I think clearly that is an area that needs to be explored as well 
as, as I said, national practice standards for medical standards, as 
well as a few other areas. 
   But one of the things you have to keep in mind under our current 
health care system, the incentives are for everybody to do more, more, 
and more. Why? Because providers get paid more, because they reduce 
their litigation risk, and because individuals are not paying for it. 
   So the current incentives under our system are, whether it is 
technology, whether it is drugs, or whether it is procedures, is to do 
more, more, more. One of the things we are all going to have to come to 
grips with is there is a difference between whether or not people ought 
to have opportunity to gain access to every technology procedure and 
drug that exists versus whether the taxpayers ought to pay for it. 
Because the fact is that if there is one thing that could swamp the 
ship of state and bankrupt America, it is health care. There are lots 
of ways you can get there but one of the ways that forces you to get 
there is to have a budget for health care. 
   I mean, there are a number of procedures that could be done that do 
not meaningfully improve or extend life but they cost a tremendous 
amount of money. And it is reality. It is tough but it is reality. 
   Senator CONRAD. Senator Gregg, any final comments? 
   Chairman GREGG. I want to followup on that, but I had another issue 
I wanted to followup on, too. But let me followup on that. This concept 
of a separate budget for health care might make a lot of sense since it 
is such a large percentage of our budget. 
   I have been thinking about how do you address this? How do you 
address this health care issue? Obviously everyone is thinking about 
it. 
   But your point earlier that because health insurance premiums are 
fully deductible and health insurance is therefore subsidized 
dramatically by our tax laws, then that creates this disincentive for 
market forces to play a role and creates, in many instances, 
over-utilization and costs which should not have to occur. 
   I have always thought that a better health care system might be one 
where we absolutely make sure that everybody is insured for a 
catastrophic event. So nobody has to fear being wiped out because they 
discover they have cancer in their family or they have a serious 
accident that harms them, so that every American knows that they are 
not going to lose their home or their life savings as a result of a 
catastrophic event. And then you allow the marketplace and individuals, 
with obviously some support for lower income people, to decide what 
percentage they are going to want to personally cover of the difference 
through insurance. 
   And you could pay for that, it would seem to me, by first allowing 
the market to create the catastrophic insurance but subsidize that by 
basically limiting the amount of deductibility for health insurance to 
a number that is reasonable so that gold plated plans are no longer 
fully deductible at the corporate level. Does that make any sense to 
you? 
   General WALKER. Let me take that, elements of it, I think, do make 
a lot of sense. 
   First, as you know Senator, it is not a deduction on health care 
that I am talking about. It is the exclusion. 
   Chairman GREGG. Yes, I mean it does not--
   General WALKER. But it is bigger that way. 
   Chairman GREGG. Of course it is. 
   General WALKER. The reason it is bigger that way is because you do 
not pay payroll taxes on it either. You can get a deduction for your 
income tax but you do not get a deduction from the taxable wage base. 
But with an exclusion you get both. It is not included in the taxable 
wage base for Social Security and Medicare nor is it in the income tax. 
   I think you are on to the right path. My personal view is that if 
you look long-term that if we were somehow to move to a system that 
assured every American that they had certain basic and essential health 
care services, and I would suggest that might include catastrophic, 
definitely protection against financial ruin due to unexpected 
catastrophic illness. Now catastrophic is different if you are Bill 
Gates or one of us. 
   But I think you also have to think about wellness and inoculations. 
Those are things I think you have to think about. And I think then to 
create options for people to get more than that if they want, but they 
have to decide how much of their resources do they want to allocate off 
for that. 
   And one of the things we have to do, we have to do more to help 
individuals assume more personal responsibility for their own health. 
Right now, even for Federal programs, if you have very poor health 
habits you do not pay a different premium. So people who are behaving 
properly with regard to smoking, eating, drinking, whatever, they are 
subsidizing people who are not. And I think we need to do more to 
figure out how we encourage people to assume more personal 
responsibility for their own health because we have a number of very 
negative leading indicators on health. 
   For example, we are No. 1 in the world in obesity. Nobody is even 
close. And that is a pre-indicator for heart disease and diabetes. And 
we need to start doing something about it. But part of that has to do 
with the individual. The individual has to assume more responsibility. 
   Chairman GREGG. Thank you for that. 
   I was pointing out to my colleague that the obesity issue is more a 
function of the subsidized agricultural industry than anything else. 
   [Laughter.] 
   General WALKER. We can get into that in a different hearing if you 
want. 
   Senator CONRAD. You will not be invited to that hearing. 
   [Laughter.] 
   Chairman GREGG. You used the term mandatory reconsideration trigger. 
What did you mean by that? 
   General WALKER. What I mean by that is that when a certain mandatory 
programs, take Medicare, Medicaid, whatever, reaches a certain size of 
the Federal budget and/or the economy, that it forces reconsideration. 
   Now something like that was put in the prescription drug bill. The 
alarm is supposed to go off this year to say that by 2012 you are going 
to hit that trigger point. But that is only Medicare. Time will tell 
what is done with that alarm, when that alarm goes off. But you need to 
think about other segments of the budget-both the spending side and tax 
preferences-- 
   Chairman GREGG. Have you looked at my SOS bill, which has that? 
   General WALKER. I have not, but I will. 
   Senator CONRAD. Mr. Walker, I was at an event last week with former 
President Clinton and he was very focused on this health care issue. 
One of the things that he said in his remarks was that we are now of 
16 percent of GDP on health care. The next highest country in the world 
is 11 percent. And that Delta, that difference between 11 percent and 
16 percent of GDP amounts to $800 billion a year in terms of health 
care expenditure in this country. 
  The second thing he mentioned, and I hesitate to quote him because I 
am just remembering this from his description and so I may have 
misheard. But he had an extraordinarily high figure of over 30 percent 
on the administrative costs of health care in this country. 
   Have you looked at that issue? 
   General WALKER. I have heard 20 to 30 percent. I can take a look at 
it when I get back. It is very high, there is no question. 
   Senator CONRAD. That seems to me, if we were analyzing this like in 
business, these outliers where you have 5 percent using half of the 
money, where you have an administrative cost that is much, much higher 
than you would see in almost every other economic segment, those are 
places it seems to me we have to focus like a laser. I would be very 
interested in any analysis you can provide the committee with respect 
to this administrative cost issue, any additional information you could 
provide the committee with respect to the 5 percent of Medicare 
beneficiaries who use half of the money, any proposals that you would 
have for how we address that to both save money and, I believe, improve 
health care outcomes. (See additional information) I would also be 
interested in your national practice standards and any proposal that you 
would have there because we now know that there are vast disparities 
across the country in how much money is being allocated to various 
health care problems without differences in health care outcomes. (See 
additional information) 
   In other words, I have seen studies in the last 10 days that show a 
500 percent difference in cost to deal with various health care 
conditions, one part of the country to another, with virtually no 
difference in the quality of outcomes. That is another thing that ought 
to jump out at us. 
   If you could provide that. (See additional information) 
   Senator Whitehouse, if you have an additional question or thought? 
   Senator WHITEHOUSE. Mr. Chairman, I was hoping that I could add to 
Mr. Walker's homework with an additional request along the lines of the 
things that you have so wisely asked about. And that would be for you 
to take a look at the information infrastructure in health care. 
   The Economist magazine reported not long ago that the adoption of 
information technology in the health care industry is the second worst 
of any American industry, lagging only behind the mining industry. The 
RAND Corporation has indicated that with adequate investment in 
information technology in the health care sector, we could save as much 
as $162 billion, with a B, per year. 
   Those are public reports and public information. I would love to 
have those added to the list for review by your organization if the 
Chairman would permit me to add to his list. (See additional 
information) 
   Senator CONRAD. I certainly would. I think it is an excellent 
question. General Walker. 
   General WALKER. If I can, first, there are actually a few areas 
where Government leads by example other than GAO. VA is one. 
   VA probably has the best technology for medical records in the 
country. And we need to learn from that. 
   You are correct, national practice standards could help reduce 
costs, improve consistency and enhance quality. 
   Last thing, I want to come back to something that is relevant to 
this discussion that Senator Allard mentioned before. This country 
directly spends $2.5 trillion to $3 trillion per year. It issues tax 
preferences equal to $700 billion to $800 billion a year in foregone 
revenue. And that is backdoor spending. That is what tax preferences 
are. They both affect the bottom line. 
   But for the most part, we do not really know whether the spending 
programs are effective and whether the tax policies are effective. I 
think one of the things that we sorely need in order to be able to make 
intelligent decisions to help reengineer not just spending policy but 
tax policy is a set of key national indicators, outcome-based 
indicators--economic, safety, security, social, environmental--that 
will help us to answer three questions: Where are we today? How are we 
trending? And how do we compare with others? 
   Senator Allard is correct to say that there are differing degrees of 
reliability of data. But we need to seek to work to develop these. Some 
countries have them. Others do not. We are working with the National 
Academy of Sciences to try to make this a reality, as well as with the 
OECD. 
   Frankly, I think it is a great opportunity for a public/private 
partnership because if Congress had this data it could make a lot more 
informed judgments in the executive branch about where we should and 
should not be spending and where we should and should not be issuing 
tax preferences. I think it is something that needs to be on the radar 
screen. 
   Senator CONRAD. One final thought, and I like that idea very much. 
We would hope that as you develop these that you would let this 
committee know, because I think there would be strong interest here in 
this notion of national indicators. (See additional information) 
   One of the things I have always thought we should do is have a 
periodic review of programs to see how much money is actually being 
delivered to where it is intended. One of the things that has really 
concerned me is in the few times I have had a chance to look at a 
program, it may have started a very well intended way, it may have 
worked well at the beginning, but over time hasten ossified and 
calcified and is not delivering the benefits to where they are intended 
at all, or not at least even a majority of the benefits. Instead, it is 
getting caught up in some kind of administrative stream. 
   Do you do a review of major programs to see how much of what goes in 
actually comes out the other side for the purposes intended? 
   General WALKER. To my knowledge we have not but it is a good idea. 
Obviously, as you know, the executive branch has something called the 
Program Assessment Rating Tool, which is supposed to help assess the 
effectiveness of certain programs. Unfortunately, that is just spending 
programs, it is not tax policies. But I am not sure that this is even 
part of that effort. 
   Clearly, it is similar to what you said before about overhead costs 
for health care. We need to understand how much money is actually going 
to the targeted players. And there is little doubt in my mind that we 
have way too much overhead. I mean, think about it. 
   Senator CONRAD. Way too much overhead. 
   General WALKER. Think about this for a second. I have sent up to you 
and every member of the Senate our 21st Century Challenges document, 
Re-Examining the Base of the Federal Government. 
   Just look at how the Government is organized. We have over 10 
regions. We have all of these different grade levels. That is based on 
the 1950's. It is based on technology and transportation systems and 
management models of the 1950's and we are still trying to operate that 
way. 
   Take the Pentagon. If it was 20 percent smaller, it could probably 
 be 50 percent more productive. For example it takes over 20 units to 
sign off on activating and deploying 10 reservists or more. There is 
tremendous opportunity to delayer, de-silo, and streamline Government. 
   Senator CONRAD. And it will never happen unless we have the 
information. 
   We would like to talk to you further about this matter because I 
really do think we have to find a way to bring this to the attention of 
our colleagues. And it will never happen unless we set up some kind of 
structure to periodically review. 
   I tell you, I am appalled by what I am seeing in terms of 
administrative overhead. These agencies take a cutoff the top before 
the money ever gets delivered for the purpose intended. It is not 
unusual for this to be 20 percent. Now there is no excuse for 
administrative overhead to be of that magnitude. 
   So I would very much like to have a discussion with you about how we 
set up an ongoing program to review the administrative overhead that is 
on these programs. 
   With that, I want to again thank you so much for being here today. 
And thanks once again, Chairman Gregg, for his many courtesies that 
have been extended to our side of the aisle during his chairmanship. 
   [Whereupon, at 12:19 p.m., the hearing was adjourned.] 

              ADDITIONAL INFORMATION FROM GENERAL WALKER 

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          PREPARED STATEMENT AND QUESTIONS FROM SENATOR GRASSLEY 

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                   ANSWERS TO QUESTIONS SUBMITTED 

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                     HEARING ON LONG-TERM ECONOMIC AND 

                              BUDGET CHALLENGES
 
                                 _______

                           THURSDAY, JANUARY 18, 2007                                                        

                                           U.S. SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:02 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Lautenberg, Cardin, Sanders, Whitehouse, 
Gregg, Allard, Bunning, and Crapo. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

                OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. I will call the hearing to order. 
   I wanted to especially welcome the Chairman of the Federal Reserve, 
Mr. Bernanke, to the Budget Committee. We have, over the years, had a 
tradition in this committee of hearing from the Chairman of the Federal 
Reserve on the economic conditions of the country and the challenges 
that we face, the opportunities that are there. And so this is a 
continuation of that tradition. 
   Some weeks ago I had a chance to visit with Chairman Bernanke over 
lunch and it was, I thought, a constructive and productive discussion. 
We certainly valued it for the insights to the fundamental 
underpinnings of our economy and what we could do to make things better 
and more secure for the future. 
   Senator Gregg and I are especially committed to facing up to our 
long-term fiscal imbalances, the challenges that we confront with 
Medicare and Social Security, and the embedded deficits that we now 
face. We are very eager for the Congress of the United States and the 
White House to work together to devise a long-term plan to face up to 
these challenges because we think they pose a risk to our long-term 
economic security. 
   I have noticed increasing discussion in the press about the need to 
address these long-term imbalances. I wanted to just go through a few 
slides, if I could, and talk about some of the issues that we think are 
important to keep in mind. 
   First of all, the deficit last year was reported at $248 billion. At 
the same time, the debt of the country increased by $546 billion. All 
too often these increases in the debt get left out of the reporting.
   The biggest reason for the difference is Social Security, where $185 
billion of Social Security Trust Fund money that is in temporary 
surplus was used to pay other bills. 

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   The result of this pattern of increasing deficits and debt, on the 
debt side of the ledger, is that we are building this wall of debt. At 
the end of 2001, we had $5.8 trillion of gross debt. At the end of last 
year, that had soared to $8.5 trillion. If we stay on the current 
course, the estimates are by 2011 we will be $11.6 trillion of debt. 

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   All of this is compounded by a dramatic reduction in the savings 
rate in this country. Of course, when you have dissavings by the 
Federal Government, when the Federal Government is running deficit, 
that reduces the savings rate. This is the individual savings rate 
according to the Bureau of Economic Analysis. We see the first negative 
savings rate in 2006 since the Great Depression. 

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   As a result of the twin deficits, budget deficit and trade deficit, 
we are now borrowing extraordinary amounts of money. Last year we 
borrowed 65 percent of all of the money that was borrowed by 
countries in the world. The next biggest borrower was Spain, at about 
one-tenth as much. Many of us believe this is an unsustainable level of 
borrowing and has to be addressed. 

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   Of course, all of this is occurring before the baby boomers retire. 
The baby boom generation, that is going to dramatically increase the 
number of people eligible for Social Security and Medicare from some 40 
million today to over 82 million by 2050, fundamentally changes the 
decisions that we must make. 

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   There's been a lot of talk about Social Security and the long-term 
gap between funding and outgo in that program, the 75-year shortfall in 
Social Security is about $4.6 trillion. That is the estimate. But the 
75-year shortfall in Medicare is much bigger, seven times as much, $32 
trillion. This is, many of us believe, the 800-pound gorilla. These 
health care accounts, Medicare being the most prominent but Medicaid 
and veterans' health care also part of the consideration. 

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   Not only do we have a problem on the spending side of the ledger, 
but we also have a problem on the revenue side of the ledger. This 
chart shows what happens if you extend all of the tax cuts from 2001 
and 2003 and you combine them with the trust funds going negative 
because out in the future, as we get toward 2017, 2018, these trust 
funds that are throwing off large cash surpluses now go cash negative. 
And at that very time, you can see by the chart, the cost of making all 
of the tax cuts permanent explodes as well, driving us right over a 
cliff into much deeper deficits and debt. So we're going to have to 
face both the spending side of the equation and the revenue side of 
this equation if we are going to be successful. 

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   Why does it matter? Are these just numbers on a page, not attached 
to the economic condition of our country? No. We think these things are 
very much linked to the long-term economic security of America. We saw 
in the Wall Street Journal, the Economic Forum warned that U.S. budget 
deficits in America are causing our economy to be less competitive. 
This is the World Economic Forum judgment last year that reduced the 
competitive ranking of our country because of our very large deficits, 
both trade and budget. 

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   The Comptroller General who was the first witness before the Budget 
Committee, said this in his testimony: ''When, not if--when--foreign 
investors decide as a matter of mere prudence and diversification that 
they are not going to expose themselves as much to U.S. debt, then 
interest rates will rise and that will start a compounding effect. And 
so what's important is that we act so that they don't take that step.'' 

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   The Financial Times reported that China was forcing the dollar into 
the spotlight. ''China made its presence felt in the currency markets 
this week''--and this was in November of last year--''China made its 
presence felt in the currency markets this week as the prospect of the 
country diversifying its large foreign exchange stockpiles sent the 
dollar reeling to a 10-week low against the euro and to its weakest 
level in 18 months against the sterling.'' 

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   Let's go to the final chart, that shows what has happened to the 
dollar against the euro. Since 2002 the dollar is down about 30 
percent. This should be a warning signal to all of us about the 
potential effect of our fiscal and monetary policies and how it can 
have an effect on the larger economic well-being of the country. 

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   Let me indicate to Chairman Bernanke that we are not going to ask 
you about dollar valuation. We are not going to ask about short-term 
interest rate movements, because we know that is not appropriate in 
your role as Chairman of the Fed. We want to indicate to all of the 
members that the Chairman is constrained in what he can say on dollar 
valuation, on interest rates, and we understand that and respect it. 
With that, Senator Gregg. 

           OPENING STATEMENT OF RANKING MEMBER SENATOR JUDD GREGG 

   Senator GREGG. Thank you, Mr. Chairman. And thank you, Mr. Chairman, 
for joining us today. It is very important to hear your thoughts. 

   The Chairman has set the table on the issue that we consider--the 
two of us, I believe--to be the primary fiscal policy issue which we 
face as a country, which is the out-year cost of our Government to 
America. 
   It is a function, as the Chairman mentioned, of demographics. I 
think this just needs to be reinforced. We are facing the largest 
retirement generation in the history of the country. It will double the 
size of the people in the retirement generation. The practical effect 
of that, of course, is that you will have fewer people working to 
support the retired population. 

   The implications of this are really reflected in this chart, where 
three major Federal programs, Social Security, Medicare, and Medicaid, 
will absorb what has traditionally been the historical amount of 
spending which the Federal Government takes out of the economy, 20 
percent, by about the year 2025. So at that point there will be nothing 
else the Federal Government can theoretically do and maintain a 20 
percent burden on our national economy other than pay for Social 
Security, Medicare, and Medicaid. National defense cannot be done, 
education cannot be done, environmental protection cannot be done. 

   And the problem worsens as the baby boom generation goes into full 
retirement. The number goes up and almost hits 30 percent, those three 
programs, as we head into the 2030 decade. 
   The practical implications of this are staggering for us as a 
Nation, as the chairman has outlined. The question becomes how do we 
address it? The issue is reflected, I think, in the fact that if 
historically we have taken 20 percent of the national economy as the 
Federal spending, and historically taken about 18.2 percent of the 
national economy in tax revenues, how high can the Federal Government 
go into its burden on the national economy without undermining the 
productivity of the economy and pushing us into some sort of spiraling 
down in quality of life, quality of experience for our next generation? 
Or to put it in real terms, at what point does the cost of the retired 
generation get so high that the younger generation can no longer afford 
to have the quality of life that our generation has had? 
   This is reflected in the unchecked effect on Federal spending. It 
would go as high as, theoretically, 45 percent of the gross national 
product just on entitlements if it goes forward into the years 2040. 
   And that is reflected even though we have seen dramatic increases in 
taxes. The Chairman has pointed out that, in his view, tax revenues in 
the future, if we continue to maintain the tax cuts which we have in 
place or the tax burden which we have in place, would significantly 
drop. I am not sure. I do not happen to believe that. That is a static 
estimate of what tax revenues are. 
   We have actually seen that with a fair tax rate we create more 
productivity in the economy, and has a result we create more revenues 
for the Federal Government. In fact, in the last 3 years Federal 
revenues have jumped more significantly than at any other time in 
history. We are seeing that we are now over the historical norm. We are 
over 18.2 percent of the national gross product coming in in revenues. 
We are about 18.5 percent. We headed toward 19 percent if the estimates 
of the administration are correct, and I suspect those estimates are 
going to be assumed in whatever budget comes out of this committee. As 
a practical matter, we even have a more progressive tax law today than 
we had during the Clinton years. 
   So even though we have cut rates, we have actually generated a 
higher--we have actually caused the higher income people in this 
country to be paying more of the tax burden, 84, 85 percent of the tax 
burden, versus 81 percent under the Clinton years, the top 20 percent. 
   So I do not believe you can tax your way of this problem. There are 
basically four different approaches to this problem: increase taxes, 
adjust benefits, increase the number of people paying in which would be 
expanding immigration, I presume; or inflating our way out of the 
issue. 
   And I guess what I am going to want to focus on with you, Mr. 
Chairman, is at what level will the Federal Government be taking too 
much out of the economy to make the economy work right and be 
productive? And second, how do we address the issue of the fact that 
one of the options here is inflating your way out of this problem? 
Which would be a horrific decision on our part as a Government, but 
potentially something that the marketplace might force on us, looking 
at this type of debt burden facing us. 
   So I am going to be interested in your thoughts on this critical 
issue of fiscal policy for us and hopefully you can give us some 
guidance. Thank you. 
   Chairman CONRAD. Again, our welcome, and please proceed with your 
testimony. We are very pleased that you are here, Chairman Bernanke. 

  STATEMENT OF HON. BEN S. BERNANKE, CHAIRMAN, BOARD 
OF GOVERNORS OF 
                    THE FEDERAL RESERVE SYSTEM 


   Chairman BERNANKE. Thank you, Chairman Conrad, Senator Gregg, and 
other members of the committee. 
   I am pleased to be here to offer my views on the Federal budget and 
related issues. At the outset, I should underscore that I speak for 
myself only and not for the Federal Reserve. 
   As you know, the deficit and the unified Federal budget declined for 
a second year in fiscal 2006 following the $248 billion from $319 
billion in fiscal 2005. 
   As was the case in the preceding year, the improvement in 2006 was 
primarily the result of solid growth in tax receipts, especially in 
collections of personal and corporate income taxes. Federal Government 
outlays in fiscal 2006 were 20.3 percent of nominal gross domestic 
product, receipts were 18.4 percent of GDP, and the deficit--equal to 
the difference of the two--was 1.9 percent of GDP. These percentages 
are close to their averages since 1960. 
   The on-budget deficit, which differs from the unified budget deficit 
primarily in excluding the receipts and payments to the Social Security 
system--to which Senator Conrad made allusion--was $434 billion or 3.3 
percent of GDP in fiscal 2006. As of the end of fiscal 2006, Federal 
Government debt held by the public, which includes holdings by the 
Federal Reserve but excludes those held by Social Security and other 
trust funds, amounted to about 37 percent to 1 year's GDP. 
   Official projections suggest that the unified budget deficit may 
stabilize or moderate further over the next few years. Unfortunately, 
we are experiencing what seems likely to be the calm before the storm. 
In particular, spending on entitlement programs will begin to climb 
quickly during the next decade. In fiscal 2006, Federal spending for 
Social Security, Medicare, and Medicaid together totaled about 40 
percent of Federal expenditures, or roughly 8.5 percent of GDP. 
   In the most recent long-term projections prepared by the 
Congressional Budget Office these outlays are projected to increase to 
10.5 percent of GDP by 2015, an increase of about 2 percentage points 
of GDP in less than a decade. By 2030, according to the CBO, they will 
reach about 15 percent of GDP. As I will discuss, these rising 
entitlement obligations will put enormous pressure on the Federal 
budget in coming years. 
   The large projected increases in future entitlement spending have 
two principal sources. First, like many other industrial countries, 
the United States has entered what is likely to be a long period of 
demographic transition, the result both of the reduction in fertility 
that followed the post-World War II baby boom and of ongoing increases 
in life expectancy. Longer life expectancies are certainly to be 
welcomed. But they are also likely to lead to longer periods of 
retirement in the future, even as the growth rate of the work force 
declines. As a consequence of the demographic trends, the number of 
people of retirement age will grow relative both to the population as a 
whole and to the number of potential workers. 

   Currently, people 65 years and older make up about 12 percent of the 
U.S. population and there are about five people between the ages of 20 
and 64 for each person 65 and older. According to the intermediate 
projections of the Social Security Trustees, in 2030 Americans 65 and 
older will constitute about 19 percent of the U.S. population and the 
ratio of those between the ages of 20 and 64 to those 65 and older will 
have fallen to about three. 
   Although the retirement of the baby boomers will be an important 
milestone in this demographic transition, the oldest baby boomers will 
be eligible for Social Security benefits just next year, the change in 
the Nation's demographic structure is not just a temporary phenomenon 
related to the large relative size of the baby boom generation. Rather, 
if the US fertility rate remains close to current levels and life 
expectancies continue to rise, as demographers generally expect, the 
U.S. population will continue to grow older, even after the baby boom 
generation has passed from the scene. If current law is maintained, 
that aging of the U.S. population will lead to sustained increases in 
Federal entitlement spending on programs that benefit older Americans 
such as Social Security and Medicare. 
   The second cause of rising entitlement spending is the expected 
continued increase in medical costs per beneficiary. Projections of 
future medical costs are fraught with uncertainty, but history suggests 
that, without significant changes in policy, these costs are likely to 
continue to rise more quickly than incomes, at least for the 
foreseeable future. Together with the aging of the population, ongoing 
increases in medical costs will lead to a rapid expansion of Medicare 
and Medicaid expenditures. 
   Long-range projections prepared by the CBO vividly portray the 
potential effects on the budget of an aging population and rapidly 
rising health care costs. The CBO has developed projections for a 
variety of alternative scenarios based on different assumptions about 
the evolution of spending and taxes. The scenarios produce a wide range 
of possible budget outcomes, reflecting the substantial uncertainty 
that attends long-range budget projections. However, the outcomes that 
appear most likely, in the absence of policy changes, involve rising 
budget deficits and increases in the amount of Federal debt outstanding 
to unprecedented levels. 
   For example, one plausible scenario is based on the assumptions that 
Federal retirement and health spending will follow the CBO's 
intermediate projection; that defense spending will drift down over 
time as a percentage of GDP; that other non-interest spending will grow 
roughly in line with GDP; and that Federal revenues will remain close 
to their historical share of GDP, that is, about where they are today. 
Under these assumptions, the CBO calculates that by 2030 the Federal 
budget deficit will approach 9 percent of GDP, more than four times 
greater as a share of GDP than the deficit in fiscal year 2006. 
   A particularly worrisome aspect of this projection and similar ones 
is the implied evolution of the national debt and the associated 
interest payments to Government bond holders. Minor details aside, the 
Federal debt held by the public increases each year by the amount of 
that year's unified budget deficit. Consequently, scenarios that 
project large deficits also project rapid growth in the outstanding 
Government debt. The higher levels of debt, in turn, imply increased 
expenditure on interest payments to bondholders which exacerbates the 
deficit problem still further. Thus, a vicious cycle may develop in 
which large deficits lead to rapid growth in debt and interest payments 
which, in turn, add to subsequent deficits. 
   According to the CBO projection that I have been discussing, 
interest payments on the Government's debt will reach 4.5 percent of 
GDP in 2030, nearly three times their current size relative to national 
output. Under this scenario, the ratio of Federal debt held by the 
public to GDP would climb from 37 percent currently to roughly 100 
percent in 2030, and would continue to grow exponentially after that. 
The only time in U.S. history that the debt-to-GDP ratio has been in 
the neighborhood of 100 percent was during World War II. People at the 
time understood the situation to be temporary and expected deficits and 
the debt-to-GDP ratio to fall rapidly after the war, as in fact they 
did. 
   In contrast, under the scenario I have been discussing, the 
debt-to-GDP ratio would rise far into the future at an accelerating 
rate. Ultimately, this expansion of debt would spark a fiscal crisis 
which could be addressed only by very sharp spending cuts or tax 
increases or both. 
   The CBO projections, by design, ignore the adverse effects that such 
high deficits would likely have on economic growth. But if Government 
debt and deficits were actually to grow at the pace envisioned by the 
CBO scenario, the effects on the U.S. economy would be severe. High 
rates of Government borrowing would drain funds away from private 
capital formation and thus slow the growth of real incomes and living 
standards over time. Some fraction of the additional debt would be 
likely financed abroad, which would lessen the influence on domestic 
investment. However, the necessity of paying interest on the foreign 
held debt would leave a smaller portion of our Nation's future output 
available for domestic consumption. 
   Moreover, uncertainty about the ultimate resolution of the fiscal 
imbalances would reduce the confidence of consumers, businesses, and 
investors in the U.S. economy with adverse implications for investment 
and growth. 
   To some extent, strong economic growth can help to mitigate 
budgetary pressures and all else being equal fiscal policies that are 
supportive of growth would be beneficial. Unfortunately, economic 
growth alone is unlikely to solve the Nation's impending fiscal 
problems. Economic growth leads to higher wages and profits and thus 
increases tax receipts, but higher wages also imply increased Social 
Security benefits as those benefits are tied to wages. Higher incomes 
also tend to increase the demand for medical services so that 
indirectly higher incomes may also increase Federal health 
expenditures. 
   Increased rates of immigration could raise growth by raising the 
growth rate of the labor force. However, economists who have looked at 
the issue have found that even a doubling in the rate of immigration to 
the United States, from about one million to two million immigrants per 
year, would not significantly reduce the Federal Government's fiscal 
imbalance. 
   The prospect of growing fiscal imbalances and their economic 
consequences also raises essential questions of intergenerational 
fairness. As I have noted, because of increasing life expectancy and 
the decline in fertility, the number of retirees that each worker will 
have to support in the future, either directly or indirectly through 
taxes paid to Government programs, will rise significantly. To the 
extent that Federal budgetary policies inhibit capital formation and 
increase our net liabilities to foreigners, future generations of 
Americans will bear a growing burden of the debt and experience slower 
growth in per capita incomes than would otherwise have been the case. 
An important element in ensuring that we leave behind a stronger 
economy than we inherited, as did virtually all previous generations in 
this country, will be to move over time toward fiscal policies that are 
sustainable, efficient, and equitable across generations. Policies that 
promote private as well as public saving would also help us to leave a 
more productive economy to our children and grandchildren. 
   In addition, we should explore ways to make the labor market as 
accommodating as possible to older people who wish to continue working, 
as many will as longevity increases and health improves. 
   Addressing the country's fiscal problems will take persistence and a 
willingness to make difficult choices. In the end, the fundamental 
decision that the Congress, the administration, and the American people 
must confront is how large a share of the Nation's economic resources 
to devote to Federal Government programs, including transfer programs 
such as Social Security, Medicare, and Medicaid. Crucially, whatever 
size of government is chosen, tax rates must ultimately be set at a 
level sufficient to achieve an appropriate balance of spending and 
revenues in the long run. 
   Thus, Members of the Congress who put special emphasis on keeping 
tax rates low must accept that low tax rates can be sustained only if 
outlays, including those on entitlements, are kept low as well. 
Likewise, members who favor a more expansive role of the Government, 
including relatively more generous benefits payments, must recognize 
the burden imposed by the additional taxes needed to pay for the higher 
spending, a burden that includes not only the resources transferred 
from the private sector but also any adverse economic incentives 
associated with high tax rates. 
   Achieving fiscal sustainability will require sustained efforts and 
attention over many years. As an aid in charting the way forward, the 
Congress may find it useful to set some benchmarks against which to 
gauge progress toward key budgetary objectives. Because no single 
statistic fully describes the fiscal situation, the most effective 
approach would likely involve monitoring a number of fiscal indicators, 
each of which captures a different aspect of the budget and its 
economic impact. 
   The unified budget deficit projected forward a certain number of 
years is an important measure that is already included in the 
Congressional budgeting process. However, the unified budget deficit 
does not fully capture the fiscal situation and its effects on the 
economy, for at least two reasons. 
   First, the budget deficit by itself does not measure the quantity of 
resources that the Government is taking from the private sector. An 
economy in which the Government budget is balanced but in which 
Government spending equals 20 percent of GDP is very different from one 
in which the Government's budget is balanced but spending is 40 percent 
of GDP, as the latter economy has both higher tax rates and a greater 
role for the Government. Monitoring current and prospective levels of 
total Government outlays relative to GDP or a similar indicator would 
help the Congress ensure that the overall size of the Government 
relative to the economy is consistent with members' views and 
preferences. 
   Second, the annual budget deficit reflects only near-term financing 
needs and does not capture long-term fiscal imbalances. As the most 
difficult long-term budgetary issues are associated with the growth of 
entitlement spending, a comprehensive approach to budgeting would 
include close attention to measures of the long-term solvency of 
entitlement programs, such as long-horizon present values of unfunded 
liabilities for Social Security and Medicare. 
   To summarize, because of demographic changes and rising medical 
costs, Federal expenditures for entitlement programs are projected to 
rise sharply over the next few decades. Dealing with the resulting 
fiscal strains will pose difficult choices for the Congress, the 
administration, and the American people. However, if early and 
meaningful action is not taken, the U.S. economy could be seriously 
weakened with future generations bearing much of the cost. The 
decisions the Congress will face will not be easy or simple but the 
benefits of placing the budget on a path that is both sustainable and 
meets the Nation's long-run needs would be substantial. 
   I thank you again for allowing me to comment on these important 
issues and I would be glad to take your questions. 
   Thank you, Mr. Chairman. 
   [The prepared statement of Chairman Bernanke follows:] 

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   Chairman CONRAD. Thank you, Mr. Chairman. I think you have sent a 
very clear message and one that I hope people are paying close 
attention to. 
   As I hear you describe it, we are on a course that is unsustainable 
and requires our action. Let me ask you this, last week I read in one 
of the major newspapers that deficits were at 1.8 percent of GDP and 
so not to worry, that is sustainable for the long-term. What would your 
reaction be to that notion? 
   Chairman BERNANKE. Senator, the unified budget deficit is at a 
normal historical level, but other measures of the deficit would 
suggest a much more serious situation. For example, there are accrual 
methods of the budget deficit which incorporate increased obligations 
to Federal pensions, to veterans' programs and the like, which show a 
much higher deficit. 
   But in particular, as I mentioned in my remarks, the short-term 
unified budget deficit really has nothing to say about the long-term 
implications of our projected entitlement spending. And that's why I 
suggested that, in making fiscal plans, the Congress should consider 
not just the current unified budget deficit, which is sort of a flow 
measure of current debt, but also measures of long-term solvency such 
as the present value of unfunded liabilities. 
   Chairman CONRAD. If we were to put this in plain language for the 
American people, and you were asked how urgent is this situation? How 
urgent is it that we address these long-term imbalances, which as you 
describe could swamp the boat, could have very adverse affect on our 
 economy if we do not take action. How would you rate the urgency of 
the need for a response by the Government? 
   Chairman BERNANKE. Senator, one might look at these projections and 
say well, these are about 2030 and 2040 and so we do not really have to 
start worrying about it yet. But in fact, the longer we wait the more 
severe, the more draconian, the more difficult the adjustments are 
going to be. 
   I think the right time to start is about 10 years ago. I think we 
are already well into the process of demographic change. The sooner we 
can make significant progress, the sooner we can begin to lay out a 
plan for dealing with these looming fiscal imbalances, the less the 
adjustment will be, the less the impact will be on the U.S. economy and 
the easier it will be for our fellow citizens to plan for their own 
retirements and for the welfare of their children. 
   Chairman CONRAD. Another thing that is said to me very often is when 
Senator Gregg and I have made these presentations, people are watching 
on television. I have had people call my office and say senators, you 
are you are talking about projections. You are talking about 
projections for what is going to happen in 20 years. How can you have 
any confidence in those projections? Aren't you being alarmist by 
suggesting that there is a big problem down the road? 
   How would you respond to people who ask that question? 
   Chairman BERNANKE. Senator, you are correct that the history of 
budget projections has not always been the most accurate. We have had 
big swings in recent years, of course. But with respect to the 
entitlement programs, I would make a couple of comments. 
   First, the Social Security projections are based on very reliable 
estimates of where our population is going to be in 20 and 30 years. We 
know what the population is going to look like because the people are 
already born. We know the composition of our population. We know how 
they are going to age. 
   Chairman CONRAD. So that part of it is really not a projection at 
all? 
   Chairman BERNANKE. That part of it is not particularly uncertain. 
   On Medicare, there is more uncertainty, but I would note that some 
of the projections that are made are actually somewhat conservative in 
the following sense: an important assumption about Medicare projections 
is how quickly will medical costs grow. The standard assumption that is 
made by the Medicare Trustees is that medical costs per beneficiary 
will grow at 1 percent a year faster than the average per capita 
income. In fact, over the last three decades the cost of medical care 
has grown at 2.3 percent a year faster than average income. 
   Consequently, to achieve even these very draconian outcomes that the 
Congressional Budget Office and the Medicare Trustees have presented, 
we would actually have to have a somewhat significant decline in the 
growth of medical costs. 
   So it is certainly true that there is a lot of uncertainty, but 
there is very good reason to believe that unless very extraordinary 
changes occur in the cost of medical care, for example, these budget 
issues are going to be very large and very soon. 
   Chairman CONRAD. If you would compare for us the challenge of 
Medicare versus Social Security in terms of the gap between the cost 
and the revenue associated with it, how would you characterize where 
the biggest part of the challenge lies? 
   Chairman BERNANKE. Senator, as I just indicated, there is perhaps 
more uncertainty about Medicare than there is about Social Security. 
But the best guess estimates that the Medicare Trustees and others 
have put together put the very long run imbalances associated with 
Medicare on something of the order of six times the size of the Social 
Security deficit. So the Medicare issue is very large. 
   I would add that to address the Medicare issue we are going to heed 
to think more broadly about our health care system overall--about how 
to make it more efficient and how to control costs--so that we can 
deliver good medical care but without such a rapid increase in medical 
costs. 
   Chairman CONRAD. The other thing I think that is important for us to 
address is what difference does all of this make? I am sitting out 
there in my living room watching this. You have these economists 
sitting around a table down in Washington talking about projections 20 
years from now. How is this really going to affect my life? 
   If you were to try to say to a person who might be watching out 
there, so what? So what if the Government runs a little bigger deficit? 
How is that really going to affect my life? 
   Chairman BERNANKE. First, we are going to be seeing this impact on 
the deficit just a few years from now. It is not that far in the 
future. If the deficit begins to widen further, we are going to see 
more draining of funds away from capital formation. That is going to 
mean the economy is going to grow more slowly. It is going to mean that 
wages are not going to grow as fast because workers do not have as much 
capital to work with. It is going to mean that we will be borrowing 
more from foreign lenders and increasing our obligations to them. 
   So it will soon have, even if there's no change in fiscal policy, an 
effect on the vibrancy, the efficiency, the growth rate of our economy, 
which will be palpable and which Americans will see. 
   Moreover, to the extent that Americans are counting, for example, on 
the current-law Social Security benefits and the current payroll taxes, 
they are going to have a surprise at some point because the two sides 
are not commensurate in the long run, and they are either going to be 
finding themselves with lower benefits at retirement than they expected 
or higher payroll taxes or some combination. And that is also going to 
affect them in a very real pocketbook kind of way. 
   Chairman CONRAD. Thank you. I hope people are paying close 
attention. 
   Let me just conclude on this question: how about tax cuts? In your 
judgment and the considered judgment of economists, do tax cuts pay for 
themselves? Do you get more revenue with a tax cut than you would 
otherwise have had? 
   Chairman BERNANKE. The effects of a tax cut depend on the nature of 
the cut, the type of cut it is, and so on. I think the general view is 
that tax cuts do not usually pay for themselves. The fact that tax cuts 
can increase growth or increase the size of the economy means that they 
partially offset the revenue losses as a usual matter. 
   But I think the issue with tax policy is not whether the tax cut 
pays for itself. The question really is what is the balance between 
taxes and spending that is right for our economy? We do not want to 
have wasteful spending because that requires higher taxes which are 
detrimental to economic growth. But important spending, spending we 
need to do, we are going to have to find a way to finance, and we 
just would like to find the best possible way to finance that that 
has the minimum adverse impact on our economy. 
   Chairman CONRAD. Really the question here is one of balance is it 
not? If we are going to have a certain level of spending, we have to 
raise the revenue to pay for it. But we have to keep in mind when we 
are setting that level of spending that as we raise more and more 
revenue that has potential adverse impacts on our economic 
competitiveness, and on economic growth. That is really the kind of 
balance that you are talking about, is it not? 
   Chairman BERNANKE. That is exactly right, Senator. 
   Chairman CONRAD. Senator Gregg. 
   Senator GREGG. Thank you. Picking up where the Chairman has left 
off, it comes to the question of the point I made in my opening 
statement. I happen to believe there are certain tax cuts which pay for 
themselves, capital gains, for example. Certainly, in the short run it 
pays for itself. 
   On the reverse side of that, if you raise taxes to a level where you 
create a disincentive for productivity or a disincentive to do taxable 
activity or create an incentive for tax avoidance, because you are 
taking 60 percent or 50 percent or 70 percent of the next dollar 
earned, and people say they simply are not going to go out and be 
productive because they do not want to give the Government the 50, 60, 
70 percent. Or they are going to invest in something that is arbitrary 
and capital flowed then becomes not more efficiently used but 
inefficiently used to try to avoid taxes, is that not the reverse? That 
you get tax burden to a level where it is counterproductive to the 
economy? 
   Chairman BERNANKE. That is right, Senator. When you raise taxes, you 
almost always distort incentives. You create what economists call dead 
weight loss or loss of efficiency. One estimate that has been made is 
that for every dollar you raise in taxes you not only take a dollar 
from the economy but you create 20 cents of essentially waste 
associated with people not making the decisions they would have made in 
the absence of those taxes. 
   That is not to say that you should not have taxes. You have to have 
enough taxes to fund your spending. It just says that as you think 
about the right level of spending in the economy, as Senator Conrad 
said, you need to take into account the full effects of those taxes on 
the broader economy as well as on the budget. 
   Senator GREGG. I agree with that. And that gets to the point of what 
is the correct burden of the Federal Government on the economy which 
you have to fund? Looking at these charts, which your testimony was 
even more stark than ours, quite honestly, you are looking at numbers 
that are staggering, 45, 50 percent of GDP being used to support 
entitlement programs or Government spending, if you were to carry 
these numbers out. But even a conservative number gets you well over 20 
percent, gets you up around 30 percent with the present demographic 
situation. 
   So let me ask you four questions, some of which are related and some 
which are not. The first, is there a range in which the Federal 
Government should find itself as taking a percent of gross national 
product? Today it takes 20 percent. It has been as high as 22 percent 
historically. It has been as low as 18 percent. The revenues for the 
Federal Government have historically been about 18.2 percent. They have 
been as high as 22 percent and they have been well below 18 percent, 16 
percent. 
   What is the range that is a reasonable number? And should we not 
back into what we are looking at as an entitlement or a Government 
burden from that range? That is the first question. 
   The second question, I think you have focused on what is the essence 
of the problem for us, which is health care. Social Security can 
actually be fixed rather easily and the burden is not dramatic and we 
can do it. Health care is complex. GAO says it is $60 trillion in 
unfunded liability. Your number was, I think, $38 trillion. It is huge. 
Do you have some concepts as to how we approach the health care? 
Because that seems to be the gravamen of the question. 
   On two ancillary issues, because my time will run out before you get 
to these--
   Chairman CONRAD. Feel free to let him answer that. 
   Senator GREGG. Let me just put these on the table. 
   Can you give us your thoughts on hedge funds and monitoring hedge 
funds, and on capital markets and the risk of America losing its role 
in being the primary premier place where people come to raise capital? 
   Thank you. 
   Chairman BERNANKE. Thank you, Senator. 
   On the range of taxes, I should say now what I will probably be 
saying several times, which is I am here to try to give economic 
analysis and help as much as I can. The Federal Reserve, of course, is 
nonpartisan and does not make the value judgments that Congress has to 
make in the end. And so I am going to try to avoid making specific 
recommendations for tax or spending policies. I will just try to 
comment as an economist on what the issues are that you are raising. 
   With respect to the range, the fact is that the share of Federal 
spending in the economy varies a lot across countries. There are 
countries in Europe, for example, that have much higher shares than we 
do. I think it is arguable that, for example, they pay some cost for 
that and it involves, for example, less hours of work in Western 
Europe, perhaps slower productivity growth. 
   So I do not think there is a magic number. But when you think about 
the share of the economy that you take in taxes, and think about the 
structure of the tax system as well, which is also very important, you 
really have to make a tradeoff, a balance, between the cost that that 
imposes on the economy versus what you are paying for. 
   So I am sorry that I cannot give you a magic number. I will only say 
that there is a difficult balance and is a variety of international 
experience. It is interesting to look at other countries and see how 
they have fared. But ultimately, it is up to the Congress, to make that 
judgment. 
   Health care is an enormous topic and there are many issues 
associated with it. We have, in some ways, the best health care system 
in the world-in the sense that when it comes to a difficult procedure, 
this is where people come because we have the best technologies and the 
best hospitals, the best doctors. But we also have a very inefficient 
system in that the total cost we pay is much higher than other 
countries and, in many cases, we do not deliver as productively or as 
efficiently. 
   Again it is a large issue. Some of the questions one might want to 
ask are the costs and benefits of, and how quickly we should try to 
move to, universal coverage. The benefits of universal coverage include 
better risk pooling and perhaps lower costs of uncompensated care and 
the like. But the cost of universal coverage is that we have to make 
sure that the poor and people with pre-existing conditions are able to 
buy insurance, and that can be very expensive. So there is a tradeoff. 
   Another question that Congress has to face is, who is going to 
manage the health care system? Is it going to be the Government 
directly, as in the case in parts of Medicare? Will it be via the 
private sector, as in Medicare Advantage or Part D, where the Federal 
Government pays part but the private sector, private insurance, HMOs 
and so on actually manage the care? How will it be funded? There is a 
raft of questions. 
   I think one thing that is encouraging to me, as a general matter, is 
that we are seeing a lot of experimentation: at the Federal level with 
Medicare, for example, and at the various States. We have seen a number 
of States which have tried new things, and I think we will learn from 
that. 
   But it is a very important matter, and we need to keep this front 
and center. 
   I think that even beyond the issue of Medicare for Americans as a 
whole, the cost of medical care, the portability of insurance, the 
availability of insurance are very crucial issues for well-being. 
   May I continue with your other questions, Senator? 
   On hedge funds, the philosophy the regulators have taken since the 
President's Working Group issued a report after the LTCM crisis in 1998 
has been a market discipline approach. We have tried to discipline 
hedge funds not by direct regulatory oversight but indirectly, by 
making sure that the people they trade with, so to speak, have 
incentives to pay close attention to what they are doing. 
   So in particular, the Federal Reserve and other bank regulators and 
the SEC work very hard to make sure that commercial banks and 
investment banks who are counterparties to hedge funds, who provide 
brokerage services to hedge funds, are doing due diligence to make sure 
that the hedge funds are operating in a way that will not pose 
excessive risk to those counterparties. 
   Similarly, the SEC is working to make sure that investors in hedge 
funds have the opportunity and the incentive to impose discipline on 
those hedge funds, as well. 
   That system has worked pretty well so far. I think it is always 
worth reviewing and thinking about how better to manage the system. But 
that is the general philosophy that we have taken in the regulatory 
community. 
   On the capital markets competitiveness, again this is a very big 
issue. It is true, for example, that the number of initial public 
offerings taking place in U.S. markets has been much lower in recent 
years relative to capital markets in other countries. To some extent, 
that is simply a result of the fact that capital markets in other 
countries, the UK, in Asia and elsewhere, are growing and maturing, and 
it is natural that they would take over part of the business as they go 
forward. 
   But we also have to look carefully to make sure that our regulatory 
regime, our broad set of laws and regulations, are not imposing undue 
burdens on American capital markets and U.S. corporations to ensure 
that there is a reasonable balance between the costs and benefits of 
those regulations. 
   Senator GREGG. Thank you. 
   Chairman CONRAD. Senator Sanders. 
   Senator SANDERS. Thank you very much, Mr. Chairman. And thank you 
and the ranking member for holding this important hearing. Mr. 
Bernanke, thank you very much for your thoughtful comments. 
   Mr. Bernanke, I would like to discuss with you three issues. No. 1, 
do you have a concern about the growing income inequality in the United 
States of America today? The fact that we have by far the most unequal 
distribution of wealth and income of any major country on earth? The 
fact that the richest 1 percent own more wealth than the bottom 90 
percent. That the richest 13,000 families earn almost income as the 
bottom 20 million American families. The fact that the middle class is 
shrinking, poverty is increasing, while the gap between the rich and 
the poor grows wider? I would like to comment on that in a moment. 
   My second question deals with the Federal deficit. We have had a 
number of record-breaking deficits, of course, in recent years. And you 
and the Chairman and ranking member have highlighted the long-term 
problems, which I certainly agree with. 
   But in the midst of all of these deficits, the President of the 
United States has pledged to make all of his tax cuts permanent, 
including those to millionaires and billionaires at the time when the 
wealthiest people in America have never had it so good. Over the next 
four calendar years the cost of the tax cuts for the top 1 percent of 
households with average incomes of over $1 million will total nearly 
$350 billion. 
   If the President's tax cuts are made permanent, households with 
annual incomes of more than $1 million, a group that comprises 
three-tenths of 1 percent, the wealthiest three-tenths of 1 percent 
would receive approximately $648 billion in tax cuts over the next 
decade. 
   So my question to you is could you speak to us about the ''wisdom'' 
of the President's policies of continuing to give mammoth tax breaks to 
the wealthiest people in this country who have never had it so good, 
and in the process significantly driving up our national debt? 
   The third issue I would like you to comment on briefly is our trade 
policy. As you know, our trade deficit is on track to exceed $800 
billion in 2006 and we now have a record-breaking $900 billion current 
account deficit. 
   There are a number of us in Congress, I think a growing number of 
Americans, who are now catching on that our current unfettered free 
trade policy has not only been a disaster in terms of the loss of 
millions of good paying manufacturing jobs but it is a disaster in 
terms of long-term economic trends when you run up record breaking 
trade deficits year after year after year. 
   In your view, given the fact that we have lost millions of good 
paying manufacturing jobs, given the fact that we may be losing or on 
the cusp of losing millions of good paying information technology jobs 
as a result of unfettered free trade, given the fact that our 
manufacturing base is virtually collapsing, do you think it is time to 
perhaps rethink the current trade policies that we have? 
   Those are the areas that I would very much appreciate your 
commenting on. 
   Chairman BERNANKE. Thank you, Senator. Those are all very important 
issues. 
   On inequality, it is certainly true that the degree of inequality in 
our economy has been rising. It has been going on for a long time, and 
we now have greater income inequality than many other industrial 
countries. 
   Senator SANDERS. Is there any other country in the world, major 
country? 
   Chairman BERNANKE. There are some, but--
   Senator SANDERS. Major countries? 
   Chairman BERNANKE. Brazil. 
   Senator SANDERS. OK, Brazil, yes. 
   Chairman BERNANKE. I think it is an important issue. 
   First of all, it is part, of the American ethos that we want 
everyone to have opportunity, economic opportunity, and a good 
economic standard of living. 
   It is important also for political reasons in the following sense: 
our growth and our dynamism depend in an important way on the 
willingness of the general population to support flexible labor 
markets, for example, to support the effects of trade on the economy. 
If people are starting to believe that trade, for example, does not 
benefit them personally, then they may become less willing to support 
trade and that, from my perspective, is a concern. 
   So it is a very large topic. I hope to give some remarks on this 
fairly soon about some of the causes and responses to it. 
   Senator SANDERS. But it is an issue. The fact that we have such a 
huge gap between the rich and the poor and the--
   Chairman BERNANKE. Yes, it is certainly an issue. It is something 
that would be good to address. 
   I would just reiterate that it is a very long-term trend. It is not 
something that happened yesterday. And trying to understand it is 
something economists have been spending a lot of time on. It would be 
interesting to think further about it. 
   On the Federal deficit and the tax cut, as I said, I am not going to 
support or defend or oppose specific tax or spending measures. With tax 
cuts you face the usual tradeoff: lower taxes tend to improve 
incentives and generate more efficiency and more growth. 
   Senator SANDERS. But you just mentioned a moment ago, which I think 
most economists agree, that tax breaks do not pay for themselves. My 
question is if you give hundreds of billions of dollars in tax breaks 
to the wealthiest people who really do not need it, which drives up the 
deficit, I have a hard time understanding how that makes any sense at 
all. Can you help me on that? 
   Chairman BERNANKE. To the extent that--and there is 
disagreement--but to the extent that the lower marginal rates create 
additional effort and additional work and additional productivity, 
additional innovation, they will create a broader growth in the overall 
economy. Maybe it is worth it. I am just saying there is a balance of 
issues here. On the one hand is the progressivity issue which you are 
referring to. On the other hand, is whether the tax code is promoting 
growth. 
   May I suggest that there are many ways to increase progressivity. 
Another way to do it would be to broaden the base. There are a number 
of deductions, for example, exemptions and exclusions in the tax code, 
which are not capped and which benefit higher income people more than 
lower income people. That is another way to look at it. 
   So there are many different ways to think about how to address 
progressivity. But in doing so you should think also about the 
implications for economic growth and efficiency. 
   On the trade deficit, this ties in very well to the debate we are 
having today in this meeting. The fundamental source of our trade 
imbalance is that we, as a country, are saving much less than we are 
investing. Therefore, we have to borrow the difference abroad. Whereas 
other countries are saving more than they are investing and therefore 
they are lending to us the difference. That is the essence of the 
imbalance that we have in the world today. 
   Senator SANDERS. Let us get back to the question, if we could, sir. 
We have an $80 billion trade deficit. We have lost millions of good 
paying manufacturing jobs, all of which leads myself and many millions 
of Americans to believe that NAFTA, PNTR with China, et cetera, et 
cetera, are not working particularly well for the American people. 
Comment? 
   Chairman BERNANKE. I do not agree with that. I think that there are 
certainly people and workers who are displaced, who lose from trade. 
But broadly speaking, I believe that trade and openness are good for 
the economy. Trade creates broader opportunities for growth and 
investment. 
   Senator SANDERS. We just have a limited amount, so forgive me. You 
are giving me the rhetoric. But the fact is you are concerned about 
deficits. That is why you are here today; right? 
   We have an $800 billion trade deficit. Is that a concern? 
   Chairman BERNANKE. The deficit we have been talking about is the 
fiscal deficit. 
   Senator SANDERS. Well, but you have a trade deficit that is also of 
concern. 
   Chairman BERNANKE. It is a concern, but I do not think it comes from 
our trade policies. It comes from our saving and investment policies. 
   Senator SANDERS. You do not think our trade deficit comes from our 
trade policies? 
   Chairman BERNANKE. No, I do not. 
   Senator SANDERS. You do not think a $200 billion trade deficit with 
China and the fact that it is hard to buy an American product-- 
   Chairman BERNANKE. The connection is very marginal. I would also 
like to say that I think it is really a bit of an exaggeration to say 
that the U.S. industrial base is decaying. In fact, we just got good 
industrial production numbers yesterday. The United States is the 
largest manufacturing country in the world. Our manufacturing output is 
growing. We have some of the best high-tech manufacturing industries in 
the world. 
   The main reason that manufacturing jobs have declined so quickly is, 
perversely, because manufacturing has been so productive that firms 
have found ways to make do with fewer and fewer workers. And that has 
led to a smaller number of workers in manufacturing. But I do not 
think it is the trade issue. I think, in that particular case, it is 
the productivity issue. 
   I do believe that the best way to address the current account 
deficit is for a balanced adjustment, for us to increase our saving, 
both at the household level and at the fiscal level, and for countries 
like China to increase--
   Senator SANDERS. Is it not hard for the average household to 
increase their savings when, in many cases, the jobs they now have are 
paying lower wages than what they had 20 years ago? 
   Chairman CONRAD. Let me just intercede, if I can. 
   Senator SANDERS. Thank you, Mr. Chairman. 
   Chairman CONRAD. We are a little past the Senator's time. We will go 
back to another round. 
   Senator SANDERS. Thank you very much, Mr. Chairman. 
   Chairman CONRAD. We will go to Senator Allard. 
   Senator ALLARD. Dr. Bernanke, welcome to the committee. 
   I have always believed that there is a certain balance between the 
level of taxation and revenues. In other words, if you tax 100 percent, 
you are not going to get any revenues to the Federal Government. If you 
do not tax anything at all, you are not going to get any revenues--but 
somewhere in between there is this balance. I think it is referred to 
as the Laffer curve. I would like to hear you comment a little bit on 
Laffer's curve, if it plays in your thinking. 
   I am interested to know whether we have the proper balance today and 
are maximizing revenues to government, whether it is Federal Government 
 or State governments. If you look at what has happened in the last few 
years, it seems to me that it is working. But I would just like to get 
your perspective on that. 
   Chairman BERNANKE. As I indicated before, the conventional wisdom 
among economists is that tax cuts do not necessarily pay for 
themselves. That is not really an argument against tax cuts. It is 
really a question of balancing the benefits of the tax cuts for the 
economy against the fact that you would have to reduce Government 
spending in the long run to get that balance. 
   I think, in general, that it would be a good idea for us to look at 
the tax code, to ask ourselves whether there are ways of simplifying 
it, broadening the base, reducing complexity, reducing compliance 
costs, and maybe increasing collection that would allow us to get more 
revenue without greater burden on the economy. The tax code has become 
a very complex system, and I think periodically it makes sense for 
Congress to review it and try to find ways to improve it. 
   Senator ALLARD. But do you worry, in general terms, about the level 
of taxation and the effect on the economy? 
   Chairman BERNANKE. The message I am bringing today is only that 
there is a decision that Congress has to make about how big a 
government you want. Whatever it is, you have to pay for it. That is 
what I am saying. 
   Senator ALLARD. But if you have 100 percent taxation, does that have 
an effect on the economy? 
   Chairman BERNANKE. Of course. 
   Senator ALLARD. Do you understand what I am trying to get at? 
   Chairman BERNANKE. Let me try to respond. The Laffer curve idea is 
correct if rates are extraordinarily high. If rates are very high--if 
they are at 100 percent, 90 percent, so high that they essentially 
drive out the activity being taxed--then it is true that in that 
situation you could actually raise revenue by cutting taxes. That is 
correct. 
   But I do not think--there may be differences of degree--that for our 
income tax system we are on that side of the Laffer curve. I think that 
where we are now, if we cut income taxes, we will probably lose some 
revenue. 
   Again, that is not the key question. The key question is balancing 
the level of taxation and the implications of that for the economy 
against a level of spending that is appropriate and is really providing 
good benefits for the economy. That is the balance you have to think 
about. 
   Senator ALLARD. It seems to me that when you look at the economic 
figures that we are looking at today, that you cannot be that critical 
of where we are today, can you? 
   Chairman BERNANKE. The economy has recovered quite a bit from the 
2001 recession and the weakness that we saw through 2003. We have had a 
pretty good run in terms of growth and productivity. 
   Senator ALLARD. Your predecessor, Dr. Greenspan, when he talked 
about trade he did not concern himself too much with trade deficits. 
You seem to be more concerned about the trade deficits. 
   A question I have is does it really matter who purchases our 
Treasury certificates? In other words, who buys our debt? And if it 
does matter, does it make a difference whether it is domestically or 
internationally owned debt? 
   Chairman BERNANKE. It makes a difference only in that if it is 
domestically purchased, then the interest on the debt will go to 
domestic people and be part of the domestic income. If it is purchased 
by foreigners, it will go to the foreign holders of the debt. 
   The existence of foreign lenders, in the short run at least, is a 
good thing because it means that we can invest more than we otherwise 
could, given the amount of saving we have. So we want to invest more 
than we save. The only way to do that is to borrow abroad. 
   The concern I have is that the current account deficit is now quite 
large and still growing. There is a good reason to believe that 
ultimately it needs to start coming down slowly. I think that fiscal 
policies that create better balance between taxes and revenues, between 
spending and revenues, have a lot of virtues in their own sake. But 
they would also, to some extent, contribute to bringing down that 
imbalance on the external side, as well. 
   Senator ALLARD. The Bureau of Labor Statistics has recently 
introduced a new price index. They call it the chain CPI. I wonder if 
you would elaborate on that. They are claiming that that is more 
accurate than the current CPI that we are using today. I would like to 
hear your feelings on that new measurement. 
   Chairman BERNANKE. Senator, yes, I think it is somewhat more 
accurate. The existing CPI, the one we are all familiar with, takes a 
fixed basket of goods and values the change in the cost of that basket 
from month to month, from year to year. 
   The problem with that is it does not take into account the fact that 
as prices change, people will change the goods and services that they 
choose. If oranges become more expensive, I might eat more apples 
instead. 
   The chain-weighted CPI allows, to some extent, for the adjustment 
that people make to go from higher priced goods to lower-priced goods, 
and therefore is probably a better measure of the true cost of living 
increase than the standard CPI. 
   Senator ALLARD. Do you think that the procedure that we are using 
now with CBO and OMB, that those projections overstate inflation? 
   Chairman BERNANKE. Presumably, the projections they are making are 
in terms of what they think the standard CPI inflation will be. At the 
Federal Reserve, we have done numerous studies of these indices, and we 
do think, for example, that the standard CPI does overstate true 
inflation, if we could measure true inflation, by some amount between 
one-half and 1 percentage point. 
   Senator ALLARD. Do you think with those agencies we need to go to 
the chain CPI to get a better result? 
   Chairman BERNANKE. A really operational question one might ask is 
whether we should use the chain CPI or some other measure to index 
entitlement benefits and also to index the tax code. If your 
objective--as Congress--is to tie benefits payments and the tax code 
more directly to what I would call true inflation, you would have a 
more accurate measure of true inflation by using the chain CPI or some 
alternative measures. So that would be one consideration. 
   Senator ALLARD. Thank you, Mr. Chairman. I see my time has expired. 
   Chairman CONRAD. I thank the Senator, and I especially thank him for 
his question on the CPI matter because I think that is going to be an 
important part of the discussion here as we try to figure out a way to 
get this horse back in the barn. 
   Senator CARDIN. 
   Senator CARDIN. Thank you very much, Mr. Chairman. Mr. Chairman, it 
is a pleasure to have you before our committee. 
   I want to followup on the savings issue. We do talk a lot about the 
budget deficit and the trade deficit. We have a major savings deficit 
in this country. 
   Although I am not really clear of the relationship between the 
savings deficit and the trade deficit, and I would like to explore that 
at a different time, I am very concerned about the savings deficit in 
this country. I think we all are. From an individual point of view, we 
know that individuals do not have enough put away in savings to deal 
with life's circumstances. We are well below what economists say we 
should have for the purposes of individual security. 
   This also adds to the wealth disparity in America. Those at the 
lower income levels save the least and are much more vulnerable. And it 
does put more pressure on us, in Congress, to deal with the entitlement 
programs. 
   So for all of those reasons, it is important to increase the 
national savings rate and increase individual savings rates. And from a 
national point of view, our savings rates are very, very low. We do not 
have the amount of savings that are useful for investment in America 
and that makes it necessary for us to borrow capital from abroad. 
   Now, one can argue whether our economy is hurt by our indebtedness 
to countries. But I must tell you because of the large sums borrowed 
from financial entities that are controlled by other governments that 
do not always agree with America's foreign policy, I think there is 
also a security issue here that could compromise country's independence. 
   I have raised the issue of whether we really can challenge China's 
monetary policies on how it ties its currency to ours. Are we truly 
independent on our challenges there, knowing how much capital is coming 
in from China to America today? 
   So for all of those reasons, I think we need to improve our domestic 
savings rates. 
   I know that you are reluctant to comment on specific proposals. We 
have passed a savers' credit, which is targeted toward lower-income 
people. There are efforts being made to increase the savers' credit, to 
make it easier for lower wage workers to put money away for retirement. 
To the extent that that type of incentive increases savings by lower 
income people it seems to me, from your testimony, that would have a 
very positive effect on our economy. 
   To the extent that we can encourage businesses to provide retirement 
plans for their employees, where they put some money on the table, 
workers are much more likely to participate in those plans. We know 
this from our experience, with the Federal Employees Thrift Savings 
Plan (TSP), which the Federal Government contributes to. 
   Our savings rates are declining, the number of defined benefit plans 
is declining, and employer-sponsored plans are not increasing at the 
rate that all of us believe is necessary. 
   So try to help me on this. I know you are reluctant to make specific 
recommendations, but the savings deficit, it seems to me, is a major 
problem for our economy. 
   Chairman BERNANKE. Senator, first of all, I certainly agree with 
that. 
   Senator Sanders asked about inequality. The inequality in wealth and 
savings is far greater than the inequality in income. I think it is a 
problem, both for individual families and for our economy as a whole. 
It has been a long-standing debate in the economic literature about 
how we can get people to save more. 
   I think one promising direction which I will comment on, because the 
Congress has recently moved in this direction, has to do with ideas 
that have been developed in what is called behavioral economics, which 
is the idea of merging psychology with economics and using 
psychological principles. 
   One of the results of those studies is that if people are told that 
they have a 401(k) plan at work and are asked whether they would like 
to contribute to it, they will say no. But if you deduct from their 
income as a default into their 401(k) plan and ask whether they want to 
opt out, most of the time they will not. So having an opt-out 
provision, which still makes it voluntary, actually seems to have some 
impact on saving behavior. 
   So recently, in the Pension Bill, there were some provisions that 
made it easier for employers to do that. 
   I think that is a promising approach and as you indicate, it could 
be extended. Even if there is not an employer match, it could be 
extended to people without 401(k)'s, either through work or through a 
government program, to allow people to have a tax-favored place to 
save. So I think that is one promising direction. 
   The other approach that Congress has taken over the years is various 
kinds of tax policy, tax breaks and so on, for saving. IRAs are an 
example. Unfortunately, the evidence is really quite mixed on how well 
they work. For some people, having tax-free money in an IRA means they 
can save less or they can just move assets from somewhere else and put 
them into the IRA. There is quite a controversy about how much those 
sorts of measures help. 
   So I think the two things that I would suggest--strangely for an 
economist--would be not the straight incentive measures but using these 
psychological methods to try to induce people to understand the 
importance of saving and to make them opt-out of some kind of plan. 
   The other thing that is important, and the Federal Reserve is very 
involved in supporting this, is that people often just do not have the 
knowledge, the information, about how to invest even in simple ways, 
how to take advantage of the existing tax breaks and the like. So we, 
at the Fed, have worked very hard on financial literacy, for example, 
to try to get people to understand better what their options are. 
Obviously that is not a magic bullet, but to some extent that would 
also help people budget better and perhaps save more. 
   Senator CARDIN. It is good advice. Financial literacy is one area 
where I think all of us can agree we have to do a much better job. 
   One of the real concerns about the decline of defined benefit plans 
is they are generally better managed than an individual's 401(k) or 
their own defined contribution plans. The automatic enrollment feature, 
we will see how that works. I am very encouraged but I think you are 
right, I think that will help a great deal in encouraging participation. 
   I would just emphasize that when an employer or the Government puts 
money on the table, individuals at all income levels are much more 
likely to take advantage of that. That is why anything we can do to 
encourage companies to provide pension plans for their employees is 
going to be helpful in increasing our savings rates. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Senator Bunning. 
   Senator BUNNING. The timing is too good. Thank you, very much. 
   Chairman Bernanke, good to see you again. I congratulate you and the 
Fed in keeping interest rates where the American people can stand and 
the economy can prosper. I congratulate you, and that is not always the 
case. 
   Current account deficits and things about the budget, I am more 
concerned about out-years, as you have mentioned. I think we will see 
our deficits and our continuing income be at higher levels than we 
anticipated as far as revenues to the Treasury. And therefore, the 
reduction short-term in the deficit will be positive. 
   I am completely consumed by the fact that 2030, if we do not do 
something, that the three things called Social Security, Medicare, and 
Medicaid will consume the entire Federal budget. And therefore, we will 
not have a Defense Department, we will not have a Department of Labor, 
we will not have any other agencies of the Federal Government that can 
function. 
   Do you, in your wisdom, see some way that we can manage that? 
   Chairman BERNANKE. That is, of course, the question we are here to 
discuss. There are, for each of these programs, both revenue raising 
measures and ways of reducing expenditure. I would be happy to go over 
the list if you like. 
   Obviously though, as I said before, I do not want to pick and 
choose. I think it is up to Congress to make those tough decisions 
about-- 
   Senator BUNNING. We are in need of help. 
   Chairman BERNANKE. Just to take an example, Social Security. The 
major options on the benefit side, I think, are first changing the 
indexing formula. 
   Senator BUNNING. The index as far as when a person can retire and 
the aging-- 
   Chairman BERNANKE. No, I am referring Senator, to the way you 
calculate the initial benefit. Currently, the initial benefit is tied 
essentially to wages, which means that the replacement ratio, the share 
of wages, remains constant. 
   Senator BUNNING. I understand. 
   Chairman BERNANKE. The strongest measure, which was suggested by the 
recent Commission on Social Security, would be to switch to price 
indexing, which would keep the real value of the benefit constant but 
not the replacement ratio. That would solve the entire shortfall, as I 
understand. 
   A second measure would be something along the lines of what Robert 
Pozen has suggested, the progressive indexing measure, which would keep 
the--
   Senator BUNNING. I think Chairman Greenspan also agreed with it. 
   Chairman BERNANKE. I am simply referring to some of the possible 
options here. That would keep the 30 percent lowest income people still 
indexed to wages, the very highest people indexed to prices, and those 
in between-- 
   Senator BUNNING. Somewhere in the middle. 
   Chairman BERNANKE [continuing]. On a sliding scale between them. 
That would also close a fairly substantial part of the Social Security 
shortfall. 
   Increasing the retirement age gradually over time, particularly if 
you indexed the longevity subsequently--as life expectancies increased 
the retirement age would increase--would also reduce the long-term 
shortfall. 
   Senator BUNNING. On the same scale as we are doing now, from 65 to 
67? 
   Chairman BERNANKE. Yes. So increasing the retirement age to 70 by 
2029 would be another approach. Again, I am just listing possibilities. 
   We mentioned earlier the chain weighted CPI. You could use that to 
index the benefits after retirement. That would provide a slightly 
smaller rate of increase in benefits. 
   Senator BUNNING. How do we get around the promise that was made when 
people got into Social Security? How do you suggest that we tell the 
American people? Or do we set a date certain, say 20 years down the 
road, all those who got into Social Security at age 20 who are now 40, 
when they become 50 will have to get a different rate of return on 
their Social Security? 
   Chairman BERNANKE. Congress has made changes in benefits promises 
before. In the early years, the changes were mostly up. But in 1983, 
for example, following that commission, there were some changes down. 
Senator BUNNING. We were going to go busted, so is was easier then. 
Chairman BERNANKE. It is the same situation now; there are stresses on 
the system. 
   So just to be evenhanded, of course, the other side of the equation 
is payroll taxes. You could raise payroll rates under either the 
existing ceiling or you could raise the ceiling and the rates. So there 
are revenue side approaches, as well. 
   Senator BUNNING. We did that on Medicare and unfortunately that is 
one of the things that is not going to pay its way. We uncapped 
Medicare completely. And unless we raise the rate as far as the tax is 
concerned, we will not successfully change the policy of Medicare going 
busted earlier. 
   Chairman BERNANKE. That is right, Medicare is a much bigger problem 
than Social Security. And the Part A Trust Fund is 10 or 15 years away 
from insolvency, as I recall. 
   Senator BUNNING. That is correct. 
   Chairman BERNANKE. So anyway, Senator, I am just listing a number of 
the possible options one could take. 
   Senator BUNNING. Health care is another huge, huge problem that we 
are going to have to consider the fact that either we are going to have 
to lower benefits or share more of the cost with the employees and 
somehow pay the bill. The bill is getting to be a portion that we 
cannot pay federally. 
   Chairman BERNANKE. There is an enormous impending imbalance in 
Medicare. One way, if I may kill two birds with one stone, is to think 
about reform of the entire health care system. There are a lot of 
things that could be done, I think, to make the health care system more 
efficient and to control costs. That, obviously, would be good for the 
entire economy, as well as provide benefits for the fiscal budget as 
well. 
   Senator BUNNING. I think that is an answer, looking at the health 
care system in its entirety and making some new suggestions. 
   Thank you very much. 
   Chairman CONRAD. I thank the Senator. Senator Whitehouse. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. Welcome, Mr. Chairman, 
good to meet you. 
   You opened your testimony, sir, with the description of the deficit 
in the unified Federal budget as $248 billion. We had Comptroller 
General Walker here just recently and he put that into the context of a 
number of different figures. He identified the unified budget deficit 
of $248 billion. He identified the on-budget deficit, setting aside the 
Social Security cash offset, of $434 billion. He calculated a net 
operating cost on an accrual basis for financial reporting of a 
negative $450 billion. And our Chairman indicated another measure, 
which was that the national debt increased by $546 billion. 
   Among those four different measures of the fiscal slide that we are 
on, why is it that you picked the $248 billion number? 
   Chairman BERNANKE. Senator, first, one of the themes in my testimony 
was that we need to look at multiple measures to really get a full 
picture of the fiscal situation. So I did mention that number. But in 
the next sentence I mentioned the on-budget deficit, which you are 
correct, is about $434 billion. 
   You discussed the net operating costs, the accrual deficit, which is 
another interesting concept. I took it out of this draft for the 
following reason: the net operating cost which is now currently 
reported by the Department of the Treasury, which you correctly point 
out is $450 billion, adds to the deficit the accrual of obligations to 
pensions for Federal employees, as well as certain veterans' benefits. 
But in a sense it is really an understatement because it makes no 
provision for the increased obligations under the entitlement programs. 
The Governmental Accounting Standards Board is looking at ways to 
consider a net operating cost measure that actually includes, in 
addition, the obligations under entitlements. So as I mentioned at the 
end of my remarks, I think there are multiple measures to look at. The 
current deficit does say something about how much extra debt is being 
borrowed, how much extra debt is being issued to the general public, as 
opposed to the Trust Funds, for example. 
   But the present value of the unfunded liabilities of Social Security 
and Medicare is a very important number and is indicative of the long 
run imbalance that we face. 
   So what I was trying to argue is that to really understand this 
complex thing we call the Federal budget, you need to look at a number 
of measures. I would agree with what I think was implied by your 
question, that looking only at the unified Federal budget deficit, 
which is less than 2 percent of GDP, while of some interest for some 
purposes, tends to understate the severity of the fiscal problems that 
we face. 
   Senator WHITEHOUSE. That was precisely my point. I appreciate it. 
   Chairman BERNANKE. Including the entitlements. 
   Senator WHITEHOUSE. The other point I wanted to touch base with you 
on is, as Senator Sanders asked you about, the increasing gap between 
the rich and the poor. I understand that in your response to him you 
indicated that you would be speaking more to this shortly. I would like 
to request that if your remarks to be delivered shortly on this do not 
address certain topics, if you could get back to me on them. 
   It strikes me that there are secular causes related to the global 
economy for this shift. It is not that the rich have suddenly gotten 
smarter and more productive and the middle class has not. And so I 
would like to inquire of you what you think the secular forces are that 
are at work driving this gap? How bad it presently is compared to 
historical trends and norms? How urgent you feel it is that something 
be done about it? And what options that the Senate might engage in 
commend themselves to you? 
   Obviously, that is a 30 minute speech so please do not feel obliged 
to answer me now. But I do want to lay those down so that when your 
remarks come up, if they do not answer that, you can respond. 
   The last thing I would like to do is followup on what you said to 
Senator Bunning about the health care system. I could not agree with 
you more. I think our health care system is a nightmare. It is 
disastrous. And I think it would be a real tragedy if our Congress were 
to go out and reduce benefits and require people to pay more into this 
health care system without having taken the preliminary steps of doing 
our best to reform what is the most wasteful and extravagant system in 
the world. 
   And to the extent that you have folks at the Federal Reserve who are 
interested in working on that, I would love to be in touch with them, 
because I feel it is vital that we pursue this. 
   Chairman BERNANKE. Thank you, Senator. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Chairman CONRAD. I thank the Senator. 
   I would like to go back to the question of health care because 
everybody on this committee recognizes, this is the 800-pound 
guerrilla. If we do not make meaningful progress there, frankly all the 
rest of what we do is not going to address this problem meaningfully. 
One of the things that I have tried to focus on is one statistic that I 
find especially powerful. Roughly 5 percent of Medicare beneficiaries 
use half the money. Five percent use one-half of the budget. They are, 
of course, the chronically ill. They have multiple serious conditions. 
We did a study with about 20,000 patients, I think it was 21,000 
patients. We put a case manager on every one of their cases to better 
coordinate their care. The first thing they did was go into their homes 
and get out all of the prescription drugs they were taking. On average, 
they found they were taking 16 prescription drugs. And after review, 
they were able to cut that in half. 
   As a result of that effort and the others that were made to better 
coordinate their care, with this group they cut hospitalization 50 
percent. As a result, there were very dramatic financial savings but 
there were also better health care outcomes. People were healthier. 
   I did this with my own father-in-law in his final illness. We went 
and got all of the prescription drugs out of the table, and he was 
taking 16. I got on the phone to the doctor and went down the list. 
About the third one the doctor said to me my god, Kent, he should not 
be taking that. He should not have been taking that the last 3 years. A 
little further down the list, two drugs he was taking, the doctor said 
Kent, those two drugs work against each other. You should never be 
taking them together. 
   I said doctor, how does this happen? It was very simple. He said he 
has four different doctors. He has a heart specialist, he has a lung 
specialist, he has an orthopedic specialist, he has me as his family 
practice doctor. All of them prescribing for him, none of them know 
what the other one is doing. He said he is getting prescription drugs 
from the hospital pharmacy, he is getting them from the corner 
pharmacy, he is getting them from the pharmacy at the beach, he is 
getting them mail order. He is sick and confused. His wife is sick and 
confused. And we have nobody, in effect, managing the case. 
   He said I am supposed to be. I am his family practice doctor. But I 
 do not know what the heart doctor has prescribed. I do not know what 
the lung doctor has prescribed. And of course, it is even more 
complicated than that because it was not just one heart doctor. There 
were three heart doctors. It wasn't one lung doctor, there were several. 
Is this something you have looked at at all in terms of focus? Does it 
make sense to you that we further pursue this? What reaction might you 
give to this basic concept, that we have a small percentage of the 
population that is using most of the money? 
   Chairman BERNANKE. Senator, first, you have identified some 
important issues. It is the case, because of the conditions you 
referred to, that a large part of the money is used by a relatively 
small share of the population. 
   I think the approach that this cries out for is what you might call 
integrated health care management, in which the health care of an 
individual is coordinated, their prescription drugs are coordinated, 
there is an overall evaluation in what that person is doing. 
   From a policy perspective, though, there are some interesting 
questions about how best to achieve that. Let me give you three models. 
One model, which applies at least to some people, would be sort of 
consumer-directed, which says people are primarily responsible for 
themselves and their families. For people who are competent--who are 
not that ill or are relatively well-educated and so on--perhaps
self-responsibility may be the right approach. 
   For those who need more extensive management from professionals, 
there are two models. In one Government provides money but the patient 
chooses from a set of providers, HMOs or PPOs or other private-sector 
providers, whose profitability depends on their ability to manage the 
entire health care situation, including preventive care and so on. 
The last model is a Government provision system where again, if the 
Government is providing, it is important that there be serious attempts 
to make sure that provision is as efficient as possible. The kinds of 
things you are talking about, a caseworker or an integrated approach, 
would be important in that context, as well. 
   Chairman CONRAD. Would it not be important that we have better case 
management, whatever model we adopt? That somehow, we have, especially 
with this chronically ill population, which tends to be older people 
with multiple serious conditions, somehow--although our health care 
system is exceptional in so many ways. 
   You know, my grandfather was a doctor. He was the medical chief of 
staff of our hometown hospital. When people are ill in other countries, 
where do they want to go? They want to come here. 
   It is also true we have by far the most costly health care. We here 
at 16 percent of gross domestic product now in health care. I think the 
next highest country is 11 percent. And that delta, that difference 
between 16 percent of GDP and 11 percent is $800 billion. 
   So it would seem to me that whatever system we adopt, providing 
better case management is part of a more effective health care system. 
Does that strike you as accurate? 
   Chairman BERNANKE. Yes. I might add that I think a very important 
element of that would be improving our health IT, information 
technology, system which I know is currently, to some extent, underway. 
But if a doctor could look online and see what prescriptions the 
patient already has and what their previous conditions were and so on, 
that would eliminate some of the problems that you are talking about. 
Chairman CONRAD. You know, I just held a health information technology 
summit in my State, with all of the major health care providers. One of 
the ideas that was presented there was a health passport, if you will. 
It would be a record that somebody could have with them. It also be 
online at their doctors, that would have in a computer record all of 
the contacts with medical professionals. 
   So that heart doctor would know what the lung doctor prescribed. The 
family practice doctor would know what the other doctors had 
prescribed. And not only meds that were prescribed but also tests that 
were given. I know my stepfather had, I think, three MRIs in the last 
year of his life, from three different sources. This is the kind of 
thing that really does explode cost without improving health care. In 
fact, it probably makes health care, certainly the comfort of the 
patient less. 
   Let me ask one final question and that is the matter of the tax gap. 
We have not talked about that today. The Internal Revenue Service 
Commissioner came before this committee and testified the tax gap is 
now somewhere in the range of $350 billion a year, and that is based on 
an estimate. I happen to believe it is a conservative estimate, given 
how that estimate was arrived at. 
   So if our tax system at current rates was generating the revenue 
intended, we would not have a deficit. The deficit would be eliminated. 
Any thoughts you have on this tax gap, the difference between what is 
owed and what is being paid? How we could better capture that revenue 
without a tax increase or a rate increase? 
   Chairman BERNANKE. Senator, I agree that is a very important issue. 
You are never going to get 100 percent compliance but you could get 
better compliance. I think it is important not only for the revenue, as 
you mentioned, but also because our system is very much based on 
self-enforcement. People turn in their tax returns because they are 
basically honest and they think other people are doing it as well. If 
people have the sense that lots of people are cheating the system and 
are not paying their fair share, then they are going to be less willing 
themselves to pay their taxes. 
   How to increase collection is a difficult issue. Let me raise one 
possibility that might be worth exploring. In the United Kingdom there 
is currently a paperless return system where it is possible, 
essentially through what is the equivalent of W-2 forms or withholding 
at the employer-level integrated with other types of income, that the 
tax obligation of the worker could be calculated essentially 
automatically, and there is no need for a form because there is no 
refund. Basically it is an exact measure. So it is a method of 
essentially automatic deduction. That would be one approach. 
   Otherwise, it is difficult to say. I think some of the areas where 
the tax gap is larger, maybe small business and some others, pose some 
difficult problems in terms of collecting. People who have 
off-the-books income, things of that sort, so there are some difficult 
issues there. I do not think I have any really great suggestions. 
   But to the extent that we can increase compliance, it would be good 
for the system as well as good for the revenue. 
   Chairman CONRAD. Do you think we ought to consider tax reform as 
part of an overall effort here? One of the things that strikes me is we 
have a tax system that was largely devised in the 1930's, 1940's, 
1950's, and we have a world that is fundamentally changed. 
   One thing that has struck me is maybe we need to have, as one part 
of a strategy, a really thorough review of our tax structure and 
system, tax reform that could make collections more efficient, more 
effective. And at the same time, strongly consider our economic 
position in the world and our competitive position in the world, 
because I am more and more convinced, as a member of the Finance 
Committee, that we really do not have a system that maximizes our 
competitive position. 
   Chairman BERNANKE. I think there is a good case for looking at 
alternatives. We have a number of problems now, including the 
complexity of the system, the Alternative Minimum Tax, what are we 
going to do about that, and so on. 
   I will say something that I hope will be uncontroversial, which is 
that the current tax code is very burdensome. Some estimates a few 
 years ago suggested that the average taxpayer spends 27 hours on their 
taxes every year and that the total cost of compliance, including the 
hours spent, is over $110 billion a year. You could think of that as 
part of the tax gap as well. If that cost could be reduced, you would 
be saving the economy a significant amount of money and perhaps making 
people more willing and able to comply with the law. 
   Chairman CONRAD. Senator Gregg. 
   Senator GREGG. I am interested to know why you think the markets do 
not factor in, it appears, the implications of the numbers which you 
have talked about here in the out-years relative to long-term debt? If 
I was buying long-term debt 10, 15, 20, 30 years out, I would sure want 
a much higher interest rate than what appears to be what the markets 
are demanding today. What are they assuming we are going to do that I 
am not aware of? 
   Chairman BERNANKE. Senator, I think my predecessor commented also on 
this puzzle. Thirty-year bonds are paying interest rates not much more 
than 5-year bonds. 
   Evidently either this is a trading phenomenon and the holders of the 
bonds are not really thinking about 30 years in the future, or, the 
other possibility, is that one way or another the bondholders do expect 
that Congress will take whatever measures are needed to ensure that the 
bonds are paid off and that it is done in the context of price 
stability. 
   Senator GREGG. Which gets me to my second point which you alluded 
to, price stability. One way that this has been handled in other 
economies has been to inflate the economy. How do we avoid that? 
   Chairman BERNANKE. The Federal Reserve is independent and the 
Federal Reserve will follow its mandate and ensure that prices remain 
stable. 
   Senator GREGG. That is comforting. 
   Chairman BERNANKE. Thank you. 
   Senator GREGG. On the issue of tax reform, do you believe a 
consumption tax is a vehicle that we should be looking at? And if you 
do, how do you avoid the inherent problems which come from putting that 
sort of an engine on the government and causing the government to just 
explode in size? 
   I come from a State that has neither a sales or an income tax. We 
look at our neighbors in Vermont and Massachusetts, where our neighbors 
were told that if they just put in a sales tax their income taxes would 
go down. What they found is that their government just got a heck of a 
lot bigger and their income taxes stabilized for a few years and then 
started going back up. 
   Chairman BERNANKE. Senator, as you know, I cannot really endorse a 
particular approach. But I will say a word about feasibility, which is 
that consumption taxes can be implemented lots of different ways. One 
way is through a value-added tax, which a lot of European countries 
use. Another way is through a retail sales tax. A third way would be 
through a saving exemption approach where you look at your income at 
the end of the year and you document how much you have saved and that 
part is deductible. That essentially becomes a consumption tax. 
   So there are a number of ways to move toward a consumption tax, and 
so I do not think the feasibility is really the issue. I think the 
issue is whether it produce a more efficient economy. In addition, 
since wealth is unequally distributed and the higher income people are 
much more likely to have capital income, could we structure a 
comsumption tax in such a way as to maintain the degree of 
progressivity that we would like to see in the tax system? 
   Senator GREGG. Of course, the response to that is that wealthy 
people buy a lot more, so they would pay a lot more in taxes if you had 
a consumption tax. 
   But in any event, thank you for your answers. Thank you for being 
here today. I especially appreciate your opening statement. I think it 
was absolutely correct, right on, and a clarion call that I hope some 
folks will listen to. We are certainly going to try to be an echo 
chamber for you. 
   Chairman BERNANKE. Thank you for the opportunity. 
   Chairman CONRAD. Senator Bunning has a followup. 
   Senator BUNNING. I just want to find out if somebody has questioned 
you about PAYGO? Has anybody here questioned you? 
   Chairman BERNANKE. No, sir. 
   Senator BUNNING. The Senate PAYGO point of order has existed in some 
form since 1993. The PAYGO point of order currently in place stems from 
the 2004 budget resolution and makes it out of order to consider 
legislation that would increase the deficit by more than the amount of 
the deficit increase, if any, assumed in the most recent adopted budget 
resolution. 
   From 1990 to 2002, under statutory PAYGO, any deficit increases that 
were enacted were added together and put on PAYGO scorecards. At the 
end of the year any balance on the scorecard were supposed to be 
reduced by a sequestration. However, no sequestration has ever 
occurred, despite large PAYGO balances. 
   The original purpose of this mechanism was to encourage Congress and 
the president to only enact changes to mandatory spending and revenues 
which were offset so as not to increase the deficit. 
   Question: do you think that PAYGO point of order is an effective 
budget enforcement tool? Or does it merely exist to replicate other 
budget enforcement tools that already exist? 
   Chairman BERNANKE. Senator, these parliamentary rules that have been 
set up to try to address deficits are very complex. And as you point 
out, their efficacy depends on a lot of things, including how willing 
the membership is to following through. I do not really have the 
expertise to advise on the types of rules, PAYGO and others, for 
addressing budget issues. 
   I think the comment I would like to make is one that I made in my 
opening remarks, which is that I do think, from an economic 
perspective, that it is useful not to focus too much on a single 
measure of fiscal stability but to look at a number of different 
measures including, for example, the share of total spending in the 
economy and, very importantly, given the discussion we have had today, 
the long-run solvency of the entitlement programs. 
   Senator BUNNING. Thank you very much, Mr. Chairman. Thank you, 
Chairman Bernanke. 
   Senator CONRAD. Thank you, Senator. 
   Again, Mr. Chairman, thank you very much. We promised to get you out 
of here by noon. We will be good to our word and get you out even a 
little earlier. 
   We very much appreciate the constructive testimony you have provided 
here. And we hope people are listening about the need for us to address 
these long-term imbalances, to take these challenges on, and the sooner 
we do so the better. 
   Thank you, sir. 
   [Whereupon, at 11:50 a.m., the hearing was concluded.] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

                        THE GROWING TAX GAP AND STRATEGIES 

                                  FOR REDUCING IT 

                                      -------       
                             TUESDAY, JANUARY 23, 2007 

                                           U.S. SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:05 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Wyden, Stabenow, Menendez, Lautenberg, 
Cardin, Sanders, Whitehouse, Gregg, Grassley, Allard, and Crapo. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

                   OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. The committee will come to order. 
   I want to thank members of their participation today. I want to 
especially thank the panel that we have, really three excellent 
witnesses. Robert McIntyre, the Director of Citizens for Tax Justice, 
good to see you again. Michael Brostek, the Director of Tax Issues for 
the Strategic Issues Team of the Government Accountability Office, the 
GAO. John Satagaj from the Small Business Tax Compliance and Fairness 
coalition, welcome. Good to have you here, as well. 
   The hearing this morning is about the growing tax gap and strategies 
for reducing it. The tax gap, as we all know, is the difference between 
what is owed and what is actually being paid. And we now know that, 
according to the Revenue Service, the tax gap is running at about $350 
billion a year. Let me repeat that. The tax gap is estimated by the 
Revenue Service to be $350 billion a year. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   That is money that should be in the coffers of the Federal 
Government, according to existing tax law. We are not talking about a 
tax increase here. We are not talking about increasing any rate. We are 
talking about collecting the money that is due and owed under the 
current law. 
   The tax gap, I believe, is unfair to the vast majority of taxpayers 
who pay what they owe. We know that the vast majority of Americans do 
pay their taxes. The vast majority of companies pay what they owe. But 
we have a growing number of both individuals and companies that do not. 
Unfortunately, our Nation's budget picture is not good. As we see on 
the chart, last year the deficit was $248 billion but the debt rose by 
$546 billion. 
   While increased spending has contributed to the deficit and debt, 
the dramatic decline in revenues has been an even larger factor. In  
fact, real revenues-that is adjusted for inflation-have experienced 
little growth since 2000, as we see in this chart. It is true, and my 
colleague will perhaps reference, that the last several years we have 
seen healthy growth in revenues. But if we go back to 2000, we see that 
we are only now getting back to the revenue base we had then. 
   That brings us to our hearing today on the tax gap. The growth of 
the tax gap is one of the factors contributing to the revenue drop. 
According to the IRS's latest estimate, the tax gap in 2001 was $345 
billion for that year alone. To put a $345 billion tax gap in some 
perspective, considered that it is almost $100 billion larger than the 
size of the entire deficit in 2006. 

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   While we will never be able to close the tax gap entirely--and make 
no mistake, we understand we are not going to collect all $345 billion 
a year, there is always going to be some tax gap--but it is clear that 
much more can and should be done. 

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  In testimony before this committee, the IRS Commissioner stated 
''You can clearly reduce the tax gap $50 billion to $100 billion a year 
without changing the way the Government interacts with its citizenry.'' 
In other words, we can close a considerable amount of the gap without 
resorting to draconian or intrusive measures. 

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   It is important to remember that the added burden placed on taxpayers 
from the tax gap is very real. In her 2006 annual report to Congress, 
the National Taxpayer Advocate wrote, and I quote, ''Compliant 
taxpayers pay a great deal of money each year to subsidize 
noncompliance by others. Each household was effectively assessed an 
average surtax of about $2,680 to subsidize noncompliance in 2001. That 
is not a burden we should expect our Nation's taxpayers to bear 
lightly.'' 

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   To close the tax gap, we need to enhance reporting and withholding 
requirements for certain taxpayers. We know that taxpayer compliance 
improves dramatically with increased reporting and withholding. For 
example, according to the revenue service, for income that is subject 
to substantial reporting and withholding requirements such as wages and 
salaries, we see a 99 percent compliance rate. When reporting 
requirements are in place we see a 91 percent compliance rate. But when 
there is neither, we see a sharp drop in the compliance rate, falling 
to less than 50 percent. 

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   The other way to close the tax gap is through better enforcement by 
the IRS. In his testimony before the Budget Committee last year, the 
IRS Commissioner noted that the IRS yields approximately $4 in revenue 
for every additional dollar spent on enforcement. We simply cannot 
bring the budget back to balance by looking only at spending, although 
he must certainly do that. 

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   In my judgment, we cannot do it solely on the spending side even 
with entitlement reform which is absolutely required. There is also 
going to have to be additional revenue. And I would strongly prefer 
that instead of talking about tax increases, that before we start 
talking about tax increases for anyone, we aggressively go after this 
tax gap. It is only fair and, I think, right. 
   With that, I turn to my colleague, Senator Gregg. 

             OPENING STATEMENT OF SENATOR JUDD GREGG 

   Senator GREGG. Thank you, Mr. Chairman, and I want to congratulate 
you. These first series of hearings that you have held have really been 
right on and they have been addressing issues which are critical to our 
Nation's economic health and social health and our cultural health. 
This is another one in that series and I thank you for holding this 
hearing. 
   This has been an issue that you have talked about a lot over the 
years. And in response actually to your concerns in the last budget 
which we put together--which you regrettably did not vote for, and I 
cannot understand why--we did put in the reserve fund in order to fund 
the IRS to assist them in collecting more money to get some of those 
revenues back that you have reflected in your statements. 
   And so I am in total agreement that this is a critical area of need. 
   I would also like to cite the fact that I do disagree with your 
characterization of revenues as they are presently coming in. I want to 
congratulate the former chairman of the Finance Committee who is with 
us today and a member of this committee, for having put in place a tax 
law which has allowed us to generate massive increase in revenues as a 
result of economic activity in this country. 
   Over the last 3 years, we have seen some of the biggest revenue 
growths in the history of the Nation. Historically the Federal 
Government has taken 18.2 percent of the Gross National Product in 
revenue. We are now over that number. We are up to about 18.5 percent 
of Gross National Product. So we are generating more revenues than we 
have historically generated. Obviously, not enough to close the gap 
because spending is above where it should be. 
   But in addition, the tax laws under the leadership of Senator 
Grassley have become more progressive. The top 20 percent of American 
taxpayers today on the income tax side bear about 85 percent of the tax 
burden. Under the Clinton years they bore about 82 percent of the tax 
burden. The bottom 40 percent of income earners in this country today 
do not pay taxes but they receive income back under the Earned Income 
Tax Credit and other benefits which actually is double what they 
received during the years of the Clinton Administration. 
   So we actually have a more progressive system while generating more 
revenues. That is the good news. I think it is because we have 
incentivized the market. We have said that we are going to say to 
people who are job creators, we are going to give you an incentive to 
go and create jobs by being more productive by having a reasonable tax 
rate on capital formation. 
   Obviously a difference of opinion there, but I believe--I wanted to 
make the point that I wanted to make relative to the fact that revenues 
are up. 
   But they could be up further through the collection of taxes that are 
presently owed. That brings us to this hearing. It is an issue which is 
a difficult issue. We can increase IRS support and the IRS, in return 
for that, says they can get us more revenues, maybe somewhere between 
$50 billion and $100 billion can be collected simply by having a more 
aggressive stance from the Internal Revenue Service and giving them the 
funds to accomplish that. 
   But that does not really get to the underlying issue which is the 
tax gap that is over $350 billion or in that range, which is a big 
number. And that really comes back to the structure of the tax laws 
itself, in my humble opinion. We have a tax law that is incredibly 
complex, massive in size, nobody understands it. After finishing law 
school I went back to school for 3 years and got a graduate degree in 
tax policy and taxation, and I do not do my own taxes because it is too 
complex. It is just not a system that encourages efficiency. 
   A lot of this failure to comply is not intentional. It is simply 
that the laws are so complex. Some of it is intentional, obviously, 
there is an underground economy. But a lot of it is just simply that 
the law is so complex. 
   So we need to take another look at our tax structure and come up 
with something that is more manageable, more understandable, and 
therefore more enforceable. I think the Chairman has pointed out that 
when you have an enforcement mechanism which is easily put in place, 
such as a payroll tax deduction, you get a high percentage of 
compliance. But when you do not have that enforcement mechanism because 
you have an economy that is outside of that capacity to collect, you do 
not get the percentage of participation you should. 
   So I think we need to look at tax systems which will allow us to get 
a better percentage of return for taxes that are owed. And that is 
something I hope we will discuss in this hearing. 
  But in any event, I certainly appreciate the Senator holding this 
hearing and I look forward to hearing from our witnesses. 
   Chairman CONRAD. Thank you, Senator. 
   We will go to the witnesses now. Mr. McIntyre, welcome. It is good 
to have you before the committee once again. Please proceed. 

   STATEMENT OF ROBERT S. McINTYRE, DIRECTOR, CITIZENS FOR TAX JUSTICE 

   Mr. MCINTYRE. Thank you. 
   Senator Conrad and members of the Budget Committee, I am Bob 
McIntyre and I direct Citizens for Tax Justice, which is a tax policy 
and research group that fights for a fair tax system for middle income 
families all over the country, Federal, State and local. I have been 
doing this for 30 years. 
   Today we are talking about something that is an important piece of 
our tax puzzle, and that is the fact that we are not collecting taxes 
from a lot of people who should be paying them. You can look, as 
Senator Conrad pointed out at how serious our budget deficit problem 
is, how much we have been borrowing. In fact, over the last 5 years we 
have funded 25 percent of our Federal budget outside of Social Security 
with borrowed money, which is just staggering. And that was after 
balanced budgets in the years before that. 
   We know why that has happened. Income tax revenues have gone through 
the floor. They were more than 10 percent of the GDP in fiscal 2000. 
They have averaged 7.3 percent over the last 5 years, which is a 28 
percent drop. 
   Now we have had a minor improvement lately. Income taxes are only 25 
percent below where they were in fiscal 2000. That is the problem. Now 
we are not going to solve that problem while George Bush is president 
because he would veto any attempt to repeal his tax cuts. We know that. 
But Republicans and Democrats and President Bush, a Republican, must be 
able to agree that ought to collect the taxes that are due, that people 
who are cheating on their taxes should not be allowed to do so. If we 
cannot agree on that, well, my. 
   So what can we do? Let us talk about the tax gap, the nature of it. 
The IRS has a figure. It is not a very reliable figure. It is based on 
very old data or very incomplete research. They say the net figure is 
about $300 billion after they have collected $50 billion or so from 
catching people. 
   But it is bigger than that, in my view, because they do not count 
all of this offshore tax dodging because they do not know about it. 
They do not count all of these corporate tax sheltering deals because 
they do not know about them or do not know enough about them to 
measure. So it is really an even bigger figure than that. 
   Those are the things that are doing the most damage right now to our 
tax system, in my view. And that is what my written testimony focuses 
on, and that is what I want to focus on in my few minutes today. 
   As Senator Conrad pointed out, we have a country of honest wage 
earners. They pay their taxes. Maybe not because they are morally 
superior but maybe because their income is known to the IRS. There is 
information reporting, there is withholding, and that works. 
   But when you get to the kinds of income that the IRS does not know 
about, whether it is capital gains or business profits that there is no 
paper trail that goes to the IRS, then we have a problem. The people 
who have these kinds of income are not all a bunch of crooks. Some are. 
But they all need help. They need our help to pay their taxes honestly 
and be good patriotic Americans, like I am sure they all want to be. 
   So how can we help them? Well, we need to get rid of the secrecy as 
much as possible so that there is a paper trail to the IRS, so that the 
IRS knows about these kinds of income. You can do some of it with 
1099s. You can do some of it with agreements with other countries, 
which is a huge problem, so we get information from them. We have a 
long list in our testimony of proposals that get into that area. 
   We also need to clarify the law. We have laws against most of these 
offshore tax cheating activities. But arguably they are not completely 
clear. And if you are a lawyer, everything is arguable. I went to law 
school, too. 
   We need to make it completely clear so that people do not have a leg 
to stand on when they get into these deals. That means that the people 
who are advising them, the lawyers, the accountants, the investment 
bankers, will be in serious trouble if they help them out in these 
schemes. So clarification is a good thing. 
   Penalties would also be a good thing. I know we have been increasing 
penalties. They are obviously not high enough because the chances of 
being caught are so low. Penalties on the advisers, even more 
penalties, would be a good idea. 
   Finally, we need to give the IRS the resources it needs. The IRS has 
been cut back and cut back, so now the number of people who are devoted 
to examinations are down by almost one-third since 10 years ago. That 
is a huge problem. 
   Let me just say that this may sound easy and I am implying it is 
easy, that everybody ought to agree. But there is a lobby that does not 
agree and they have a lot of power. You could argue that the House Ways 
and Means Committee for the past 6 years has been a wholly owned 
subsidiary of the major accounting firms. Every attempt by the Senate 
to crack down on cheating has been resisted in the House up until now. 
I do not think that is going to be the case anymore. 
   But there is an organized Tax Cheaters Lobby. It is financed by the 
banks, the accounting firms, and the lawyers who offer this kind of 
advice. They have front groups. One of them is called the Center for 
Freedom and Prosperity, a grandiose title. But I prefer to call them 
all Tax Cheaters Lobby because that is more intelligible. 
   Fortunately, there are a lot of people, in the Senate, in 
particular, who have been leading the fight in the other direction, and 
that is the good news. Carl Levin and Norm Coleman over at the 
Investigations Subcommittee. Byron Dorgan, your colleague from North 
Dakota who has been fighting against corporate and offshore cheating 
since he came to Congress. Senator Grassley, who as Senate Finance 
Committee Chairman has helped exposed some of these terrible abuses, 
and proposed legislation--and occasionally adopted legislation--to try 
to crack down on it. 
   So these are the people you should be looking to once you give them 
the mandate do something about it. 
   In my testimony, I have a lot of details about going after offshore 
tax evasion. 
   There are a lot of little things you can do and there are two big 
ones. One big one is to get the tax haven countries to disclose what is 
going on with our citizens. The only way you are going to do that is to 
have pressure on them so that, for example, if they do not disclose, 
our banks cannot talk to them, cannot send any money to them. They are 
out. They have to disclose. 
   The Cayman Islands, by the way, is worried about that enough that it 
is starting to think about giving us some serious disclosure. The 
problem in the world is if you have just one tax haven country, you are 
up the creek because that is where the money will go. So we need to go 
after them all. And we need to get the European countries to work with 
us on this. They are dying to do it because they have the same problem 
we do. 
   We see some of our celebrities moving their money offshore. The 
Levin-Coleman hearings found three people that were moving billions of 
dollars offshore. Well, the British have the same problem. The Rolling 
Stones and Bono have moved their song writing royalties to the 
Netherlands, which does not tax royalties. Their tax rate on billions 
of pounds has been 2 percent. So we need to work with the rest of the 
world on this. 
   I see my time is up but finally, the IRS. If you could phase in a 
doubling of their enforcement budget over the next five or 6 years, the 
returns would be enormous and it would get us back on the right path. 
Maybe you need to change the budget rules. After all, if the IRS was 
treated like any other agency, it would have offsetting receipts. OK, 
we spent $11 billion, our offsetting receipts were $2.2 trillion--do 
you see what I am saying? 
   Why do they not get treated that way? The National Park Service gets 
to count the fees for going in to the parks? The National Taxpayer 
Advocate has suggested something along these lines. Really, it is kind 
of wacky that you should freeze the IRS budget when it costs you 10 
times or 15 times what every budget cut that you put in saves. 
   So those are my recommendations. I have a long piece of written 
testimony and I thank you for the opportunity to be here. And I am 
sorry I went over a minute. 
   [The prepared statement of Mr. McIntyre follows:] 


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   Chairman CONRAD. Thank you very much for your testimony. 
   Mr. Brostek, welcome. I should indicate once again, Mr. Brostek is 
with the General Accounting Office, who have studied this issue in some 
detail. We welcome you to the committee. 

            STATEMENT OF MICHAEL BROSTEK, DIRECTOR, 
              TAX ISSUES, STRATEGIC ISSUES TEAM, 
              GOVERNMENT ACCOUNTABILITY OFFICE 

   Mr. BROSTEK. Thank you, very much. 
   Chairman Conrad, Senator Gregg, and members of the committee, I am 
pleased to participate in the committee's hearing today on approaches 
to reducing the tax gap. 
   My statement discusses the need for multiple approaches to 
successfully reduce the tax gap, including the importance of quality 
service to taxpayers and then covers potential reductions in the tax 
gap that could ensue from simplifying or reforming the tax code, 
providing IRS more tools to deal with noncompliance, and dedicating 
more resources to enforcement. 
   Before I address the approaches for reducing the tax gap, perhaps it 
would be useful to explain a little more about what the tax gap 
entails. The tax gap, as was mentioned, is the difference between the 
tax amounts that taxpayers voluntarily and timely pay and what they 
should pay under the law. The tax gap covers the individual and 
corporate income taxes, employment taxes, estate taxes and excise 
taxes. Individual income taxes have the largest estimated gap, about 
$244 billion out of the total gross gap of $345 billion estimated by 
IRS for tax year 2001. 
   For each type of tax there can be three different kinds of 
noncompliance: under reporting of income, under payment of taxes that 
are owed, and non-filing of returns. Of these, under reporting of 
income is by far the largest noncompliance issue with an estimated $285 
billion of the total gap attributed to under reporting of income. 
   Under reporting of income includes not only the direct failure to 
report income that was earned, but also such things as over claiming 
deductions and credits that offset income. 
   In summary, the tax gap is a persistent problem and, as the saying 
goes, we will keep on getting the same result--an unacceptable gap--if 
we keep on doing the same things. We need to try new approaches. We 
need to make greater use of current effective approaches. 
   While simplification, more tools, and more resources all have the 
potential to help reduce the tax gap, using multiple approaches is 
likely to be the best strategy. No one strategy is likely to fully and 
cost-effectively reduce the tax gap, for example because the gap has 
multiple causes, spans differing types of taxes, and differing types of 
taxpayers. 
   Providing quality service is a necessary foundation to achieving 
high levels of compliance. IRS taxpayer services includes such things 
as education and outreach programs, simplifying tax processes, and 
revising forms and publications to make them electronically accessible 
and more easily understood by the taxpayers. Quality services can help 
those who wish to comply but do not understand their obligations, and 
such services are also needed if other approaches are taken to reduce 
the tax gap. 
   For example, even if we simplify the tax laws, as has been 
suggested, IRS would need to have an outreach program to educate 
taxpayers about those changes and to answer questions that would 
undoubtedly come from the taxpayers. 
   In addition to quality service, a few of the following things are 
also important to tax gap reduction. We need to periodically measure 
noncompliance and its causes, set tax gap reduction goals, consider the 
cost and burdens associated with various efforts to reduce the tax gap, 
evaluate the results of any initiatives that are undertaken so we know 
what works, optimize IRS's internal allocation of resources, and 
leverage technology. 
   Turning to simplification or tax reform, there is no reliable 
estimate of the degree to which simplification could reduce the tax 
gap. Nonetheless, one indication of the potential is that IRS estimated 
a revenue shortfall of $32 billion occurred in 2001 due to errors that 
taxpayers made in claiming various tax credits, deductions, et cetera. 
Over the decades, the tax code has layered on more and more special tax 
provisions with the number of tax expenditures, as they are called, 
like credits and deductions doubling in number between 1974 and 2005. 
By making the rules across differing tax provisions more uniform, by 
merging multiple related provisions, and by deleting provisions that 
may not be accomplishing their intended purpose at an acceptable 
revenue cost, the tax code could be simplified. And if so, both 
intentional and unintentional errors should decline. 
   Further, to the extent that tax simplification reduces errors, IRS 
would be able to relocate its resources to focus on more problematic 
areas of noncompliance. However, of course, each tax code provision was 
created for a purpose and simplifying the code is likely to be 
challenging. 
   Tax reform also has the potential to reduce the tax gap, but it is 
most likely to be effective if any reformed system has few, if any, tax 
preferences and importantly, taxable transactions are transparent to 
the tax agency. These characteristics are difficult to achieve and, to 
my knowledge, all tax systems have some sort of tax gap. 
   Tax withholding and information reporting are among the most 
powerful tools for promoting compliance. If we can spread these tools 
across more types of income that are the major contributors to the tax 
gap, substantial tax gap reductions are likely. Our recent work 
suggests that requiring information reporting on the basis for security 
sales like stock transactions has the potential to improve compliance 
with capital gains reporting. Importantly, a key additional benefit 
would be less taxpayer burden to understand and comply with the complex 
basis reporting rules. Additional opportunities for withholding and 
information reporting exist for payments to independent contractors and 
for payments made to corporations for services they provide to 
businesses. 
   Finally, devoting additional resources to enforcement has the 
potential to reduce the tax gap by billions of dollars. In part, 
devoting greater resources to enforcement could reduce the gap because 
every year IRS identifies far more cases of probable noncompliance than 
it can possibly address. How much the tax gap could be reduced if IRS 
resources were increased would depend on a number of things, including 
importantly information. Which taxpayers are noncompliant? Why are they 
noncompliant? And what amount of tax noncompliance can be corrected for 
a given dollar of additional investment in IRS resources? 
   We and others have frequently called for improved information like 
this to ensure sound management of IRS's limited resources. In part, 
this is why we have encouraged IRS to undertake compliance studies like 
the National Research Program that resulted in this most recent tax gap 
estimate. 
   As a caution, if additional resources are devoted to enforcement, 
returns on that investment are likely to lag as IRS hires and trains 
new personnel. In the past, hiring initiatives generally have reduced 
revenues in the initial year because new agents tend to be less 
productive than experienced agents, and IRS uses experienced agents to 
train the new agents which reduces the experienced agents' 
productivity. 
   Also, several years tend to lapse between the assessment of taxes 
and the collection of those taxes. For instance, in a 1998 study we 
found that 5 years after taxes were assessed against individual 
taxpayers for business income, 48 percent of those taxes had been 
collected. 
   This concludes my oral statement. I would be happy to answer any 
questions. 
   [The prepared statement of Mr. Brostek follows:] 

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   Chairman CONRAD. Thank you, very much. 
   Next we will turn to Mr. Satagaj from the Small Business Tax 
Compliance and Fairness Coalition. Welcome. 

                STATEMENT OF JOHN SATAGAJ, SMALL BUSINESS LEGISLATIVE 
                  COUNSEL, SMALL BUSINESS TAX COMPLIANCE 
                  AND FAIRNESS COALITION 

   Mr. SATAGAJ. Good morning. My name is John Satagaj. I am here on 
behalf of the Coalition for Fairness in Tax Compliance. I co-chair this 
with my colleagues at the National Federation of Independent Business 
and the U.S. Chamber of Commerce. 
   Bob above mentioned that he has been doing this for 30 years. Mike 
was telling me he has been at GAO 30 years. I have been doing small 
business 30 years. So you have a lot of experience before you. 
   It reminded me, when Bob started his remarks, it is all about 
perspective. He started out his comments about we are a Nation of 
honest wage earners. I think of us as a Nation of small businesses and 
entrepreneurs taking risk, creating jobs, and signing the paycheck of 
those wage earners. So my perspective on this comes from that 
perspective, that of those small business that are creating those jobs. 
We have a few points. 
   Our coalition is not anti-tax gap. We are here to find solutions to 
this. But it is important for us that several things happen. No. 1, we 
have the proper research to understand what the problems are. Mike has 
mentioned some of the problems that we have there. 
   That we find reasonable solutions, the ones that do not create 
burdens, that respect the complaint taxpayer. Do not forget, most of 
this money is coming in a voluntary system and people are compliant. So 
what we do cannot hurt the compliant folks. So we have to remember 
those things as we move forward on this. 
   And as we look at what we need to do, you will find out, as Mike as 
already mentioned, we are failing to get the research done that we need 
to understand what causes the tax gap, why people are not reporting 
their income. Tax gap studies started in the 1960's. I think GAO 
published the first report in the 1970's. You can look at everyone of 
those reports, and I guarantee you almost every one of them says the 
same thing about we do not have enough research. 
   It is easy to paint this with a nice broad brush. Tax gap, one 
solution fits all. It does not work that way. When you get below that 
level, it is hard to figure all of those disparate and discrete areas, 
that are the problems in the tax gap and understanding then. 
   Let me give you one quick example, sole proprietors. We say $68 
billion comes from the folks that fill out their 1040, attach a 
Schedule C and have business income. 21 million taxpayers are sole 
proprietors. 13 million of them have $25,000 or less on that Schedule 
C. 
   What is the problem? Some folks say let us do withholding. 21 
million taxpayers, withholding tomorrow. There is one big question, if 
you are going to do withholding, that no one can answer for me. How 
many of those 21 million do business primarily with consumers? If you 
do business primarily with consumers, I ask you, who is going to impose 
withholding, telling the consumer by the way, when you do business with 
X, withhold $20 from them? We cannot answer that very fundamental 
question. 
   No. 2, if you are going to have a reasonable burden on those folks, 
on the 21 million, if 13 million of them do $25,000 or less, you are 
going to have to look pretty carefully at what you impose on them in 
order to get any sort of revenue. Even if they are the worst tax cheats 
in the world and they are only reporting half of their income, that is 
still a $50,000 business. That is a very small business we are talking 
about here. So you are challenged to come up with a solution. 
   First, we need the research. Second, we need reasonable solutions 
that are directed to the problem. And until you understand what the 
problem is, you are not going to come up with a solution. 
   Next, about respect. It is easy, and we know how it is here, 
particularly when we are talking about public policy as opposed to the 
compliance at the IRS. The tax gap. We are going to use the tax gap at 
least 20,000 times in this Congress to pay for something. The important 
thing is that when we work on the tax gap, let us be honest with the 
taxpayers and work on tax gap initiatives, not on something that is 
used for another purpose. 
   A good example of one that has already spun out of control in the 
last Congress, Government contractors' withholding. The notion was 
there was a problem there. Well, now all Government contractors have a 
3 percent withholding on them. That spiraled right out of control right 
from the very beginning. 
   There are going to be proposals that people are going to say we want 
to use it for PAYGO. But you know what, they are going to call it tax 
gap closing. And I guarantee one that is going to be called that way, a 
proposal to repeal LIFO. It came up in the last Congress and I bet it 
will come up in this Congress as a PAYGO for something. And somebody is 
going to get up on the Senate floor, one of you is going to say, you 
know what, let us close the tax gap and repeal LIFO. LIFO is a 
legitimate concern. If you choose to look at that, look at it for that 
purpose. But do not call it tax gap closing, because it is not tax gap 
closing. There are honest taxpayers out there who have been relying on 
this for years in order to do this. 
   What we need to do is get the research, get the reasonable results, 
and let us respect the compliant taxpayer in the process. 
   A couple of last things--
   Chairman CONRAD. Maybe I could just stop you on that point because I 
am sure there are people who are listening who wonder what is LIFO 
about? That is last-in first-out accounting for inventory. 
   That is important to say to people who might be listening and 
wondering what is about. 
   Mr. SATAGAJ. Good point. And it is one that obviously is allowed 
under the tax code. 
   Chairman CONRAD. I think we should make very clear, you are right, 
that does not have anything to do with the tax gap, because that is in 
law. What we are talking about here is people who are not obeying the 
law. 
   Mr. SATAGAJ. Exactly. And that is my point exactly, is that we need 
to have the discipline. When we are talking about the tax gap, let us 
stay focused on the tax gap and respect the compliant taxpayers. 
   The last point I would like to make is about the size of the tax 
gap. Bob started out by saying it was $345 billion. It could be bigger. 
   I started out $345 billion, it is actually $290 billion. It is 
smaller because there is a net amount that you could collect $55 
billion really is a timing issue and so forth. So it is actually 
smaller than the $345 billion from a starting point then we discussed 
there. 
   So in conclusion, we are here to work with everybody. We want to 
work with all of you here on Capitol Hill, in Congress, work with the 
GAO. We have met numerous times already with the IRS and Treasury 
looking at identifying the research that we need, what kind of 
solutions we can come up with that meet those things. 
   We can do this, but there is no short-term solution and this is not 
going to happen overnight. It is going to take a lot of work on all of 
our part. 
   Thank you, Mr. Chairman. 
   [The prepared statement of Mr. Satagaj follows:] 

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   Chairman CONRAD. Thank you, Mr. Satagaj, and thank you for those 
constructive thoughts. 
   Just on the question of how big the tax gap is, I believe it is much 
larger than $345 billion because I have looked into how they made the 
estimates. And I do not want to bore people with the details of how 
that was done. But I think honestly if you evaluate the way they made 
the estimates, the likelihood is the tax gap is substantially bigger. 
   First of all, that is a number from 2001. We are in 2007. If we look 
back historically, we have seen that the tax gap has grown inexorably 
and, in fact, has exploded in recent years. 
   Second, if you talk to people in the accounting profession, they 
will tell you that what we call aggressive accounting has increased 
geometrically. That is because of competitive pressures, accounting 
firms have become much more willing, if not eager, to engage in very 
aggressive accounting practices with respect to taxes that are due. 
   Let me just go to the question I would ask each of you. If you could 
give two ideas that would make a meaningful difference with respect to 
the tax gap, what would they be? Mr. McIntyre? 
   Mr. MCINTYRE. Well, if I only had two things, No. 1 would be to get 
more information from the tax haven countries about our people and 
corporations who have activities there or pretend to have activities 
there. 
   And second, a very substantial increase in the IRS budget for 
enforcement. 
   Chairman CONRAD. All right. Mr. Brostek? 
   Mr. BROSTEK. I would first encourage more information reporting. 
Although I do not have a laundry list of things that would necessarily 
bring $300 billion down to zero, if we get information reporting on 
various types of income, it will achieve high levels of compliance, as 
we have seen. 
   I would also look for opportunities to simplify some of the complex 
provisions that help people who would like to cheat figure out ways of 
doing so and that confuse honest taxpayers. 
   Chairman CONRAD. OK. Mr. Satagaj? 
   Mr. SATAGAJ. There are two things. One is taxpayer education. We 
started on a road in 1998 to encourage better education and outreach to 
the community. If you work with small businesses, you know it is hard 
work to get the message out. You have to repeat it time and time again 
and over and over. And we are still not reaching the level we can. We 
can do better on that. 
   Tax simplification, of course, is a way I believe that we can get 
more folks in there because there are still is a lot of folks who say, 
you know what, this is too complex and I am not doing the job. And so I 
think those two things could go a long way to helping us. 
   Chairman CONRAD. Let me ask you this question, and ask each of the 
witnesses. How about tax reform? We have a tax system that was largely 
constructed in the 1930's, the 1940's, and the 1950's. The world has 
changed. We have, I think, what is clearly a growing tax gap which 
raises questions about the efficiency of the underlying system. How 
much emphasis would you put on fundamental tax reform in order to 
achieve a result? Mr. McIntyre? 
   Mr. MCINTYRE. If we could take the tax system back to say where it 
was--at least on the base--after the 1986 reform act, that would help a 
lot. Since then we have added all kinds of new special tax breaks, made 
the tax forms finer and finer print to fit because of all of the extra 
lines. And that has annoyed the honest taxpayer and created 
opportunities for those who would like to be less than honest. So that 
would help. 
   But perhaps most important about that kind of a tax simplification 
reform effort would be to correct a growing problem. You have the IRS 
running half of the Government these days, it seems like. Health care, 
education, savings policies. They have to do all of these things. That 
is not what they are supposed to be doing. It is not what they are 
trained to do. They are supposed to be collecting revenues fairly and 
efficiently. If they could get back to their real job, they would do a 
much better job of it. 
   Chairman CONRAD. Mr. Brostek, what would you say about this question 
of tax reform as an essential component? 
   Mr. BROSTEK. I do believe that tax reform should be part of the 
strategies that are pursued for reducing the tax gap, in part because 
if we are able to make the code simpler, reduce the number of credits 
and deductions and exclusions from income, we can have lower tax rates. 
And the lower the tax rate is, the less incentive somebody has to 
escape taxation. It would also help us raise revenues efficiently in 
the economy. 
   I would also point out that tax reform is not necessarily synonymous 
with high levels of compliance. One of the things that is sometimes 
thought about when tax reform is discussed is moving to a consumption 
tax. Consumption taxes can have high levels of noncompliance, as well. 
The National Audit Office in the U.K. has estimated that their value 
added tax has had a tax gap of about 15.7 percent. That is roughly what 
we have in this country. 
   So reform itself can be helpful, but it is how that reform is done. 
We really need to have transactions transparent to the tax 
administrator in order to have tax reform work well. 
   Chairman CONRAD. Mr. Satagaj? 
   Mr. SATAGAJ. I have already tipped my hand because I mentioned tax 
simplification as one of the ways I think we do a better job, and that 
is fundamental to tax reform. I think you do have to be a little 
careful of the difference between tax reform and tax simplification. 
   As Mike has already pointed out, you can get tax reform without 
actually simplifying. I think the important point is the comfort level 
 of the taxpayer has to be high enough, whatever system you have, that 
they are willing to be compliant at the levels that they are currently 
compliant. 
   Chairman CONRAD. Let me just say on the point that Mr. McIntyre 
made, we have a building down in the Cayman Islands, one building, a 
five-story building, that is the home to something like 8,000 
companies. 
   Senator GREGG. Do you have a picture? 
   Chairman CONRAD. I do, it is on its way. 
   This building is home to some 8,000 companies all claiming they are 
doing business out of that building. I have said it is the most 
efficient building in the world, a very modest building. But an amazing 
amount of business activity out of that building. 
   I think, Mr. McIntyre, you have hit on something here with respect 
to information from tax haven countries. There is tremendous leakage in 
those countries. When I was tax commissioner in my State, and for a 
time the chairman of the Multistate Tax Commission, I followed the 
transactions of one multinational corporation and found that in the 
sale of grain, that grain had changed hands eight times before it left 
this country and then went offshore. The last I was able to follow it, 
it was down in the Cayman Islands, selling from one company to another. 
It was amazing, no taxes reported in this country, and although they 
showed tremendous profits in the Caymans, no taxes there because they 
did not have any taxes. 
   I found that when I was tax commissioner, one oil company that 
showed losses at every step of the marketing chain in the United 
States, showed huge profits in the Cayman Islands with one employee. 
Millions of dollars in profits because that is where they showed all of 
their profits. 
   Actually, that man is really a hard worker. He is down there 
producing millions of profits when thousands of employees in the United 
States produced none. 
   Look, these are scams that are being run that are really unfair to 
the vast majority of people who are honest. I think, Mr. Satagaj, you 
said it well. The fact is most people, I think a significant vast 
majority of Americans, pay what they legitimately owe. Companies pay 
what they legitimately owe to the extent they understand it. 
   But there are a group out there, and unfortunately I think it is a 
growing group, who think they can get away with murder. And they are 
shoving the burden onto all of the rest of us. 
   Senator Gregg? 
   Senator GREGG. Thank you. 
   Picking up on that note, obviously better transparency as to what is 
happening offshore would be very useful. But it does require an 
international effort. I think Mr. McIntyre made that point. If we do it 
unilaterally we actually end up disadvantaging ourselves in the 
international trade. So it has to be done with the Europeans and with 
the major economies in Southeast Asia. But it should be done, I am 100 
percent in agreement with that. 
   I also have some horror stories I could relate that I am familiar 
with, as to people avoiding taxes by using those shelters. 
   So I think that is something that can be done. This committee does 
not have jurisdiction over that, but it should be done. 
Something else that could be done is better reporting basis on capital 
assets. I think that is clearly some direction we are moving into and 
it clearly should occur. 
   I am interested, however, in this question which you have pointed 
out, Mr. Satagaj, that is basically that unless you have the system 
that people have confidence in is fair and understandable, you are 
never really going to get compliance. This goes back to the 1986 act 
which has been highlighted here as an example of an attempt to make our 
system fairer and more level, in which a lot of deductions were 
eliminated in exchange for reducing rates. 
   I guess I would ask whether or not people think that is a template 
that we should return to? It has been 20 years since the 1986 act, and 
we have now recluttered the code with all sorts of new deductions for 
purposes which are outside the intention of raising revenue. 
   That initiative, in 1986, I was on the Ways and Means Committee. It 
was a bipartisan initiative led by Chairman Rostenkowski and the 
President, with the Congressional leaders being Jack Kemp and Bill 
Bradley. I guess the question is should we return to that sort of a 
really major effort to reduce the underbrush and the tax laws and get 
back to rates that are simpler but collect more revenues because there 
are fewer deductions that are being used for the purposes of avoiding 
taxes? 
   Mr. MCINTYRE. I am obviously for it. 
   Senator GREGG. That is great. I am impressed that your organization 
would be for that. I think that is very positive. 
   Mr. MCINTYRE. I just want to point out that in 1986 we played a 
major role in getting that bill through the Congress with the studies 
we did exposing the kinds of tax avoidance that got the public 
exercised and got President Reagan on board, as a matter of fact, 
according to his Treasury Secretary at the time. 
   So yes, 1986 was the right direction. It had one flaw which was 
easily corrected, that it did not raise enough money to pay for the 
Government. But that is just a rate issue. That is what we need to do, 
establish a tax base like 1986, with rates sufficient to pay for what 
we spend. What we spend and what we take in are obviously two important 
questions. But whatever you decide to spend, you ought to pay for it. 
   Senator GREGG. Mr. Brostek? 
   Mr. BROSTEK. I think that broad template is quite reasonable to 
return to. It is not that there cannot be legitimate tax deductions and 
tax credits. There can be things that are done well and efficiently 
through the tax code. But we certainly think that the growth of these 
special provisions ought to be reviewed. And we ought to make sure that 
the provisions we have are accomplishing a purpose at a reasonable 
revenue cost. 
   Mr. SATAGAJ. Obviously, I agree. One of the important things, 
though, is you have to decide-which is just what Mike said. You have to 
decide what is the purpose. Not a purely neutral system. But our 
current tax code does have some purposes and we reward, for example, 
home ownership as important. And if you go into a tax reform debate, 
you need to decide that. Are we going to accomplish some goals in 
addition to just raising revenue? 
   And that is the big challenge of sorting that out. Once you get that 
decision made, it becomes a little easier how or where you go. But the 
notion that you are just going to do this to raise revenue, I do not 
think, is an acceptable starting point. 
   Senator GREGG. I appreciate all of your comments. I would like to 
see us move in that direction. 
   Another ancillary point that has been made here is the accounting 
firms. We are down to four major accounting firms in this country, and 
that has been a function really of reform. We have essentially reformed 
our way out of accounting firms and competition amongst accounting 
firms, and therefore we do not have any accounting firms left. 
   I guess my question would be to you, do you think having more 
accounting firms and some competition there would create a better 
atmosphere? Or are four major firms doing all of the audits in this 
country the way to do it? 
   Mr. SATAGAJ. I will wear my entrepreneurial hat. I would like to see 
more small accounting firms. I think obviously that small businesses--
are not going to the big firms anyway. They need good accounting advice 
and so I think it would be very helpful. 
   We have talked about it. Commissioner Everson has been very 
aggressive in a lot of areas as it relates to tax shelters and the 
like. We have a lot of work being done in that area. But it is what we 
do with the small businesses and the advice we give them that I think 
is important. And I think some more activity in that area is a plus in 
my book. 
   Mr. MCINTYRE. It would be nice to have some more accounting firms 
that were less ethically challenged than the current four. 
   Senator GREGG. I would be interested in your thoughts on how we do 
   that in the context of today, when you require size in order to 
basically meet the amount of compliance that we put on these firms. 
I guess my last question would be in the context of the 1986 act, was 
the Breaux-Mack Commission, did they put forward some ideas that would 
lead to some better compliance? Or do you reject their ideas? Because 
that is the most recent major tax commission. 
   Mr. MCINTYRE. They had some fundamental problems. They had a $7 
trillion add-on to the deficit over the next 10 years. But beyond that, 
on the international area they said they were going to make it harder 
for the IRS to get compliance. So I was very disappointed in that 
effort, as well. It was not that fine of a piece of work, in my view. 
   Mr. SATAGAJ. I do actually. Chairman Rossotti was on that 
commission, as well. There is actually a large small business component 
to what they proposed. And intriguingly, it actually promotes more of a 
cash accounting system but it provides incentives to go to that. And it 
is a little bit about the transparency. 
   I think those of us in the small business community, maybe we would 
be willing to give some more transparency in return for something that 
makes our life easier. If you could get to cash accounting and in 
return you did have to make some more transparency, that would be good. 
A lot of folks do not look at the small business proposal in the 
Breaux-Mack Commission's work. But there are some interesting thoughts 
about how you work with the small business community to make it simpler 
but more transparent. 
   Senator GREGG. Thank you. 
   Chairman CONRAD. Given the number of senators here, we are going to 
go to 5 minute rounds to accommodate as many Senators as we can. 
   Senator WYDEN. 
   Senator WYDEN. Thank you, Mr. Chairman. This has been an excellent 
panel. I have been particularly pleased because, having introduced the 
fair flat tax reform which modernizes the 1986 act by closing loopholes 
so that you can lower rates, I have been really pleased with the 
response that you all have given this morning. 
   Ever since I introduced that legislation, when witnesses show up 
they all say we ought to try to update the 1986 kind of concept. But 
gosh, everyone says it cannot ever be done. The newspaper reporters are 
always describing it will not happen, this is a lonely crusade that 
this fellow from Oregon has taken on. 
   What I found striking this morning is you all have given us a way to 
jumpstart the effort to close the tax gap and also do tax reform. And 
that is through tax simplification. 
   There have been 15,000 changes in the tax code since the last 
reform. It comes to three for every working day over the last 20 years. 
People spend more to fill out forms than our Government spends on 
higher education. 
   I have a one page 1040 form with 30 lines in my Fair Flat Tax Act. 
Senator Gregg mentioned the Breaux-Mack Commission. Their's is about 
seven lines longer. For purposes of Government work, it is a no-brainer 
to put the two of them together. 
   I just want to go down the row and ask, we can start with Mr. 
McIntyre, would it not make sense to come out of this hearing and say 
the next step that could promote common ground--and I note, Mr. 
McIntyre, you have been trying to do that with your cleanse the code 
effort, and I have been glad to be part of it--would it not make sense 
to come out of this effort and say let us go now to tax simplification 
and use it to jumpstart a real plan to close the tax gap and to reform 
our tax law? 
   Let's start with you. 
   Mr. MCINTYRE. I am certainly in favor of the outlines of your tax 
reform plan. I have a couple of quibbles, but very few. So if we could 
find a way to move that forward, and if this was a good way to make 
that happen I would be in favor of it. 
   My big caveat is I cannot figure out how any good tax reform could 
be signed by the current president of the United States. So it makes me 
very nervous that we would end up with something bad. 
   Senator WYDEN. I told the President that another tall Democrat on the 
Senate Finance Committee named Bill Bradley wanted to work this out, as 
well. My jump shot is not as good as a Bradley's, but I still think the 
spirit of 1986 can be replicated. 
   Mr. MCINTYRE. There is one difference. When Ronald Reagan read our 
corporate studies, finding out that General Electric, his former 
employer, was not paying any taxes, he was appalled and said, ''do 
something about it.'' When we put out our most recent corporate study, 
saying that under President Bush's policies 82 companies out of 275 
were paying nothing at all, Bush's people said, ''is it only 82?'' 
   Senator WYDEN. Mr. Brostek, on starting this with tax 
simplification, what is your reaction to that? 
   Mr. BROSTEK. I think that is a good strategy for starting to try to 
address the tax gap. 
   Senator WYDEN. Very good. 
   Mr. Satagaj, I was really pleased to hear your comments today on tax 
simplification, because I know, having worked with my small business 
community, that people are just fighting for survival. And so the 
inclination is to always kind of tinker with the code a little more. 
But I gather you would be comfortable with that simplification, as 
well. 
   Mr. SATAGAJ. Simplification, my caveat is the one I said a few 
moments ago, you have to buy into a purpose of what you are going to do 
with the tax code. That is far more difficult. It is nice to look at 
the 1040 and the lines and stuff like that. But if you look, for 
example, at the rest of the recommendations of the President's Advisory 
Group, there is a lot of complexity behind that, particularly on the 
business side. It is not just a little form to fill out. There are a 
lot of decisions that go behind that. 
   So is a far more difficult challenge than getting a little consensus 
that it is time to clean up. It is getting the consensus on the purpose 
that is far more important. 
   Senator WYDEN. Mr. Chairman, I would just note that a number of us 
here serve not just on this committee but on the Finance Committee. 
Given the number of witnesses that constantly come up and say you have 
to drain this swamp, I think we need to do something. One member of the 
Senate Finance Committee told me, ''I do not really know about your 
bill as it relates to every provision. But after 20 years, this has 
just gotten out of hand. We have to cleanse the code.'' 
   And I hope, Mr. McIntyre, that your group, the Cleanse the Code 
coalition, can really get out and prosecute the case about what we can 
do in this country by cleaning out some of the clutter, getting more 
transparency, closing the tax gap and jump starting us to real tax 
reform. 
   I commend all three of you for an excellent presentation. Mr. 
Satagaj, I am going to be back at you specifically about my 
legislation. 
   Mr. SATAGAJ. I look forward to it. 
   Senator WYDEN. I thank you. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Senator Wyden. 
   I would like to take this moment to indicate that I am going to form 
at least two working groups of the Budget Committee, one on health care 
and one on this whole issue of tax gap tax reform. I am going to ask, 
on the health care piece of it, that Senator Wyden and Senator 
Whitehouse lead that effort. I am going to ask, with respect to that 
tax reform piece of it, that Senator Wyden and Senator Stabenow be 
involved with that. I would welcome the interest of other members on 
these two committees. And I am going to indicate that there will be 
others that we will form. 
   The magnitude of the challenges that we face are so large that I 
think we have to establish some working groups of smaller members of 
the committee to come back to the full committee with specific 
proposals. I have had long discussions with Senator Whitehouse and 
Senator Wyden on the whole question of the health care piece of it. I 
know that Senator Wyden has been especially engaged in that issue, as 
well as the tax reform. I do not know if it is fair to burden with 
asking you to also be involved on the tax reform piece. 
   And Senator Stabenow, you are a member of the Finance Committee. I 
hope that you would be engaged in that effort. 
   We will ask Senator Grassley to be involved on the other side with 
the tax reform pieces, the ranking member of the Finance Committee. On 
health care, we will ask members on both sides who is willing to put in 
additional time with respect to those issues. 
   But I think it is absolutely urgent that we come back with specific 
proposals and that is what I am going to be asking these working groups 
to do. 
   These will not be the only, there will be a number of other areas 
that we need to address as well, and we will be talking about those in 
the coming days. 
   Senator Allard, thank you for your patience, sir. 
   Senator ALLARD. Thank you, Mr. Chairman, and thank you for setting 
up this panel. 
   In this discussion, I think the assumption is that the IRS is the 
perfect agency and they do not make mistakes and some of the things 
that they deal with are ignored, as far as performance is concerned. 
   I do not know whether anybody on this panel has looked at the 
business system modernization that has been going on at the Internal 
Revenue Service. But what I see in looking at what shows on paper is 
that that particular program is not meeting its performance goals. The 
President, in the last budget, actually had decreased its funding 
because it was not meeting its performance goals. 
   Can either one of you comment on the purpose of that particular 
program, and whether it is working from your perspective or not? 
   Mr. SATAGAJ. Actually, I am glad you brought that point up because 
earlier when the Chair asked for a couple of suggestions on how to 
close the tax gap, I had a third. One of them is the problem in the IRS 
with its ability to accomplish anything with the information it 
currently has. For example, if you get into the 1099s and the issue of 
matching them and do you have the capability to do that? 
   Right now it is my belief that the IRS is behind in exactly the way 
you are saying in those kind of things. I remember the first time I saw 
an IRS Service Center and they had what they called a Gideon table. I 
do not know if you all are familiar with that, but is a desk with about 
a zillion little slots that they throw tax returns into. 
   Well, I saw that in 1985 and it is still in use. They may still have 
it. 
   But the notion of the computerization and the modernization and all 
of that, it has a long way to go yet. There is no doubt about that, in 
my opinion. 
   Senator ALLARD. Anybody else looked at that program? 
   Mr. BROSTEK. Although I have not personally be involved in reviewing 
that program, GAO has looked at it a number of different times. And it 
is certainly true that it is well behind the milestones that were 
originally established and IRS has struggled over a number of years to 
be sure that it has sufficient management capacity to manage this kind 
of transformation in their IT systems. 
   It is also fundamental to getting efficiency improvement in how IRS 
uses its own resources. The ability to process more information 
electronically and to analyze it rapidly, is key to then better 
identifying how to allocate their own resources. 
   Senator ALLARD. Do you think electronic filing would help with that 
particular program? 
   Mr. BROSTEK. I do. One of the things that that allows IRS to do--and 
give them some credit, they have begun doing this--is to reduce the 
amount of work force that is doing the kind of things that Mr. Satagaj 
just mentioned, pushing paper around, and instead use work force that 
have higher-level abilities to actually figure out who is non-compliant 
and audit them and get the money that is owed. IRS has been able to 
close down the paper processing pipeline in a couple of service centers 
because of the increase in electronic filing. Further electronic filing 
will help them continue that. 
   Senator ALLARD. I have run into several individuals who are just 
starting out in life. They are young families. And the IRS has sent a 
notice to them that they did not pay enough taxes. One family pointed 
out and said well, they are claiming I do not have a kid. I said I 
distinctly remember getting up early in the morning and changing 
diapers. So do not tell me I do not have a kid. 
   But to try and correct that, I mean the margin of error on something 
to correct that form is $85 or $65, it is some amount less than $100. 
And what their accountant will tell them is, you are better off just to 
pay the thing instead of fight the IRS on it. 
   Has anybody ever done a study to find out how much effort is made to 
collect money from taxpayers who owe under $100? You are getting down 
to a minuscule amount. On one taxpayer it may not amount to much. If 
you are just a starting family, it is a fortune. If that happens with 
500,000 families, for example that file joint returns, you are talking 
about $50 million. 
   So has anybody ever looked at those small collections that the IRS 
spends time on and enforces? How much enforcement action is put in that 
particular area? And what do you do about those kind of situations? 
   Mr. BROSTEK. I am not personally aware of whether a study has been 
done on that exact issue of how much resources go into these kinds of 
small dollar issues. 
   I do know that IRS has various thresholds in pretty much all of its 
enforcement programs, and they do try to allocate their resources to go 
after suspected noncompliance that would be worth pursuing. 
   It is, in part, a speculation on my part, but a situation that you 
are talking about could be something that is being turned out from 
their information returns program where they match up information 
returns. That is a fairly inexpensive program for them, because it is 
largely computerized. The generation of the notice is computerized. 
Their biggest expense is when people call in to try and figure out how 
they can take care of their situation. 
   So there are some situations where a relatively small dollar amount 
might still be efficiently pursued by the IRS. 
   Senator ALLARD. In that electronic program, how does an error like 
that happen? They did not even recognize the one kid. 
   Mr. BROSTEK. Again, I do not know what the circumstances were there. 
It is possible that they had not recorded the Social Security number 
for the dependent on their tax return, or perhaps made an error in 
putting that number down on the tax return, and therefore the IRS did 
not recognize that there was a valid child for the couple. 
   Senator ALLARD. Thank you. My time has expired. 
   Chairman CONRAD. Senator Stabenow. 
   Senator STABENOW. Thank you, Mr. Chairman. 
   And first, thank you for once again providing us with a very 
important hearing that is extremely relevant to what our task is. So 
thank you for doing that. 
   Also, thank you for the working groups. As Senator Snowe and I have 
been working on the issue of health information technology, which I 
know you are interested in, and Senator Whitehouse and I have spoken 
about it as well. We are looking at at least $100 billion in savings 
there if we focus on health IT. So I am hopeful that we might wrap that 
into what we are talking about, as well. There is tremendous savings 
there. 
   Welcome to all of our panelists. Thank you for your thoughtful 
information. Particularly Mr. Satagaj, I want to welcome you 
representing small business. You are, I know, connected with the 
association of a dear friend of mine, Peter Perez. He certainly keeps 
me focused on what small businesses are concerned about. 
   Mr. SATAGAJ. Me, too. 
   Senator STABENOW. So I appreciate your being here. 
   I did want to look from a broad perspective at what we have heard 
today because I am very concerned about what this means for middle 
income families, small businesses, the majority of people in our 
country. 
   Mr. McIntyre, you said that the largest cause of the enormous 
deficits has been the drop in personal income taxes, about 28 percent, 
again the highest income individuals less likely to be a wage earner, 
more likely to be a non-wage earner, a 28 percent drop. The lowest, in 
terms of revenues as a share of GDP, in the last 55 years. 
   But then when we look at that and then we look at also your 
testimony saying that it is actually a wage earner, a person who gets a 
paycheck, which is the majority of Americans, who are most likely to 
file their taxes, the most honest in that sense of filing and reporting 
and so on. And that where the challenge is are non-wager earners whose 
income comes from stocks, real estate annuities, foreign income and so 
on, where there is more of a challenge in under reporting for reasons 
whether that is on purpose or not. And it may not be. 
   But it shows a picture, Mr. Chairman, that is of great concern to me 
about what is happening to the majority of Americans who did not 
receive a benefit from the tax cuts, are paying their taxes dutifully. 
What they get from the bargain is less resources for their children's 
school or access to college or challenges around health care or 
whatever. 
   And yet we see of the $350 billion, or whatever the number is, that 
if everyone was paying their fair share, we would in fact be investing 
in things that all Americans believe are important for quality of life. 
So I think this is a critical, critical issue. 
   In terms of enforcement, Mr. McIntyre, I'm wondering if you are 
recommending that the majority of enforcement go to non-wage earners? 
It seems to me we hear about a lot of folks, middle income families and 
so on, the IRS issues related to working folks. Are you recommending 
that, in fact, we change the focus more toward those individuals based 
on this picture that represent the majority of noncompliant taxpayers? 
Mr. MCINTYRE. Yes. The increase in enforcement that is needed the most 
is going after these upper income people and large multinational 
corporations that are moving income and profits offshore. There are 
other tax shelters that need to be investigated, too, and Senator 
Grassley has exposed a number of those. But the offshore situation is 
the worst. And I can tell you that it is not your average wage earner 
engaged in these abusive practices. 
   Senator STABENOW. Absolutely. 
   When you mentioned the penalties when you were speaking, increasing 
penalties, could you give an example of what kind of increase, which 
you would recommend as it relates to penalties to address these kinds 
of things? 
   Mr. MCINTYRE. For instance, we have some penalties for tax 
preparers that intentionally file wrong returns for people. Some of 
them are only $50 or $100. With an audit rate now in the 0.8 percent 
range, and clients that will pay you to help them cheat--some will, 
anyway--well, it is just not enough because you are not going to get 
caught very often. So if the chances are one in 100 of getting caught, 
we want a penalty that is very severe, not $50 or $100 but thousands of 
dollars. Maybe that will scare some of these people. 
   Senator STABENOW. Thank you, Mr. Chairman.   
   Chairman CONRAD. Thank you, Senator Stabenow. 
   If I could just put up the--on the question Mr. McIntyre was just 
raising, here is now the picture of the building in the Cayman Islands. 
I was wrong. I think I said 8,000 or 10,000. 
   Mr. MCINTYRE. They probably got 4,000 more in the time you had to 
get that put together. 
   Chairman CONRAD. 12,748 companies call this building home. Looks 
like a relatively modest building but it must be wired with the latest 
technology to have 12,000 companies doing business out of this 
building. 
   They are not doing business out of this building. They are engaged 
in a tax dodge out of this building. And that is precisely what Mr. 
McIntyre is referencing when he is talking about these offshore tax  
havens. 
   Frankly, if you look at the estimates that the IRS has for the tax 
gap, I think this is where they really missed the boat. I think tens of 
billions of dollars are being flushed through these tax haven 
operations and it is really terribly unfair to the vast majority of 
honest taxpayers in this country. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Mr. Satagaj, I assume that the Chairman's picture, where you have 
12,000 businesses crammed into a five-story building, is not the type 
of small business that you are representing? 
   Mr. SATAGAJ. I was thinking that. I am pretty sure none of our 
members are one of those occupants. 
   Senator WHITEHOUSE. When you all talked about the idea of requiring 
substantially increased enforcement, I could sort of feel a chill 
emanating across the country from this committee room as people who 
spent-we heard from Chairman Bernanke-an average of 27 hours coping 
with the filling out of their tax forms. The ordinary wage earner 
these days probably has two jobs and also moonlights, so it is a 
little bit more complicated. And I think there are a lot of Americans 
who have the sense that if the IRS really came after them, somehow or 
other they would probably be able to find something just because it is 
so complicated. 
   So the idea of additional enforcement, I think, carries some real 
hazard in terms of public acceptance. And in terms of dealing with that 
question, I am interested in having you quarter up a little bit more 
the question that Senator Stabenow raised, which is the focus of that 
additional enforcement will fall into four rough categories: major 
corporations, small businesses, high net worth individuals, and 
ordinary folks. Roughly, where do you think the $350 billion or more, 
specifically the $100 billion that you think is readily collectible, 
where does that fall in rough numbers into those four categories of 
corporate and individual taxpayers? Or non-taxpayers, as may be the 
case. 
   Mr. MCINTYRE. The offshore area, which is my primary focus here, is 
all upper income, very upper income people and large corporations. So 
those are your two areas that I think should be the focus. I think that 
is where there is a huge amount of money. 
   Senator WHITEHOUSE. Out of the $100 billion, what would the amount 
be that you would guess relates just to the offshoring? 
   Mr. MCINTYRE. There is probably $100 billion in those two alone, 
according to estimates. Nobody knows for sure because these things are 
all secret. But we do know that there is $11 trillion in offshore 
accounts worldwide, which at some reasonable rate of return is probably 
earning something like $1 trillion in income every year. And the United 
States share of that is probably close to half. 
   So that is $500 billion on untaxed money right there that, even at a 
20 percent rate, is $100 billion. 
   Senator WHITEHOUSE. So the average American taxpayer can feel 
reassurance that if we double the enforcement, there is not going to be 
somebody knocking on their door? 
   Mr. MCINTYRE. The average American taxpayer wants the police to go 
after criminals. If you told the average American that we were going to 
hire some more policemen because there is a crime wave going on in your 
neighborhood, they will be happy about that, not sad. 
   Well, we have a crime wave going on among people who are very 
respectable and very wealthy and very prestigious, but they are not the 
average American. 
   Senator WHITEHOUSE. Thank you. 
   Mr. BROSTEK. I am not sure that I can give you a clear answer on how 
to quarter this up. 
   I agree with the point that we really do not know well, for these 
overseas transactions, what the level of noncompliance is. It is an 
area that is very difficult to study because of the transparency issue 
that we talked about before. If somebody is trying to hide something, 
it is difficult for IRS to get behind that, particularly when you are 
talking about sovereign nations. There does seem to be a potential that 
there are big dollars involved. We are pleased that IRS has been trying 
to put some emphasis into trying to figure out how to tackle that. 
   Small businesses, for the universe that IRS has the best measurement 
of, which is the individual income tax, small businesses do stick out 
as one of the noncompliant groups, in general. It is a tough problem, 
given what Mr. Satagaj was talking about. There are millions of really 
small businesses. It all adds up to big dollars but you are talking 
about a lot of small dollars to go after. 
   And from the taxpayers' perspective, one of the things that was 
mentioned earlier is that small businesses are less than 50 percent 
fully compliant. That means that those who are compliant are competing 
against a business that has an unfair advantage. And that can be a 
substantial unfair advantage. 
   So I think that is part of what IRS needs to take into account. 
Senator WHITEHOUSE. Mr. Chairman, I think that it is important to get 
after this. And just from my own personal experience, I can remember as 
U.S. Attorney running an FBI investigation that ground to a halt, 
probably in a building very like yours, where the FBI, pursuing a 
criminal matter, simply could not penetrate the multiple veils of 
Cayman Islands offshore corporate shells in pursuit of a criminal case. 
So to ask the IRS to do it more effectively without further help from 
this committee, I think is a tough burden to put on them. 
   Chairman CONRAD. I think the Senator makes a very good point and a 
powerful point. 
   That this thing is going on right before our eyes, it is inexcusable 
really. Mr. Satagaj, you are here representing small business. I come 
from a small business family. My family was in the printing and 
newspaper business. They paid their taxes. And it was not always 
comfortable to do so. But to have this kind of scam going on, were 
others just evade and avoid what they legitimately owe and stick the 
rest of us with the bill, this just cannot be acceptable. 
   We have to find a way to aggressively go after this. To have 12,000 
companies supposedly doing business out of this building is not 
credible. It is farcical. 
   And there are so many other scams. We have a situation now where 
companies are buying sewer systems-this is true, this is not a joke. 
They are buying sewer systems in Europe, depreciating them on their 
books, leasing them back to the cities in Europe that paid for them 
with taxpayer dollars there. I mean, that is inexcusable, that that 
kind of thing is going on. 
   Senator SANDERS. 
   Senator SANDERS. Mr. Chairman, thank you for holding this very 
important hearing. 
   I just came, and the reason that I was late is I came from a meeting 
of the Veterans' Committee where some of us believe that the VA is 
grossly underfunded, that our veterans are not getting the health care 
and other benefits that they need. One of the reasons is that there is 
presumably not enough money available. 
   So this is not some kind of abstract issue. This is a question of 
whether children get health care, veterans get the benefits that they 
need. And it is absolutely appropriate for this committee to take a 
hard look at why people who have the capability are intentionally 
avoiding paying what they are supposed to be paying in taxes according 
to the law. 
   I just have a few questions. According to a recent New York Times 
article written by David K. Johnson, he says--and I quote--''Top 
officials at the IRS are pushing agents to prematurely close audits of 
big companies with agreements to pay only a fraction of the additional 
taxes that could be collected.'' 
   One IRS employee, according to the New York Times, says that when it 
comes to corporate audits the IRS is ''giving away the store.'' 
   Another describes the corporate audit process as ''catch and 
release.'' 
   I would like to ask Mr. McIntyre and Mr. Brostek if they believe 
that the IRS is doing all that it can in collecting corporate taxes? 
And if not, what do you believe that they should be doing. Mr. 
McIntyre? 
   Mr. MCINTYRE. I think it is a question of resources, not a question 
of intent on the IRS's part. As the auditors told the New York Times, 
they are not doing as much as they should be doing. 
   Last September GlaxoSmithKline settled a long-running tax dispute 
with the IRS for $3.5 billion, which is a record settlement. Great, 
except that the IRS pointed out they actually owed $15 billion. So they 
were only paying 23 cents on the dollar. That is the kind of thing that 
you were talking about from those New York Times articles, that they 
just do not have enough people who can sit on these cases and pursue 
them long enough. So they are doing these fast audits, where they get 
what they can. 
   But you were a corporation that for whatever reasons thinks you 
 should not be paying taxes hey, you get caught and you pay back 22 
cents on the dollar. 
   Senator SANDERS. These large corporations, large drug companies, 
have incredible resources and can hire the best tax people and the best 
lawyers in America. 
   Mr. MCINTYRE. Or the worst, depending on your point of view. 
   Senator SANDERS. Certainly, the IRS does not have that capability. 
Isn't that our fundamental problem, with a Government agency taking on 
corporations that have unlimited resources and incredible capabilities 
of getting the best, or the worst if you like? 
   Mr. MCINTYRE. These cases, typically once they are discovered, are 
not that complicated. You do not have to have a graduate degree in tax 
sheltering to figure out that they are illegal. The deal is that they 
are covered up so that they are very hard to discover. Once they are 
discovered, with most of these offshore things, a first-year law 
student could win the case. 
   So it is not that the Government employees are incompetent. It is 
just they have too much work to do, compared to the number of people 
they have. 
   Senator SANDERS. Mr. Brostek? 
   Mr. BROSTEK. I certainly would agree that there is a large audit 
universe out there that IRS cannot get to with its current resources. 
There is a decision for Congress to make about how that weighs up 
against other governmental priorities. 
   I do not know precisely how this initiative is working that was 
written up in the article. One of the things that IRS is, I think, 
trying to take into account is the deterrent effect of auditing more 
people. And so I think part of their philosophy or their thinking here 
is we may not get all of the money from some of these corporations that 
we audit. But if we can audit more of them, have an audit presence 
across a larger portion of the corporation universe, we may actually 
improve compliance more than if we go for every-- 
   Senator SANDERS. And one can understand that. But isn't the answer 
to do both? 
   Mr. BROSTEK. If you were unconstrained in resources, that would 
certainly be-- 
   Senator SANDERS. But isn't that a good investment? Here is a case of 
hiring more staff, which one would think would more than pay for itself 
if we began to make a dent on some of these issues that the Chairman 
was talking about. Am I missing something here? 
   If you could bring in billions of additional dollars hiring a few 
hundred or even a few thousand more staff would be minuscule compared 
to what you are bringing in. Am I missing something on that? 
   Mr. BROSTEK. Your logic is generally sound, yes. 
   Senator SANDERS. Mr. Brostek, in February of 2004 the GAO found that 
Department of Defense contractors owed about $3 billion in unpaid taxes 
as of September 30, 2002 because the DOD had failed to implement IRS 
collection procedures. 
   In addition, GAO often ''found abusive or potential criminal 
activity relating to the Federal tax system'' through a GAO audit 
investigation of 47 DOD contractors. 
   To your knowledge, has the Department of Defense or the IRS done 
anything to collect these unpaid taxes? 
   Mr. BROSTEK. I would have to get back to you on that, sir. That is 
not an area that I was doing the work in. Perhaps I could give you a 
response for the record. 
   Senator SANDERS. If you could, please. 
   Let me ask you another question, sir. In 2004, the GAO found 59 of 
the largest publicly traded contractors in fiscal year 2001 reported 
having a subsidiary in a tax haven country. Do you believe that 
companies with offshore tax havens have an unfair advantage over 
companies that do not in competing for Government contracts? If so, 
what can we do to correct this problem? 
   Mr. BROSTEK. As I recall, the conclusion in that report was that the 
 contractor who had an offshore presence in a jurisdiction that had a 
low tax rate could have a cost advantage over a purely domestic 
contractor. We did not have a recommendation for how to address that 
situation and I do not have one for you today, I'm afraid. 
   Senator SANDERS. That is something that we should be--yes. 
   Mr. McIntyre, in your testimony, you gave us a number of options to 
consider that would reduce the tax gap, ranging from cracking down on 
offshore tax shelters and stock option abuse to increased reporting 
requirements on capital gains and an addition of more IRS auditors. 
What do you think would be the most important step for Congress to take 
in making sure the corporations and wealthier individuals pay their 
fair share? 
   Mr. MCINTYRE. You could raise tax rates, but that only gets the 
honest people. So if you are trying to get the ones who are not paying 
their fair share, then the answer is you need more enforcement. And you 
also need more disclosure. 
   Because so much of this tax sheltering is happening offshore, we 
need to resuscitate an effort that President Bush jettisoned back in 
2001 and get these tax haven countries to tell us, and tell Britain and 
France and Germany and all of the other developed countries, what our 
citizens and their citizens are doing in those places. 
   If we get that information, then most of those schemes can be 
uncovered and people will stop doing them eventually. 
   Senator SANDERS. What kind of staff increases do you think the IRS 
needs to do? What has to be done? Do you have any sense on that? 
   Mr. MCINTYRE. They are down about one-third from where they were 10 
years ago in enforcement. So you would need a 50 percent increase just 
to get back to where you were 10 or 12 years ago. And we are a bigger 
economy and so forth now. 
   Senator SANDERS. And more complicated tax laws as well. 
   Mr. MCINTYRE. Yes. You might talk about thinking about how to double 
the size of that enforcement staff over a period of time. You cannot do 
it instantly. It takes a long time to train people and work them in. 
But that would be the kind of goal. 
   Senator SANDERS. I presume you have little doubt that paying for 
that increased staff would more than be balanced by the kinds of 
revenue that you are bringing in? 
   Mr. MCINTYRE. It is hard to imagine that it would not be. The IRS 
has an $11 billion budget and brings in $2.2 trillion, so it is about 
230-to-one on the whole process. With incremental--increase in funding, 
you are not going to get that ratio. But you are going to get $10 or 
$20 or $30 or $40 per dollar spent, depending on where you put the 
money. 
   Senator SANDERS. Thank you, very much. Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator Sanders. 
   Let me just conclude by asking each of you how much do you think can 
be reasonably obtained by reform of our current processes: increased 
reporting, increased withholding where appropriate, increased resources 
for IRS, tax reform, going after this international tax haven, 
requiring reporting of those transactions. 
   How much do you think over a period of time--obviously I am talking 3 
years out because you are not going to turn around this ship quickly. 
But three or four or 5 years out, how much money per year do you think 
could be obtained by an aggressive approach to this tax gap? 
   Mr. MCINTYRE. That is a hard question because of the required 
training of the IRS employees and so forth. But let us say we had not 
cut back 10 years ago and the IRS still had full manpower. I would 
think you could be picking up--if you also made some of the changes I've 
suggested here--$100 billion a year more in a steady state. Maybe more 
than that if people stop doing these things. 
   Scaring people out of entering into shelters is even better than 
catching them after they do it. And that is one of our goals here. 
   Chairman CONRAD. Mr. Brostek? 
   Mr. BROSTEK. I really do not have an empirical basis to give you a 
good estimate there. 
   One piece of input on that. Commissioner Rossotti, in his last 
report to the IRS Oversight Board, estimated that--if they had the 
resources in IRS to followup on all of the cases of suspected 
noncompliance; where they were pretty sure someone was noncompliant--he 
calculated that about a $2.2 billion increase in their budget would 
yield about $30 billion. 
   Again, we did not audit that estimate. I do not know how reliable it 
is. But it gives you a sense just from the enforcement perspective, 
that there would be large amounts of money that could be available. 
   Chairman CONRAD. Over what period of time was that? Do you know? 
   Mr. BROSTEK. He was suggesting that the way to approach this, given 
what we have been talking about, that it takes some time for IRS to 
gear up, would be--and it was his proposal--to give IRS a real budget 
increase of 2 percent a year over a number of years. I do not remember 
the specific number, but it was seven, eight or 10 years in time, to 
allow them to increase their capacity gradually. 
   And so that $30 billion would have been after IRS had received these 
budget increases that he was proposing. 
   Chairman CONRAD. That would just be on the enforcement side? 
   Mr. BROSTEK. Correct. 
   Chairman CONRAD. Frankly, I think there is more money to be 
recovered on the reporting side by increased reporting that on the 
enforcement side. I do not denigrate the need to have more enforcement. 
   But frankly, I think if you had more transparency on these 
international transactions, but also in reporting on money flows where 
the IRS then had the ability to match up what is reported versus what 
is actually happening. I think there is bigger money to be had there. 
   Mr. BROSTEK. I would agree with you, that if you had the ability to 
do more transparent transactions, that you are going to obtain higher 
levels of compliance and probably not need the IRS resources. 
   In the charts that were shown earlier, if you have information 
reporting that IRS can make use of, the level of compliance is very 
high. And it stays high because, in essence, we are auditing all of 
those transactions every year. 
   Chairman CONRAD. And that is self-policing in the sense that people 
know look, everybody is going to know what it is. 
   Mr. BROSTEK. Right. 
   Chairman CONRAD. Mr. Satagaj, let me ask you this question, because 
you are here representing an extremely important constituency group. 
You earlier talked about how do you do this without hurting the 
compliant taxpayer, those who are already paying--and they are the 
significant majority here--who are paying what they legitimately owe or 
pretty close to what they legitimately owe. 
   What do you think the tradeoff is here, what could we do that would 
be seen as fair by small business in terms of increased reporting to 
get the bad actors--especially on this international side. Very few 
small businesses are--I would venture to say none of your constituents 
are over in this Cayman Islands building. I do not think they have 
offices over in the Caymans. 
   What do you think? How could this be done in a way that would enjoy 
the support of the small business community? 
   Mr. SATAGAJ. We have been looking at it a lot already. As I said at 
the beginning, we are not against this. We want to find some way and 
find some solutions. 
   Do not forget, we are dealing with primarily compliant taxpayers. 
This is under reporting of income by someone who is in the system. So 
you do not want a proposal that pushes people out of the system. We 
will end up with a cash economy, even with the information reporting or 
withholding, you will push people in the wrong direction. 
   And we do not know why they are under reporting. You would say yes, 
well, we can do the information return. But if you are under reporting, 
are you going to capture the information in an information return? 
Where is that going? 
   For example, right now with 1099s--and Mike knows this as well as I 
do--they require someone to issue a 1099 for $600. That low, that is a 
pretty small transaction. 
   Now who are you missing in there, when you are under $600? And why 
are they under reporting? Is it collusion between two parties? 
   There is so much there that what my guess is that what you are going 
to find out--and this is the danger with the information reporting or 
withholding--is you push people in the wrong direction instead of the 
right direction. I think we just have to figure out and identify more 
carefully who is it that is under reporting? And what is the 
transaction that they are under reporting? We have no sense of that in 
any of the data or the research that I have seen. 
   Chairman CONRAD. Let me just say from talking to people in the 
accounting profession, I will tell you what they tell me, and these are 
the people who are on the front lines. I have a lot of people that I 
have worked with over the years who are in the accounting profession. 
We have had some bad actors in the accounting profession. We have also 
had some--I used to be a tax commissioner. I can tell you firms that 
were the gold standard in accounting who I knew were honest and did a 
good aggressive job of representing their clients. But at the end of 
the day advised their people to pay what they legitimately owed. 
   What they are telling me is you have several classes here. You have 
under reporting, especially in places where basis is an issue. I see 
all of the witnesses nodding. I think we all know how that works. 
   If you are looking, especially at real estate transactions, what 
matters is what you paid for the property, the depreciation you took 
while you held that property, and what you sold the property for. Your 
basis for tax purposes is determined by subtracting from what you paid 
for the property the depreciation you took. 
   People in the accounting profession tell me there is tremendous 
under reporting of what is the true basis in a property and real 
estate. 
   That the same is true for purposes of capital gains. Obviously, 
there you do not have the depreciation issue but you have what you paid 
for stock initially versus what you sold it for. And that there is an 
appropriate reporting there. 
   The third area is those who are self-employed who are simply under 
reporting their income. 
   The fourth area, and the accounting profession has told me 
repeatedly, is this offshore business. That this is huge and growing 
and extremely abusive. That companies simply moving this income 
offshore, where there is no transparency, no ability for serious 
oversight, and this is a real hemorrhage of both wealthy individuals 
and a certain sector of corporate America. A minority, but significant 
in dollar terms. 
   Those are areas that people who are in the accounting profession, 
talking off the record to me, have said they think are the biggest 
areas of abuse. 
   Any response to any of that? Any sense from your own experience or 
own contacts? Mr. Satagaj? 
   Mr. SATAGAJ. Just on one point, and we all have anecdotal 
information, and that is part of the problem. Particularly with the 
sole proprietors, I go back to one of the very first questions I 
raised. We do not know how many sole proprietors do business primarily 
with consumers versus other businesses. And so my guess is that it is a 
consumer-to-business transaction that is most likely not to be reported 
as income. 
   You can hear your accountant friends say that and I do tax law, I 
know what you are talking about, too. But we do not know in any way 
that we can make a systematic decision OK, this is what we need to do 
about it. Because you are going to deal with that under reporting far 
differently than someone who is getting their income from business. 
You can go to these areas, but the truth is we are really missing some 
basic information here. 
   Chairman CONRAD. That is a point very well taken. If there is one 
thing that is very frustrating, first of all, we are dealing with a 
study that tries to indicate the size of the tax gap in 2001. And it is 
based off returns from the 1980's, updated through a series of attempts 
to make it relevant to today. 
   Truthfully, I believe that I think the tax gap is far in excess of 
the Revenue Service estimate, now that I understand how the Revenue 
Service made that estimate. I sat down with representatives and went 
through in some detail how they arrived at this number. I think, if 
anything, it just jumps out at me that it probably significantly 
understates how big it is. 
   We have come to the end here. I want to thank all of the witnesses 
for participating in this panel. It is certainly beneficial to this 
committee, as we wrestle with these issues and try to address the 
longer-term fiscal imbalances that our country faces, which according 
to the first two witnesses we had before this committee--the head of 
the General Accounting Office and now most recently last week, the 
Chairman of the Federal Reserve--they alerted us to the very serious 
nature of these long-term fiscal imbalances and the adverse effect it 
could have on our country of a failure to act. 
   We thank you very much for your constructive suggestions here today. 
With that, we adjourn the meeting. 
   [Whereupon, at 11:45 a.m., the hearing was concluded.] 

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                    THE CBO BUDGET AND ECONOMIC OUTLOOK 
                                      _________               

                           THURSDAY, JANUARY 25, 2007 
                                              
                                                   U.S. SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:03 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Nelson, Cardin, Whitehouse, Gregg, and 
Allard. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority.                  


            OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. The Committee will come to order. 
   I want to welcome everyone to the hearing today on the Congressional 
Budget Office's January budget and economic outlook. 
   I want to particularly welcome our new Director of the Congressional 
Budget Office, Dr. Peter Orszag. I notice that Dr. Orszag has with him 
a special assistant. Maybe Dr. Orszag, you could introduce your 
daughter, who is with you. 
   Mr. ORSZAG. Yes, my 6-year-old daughter, Layla, is sitting right 
behind me. And she's very good at math. So if I need some help she 
might step up here. 
   Chairman CONRAD. We will look forward to that. 
   We are delighted that Dr. Orszag has taken this position. Dr. Orszag 
is a distinguished economist, one of the most prolific writers in the 
economic field. He has dealt with almost all of the major issues that 
are facing us as significant challenges in the years ahead. 
   I am also especially pleased to note that he was a successful 
businessman and brings those skills to the job, as well. 
   We also want to recognize Dr. Marron, who is the Acting Director. We 
are especially pleased that we understand that you will be staying and 
we are delighted by that. We thank you for your service, as well. 
   We have this hearing to review CBO's outlook. 
   Senator GREGG. All three of us went to the same high school. 
   Chairman CONRAD. Oh, we did? I deny it. 
   [Laughter.] 
   Chairman CONRAD. I have had a chance now to review CBO's report, 
which was released yesterday. I think it is very important for us to 
say there is nothing in this report which alters the fact that our 
Nation's long-term fiscal condition is completely unsustainable. 
   It is important to remember that CBO is required to assume a 
continuation of current law and is not allowed to add in the cost of 
likely policy changes. So this is no criticism of CBO. They are 
constrained by the requirements under which they operate. 
   Looking just at 2007, CBO's deficit estimate understates the 
shortfall because it does not account for the $100 billion war 
supplemental President Bush is expected to send to us. Nor does it 
account for the cost of fixing the Alternative Minimum Tax. 
   Again, this is not any fault of CBO's. This is the way they are 
required to do things. They are required to base their assessments on 
current law without respect to policy changes that might occur. 
   Let me put up the first slide and we will try to go through this 
quickly. While CBO estimates with omitted costs that the deficit will 
fall to $218 billion, that number tells only half of the story. Let me 
indicate that $218 billion is not their estimate. Their estimate is 
$172 billion. But when we add back what we see as omitted items, the 
President's war supplemental that has not come up here, the need to fix 
Alternative Minimum Tax, we come to a deficit of $218 billion. But that 
significantly understates the red ink, because the debt will increase 
by $510 billion during this year. 

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   The 10-year baseline projection by CBO understates actual deficits 
because CBO, as I have said, has to assume continuation of current law. 
We get a more realistic picture when we put back adjustments for the 
following items: we add in the cost of the President's proposal to make 
the tax cuts permanent. That is a cost over 10 years of $2.3 trillion. 
We add in the cost of Alternative Minimum Tax reform. That is a cost 
over 10 years of over $1 trillion. We add in the cost of the 
President's proposed defense buildup, and that is a cost of well over 
$800 billion. No, the defense buildup is somewhere around $260 billion. 
The ongoing war cost is over $860 billion. We add in the associated 
cost of debt service on all of the above items and that is approaching 
$900 billion. 

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   We remove the multiyear cost of extending the 2007 emergency funding 
and get a total adjustment of $4.6 trillion over the next 10 years. The 
$4.6 trillion is not to the good side, it is the red ink side. 
   Once we have made these adjustments to CBO's baseline estimate, this 
is the picture we get of our long-term budget outlook. It shows that 
significant deficits continue throughout the next 10 years at a time we 
should be paying down debt to prepare for the coming retirement of the 
baby boom generation. 

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   The reality is that we are facing a wall of debt. At the end of 
2001, the year the President took office, gross debt was $5.8 trillion. 
Under CBO's adjusted baseline, we can see the gross debt will reach $9 
trillion by the end of 2007. And if we continue with these policies, 
gross debt is projected now to soar to over $12 trillion by the end of 
2012. I want to emphasize, that is not CBO's estimate. That is our 
estimate, taking the CBO number and adjusting it for these omitted 
costs. 

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   The revenue improvement in CBO's report results from adjustments in 
CBO's calculations that have nothing to do with stronger economic 
growth. In fact, CBO's latest figures for economic growth in 2006 and 
2007 are actually weaker than the Agency predicted last August. Let me 
indicate, for 2006 the forecast for economic growth was reduced from 
3.5 percent to 3.3 percent. And looking ahead to this year the previous 
forecast, which estimated economic growth would be about 3 percent, now 
says economic growth will be 2.4 percent. 

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   The revenue improvement that we see in this forecast must be 
considered in the context of the serious collapse in revenue that 
occurred after 2000. Real revenues, that is adjusted for inflation, 
only recently exceeded their 2000 level. I know my colleague will want 
to talk about the last 3 years where we have had significant revenue 
growth, but that is after we saw significant revenue declines. We saw 
in 2000 we had revenue of just over $2 trillion. We only got back to 
that amount in real terms in 2006. So we have had revenue stagnation 
for six or 7 years and now the estimate for this year is good growth. 

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   Unfortunately, when we compare this revenue growth to previous 
recoveries, we still see that this is lagging well behind the revenue 
growth we have seen in previous recoveries. In fact, if we look at the 
average of the nine previous business cycles, look at all of the 
recoveries since World War II and compare revenue growth to teach of 
those other recoveries this recovery is running $127 billion short of 
the typical recovery. 

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   In his recent testimony before the Senate Budget Committee the head 
of the GAO, Mr. Walker, summed up our fiscal outlook as follows: ''We 
are an imprudent and unsustainable long-term fiscal path, and while the 
short-term deficits have improved in recent years, the long-term is 
getting worse every second of every minute of every day and the time 
for action is now.'' 

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   Comptroller General Walker has it exactly right. And I am pleased to 
say on that issue Senator Gregg and I are in agreement. Our long-term 
situation is unsustainable. We need to respond to it and we need to do 
it as quickly as we can. 
   With that, I welcome Senator Gregg. 

               OPENING STATEMENT OF SENATOR JUDD GREGG 

   Senator GREGG. Thank you. 
   Doctor, it is nice to have you. It is especially nice to have your 
daughter here, future Exeter student probably. 
   Let me pick up where Senator Conrad left off, which is the issue of 
the long-term. Because essentially what the CBO projections say, and 
although I do not agree with all of the comments made by the Senator 
from North Dakota, the Chairman, he is correct that there is a lot that 
is left out because of the rules that you have to function under, such 
as the war costs and the AMT issue. 
   But following the mechanics of the CBO baseline, basically if we put 
things on automatic pilot we would end up in surplus in 2012. But the 
statutory baseline obviously leaves things off the table that Congress 
is likely to be put back in, so the baseline surplus number in 2012 
would end up being different. Even though a possible surplus looks like 
that is good news, obviously very good news, it does not address that 
truly acute issue which we confront, which is the fact that once the 
baby boom generation begins to retire, all of the numbers go south on 
us in a very aggressive way. 
   And in your own estimates you are projecting that there is going to 
be an approximately 6 percent average annual growth in entitlements 
 over the next 10 years, and that by the year 2017, entitlements will 
absorb close to 11 percent of the GDP. And as we move out into the 
years, that number goes up dramatically and becomes unsustainable. 

   I think it is important, to note that these short-term deficit 
projections, which are improved, are a function primarily of revenue 
growth. If you look at what percentage of GDP is the Federal Government 
generating in revenues, historically we get 18.2 percent of GDP. Today 
we are getting about 18.4 percent of GDP. So our revenues are robust 
and they are getting stronger. And CBO's projections are for fairly 
strong revenue growth as we go forward. And as a result, the Government 
is moving in a very positive direction for the next few years from a 
standpoint of the deficit. 
   But that does not resolve the problem in the out years because you 
cannot tax your way out of this problem. You cannot grow your way out 
of this problem. The only way that you are going to address this 
problem is if you look at the programs which are in place and try to 
make them affordable for our children at the same time as we allow them 
to continue to be strong programs for those who are retired. 
   So I would be interested in your thoughts on that, and I do think it 
is important that we highlight that and that would not allow the 
short-term good news, which is very positive, to cause us to take our 
eye off the real issue which is the long-term seriousness of the 
problem. 

   So we appreciate you coming here today. We appreciate your 
willingness to take on this job. 
   I also want to join the Chairman in thanking Donald Marron for his 
wonderful service, extraordinarily good service, and the fact that he 
is willing to stay on and participate at CBO is critical. 
   You are our umpire, our fair arbiter, and we appreciate the fact 
that you have been willing to take on this job, and to have your 
expertise at the table is going to be a big assistance to us. 
   Thank you. 
   Chairman CONRAD. Thank you, Senator Gregg. 
   Dr. Orszag, please proceed with your testimony. 

                  STATEMENT OF HON. PETER R. ORSZAG, DIRECTOR,
 
                         CONGRESSIONAL BUDGET OFFICE 


   Mr. ORSZAG. Thank you very much, Mr. Chairman. Mr. Chairman and 
Senator Gregg, I want to first note that I very much look forward to 
working with you and the rest of the committee and the rest of the 
Congress as I assume this new position. 
   I also want to just emphasize how delighted I am to be coming into 
a position that has such an outstanding staff and that allowed me to get 
briefed and ready for this testimony in a short period of time. 
   I want to make five points about the document that we released 
yesterday, and I think it is important in interpreting the economic and 
budget outlook to take all five points into account. So with that 
caveat in mind, the first point is the path of the budget under the 
baseline. 
   As you both know very well, that baseline has a particular set of 
rules associated with it which I will return to in a moment. But under 
that path, the budget deficit does fall from $248 billion in 2006 to 
$172 billion this year and then falls further in 2008 to under $100 
billion. It then increases slightly in 2009 and 2010. It essentially 
reaches balance in 2011 as various revenue provisions expire as 
scheduled under current law, and then moves into surplus in 2012 and 
thereafter, again under the assumptions of the baseline. Under that 
baseline, publicly held debt would fall from 37 percent of the economy 
to 20 percent by the end of the 10-year period. 
   The second point though is that, as is now well known, that official 
baseline reflects a particular concept, which is the application of 
current law with regard to both revenues and spending. It therefore 
leaves out various things that outside observers believe will occur in 
terms of change policy that will affect budgetary outcomes. 
   Mr. Conrad, as you have already mentioned, what we did was we 
provided a variety of alternative policy paths, changes in policies, 
that would allow members of this committee and others to evaluate the 
impact on the budgetary outcomes. I provide just one example of those 
changes in policies. 
   The baseline, as you know, assumes that discretionary spending only 
keeps pace with inflation and not with population growth or with 
overall economic growth. As a result, discretionary spending falls from 
7.8 percent of the economy to 5.8 percent of the economy. If instead, 
and excluding the spending on the global war on terrorism, 
discretionary spending kept pace with overall economic growth, the 
budget balance in 2012 would deteriorate by $122 billion and over the 
10-year period by $1.5 billion. Those are inclusive of debt service 
costs associated with the change in policy. 
   Furthermore, the official baseline assumes that all of the tax 
provisions that are scheduled to expire, most of which in 2010, 
 actually do expire. If instead the 2001 and 2003 tax legislation were 
continued past 2010, the deficit in 2012 would be $267 billion lower 
and the 10-year impact is $2.3 trillion. 
   Furthermore, the baseline assumes that the Alternative Minimum Tax 
will rise from affecting 4 million taxpayers in 2006 to 33 million by 
2010. The combination of the assumptions with regard to current law on 
the EGTRRA and JGTRRA, that is the 2001 and 2003 tax provisions, and 
with regard to the Alternative Minimum Tax provide the primary 
explanation for why revenue increases from 18.6 percent of the economy 
this year to roughly 20 percent in 2011 and thereafter. 
   If you prevented the Alternative Minimum Tax from growing in the way 
that is suggested under the baseline, again the deficit impact in 2012 
would be roughly $50 billion and the 10-year impact would be over $700 
billion. The Alternative Minimum Tax and the 2001 and 2003 tax 
provisions interact, and taking those interactions into account would 
add another $61 billion in 2012 and $542 billion over 10 years. 
Put that together and instead of a surplus of $800 billion, under this 
change in policy there would be a deficit of over $4 trillion over the 
10-year window. 
   Obviously, policymakers can evaluate different courses of future 
policy and evaluate the impact on the budget outcomes under those 
changes.  
   My third point is that there is significant uncertainty that 
surrounds budgetary projections because of future economic developments 
and other technical changes. Just to put that in context, this year 
spending will be about $2.7 trillion, revenue we project at $2.5 
trillion. That means that if you are 5 percent too high on spending and 
5 percent too low on your revenue projection, you shift from a 
projected deficit of $200 billion to an actual surplus of more than $50 
billion. I think it is important for everyone to realize, because the 
deficit is the difference between two large numbers; being slightly off 
on those two large numbers can have a very big impact on the difference 
between the two, the deficit. 
   So we try to characterize or present for you the implications of 
that uncertainty. Under our baseline, in 2010 we show a deficit of 
roughly 1 percent of GDP, 0.9 percent of GDP. But based on past 
experience, there is a 20 percent probability the deficit may be 3 
percent of GDP or larger under current law and there is a 5 percent 
probability that the budget would actually be in surplus of 3 percent 
of the economy or more. 
   So we are trying to provide some insight into the span of the 
uncertainty that surrounds future budgetary outcomes. 
   The fourth point is that, consistent with the emergence of projected 
surpluses under the baseline, there has been a significant shift in the 
budget baseline since last August. I would emphasize immediately 
though, and Senator Conrad you already pointed to this, this is not the 
result primarily of changes in economic assumptions. Those changes in 
economic assumptions have a very modest effect on the 10-year numbers. 
   Nor are the 10-year numbers primarily due to changes on the revenue 
side. In fact on the revenue side, from all the various components, the 
overall impact is only a little bit more than $50 billion over the 
10-year window. There is a more significant impact in the short term 
and then that diminishes over the long-term. For the 10-year period as 
a whole, most of what is happening is on the outlay side. 
   There are two parts. One part is purely artificial. It reflects for 
how we account for, under current law, discretionary spending. As you 
know, we take enacted appropriations in the current year and inflate 
them out over the rest of the projection window in the baseline. Last 
August, when we were doing the projections, the enacted appropriations 
included $120 billion for Iraq, Afghanistan, and the global war on 
terrorism and $56 billion for domestic relief activities, for example 
with regard to Hurricane Katrina. 
   This year thus far the Congress has appropriated $70 billion for 
operating if Iraq and Afghanistan and there is no corresponding 
appropriation for domestic relief activities. As a result, our baseline 
now is reduced by $497 billion on defense spending and $500 billion on 
non-defense spending. In other words, roughly half of the improvement 
in the 10-year numbers is purely a mechanical implication of how we 
account for supplemental and unusual spending and does not reflect 
anything about the underlying fiscal environment. 
   Another component of it though does reflect changes on the outlay 
side with regard in particular to Medicare and Medicaid. There have 
been some real changes in projections of those programs. There has been 
an improvement over the 10-year window of roughly $445 billion in 
Medicare spending, the majority of which is in Part D. Part D spending 
we now project for that 10-year window to be $265 billion lower than in 
August. That reflects both the actual information we now have on 
enrollee behavior and patterns and the fact that bids for this year are 
coming in 15 percent lower than last year, and also that we now expect 
that larger share of beneficiaries will have other coverage and not 
take up the Part D benefit. I would be happy to talk further about 
those changes during the question and answer period. 
   But, I would emphasize that nothing in those changes alters the 
fundamental conclusion that over the long term Medicare and Medicaid 
will continue to grow more rapidly than the overall economy and will 
put severe pressure on the overall fiscal picture. 
   That brings me to my final and perhaps most important point. The 
long-term picture facing the Federal Government is not pretty. Under 
current law, without addressing in particular ongoing cost increases in 
our health programs, we face a very serious fiscal imbalance. I would 
agree with both Chairman Bernanke and Mr. Walker that it is better to 
address that sooner rather than later because it opens up more options 
for how to address the problem. 
   Even within the budget window you can start to see the pressure that 
is building. Medicare and Medicaid, the Federal share of Medicaid, 
amount to 4.5 percent of the economy today. By 2017, the end of our 
projection window, we project that they will amount to 5.9 percent of 
our economy. If health care costs continue to grow at the same rate as 
they have over the past 40 years, which is the top line in this chart, 
by 2050 those two programs alone would account for 20 percent of the 
economy, which is basically the size of the entire Federal Government 
today. 
   Even if health care cost growth slowed so that it is only 1 
percentage point faster than economic growth, those two programs would 
account for 10 percent of the economy. That is the fundamental 
long-term problem facing the Federal Government, and it is related to a 
problem facing the private sector also, which is cost growth in the 
health sector. 
   I look forward to working with you to provide you with the 
analytical input so that you can start to address that fundamental 
problem in the long-term fiscal picture for the United States. 
   So just to very briefly summarize, there is some short-term good 
news in this report. But the good news is not quite as good as it might 
initially seem. And the long-term picture remains very, very serious 
and deserving of attention. 
   Thank you very much, Mr. Chairman. 
[The prepared statement of Mr. 
Orszag follows:]


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   Chairman CONRAD. Thank you. And thank you for your excellent 
testimony and the work of you and your staff. I think you have put it 
in perspective that the short term we have seen some improvement. The 
long-term really has not changed and it is a daunting picture. 
   I know Senator Gregg has presented this to his caucus and before 
this committee. I have presented it to my caucus. It is a hard thing to 
get people, I guess it is very deep in human nature. It is hard to get 
people to respond to something that is over the horizon or down the 
road or off in the future. 
   Could you tell us when you say we should act sooner rather than 
later, what would you say if you were addressing our colleagues as to 
why? Why it is important to act sooner? Our colleagues, in fact, I had 
a colleague say to me yesterday, Kent, you are talking about a problem 
that is off in 2018. We have a lot of urgent problems to deal with 
right now. This is not urgent. 
   Mr. ORSZAG. I have two responses. The first is the longer we wait, 
the larger the burden that we are putting on future generations, and I 
am not going to invoke my daughter but people like my daughter. That 
raises not just economic questions but other questions as well. 
   The second reason though is the sooner that we act, the more that we 
can try things and experiment and see what works and see what does not 
so that we can evolve in our approach. This underlying problem is not 
going to be solved with the snap of a finger and just a one-off 
solution. 
   So I think it is pretty clear that what we need to be doing is 
trying different things, and it is obviously up to you to decide what 
things we should try. But try different things, see what works, and 
then adapt as we go. 
   The longer you wait, the less experience you'll have. I was, for 
example, interested that in the New York Times this morning there is a 
report on the effort that CMS, the Medicare agency, is experimenting 
with paying for performance and the early results there. But that is 
the kind of effort--in the so called Premier Program--the kind of effort 
that will help give you the information you need to bend those lines. 
If you just wait, you are acting in a void. 
   Chairman CONRAD. Let me ask you this question. Last evening I was 
interviewed on television with a colleague and I was asked what had 
been the contributing factors to the deficits. And I said well, it is 
obviously increased spending and tax cuts. The two of those together 
have exploded the debt. 
   My colleague said no, the Senator is wrong on the question of tax 
cuts. She said tax cuts produce revenue. I was really kind of taken 
aback and I said you know, in my judgment, tax cuts contribute to 
economic growth but they in no way pay for themselves. That is been the 
testimony of the head of the Federal Reserve. That has been the 
testimony of previous CBO directors. That has been the result of the 
Treasury's own study that shows tax cuts maybe offset 10 percent of 
their costs. There are other studies that have been done by CBO. 
CBO said to us, in their analysis, that tax cuts would stimulate enough 
economic growth to replace 22 percent of lost revenue in the first 5 
years. Those were on optimistic assumptions. On pessimistic 
assumptions, the growth effects of tax cuts did nothing to offset 
revenue loss. 
   So whether it is zero or 10 percent or 22 percent, the studies that 
we have been presented with say that tax cut simply do not pay for 
themselves. They slightly offset their additions to the deficit. 
   I would ask for your review. What would you say is the state of the 
economic literature on this question of do tax cuts pay for themselves? 
I would just say, if they do, this is the greatest news we could have 
because we could have a whole new round of tax cuts and eliminate the 
deficit. 
   [Laughter.] 
   Mr. ORSZAG. Senator, the effect of a tax cut depends in part on what 
kind of tax cut it is and how it is financed, whether it is financed by 
a deficit. Many tax cuts can generate some economic growth, some 
additional economic activity. But the vast bulk, the preponderance of 
the evidence strongly suggests that that additional economic activity, 
which generates some additional revenue, offsets only a modest share of 
the original cost. So whether it is 10 percent or 20 percent or 25 
percent, some go even higher than that, the credible evidence I have 
seen suggests that the offset is only a small share of the original 
cost. 
   Chairman CONRAD. To be fair, I should say Gregg Mankiw, who was 
Chairman of the President's Council of Economic Advisers, said in his 
analysis where you have capital taxes there you could get as much as a 
50 percent offset on capital taxes. On others, on income taxes, he said 
17 percent, which would be pretty close to the 22 percent CBO found in 
the first 5 years under optimistic assumptions. 
   I thank you for that answer. Senator Gregg? 
   Let me indicate that we are going to have a vote momentarily, at 
10:30. That is unfortunately why you see attendance is not as we would 
normally have, because they have called a vote for 10:30. 
   Senator GREGG. 
   Senator GREGG. Thank you. Thank you, Mr. Chairman. 
   Picking up on this line of thought relative to the implications of 
tax policy, the reverse of the case the Chairman is making also 
probably applies. That is, you can raise taxes to a point where you 
significantly stagnate economic activity. Would that not be true? 
Mr. ORSZAG. Yes, and actually let me quickly add a very important 
caveat. I was speaking with regard to studies that apply to basically 
the current structure of the U.S. tax system. As you move up to higher 
and higher marginal tax rates, that conclusion could be different. 
   Senator GREGG. Of course, that was Arthur Laffer's studies that 
showed that. 
   The issue, I think, is what is the right tax level? Obviously it is 
not zero and obviously it is not 100 percent. It is somewhere in 
between. It would seem to me that when you have a tax law which is 
today producing revenues that exceed the average revenues that we 
historically haveten in this country, the average being 18.2 percent 
and we are now getting 18.5 percent, that you have a tax law that is 
working fairly well. 
   My real question here, because the issue is closing the gap in the 
out years between liabilities and revenues relative to entitlement 
programs, gets to the issue of what size Government can the economy 
afford and still be efficient, productive and growing? And when does 
the Government become so large that it creates an inefficient economy 
and one which is not as productive and thus, does not create as many 
jobs? 
   Historically, we have spent about 20 percent of the Gross National 
Product on the Federal Government and we have taken in about 18.2 
percent, so we have run a structural deficit. 
   But what is the number that you would say the Government can 
afford--at what size? If we know entitlement spending, if it is allowed 
to continue at its present pace, Medicare and Medicaid being the 
primary drivers of this, will exceed potentially 30 percent of Gross 
National Product by the year 2040, which seems to be a staggering 
number, and you know you are going to have to rein that back to some 
number that is manageable, do you have a manageable number? Is it 20 
percent? Is it 22 percent? Is it 24 percent? 
   Mr. ORSZAG. Senator, I think ultimately the level of spending and 
revenue is up to policymakers like yourself to decide. What I would say 
about the economic effects is a lot depends not just on the level of 
revenue as a share of GDP but how you raise that revenue, whether it is 
through individual income taxes, whether it is through corporate income 
taxes, whether it is through consumption or value added taxes, can have 
a significant effect on the economic implications. 
   The other thing I would say is I do not think that there is a single 
threshold. I cannot give you a jump off the cliff kind of threshold. A 
lot of the effects that are associated with revenue changes tend to be 
gradual and linear so that they just grow bigger as you move up a 
curve, rather than having a single jumping off kind of point. 
   Senator GREGG. I do not have time right now, but I would be 
interested in which one of these-you clearly view taxes not as 
monolithic but as being divisible into some that produce more 
productivity and some that produce less. I would be interested in 
getting your written thoughts on that, if you had a chance. 
   One question I did want to ask, the House just a little while ago 
passed what they call the Medicare Prescription Drug Price Negotiation 
Act, which basically tells CMS to negotiate prices with drug companies 
relative to Part D premiums, with the representation that is going to 
save some money somehow. 
   CBO a year ago gave us a commentary that it would not, for what I 
think are fairly strong and obvious reasons. I am wondering if that 
remains CBO's view of that position? 
   Mr. ORSZAG. Yes, it does, and let me just try to explain both why 
and also why some of the price comparisons that I have seen with regard 
to say the prices that the Veterans Administration gets relative to 
some of the prescription drug plans are not really appropriate to the 
legislation that was introduced or passed by the House. 
   The reason that the Veterans Administration can get lower prices 
than other players is twofold. One is that there is a direct price 
intervention where the Federal Government, under the Federal Supply 
Schedule and the Federal Ceiling price, requires a particular set of 
effectively discounts or best prices to be offered. 
   The second is that the Veterans Administration then runs a 
formulary. It includes some drugs on its list and excludes others. 
The House legislation does not take either step. And I would note, you 
can get price reductions through those two steps, but there are broader 
ramifications from them. So just price negotiation by itself is 
unlikely to produce any significant cost savings because you do not 
have either of the tools that the Veterans Administration and some 
other government programs used to get price reductions. 
   And if you were to apply those kinds of tools in the Medicare 
program, there would be other consequences that would need to be 
weighed very carefully. 
   Senator GREGG. Specifically rationing. There would be rationing the 
drugs that would be available to citizens under Part D 
   Mr. ORSZAG. A formulary does include some drugs and exclude others. 
That is the definition of a formulary. 
   Senator GREGG. It is called rationing. Thank you. 
   Chairman CONRAD. I would like to just go back, if I can, to this 
question of taxes. And I would say to Senator Gregg, I just asked the 
staff to get for us the effective tax levels in other countries and 
their rates of economic growth. If you look at all taxes in the United 
States, Federal, State and local, we are at 26.4 percent of GDP and our 
real growth, real GDP growth for the last 10 years has been just under 
1 percent. 
   Interestingly enough, Sweden has had a much higher rate of growth, 
2.2 percent and a tax burden almost double ours, 50.2 percent. Denmark 
has had a higher rate of economic growth than have we over the last 10 
years, and they are almost at 50 percent. The United Kingdom has had a 
much higher rate of economic growth than we have and they have a tax 
burden 10 points higher, per capita I should say. 
   It really raises interesting questions about where the breakpoints 
are. 
   I must say I was very surprised by these numbers. I thought we would 
probably have higher rates of economic growth than these countries that 
have much higher levels of taxation. Any comment that you would want to 
make? 
   Mr. ORSZAG. A couple of comments. As you know, the structure of 
taxation in European countries is different from here with more 
reliance on value added taxes. 
   I would also say a lot of the popular discussion of Europe fails to 
distinguish between the Scandinavian countries, some of them that you 
just mentioned, and continental countries like France and Germany. The 
economic experiences do vary fairly significantly between the 
Scandinavian countries and the continental European countries. 
   Chairman CONRAD. I am Scandinavian. I am Danish, Swedish and 
Norwegian. 
   Mr. ORSZAG. Almost all of them. 
   Chairman CONRAD. Yes, I am sort of the Scandinavian melting pot. 
I look even at Italy. Italy has had higher economic growth, 
substantially higher. Growth of real GDP per capita in Italy, 2.3 
percent versus our 0.9 percent, and yet they have a level of taxation 
that is almost 43 percent, 50 percent higher than ours. 
   You raise, I think, a very important question, and that is different 
types of taxation have different economic effects. 
   This vote has started so I am going to go and cast my vote. So we 
will come back. There are other members who have indicated they want a 
chance to ask questions, as well, and we are waiting for this vote. So 
we will go do that. We will put the committee in adjournment awaiting 
the call of the Chair. 
   [Recess.] 
   Chairman CONRAD. We will resume the hearing with Senator Whitehouse 
and his questions. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Welcome and congratulations. I look forward to working with you. 
   I wanted to followup on a couple of things that I heard, I was not 
here but I had reported to me that happened in my absence. I had to be 
in the Judiciary Committee, my apologies. 
   The first has to do with Medicare Part D and the so-called 
noninterference clause. During my campaign, this was a very big issue 
in Rhode Island. There were studies that I cited to during the course 
of the campaign that showed not only were there substantial savings 
available if the non-interference clause were repealed and if the 
Federal Government took the logical next step and began to negotiate 
and drive prices down, but that the amount of savings would be enough 
to fill the so-called doughnut hole and provide coverage for folks so 
that we were not seeing the kind of things that I saw in Rhode Island 
like the 93-year-old lady who, after 93 years of independence loses her 
apartment because she cannot afford both her rent and the cost of her 
pharmaceuticals while she is in the doughnut hole. 
   I gather that you said that you did not see that there would be any 
savings from that. I am just wondering if you would explain what the 
analysis is that gets you to that point? And what your assumption is 
about what the Federal Government would do in answer to that 
legislative change that could produce no net savings? 
   Mr. ORSZAG. Thank you, Senator. I am glad you asked that question. 
   I want to make it very clear that there are potential savings in a 
$50 billion program. The question is how those savings could be 
realized. I did not say and do not believe that there are not price 
reductions that are possible for pharmaceutical prices under the 
Medicare Part D program. 
   The question is what steps are necessary to get those deductions, 
and there are other consequences. 
   Senator WHITEHOUSE. Are there steps that would involve the Secretary 
of the Department of Health and Human Services? 
   Mr. ORSZAG. Absolutely, but just negotiating authority by itself, 
without either legislation specifying a direct price intervention, in 
other words that Medicare Part D plans would be offered, for example, 
the best price offered in the private market, or without the Secretary 
having the ability to set a Federal Government formulary, that just 
negotiating authority by itself is unlikely to give the Secretary any 
leverage. 
   One could imagine the Secretary taking other nonprice things into 
account. Imagine the Secretary taking steps that involve things outside 
of the price negotiations themselves. But that is difficult to imagine 
right now and the legislation does not direct the Secretary to do so. 
   So if the Secretary just walks in and says I am here to negotiate 
over price, but there is no statutory requirement that you offer the 
best price that is offered to anyone, and I do not have the authority 
to set up my own formulary, there is very little leverage. And that is 
why we do not think that there will be any significant price reduction. 
I would note just quickly that giving the Secretary that kind of 
authority, what I just mentioned, has other consequences. For example, 
with regard to Medicaid where there is a direct price intervention 
also, the evidence suggests that pharmaceutical companies raise prices 
in the rest of the retail market to partially offset the reduction that 
is offered to Medicaid. In a program as big as Part D, which is now 
more than a quarter of retail sales, we will need to carefully evaluate 
the pros and cons of the kinds of steps that would unlock the savings 
that many people believe are potentially there. 
   Senator WHITEHOUSE. Thank you. I think my time has expired. 
   Chairman CONRAD. Senator Allard. 
   Senator ALLARD. Thank you, Mr. Chairman. I also apologize for not 
being here earlier. We had a conflicting hearing that I had to attend 
at that particular point in time. 
   One of the things that has concerned me is when we look at the 
baseline we tend to treat expiring taxes differently than expiring 
programs, making the assumption that the expired program is going to 
continue in perpetuity. That is not the case of all taxes. Excise 
taxes, for example, dedicated to a trust fund are assumed to extend out 
in perpetuity. 
   But many of those taxes that are set to expire here in 2010 are not 
assumed to be extended. 
   Would you share with me what your view is? It seems to me we have an 
inconsistency here. If you have spending, whether it is on the revenue 
side or whether it is on the programmatic side, spending is spending. 
It ought to be really reflective. I would like to hear your comments on 
that. 
   Mr. ORSZAG. Senator, as you know, the baseline rules that we apply 
are long-established historical rules that we continue to apply and 
there is an inherent logic to them. I would say that there may be a 
difference between the baseline for projecting likely future outcomes, 
for example most people predict that at least part of the 2001 and 2003 
tax legislation will continue. So in the most likely scenario those tax 
provisions will continue. That is one question. 
   A separate question is for budget scoring purposes what baseline 
should you be measuring changes from? The current set of rules do have 
a sort of adding up or internal logic to them. I would just note that 
the purpose of a baseline for predicting future budget outcomes and the 
purpose of a baseline for measuring policy changes and scoring purposes 
can sometimes come in conflict. And that is occurring now. 
   Senator ALLARD. Let us take AMT, for example, the Alternative 
Minimum Tax. They continually get extended every year. They will likely 
continue to be extended every year because they have both Republican 
and Democrat support. Why in the world don't we just figure that into 
the baseline, like an expiring program, for example? If you look at the 
record of the Congress, they are generally extended. There is sort of a 
group of expiring provisions that we bring forth every year that we just 
assume are going to be extended out every year. And yet we have a 
program out here that expires but we assume it is going to be extended, 
even though we do not even have a history in this Congress of extending 
that program. 
   So I think there is some inconsistency there, and I think it needs 
to be addressed. I know that we have certain assumptions built into the 
baseline. My point is that maybe we ought to take another look at these 
baseline assumptions and think if we are treating, when we extrapolate 
out these baselines, taxes the same way we are treating spending 
programs. 
   Mr. ORSZAG. Senator, what I would say is I think that a key 
principle should be that the cost of a particular policy path should be 
included in the budget process at some point, either at the time of 
enactment or when something is extended. The current scoring goals are 
intended to produce that outcome, so that for example on the revenue 
side, something that sunsets is not scored for the subsequent years 
when it is initially enacted. But then, if those provisions were 
extended, the cost shows up then. 
   So I think the important point is that the cost shows up in the 
budget process somewhere, either at the time of initial enactment or at 
extension. 
   With regard to other programs that are on the outlay side and are 
assumed to continue, a change that is made now will be continued in the 
initial scoring even if it expires within the budget window, so that 
the cost shows up today. Again, I think the important principle, 
regardless of how you do it is that the cost shows up somewhere. 
   Senator ALLARD. Don't you think that is an inconsistency? 
   Mr. ORSZAG. You could look at it either way. On the one hand, on the 
outlay side, even if you say something is going to stop with regard to 
some of the programs--
   Senator ALLARD. Even though it expires, you assume it is going to 
continue on. It seems like an inconsistency there. 
   Mr. ORSZAG. But again the important point is that the cost of a 
change shows up somewhere. It adds up and it does not just disappear 
from the process. I think that is important to the integrity of the 
budgetary process. 
   Senator ALLARD. Mr. Chairman, my time has expired. 
   Chairman CONRAD. Let me just say, Senator Allard is asking important 
questions. This baseline, these baseline issues are thorny. They are 
difficult. Let me take a stab at this, and correct me, Director Orszag, 
if I misstate something. 
   You are required by the law to, on the baseline, continue current 
policy. On the tax cuts, Congress chose to sunset the president's tax 
cuts. They did that for a reason. They wanted to have more tax cuts and 
they wanted to reduce the appearance of the cost of them. And so they 
sunset them. 
   Of course, the CBO baseline has to take account of that change, 
because Congress has said these tax cuts end at a certain point. And at 
that point you are obligated by the law to terminate them. Isn't that 
the case? That is not a matter of choice. 
   Mr. ORSZAG. Senator, we follow the baseline rules that were 
initially set by law. That law has expired but tradition and norm 
suggest continuing them. 
   We are looking to you for guidance as to how the Budget Committees 
believe the rules should operate. One of the reasons that there is this 
tension or awkwardness now is that the size of the sunsets in tax 
provisions are much larger than they were historically. And that 
creates some of this question about the right baseline to be using for 
a variety of purposes. That is unusual historically. We have not 
historically had such a large component of the tax code expiring within 
the budget window. 
   Senator ALLARD. Would the Chairman yield on that? 
   Chairman CONRAD. I would be happy to yield. 
   Senator ALLARD. Look at No Child Left Behind, for example. That is 
up for reauthorization. In all of our assumptions, we always said that 
program is going to continue out. That is a pretty sizable program. 
   It seems to me there is an inconsistency there, because if that was 
a tax provision, and we know it is sunsetting, then we would assume 
that it is not going to be extended out. 
   So I think that maybe the Budget Committee ought to spend some time 
making sure that we treat both of those aspects of the ledger in a 
balanced way, that is my point. 
   Chairman CONRAD. It is a point that is not without merit. 
   Let me say this, on the tax cuts side of it, the reason CBO has to 
sunset the tax cuts and therefore change the baseline is because 
Congress sunset them. Congress made a choice. And Congress did it for 
a reason. Congress sunset the tax cuts because Congress wanted to have 
larger tax cuts, the administration wanted to have larger tax cuts than 
they really wanted to show in the out years. 
   Now on the spending side of the ledger, typically things that are 
put into law, for example all the mandatory programs, those are 
permanent programs. Medicare is not sunset. Social Security is not 
sunset. 
   So that is a problem that we are presented with. 
   Senator ALLARD. The same argument, we did sunset No Child Left 
Behind. 
   Chairman CONRAD. Maybe the Director can help us with that specific 
example. 
   Mr. ORSZAG. My understanding is that the spending associated with 
the No Child Left Behind program is on the discretionary side. So in 
the baseline it is a different set of issues than mandatory spending. 
Senator ALLARD. My argument is not with the mandatory programs. My 
argument is with the discretionary programs that we put in. We sunset 
them and then do not treat them the same area as we would a tax cut. 
That is just the point I am making. 
   Mr. ORSZAG. If I could just comment briefly on the discretionary 
side, both to be clear about what we do in our baseline and also to 
point out that the discretionary spending programs generally operate in 
a different system than, for example, the pay-as-you-go rules. There 
are different rules that are associated with them. 
   In our baseline, one of the reasons that some people think that our 
baseline is biased the other way in a sense is that we assume that 
discretionary spending keeps pace with inflation. Historically such 
spending has grown more rapidly than that. So there are some who say 
the baseline understates likely discretionary spending because 
discretionary spending is likely to keep pace with population growth or 
something else. 
   But obviously you are raising a very important set of issues and I 
would very much look forward to working with you about both baseline 
and scoring issues as we move forward. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   Chairman CONRAD. Absolutely, Senator. Thanks for raising the 
question. 
   Let me go back to the question of the tax cuts because my able 
staff reminds those were done in reconciliation, which requires them to 
be terminated. They could not be made permanent because of the 
reconciliation rules. And they chose to do it in a reconciliation 
process because that allowed them to fast track it, to have limited 
debate, to have limited amendments. And so on the tax cut side, those 
were done under special rules that required their sunset. 
   The Senator raises a good point on the discretionary spending side 
of the ledger and I think the rationale has been you have a set of 
domestic spending initiatives. Even if one gets eliminated, they are 
replaced by others. If you look at discretionary spending, it has a 
base which tracks with what is happening to population growth, that 
tracks with inflation. And we are in a situation where we are not going 
to have that luxury. 
   The Senator I think, makes a point that is important here. We are 
not going to have that luxury. If we look ahead and look at the 
mandatory programs and the spillover effect on domestic discretionary 
programs, we are not going to be able to have those programs growing 
with inflation and population growth. It is not going to be affordable 
unless we do something substantial with the long-term entitlements and 
on the revenue side of the equation. 
   Senator ALLARD. Our surpluses that accumulate in Social Security 
will no longer be transferred to the general fund. And that is entirely 
right. 
   Chairman CONRAD. That is going to be a real moment of truth. 
   Senator NELSON. 
   Senator NELSON. Good morning. 
   Senator Bunning is going to offer an amendment this afternoon on the 
Floor of the Senate that would eliminate the tax revenue that is paid 
 on Social Security retirement benefits above a certain level. How 
would you characterize the effect of this upon the budget and the 
budget in the outlying years? 
   Mr. ORSZAG. Senator, we could get you the precise numbers but, as 
you know, Social Security benefits are partially subject to income 
taxation. That part of the tax code will grow more prominent over time 
because the thresholds are not indexed and so more and more people will 
be subject to them. 
   There would be implications also for both Social Security and 
Medicare, those programs, because the income taxes that are collected 
on Social Security benefits are currently dedicated both to the Social 
Security system and to Part A of Medicare. 
   Senator NELSON. We have heard that the impact would be something to 
the effect of reducing revenue by some $200 billion over a 10-year 
period. 
   Mr. ORSZAG. I could get back to you with the specific number. We 
cannot rule that out. 
   Senator NELSON. In order to approach this on a pay-as-you-go basis, 
to eliminate that tax but to find a source of revenue that would pay 
for that loss of revenue, do you have any suggestions? 
   Mr. ORSZAG. Senator, obviously there are many revenue options that 
are available to you. I am not even quite sure of the exact magnitude 
of the revenue change, so it would be premature to be providing you 
with many options. 
   I would also, as you know, point to the Joint Committee on Taxation 
as the lead agency for the revenue side of helping you on revenue 
options. But we would be happy to provide you with the options that you 
were interested in also. 
   Senator NELSON. I went on the Budget Committee in 1978 when I was a 
member of the House of Representatives. Of course, what I quickly 
realized that it was not just an economic document, it was a political 
document. Numbers can often be made to say whatever you want to say. 
In the budget that you have presented, does the budget take into 
consideration additional expenditures for defense that would occur 
later on with regard to a supplemental being offered by the President? 
   Mr. ORSZAG. No, it includes only the enacted appropriations thus far 
this year. 
   Senator NELSON. Does the budget that you offered, does it assume 
anything other than existing law with regard to all of the tax cuts 
that are in place cease come 2010? 
   Mr. ORSZAG. All of the tax provisions that are scheduled to expire 
in 2010 do expire in our baseline. 
   Senator NELSON. So right there, in reality, what we would have to 
grapple with in working with you is enormous more spending in defense 
because we will see additional supplementals come, particularly with 
the increased effort in both Afghanistan and Iraq, and that we will see 
a huge amount of change in the revenue that will occur as a result of 
the changes in tax cuts. 
   So in the assumptions, would I be correct--and I will ask Dr. Orszag 
and you, Mr. Chairman--that where the current law in this budget would 
be built on assuming that the revenues are going to escalate higher as 
a result of the suspension of those tax cuts that are in place, the 
political reality is that some of those tax cuts are going to be 
reenacted and therefore the budget assumptions made by Dr. Orszag is 
going to be wrong because it is going to have a lot less revenue. 
   So right there, this is just a country boy talking, if you have 
increased expenditures and you have lowered revenues in what is the 
reality of the situation, the budgetary reality, you are going to have 
bigger deficits. Is this country boy saying something that make sense? 
   Mr. ORSZAG. You are absolutely correct, that higher spending and 
lower revenue leads to larger deficits. 
   [Laughter.] 
   Chairman CONRAD. Pretty sophisticated country boy over here. 
   Senator NELSON. You just take it from there. 
   Chairman CONRAD. We have calculated, Senator, that if you extend the 
President's tax cuts, if you fund the war, if you deal with the need to 
reform the Alternative Minimum Tax, if you adjust for the continuing 
supplementals, that is a $4.6 trillion difference from the CBO baseline 
over 10 years. And it is not to the positive side, it is to the 
negative side. 
   So the reality that we confront here, the ongoing war with the need 
to reform the Alternative Minimum Tax because it is going to sweep up 
tens of millions of people, the President's proposals to make the tax 
cuts permanent gives you a much different future than CBO is able to 
provide because of the rules that they are under, rules that we have 
imposed upon them by the way. 
   And on top of that you have, unfortunately, the retirement of the 
baby boom generation coming on, which is going to really put us in a 
deep hole unless we address it. And we have to address all of these 
things. We have our hands full. Dr. Orszag? 
   Mr. ORSZAG. Yes, you do have your hands full. 
   Chairman CONRAD. I would just like to go back to this question of 
tax cuts paying for themselves. The Treasury Department, their analysis 
said that you get an offset of about 10 percent. That is if you have a 
$200 billion tax cut, about $20 billion of it comes back to you because 
of the tax cut. So you are left with losing 90 percent of the revenue. 
   CBO has done the analysis that said the first 5 years you get back 
on favorable assumptions, favorable to tax cuts, you get back 22 
percent of the tax cut. On less optimistic assumptions you get back 
nothing. 
   Central to the question of the effect of tax cuts and how much of 
the amount of the tax cut is paid for by the tax cut is the question of 
whether or not the tax cuts are paid for or not paid for. Many of the 
studies assume that the tax cuts are paid for either by other tax 
provisions or by cuts in spending. 
   What happens, Dr. Orszag, when the tax cuts are not paid for but are 
just added to the deficit? Then what do we see with respect to tax cuts 
paying for part of their amount? 
   Mr. ORSZAG. In that case, actually the sign can flip. So it is 
possible that the economic impact of a deficit financed tax change is 
actually negative rather than positive. The reason is that the tax 
change by itself can spur additional economic activity, lower marginal 
tax rates leading to more work effort. But you then have the drag on 
economic growth from a higher deficit and lower national saving. It is 
the net effect, and depending on the nature of the tax change it can go 
in either direction. 
   I would also note, Senator, that how tax cuts are financed 
consistent with that is absolutely critical to evaluating their full 
impact. The 22 percent figure that you were citing is actually the 
largest number for the CBO analysis for the first 5 years of a 
particular tax change that was studied. That analysis was applying one 
model and assuming that the cost of the tax change was offset by 
increases in tax rates after 10 years. 
   Different ways of financing-- 
   Chairman CONRAD. I was trying to be as favorable as I could to the 
group that says tax cuts pay for themselves. It is very clear from 
every one of these studies, including the Treasury Department under 
this Administration, their own studies show that tax cuts do not come 
close to paying for themselves. And when they are deficit financed, 
they do not even have an additive effect but have a potential negative 
effect. 
   Is that not the case? 
   Mr. ORSZAG. I think what we can say is that financing tax cuts 
through deficits, rather than immediately financing them with 
reductions in government spending, tilt whatever you think toward it 
being more likely that the overall impact is negative. 
   Chairman CONRAD. Why does deficit financing alter the outcome on 
these studies? What is the drag that is created by deficits? 
   Mr. ORSZAG. Budget deficits tend to reduce national saving. Lower 
national saving means that we accumulate less capital. And that means 
that we grow slower than we otherwise would. 
   Chairman CONRAD. I know that Senator Allard would like to get into 
this discussion. I welcome you to it. 
   Senator ALLARD. In your discussion you talked about taxes in 
general. It was a broad discussion about taxes in general. But I do 
think to really appreciate what can happen in a dynamic tax situation, 
I think you have to recognize that some taxes have a lesser economic 
effect than others. 
   I think in your response, Doctor, you got to that. Take the child 
tax credit for example. Although it has a social purpose and we want to 
help young families that are getting started who have children, it does 
not have the same economic impact as expensing for small business, for 
example, that we had in our tax cut package, where when you expensed 
out $100,000 all of a sudden you had people going out and buying 
Bobcats, you had people going out and buying x-ray machines if they 
were doctors. 
   Chairman CONRAD. Does the Senator know Bobcats are made in my State? 
   Senator ALLARD. I do know that. I also know how to run one, too, 
Senator, and they are good. 
   All of this drives this economic activity. I visited with Dr. 
Greenspan on this issue and I just want to know how you would view 
something like an expensing provision for small business where you 
target the small business community and you generate all of this 
purchasing and everything with small business, it creates jobs, and 
keeps the economy turning. 
   Would you agree that there is a difference in the type of tax that 
you have? And some of them have a greater impact on revenues than 
others. And expensing, for example, on small business may have a very 
large impact on stimulating the economy. When you have a growing 
economy, it increases revenues, as we are seeing today, huge increase 
in revenues, to State governments as well as Federal Government. 
   Mr. ORSZAG. Senator, I think one of the most important points that I 
am hoping really does come across is that it is absolutely true that 
the effect of tax changes depend on the nature of the tax change, the 
specific provision, and also how the tax change is financed. 
   Three things actually. Where you are starting from, the nature of 
the tax change, and then how you finance it. And so just talking 
generically about tax changes is too broad. You need to get more 
specific. 
   Senator ALLARD. In other words, the level of taxation also has an 
impact, and that depicted on the Laffer Curve. 
   There is a place there on that curve where you maximize return to 
the Federal Government. You can have taxes too high and it really hurts 
your revenue, and you can taxes too low. 
   Dr. ORSZAG. That's right. 
   Senator ALLARD. And you should apply that to each tax. You cannot 
apply it to taxes, in general. 
   Mr. ORSZAG. Yes, the Laffer Curve, which is the now famous or 
infamous, depending on your perspective, depicts that. 
   The reason that CBO and others have reached the conclusion that in 
general tax cuts do not come close to paying for themselves, is that we 
believe that we are on the left side of that curve. 
   If you were on the other side of the curve, the conclusion could be 
flipped. 
   Senator ALLARD. Can I ask a question on that, Mr. Chairman? 
   Chairman CONRAD. Yes. 
   Senator ALLARD. In 2003, we had tax cuts. Do you think, in general, 
we were on the right side or the left side of that curve? Because if 
you look at the results on today's economy, it appears we were on the 
right side. 
   Mr. ORSZAG. Most of the analysis that has been done suggests that 
while there was some growth impact from the tax changes, especially in 
an economy that was weak a tax change and spur demand and that leads to 
economic growth in that kind of setting, that those changes were not 
sufficient to offset the direct impact. And thus, effectively we are on 
the left side of the curve. 
   Senator ALLARD. Thank you. 
   Chairman CONRAD. And the result is that those tax cuts did not pay 
for themselves, did not come anywhere close to paying for themselves, 
and were additive to the deficit and debt. 
   If we are dealing with reality rather than fantasy around here, tax 
cuts at current tax levels do not come close to paying for themselves, 
especially if they are deficit financed. Unfortunately, all of these 
have been deficit financed. We have had to borrow the money. And 
increasingly we are borrowing it from China and Japan. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. I just had one followup 
on our earlier colloquy. 
   The Secretary clearly has extremely broad executive authority, 
clearly has rulemaking authority, and clearly has a very broad scope of 
initiative within which enterprises could be undertaken to pursue the 
goal of lower prescription costs through the Part D program. 
   Clearly this piece of legislation, the repeal of the 
non-interference clause, would not mandate how within the scope of that 
discretion and authority, the Secretary must act. 
   I just wanted to make sure that your comment to me, because it do 
not want to hear it other places as an argument unless I have clarified 
it with you, are you saying that there is no way with that piece of 
legislation that the Secretary could exercise his initiative to bring 
costs down? Or are saying that because the scope of it is so broad and 
that change alone provides little information about what will happen 
next, that from a scoring perspective you cannot put a dollar value on 
what would ensue? 
   Mr. ORSZAG. The latter, that is correct. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Chairman CONRAD. I would like to go back to the larger issue, if I 
could for a moment. Senator Allard, would you like? 
   Senator ALLARD. Yes, if I may. 
   Chairman CONRAD. If I could just go with a question and then we will 
come back to you, if that is OK. 
   I want to go back to the longer term issue that we face because we 
have been trying to focus on this committee on the longer term issues, 
challenges that we confront. 
   You earlier put up a chart that showed under one set of estimates we 
could be consuming all of what the Government spends now just on health 
care programs. 
   Mr. ORSZAG. Correct. In particular, if health care costs continue to 
grow over the next 50 years as rapidly relative to economic growth as 
they did over the past 50, that would be the outcome. 
   Chairman CONRAD. I am told that in your most recent baseline 
Medicare, for some inexplicable reason, has not grown as fast as was 
anticipated. Can you talk to us about what you are seeing with respect 
to Medicare expenditures? Why is it--you indicated part of it is Part D? 
In fact, I think if I heard you correctly you said the majority of it 
is Part D. 
   What other factors are contributing to Medicare not meeting the 
previous cost estimates? And can we anticipate that continuing? 
   Mr. ORSZAG. Projected Medicare spending is $445 billion lower now 
than in August 2006 over the 10-year window that was used at that 
point. The majority of that, $265 billion, is coming from Part D. And 
so let me talk about that briefly and then return to the residual 
component. 
   Part D is now estimated to cost less than it did in August for two 
reasons. First, the cost per beneficiary is lower. We now have actual 
data on experience with the program and again the PDPs, the 
prescription drug plans, are coming in with lower bids than we 
anticipated. And they are below last year's level, for example. That is 
the primary cause of that $265 billion. I think that something like 
over half, maybe closer to two-thirds of it, comes from that. 
   In addition there is, in the out years, a lower enrollment rate in 
Part D. That is because we now have more information on other sources 
of coverage available to Medicare beneficiaries. And so the share of 
Medicare beneficiaries that we project will take up the Part D benefit 
had been 87 percent. It is now 78 percent for those out years. 
   Chairman CONRAD. That is what you are anticipating would be the 
take-up rate? Instead of 87 percent, 78 percent? So there are savings 
there, as well. 
   Mr. ORSZAG. Correct. 
   Chairman CONRAD. How about in traditional Medicare, Part A and Part 
B? 
   Mr. ORSZAG. With regard to traditional Medicare basically what 
happened is--and we are still looking under the hood. But the change 
there looks like it is mostly concentrated in Part A, in hospital 
insurance. The previous baseline, consistent with experience over the 
previous several years, projected a more rapid growth rate. The actual 
cost numbers came in lower than that. So what happened in this baseline 
is we just had a one-off reduction in the level of costs and then 
roughly the same growth rate thereafter. 
   Chairman CONRAD. So this is more of a temporary thing, is your 
assessment? 
   Mr. ORSZAG. At this point, or at least for projection purposes, we 
are treating it as if it is a one-off change and then the growth rate 
resumes at the same time. So we are looking into exactly what the 
causes are of that lower rate. 
   There are a lot of things that are changing at the same time and 
obviously disentangling them all will take some time but we are 
actively working on it. 
   Chairman CONRAD. If you could inform the Committee when you reach 
conclusion on that matter, obviously that could be very significant if 
it is not just a one time--that would be very important to us. 
   Senator ALLARD. 
   Senator ALLARD. Thank you, Mr. Chairman. I want to follow the 
response on taxes and the impact it has had on the economy. 
   The fact is that we are seeing a pretty good jump in revenues at the 
Federal level and nearly all of the States are having a very good 
sizable jump in revenue. If it is not the tax cuts, what do you 
attribute that to? 
   Mr. ORSZAG. There are a variety of forces at work. Again, the tax 
changes could have caused some part of it. The question is whether they 
are the only cause. 
   Senator ALLARD. I do not think anybody is saying that. But would you 
say they contribute a significant part of it? 
   Mr. ORSZAG. They contributed some part to having the economy recover 
from the 2001 recessionary period. The tax cuts spurred demand and 
helped to boost growth. 
   With regard to the particular pick up in revenue over the last year 
or two, there are a variety of explanations being put forward. We do 
not have enough detailed individual information yet to evaluate all of 
them. 
   But for example, some things that people are putting forward as 
possible explanations, for any given level of overall economic 
activity, if that overall activity is more concentrated in higher 
income households than in middle-income households, then revenue will 
be higher than we projected for that given level of economic activity 
because our tax code is progressive. 
   We do not know yet, but it is possible that that is one explanation 
for why revenue is coming in higher than we projected. But there are 
others and we do not have the individual tax data yet to be able to 
give you a full answer. 
   Senator ALLARD. Let me move to Medicare Part D. In January of this 
year, CBO acknowledged market-based competitive bidding as one of the 
primary reasons for the significant decline in Part D spending of $136 
billion to nearly 26 percent of what was projected. 
   Do you agree with that CBO finding? And do you believe that could be 
attributed to the market-based competition? 
   Mr. ORSZAG. Again, the bids are coming in and pricing is coming in 
better than anticipated and that is likely a reflection of the 
competition that is occurring in the private market. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   Chairman CONRAD. I would like to go back to the whole question of 
what stimulates economic growth because I think we would all 
acknowledge tax cuts in a certain environment help stimulate economic 
growth. When the economy is underperforming, tax cuts are stimulative. 
Spending is stimulative. 
   Would you agree with that, Dr. Orszag? 
   Mr. ORSZAG. In a weak economy, where firms have extra workers and 
plant and equipment ready to produce things if someone would just buy 
them, either additional spending or a tax reduction which then spurs 
private spending will boost economic activity. 
   Over the long term, the question is a much different one because the 
question then becomes how do you encourage a greater capacity of firms 
and workers to produce things rather than generating enough demand for 
them? 
   Obviously, the tax system is only one of many inputs into that 
question. 
   Chairman CONRAD. In fact, running large budget deficits is 
stimulative, is it not the case? 
   Mr. ORSZAG. In the short-term, but not in the long-term. 
   Chairman CONRAD. So in the short term, if you have a weak economy, 
running large budget deficits helps stimulate. But there is a drag 
effect over time. 
   Mr. ORSZAG. That is correct. 
   Chairman CONRAD. And that is why when you look at the question of 
tax cuts, tax cuts can be stimulative if conditions are--I would argue, 
in fact I proposed very significant tax cuts in 2001. I proposed about 
half as much as the President proposed, because I wanted to take the 
rest and deal with the Social Security shortfall. 
   But I think we all understand that under certain conditions both tax 
cuts and spending are stimulative. 
   The question I have been trying to raise is do tax cuts pay for 
themselves? I think both the academic research from the Treasury 
Department,  from economists outside the Government, indicate they 
simply do not. They can offset part of their costs. But that offset is 
reduced if they are deficit financed. 
   Is that not the conclusion that we should reach if we are trying to 
do this on a rational basis? 
   Mr. ORSZAG. That is what the vast preponderance of analysis suggests. 
   Chairman CONRAD. Let me go to these larger questions once again, 
because if we are looking at the long-term imbalance in Social Security 
and contrast that with the long-term imbalance in Medicare, does CBO 
analysis show, as the GAO analysis showed, that the shortfall in 
Medicare is maybe seven times as much as the shortfall in Social 
Security? 
   Mr. ORSZAG. There are accounting questions regarding how you 
allocate shortfalls but there is no question that the Medicare 
inbalance, Medicare and Medicaid combined in particular, is 
substantially larger, many times larger than the Social Security one. 
   Chairman CONRAD. Have your people done any analysis on what we might 
do, a menu of options for how we could have savings in those accounts? 
   Mr. ORSZAG. Senator, we are actively working on various options for 
basically reducing cost growth in health care that you could evaluate. 
Let me just pause on that for a second because I think there is too 
aspects of it that are very important to emphasize. 
   One is I think it is a mistake to look at containing costs just 
within the Federal programs themselves, Medicare and Medicaid. The 
underlying driver of that cost growth, the costs in those programs, is 
the underlying rate of cost growth in the health sector as a whole. And 
tackling that problem is perhaps the fundamental fiscal challenge and 
an important economic challenge facing the Nation. So we need to be 
thinking about things that will restrain that cost growth. 
   The second point is I believe that there are opportunities to do 
that while still promoting innovation and imposing no harm on 
Americans' health. There is a variety of evidence suggesting that at 
the margin for each additional dollar we spend on health care, we do 
not get very much in terms of additional health benefits. That opens up 
the possibility that we could take some cost growth out of the system 
while not harming and perhaps even helping many Americans' health. 
   Chairman CONRAD. Let me just say, on behalf of the Committee, that 
we would ask you to come back to us as quickly as you can with options 
for saving money. And obviously, we would like to save money in a way 
that does not adversely affect healthcare outcomes. In fact, I believe 
there are places where we could actually save money and improve health 
care outcomes. I have talked to my colleagues about that many times 
with respect to better coordinating the care of the chronically ill. 
   Senator CARDIN. 
   Senator CARDIN. Thank you, Mr. Chairman. Dr. Orszag, welcome. Thank 
you very much for being willing to come forward and we congratulate you 
on your new appointment. 
   I congratulate you for being willing to come into the middle of this 
battle that we have going on regarding our budget, and I look forward 
to your help. 
   I want to cover two points, one on savings initiatives. You and I 
have worked in the past on improving savings rates in this country in a 
fiscally responsible way, targeting as many resources as possible to 
those who need the most assistance, our lower wage workers, and also 
increasing our national savings rate. 
   I hope that we will have a chance during the budget debate to talk 
about the impact of our savings rates on our short-term and long-term 
budget situation. 
   Let me ask a specific question on Medicare. I know that you have 
answered questions dealing with the pricing of prescription medicines 
in Medicare Part D. Your projections are a little lower as far as the 
Medicare spending is concerned. And there are certain aspects of the 
Medicare law on prescription drugs that I would like to get your help 
as to its impact on Federal spending. 
   The law requires that all of the Medicare Part D plans be 
administered by private insurance companies. There is no governmental 
insurance option. Statistics indicate that a Federal health care 
programs have for lower administrative costs than private health plans. 
If the Federal Government offered a public option, would that have an 
impact on some of the cost issues? I believe that is one way in which 
we could bring down the cost of Medicare Part D, as we do of course in 
the other parts of Medicare where the Government provides services and 
private insurance can also provide them. 
   I am interested as to what impact seniors' confusion about Part D 
may have had on your projections. Many seniors in my community have not 
signed up for Medicare Part D because they quite frankly cannot figure 
it out. So are these projections taking into consideration that many 
seniors who perhaps should be in Medicare D are not, and that is 
contributing to some of our cost savings? 
   I know you have been asked this question in the past. But my comfort 
level is not quite there on how much we can save if we allowed Medicare 
negotiated price. Common sense and Economics 101 tell me that the 
larger the market, the lower the price will be. So if you can put 
forward a larger market to a pharmaceutical manufacturer, you are going 
to get a lower price. 
   So it seems to me there is a substantial savings that we can achieve 
for taxpayers if we allow the Government to negotiate based upon the 
fall market in the Medicare program. 
   I would hope that as we start our deliberations on this year's 
budget, where entitlement spending for Medicare plays such a large 
role, we will be able to get more information about policy changes that 
could have a major effect on saving taxpayers money without adversely 
affecting Medicare beneficiaries' access to needed services. 
   Mr. ORSZAG. Senator, first with regard to complexity. Before 
answering the specific question, I do want to emphasize that I think in 
a variety of areas the evidence is very strong that complexity causes 
significant problems, whether it is with regard to higher education 
programs or retirement savings programs. That for any given level of 
effort by the Federal Government, the more complex it is the less 
impact it has in terms of improving outcomes for households. 
   So finding ways of still achieving the same purpose through 
simplified and default and other options, I think is a broad theme that 
is worthy of a lot of attention. 
   With regard to the specific question of enrollment, and just to 
clarify, the new projections entail lower enrollment rates over the 
long-term primarily because we now believe that beneficiaries will 
have--more beneficiaries will have other good coverage for prescription 
drugs than Medicare Part D and therefore will not take up Part D. 
   But in the very short term, there's actually a higher level of 
enrollment now than we projected last August. So the 2006 numbers are 
coming in with somewhat higher enrollment than we had thought in 
August. 
   Again, just to come back to, I guess, the central question of 
negotiating authority, I want to again emphasize that the reason that 
negotiating authority just by itself, in the absence of other steps, 
does not generate a large cost saving in our view, is that by itself it 
does not tap the potential steps that could lead to those savings. 
   So there are other things that are unimaginable and you would had to 
carefully evaluate the pros and cons. But a lot of the comparisons that 
have been done, comparing for example the VA program to Medicare, the 
prescription drug plans under Medicare, ignores the fact that the VA 
program has a formulary and it also has access to basically a direct 
price intervention through the Federal Ceiling Price and the Federal 
Supply Schedule which requires private firms to offer to the Veterans 
Administration effectively the best price that they offer on private 
markets. Which is not a feature of the legislation that passed the 
House. 
   Senator CARDIN. Mr. Chairman, your patience. 
   I understand there are other moving parts here, and it is very 
important for Congress to consider them also. I could not agree with 
you more. 
   But basic economics tells me this: that if government is negotiating 
a price with a manufacturer and has a larger market share, then that in 
and of itself would generate a more favorable opportunity for the 
taxpayer than would 40 separate private companies each negotiating a 
price for their enrollees. 
   Mr. ORSZAG. The problem is that the Secretary does not really 
control that market share. Part D is a little bit above one-quarter of 
the prescription drug market. If the Secretary could walk into a 
negotiation and say if you offer me this discount that 25 percent of 
the market is going to go your way effectively, very significant price 
reductions could be imagined. But that is not what would happen under 
just giving the Secretary negotiating authority because the Secretary 
cannot prohibit or prevented the drug from being listed or not listed 
on the PDPs, the prescription drug plans. 
   So by itself, the Secretary would then be in the position of walking 
in and, unless there were other regulatory steps brought into the 
discussion, which would raise a different set of issues, saying I am 
here to negotiate prices but I will not really be able to control or 
steer toward you any additional drug purchases. And in that situation, 
it is not clear why the Secretary would succeed in getting any 
significant price reductions. 
   Senator CARDIN. We need to explore this in greater detail. Clearly 
Medicare Part D was designed to make it difficult for Government to get 
directly involved in these areas, in addition to the negotiating 
restrictions. The history of Medicare is different than that. So this 
is truly different than the history of Medicare. 
   As as we look at saving taxpayer dollars, we should be prepared to 
redesign the program to save taxpayer money without adversely affecting 
seniors' access to prescription medicines. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Let me just go back to this point because we have a 
complex mix here on what is happening with Part D. We have lower plan 
bids. Some have said that one factor there may be overall prescription 
drug spending seems to be slowing. Do you anticipate or do you believe 
that that could be a factor here? 
   Mr. ORSZAG. That could be a factor, yes. 
   Chairman CONRAD. We also have been told that lower plan bids may be, 
in part, a business strategy by those offering the plans to capture 
market share. Could that be part of the reason we are seeing lower plan 
bids? 
   Mr. ORSZAG. It is possible. The market is, the top few plans account 
for a very large share of the existing market. 
   Chairman CONRAD. Let us talk about that a little bit. How many plans 
now, do you have this information at hand, how many plans do we have 
around the country? And what is the share of market for the top five? 
   Mr. ORSZAG. I know that the number of plans is quite high, and I 
believe that the share of the top five plans is also quite high. But I 
do not want to cite a number without being sure. 
   Chairman CONRAD. Does anybody on your staff here know what the top 
five plans would have, in terms of market share? 
   Mr. ORSZAG. We will get you that information. I have seen from other 
sources numbers that, the top five would be, I believe, even the 
majority of the market and perhaps well over the majority. But we will 
get you the precise number. 
   Chairman CONRAD. I think that is important to our understanding of 
what is going on here. 
   One closing question for me. Last week, Mr. Bernanke was here, the 
Chairman of the Federal Reserve, and he said this: Official projections 
suggest the unified deficit may stabilize or moderate further over the 
next few years. 
   Then he went on to say unfortunately, we are experiencing what seems 
likely to be the calm before the storm. 
   He went on to warn this committee that notwithstanding the likely 
improvement in the short term, that we remain on an unsustainable 
long-term path. 
   I would ask you, do you agree with the assessment by the Chairman of 
the Federal Reserve? 
   Mr. ORSZAG. Very much so. The Nation's long-term fiscal imbalance is 
quite serious and the sooner that policymakers address it the better. 
   Chairman CONRAD. I think that is the case. And that is the 
consistent message this committee hasten. It is the consistent message 
we got from the head of the General Accounting Office, from the 
Chairman of the Federal Reserve. And I am very hopeful that we find a 
way, Democrats and Republicans, to come together to face up to this 
long-term challenge and to do it sooner rather than later. 
   I think that is clearly in the national interest. Senator Gregg and 
I have been endeavoring to devise a process to address that. And we 
thank you very much for your testimony. 
   Are there any further questions from members? Senator Allard. 
   Senator ALLARD. Mr. Chairman, I do have a couple of things I would 
like to followup on, if I may. 
   I want to followup on our earlier discussion where you had said that 
you felt like the tax cuts that were put in place in 2003 actually were 
deficit financed tax cuts. If that's true--and then you went on further 
and said that would reduce savings. We have seen savings go down in 
that respect. But what we have not seen go down is long-term interest 
rates. 
   Before the tax cuts, the rates were hovering well over 5 percent. 
Since 2003 until now, they have been mainly around 4.5 percent, maybe 
on the high 4 percent side. 
   If we have damaged savings so much, how come those interest rates 
remain so low? 
   Mr. ORSZAG. That is a very good question. There are a variety of 
explanations that are being put forward. 
   Lower national saving means one of two things. It means either lower 
domestic investment or it means more borrowing from abroad. That is 
sort of an accounting identity. 
   So if we are only saving 1 percent of our income on that, it means 
we are only investing 1 percent of our income here in the United States 
or we are borrowing the difference from abroad. 
   Over the past several years there has been a very significant 
increase in the amount that we borrow from abroad. The reason that 
matters to the discussion is the mechanism for a given level of 
national saving affecting domestic investment is typically the interest 
rate. 
   So in short, what may be happening, or at least one explanation for 
what has happened, is as the world economy becomes more integrated and 
capital flows become easier across countries, the effect of domestic 
changes in budget outcomes, for example, is muted in terms of the 
interest rate effect and it shows up more in terms of international 
borrowing then a purely domestic mechanism. 
   Senator ALLARD. In that way, international borrowing may help our 
economy grow because it held our interest rates down. 
   Mr. ORSZAG. That is true, although I would note that foreigners do 
not lend us money for free. And so we do ultimately have to repay what 
we borrowed. 
   Senator ALLARD. But it is at a lower rate than it would ordinarily 
be. 
   Mr. ORSZAG. There is an interesting question about whether we are 
able, for a variety of reasons, to borrow at relatively low rates. In 
which case, the benefits of the investments that we can make with that 
borrowed money may exceed the repayments that we have to make. And 
there could potentially be some net gain from that. But it is smaller 
than the total. 
   Senator ALLARD. What are some of the other theories that could be 
used to explain that? You said there were several theories and you 
suggested this is one of them. 
   Mr. ORSZAG. That is one theory. Another theory is that, another 
prominent theory--and I probably should have mentioned in the same 
breath--that financial markets expect that whatever steps one takes on 
the budget, then it generates a certain projected outcome, that you all 
will take steps before a catastrophe hits to avoid that catastrophe.
Therefore, they price that into long-term-- 
   Chairman CONRAD. They are counting on us. 
   Mr. ORSZAG. Yes, it is all on you. 
   What is interesting about that is if that perspective is correct, 
then if at some point financial markets realize that is not the case, 
you will then break from their perception. And you could potentially 
have a significant adjustment at that point. 
   Anyway that is another explanation. There are others and I would be 
happy to sit down and discuss them in more length. 
   Senator ALLARD. Mr. Chairman, I know you are trying to wrap this up 
but I want to bring up the issue of military spending. 
   What you are projecting in the baseline is $145 billion on defense 
spending. We have already moved $70 billion over into 2007. It seems to 
me that that is pretty low. Around $100 billion is what we might expect 
in spending. 
   Do we need to take a look at the model that you are using for this? 
Or is this something we are not going to be able to deal with through 
model changes and it is just a problem we have with the way the Defense 
Department is coming in with their increased requests and emergency 
spending? 
   Mr. ORSZAG. A couple things quickly. First, which regard to the 
baseline, we include $70 billion in appropriated money because-- 
   Senator ALLARD. In the $145 billion you do? 
   Mr. ORSZAG. $70 billion for 2007. And there is likely to be more 
money appropriated. 
   Senator ALLARD. Let me get this straight. I have here in my notes: 
CBO projects a 2007 funding level for the global war on terrorism of 
$145 billion. 
   Mr. ORSZAG. Oh, I am sorry, under an alternative path. Thank you. 
   So one of the alternatives, not the main numbers, but one of the 
changes in policies or the alternatives includes, yes, total of $145 
billion for 2007. 
   I would say two things about the cost of ongoing operations, which 
obviously we are only talking about the fiscal cost. And I want to just 
focus on those and leave up to you other aspects of it. 
   The cost per month of ongoing operations appears, for the global war 
on terrorism, to be about $10 billion according to our information, and 
for the Iraq theater about $8.5 billion a month. We do not fully 
understand why those cost numbers are higher that they had been 
previously. And so that is one thing that needs to be better understood. 
   And in that context, the information that we have access to from the 
Defense Department and their systems do not allow us to have full 
insight into costing out both what is happening and what is likely to 
happen. And I understand that the Administration and others, and 
presumably this committee, are looking at different ways of trying to 
track both the budget authority and the actual spending that is 
associated with that particular set of defense activities, as opposed 
to everything else, more carefully. 
   Chairman CONRAD. Might I just, on this matter, Senator, say that in 
visiting with high level military officers part of what is happening, I 
am told, is we are living off the balance sheet. That is, that we are 
degrading equipment in a way that is going to come back in higher 
costs. 
   That is, when you are at this level of operations, the Army is going 
through Humvees, tanks, guns. The Air Force, at this high level of 
operations tempo, that the operations and maintenance expenses are 
going up because equipment is being degraded. That their requirement 
for replacement equipment is going up as this conflict is prolonged. 
Senator ALLARD. I could see how that would happen because it is a 
pretty harsh environment. 
   Chairman CONRAD. Very harsh environment, very hot, and they sand, 
they tell me it is eating up engines. Of course, this affects all of 
the services. The leading edge obviously, the Marines and the Army, in 
terms of their equipment losses. The Air Force, they have just been up 
to see me and talking about the additional costs that they are 
experiencing. 
   I think as we have analyzed this so far, we think this $10 billion a 
month significantly understates the cost that is going to come in on 
us. And we will have to wait and see what the supplemental request of 
the President shows. But we are hearing $100 billion, somewhere in that 
range. 
   Dr. Orszag? 
   Mr. ORSZAG. I was just going to return in the spirit of being 
responsive to this committee to get back to you immediately on your 
question about prescription drug plans. The top three plans, I am told, 
account by themselves for more than half of the prescription drug plan 
and Medicare Advantage by enrollment by themselves. So the top five 
players would be over half. 
   Chairman CONRAD. I have suspected that that would be the case. You 
can see in industry group after industry group that you have three or 
four who overwhelmingly dominate. And I think over time we can come to 
expect, even though you have dozens and dozens of plans across the 
country, that in a relatively short period of time there will be 
concentration in the market and that we can anticipate that that will 
be the case. There will be three or four that will dominate probably 
somewhere around 80 percent of the market. It is rapidly moving in that 
direction. And that is basically the information you have confirmed for 
us. 
   Let me indicate, we had said that we would try to end at noon and we 
will try to be good to our word. 
   Dr. Orszag, outstanding first performance before the Senate Budget 
Committee. We appreciate so much the contribution that you are making 
there and your excellent staff, as well. 
   And Dr. Marron, we are so glad to see you as a continuing part of 
this team. 
   Thank you very much. The hearing is adjourned. 
   [Whereupon, at 12:02 p.m., the committee was adjourned.] 

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                     DEFINING OUR LONG-TERM FISCAL 

                              CHALLENGES 

                                ______    
                       TUESDAY, JANUARY 30, 2007 
                                         
                                                      U.S. SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:04 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Wyden, Stabenow, Menendez, Cardin, 
Sanders, Allard, and Bunning. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

                OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. I bring the hearing to order. 
   I want to welcome everyone to the Budget Committee today. I want to 
particularly welcome our distinguished witnesses. Dr. Robert 
Reischauer, the President of the Urban Institute and the former head of 
the Congressional Budget Office; Robert Greenstein, the Executive 
Director of the Center on Budget and Policy Priorities; and Dr. Eugene 
Steuerle, a Senior Fellow at the Urban Institute. I very much welcome 
you all here and we appreciate your guidance to the committee. 
   Let me begin with a quote from the Federal Reserve Chairman Bernanke 
in his testimony earlier this month to this committee. In describing 
the urgency of addressing our deteriorating budget outlook, he said one 
might look at these projections and say well, these are about 2030 and 
2040 and so we really do not have to start worrying about it yet. But, 
in fact, the longer we wait, the more severe, the more draconian, the 
 more difficult the adjustments are going to be. I think the right time 
to start is about 10 years ago. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   I think Chairman Bernanke had it about right. 
   We are now facing, as this next chart shows, a wall of debt. At the 
end of 2001 we had a gross debt for the country of $5.8 trillion. Under 
CBO's adjusted baseline we can see that gross debt will reach $9 
trillion by the end of this year. And if we continue on this course, 
gross debt is projected to sore to $12 trillion, more than $12 trillion 
by 2012. All of this really at the worst possible time, right before 
the baby boom generation retires. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   The number of Social Security beneficiaries is projected to more 
than double to some 82 million people by 2050. This is the trajectory 
that we are on. I call this the demographic tsunami. You can see all of 
these people have been born. This is not a matter of a projection. 
These people have been born. They are alive today. They are going to 
retire. They are going to be eligible for Social Security and Medicare. 
There is no way around that. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   We need to remember that Social Security is not the biggest budget 
challenge. Because of rising health care costs over the next 75 years, 
the shortfall in Medicare is seven times the shortfall in Social 
Security. The shortfall, the projected 75-year shortfall in Social 
Security is $4.6 trillion. The 75-year shortfall in Medicare is over 
$32 trillion. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   But we do not just have an entitlement problem. We also have a 
revenue challenge. If all of the President's tax cuts are made 
permanent, the cost will explode at the very time the cash surpluses in 
Social Security and Medicare become deficits. In other words, the 
President's tax cuts will dramatically worsen an already deteriorating 
long-term budget picture. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   This chart, I think, is extremely important for my colleagues and 
for the public to understand. The green part of these bars is the 
Social Security surplus that then turned to deficits. The blue are 
Medicare, Medicare deficits. And red is the cost of making permanent 
the tax cuts from 2001 and 2003. 
   This is not a pretty picture because what it shows is right now 
Social Security is throwing off big surpluses. But when those turn to 
cash deficits, at that very time the cost of the President's tax cuts 
explode. The combined effect takes us right over the cliff. 
   Since so much of our long-term budget shortfall can be attributed to 
rising health care costs, health care reform has to be at the heart of 
any solution. Our health care system is not as efficient as it should 
be. The U.S. is spending far more on health expenditures per capita 
than any other country in the developed world. For example, the U.S. 
spent $5,711 on health care expenditures per capita in 2003 compared to 
$2,100 in Finland. Despite this additional health care spending, health 
outcomes in the U.S. are no better than health outcomes in the other 
OECD countries. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   You can see, I just picked out Finland. Finland is at the low end. 
But you can look at all of the major countries of the developed world. 
The United Kingdom, they are just over $2,300 per capita, less than 
half of what we spend, all the way up to Switzerland. You can see they 
are $3,800, still far below us. 
   The country that is closest to us is Luxemburg, just under $4,000 
per capita. 
   As we see the same thing when we look at health care expenditures as 
a share of our gross domestic product. For example, the U.S. spent 15 
percent of GDP on health care expenditures in 2003. We believe we will 
be at about 16 percent of GDP this year compared to Ireland, 7.2 
percent. The next highest to us is Switzerland at 11 percent of GDP, 11 
percent of GDP. This year we are at 16 percent. 
   If we were 11 percent of GDP instead of 16 percent, we would save 
$800 billion in 1 year. 
   Clearly, just slashing Medicaid and Medicare is not the answer. One 
area, I  believe, we need to focus on is the fact that about 5 percent 
of Medicare beneficiaries use half of the money. That is, I think, a 
startling and powerful statistic. Approximately 5 percent of Medicare 
beneficiaries use half the money. These are the chronically ill. They 
are people with multiple serious conditions. I think we are learning 
more and more. If we focused on that category, we could both improve 
health care outcomes and save money. 
   I believe our fiscal problems are not insurmountable. We can put our 
fiscal house back in order but it is going to take a good faith effort 
on everyone's part. And both political parties, and those of us who 
represent individual states, and those of us who have a party label by 
our name, I think all of us have to be prepared to give up on some of 
our fixed positions if we are going to make long-term progress. 
   With that, I want to turn to my colleague, Senator Allard, who is 
filling in ably for the ranking member of this committee, Senator 
Gregg, who could not be with us this morning. 
   Welcome, Senator Allard. 
  
                      OPENING STATEMENT OF SENATOR ALLARD 

   Senator ALLARD. Thank you, Mr. Chairman. 
   I would like to join you in welcoming the panel members. I am 
looking forward to your testimony, and I know it is not always easy to 
put your personal schedules aside to be able to testify before this 
committee. But we have an important subject before us and I do commend 
the Chairman for his efforts in trying to deal with these long-term 
liabilities. 
   It is not really news to anybody. The Congress has known this has 
been coming on for a long time. But there has been an unwillingness for 
the Congress to respond to these issues. So I do appreciate the 
leadership that Senator Conrad is bringing forward as Chairman of the 
Budget Committee. 
   The baby boomers are going to start retiring in 2008. That is next 
year. If we look at the population growth of those 65 and over the 
numbers are staggering. In 2005 we are looking at 37 million. We see 
that doubling in 30 years, so that in 2035 we have 75 million people 
that are going to be pulling on our entitlement programs, which are 
directed to an aging population. That is Social Security, Medicare, and 
Medicaid. 
   When this was set up in the 1960's we had one beneficiary for every 
5.1 workers and now have about 3.3 workers for everybeneficiary.In 
2035, when we are projecting 75 million, there will only be 2.1 workers 
for each beneficiary or retiree. 
   It is a huge problem that we have before us. Under current law the 
mandatory spending will grow at an average of 6.1 percent per year 
during 2007 to 2016, reaching somewhere around $2.5 trillion. 
But the entitlements, as the Chairman pointed out with his charts, are 
the real problem. We simply have to establish a will in this Congress 
to deal with the huge numbers that we are looking at with Social 
Security, Medicare and Medicaid. 
   If we look at Social Security, Medicare, and Medicaid, unless 
something is done, as a percentage of gross domestic product, spending 
on just these three programs is going to grow higher than one-fifth of 
the economy. Here is what we are looking at: in 2010 it will make up 
about 9.5 percent of gross domestic product. In 2030, about 18 percent 
of gross domestic product. And in 2050, 25 percent of gross domestic 
product. 
   But the astounding thing about it is not only are the percentages 
increasing as a percentage of gross domestic product, but gross 
domestic product is growing at a phenomenal rate. If you look at the 
growth of our entire economy from 2003 to now it has grown in an amount 
equal to the size of the entire Chinese economy. And so these are 
figures that are being extrapolated on top of a very fast-growing 
economy that we have currently. 
   I am not saying it is always going to be there, but our economy 
seems to be perking along pretty well, and I do not see any signs of it 
letting up. And when you look at those percentages and look at the 
growth of the gross domestic product, it is just phenomenal. 
   This problem is serious, and I do not see us being able to tax our 
way out of it. I think it is going to take a balanced solution. We are 
going to have to look at a number of things to do to begin to resolve 
this commitment. It will continually add to our deficit and, as a 
result, add to our total debt. 
   Some things have been done in an attempt to address this problem by 
the previous Chairman, Senator Gregg, with his SOS bill that he 
introduced last year. I think that there are some bipartisan groups 
looking at a commission to put some entitlement recommendations before 
the committee. While Social Security is a problem, Medicare and 
Medicaid is a greater problem and a much more complex issue to solve 
from my perspective, and I think most everybody would agree with that. 
But I think maybe we need to start off with a simple solution with 
Social Security and then begin to address Medicare. But we cannot delay 
it because Medicare is going to be a problem here shortly and it is 
going to be a huge problem when it hits us. 
   So I again commend the Chairman for running these series of hearings 
and look forward to your testimony. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator Allard. 
   Next we will turn to our witnesses and we will hear from each of 
them in turn, and then open the panel to questions from the members. 
   Welcome, Dr. Reischauer. It is always good to have you back before 
the committee. 
   Are we going to start with Gene or with Bob? 
   Welcome. 

           STATEMENT OF ROBERT GREENSTEIN, FOUNDER AND EXECUTIVE 
              DIRECTOR, CENTER ON BUDGET AND POLICY PRIORITIES 
   
   Mr. GREENSTEIN. Thank you, Mr. Chairman. 
   Yesterday, we released new long-term budget projections through 2050 
that incorporate the new CBO report that came out last week and take 
into account recommendations from a number of the Nation's leading 
budget experts. 
   There are five key findings. First, the Nation's budget policies are 
unsustainable. 
   Second, the main source of rising expenditures is rising health care 
costs throughout the U.S. health care system and demographic changes 
that would drive up spending for the ''big three'': Medicare, Social 
Security, and Medicaid. 
   Third, increases in health care costs per beneficiary in Medicare 
and Medicaid mirror increases in costs in the overall U.S. health care 
system and a solution to the long-term fiscal problem will necessitate 
reform in the overall health care system. 
   Fourth, Federal programs other than Medicare, Medicaid, and Social 
Security, including entitlements other than the big three, are 
projected to shrink as a share of the economy and are not contributing 
to the problem. 
   Fifth, the tax policy decisions you must make in coming years will 
have a large impact. 
   Let me take each of these five areas in a little more detail. 
   Our projections show that if you stay on the current course, make no 
changes in the ''big three'', make all the tax cuts permanent and, 
continue relief from the AMT without paying for it, deficits will reach 
20 percent of GDP by 2050 and the national debt will reach 230 percent 
of GDP by 2050, as this graph shows. 

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   Another way of measuring the size of the problem is to look at what 
analysts call the fiscal gap, which is the amount of program reductions 
or revenue increases needed to ensure that the debt as a share of the 
economy is no higher in 2050 than it is today. Under our projections, 
the fiscal gap is 3.2 percent of GDP. 
   Now what that means is that stabilizing the Nation's finances would 
require budget cuts or tax increases starting immediately equal to 3.2 
percent of GDP per year. That would mean budget cuts and/or tax 
increases totaling $460 billion dollars in 2008 alone, because that is 
3.2 percent of GDP. That is how big the problem is. 
   Second, health care costs rising throughout the health care system 
and demographic changes will cause Medicare, Social Security, and 
Medicaid to rise by 2050 by a projected 13 percent of GDP. 
   Third, the growth in Medicare and Medicaid costs mirrors and is 
driven to a large extent by cost growth in the health care system as a 
whole. For the past 30 years the average annual rate of increase in 
Medicare and Medicaid costs per beneficiary has been very close to the 
rate of increase in health care growth per beneficiary systemwide. 
   This is why Comptroller General David Walker has testified, and I am 
quoting, ''Medicare and Medicaid cannot grow over the long term at a 
slower rate than the rest of the health care system without resulting 
in a two-tier health care system.'' And he continued ''To address the 
long-term fiscal challenge, it will be necessary to find approaches 
that deal with health care cost growth in the overall health care 
system.'' 
   No. 4, programs other than the big three. The new CBO forecasts that 
came out last week shows that entitlements other than the big three as 
well as domestic discretionary programs will fall through 2017 modestly 
as a share of GDP. That continues a trend of the past 30 years and is 
expected to continue beyond 2017. This is why it is not really accurate 
to speak of a general entitlement crisis rather than to focus on the 
projected increases in Medicare, Medicaid and Social Security and the 
factors that drive them. 

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   Finally, the tax policy decisions Congress must make over the next 
few years will have large effects. Specifically, allowing the recent 
tax cuts either to expire as scheduled or to continue them but to pay 
for their costs under PAYGO would reduce the long-term fiscal gap by 
three-fifths. The tax cuts, when fully in effect, will cost about 2 
percent of GDP. The fiscal gap is 3.2 percent of GDP. Either letting 
them expire or extending them but paying for it will shrink the 
long-term fiscal gap from 3.2 percent to 1.3 percent of GDP. 
   Or stated another way, making the tax cuts permanent without paying 
for them will double the fiscal gap through 2050 relative to what it 
otherwise would be. 
   Why is that effect so large? Because the decision is occurring in 
the next few years. And if one achieves deficit reduction of about 2 
percent of GDP in the next few years, after 2010, that effect quickly 
compounds year by year in terms of debt and interest payments and 
ultimately reduces the deficit by significantly more than 2 percent of 
GDP. 
   It is simply an illustration of the larger point which you made, Mr. 
Chairman, the sooner you act, both on the revenue and the entitlement 
side, the larger the long-term effect and the smaller the depth of the 
reductions that ultimately have to be made. 

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   Our bottom line is that it is politically implausible to close a gap 
of this size either solely by cutting programs or solely by raising 
taxes. Doing so would require the equivalent of an immediate permanent 
18 percent increase in tax revenues or an immediate permanent 15 
percent cut in all programs, including Social Security, Medicare, 
defense, antiterrorism activities, education, veterans benefits and the 
like. All parts of the budget have to be on the table and systemwide 
health care reform must be part of the solution. 
   Let me close with a few quick policy observations. As you noted, to 
make these kinds of changes in health care, taxes, and Social Security 
is going to require a large difficult bipartisan agreement which may 
take a few years to build the basis for. But some immediate, more 
modest, but still important steps could be taken. And there are some 
immediate things one wants not to do in order to keep the problem from 
getting worse. 
   So a few very quick suggestions. No. 1, I would seriously consider 
the medications for Medicare savings in the Medicare Payment Advisory 
Commission, of which Mr. Reischauer is a Vice-Chairman. I would 
seriously consider the revenue options in the report the Joint Tax 
Committee provided to Congress about 2 years ago, which has a series of 
options to narrow or curb unintended or unproductive tax expenditures 
and to improve tax compliance. 
   Third, I would consider a report issued last week by the Urban 
Institute Brookings Tax Policy Center that provided a series of options 
for revenue neutral reform of the Alternative Minimum Tax. 
   I note here that there has been discussion lately of AMT repeal. If 
the 2001 and 2003 tax cuts are not extended, AMT repeal would cost $800 
billion over the next 10 years. If they are extended, it would cost 
$1.5 trillion over the next 10 years. And even continuing the current 
practice of providing an AMT patch each year without paying for it is 
becoming increasingly expensive and fiscally imprudent. On that course, 
it will cost you $70 billion a year by 2010 and more thereafter. 
   I would also consider freezing costly expansions not yet in effect. 
For example, two tax cuts that President Bush did not request, that 
were added on top in 2001, are only partially in effect now. They are 
slated to triple in size between now and 2010. These are two income tax 
adjustments. 
   Analysis by the Tax Policy Center shows that nearly two-thirds of 
these tax cut benefits not yet in effect would go to the 0.3 percent of 
Americans over $1 million a year, 90 percent will go to the 4 percent 
of Americans over $200,000 a year. If you simply held them at today's 
levels, and did not take away a dollar in tax cuts from anyone who is 
getting it, but did not allow them to triple in size between now and 
2010, you would save $13 billion in the next several years, which is 
about the amount needed to avert deep cuts in the State Children's 
Health Insurance Program that will occur if SCHIP is frozen for the 
next 5 years at the Federal budget baseline. 
   Finally, I would seriously consider, across the Government, 
replacing the traditional Consumer Price Index with the new improved 
alternative CPI that the Labor Department has developed that measures 
inflation a little more accurately. I am talking about things from 
Social Security COLAs to the indexing of the tax code, evenhanded 
across the Government. 
   The new CPI rises a few tenths of a point per year more slowly than 
the traditional one. The savings initially are small. They grow over 
time when you need them as your fiscal problem expands. And it really 
should not be viewed as a benefit cut or a tax increase. It is simply 
doing what the law currently intends, adjusting for inflation rather 
than over-adjusting for inflation. 
   With that, I will conclude. Thanks for inviting me today. 
   [The prepared statement of Mr. Greenstein follows:] 

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   Chairman CONRAD. Thank you very much, Dr. Greenstein. Thank you for 
those new numbers that, in many ways, confirm what we have been talking 
about with the previous witnesses, the Chairman of the Federal Reserve 
and the head of the General Accounting Office, who both outlined in 
some detail the really daunting challenges that we face. 
   Now we will turn to Dr. Reischauer. Thank you. Thanks for being 
here. And please proceed with your testimony. 

   STATEMENT OF DR. ROBERT D. REISCHAUER, PRESIDENT, URBAN INSTITUTE 
   
   Mr. REISCHAUER. Thank you, Mr. Chairman, and members of the 
committee. I appreciate the opportunity to appear before you today. 
With your permission, I would like to submit my prepared statement for 
the record and confine my remarks to an elaboration of a couple of 
points made in that statement. 
   Chairman CONRAD. We would be happy to take your statement in full. 
   Mr. REISCHAUER. First, today, through Mr. Greenstein's testimony, 
and during the committee's recent hearings, you have heard a number of 
experts present long-run budget projections that show that debt and 
deficits begin to soar around the third or fourth decade of this 
century as interest expenses, which are the one component of the budget 
that truly is uncontrollable, begin to explode. 
   The fact that the current budget situation appears, at least on the 
surface, to be rather benign and that three-plus decades is a long time 
out, may lead some to believe that we need not rush to make the policy 
adjustments required to make the fiscal situation sustainable. This, as 
you have already heard, would be a big mistake, for it is inconceivable 
that the paths portrayed in these long-run projections will play out as 
presented. 
   As the fine print that accompanies most of these projections notes 
on, these estimates do not take into account the feedback effects of 
deficits on the economy which will act to depress economic growth 
significantly and that will further exacerbated the fiscal situation. 
Nor do these projections examine the ramifications of the growing 
ownership by foreigners of dollar denominated assets on the well-being 
of U.S. citizens. The profits, rents, dividends, interest and capital 
gains associated with those assets will be paid to foreigners, raising 
their, not our, standard of living. In other words, a growing fraction 
of the fruits of whatever economic growth we do enjoy will be captured 
by foreigners because they will be the ones who own the capital. 
   For these reasons, it is highly likely that policymakers will be 
forced to begin the adjustment process far sooner than a superficial 
reading of these long-term budget projections imply. If we do not begin 
to take steps to live within our means soon, we run an increasing risk 
that some unpredictable crisis will dictate both the timing and the 
pace of the unavoidable adjustment process. 
   This does not mean that we have to swallow all of our medicine at 
once, that we have to sit down today to work out an adjustment of 3.2 
percent of GDP, which is the Center on Budget and Policy Priorities' 
new estimate of the gap. But it does mean that we need to show a 
good-faith effort that we are willing to begin this process. 
   In addition to some modest tax and spending restraints enacted 
immediately, we should adopt policies that may go into effect many 
years from now but will indicate the direction that we are headed in. 
Recall that in 1983 we adopted changes to the normal retirement age in 
the Social Security program that did not affect beneficiaries until the 
year 2000, 17 years later. But it gave an indication that we were aware 
of a problem and we were going to do something about it. 
   In addition, I would urge you to consider enacting mechanisms that 
provide for automatic adjustments when and if things go off path. These 
might include mechanisms that shave the automatic indexation both in 
our tax code and in our entitlement programs. They would be a form of 
failsafe so that those who are skeptical about Congress's ability to 
address problems in a timely manner would know that behind the scenes 
automatic trigger devices might dampen the damage. 
   Second, it is clear, as you have heard from other witnesses, that 
the primary cause of the long-run fiscal problem is the inexorable 
growth in per beneficiary health spending which significantly exceeds 
the growth in per capita GDP. If, through some miracle, we were able to 
hold per capita health spending in Government programs to the level of 
per capita GDP growth, it would not be a heavy lift to get the rest of 
our fiscal house in order. 
   But unfortunately, there are no miracles on the shelf. The problem 
of rapidly growing health costs is not confined to U.S. Government 
programs, as Mr. Greenstein has pointed out. The same pressures affect 
both the private sector and foreign countries. What is different is 
that the private sector and foreign countries have mechanisms that 
force the parties to consider the tradeoffs between improved health 
care and other priorities. 
   For example, in our employer-provided health care system, employers 
and workers must choose between receiving their compensation in the 
form of better health insurance on the one hand or in the form of 
higher cash wages and more generous non-health benefits on the other. 
In countries that budget explicitly for their national health systems, 
tradeoffs are made between higher taxes, charges and premiums on the 
one hand and new and more costly health benefits on the other. 
   With open-ended entitlement programs and a seemingly unlimited 
capacity to borrow, we have only very weak constraints on our major 
Government health programs. 
   In my opinion, we will probably need to fundamentally restructure 
the Nation's health care delivery system and the mechanisms used to 
finance it if we hope to moderate cost growth without compromising the 
quality of care. 
   This is a daunting challenge because it affects not just public 
programs but rather the entire health system of our country. As Mr. 
Greenstein has noted, and David Walker has said many times, we are not 
about to create in this country a separate delivery system for the 
elderly, disabled and poor, one that is different from that that 
workers and their dependents enjoy. Nor are we about to tolerate one 
level of care for Medicare and Medicaid beneficiaries and another level 
of care for those enrolled in the employer-sponsored system. 
   Over the long run, I think we are going to have to move away from 
the current fragmented, uncoordinated delivery system, a system in 
which individuals buy their care a la carte using insurance that is 
heavily subsidized by the Federal Government. We are going to have to 
move toward more coordinated mechanisms for delivering care and are 
going to have to begin to define what basic, essential health care is 
and provide access to that care to the entire population. 
   This obviously is an area that goes well beyond the jurisdiction of 
this committee and I close by suggesting that should the will be there 
to move in this direction, it will probably involve some initial 
investment in infrastructure and information technology to facilitate 
such a transition. 
   Thank you, Mr. Chairman. 
   [The prepared statement of Mr. Reischauer follows:] 

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   Chairman CONRAD. Thank you, Dr. Reischauer. 
   Dr. Steuerle, welcome. Good to have you back before the committee. 

       STATEMENT OF DR. EUGENE STEUERLE, SENIOR FELLOW, URBAN INSTITUTE 

   Mr. STEUERLE. It is good to be here. I would like to express my 
appreciation to all the members of the committee for their bipartisan 
effort to tackle this very important problem. 
   One of the reasons I enjoy being before this committee is because it 
has a tradition along those lines, to work together on those issues. 
I would like to begin by undertaking an imaginary exercise with you. 
Suppose that during the presidency of William Howard Taft, Congress had 
enacted laws that would predetermine all spending and tax subsidies for 
today and throughout the 21st century. As economic growth led to higher 
Government revenues, these legislators would have continued to 
prescribe, now from six feet under, how to divvy up the spoils. Their 
ingrained policy wheels would run over future elected officials and 
voters and prevent any new priorities members wanted to enact. Each 
political party would hope to see the other party forced to do damage 
control in the budget but view it as political suicide to do anything 
substantial itself. 
   Ludicrous scenario? Not really. In recent decades, we have 
essentially wound just such a straitjacket around ourselves. Never 
before has the law predetermined so much of our future spending and 
tax subsidy priorities. Yet it makes no more sense to commit economic 
resources that far into the future today than it would be to decide 
where to station troops into the next millennium. 
   In my view, only major systemic reform can restore a normal 
democratic process. We need budget slack--that is wiggle room for new 
policy between future Government revenues and current spending 
commitments. 
   I want to be very clear about this. Deficit reduction is not enough 
to get us there, because you would still end up having committed all 
those future revenues. 
   In the remainder of my testimony, I would like to highlight some 
extremely important consequences of our current budgetary situation, 
consequences I think that are of concern to members of both parties. 
First, larger shares of our budget spent on retirement benefits leaves 
an increasingly smaller share to finance activities more likely to 
promote productivity such as nursing advice for pregnant mothers, early 
education for the very young, and after school activities for older 
children. 
   Second, our system of elderly support has morphed into a middle-aged 
retirement system. A couple retiring at age 62 today can expect to get 
benefits for 26 years. When Social Security was young, the average 
worker retired at about age 68. To retire for an equivalent number of 
years today in Social Security, a person would retire at about age 74. 
I have a few graphs in my testimony that are being shown which try to 
summarize some of this information. 
   Third, most economic projections include a slower rate of growth of 
the labor force, partly because so many people now retire in late 
middle age. Keep in mind that for any given tax rate supporting old age 
programs you may decide to enact or compromise upon, a structure of 
significantly higher benefits can be maintained if people work longer. 
Why is that? Because if they work longer, there are more revenues. 
   Fourth, almost every year a smaller share of Social Security 
benefits goes to the oldest and most vulnerable in terms of health 
needs and capacity for working. If progressivity is defined by how well 
the vulnerable are served, the system is becoming less progressive 
every year. 
   Fifth, lifetime benefits in Social Security and Medicare for an 
average couple have now risen from about $250,000 in 1960--these are 
real dollars--to over $750,000 today and are scheduled be over $1.2 
million for a couple retiring in about 25 years. We cannot keep adding 
benefits for this part of the population without shrinking services for 
the rest of the population. 
   Sixth, building eternal growth into permanent programs affects taxes 
as well as spending. Two examples provided in my testimony are for Roth 
IRAs and for tax subsidies for the purchase of health insurance. These 
policies are badly designed not simply from a budget standpoint 
(because they give away revenues or spend revenues before we even 
determine the needs of the day), but also because the additional amount 
spent on them may actually decrease saving and decrease the number of 
people with health insurance. The President has or attempted to address 
this latter issue in part with his recent proposal on dealing with the 
tax exclusion for health insurance. 
   Seventh, within a quarter century, close to one-third of the adult 
population is scheduled to be on Social Security. If we add other 
individuals in society who are dependent upon other assistance 
programs, we are approaching the day when about one-half of the 
population will be significantly dependent upon Government for its 
support. A Government that treats everyone as needy, treats no one as 
needy. 
   Eighth, the squeeze on children and working families is being felt 
now. It is not awaiting for some day in the future. Under reasonable 
projections within a very short period of time, all revenues will be 
eaten up by Social Security, Medicare, Medicaid, defense, and interest 
on the debt with nothing left for anything else. Your charts, Mr. 
Chairman, as well as those of Dr. Greenstein, also support that fact. 
Ninth, the continually declining share of the budget for discretionary 
spending means continually declining Congressional control over the 
budget. My own suggestion here to deal with this issue, in part, is to 
change the presentation of the budget at the time when the President's 
budget comes out. It requires no legislation. It only requires the 
Congressional Budget Office and the Office of Management and Budget to 
present budgetary changes first in a way that combines automatic and 
discretionary changes. 
   One example I give in my testimony, and that you can see on the 
monitors next to you, is that according to Congressional Budget Office 
revenue projections, revenues will be increased in 2010 by about $286 
billion over and above what they are today. These are real revenues, 
but almost all of those revenues have already been pre-committed to 
growth in Social Security, Medicaid, Medicare and interest on the debt. 

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   This type of presentation shows you--and allows you to show the 
public--the lack of control you have over how to allocate these 
additional revenues. A more informative presentation requires showing 
not just changes from current law but total changes from what we are 
doing today, thus, we combine together changes in current law and 
changes from terms of what we are spending today into a single 
presentation. 
   My final consequence is a bit personal. As a member of the baby-boom 
generation, I grew up with a cohort who believed we were trying to do 
something about improving what Government can do. And yet now, as 
currently scheduled, our legacy is to bequeath a Government whose 
almost sole purpose is to finance our own consumption in retirement. 
In sum, by abandoning control over the budget, we have put in place a 
system where politicians are forced to compete by giving away the 
future. Projected deficits are merely a symptom, they are merely a 
symptom, of this modern legislative push. 
   The budgetary consequences I have outlined follow from neither 
progressive nor conservative principles. They must be addressed on 
grounds of both fairness and efficiency if Government is to serve all 
of the people, if it is to be nimble in addressing new needs and 
emergencies, and if it is to restore democracy to the people. 
   Thank you. 
   [The prepared statement of Mr. Steuerle follows:] 

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   Chairman CONRAD. Thank you. Thanks to the entire panel. 
   Let us get right to it, if we could. We have been searching for 
things that we could do on this committee in this budget resolution 
and, as you perhaps know, Senator Gregg and I have been searching for a 
process that would compel at least the presentation of a plan to our 
colleagues in the Congress later this year of a long-term plan to 
address the fiscal imbalances that we confront. 
   So we are interested in both the short term and the long term. 
Mr. Greenstein, you indicated as one of your suggestions, that we deal 
with the CPI, that we have a more accurate adjustment to the CPI than 
the current formula permits. How much difference, have you done any 
calculation of how much difference that would make over time on both 
the spending and the revenue side? 
   Mr. GREENSTEIN. I believe that an estimate was done by the Brookings 
Institution. This is not a recommendation that is peculiar to me. Many 
budget analysts across the political spectrum have made it. It is 
included in a Brookings book, Restoring Fiscal Sanity, that came out a 
couple of years ago. I am not sure my memory is going to be right here. 
   My recollection is that by the 10th year it might save something 
like $30 billion or $35 billion. 
   The point is not the 10-year savings. It is when you go further out. 
I am not going to trust my memory for the farther out figures, but we 
can look into them and get back to you and the committee and give you 
our best figures. 
   I want to make one caveat about my own recommendation here, and that 
is over time this would be an important change, moving to what is 
sometimes called the superlative CPI. What would be a mistake, I think, 
would be to move to it without firewalls that ensure that the savings 
are going for deficit reduction and, of course, for closing the Social 
Security long-term imbalance. 
   If you were to do this and you simply took the savings and used them 
to finance program increases and tax cuts, you would have gained 
nothing and you would have foregone an important instrument for the 
future. 
   So I think you should make this change with the CPI but I think you 
should not do it until you are combining it with firewalls that make 
sure that money is dedicated to long-term deficit reduction and is not 
used to finance expansions or tax cuts now. 
   Chairman CONRAD. Well, you make a very good point. The question is 
how you construct firewalls that last around here. Sometimes we have 
constructed them and they last for a few years, but as soon as they 
start to achieve real savings, there is a tremendous impetus around 
here to go after it for additional spending or for additional tax cuts. 
Unfortunately, in the last several years, we have been doing both and 
so keep digging the hole deeper. 
   Mr. GREENSTEIN. I do think in 1990 and 1993 there were major deficit 
reduction legislation and the savings helped. Part of that was because 
of the pay-as-you-go rules and the construction of the pay-as-you-go 
scorecard so that you did not get to put the savings from those bills 
on the scorecard and spend them. And it worked. So I think we ought 
to-- 
   Chairman CONRAD. It really did. It certainly helped. All of these 
moves to discipline Congressional action on both the spending and the 
revenue side contribute. But if there is no will, there is no way. And 
we go back to the 1990's. That held for a period of time and ultimately 
it broke down. 
   Mr. GREENSTEIN. One other very quick point. I also think it would be 
helpful to change the rules so that reconciliation can only be used for 
legislation that reduces deficits. Whether someone wants to expand the 
prescription drug benefit, reduce taxes, or whatever, you should not be 
able to fast track it with 51 votes. It should be harder to do that. 
That, to me, is another one of these firewalls that would be helpful. 
   Chairman CONRAD. On both the spending and the revenue side? 
   Mr. GREENSTEIN. Yes. 
   Chairman CONRAD. Dr. Reischauer, I want to turn to you, if I could. 
You indicated in your testimony that there has been work done at 
Dartmouth that shows that per beneficiary Medicare costs vary two to 
one across the Nation's hospital districts. And health outcomes are 
negatively correlated with the higher spending. 
   Can you tell us a little more about that? As I understand what you 
are saying here, is that this Dartmouth study indicates we could have 
one part of the country where they are spending twice as much on 
Medicare beneficiaries as in another part of the country and actually 
getting worse health care outcomes? Is that the conclusion of their 
work? 
   Mr. REISCHAUER. The studies done by Elliott Fisher and a number of 
other individuals, have shown wide variation in per beneficiary 
Medicare spending after adjusting for differences in input prices and 
the underlying health conditions of the Medicare population. Spending 
as the extremes are about two to one apart. 
   There is certainly no significant positive relationship between 
spending or service utilization, which is what this is about, and 
health outcomes. To the extent there is any correlation, it is a weak 
negative correlation. What health economists have found is that there 
are wide differences across the country in the practice patterns of 
physicians and on the expectations of patients. 
   And so for the same condition you will see patients in Miami going 
to the doctor, let us say 15 times a year, and those in Minneapolis 
going seven times a year. You will see across individual hospitals 
within one metropolitan area even wider variation in the number of 
consults from specialists for a particular condition. 
   So health care, in a sense, is not a science. It is an art. And we 
have not spent a sufficient deal of resources or time trying to figure 
out what is the optimal amount of health care, what are the right 
procedures, what are the right treatments to give an individual in 
these kinds of circumstances to maximize health outcomes. 
   And so a problem arises when we discover that in Miami they use 
twice as many resources for a congestive heart failure case as they use 
for a congestive heart failure case in Minneapolis. What do we do? We 
cannot move the Miami population to Minneapolis. We have a very 
difficult time, changing the pattern of practice of the physicians in 
the high utilization area. 
   We have to think of incentives that can bring this wide variation 
more toward some optimal level which will save money without 
jeopardizing the quality of health care. 
   Chairman CONRAD. All right, good points. 
   Senator ALLARD. 
   Senator ALLARD. You have all mentioned, to some degree, I think in 
your testimony, this concept of shared sacrifice. So how do we do this? 
Do we do something like an across-the-board cut, impacting all programs 
proportionally the same? How do we prioritize our fiscal discipline, I 
guess is the question that I am asking? What criteria do we decide to 
say well, maybe this program is more important than another? Maybe it 
has more cuts. How do we decide what program is maybe performing and 
which is not performing? And do we set criteria along those lines? I 
would like to hear your comments. 
   Mr. STEUERLE. Mr. Allard, if I may speak first, I think the most 
important thing this committee could do with respect to teaching 
Congress would be to try to somehow or another get a refocus on the 
long-term even before the short-term. I realize that is not the normal 
budget process but, as everyone on this committee knows, the game that 
is played in the budget process is to do what you can within a budget 
rule for 3 years, 5 years, 10 years or whatever, and then not worry 
about the period beyond that. So many recent enactments that have cut 
the deficit in the short run have actually added to the long-term 
deficit. 
   We all know the games that are played and we know why they are 
played. It is because the budget rules right now orient themselves 
toward the short-term. And so we constantly attempt only to get the 
short-term in order. 
   And while I actually agree with many of Dr. Greenstein's proposals, 
a lot of them get us to the short term but they leave us on this path 
of continually rising expenditures as a percent of GDP--rising 
expenditures that are not oriented toward our most current needs. If 
you really think about where we are increasing spending, where we are 
talking about having a budget crisis, these are in areas where good 
things are happening to us. We are living longer, we are getting 
better health care. And we are saying we cannot control that retirement 
and health budget, and, therefore, we do not have money to spend on 
homeland security or children's education or kids that are out of 
school on the street when they should not be. 
   So where we have problems, we say we do not have money, and where we 
really having good things happening to us, we are spending more. 
   I think the budget process has to focus on the long-term. Now how 
would I do that? How would I think about changing the process? 
   One thing I would do is to ask perhaps CBO or the General Accounting 
Office, but probably the Congressional Budget Office, to identify every 
part of the budget where there is automatic growth. And I would include 
of all the tax provisions, all of the tax subsidies as well, not just 
direct expenditure. Where is this automatic growth preempting you, as a 
Congress, from making discretionary decisions? Then use that 
information to see if you cannot come to some agreement on how to 
constrain that automatic growth. 
   Now controlling some of the growth, as in the case of health care, 
is much, much tougher than others. Some cases, like Social Security, 
are easier to identify some ways to gain control, although there would 
be the political dynamic of how to decide what to do. But I think you 
have to start there. If you do not start with the automatic growth and 
the long-term, I do not think we will ever, ever get this system in 
order. 
   Then you have to address an additional budget rule: are you going to 
allow any new enactments to spend money way into the future, make 
commitments for the future, for which the resources are not provided? 
It seems to me you have to move toward some sort of rule that deals 
with that issue, as well. 
   I am not suggesting all this is easy. I think there has been a 
30-year process of both political parties figuring out more and more 
ways to spend away the future because it was not in the budget window. 
That was not the case in the 1960's or earlier. When discretionary 
spending was level, revenues would grow with the economy, and you 
always moved into a surplus when you went into the future. 
   We have moved to a world now where each party continually tries to 
spend more and more for the future, take more and more control for the 
future, because they are afraid of what the other party is going to do. 
   That is why it takes a compromise between the two parties to say 
neither is going to spend the future. We are going to let the voters 4 
years and 8 years hence start deciding what to do. And so you limit 
what can be done in the future. If there is growth in programs, it is 
capped after 5 years and you have to re-vote whether there would be new 
growth after that period, whether it is wage indexing and Social 
Security, whether it is the open-ended nature of health benefit 
programs, whether it is a program like Roth IRAs and Roth 401(k)'s that 
spend out in the future. 
   It seems to me the trick is to identify all of those automatically 
growing parts of the budget and to try to figure out some way to reach 
an agreement on dealing with them. 
   Mr. GREENSTEIN. A few problems. Some of the suggestions I made at 
the end of my testimony were merely intended to be first steps. 
Ultimately, as Gene says and as Bob has said, we have to do a much 
heavier lift. 
   I am not a fan of across-the-board cuts. I think they are a bit of 
an abdication of policymakers' responsibilities to make the tough 
choices. There are some areas in the budget where we are going to need 
some additional resources. The President, for example, talked in his 
State of the Union, about global AIDS, Millennial Challenge Fund, 
alternative energy research. Everything in the budget is not equal. And 
we have to go and make the appropriate choices, rather than just saying 
everything gets cut X percent, which will be inappropriate for some 
programs and may too small a reduction for others. 
   This suggests having a high premium on efficacy. In some areas we 
need more information and evaluation of what is working and what is 
not. And that includes looking at efficacy both on the spending side 
and on the tax side. We have, I forget the figure, something like $800 
billion a year in tax expenditures in the budget and some of them are 
not performing as intended. 
   I think another criterion that should be put into the mix is the 
fact that due essentially to trends in the private economy and global 
pressures, we have had a several decade trend toward increasing 
inequality in this country. And it would be unfortunate to deal with 
the budget problems in a way that exacerbated the trend toward 
increasing inequality. 
   To kind to put it in a phrase, in the mid-1980's at one point, David 
Stockman--then Ronald Reagan's budget director, made a statement that I 
think sums up a principle. He said when you need to deal with the 
deficit, you should go after weak claims not weak clients. The hard 
task is identifying which are the weak claims. Often the weak claims 
have the strongest clients defending them. And reaching bipartisan 
agreement to pare back the weak claims, whether they be on the 
expenditure or on the revenue and tax expenditure sides of the budget. 
   Mr. REISCHAUER. Let me comment on two extreme approaches. One would 
be the technocratic approach where experts would measure the 
effectiveness of every Federal program and the ability of various 
revenue sources to generate additional revenue by doing the least harm 
to the economy. And we would use that information to cut spending and 
increase revenues. And the objection to that, besides the fact that we 
do not have that kind of information, quite simply would be that, the 
reason we do things depends on much more than the effectiveness with 
which we can do them. Some things are very important. We know that our 
policies are not particularly effective but we have to do something to 
address these issues. Where you come out is, of course, where the 
Congress has come out with respect to the distribution of spending and 
tax sources in the budget each year. 
   So then you go to the other extreme which is that if current 
problems reflect what our priorities are why don't we just shave 
everything by X percent or raise all taxes by Y percent because that 
would reflect our relative weighing of priorities. 
   We know that is not the case either because of the inertia or the 
embedded strength of existing programs, that if somehow we could wipe 
the slate of Federal programs clean and start anew, we would probably 
end up with quite a different set of spending programs. 
   So this is a terribly difficult kind of problem to be faced with 
because neither of these extremes is either possible or appropriate. I 
guess that is why we elect a Congress to grapple with this really 
insoluble set of decisions. 
   Chairman CONRAD. Senator Stabenow. 
   Senator STABENOW. Thank you, Mr. Chairman. 
   First of all, I want to thank for a very thoughtful and critically 
important panel. Thank you to each of you. 
   I did want to start by commenting, if I can use the Chairman's 
charts, one of your illustrious charts, to just emphasize that when we 
are looking at the numbers that you showed us, the cost of extending 
the tax cuts are more than the combined costs of Social Security and 
Medicare. I think this is incredibly important. I know that just on 
Social Security alone that if we were to say 30 percent of the tax cuts 
will not be extended instead of 100 percent, you could fully close the 
gap of Social Security alone. 
   I think this is a very, very important chart and I appreciate the 
comments related to all of that when we talk about how do we get where 
we need to go. 
   On health care, I also very much appreciate, Dr. Reischauer and Mr. 
Greenstein, both of you talking about the fact that as it relates to 
health care it is not just Medicare, is this not just Medicaid. It is 
the health care system, that we need to fundamentally restructure the 
health care system. 
   Mr. Chairman, I would just make the point that this very much is 
about jobs, as well. I had a chance--I was on a town hall meeting in 
Detroit with the big three automakers, a major town hall last night, 
where it was very interesting. We know that about $1,500 per vehicle is 
health care costs. But we had a gentleman from the Canadian UAW who 
said that their costs are $200 per vehicle. 
   In fact, we have employers, manufacturers, that are literally going 
5 minutes across the bridge into Canada to set up shop now and build 
facilities because of health care. The wages are the same, it is the 
same bargaining units. Everything is the same but health care. This is 
about jobs, as well as about our economy. 
   Last week there was an article in the New York Times business 
section where the president of the Business Roundtable made the 
following statement, which I thought was very significant: health care 
costs are the single largest cost pressure that employers face, far 
exceeding energy, labor, materials, or even litigation. 
   So it is not only something that we have to tackle but the business 
community is desperately asking us to tackle this, as it relates to our 
ability to compete in a global economy. 
   There is really something wrong when we look at the fact that the 
average industrialized country spends less--we are spending twice as 
much in GDP as the average industrialized country for our health care 
system, but we have close to 50 million people with no health 
insurance. It just does not add up. 
   So I very much appreciate your having this panel. And while I 
believe very strongly that we have to fundamentally restructure the 
health care system, and that we actually save money doing it. I believe 
that. I believe we have done this hodgepodge kind of effort that has 
actually increased costs rather than decreased costs. 
   But I would like to ask a couple of questions that relate to 
something that, as we do that, which is a tough thing to do and we have 
to do it in a bipartisan way to fundamentally restructure things, there 
are costs savings that we have not mentioned today. I wanted to just 
mention two and ask for any comments from the panel. 
   First of all, health information technology. Olympia Snowe, Senator 
Snowe and I have introduced legislation to accelerate the use of that 
both through tax incentives for the private sector, as well as support 
for nonprofits. We have heard numbers anywhere from $70 billion a year 
in savings to $100 billion from the President's own IT expert, Dr. 
Braylor, to $300 billion from the RAND Corporation, just focusing on 
e-prescribing alone. 
   Those are huge numbers, huge numbers for us. I am wondering if any 
of you would have a comment on that, both in terms of saving lives. I 
know in my home State of Michigan that has really been aggressive on 
this, we have increased quality, we have created more information for 
people to compare, as the President talks about transparency and 
 comparing prices and so on. And we also see the beginning of savings 
in dollars. 
   And then the other relates to the prescription drug front. We know 
that the average retail price of a brand-name prescription drug was 
$102 back in 2005 and the average retail price of a generic was $30. 
Senator Lott and I have legislation to close three loopholes that 
brand-name companies are using to stop generics from going on the 
market. 
   Those are two shorter term but very significant ways to save large 
amounts of dollars, and I wondered if any of the panel would like to 
speak to that? 
   Mr. STEUERLE. Mrs. Stabenow, if I could just address the first 
issue. I am on the National Committee on Vital and Health Statistics, 
whose job it has been over the years to try to promote the very thing 
you are talking about, health information technology. We strongly 
believe if we could move more to a world of electronic prescribing of 
drugs, and electronic transmission of information, we could provide 
enormous protection to people--for instance, those who are moved, such 
as after a hurricane, or those who do not get all the information on 
their drugs, or who get duplicate tests. We think there is enormous 
efficiencies that will come about from health information technology. 
The one thing we do not know is whether, on net, that will reduce 
costs. This is one of those areas in health care where we attempt to 
improve efficiency; it is an effort we should make. But it could also 
lead to an increase in demand for services as people determine that 
there are more needs that they have, that their drug tests need to be 
improved, and so on. 
   And so the answer to your question on the cost saving is tentative. 
The answer on efficiency improvement is not. I think most people agree, 
we should be moving in this direction. 
   That gets us back to the issue that I think Dr. Reischauer has 
raised, which is that you still need, at some point, to decide how you 
are going to try to cap or limit the automatic growth in the system 
independently of these improvements and efficiencies. 
   My own calculations now show that with Government subsidies-- 
Medicare, Medicaid, other health programs and tax subsidies--you are 
now spending $11,000 per household. That is total health care costs per 
household now are $19,000 per household. Total health spending in the 
United States divided by the number of households is $19,000. 
Government is now providing $11,000 of that total. 
   In the next 4 years you are scheduled under projections to raise 
government spending to $13,000. You are going to spend $2,000 more over 
the next 4 years. And yet you have no control over how you are spending 
that $2,000. 
   So you still have to get at this issue of how are you going to try 
to manage and control the money you spend-even at the same time that 
you are identifying what you want to achieve with these efficiency 
improvements. You do not want to achieve cost saving in a way that case 
would cut back on technology improvement as a way of saving money, 
which would be the very area where you are actually trying to improve 
health care. 
   Mr. REISCHAUER. I think you have pointed to two very important 
areas. With respect to health information technology, as Dr. Steuerle 
has pointed out, I think there is a general consensus that aggressive 
application of such technology will lead to significant improvements in 
health care quality but that the jury is still out with respect to 
overall how much might be saved. 
   It is clear that if we want to move into a new world, a transformed 
delivery system, one in which there is more coordinated care, more 
accountability through pay for performance and mechanisms like that, 
one in which individuals are active in the market more than is the case 
now in the selection of providers and services, that cannot be done 
without a much more expansive information technology base than we have 
now. So in a way it is essential to move forward in structural reform 
to have better health information technology. 
   Just abstracting from all of that, of course we will save 
duplicative tests and things like that, which will save relatively 
small amounts of money probably over time because many of these 
duplicative tests were taken 6 months ago and really, you are now the 
attending physician, do you really want to trust that one rather than 
get a new one? 
   With respect to prescription drugs, I think you are right to suggest 
that there have been some abuse of the patent system and effort by some 
pharma members to extend the life of their patents and restrict the 
entry of generic drugs and the Congress should act and the 
Administration should act to end those abuses. 
   We have seen, over the past decade, a very significant movement of 
the population toward generic scripts and there is more to go. 
   Chairman CONRAD. Senator Bunning. 
   Senator BUNNING. Thank you, Mr. Chairman. 
   Chairman Greenspan, when he was the head of the Federal Reserve and 
I was a lowly member of the House Budget Committee at the time, about 
10 or 12 years ago I believe it was, made the suggestion about the CPI 
and using the new improved version, whatever you call it. 
   The Congress, in their wisdom or lack of will, has not been able to 
get past the results of using the new CPI because of the resulting 
lowering of certain benefits to a great number of constituents. For 
instance, those collecting Social Security would not get as large of 
increase each year if the CPI were adjusted as you have proposed. 
   So if you can somehow convince the Congress that it is a healthy 
thing to do long-term, I am with you 100 percent. But I do not know how 
many members of this committee have the will to use the new improved 
CPI because less benefits will pay to more people. 
   Mr. Greenstein, you mentioned entitlement spending and I want to get 
to that because the CBO baseline spending projections for January 2007 
mandatory spending is $1.455 trillion, and 82 percent of that is in the 
big three, Medicare, Medicaid, and Social Security. If we project that 
out 2008 to 2017, $19.937 trillion, of which 86 percent are the big 
three. 
   So you mention the fact that mandatory spending in other areas were 
being reduced. It is a very minute 14 percent if we look at it 
long-term. And what is ballooning the mandatory spending is the big 
three, if you look at $19.937 trillion over 2008 to 2017. 
   Now our budgeting rules appear not to be equal when you look at the 
current baseline budgeting. Mandatory spending programs set up under 
the law are assumed in the baseline to be extended but tax provisions 
that are set to expire are assumed, under the baseline, to indeed 
expire. The effect of this is that extension of tax provisions are 
subject to budget enforcement and extensions of mandatory spending 
programs are not. 
   Do you think it makes any sense to treat spending and tax cuts 
differently? 
   Mr. GREENSTEIN. Several parts to your question. 
   Let me just say, before answering, I want to express my excitement 
on being here. As a young kid, growing up in Philadelphia, in the 
1950's, I watched every pitch on TV of your perfect game, and went 
running around my living room cheering when you threw that last pitch. 
   Senator BUNNING. So did I. 
   [Laughter.] 
   Mr. GREENSTEIN. Let me start with the CPI. One piece of good news is 
that since Greenspan issued that report, the Bureau of Labor Statistics 
 has made a number of changes administratively. And actually, the 
majority of the distortions that his commission talked about have been 
corrected. 
   However, there is one key distortion that cannot be corrected in the 
regular CPI, that is why they developed-BLS, the Bureau of Labor 
Statistics-the alternative CPI I mentioned, which I recommend Congress 
adopt. 
   You raise the point of how could you get it adopted politically? My 
thought is the following. I think if one simply moved a piece of 
legislation to move Social Security indexing of the tax code and the 
like to the alternative CPI, as you say, it would fail. However, I 
think if this were part of a larger bipartisan budget agreement where 
you restored long-term Social Security and made substantial progress on 
the long-term deficit, and this were a piece of it, and one showed that 
this was part of how one restored long-term solvency and protected the 
economy and the budget for the long-term, then as part of a larger 
architecture I would hope that it would be more possible to move. 
   I think a lot of us also need to do education to explain to people 
that this should not be regarded as either a cut in Social Security 
benefits or an increase in taxes because the intention of the Social 
Security Act and the Internal Revenue Code is to adjust for inflation 
accurately, not to over-adjust. 
   On your second point about entitlements in the big three, I do not 
think we are disagreeing. What I was urging is some more precision in  
language. I think sometimes when people hear the general term 
''entitlement crisis'', they may presume that unemployment insurance, 
the school lunch program, that everything is going through the roof. 
Whereas as we have been doing here today, and as you suggested, we 
really need to focus on the big three. They are the drivers. And then 
the factors that are driving the big three, particularly the health 
care costs. 
   With regard to the baseline, I would respectfully disagree. I do 
think that when one looks at it carefully--
   Senator BUNNING. What are you disagreeing with? I asked for your 
opinion. 
   Mr. GREENSTEIN. I disagree with the conclusion that there is 
inequity in the treatment of taxes and entitlements in the baseline 
for the following reason. It is true that if a tax cut is set to 
expire, the baseline does not assume its continuation. But it is also 
true, let us take the 2003 tax cut law as an example, that when the 
capital gains and dividend tax cut was enacted to run through, I 
believe it was 2008, no cost was scored for 2009, 2010, 2011, 2012 and 
thereafter. 
   If there is an entitlement program or expansion and the committee of 
jurisdiction says well, we are going to let it expire after 3 years in 
order to avoid being charged with costs from years of four through 10, 
it does not work. They get charged by CBO with costs for all 10 years. 
So the key I think, and maybe one could look at making some 
adjustments, but the key is that whether it is an entitlement or a tax, 
you have to make sure you get scored for a cost in every year in that 
budget window. The current treatment actually does do that. If you want 
to change the rules, you need to be very careful, I think, to not have 
a transition where, whether it is entitlements or taxes, you have years 
in which an increase does not get scored at all. 
   So again, with regard to the 2001 and 2003 tax cuts, again the 2003 
is a good example, they could have been made permanent but then they 
would have been scored every year in the five and 10-year windows, 
rather than only scored for the years until they expire. 
   Senator BUNNING. Thank you. 
   Chairman CONRAD. Senator Menendez. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   I want to thank you for the continuing series of hearings that we 
have been having to lay out the Nation's fiscal picture and its health, 
or lack thereof, and I appreciate the panels you have brought together. 
I appreciate the testimony of this panel. 
   Last week the testimony from the CBO Director appears to be a rosy 
fiscal picture for the short-term but it is almost certainly a false 
hope for the deep and long-standing issues we face in the long-term. 
That is some of what I would like to go to. 
   Let me start off with Mr. Greenstein. To me a budget is about 
values, both as to how we raise revenues for it, as well as to how we 
spend it. Americans have budgets in their own lives, even if they do 
not think of it in that context. It is how they derive their income and 
how they spend their income for education, keeping a home for their 
family, for health care, tithing to their church or synagogue as an 
expression of their personal values. I think the national budget is an 
expression of our collective values. 
   In that context, I think many of us questioned the President's claim 
that the budget can be balanced by 2012, given the vast number of 
anticipated but excluded costs that, when included, provide a very 
different picture. 
   I believe, I think it is widely believed, the President's budget is 
expected to also allow for the current tax cuts to be made permanent. 
Can you talk a little bit about what type of cuts to domestic programs 
might be necessary if that is the reality? 
   I know, for instance last year the Center pointed out in a report 
that the President's budget proposal for this year proposed some rather 
massive cuts to key domestic programs, including $52 billion for 
education, $24 billion in health care programs over a 5-year period, 
$183 billion over 5 years total. Obviously there is a lot of values of 
people who depend upon those for their very existence. 
   Can you give us a sense of what we might be facing if, in fact, the 
President comes forth with a budget that keeps the tax cuts permanent 
and the consequences that may flow from that? 
   Mr. GREENSTEIN. The first comment, I would urge you to look 
carefully at the budget when it comes out and see whether the balance 
in 2012 is in reality or just on paper. From the reports we have so 
far, it sounds like the budget will extend relief from the Alternative 
Minimum Tax just for 1 year and thereby effectively assume that by 2012 
about 40 million Americans are under the AMT, which we know will not be 
allowed to occur. If you continue the current AMT patch without paying 
for it, in my testimony I recommended AMT reform be done in a revenue 
neutral manner. But if the current course is continued, and it is 
extended without paying for it, that is $95 billion in 2012 that will 
not appear in the budget. 
   We are also unclear whether, with regard to Iraq, Afghanistan and 
the war on terrorism, whether there will be anything in there for 2012. 
But the point you are particularly referring to is that I think it is 
likely that the budget will continue the practice of the last few 
budgets of having significant reductions proposed in a number of 
domestic discretionary programs in the coming year, this would be 2008, 
with specific proposals, but then much larger reductions in domestic 
discretionary as a whole in years after 2008 without any of the 
specifics being there, thereby assuming reductions in the domestic 
discretionary programs that ought to be viewed either as very 
unrealistic and unlikely ever to occur or, if they really did occur, 
would have some pretty significant effects in a range of areas. It 
could be education, could be child care, could be a whole array of 
issues. 
   I also think we are talking here this morning, I think the panel in 
general, mostly about the big three programs, health care and revenues. 
I think it is an illustration of the fact that as you look, whether it 
is to 2012 or to the long-term picture, in my view there are not large 
savings to be had on the domestic discretionary side of the budget. It 
has declined as a share of GDP over time. It is actually, by 2007, with 
the CR that was filed last night, going to be a little below where it 
was in 2001 as a share of GDP, which contrary to the popular impression 
that it has exploded. 
   And while there are areas one can and should get savings in domestic 
discretionary, there are a number of areas in domestic discretionary or 
some areas that are going to require additional resources, whether they 
be in the area of global disease and poverty, alternative energy 
research, child care, which has been frozen for a number of years and 
were we are actually reducing the number of children in low-income 
working families who get child care each year. 
   If we do things that help deal with global warming but raise some 
costs to consumers, we are going to do need to look at the low-income 
energy assistance program. So I think you are right that the budget is 
a reflection of values and it ought to be looked at in that context. 
   One last comment. The Urban Institute Brookings Tax Policy Center, 
which I think Gene is a Co-director of, their estimates are that if the 
tax cuts are extended, or maybe it is even in 2010 the last year you 
can take this out, that the average tax cut for people with incomes 
over $1 million a year will exceed $150,000 per household per year. 
I think there are some value questions about having tax cuts of that 
magnitude and then cutting programs, including some effective programs, 
for the less fortunate and struggling families on the grounds that the 
budget requires us to do it. It is why I think the suggestion is being 
made here that all parts of the budget be put on the table. And it is 
kind of why I like that David Stockman phrase about let us look at weak 
claims, not at weak clients. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   Chairman CONRAD. Senator Wyden. 
   Senator WYDEN. Thank you, Mr. Chairman. 
I, too, appreciate your holding these hearings and giving us the 
opportunity to dig into these long-term issues. I particularly think 
health reform and tax reform are key to getting on top of these 
long-term challenges. 
   Let me start with you if I might, Mr. Reischauer. You have talked 
persuasively about the issue of health care and health care costs in 
terms of our long-term picture. It seems to me that it is simply 
impossible to fix health care unless you say you are going to cover 
everybody for the essentials. Otherwise we will constantly have cost 
shifting from the people who have no coverage to people who do have 
coverage and folks in emergency rooms pick up their bills and the like. 
Do you share that view that to fixed health care you have to say you 
are going to cover everybody? 
   Mr. REISCHAUER. Senator, I do. I think it is essential that when we 
consider alternatives for restructuring the health care system that 
those alternatives encompass the entire population. It need not be that 
everybody has guaranteed access to the same generous level of benefits. 
I think we need to, as a society, begin to define what we regard as the 
basic health care package that no American should be without and ensure 
that everyone has the financial wherewithal to purchase or be provided 
that level of insurance. 
   Senator WYDEN. Thank you. And I think that is an important part of 
bringing Democrats and Republicans together, in terms of fixing health 
care. 
   One other question with respect to the tax code and health, and 
perhaps I will direct this to you, Mr. Greenstein. I think you can have 
a debate about how exactly you should go about doing this. But it is 
indisputable that the tax code on health is regressive. If you are a 
highflying CEO, you can write off the cost of getting a designer smile 
on your taxes. However, if you are a hard-working gal at the local 
hardware store, you probably do not get much of anything out of the tax 
code. 
   Do you agree that--and this is not about the details of how you do 
it--but that fixing the tax code and particularly its regressivity, is a 
part of sorting out what we need to do to fix health care down the 
road? 
   Mr. GREENSTEIN. Yes, I do not think there is much disagreement that 
the current tax treatment of health care is regressive and looking at 
that would be part of overall health care system reform. 
   I do think when we look at it, we need to look not only at the 
dimension of progressivity/regressivity. We need to be very careful to 
look at the dimension of healthier people versus sicker people. 
   So we have a tax treatment now that supports an employer-based 
system that has warts. It also has the merit of pooling healthier and 
sicker people. I think the President's plan commendably raises the 
issue of the tax treatment of employer-based coverage, but I think it 
then makes the mistake of doing it in a way that would accelerate the 
unraveling of employer-based coverage and put people into the 
individual market which, as you know, is deeply flawed now and does not 
really work for people with serious health conditions or who are 
sicker. 
   So we need to look at both a more progressive approach. But in doing 
so, I think almost the first principle is that we have to make sure we 
have adequate pooling mechanism that pools the healthy and the sick 
together, rather than fragmenting them. 
   Senator WYDEN. I think that is a thoughtful point and I tried to 
include that a couple of different ways in my Healthy Americans Act. 
Mr. Reischauer and I have talked about that as well, you have to make 
sure that there is some risk adjustment process to deal with it. 
   Let me ask a quick question for Mr. Steuerle, who has always been 
one of my heroes on the tax reform debate. My sense is that we still 
have sound thinking from 1986, and that if we say we are going to clear 
out a lot of the clutter, all of those breaks, we can have 
progressivity and still drive down rates. Do you share that view? And 
how does that fit into a sensible approach for our economy in the 
future? 
   Mr. STEUERLE. Senator, like you, I strongly believe that base 
broadening is preferable to rate increases. And I think that conclusion 
is true whether you are looking at it from a conservative or a liberal 
view point, that this type of tradeoff provides a more efficient tax 
code and it provides more progressivity. 
   My one caveat has to do with the extraordinary level of commitments 
we now have on the spending side of the budget. My own view, in fact, 
is that we should not label taxes by the revenues we collect, but that 
we should label taxes as equal to the spending we actually undertake. 
   For instance, if we are a household and we spend $20,000 and we only 
earn $15,000 and we leave a $5,000 debt to our children it does not 
mean we did not spend $20,000. The amount of collections we have to do 
to pay off that $20,000 is still $20,000. 
   And so we have, if you think about it, not a tax rate of 17 or 18 
percent of GDP. That represents revenues collected currently. The tax 
rate we have is equal to the spending rate we have, which is higher and 
going much, much higher. 
   So the question on how far you can go in lowering rates is largely 
going to depend on whether we also get some of this spending under 
control. You are right, at current levels, given current revenue 
collections, there is no doubt a broader bass means we can have lower 
rates. Whether we can lower them relative to what we have 
currently--given that we are not collecting enough to pay our bills--is 
a more complex question. 
   If I could just add one footnote to your question on health care, 
too, because I have had a number of proposals exactly along the lines 
that both you and Mr. Greenstein talked about: to try to cap or somehow 
or another limit the current exclusion and convert it toward a credit 
or a voucher. This is the direction that most of us think that we 
should go. 
   It is not just an issue of being more progressive. The current 
subsidy, because of the way it is designed, at the margin increases the 
demand for health insurance--expensive health insurance--which 
increases the demand for health care, which makes health care more 
expensive, which increases the number of uninsured. 
   So we have the extremely perverse situation right now where the 
current subsidy is not only not buying more people into the insurance 
market. We are spending more every year to pay for more people to be 
uninsured. It is that perverse. 
   The issue of what we actually enact down the road is one over which 
there will be controversy. That should not, I think, deter us from 
saying we have to cap, at least cap, these subsidies--cap some of these 
very perverse programs. This is on the tax subsidy side. We could look 
on the spending side, too, and not let programs there automatically 
grow when they are operating so perversely. 
   If we only get to capping them when we finally are in agreement was 
to what the ultimate health reform is going to be, or the ultimate tax 
reform, then I think we are in trouble. 
   Senator WYDEN. Mr. Chairman, I could not improve on the last 
comment. 
   And I thank you for the questions. 
   Chairman CONRAD. Thank you. 
   Senator SANDERS. 
   Senator SANDERS. Thank you very much, Mr. Chairman, for holding this 
important hearing. 
   Let me start off with Mr. Greenstein and others, Dr. Reischauer and 
others, can pick up on it. 
   What impact on the deficit situation would occur if tomorrow the 
Congress rescinded all of President Bush's tax breaks that went to the 
wealthiest 1 percent? 
   Mr. GREENSTEIN. I would have to get back to you with the specific 
figures. In my testimony I note that if all of the 2001 and 2003 tax 
cuts, not just those for the top 1 percent, either expired or to the 
degree they were extended were paid for, that three-fifths, 60 percent, 
of the fiscal gap through 2050 would be eliminated. 
   Now I am trying to recall, the tax cuts for the top 1 percent or 
what about a third of the total? About a third of the total. So it 
would close about one-fifth of the fiscal gap through 2050. That is 
assuming one did it now. 
   The reason the effects would be this large would be that--in anything 
in the tax and expenditure area, the sooner you do it, the more years 
over which the interest payment savings compound. And therefore over a 
period going out to 2050, you get a big effect. 
   So on these long-term projections to 2050, the top 1 percent would 
close about a fifth of long-term fiscal gap and the tax cuts as a whole 
about three-fifths. 
   Mr. STEUERLE. Can I put it in some other numbers? The tax cuts of 
President Bush are on the order of 1 to 1.5 percent of GDP, depending 
on how we measure it. So if you take about a third of that, you are 
talking about one-third to one half of 1 percentage point of GDP. 
   And just by way of comparison, the scheduled growth in Social 
Security and Medicare and Medicaid is on the order of about 6 to 8 
percentage points of GDP over 50 years. 
   So these tax cuts may solve some of the fiscal gap in the short run, 
if you assume a lot of things inherent in Bob's projections, which 
includes a constantly declining share of the national income that goes 
for discretionary programs and a lot of other things. 
   The comparison I usually make is what is the size of the tax cuts 
relative to how Social Security and Medicare and Medicaid are 
continually dominating the budget and usurping other spending? I think 
it has to be put in that context. 
   Mr. GREENSTEIN. I think both ways of looking at it are important. 
Again, as I said in the testimony, if one dealt with all of the Bush 
tax cuts tomorrow, we would still have an unsustainable long-term 
fiscal path for the reasons Gene mentions. If we were to look at a 
period longer than 2050, which I do not recommend given the uncertainty 
of numbers, dealing with the tax cuts would close a smaller percentage 
of the hole. 
   One last small point. Our estimate of the impact of the tax cuts is 
a little closer to 2 percent of GDP. The difference between Gene's 
figure and the one I am citing is simply the following: when we talk 
about the cost of the tax cuts, we are including within them the 
increase in the cost of Alternative Minimum Tax relief that was created 
by the tax cuts. The 2001 and 2003 tax cuts doubled the number of 
 people subject to the AMT and more than doubled the cost of AMT 
relief. 
   So I am including that cost in my figure. And when you do, it is 
closer to 2 percent of GDP. 
   Senator SANDERS. Next week the President is going to provide us with 
his budget. He has, as I understand it, already indicated that he wants 
his tax breaks to be made permanent and he wants to move this country 
to a balanced budget, I believe, in 5 years. 
   We will find out soon enough, but it sounds to me that if you are 
not going to rescind any of the tax breaks, and if you can move the 
country to a balanced budget in 5 years, there are going to be some 
pretty savage cuts on programs that lower income people and working 
people are now dependent upon. Am I missing something in that guess? We 
will find out soon enough but is that a fair assumption? 
   Mr. GREENSTEIN. I think that is probably right. I do not think that 
is the only factor. I think the President will present a 5-year budget 
and that if you extended it beyond 5 years, you would find the deficits 
would come back up as time go by. 
   I think the President will help himself get to the goal by leaving 
some costs out. For example, I think he will assume in 2012 that there 
is no AMT relief, that 40 million Americans are subject to the AMT. 
That will lower the cost of his own tax cuts on paper in 2012, there is 
a $95 billion-- 
   Senator SANDERS. You are not suggesting he is going to raise taxes 
on tens of millions of people, are you? 
   Mr. GREENSTEIN. I am just saying I think that is the way the budget 
numbers will be arrayed. And because he is doing that, the size of the 
domestic cuts he needs to show balance on paper in 2012 will be smaller 
than if he assumes that AMT relief continued. 
   Even with that though, I do think the budget will have significant 
cuts. I think a lot of them will be unspecified. I think he will show a 
big reduction in 2012 in overall domestic discretionary programs, but 
that there will be no specifics after 2008 for what the cuts in the 
domestic discretionary programs are. 
   Mr. REISCHAUER. It is also conceivable that the budget might contain 
some significant Medicare savings. As you know, next year the Congress 
and the President will be faced with a 45 percent of general revenue 
limitation on Medicare expenditures, which will cause the President to 
submit and you to consider a package of policy changes that bring 
Medicare spending in compliance with that restriction. And the budget 
could contain possibly unspecified Medicare cuts in 2012. 
   Mr. STEUERLE. Can I just add one tiny footnote here? We are doing 
some projections at the Urban Institute on the children's budget, 
seeing how much children are getting out of the budget. They are 
already scheduled right now to get a decline, even before you have any 
additional savings, because their share of domestic spending is being 
squeezed between what is happening with the tax cuts and what is 
happening with the continuing orientation of the budget toward us baby 
boomers. They are starting to get the short shrift already. 
   Senator SANDERS. This, by the way, at a time when we have the 
highest rate of childhood poverty in the industrialized world. 
   The only point that I would make, Mr. Chair, to conclude my remarks, 
is when we talk about health care let us never forget as part of that 
discussion that the United States spends almost twice as much per 
person on health care as any other industrialized nation while at the 
same time we have some 47 million Americans who have no health 
insurance at all. 
   I think it is widely understood that our system, our non-system--it 
is not a system--is the most inefficient wasteful and bureaucratic of 
any in the industrialized world. 
   Mr. Chair, thank you very much. 
   Chairman CONRAD. Thank you, Senator. 
   Senator CARDIN. 
   Senator CARDIN. Thank you very much, Mr. Chairman. 
   Let me thank all of our witnesses for their testimony. 
   I must admit, this has been a frustrating exercise for many, many 
years here in the Congress. I listened to similar testimony as a member 
of the Budget Committee in the House. And I just want to thank the 
Chairman for having this hearing on long-term fiscal challenges, 
because I see us act over and over again, session after session, on 
short-term objectives, and we have not addressed long-term needs. 
Dr. Reischauer, you point out, and I think rightly so and you are not 
the first witness before this committee to point this out, that unless 
American households and businesses increase their savings very 
dramatically, the continued viability of our Nation's economy will 
depend increasingly on the willingness of foreigners to accumulate ever 
larger holdings of dollar dominated assets. We have heard over again 
about the vulnerability of our economy. And our economy's growth, in 
large measure, will not generate the revenues we need to balance the 
budget long-term. 
   I would be interested as to whether you have certain suggestions as 
to how we can make a dramatic increase in our savings as a Nation 
through proposals that have some degree of political viability. 
   Mr. REISCHAUER. I think, as my colleague at the Urban Institute, Ned 
Gramlich, and others have pointed out to this committee, we seem to be 
incapable of devising policies or encouragements that cause the 
American public to increase its savings. And the most efficacious way 
to raise national savings seems to be to reduce Federal deficits. 
   And that, of course, throws the ball back into your court. And as 
you said, it is very difficult to get Congress to address that issue. 
   Senator CARDIN. I agree with you. I think that we could really 
increase national savings if Government took less money out for 
refinancing its own operations. 
   I want to talk, though, about Medicare issues because, as you point 
out, the President is likely to come forward with some Medicare cuts in 
his budget. In the 1997 Balanced Budget Act, we made a very difficult 
decisions in cutting Medicare costs, thinking that we were lowering 
health care costs in this country. 
   Mr. Greenstein, I agree completely with your statement that 
increases in health care costs per beneficiary in Medicare and Medicaid 
essentially mirror increases in costs per beneficiary in the overall 
U.S. health care system. So unless we deal fundamentally change the 
health care in this country, and change the way that we deliver care in 
a fundamental way, instead of picking on Medicare will do little to 
bring down health care expenditures. We might shift costs around. We 
might limit access to care. But it will have limited effectiveness in 
lowering overall costs of the Medicare system. 
   Senator CARDIN. I saw in 1997, when we changed the physician 
reimbursement system and thought we were doing something that would 
reduce costs. The resulting system has not done that. And the use of 
SGR has created a great deal of inequities within the system itself. 
I am worried, as we look at Medicare to solve the health care cost 
issues at the national level, we are liable to cause real access 
problems for our seniors and shift additional costs on to them rather 
than fundamentally addressing the health care crisis. 
   I welcome your thoughts on that. 
   Mr. GREENSTEIN. I agree, and that was the theme of my testimony and 
a lot of the discussion today, that we are not going to get big 
dramatic long-term savings, big dramatic long-term reductions in the 
rate of growth and Medicare costs without larger health care system 
reform. 
   I would note, however, that--I do not know whether the President 
will include these in his budget or not--but there are proposals that 
the Medicare Payment Advisory Commission, that Bob Reischauer is Vice 
Chair of, has proposed that would get some savings in Medicare without 
harming beneficiaries. They have identified areas where Medicare is 
actually overpaying, such as in areas where private plans are getting 
paid more by Medicare than it costs Medicare to serve the same people 
in fee-for-service. So there are some adjustment that Congress can, and 
I think should, make it short order. 
   Senator CARDIN. Let me disagree with you on that. There are areas 
obviously we need to reform. 
   Let's take the Medicare physician reimbursement system. We all know 
 we are going to make modifications to it because it is not sustainable 
in its current form. Those modifications are not built into the future 
projections of Medicare spending. They should be. 
   The therapy caps are not sustainable for outpatient physical, 
occupational, and speech-language therapies. We know that. We keep on 
modifying it every year. Those caps were imposed arbitrarily in 1997 
purely to get cost savings. They were added without hearings and 
without consideration of the impact on patient care. Eliminating the 
caps and ensuring access will cost Medicare more money in the future. 
   Congress enacts these cuts because it makes short-term budgets 
appear more manageable; but in doing so, it has built additional 
accrued liabilities into the Medicare system. This is because Congress 
knows it is not going to allow those policies to persist because they 
are not sustainable from a medical policy perspective. 
   Mr. GREENSTEIN. Agreed. And let me defer to Bob here, but I would 
hope that you will make some of those adjustments for sure, as you have 
been doing each year. 
   One could finance them and maybe get some net savings with some of 
the MedPAC recommendations. I think those are sounder than simply 
continuing on, I forget what it is, 4.5 percent, whatever the reduction 
in Medicare physician payments are. 
   But I think the MedPAC recommendations, I would put them in a 
different category and I think they deserve careful scrutiny. 
   Senator CARDIN. Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator. 
   I would like to just say to the three of you, we have had three 
hearings before this one. We have had the head of the General 
Accounting Office, David Walker. He said to us our long-term situation 
is completely unsustainable. 
   We had the Chairman of the Federal Reserve, Ben Bernanke. He said to 
us we should have been working on this 10 years ago, that the budget, 
the fiscal outlook for the country, is completely unsustainable. 
Then we had the head of CBO, and he delivered some good short-term 
news, that is deficits somewhat reduced this year from what was 
previously thought. But he warned very clearly that our long-term 
situation is unsustainable. 
   The three of you have come. The three of you are three of the most 
respected people in the country on these issues. The three of you each 
have a long track record and very substantial credibility on both sides 
of the aisle. That is why you are asked to repeatedly come before this 
committee, because you have credibility. You are warning us of the 
long-term circumstance. 
   I would just like, before we conclude, to ask each of you to give us 
your best idea to deal with the short-term and long-term. So what is 
your best idea to deal with these things short-term and your best idea 
to deal with the challenges we confront long-term? 
   Mr. GREENSTEIN. I do not think any of us have a silver bullet. I 
would distinguish between areas, like Social Security and various 
things in the revenue area where we know what the options are but the 
political will has not been there, and the health care area we have 
been talking so much about where we do not know exactly what the things 
are that will yield savings of X amount and deal with the big drivers 
of systemwide health care cost growth that, in turn, are driving 
Medicare and Medicaid costs upward. 
   Given how heavy these lifts are, I do not see how you get there from 
here without a bipartisan agreement that includes both ends of 
Pennsylvania Avenue. And if it takes several years to get there and to 
build the basis for that, then it does. But the sooner we start, the 
better. 
   I think we need to get the public--members of Congress on both side 
of the aisle, but the public, they are all related, you represent the 
public--beyond thinking that various things just have to be off the 
table. We cannot touch a dime in anybody's future benefits in Social 
Security. We cannot change anything in the 2001 and 2003 tax cuts. As 
long as there are those barriers, you will not make progress because 
until you can deal with all of those things, I do not think you will be 
able to make many of the really big decisions. 
   As I urged earlier, I do think--this is a sort of a suggestion, to 
 use a cliche, to walk and chew gum at the same time. That as you, you 
and Senator Gregg, Secretary Paulson, whoever, are trying to get things 
started on what is probably going to take awhile on the long-term, at 
the same time to identify what things can we do immediately first to 
stop the practice of recent years of digging the hole deeper with every 
session of Congress. 
   And second, to look for those things that can start to make some 
progress right away, even though they are going to be modest compared 
to the bigger things you ultimately have to do. 
   Chairman CONRAD. Mr. Reischauer, what would you recommend? 
   Mr. REISCHAUER. The problem here, of course, is that there is no 
mechanism to force action and there is no ability to provide 
protection, political protection, for those who might make the 
difficult decisions. In a democracy, it is terribly hard when the sun 
is shining to convince people to buy a raincoat and an umbrella for 
inclement weather that may happen 3 weeks from now, may happen 2 months 
from now, may happen next year. 
   And so what we need is to make the discussion, that you have heard 
three times now from your various witnesses, more real. The tendency 
over the last decade or so has been for individuals like us and the 
leaders that have testified before you in the earlier sessions to paint 
the picture in ever more dramatic terms. Billions turn into trillions, 
the crisis is looming in the future. But this has no reality for 
people. 
   And I think the first and only thing I would have to offer is that 
we really need Presidential leadership. I do not think this is an issue 
that Congress can lead on. Congress can follow, Congress can join hands 
with--must join hands with the executive in this. But there is an 
important educational role that only the president can play. And this 
should be cast not in terms of shared sacrifice or pain or avoidance of 
disaster, but rather as an investment, an investment for our children 
and our grandchildren. 
   Because as several of us have pointed out, we are really going to 
hand off to our children and grandchildren an economic and budget 
situation that will bedevil their lives. 
   And this, like investments in physical capital, infrastructure, 
technology, is very much a very real way of improving their living 
standards in the future. 
   Chairman CONRAD. Dr. Steuerle? 
   Mr. STEUERLE. Senator, again thank you for this opportunity to be 
here, and thank you for the compliments you made to all of us. 
   In my view there are some things that the committee can do. In part, 
they have to do with presentation. 
   I gave one example in my testimony. I think we need to have ways of 
showing what is happening both automatically and on a discretionary 
basis in the budget as a whole, so that you can see how much of the 
revenues you are going to have in the future whether three-quarters or 
120 percent, depending on what period you are looking at--are already 
committed. I think that is an important part of the process. 
   It is also important to change the language so that when we talk 
about increasing education spending by 1 percent in nominal terms, and 
cutting it 2 percent in real terms, that is not called an increase. 
When we cut Medicare spending from an 8 percent to 7 percent, we should 
not call that a cut. That is because we are measuring it not relative 
to current levels, but we are measuring it relative to something we 
call ''current law'' a concept that nobody in the public understands, 
and, I would guess, most members of the Congress do not understand, 
and, quite honestly, I do not even fully understand if you really ask 
me for every detail. I think that presentation is enormously important. 
   One reason is to make our language more accurate to garner the 
cooperation of the baby boomers who are about to retire. Because if we 
are really talking about where the money is, it is in Medicare and 
Social Security. That is, it is largely the baby boomers who are 
scheduled to garner almost all of the expenditures of Government. We 
have to convince ourselves, in some sense, that we are part of the 
solution. 
   I will say--and I did not get into this issue because I did not have 
time in my oral testimony--I think there is enormous opportunity in 
this approach. As I mentioned before, I think the budget is upside 
down. We are spending more in areas where we are actually improving as 
an economy. 
   Older people 55 to 75 represent for the first half of the 21st 
century what essentially women did for the last half of the 20th 
century. They have enormous human capital that has been underutilized 
in the labor force. In every reform you look at, I would really 
encourage you to look at how we can encourage more work out of this 
more mature, yet not old, population. Because more work means we do not 
have to increase tax rates or cut benefits rates because there is more 
income in the economy and more revenues. 
   As a practical matter, and several of us mentioned this earlier I 
think you could also work on triggers. I do not think triggers are 
perfect, but they least force some action. When Social Security is 
projected to be out of balance, there could be a trigger that says we 
cut back on the automatic growth. 
   The same thing in Medicare. There is a trigger now, which does not 
have a lot of mileage to it, but it requires the president to give you 
a proposal when Medicare spending exceeds a certain portion of general 
revenues. I think it needs a few more teeth. I think we could work on 
some triggers that at least force action. That is not a long-term 
solution to these programs but I think it is a important partial step. 
   Chairman CONRAD. Thank you. Thank you for that. 
   Senator ALLARD. 
   Senator ALLARD. The next two questions I have, I am just going to 
try to push the limits a little bit and just see what you think about 
some things that we are looking at. 
   We have had suggestions from the Federal Reserve as well as the 
Board of Trustees of Social Security, that to get us out of the 
unsustainable mode on Social Security and Medicare and Medicaid that 
what we need to do is we need to apply--particularly in Medicare and 
Medicaid--we need to apply kind of a gross domestic product plus one 
formula. 
   In other words, you take gross domestic product, you limit spending 
increase to Medicare and Medicaid to 1 percent over that over the next 
10 years. What that spells out in percentage of reducing Medicare 
spending would be by 2 percent and it would reduce Medicaid spending by 
3 percent over this period of time. 
   Do you think that is reasonable? 
   Mr. REISCHAUER. The question is not the reasonableness of the 
objective, but how one would implement it, what one would do to bring 
compliance. Would we cut payments? Would we reduce the number of people 
eligible for the program? Would we increase premiums paid and 
cost-sharing by the beneficiaries? 
   That is where the rubber hits the road. 
   Mr. GREENSTEIN. I would add, I think there are problems in trying to 
enforce such a target in the absence of reform in the overall health 
care system. Take Medicaid as an example. Studies at the Urban 
Institute, that Bob is the President of, find that Medicaid costs per 
beneficiary are lower on average than costs per beneficiary of people 
in comparable health in the private sector system. The principal reason 
is Medicaid pays providers less. Some providers will not participate in 
Medicaid as a result. If one cuts those payments a lot more without 
changing the fees charged in the private sector, one can destabilize 
the program. 
   Or another issue. Working poor parents. In the typical State, the 
income limit for Medicaid for working poor parents is two-thirds of the 
poverty line. You make 70 percent of the poverty line, you are 
uninsured unless your employer covers you in the typical state. You are 
too rich to get insurance. 
   So we do not want to start making blunt instrument cuts in areas 
like that. That is why it comes back to this larger issue that we have 
to grapple with the overall health care system. We cannot just single 
out Medicare, and in particular Medicaid and put artificial caps on the 
growth if the health care growth systemwide continues at a significant 
higher rate. 
   Mr. STEUERLE. I mentioned earlier that the Government, through its 
expenditures and its tax subsidies, is now spending $11,000 per 
household, rising to $13,000 within 4 years. The rate of increase could 
go up even faster after that. 
   I think a systematic look at how this money is being spent could 
lead to some proposals that would allow you to be pretty tough in terms 
of capping Medicare expenditures, even having for instance, by enacting 
rules that would be somewhat arbitrary in the limited price increases 
or the price decreases you might force on various medical services. 
   But I think I would take some of that money and direct it toward 
other problems that my colleagues have mentioned. I would also move a 
bit in the direction the President has suggested (but not adequately), 
and perhaps start building up a credit or a voucher for the 
non-elderly. 
   I think that combination would accomplish several things. One, I 
think it would allocate the health budget better. Two, if you applied 
some of the savings as a deficit reduction, I think it would represent 
good budget policy. But three, as a political matter--and I do not 
usually try to jump in political matters--I think it would convince the 
public that you are trying to come out with a better health care budget 
overall. 
   It would force, of course, attention to the huge disparities in the 
way spending is done on both the tax and the direct spending side of 
the budget. 
   So I think one can go in the direction or suggest. I think it would 
be hard. You probably would have to empower much more strongly your 
MedPAC-type commissions. Bob might not like that (he's on the 
commission) or he might tell me there are limits on how far you can go 
in the direction or suggest. For instance, a commission might). That if 
they make suggestions, you would take them or you would give them some 
fast track or something and only--there are all sorts of details here. 
   But I think the objective is a good one and I think there are ways 
to try to move toward it. 
   Senator ALLARD. Mr. Chairman, I just have one more question. 
   Now we have talked about a solution on the spending side and now I 
am going to push you a little bit on the revenue side. Because my view 
is that we are not going to get any kind of political resolution to 
this until we deal with both sides, the spending and revenue side. 
Probably, from a practical standpoint, we are going to have to do that 
anyhow. 
   So let us look at marginal tax rates. In the 1940's, marginal tax 
rates were as high as 94 percent. They are now 35 percent. How high do 
we raise marginal tax rates? Or do we leave them where they are because 
they are--apparently, they are an economy driver. If you look at 
adjusted inflation revenues, it has increased from $75 billion to $1.9 
trillion in revenue to the Federal Government. 
   So do we look at bringing our marginal rates close to 94, to 90 
percent or something like that? What is appropriate, 70 percent, 50 
percent, or something less? Or do we even mess with marginal rates? 
   Mr. REISCHAUER. I think there is probably a consensus at this table 
that keeping marginal rates low is good and broadening the base is a 
preferable way to raise revenues. 
   That having been said, there are certain preferences that are 
enjoyed by very high income individuals, some as a result of the tax 
changes of the last 7 years, which it might be appropriate for Congress 
to rethink. 
   Mr. STEUERLE. I would say that if I had to identify one major concern 
with marginal tax rates--and it does have to do with where we are going 
with reform--it is that we have built so many explicit tax rates and 
various phase-outs in the tax system and the direct expenditure system 
I see low and moderate income people in various income ranges with tax 
rates that are already 50, 60, 70, or 100 percent. I fear that if we go 
too much futher toward means testing, as is sometimes suggested on 
health benefits, we are going to raise those rates even further. 
   So I have to say, those are the marginal rates I worry about the 
most. 
   The economic logic of marginal rates is that the inefficiency of tax 
system increases with the square of the tax rate. So bumping from 35 to 
40 is much less severe than bumping from 40 to 45, if you understand 
where I am going. As an extreme example jumping from 99 to 100 means 
basically people would do no work. 
   So the higher the rate gets, the more I worry about it. Thus, I 
would especially worry, as I say, about the marginal rates we are 
starting to impose on moderate income people. That requires looking 
beyond just the statutory rate to all these indirect rates. 
   And by the way, we are increasing marginal rates right now anyway 
through policies ranging from things the Alternative Minimum Tax to 
bracket creep. So we are doing some of it already. 
   Mr. GREENSTEIN. I think all of us would agree broadening the base 
and improving compliance is the first step. 
   Incidentally, when I was noting additional needs in the 
discretionary area, I forgot to include and should have, IRS 
enforcement to improve compliance. 
   Having said that, as Gene just noted, I think none of us would favor 
going remotely close to the 70 to 90 percent rates you were talking to. 
I think we may very well need, however, to revisit 35 percent versus 
39.6 percent at the top. 
   Beyond that, over the longer term, I think we will need to look at 
some other forms of revenue outside the income tax, particularly in the 
area of environmental related taxes, both to deal with the global 
warming problems and from a revenue standpoint. 
   We may ultimately need to look at a small value added tax to help 
deal with these health care issues that we have talked about at some 
point down the road. We may need to look at a hybrid of a reformed 
income tax and some more consumption-based taxes. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   Chairman CONRAD. If Senator Allard does not mind, I would like to 
just followup with something Dr. Steuerle mentioned to you in answer 
to the question. 
   I would like you to explain a little more fully if you could, you 
are talking about very high marginal rates on middle income people. 
What were you referencing there? 
   Mr. STEUERLE. What we have done in so many parts of our budget 
process is to try to save money by playing this game of phasing out 
programs. I am not saying that in some cases they should not be phased 
out. But almost all of the phase-outs are based on income. 
   So, in point of fact, your income goes up by $1 and you lose 10 
cents worth of a Pell Grant. Or you lose 33 cents of food stamps. Or 
you lose 50 cents of some other program. 
   These programs are each enacted one at a time. I have done a lot of 
analysis on these marginal rates on low and moderate income people. 
Many of these people face extremely high marginal tax rates. 
   Occasionally there is movement to do something about these rates, 
but then we contradict that effort by adding on another program. And as 
I say, even some of the proposals in the health care field have 
implicit in them something like another 33 percent phase-out rate. So 
you earn another $1 and you lose 33 cents of your health voucher or 
your health credit or whatever else it is going to be. You add that 
rate to all the others, and you end up imposing these very, very high 
tax rates. 
   In the tax system we do it a bit also. We phaseout personal 
exemptions and other items like this. As far as I am concerned, most of 
those phaseouts should not be there. If we are going to have rates, let 
us put them directly in the statutory rate schedule, and let us stop 
pretending about what is being done. We play this game of pretending 
that we lower the statutory rates, and then we come in through the back 
door and catch people through higher implicit tax rates. 
   There is very little attention to how this combined tax expenditure 
system is affecting people. 
   Chairman CONRAD. I had not thought about that. That is a very 
interesting point that you are making. 
   Mr. STEUERLE. They also impose huge marriage penalties, typically, 
if you look at those also. 
   Chairman CONRAD. That very significant marriage penalties are 
imposed by--
   Mr. STEUERLE. Typically by the way these things are phased out. They 
are often phased out on a household basis. As long as you stay single, 
you can avoid some of the phase-outs, is what often happens... 
   Mr. GREENSTEIN. You could have a household of $20,000 year. As it 
earns more money, its EITC goes down. If it has a housing voucher, that 
goes down. If it has food stamps, that goes down. 
   These are the points Gene is making, I think. If you look at both 
the tax and the transfer, the means tested program side of the ledger, 
and you add them up, for each additional $1 you earn, you can lose more 
than 50 cents. You can have a higher marginal tax rate than people at 
the top of the income scale effectively. 
   Chairman CONRAD. I would be very interested in anything you have in 
writing on this, I would be very interested in reading. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


   Let us bring the hearing to an end. We have reached the appointed 
hour. 
   I just want to stay personally and on behalf of the committee a 
special thank you to this panel. I think this has been extremely 
constructive. It has certainly helped my thinking. 
   Mr. Greenstein, thank you once again for appearing before the panel. 
   Dr. Reischauer, thank you. We have missed your steady hand at CBO. 
We have been very gifted, in this committee and the Congress, in who we 
haveten to replace you and we are delighted there. 
   Dr. Steuerle, thank you for your very thoughtful presentation here 
today. We appreciate it. 
   [Whereupon, at 12:13 p.m., the committee was adjourned.] 


  
                     EXPLORING SOLUTIONS TO OUR LONG-TERM 
                               FISCAL CHALLENGES 
                                   ________
                  
                           WEDNESDAY, JANUARY 31, 2007 

                                                   U.S. SENATE,
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:05 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Whitehouse, and Gregg. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

               OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. I would ask the witnesses to take their seats. 
 Senator Gregg has just informed me that he is running a little bit 
late, but he has asked me to go ahead and begin the hearing, and we 
will do that. 
   I especially want to welcome the really outstanding witnesses we 
have here today. Robert Bixby, the Executive Director of the Concord 
Coalition, that does such good work on trying to alert the Nation as to 
the risks of our fiscal imbalances; Dr. Joe Minarik, the Senior Vice 
President of the Committee for Economic Development with a 
distinguished background in dealing with these issues; Dr. Jason 
Furman, who is the Director of the Hamilton Project at the Brookings 
Institution, who has just taken over for Peter Orszag, who has now 
become the head of the Congressional Budget Office; and Dr. Stuart 
Butler, the Vice President of the Heritage Foundation. We look forward 
to the testimony of all of you. 
   Let me just say that we have had a series of hearings now in which 
we have tried to lay the groundwork about the seriousness of our 
long-term fiscal imbalances. We started with the head of the General 
Accounting Office, and maybe we could put up one of his statements from 
that hearing. He said we are on an imprudent and unsustainable 
long-term fiscal path, and while the short-term deficits have improved 
in recent years, the long-term is getting worse every second of every 
minute of every day, and the time for action is now. 

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   Next, we had the Chairman of the Federal Reserve come and testify 
before the Senate Budget Committee, and this is what he had to say: one 
might look at these projections and say, well, they are about 2030 or 
2040, and so we really do not have to start worrying about it yet. But 
in fact, the longer we wait, the more severe, the more draconian, the 
more difficult the adjustments are going to be. I think the right time 
to start is about 10 years ago. 
  
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   I think the Chairman of the Federal Reserve had that exactly right. 
Even in the short term, our fiscal outlook is worse than some have 
claimed. It is important to remember that the debt is growing far 
faster than the size of the deficit. While CBO estimates with omitted 
costs that the deficit will fall to $218 billion in 2007, that number 
only tells part of the story. The increase in the debt will actually be 
over $500 billion for this year. As I have said to my colleagues over 
and over, the debt is the threat. 

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   We are now facing a wall of debt. At the end of 2001, the first year 
of this Administration, the gross debt was $5.8 trillion at the end of 
that year. Under CBO's most recent estimates, the gross debt of the 
United States will reach $9 trillion this year. And we are headed, by 
the year 2012, for a gross debt of the United States of over $12 
trillion. 

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   This increase in debt is happening at the worst possible time, just 
before the retirement of the baby boom generation. As this slide shows, 
the number of Social Security beneficiaries is projected to climb to 82 
million by 2050. 

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   And we need to remember that Social Security is not the biggest 
budget challenge that we face. Because of rising health care costs, the 
shortfall in Medicare is seven times the shortfall in Social Security. 

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   Since so much of our long-term budget shortfall can be attributed to 
rising health care costs, health care reform must be at the heart of 
any solution. Our health care system is not as efficient as it should 
be. The U.S. is spending far more on health expenditures per capita 
than any other country in the developed world. 

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   For example, the U.S. spent over 15 percent of GDP on health 
expenditures in 2003. This year we are expecting we will be at 16 
percent of gross domestic product. That means about one in every six 
dollars in this economy is going for health care. 
   And if we compare that to the rest of the world, we see that we are 
spending about twice as much as other industrialized countries. In 
fact, the next highest country is at 11 percent of GDP. That 
difference, the difference between the 16 percent of GDP we are 
spending and the 11 percent of the next highest country, that 
difference represents $800 billion of expenditure per year in our 
country. 
   This chart from the Center on Budget and Policy Priorities shows 
that rising health costs are by far the biggest factor driving Medicare 
cost growth. Demographic changes from the retiring baby boom generation 
are a secondary factor, nonetheless a powerful driver as well. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   But we do not have just an entitlement spending problem, we also 
have a revenue challenge. If all of the President's tax cuts are made 
permanent, the cost will explode at the same time that the cash 
surpluses in Social Security and Medicare become deficits. In other 
words, the President's tax cuts will dramatically worsen an already 
deteriorating fiscal picture. 

   [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]   

   We can see that the Nation's gross debt explodes if all the tax cuts 
are extended without offsets. In fact, according to the Center on 
Budget and Policy Priorities, we will more than double our debt level 
as a share of GDP by 2050 if all of the tax cuts are extended without 
paying for them. 

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   Our fiscal problems are not insurmountable. We can put our fiscal 
house back in order, but only if we have the will to do so. Make no 
mistake, it is not going to be some automatic mechanism that is going 
to save us. It is going to require us to act. The sooner we act, the 
better. 
   We have asked all of you to be here today to give us your ideas on 
what we might do to address these challenges. I especially appreciate 
your taking your time to prepare testimony and to be here to give it. I 
believe these are incredibly difficult challenges. If these were easy 
things to address, we would have done it. My own conviction is it is 
going to take both parties giving up on some of their fixed positions 
in order to resolve this. I do not believe either party can do this on 
its own. I think it is going to take working together to arrive at 
solutions. And I do believe it is going to require compromise. 
   Compromise means both sides have to give in, both sides. Anybody 
that thinks it is just going to be one side, I think, is not living in 
the real world. 
   And so I want to again welcome this panel of witnesses and ask you, 
Mr. Bixby, to begin your presentation to the committee. 

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

   Mr. BIXBY. Thank you, Chairman Conrad and Senator Gregg and other 
members of the committee. I am very pleased to be here to discuss 
solutions for the long-term fiscal challenges that you have laid out. 
   As you mentioned, I represent the Concord Coalition, which is 
cochaired by two of your former colleagues: Warren Rudman of New 
Hampshire, a Republican, and Bob Kerrey of Nebraska, a Democrat. 
   The problems that we face are well defined. You and your prior 
witnesses, have laid them out. Basically an aging population and rising 
health care costs lead to unsustainable deficits and debt over the 
future. 
   We can debate, I think, whether the Government should tax and spend 
at 18 or 19 percent of GDP or tax and spend at a higher level, 25 or 
higher. But no one would advocate that we tax at 18 or 19 percent of 
GDP and spend at 25 to 30 percent of GDP. That would certainly shatter 
the economy, would be generationally inequitable, and yet that is the 
path that we are on. 
   There are no quick fixes to this, but there are certain things that 
we can begin doing now that would make for a brighter future. The 
Concord Coalition recently took out a full-page statement in the New 
York Times and recommended the following four steps: one, balance the 
budget. Second, began a bipartisn process for addressing, the long-term 
fiscal challenges, similar to what you and Senator Gregg have proposed 
doing. 
   Third, reimpose budget caps and the PAYGO mechanism that applied 
across the board to both tax and spending policies. 
   We also recommended that you might begin putting into the annual 
budget resolution some targets for long-term spending and revenues as a 
percentage of GDP that would cover several years. And that would help 
focus more attention because, as you know, we have sort of a myopic 
budget process and it is sort of hard to focus on the long-term when we 
are worrying about this year's annual appropriations. Not that those 
are not important, but it is easy to forget the long term. 
   So let me just elaborate on some of those points. Balancing the 
budget, this is not an end in and of itself. It does have long-term 
benefits. It would increase national savings by ending the drain on 
national savings caused by deficits. So it would better position us to 
deal with these long-term fiscal challenges. I think it is also 
generationally responsible because it would lower interest costs and 
interest is, of course, a major expense, about 8 percent of the Federal 
budget. So there are going to economic and generationally responsible 
outcomes that would come from balancing the budget. 
   But that is only, of course, a first step. Even if we had a balanced 
budget by 2012 or sooner, we would still have an unsustainable 
long-term problem. So getting at that is really the root of this. 
   The next step is to, as you mentioned, reduce the long-term 
entitlement costs, really the health care and retirement programs are 
what is driving this. There are no easy solutions to this, as everybody 
knows, but the primary source of the long-range fiscal drain is on the 
spending side. This will require difficult choices. 
   So the most effective solutions are those, I believe, that would 
concentrate on ways to rein in the spending. And you cannot get away 
from the two largest, most popular programs in that regard, which are 
Social Security and Medicare. I would underscore what you said before, 
that Medicare is by far the much bigger problem than Social Security. 
   This is going to require some very hard choices. I would recommend 
on Social Security, the Concord coalition has always been in favor of 
steps such as raising the eligibility age. I think the idea of 
progressive price indexing, which has come up, is one that deserves 
further consideration. I would avoid payroll tax increases as a first 
step. If more revenues are needed to come up with a politically and 
substantively balanced plan, then so be it. I think everything does 
need to be on the table. 
   Personal accounts are something that could help increase savings, 
but the money has to come from somewhere. There is no free lunch. So if 
we do add personal accounts to the system, I would recommend some sort 
of dedicated revenue source to pay for them so that they are not just 
adding to the budget deficit. Because if you have deficit-financed 
personal accounts, you are not adding to national savings. You are 
putting it in one pot and then taking it from another. 
   Medicare is by far the more difficult challenge. My red light is on. 
Gee, does that mean I do not have to talk about Medicare? 
   Chairman CONRAD. No. You still get to talk about Medicare. 
   Mr. BIXBY. I will. I thought I had that timed perfectly. 
   That really is the toughest thing. There, some of the traditional 
fixes just do not get you much. Raising the eligibility age does not 
get you much because most of the costs come from the more elderly 
people, 85 and older. 
   So I think there you are ultimately going to have to come up with 
some mix of limits on benefits, figuring out what the public is willing 
to afford, what makes sense in terms of a benefit package that we can 
say that all Americans should be guaranteed, at least in Medicare. It 
does have to extend to the entire health care system basically. You 
cannot solve Medicare in a vacuum. 
   It probably will require more contributions from beneficiaries. I 
think the idea of adding more income relating to premiums is something 
that you are going to have to do. And anything we do should try to add 
incentives for more careful use of resources. 
   Let me just conclude by saying that we cannot ignore the role of 
revenues in all of this. As I said before, I do not think raising taxes 
should be the first option. Low taxes do help economic growth and you 
do not want to stifle that. 
   On the other hand, you cannot keep taxes that far below spending for 
too long without creating economic problems of their own. So that is 
why everything does, at some point, need to be on the table to come up 
with a package. And this has to be done, as you said, in a bipartisan 
way. It also has to be done with the active engagement of the American 
people. 
   We are involved, all of us here at this table, in the Fiscal Wake-Up 
Tour. Dave Walker is involved in that, as well. We have been going 
around the country holding town hall meetings and talking to the local 
media. I think any sort of big effort like you are leading here at this 
committee really needs to bring the public along. 
   We are finding, one bit of good news if I may, that the public seems 
to be willing to hear the tough choices. What they want is to make sure 
that you are serious about them. And if they have to endure benefit 
cuts, if they have to endure higher taxes, they may not be happy about 
it. But they are willing to accept it if it will result in a brighter 
future for their children and grandchildren and not just higher 
deficits and more of the same. 
   So I think to end, the good news is that the problem is in our own 
hands. I think the public is willing to hear the truth. And I 
congratulate this committee for pursuing this most important issue in a 
bipartisan way. 
   Thank you. 
   [The prepared statement of Mr. Bixby follows:] 

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   Chairman CONRAD. Thank you very much, Mr. Bixby. 

   Dr. MINARIK. Welcome. Always good to have you. Please proceed. 


           STATEMENT OF DR. JOSEPH J. MINARIK, SENIOR VICE PRESIDENT 
                    AND DIRECTOR OF RESEARCH, COMMITTEE FOR 
                             ECONOMIC DEVELOPMENT 

   Mr. MINARIK. Thank you, Mr. Chairman, Senator Gregg, members of the 
committee. 
   Your committee's hearing record thus far has documented clearly that 
following the outlook of large and continuing budget deficits would be 
unwise and even dangerous. In addition, it is morally questionable. 
   Let me stipulate the committee's record and move on to address the 
exceedingly difficult question of how the Nation might cure these 
deficits. 
   To begin, however, let me make one point of transition between cause 
and cure. Some say today that tax cuts have made our economy strong and 
yielded a large revenue boost which will eventually pull the budget out 
of deficit. To this view I can only personally observe: been there, done 
that. 
   There was a similar, in fact far stronger, revenue boom in the 
1990's following, ironically, a deficit reduction program of which 
about half was a tax increase. In retrospect, that revenue boom was 
driven in substantial part by extraordinary returns in financial 
markets. As seasoned financial market professionals will readily tell 
you, markets go up and markets go down. The revenue boom of the 1990's 
ended, and the current revenue boom will end as well. 
   Having watched all of this happen before at close range, I would 
urge you not to let temporary fluctuations in revenues delay sound 
long-term policymaking. 
   The Committee for Economic Development, CED, has considered the 
budget problem from virtually every angle. Let me provide our 
conclusions for your consideration, reviewing all of the major 
components of the budget. 
   Briefly, first, CED has called on the Congress to reinstate the 
budget disciplines from the 1990 bipartisan budget agreement. Let me 
congratulate this Congress for taking a long step forward on that 
issue, while urging a full statutory reenactment of these disciplines. 
Second, the CED Trustees have urged the Congress and the Administration 
to seek out all possible opportunities to weed out waste and 
duplication in domestic appropriated spending and also in defense 
appropriations, which the current war effort obviously complicates. CED 
has also noted that we have no expectation that there will be nearly 
enough in discretionary savings to solve the long-term budget problem, 
especially in light of the national priorities that must be advanced 
through appropriations. 
   This leaves virtually the entire weight of deficit reduction on the 
remainder of the budget. One program mentioned currently as a possible 
subject of legislative action is Social Security. Because Social 
Security as currently configured is not sustainable in the long run, 
action is needed. Furthermore, the last major restructuring of Social 
Security, in 1983, significantly helped the unified budget and 
therefore the Federal Government's need to borrow from the public to 
fund its operations. 
   However, the kind of action now often contemplated, partial 
privatization, would make our overall budget predicament enormously 
worse. The simple reason, as Bob suggested, is that the current Social 
Security operating surplus, which is held by the Federal Treasury in 
cash and therefore reduces borrowing needs, would have to be diverted 
in significant measure to capitalize the individual accounts. That 
would constitute a net loss to the Treasury for decades. 
   There will be no benefit reduction savings from partial 
privatization for almost a decade and those savings will begin only 
very slowly while deposits into the private accounts must be made at 
full speed from the very beginning. As a result, the unified budget 
that is about to move into substantial deficit would add on even more 
debt. 
   It is of absolutely no consolation that the Social Security plan, 
taken on its own, would be actuarially sound over 75 years, or even 
longer. The Federal Government's finances would be dead long before 
then. 
   My own calculations of several years ago suggested that the Social 
Security partial privatization plan would not recover to a net break 
even for the unified budget for more than half a century. I know of no 
serious observer of the Federal budget, certainly not the President's 
own Office of Management and Budget, who would contend that the Federal 
Government's finances will remain healthy without serious restructuring 
much sooner than 50 years from now. 
   CED issued a statement on Social Security reform in 1997 which we 
reaffirmed in 2005. Specifically, we recommended gradual reductions in 
benefits that would yield permanent solvency for the system with a 
margin of safety in those calculations. The benefit reductions would 
include changes in the benefit formula, increases in both the normal 
retirement age and the age of earliest eligibility, and the income 
taxation of 100 percent of benefits. 
   To compensate for those benefit reductions, we would add private 
accounts. These private accounts would be mandatory and would be funded 
by contributions equal to 3 percent of covered payroll, 1.5 percent 
each from employer and employee. The contributions would belong to the 
employee and would be placed in purely private accounts, without being 
handled by the Federal Government. Again, these recommendations would 
leave Social Security permanently sustainable under current 
assumptions, would increase national savings, and would improve rather 
than deplete the unified budget. 
   Close observers of the Federal budget will be quick to note that the 
long-term budget problem is driven much more by health care costs than 
by Social Security. In fact, some might go so far as to characterize 
Social Security restructuring as mere batting practice before the real 
contest against rising health care costs. 
   Let me offer two cautionary notes with respect to health care costs. 
First, it is difficult to conceive of policies to cut the Federal 
Government's health care costs without restructuring the health care 
system as a whole. One could not imagine physicians under Medicare and 
under the private market practicing side-by-side for very long at 
significantly different and diverging reimbursement rates or levels of 
productivity. 
   Furthermore, our health care system is no more sustainable for 
private employers, who pick up the bill for much of the working age 
population and their dependents, than it is for the Federal Government, 
which is responsible for much of the bill for the elderly. Thus, to fix 
the health care system for the elderly, we almost certainly must fix it 
for everyone. 
   Second, it is hard to imagine a simple CBO-scoreable fix for 
Medicare or Medicaid short of a reduction of program coverage that 
would not be much less dramatic than offering the very ill only an icy 
lake and a canoe with no paddle. The Federal Government's experts 
already have learned that reductions of reimbursement rates of the 
depth that would be necessary to balance the system in the long run 
would elicit almost equally sharp increases in the volume of services 
provided, through which providers would attempt to maintain their 
incomes. 
   Moreover, such reimbursement reductions would not be sustainable in 
the context of our mixed public and private system. Large numbers of 
physicians simply would refuse to serve Medicare patients. 
   Therefore, to solve our impending Federal health cost crisis, we 
need a fundamental restructuring of the entire health care system along 
lines that will yield a qualitative, not just a measurable and 
quantitative, change in the way health care is delivered. CED looked at 
these issues in 2002 and we now conclude that we underestimated the 
magnitude of the structural change required. Accordingly, we are 
revisiting this issue now. We are starting with the employment-based 
health care system for working-aged persons and their dependents in a 
way that we believe will have important synergies with Federal programs 
for the elderly. 
   Although our deliberations are not yet complete, we have tentatively 
settled on a system that would give to the working age population a 
menu of choices similar to those available today to Federal workers 
under the Federal Employees Health Benefits Program, and to a few 
consortia of private employers around the country. 
   An independent Government agency, perhaps structured like the 
Federal Reserve Board of Governors, would play the regulatory role of 
the office of Personnel Management in the FEHBP including, for example, 
setting minimum standards for the insurance policies that are included 
in the menu. People would receive defined contributions such that 
everyone could obtain the low price plan that meets the appropriate 
standards, but those who want more expensive coverage would be 
responsible for the incremental cost out of their own pockets. 
   Beyond universal coverage, the goal of this approach would be to 
encourage consumers to be cost-conscious choosers of their health 
insurance plans rather than of individual medical services. We believe 
that giving consumers such cost conscious choices will drive both 
insurers and health care providers to improve efficiency so that they 
will be able to offer better services at lower prices and thereby 
attract more customers, just as other industries in the U.S. economy 
have learned to seek greater efficiencies so as to remain competitive. 
   Mr. Chairman, I am running over so I get to skip talking about 
taxes. I guess the only thing that I would note is that we should 
consider, when we are concerned about our tax burdens today, the 
implications of procrastination in dealing with the budget problem for 
the taxes that will be paid by our children and grandchildren in later 
years. 
   A large portion of the problem in the budget outlook is increases in 
the buildup of debt. We can forestall that by reducing budget deficits 
in the short term by any tool, even if we believe that the ultimate 
solutions to those problems are longer-term repairs for Medicare and 
Medicaid. 
   Finally, Mr. Chairman, I have to note my resentment that my friend 
over here, Mr. Bixby, mentioned the issue of grandchildren when he does 
not have any and I do. 
   Thank you and I look forward to your questions. 
   [Laughter.] 
   [The prepared statement of Mr. Minarik follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

   Chairman CONRAD. Thank you. 
Dr. FURMAN. 


                  STATEMENT OF DR. JASON FURMAN, DIRECTOR, THE 

                         HAMILTON PROJECT AT THE BROOKINGS 
                                INSTITUTION 


   Mr. FURMAN. Mr. Chairman, Senator Gregg, other members of the 
committee, thank you for the invitation to testify in one of the most 
important issues facing our Nation, the long-run budget deficit. 
   Restoring fiscal balance is essential to the current and future 
health of our economy. You have done such an excellent job outlining 
the problems we face that I will move over it very quickly, except to 
underscore that in my judgment there are three main sources of the 
fiscal gap and in order they are No. 1, the health system, and that is 
the private and public health system taken as a whole. No. 2, the tax 
cuts enacted since 2001 which, if made permanent with associated AMT 
relief, would total 2 percent of GDP. And then No. 3 would be the 
long-run outlook for Social Security, which faces a shortfall, its 
trustees estimate, of 0.7 percent of GDP. 
   With that context, I want to briefly review three steps we can take 
to address the long-run deficit. My written submission contains more 
details on all of these topics. 
   Step one, restore the PAYGO rules and stick to them to stem the flow 
of red ink. Remarkably, two-thirds of the 75-year fiscal gap was 
enacted since 2001. Of what I estimate as a 6 percentage point deficit 
over the next 75 years (and people who look at 50 years and use 
different assumptions will get different numbers), 2 percentage points 
are due the tax cut if made permanent, 1 percentage point is due to the 
Medicare prescription drug benefit, and 1 percentage point is due to 
increased discretionary spending on defense and homeland security, not 
counting Iraq and Afghanistan. 
   If PAYGO had been in effect and enforced over the last 6 years, we 
would have had a surplus today and a considerably smaller long-run 
challenge. 
   Additionally, Congress can adopt budget rules that stop 
discretionary spending from growing faster than needed to fund current 
policies and that end the practice of using the reconciliation process 
afforded by the budget resolution to increase the deficit. 
   Step two, take some simple steps-comparatively simple steps, I 
should say-to reduce the deficit today. To restore fiscal balance more 
must be done than simply restoring PAYGO. Restoring fiscal balance will 
require some combination of spending below and revenues above the 
baseline that requires the support of both political parties. 
   In my testimony I discuss the MedPAC recommendations and the tax 
gap. Here I want to go into a little bit more detail on two other 
recommendations. 
   First, there should be no more new tax cuts. The Economic Growth and 
Tax Relief Reconciliation Act of 2001 phased in tax cuts over a 10-year 
period. Several of these tax cuts are not fully in effect, including 
the repeal of the personal exemption phaseout, the repeal of the Pease 
rule that phases out itemized deductions, and the repeal of the estate 
tax. 
   These cuts were enacted in an era of surpluses and before 9/11 
brought our attention to homeland security challenges. Now that we are 
again in deficit and spending is elevated, further tax cuts above and 
beyond what is in the law today make no fiscal sense. 
   Second, let us correct the indexing of Social Security, the tax 
code, and other programs. Policymakers wisely index Social Security 
benefits and tax brackets to adjust for the cost of living. But the 
consumer price indices used for this purpose overstate inflation. 
   Specifically, they ignore the fact that consumers partially insulate 
themselves from shifting prices by switching from goods whose relative 
prices are rising to ones whose relative prices are falling. 
   Although policymakers should not substitute their judgment for that 
of the nonpartisan professionals at the Bureau of Labor Statistics, 
policymakers must use their judgment to pick the most reliable of the 
many price indices that are available today and compiled by the 
professional statisticians. A good candidate is the Chained CPI. Since 
its inception in 1999, this index has run 0.5 percentage point lower 
than the traditional CPI. If all Federal programs and taxes were 
switched to the Chained CPI, by the end of the decade the Government 
would save more than $40 billion with the bulk of the savings divided 
roughly equally between preventing de facto Social Security benefit 
increases and tax cuts that Congress never intended. Over time the 
savings would continue to grow. 
   Step three entails addressing Social Security, Medicare, Medicaid 
and tax reform. I want to briefly mention one idea in each of these 
areas. First, Social Security reform. Uncertainty about the future of 
Social Security should not be used as an excuse not to act, but it 
should be a motivation to provide for foreseeable contingencies. If the 
future is much better than we expect, benefit reductions and/or tax 
increases should automatically be smaller. If it is much worse than we 
expect, the opposite should happen automatically without having to wait 
for Congress to act. In addition to sustainable solvency, policymakers 
should strive to achieve robust solvency. 
   One promising way to introduce more robustness into the system is to 
use dependency indexing, which links changes in replacement rates or 
payroll tax rates to changes in the ratio of workers to retirees. In a 
pay-as-you-go system, the dependency ratio is the variable that 
determines the payroll tax rate needed for any given replacement rate. 
It is a function of current and past fertility rates, mortality rates, 
and immigration. 
   If, contrary to current predictions, Social Security does not face 
any financing problems, a measure like this can effectively shut off 
any benefit reductions or tax increases, removing one of the major 
objections to undertaking Social Security reform today. 
   Second, in the realm of health, reforming the $200 billion in annual 
tax subsidies for health insurance, if done right, can expand coverage, 
improve cost-effectiveness, and reduce the long-run deficit. But reform 
done wrong could undermine the employer-sponsored system without 
creating an alternative, increasing the total number of Americans 
without insurance. This is a very important issue because it is right 
at the intersection of the private sector and the public sector that is 
so much a part of the health system. 
   Converting the current tax exclusion from employer-sponsored 
insurance into a tax credit or a voucher would make the subsidy more 
progressive, provide a bigger incentive for people to get insurance, 
and reduce the long-run savings. But this would work only if it were 
done at the same time that major steps were taken to strengthen pooling 
arrangements and expand health insurance coverage through the public 
and private sectors. 
   Finally, when it comes to tax reform, I have sketched several 
options in my written submission, including proposing to curb tax 
expenditures for corporations and convert individual tax reductions to 
tax credits. In addition, we could rely more on taxes that correct 
distortions and improve the functioning of markets. 
   For example, as N. Gregory Mankiw has argued, ''A tax on carbon is 
the best way to deal with global warming.'' Combined with other tax 
cuts for working families, such a policy need not be regressive. 
   The fiscal problems this committee is trying to address are very 
difficult, both economically and politically. 
   Thank you for the opportunity to contribute to your efforts. 
   [The prepared statement of Mr. Furman follows:] 

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   Chairman CONRAD. Dr. Butler, welcome. 

               STATEMENT OF DR. STUART M. BUTLER, VICE PRESIDENT, 
                       DOMESTIC AND ECONOMIC POLICY STUDIES, 
                            THE HERITAGE FOUNDATION 
   
   Mr. BUTLER. Thank you, Mr. Chairman and members of the committee. 
   I think you will hear there are some elements of agreement on this 
panel on a number of steps, although disagreements on some others. 
   As Comptroller General David Walker observed, the present value of 
the unfunded obligations of the Federal Government is the equivalent of 
placing $170,000 mortgage, without a house as a corresponding asset, in 
the crib of every baby born in America. You have asked the panel what 
we should do about this. 
   It may be tempting to say that we should raise taxes to keep pace 
with the mounting entitlement obligations, but there are at least two 
reasons why this would not be the right course, in my opinion. First, a 
lack of future revenue is not the problem. Spending is. Federal taxes 
are already projected by CBO to rise to their highest level ever as a 
percent of GDP over the next 15 years and then they will keep rising. 
Raising taxes faster than that risks slowing economic growth. 
   Second, we are currently scheduled to pay for the huge cost of baby 
boomer retirement benefit by borrowing money from our children and 
grandchildren. But the way to stop borrowing money from our children 
and grandchildren is hardly to take their money in the form of new 
taxes. What we need to do instead is admit that we have overextended 
ourselves and seek fair and reasonable ways of reducing future 
entitlement spending by focusing resources only on those who really 
need help. 
   To do that, Congress should take the following steps: first, 
Congress should replace the drug benefit provision in the Medicare 
Modernization Act with a targeted benefit instead. The Part D benefit 
is a huge and unaffordable new entitlement. Instead of subsidizing drug 
purchases for all retirees, Congress should repeal the general 
subsidized benefit and replace it with a limited benefit targeted to 
only needy seniors. 
   Second, if you will not revamp the drug benefit, at least introduce 
full income testing for Medicare Part D and also for Medicare Part B. 
These parts of Medicare are not social insurance programs. They are 
heavily subsidized voluntary insurance programs. Congress should fully 
income adjust these parts of Medicare, raising premiums to 100 percent 
of their real cost value for affluent seniors. 
   Third, it is time to fully income test Social Security benefits for 
higher income seniors. Congress has already accepted the principle of 
including Social Security benefits in taxable income in order to recoup 
some of the benefit costs. The appropriate next step is to phase in 100 
percent income-related benefits for all single seniors with incomes 
above 25,000 and married couples above $32,000. The full 100 percent 
inclusion in taxable income should apply on single incomes over $35,000 
and married couples over $45,000. 
   Fourth, encourage Americans to work longer. We cannot sustain a 
retirement system in which typical Americans can plan on spending 
one-third of their adult life in retirement with financial support 
guaranteed from other working Americans. Congress needs to encourage 
Americans to increase their time in the work force by eliminating 
disincentives that discourage people from working longer. 
   As an incentive to work longer, Social Security taxes should not be 
imposed on people who work after their normal retirement age. Since 
half the payroll taxes are paid by employers, the employers themselves 
would also have an economic reason to retain older workers longer. 
   We need also to gradually increase the Social Security retirement 
age to at least 70 and to speed up the current scheduled increase to 
67. After that, the retirement age should be automatically adjusted to 
reflect projected increases in longevity. And I think the dependency 
aspect that Dr. Furman mentioned is also an important way of changing 
it. 
   Fifth, we need to focus the growth of Social Security benefits on 
those who need them most and trim the rate of increase for those 
retirees who need them least. This can be done through progressive 
indexation where the benefits of upper income workers would increase 
only at the rate of inflation while benefits accruing to lower income 
workers would continue to grow under today's wage growth formula. 
   And sixth, Congress should change the status of retirement 
entitlements in the budget process. The current process has two major 
shortcomings. The first is that the long-term cost of existing 
entitlements is ignored in the annual budget cycle, so Congress is not 
forced to tackle the huge unfunded obligations. 
   The second is that entitlements have the first claim on spending, 
whether or not benefits for some individuals really should have top 
priority. Today, retired millionaires automatically preempt the 
homeless and our soldiers in Iraq in the struggle for Federal funds. 
   To fix this, Congress needs to take two steps. One is to include a 
measure of long-term budgetary situation prominently in the annual 
budget with a requirement that Congress go on record each year with a 
vote to increase or reduce long-term obligations. 
   Building on this first step, I believe Congress should also begin to 
eliminate the preferred status of entitlement programs so that all 
programs are on the same level playing field and have real and limited 
budgets. The way to do this while still preserving a reasonable level 
of certainty for retirement planning would be to convert all retirement 
spending entitlements into 30 year budgeted programs that must be 
reviewed and reauthorized by Congress every 5 years. 
   I should note here that I come originally from Britain. Although the 
National Health Service is an open-ended entitlement in one sense, it 
is on a fixed budget and competes year-to-year with other budget 
priorities for the British government. I think that is the way to 
address health in this country, too. 
   Congress might utilize the Entitlements Commission proposed by 
Senator Voinovich and Congressman Wolf to propose an initial long-term 
entitlement budget. Thereafter, Congress might also use recommendations 
fro the National Entitlement Adjustment Condition, proposed by Senator 
Feinstein, to recommend ways of dealing with spending that begins to 
exceed the agreed 30-year budgets. 
   Mr. Chairman, this afternoon Mr. Bixby and I, together with David 
Walker and Isabel Sawhill from the Brookings Institution, fly to Iowa 
for a town hall meeting on options for dealing with the long-term 
fiscal problem. This will be our 19th such event. We found at each of 
these events that Americans are quite willing to talk about tough, 
bipartisan choices to reduce the burden on future generations. 
   Thank you for inviting me to testify, and I hope Congress too will 
also be prepared to consider tough choices in a bipartisan way. 
   [The prepared statement of Mr. Butler follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

   Chairman CONRAD. Thank you, Dr. Butler. 
   Let me go to each of you and ask first, to me the notion of just 
doing it on the spending side of the equation is not going to work. 
Just doing it on the revenue side of the equation, not going to work. 
It is going to take some combination of additional revenue and spending 
restraint. 
   You know, I come to these meetings and I sometimes wonder if there 
is any possibility of getting these two sides together, because on one 
side they say no benefit reductions, period. And the other side they 
say no additional revenue, period. Pretty soon you have no solution, 
period. And I think that is about where we are right now. 
   And everybody is dug in. It is our way or no way. No compromise. No 
revenue, no cuts. That is what got us here and that is what is going to 
continue, that attitude is going to continue to prevent action, in my 
judgment. Because then neither side compromises. 
   Anybody that thinks one side is going to give in on their position 
and not the other side, to me is just detached from reality. This is 
going to take both sides giving up on their fixed position. 
   With that said, I would also say it is very clear to me the spending 
side of the equation is going to have to take most of the--is going to 
have to shoulder most of the effort here, because the baby boom 
generation is a reality. It is not a projection. 
   So let me first turn to the revenue side. Is there a way to get more 
revenue without increasing tax rates? Mr. Bixby, do you know of a way 
of getting more revenue without increasing tax rates? 
   Mr. BIXBY. The first thing you could turn to is what you had a 
hearing on earlier, which is the tax gap. We know that the current tax 
system does not collect all of the taxes that are owed. So step one 
would be trying to collect all of the taxes that are owed. 
   Now I do not know how much that would get you because there is 
obviously going to be some sort of a tax gap. I do not think we can 
assume that the tax system is going to collect every dollar that is 
owed. But the tax gap may even be wider than official estimates. 
   So I think an aggressive effort in that area is warranted. 
   Chairman CONRAD. Can I just interrupt you on that and say the head 
of the Revenue Service has told us he believes they could collect $50 
billion to $100 billion a year without changing in a fundamental way 
the relationship of taxpayers and the taxing authority. 
   Mr. BIXBY. It would probably take some more investment in IRS to 
give them the tools and then you would run up against a thing of how 
aggressive do you want them to be, and what sort of push back you get 
it that point from taxpayers. 
   The second thing you can look at is the so-called tax expenditures 
or tax entitlements, things that are excluded now or things that you 
have deductions and exemptions for. 
   The President has put on the table ending the exclusion for 
employer-provided health care. He would devote the savings to new 
deductions but I mean there is--you could certainly bring in some new 
revenue that way. 
   You can look at things like the mortgage interest deduction, 
politically very sensitive but the President's Tax Commission did 
recommend that, as an alternative to the AMT. You have to look at ways 
to fund the AMT relief if you want to continue to do that. 
   So you could look at some of these big tax expenditures and think 
about closing some of those. But I am not sure that that is politically 
any easier than spending cuts because the people that benefit from them 
are quite passionate about them. 
   So there are ways you can look at--frankly, I know you have the big 
tax cut sunset coming up in 2010. You mentioned not raising rates but 
they all do expire. So it will take legislative action to extend them. 
And it does give you an opportunity. It is sort of the ultimate trigger 
to look at whether some of them are achieving their intended purpose or 
not, or whether we can afford them. And since they all do expire, you 
can get into a question about whether or not that is raising rates or 
not. 
   That is something that is on the table, certainly. 
   Chairman CONRAD. Dr. Minarik? 
   Mr. MINARIK. You had a hearing on the tax gap. Amen to everything 
Bob said. I was not able to look at the exchange that took place during 
that hearing in detail, in the remote possibility that some of these 
issues were not mentioned. 
   The resource issue for the Internal Revenue Service would be 
extremely important. In the past, when there have been efforts to try 
to improve their collection activities, they have generally been taken 
forward by taking their best people out of production, as it were, and 
putting them into training. So for a period of time, while the effort 
is underway, the activities are actually down. That suggests that you 
might need more resources fairly quickly to be able to increase the 
number of personnel and possibly keep some of the stronger employees 
working in the production part of the process. 
   A second consideration is informally one can hear that many of the 
major accounting firms consider the Internal Revenue Service to be a 
training program for them. What happens is the Internal Revenue Service 
goes out, hires personnel, gears them up. They go to audits, they are 
observed, the audit that the service is undertaking is in effect a job 
interview for the employees. And the best people get picked off fairly 
quickly. 
   What that suggests, I am an economist, if you want to hold onto 
people maybe you ought to pay them more. That obviously is a very 
difficult decision in our employment system in the Federal Government. 
   Bob is very much correct, if you are not going to raise rates under 
your income tax, and collection issues aside, you are looking at issues 
regarding the tax base. The biggest tax expenditure, as you look down 
the list, is the exclusion for health insurance. As Bob noted, the 
President's proposal, which is very much like many others, like what 
CED is considering, would assume that the exclusion for the 
employer-provided premiums would be eliminated and that those resources 
would be used to fill some of the gaps in the health care system. It 
would be very difficult to restructure the health care system seriously 
if you did not use those resources, and frankly you would just be 
raising taxes somewhere else anyway. So that is a limitation on what 
you can do. 
   Another major tax exclusion in terms of revenue cost is the group of 
tax subsidies for pension savings. Some of those are somewhat hidden in 
the sense that they involve back-loaded tax preferences, which is to 
say you deposit an after-tax dollar today but you never have to pay tax 
on anything that dollar earns forever. Under those circumstances, the 
revenue costs in the future can be extremely substantial. That is a 
very generous subsidy and might require consideration. 
   Bob is also correct, when you get past that you start looking at 
items that are probably even more difficult, including the tax benefits 
for home ownership. I guess one thought that might be worth considering 
again, which was debated in the early 1980's in the course of the 
deliberations on what became the Tax Reform Act of 1986, was the 
possibility of taking some of the tax preferences in the current income 
tax which operate as deductions, which is to say they have the effect 
of what are called upside down subsidies. They are more valuable for 
people in higher tax brackets than in lower tax brackets. In some 
instances, that seems counterintuitive with the purpose of those tax 
preferences. 
   One opportunity might be to take those what are now tax exclusions 
or deductions, turn them into credits at a reduced rates, perhaps say 
the 15 percent bracket where most wage earners are. And by doing that, 
reduce the benefit of those provisions to people in higher tax 
brackets. That could be a net revenue increase. Some people might 
consider it a rate increase for that matter. But it is one thing that 
perhaps we ought to think about. 
   Chairman CONRAD. Senator Gregg. 
   Senator GREGG. Thank you, Mr. Chairman. Thank you for holding this 
hearing. 
   Chairman CONRAD. We will get back.              

             OPENING STATEMENT OF SENATOR JUDD GREGG 
   
   Senator GREGG. And I want to thank the panel. You folks have had 
some excellent ideas, excellent proposals, which if we are able to 
amalgamate and sugar off--that is a New Hampshire term. When you make 
maple syrup, you boil the sap and you end up with a little bit of 
sugar. And we could probably solve a lot of this. 
   Let me ask you about a couple of specifics and how we would go about 
implementing them because they seem to be reasonable ideas that should 
probably be executed sooner rather than later, even if there is not a 
comprehensive approach, although I would hope we would have a 
comprehensive approach. 
   The first is this idea of going to the chained CPI. Can you explain 
what that is and then explain how it would be implemented? 
   Mr. FURMAN. Sure, I would be happy to. 
   The official CPI uses an outdated method to calculate inflation. It 
uses a fixed market basket from the initial period. That assumes that 
people cannot substitute between different goods. The fact that we 
observe people changing their consumption prices when relative prices 
change, tells us that people, to some degree, view apples and oranges 
as substitutes for each other to a limited degree. 
   The Chained CPI is calculated by the BLS and it takes into account 
people's consumption patterns at both the beginning of the period and 
the end of the period. To the degree that people actually do substitute 
when relative prices change, the Chained CPI will reflect that. If you 
do not want to switch from health care to iPods when the price of one 
rises and the price of one falls, you will not actually switch from 
health care to iPods and the two indices will be the same. 
   Senator GREGG. I think I understand the concept. How would you-- 
   Mr. FURMAN. How would you implement it? 
   Senator GREGG [continuing]. Legislate it. 
   Mr. FURMAN. It is released every month just like the regular CPI. 
The only wrinkle is that it is revised for up to 2 years after it is 
released in the way that the regular CPI is not. So the implementation 
would just be to switch whatever is done on CPI-W, which is the Social 
Security system, or CPI-U, which is the tax system, to the C-CPI-U. And 
then you would just-- 
   Senator GREGG. Would that take legislation? 
   Mr. FURMAN. That would take legislation, absolutely. And then you 
would need a catch-up provision to take into account the revision to 
the index. 
   Senator GREGG. Could you do it through reconciliation, a 
reconciliation instruction, do you think? 
   Mr. FURMAN. I am not an expert on budget rules but it would 
certainly take legislation. 
   Senator GREGG. Thank you. This idea, this dependency indexing 
method, what is that? Go over that with me, too. 
   Mr. FURMAN. Sure. It is a mathematical fact in a pay-as-you-go 
system that whatever tax rate you have, let us say it is 10 percent, if 
you then have three workers for every retiree, your replacement rate 
can be 30 percent. Your tax rate is obviously set by statute. The 
replacement rate is set through the PIA factors, the thing that 
translates your earnings into your Social Security benefits. 
   What you could do is either take your payroll tax rate and when the 
dependency ratio gets worse it automatically goes higher. Or you could 
take the PIA factors--
   Senator GREGG. Doesn't that mean you are raising taxes on working 
people? Is that not the practical effect of that? 
   Mr. FURMAN. I am giving you the flip side also. You can do 
whatever-- 
   Senator GREGG. You know the ratio is going to go haywire, when 
we-- 
   Mr. FURMAN. If you want to raise payroll taxes or if you want to cut 
benefits, then I believe a better way to implement that is to build the 
contingency in advance rather than decide today based on what the 
Social Security Trustees think about the future, which could be way off 
in either direction. This is the exact right contingency. 
   In terms of raising taxes--
   Senator GREGG. Does it affect the benefit structure, as well as the 
revenue structure? 
   Mr. FURMAN. Absolutely. It would be up to you how to design it. You 
could either dependency index the payroll tax rate, or you could 
 dependency index what are called the PIA factors. 
   Senator GREGG. You could do both? 
   Mr. FURMAN. You could do 50/50, you could do 75/25, whatever ratio 
on the benefit and tax side. This is a mechanism for taking any plan 
you might have seen that alters benefits and taxes that you may like or 
may not like and make it what I think we would all view as an 
unambiguously better plan if you built this type of contingency. 
   On the difference between taxes and benefits, I would add that Kevin 
Hassett testified to this committee last year and said ''A benefit 
reduction is as much of a tax hike to a rational individual as an 
explicit tax hike.'' This is what Kevin Hassett said. And he explained 
that what matters to people is on net what they get out of the system. 
If you cut their benefits, it makes the existing payroll tax more 
distortionary than it would otherwise be in the same way that raising 
that payroll tax would be. 
   From an economic standpoint there is no difference in economic 
efficiency within the Social Security system of going down the tax 
route or the benefit route. 
   Senator GREGG. I would be willing to debate that with you but I do 
not have time. 
   Dr. Butler, you cited your thoughts that the dependency rate should 
looked at. Can you piggyback on what Dr. Furman has said? 
   Mr. BUTLER. Yes. I think the common thread here is that we are both 
saying that the commitments we are making on the benefit side should 
take into account the ability to pay of those on the payer side, that 
is the workers. That is the common theme. 
   I think looking at some relationship between the resources of the 
working population, and the demands of the retirement population, is 
what gets you looking at the dependency measure. 
   I also argued that we ought to have a further change in the indexing 
of Social Security benefits so that you have a reduction in the growth 
of projected benefits for those who are higher income workers campared 
with lower income workers. 
   Also, of course, the change in the benefit structure I argued for 
affects those who, as retirees, have higher income. 
   So all of these approaches are basically saying it is time to 
recognize that you the burden of the commitments that we have made is 
far too high because of demographic and other reasons. So in that 
sense, I think we are both on the same song sheet in terms of how we go 
forward. 
   Senator GREGG. You are both arguing that the benefit structure 
should be more of a progressive system? 
   Mr. BUTLER. Absolutely. I am very much on the progressive side when 
it comes to looking at benefit levels. 
   Senator GREGG. I was interested in your comments on Part D, which I 
am totally in agreement with. But I think my time is up. 
   Chairman CONRAD. Senator Whitehouse. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Mr. Butler, you recommended that Social Security taxes should not be 
imposed on those who are employed after their normal retirement age. In 
the present economy, that cohort provides what proportion of our Social 
Security retirement? 
   Mr. BUTLER. I cannot answer that right now. I can get you that 
information. I do not know the number. 
   Senator WHITEHOUSE. What is your suspicion? Could you get me the 
information? 
   Mr. BUTLER. Yes, I certainly can. 
   Senator WHITEHOUSE. What is your suspicion? 
   Mr. BUTLER. As I was trying to point out, the objective here is to 
encourage people to spend longer in the work force if they do not need 
to retire. And once they--
   Senator WHITEHOUSE. I understand that. I am just trying to see what 
the present effect would be. 
   Mr. BUTLER. It is a dynamic effect because you have to take into 
account how many people would be working beyond that point. And that, 
of course, will generate income taxes on those people. It is complex. 
Senator WHITEHOUSE. I understand that, but just on the Social Security 
piece. 
   Mr. BUTLER. Certainly. I will do that. 
   Senator WHITEHOUSE. If you could start with that. 
   And Dr. Furman, you said in your written testimony, that two-thirds 
of our fiscal gap has occurred since 2001 and could have been prevented 
had PAYGO rules been in effect. What is the dollar number that you 
would connect to that? 
   Mr. FURMAN. We have added about $30 trillion or to the 75-year 
deficit in present value terms over the last 6 years, on an apples to 
apples basis. 
   Senator WHITEHOUSE. What presumptions does that make about whether 
those-- 
   Mr. FURMAN. This is if the tax cuts were made permanent. If we go 
down the course that some have set. 
   Senator WHITEHOUSE. What is the present number that has been run up 
from 2001 until now as a result of--
   Mr. FURMAN. You look at a year like this and the deficit seems not 
quite as terrible as it would otherwise have been. It is $745 billion 
worse than what was projected in January 2001 in this year. 92 percent 
of that deterioration is due to policy changes made since 2001. So we 
have added about $650 billion to $700 billion to this year's deficit 
through policies. 
   Senator WHITEHOUSE. Has that the number grown since 2001? 
   Mr. FURMAN. That number has grown both in dollar terms and as a 
share of GDP. Now some of that was unforeseen contingencies, but a lot 
of it was a deliberate policy choice. 
   Senator WHITEHOUSE. I will followup with you more on that offline, 
but I appreciate that. 
   I would also be interested in hearing from each of you, we do not 
have much time for it right now, but even if you could just fire me a 
one-pager or pick something out of an article that you agree with. 
   I do not understand at all well what the impact of immigration is on 
our fiscal situation, and to what extent new arrivals create fiscal 
benefit early on and then cause it--I assume that there is a profile of 
some kind that is the immigration effect on our fiscal situation. And I 
just would like to understand that a little bit better, if you can make 
it relatively simple. If you give me a 200 page thesis, I am not going 
to get through it. But if you can keep it simple, I will get through 
it. 
   Thanks very much. Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator. 
   I would like to go back. I had asked Mr. Bixby and Dr. Minarik a 
question and I want to continue with Dr. Furman and Dr. Butler. 
   Is there a way of getting more revenue without a tax increase? What 
is your judgment on that? Without a rate increase, Dr. Furman? 
   Mr. FURMAN. I think that for anyone who thinks that both revenues 
and spending needs to be part of the solution, and I count myself in 
that group, it is incumbent on them to make sure that the revenue 
increases are as economically efficient as they possibly could be. 
   I agree with everything that Mr. Bixby and Dr. Minarik said, so I am 
not going to repeat them. Let me illustrate one of Dr. Minarik's points 
which was the President's Tax Reform Commission on the mortgage 
interest and the change they made there. 
   They did the worst selling job for a decent idea that I have ever 
seen. Everyone knows that their proposal was to curb the mortgage 
interest deduction. I do not think that anyone knows that 20 million 
middle-class Americans would have gotten a mortgage interest tax break 
under that proposal who do not get it today. 
   Chairman CONRAD. How is that? 
   Mr. FURMAN. They were converting the deduction to a 15 percent tax 
credit that was available to everyone. Right now 50 percent of 
middle-class Americans who have mortgage interest on their homes do not 
get any benefit from the existing deduction. So they were expanding it 
to 20 million new people. 
   Chairman CONRAD. Why aren't they getting the benefit of the 
deduction? 
   Mr. FURMAN. Because they take the standard deduction. 
   Chairman CONRAD. They probably do not even know they are not getting 
the benefit. 
   Mr. FURMAN. Some of them might be making a mistake. Many of them do 
not have enough mortgage interest, so they are making the right choice. 
So the panel went out and, to some degree, sold this as curbing it from 
a deduction to 15 percent and curbing the size of the mortgage. They 
did not go out and say, we could make this thing work a lot better, 
could make it a lot more progressive. We could give a tax cut to 20 
million families that do not get one today to encourage home ownership, 
and in the process make the tax system more efficient and save money. 
I think some of these things are a matter of packaging things in the 
right way, especially when you do the deductions to credits. You can 
make it more efficient, more fair, have a lot of middle-class winners, 
and still, if you curb it at the top end, save money and improve the 
base--
   Chairman CONRAD. How would the 15 percent credit apply? 
   Mr. FURMAN. In their proposal you would just take whatever mortgage 
interest you had on a mortgage up to a certain amount--$227,000 to 
$412,000 depending on the county. You would just multiply your mortgage 
interest by 0.15 and subtract that number from your taxes. 
   The way it works right now is in effect you take your mortgage 
interest and multiply it by your marginal rate, which might be 0.15 or 
it might be 0.35, if you are more fortunate. 
   So an idea like that, I think, if sold and packaged in a different 
way, as I said, I think could both be good economic policy and good 
politics. 
   Two others proposals to add to the list are international taxation 
and pigovian taxation. Our international tax system is completely 
broken. This is not what I am recommending, but as a thought 
experiment, if we completely eliminated all taxation of foreign 
companies on the profits they make overseas, would not have to pay any 
more taxes on their profits overseas, but also said they could not 
deduct the cost of doing business overseas from their American taxes, 
we would actually raise taxes rather than lower them by about $11 
billion a year. International tax system serves to lower tax revenues 
rather than raise them. There is a lot of different ways to correct 
that. It gets very complicated, but it is a good area. 
   Finally, what economists call Pigovian taxes, taxes that correct 
externalities, are a way to improve economic efficiency and raise 
revenues. The carbon tax would be the main example. You would want to 
protect people. You might even want to make it a revenue neutral, 
distribution neutral tax reform, but that is something most economists 
would review as enhancing economic efficiency. 
   Chairman CONRAD. Dr. Butler? 
   Mr. BUTLER. Thank you. 
   When I look at revenues, as I suggested in my opening remarks, my 
concern is the level of taxes as a proportion of our Nation's output. I 
come from Europe. I have seen very high tax systems. Under current law 
we will move forward to higher and higher proportions in tax. I think 
that has to be readily understood, as opposed to changes in the 
baseline revenues. 
   When one of Joe Minarik's granddaughters gets to their middle year 
earnings, they will paying a burden about a third higher today as a 
proportion of the national paycheck. So I just want to make that point. 
When one looks, however, at the issue of revenues, to some extent this 
is a language question. Sometimes the language is important to look at 
in terms of what one can do. Dr. Furman and I both support the idea of 
changing a current tax expenditure, the exclusion for company-provided 
plans. The President wants to limit this and turn it into a different 
structure that would give much more help to lower income people and so 
on. I see that as a tax reform. 
   But it would have the effect of reducing some of the pressures on 
the Government in the Medicaid program and DSH programs and so on to 
subsidize treatment for people, because they would have their own 
resources. So one can look at that as a reduction-- 
   Chairman CONRAD. There would be some tradeoff there. 
   Mr. BUTLER. Yes, you could call it a revenue increase, of course, if 
you are only looking at one piece of it. But you can look at it as a 
reform, and in fact a neutral revenue reform, if you look at the whole 
picture. 
   Then also look at what I said with regard to benefits. I said let us 
look at clawing back some of the benefits for people who are higher 
income. If you do that--
   Chairman CONRAD. Is this directed at Senator Gregg? 
   Mr. BUTLER. By clawing back some of those benefits, if you do it 
through the tax system some people would argue that is a tax increase. 
I would argue it is a benefit reduction. Some of this is semantics. 
If the dollars stay in Washington then we often think of it as a 
reduction in spending. If we send the same dollars out and then ask for 
some of them back, we call it a tax increase. And yet there is no 
difference between the two. 
   So I think there is a lot of areas where a lot of this is semantical 
on where reform and what is a benefit reduction as a tax increase. 
   I think there is enough wiggle room there, quite frankly, to look at 
a political strategy that could make everybody feel that they are, in 
fact, winning in terms of moving forward. 
   I think that is the way to look at it. I think the wrong way to look 
at it is to say raising taxes is just a bookkeeping exercise. We just 
simply keep raising taxes because that has to be one side of the 
equation and ignore what has happened in Europe where we have reached a 
tipping point in the 1970's and 1980's where that level just got so 
high that we saw all of the downsides associated with it. 
   That is why countries like Ireland and others are actually moving to 
reduce taxes as a way of stimulating growth and improving their ability 
to pay for needed services. 
   Chairman CONRAD. Let me just say I do not disagree with you on the 
concern that you have indicated that we approach European levels of 
taxation. We went through this in one of our earlier hearings. We look 
at total tax burden in the United States. We are at about 26 percent of 
GDP, that is Federal, State and local. We look at Europe, they are 
approaching 50 percent of GDP, depending on the country. I think 
Germany is 36, but the Scandinavian countries are in the high 40's. If 
I recall, Denmark--I am part Danish--49 percent. 
   And yet some of these countries have higher rates of economic growth 
than we do. Why is that? 
   Mr. BUTLER. I think the first point is that you have to look at it 
broadly and say there is a concern about the level of taxation and to 
investigate the differences between different countries. There are 
different labor markets in different countries. In Europe there are 
other patterns, including the way taxes are levied. There is all kinds 
of factors. 
   But the underlying point that I was really trying to make is that we 
must be concerned about the level of taxation. It is rising in this 
country and it is rising toward these European levels. And therefore 
let us look at what the potential consequences are. 
   You look at some of the Scandinavian countries, and I think the 
argument is that their best days are over. That if you look at the 
long-haul--
   Chairman CONRAD. Do not tell my friends in Denmark or Norway that 
their best days are over. They do not see it that way. They are very 
confident about their future. 
   Mr. BUTLER. Well, in some other countries, I suspect they may feel 
that their best days are over. 
   But still, the point I am trying to get at, I think you accept-- 
   Chairman CONRAD. It is a legitimate point and actually a point I 
agree with. Senator Gregg and I, we may have a difference about where 
that balance point is but we share the concern. One of the reasons we 
have to deal with these long-term imbalances is we are headed for 
either tax increases that will damage our economy or benefit cuts at 
some point that become so draconian that it has a very adverse effect 
on the people we represent. 
   So how one reaches a balance here is an enormous challenge. 
   Senator GREGG. 
   Senator GREGG. I agree with that. 
   I asked both General Walker and Chairman Bernanke what percentage of 
GDP would be appropriate for the Government to take. Because I think 
when you take this down to its most basic equation, it is getting the 
revenues to meet the liabilities. And we know we are going to have 
these liabilities that are fairly significant because we are going to 
double the retired population. And we can obviously address benefits, 
and we are going to have to. And has been pointed out, probably the 
benefit side should be where the majority of the effort is made. 
   But we also know revenues are going to have to go up if you are 
going to maintain a stable economy and a productive economy because of 
the simple fact that you are going to have this huge generation that 
has to be paid for. 
   And the question becomes quite honestly, in my humble opinion, at 
what number do you raise revenue so high that you start to create a 
down cycle, where productivity falls off, where capacity for creativity 
falls off, where entrepreneurship falls off, where the creation of jobs 
fall off because people simply have a tax burden that they are not 
willing to undertake? Or the underground economy grows so fast that you 
are not generating revenues. 
   And it is that number at which basically you can afford a benefit 
structure. That will drive the process. 
   Neither Chairman Bernanke nor General Walker would subscribe to 
giving me a number. Historically, we know that 18.2 percent of GDP is 
what we were taking in revenues and we are now over that at 18.5 
percent, and we are headed up. Historically, spending has been around 
20 percent and the difference has been our structural deficit. Now 
spending is going to start to go up in the post-2015 period. 
   The question is do any of you have a number that, in your considered 
opinion, is reasonable relative to the percentage of GDP that can go 
into the government and still have the country be viable and strong 
economically? 
   Mr. BUTLER. I would say that once you go over 20 percent, you are 
getting into very risky territory. Of course, it does depend, I think 
we would all agree--
   Senator GREGG. You are talking Federal Government? 
   Mr. BUTLER. Yes. And so therefore, that would mean total Government 
in the United States-- 
   Senator GREGG. Would be around 30 percent. 
   Mr. BUTLER. Around 30 percent, which is getting into dangerous 
territory. Of course, it also depends how you levy that tax, which we 
all have to emphasize. 
   But I think also it is important to think about, when you say what 
is necessary for benefits, that there are all kinds of ways of enabling 
people to insulate themselves against the costs of bad developments in 
say health or retirement. We would all encourage the notion of 
encouraging greater savings during working lives. So that would reduce 
the need for Government to give such extensive comprehensive benefits. 
   I think other steps are possible in the health area. I work a lot in 
the health care area, and there are all kinds of steps you can take to 
reduce the probability that people will need high cost programs. 
   So I think it is very important not to think of this commitment on 
the benefit side as somehow a given, and we just have to figure out a 
way for paying for. There is a connection between all of these. 
   Senator GREGG. No, I am not suggesting it is a given. 
   Mr. BUTLER. I know you are not, but I think some people do. 
   Senator GREGG. I am simply asking a question of what percentage of 
GDP. 
   Does anybody else have an opinion on GDP burden of tax? 
   Mr. FURMAN. My only observation would just be from our recent 
history. In the 1990's the top part marginal rate, for example, was 
39.6 percent. Senator GREGG. I am not talking about rate. I am talking 
about--
   Mr. FURMAN. I understand. And tax rates were such that you would 
collect 2 percent of GDP more than what we are collecting today. I am 
not saying we should go back to exactly the tax structure we had in 
the 1990's, but that tax structure, which would be about 2 percent of 
GDP higher than we are right now, was clearly compatible with a very 
successful economy. 
   Senator GREGG. I would have to debate that a little bit because we 
had the Internet bubble, which was the most unique bubble in the 
history of the world and generated a huge amount of paper gain that did 
 not exist, which generated a huge amount of revenues to us which I do 
not see us getting again no matter what rate we had. 
   But the question is is 22 percent, which is what during that 
Internet bubble 22 percent of revenue? We got to, I think, 21 percent 
of the gross national product being Federal revenues. 
   Mr. FURMAN. It also fluctuates because of the economy. In a good 
year the economy should collect more. That is part of why it is 
disappointing that we are so low, so close to average this year when 
the macro economy is doing so well. It should go up as a share of GDP 
in a good year and down in a bad year. 
   Mr. MINARIK. Senator Gregg, Jason mentioned earlier, I think, an 
important point which is for whatever level of revenues you are going 
to collect you want to collect them in the most efficient way possible. 
The percentage of GDP that we take out of the economy in total could be 
done any number of different ways. There are more efficient ways and 
less efficient ways. 
   We just said goodbye to Richard Musgrave, who was the dean of the 
public finance discipline within economics. One point that he made in 
his textbook, his monumental textbook on the subject, was you can 
perhaps collect more revenues in total with lower distortions by using 
several different mechanisms to collect the revenues rather than 
loading them all on just one. 
   So some would argue, for example, I did not get to talk about it, 
but the Committee for Economic Development has suggested that we need a 
supplemental value added tax to try to raise more revenue at the 
Federal level with lower total distortions. One could argue that you 
might be able to raise somewhat more revenue with a value added tax, in 
addition to an income tax, than attempting to raise the same amount of 
revenues out of that income tax. That is one possible argument. 
   Senator GREGG. We had testimony last week where somebody, I have 
forgotten who it was, said that the value added tax had as poor a level 
of collection or even a worse level of collection in Europe that the 
income tax has, as far as avoidance. 
   Mr. MINARIK. That point has been debated. There are problems of 
collection with any tax. One argument that has been raised, you can go 
on two sides of this particular argument. One is that if you have the 
States collecting a sales tax and the Federal Government collecting a 
value added tax, the collection efforts at the two levels of Government 
will actually have synergies and they can both be more effective. Some 
others argue that you have a clash between the revenue needs at the 
State level and the revenue needs at the Federal level. That would cut 
the other way. 
   Clearly any tax has issues of collection. Our income tax has issues 
of collection. We have all sorts of issues of reporting. We have issues 
at the border. So nothing is going to be easy. 
   Senator GREGG. That is true, and I guess my own personal experience, 
being from New Hampshire, which is surrounded by States with both a 
sales and an income tax and we have neither, is that most of the States 
that have moved to a sales tax have done so with a representation to 
their citizenry that the income tax would be cut or reduced. And after 
about three or 4 years of stable income taxes, their income taxes start 
to go back up, even though they have a sales tax added. 
   But the first thing I was taught when I arrived here, by one of most 
brilliant people I ever served with, Barber Conable, was that all 
Government moves to the left. The issue is how. If you think of it as a 
railroad train, the question is how many engines do you have on the 
train and how fast is it going to go? And the number of revenue 
collection mechanisms you have defines the number of engines. 
   But that is a debate for another time. 
   I would ask one last question. You said you wanted a 3 percent 
retirement savings vehicle on top. Was that on top of the payroll tax? 
   Mr. MINARIK. That is correct, Senator. 
   Senator GREGG. Where you would have a 15 percent payroll tax 
essentially, or 15 percent withholding and 3 percent of it would go 
into a savings account? 
   Mr. MINARIK. The payroll tax would remain as it is today. 
   Senator GREGG. Thank you. I appreciate that. 
   Chairman CONRAD. Let me go back, in my final round of questioning, 
to this question of reform. Dr. Butler, we have sort of begun that 
conversation. I would like to include everybody. 
   Any proposals on tax reform? Dr. Minarik, I was very interested in 
what you were just discussing. Dr. Butler, you were hearing what Dr. 
Minarik was discussing there in terms of diversifying our tax base and 
basically having an income tax that would be supplemented by a value 
added tax. Does that make any sense to you? 
   Mr. BUTLER. I do not support a value added tax, because of the 
reason that Senator Gregg pointed out. Those who argue it should be a 
replacement and a more efficient way of raising taxes ignore that we 
always seem to end up with both. That was certainly the case in Europe. 
I think that there is also other issues associated with the value added 
tax in terms of its implementation, and its regressivity. It then also 
means that tax costs have to be factored into services of government. 
Costs of various services that people are paid for by government. It is 
a complicated way of doing it. 
   I actually favor much a reform toward a more standard expenditure 
tax through the income tax system, with lower rates, a much wider base 
of taxation, and elimination of double taxation. But through the income 
tax itself. I think it is a way--
   Chairman CONRAD. Could you describe that a little more fully? 
   Mr. BUTLER. Just very simply that we would take steps to make 
taxable, many of the items that are currently tax free fringe benefits, 
such as the tax exclusion for company-based health plans. 
   Chairman CONRAD. Broadening the base. 
   Mr. BUTLER. Broaden the base and lower the rates, which I think will 
be much more efficient. 
   Chairman CONRAD. Better in terms of the economic effect. 
   Mr. BUTLER. Yes, but I within that structure, as opposed to a value 
added tax system, it is much easier to say people below a certain 
income will face a lower burden. And it is much easier to do that 
through an income tax system than to say people are paying all that 
heavy value added tax so we will have to try to figure out some way of 
giving them a credit against the taxes they paid. Well, how much tax 
did they pay? And so on. So I think an income tax based system, if 
reformed, is in my opinion much more economically efficient, easier to 
administer, and fairer than something that has these different forms of 
taxation that you are trying to link together and somehow make sure 
that any one individual in different situations is treated equitably. I 
think it is much harder to do that. 
   Chairman CONRAD. Dr. Furman? 
   Mr. FURMAN. Your question is to talk about a VAT? 
   Chairman CONRAD. I am really interested in the what Dr. Minarik 
started the discussion. Dr. Butler had talked about reform proposals. 
Does it make sense to you to have a VAT as a supplement to an income 
tax? What are the things we should be thinking about? 
   As you know, there are a lot of discussions swirling around here 
about how we deal on both the revenue side and the spending side of 
this equation. But on the revenue side for the moment, reform ideas 
that you would have. 
   Mr. FURMAN. To comment on the VAT, it is something that I think is 
worthy of serious consideration. My recommendation is if we decided to 
do a VAT to raise revenues it would not make sense to do a small one, 
say a 3 or a 5 percent VAT on top of the existing income tax because 
you would get an additional layer of complexity associated with the VAT 
and the paperwork and you would still have all of the same complexity 
in the income tax system. 
   If you go down that route, I think you should do, a bigger VAT and 
take a lot of people off of the income tax, with appropriate credits on 
that side. So that when you are adding this new system, you are greatly 
simplifying the old system for a lot of people. 
   Chairman CONRAD. One of the ideas that is being discussed is 
something along those lines, where you would take off a significant 
majority of people from the income tax system altogether. They would 
not have to file tax returns anymore. 
   Mr. FURMAN. This is a proposal Michael Graetz at Yale has made. 
There are a lot of things to be worked out in that proposal because a 
lot of low-income families are getting the Earned Income Tax Credit and 
the Refundable Child Tax Credit. I do not think his proposal has worked 
them out, so I would not recommend going down that route. 
   A good general principle is that we should take advantage of the 
introduction of a new tax, if that is what you are doing, to simplify 
the old tax system. One of the ways of simplifying it would be taking 
more people off of it. 
   That would be my thoughts on a VAT. And then more broadly, we should 
think about tax expenditures and the conversion from deductions to 
credits, the reform of the international tax system, efficient Pigovian 
taxes, and something we have not gotten into at all, which is that our 
business tax system as a whole is very much broken. We keep adding 
things that make it so that you do not need to pay taxes on income at 
any level of the system. Even in a consumption tax. If that is what you 
believed in, you would not have interest being deductible for companies 
in the way that it is today. 
   We have a really incoherent system that supporters of an income tax 
or a consumption tax would reject in the context of business taxation. 
And that is another area that is very important. 
   Chairman CONRAD. If we had following goals: we need to raise the 
revenue that we need to meet the needs of a reformed entitlement 
system, and by reformed I mean obviously we have to save serious money 
there. At the same time, we wanted to simplify the tax system. We have 
had a lot of estimates given to the committee of how much is being 
spent for people to comply with the current income tax system. If we 
wanted to simplify, if we wanted to make it as economically efficient 
as possible, that is we wanted to put America in the strongest position 
we could be in competitively in terms of our tax system, what would you 
advocate as a tax system? 
   The current one, reformed by reducing the base? A VAT? Some other 
reproach? I would be interested in each of your--Dr. Butler, thoughts 
that you might have on this. 
   Mr. BUTLER. As I said, assuming you wanted to raise revenue, than 
taking that as an assumption I think a much simpler form of the income 
tax with a broad base, reducing incidences of double taxation as far as 
possible, factoring in all forms of compensation, and then giving 
appropriate exemptions or partial exemptions to people who really need 
it in order to obtain adequate income would be the right way to go. I 
think that is simpler. I am very concerned about these notions of value 
added taxes and other taxes which I think are complex. They only try to 
approximate what you can get from a much flatter broader income tax. 
But these other approaches have, I think, endless problems associated 
with them. 
   Chairman CONRAD. All right, Dr. Furman. 
   Mr. FURMAN. Sure, and before I sketch that, we have been talking 
about making the tax system more efficient. I think that is very 
important. But I would also say if you had to, for example, raise the 
top rate back to 39.6 percent, that is completely compatible with a 
thriving economy. Steps like that, if you are not able to undertake a 
more comprehensive tax reform, would raise more revenue and be good for 
the economy in the long run because they would bring the deficit down. 
In terms of a tax reform, I guess a lot of us are in agreement here 
that you take our existing income tax system and broaden the tax base. 
I agree with Dr. Butler that you do not want to double tax business 
income, but we have an awful lot of business income that is not being 
taxed at all right now. 
   Chairman CONRAD. Why is that? 
   Mr. FURMAN. For a number of reasons, but basically companies get to 
deduct their interest and then pay out a lot of their profits in the 
form of dividends which are taxed at very low rates or not taxed for 
people who have tax preferred accounts. That is one type of reason. 
Another would be a whole bunch of loopholes built into the corporate 
tax system. 
   The fundamental reason is that we have something that is half a 
consumption tax, half an income tax, and they are a very incoherent 
hybrid that I do not think any economist would want to defend or 
explain even. 
   Broadening the base in the personal income tax, reforming the 
taxation of business income and the international tax component plays 
an increasingly important role in that. Then, to the degree that you 
are adding new taxes, add ones that we think are simple and 
economically efficient. So with carbon taxes, possibly think about a 
value added tax if you can use it to simplify the income tax. 
   Chairman CONRAD. Dr. Minarik? 
   Mr. MINARIK. I have stored up a couple of observations that I think 
are pertinent to this. 
   Going back to Senator Gregg's original question, and you are asking 
about revenue sufficiency, what percentage of GDP can we collect 
without adverse economic consequences? I guess one answer to that 
question is some meaningful margin less than the next guy. And if you 
think in those terms, the U.S. public sector is significantly smaller 
than anywhere else around the world. So we have some room to maneuver. 
   Chairman CONRAD. Other than Japan, I might say. 
   Mr. MINARIK. Japan is the closest. They, of course, have no national 
defense sector to speak of, so that is one reason why there is a 
difference there. But beyond Japan, you--
   Chairman CONRAD. That is about it. 
   Mr. MINARIK. That is about it. And of course, if you want to trade 
the U.S. economy for the Japanese economy right now--I will take the 
other side of that deal. 
   That was one question that was pertinent. Again, in thinking about 
how much revenue we need, Senator Gregg's observation was well, 
Government expands to fill the taxes you have. It is 2007. Senator 
Gregg's assertion would imply that we would have balanced budgets most 
of the time. In the last 50 years, we have had four balanced budgets. 
So nine times out of 10 we have been spending beyond the revenues we 
have. 
   So the notion that having revenue sufficient to pay for the 
Government that you have right now is going to encourage higher 
spending, I think suggests that really the Congress and the 
administration just have to do their jobs to keep things within the 
limits. 
   Stuart suggested the notion of what he called a reformed income tax, 
which I think is what many people would call a consumed income tax. 
There was an example of an attempt at that a number of years ago, the 
so-called Nunn-Domenici proposal, which was formulated under the aegis 
of the Center for Strategic and International Studies here in town. 
Senator Nunn and Senator Domenici worked together on it. 
   One of their chief technical advisors was Rudy Penner of the Urban 
Institute. If you ask him about that experience, he will tell you that 
he went into it as an enthusiastic supporter of the notion of a 
consumed income tax. He finished it with the notion that there was no 
way that was ever going to happen. 
   There are a lot of technical issues involved there, including but 
not limited to the question of how you try to accommodate everyone who 
under the current system has some kind of a tax break and is going to 
want it to be translated into the new system. 
   You can look at just about any possible tax, come up with a pristine 
version of it that will look attractive, and then try to make it real 
and run into a lot of problems. 
   Just to be a little bit more complete about what CED discussed in 
its document which was released early last year, we did advocate 
broadening the base of the income tax while reducing the rates that 
would be imposed. A 10-percent value added tax, Jason is exactly right, 
your administrative ante to have a value added tax is the same whether 
the rate is 1 percent or 10 percent, you might as well get some money 
out of it. 
   Stuart is correct, that it is not easy to provide low income relief 
to compensate for the value added tax that you are collecting. That is 
simply a problem that we have to accept. For 30-some years now we have 
had an Earned Income Tax Credit. One side observation, we created it in 
part as a substitute for increasing the minimum wage. That notion was 
we wanted to make work pay for people with low incomes. We did not want 
to impose that on their employers. We thought that would be 
economically disruptive. So we created an Earned Income Credit. Nothing 
is free. You have to pay for that to make it work. But that, I think, 
is acknowledged. It has to be a problem but it is a necessary 
ingredient if you want to have that kind of benefit. 
   Personally, I think that we are getting to the borderline where it 
will be very hard to raise under the income tax the revenues that we 
will need with demographic change, even assuming that we can freeze in 
its tracks the rate of health care cost per beneficiary under Medicare. 
Health care costs through the economy are growing 2.5 percentage points 
per year faster than GDP. So that is going to be a problem. 
   We are going to need more revenue. We will have to decide whether we 
can get that revenue out of our existing institutions. If we are going 
to do that, we have to increase their efficiency substantially. If not, 
we are going to have to look somewhere else. A value added tax is one 
possibility. A carbon tax is another possibility. 
   One other footnote and I will close, either a value added tax or a 
carbon tax might look regressive and would be regressive taken on its 
own. If revenues from either of those taxes were devoted to financing 
a reformed health care system which would provide universal coverage, 
the combination of a health care benefit and one of those regressive 
taxes for low income people would probably, in the final analysis, look 
much more progressive because you would be removing that burden of 
paying a health insurance premium. 
   Health insurance premiums are virtually the same per person or per 
family up and down the income scale. A person with a very high income 
would pay much more in value added tax than the value of the health 
insurance premium he is getting. A person with a low income, it would 
be the reverse. So put those two together and you might be able to get 
a progress result out of what would look like a regressive tax. 
   Chairman CONRAD. Let me just say, one of the things that we have had 
testimony before the committee on tax scams that are occurring, 
especially offshore. In the tax gap hearing one of the recommendations, 
a very strong recommendation, that came from that panel is that you 
need to have international reporting because all countries are 
suffering from--I held up a picture of a building in the Cayman Islands, 
a five-story building, that is the home to over 12,000 companies. It is 
a very efficient building. 
   They all say they are doing business there. They are not doing 
business there. They are engaged in tax scams there. What they are 
doing is showing profits in subsidiaries located there because they do 
not face taxes and they are shorting all of the other countries and, in 
effect, shorting other companies. Because other companies that are 
domiciled here do not engage in that kind of scam. 
   How about reform in an area like that? I assume that nobody would 
object to closing off that kind of taking advantage of the system. Mr. 
Bixby, does your group have a position on that? 
   Mr. BIXBY. It is not an area that we have looked at very closely but 
nobody could have any objection to closing down tax scams, and I think 
they certainly--the IRS has been relatively aggressive in that area 
recently but clearly there is more work to be done. I certainly think 
that that is an area that you could get into and there would probably 
be a great deal of public support for it as well. 
   But I think getting into a real tax reform initiative would be a 
good thing to do in the context of looking at these challenges. And you 
have the vehicle. Aside from what you mentioned, we have the AMT issue 
out there which is really the big driver for a tax reform debate 
because it is so big and there is a broad bipartisan consensus that it 
needs to be addressed, that I think it really could be the engine that 
drives a major tax reform initiative like we had in the 1980's. 
   And you can get into these issues about the tax gap. You can get 
into the issues about the tax scams. You can also get into the issues 
about closing these major tax expenditures that people do not even 
necessarily realize our--I like to call them tax entitlements because 
that is really what they are. But they ought to be on the table. 
   And the President has put one the major ones on the table. So you 
sort of take that in combination with the upcoming AMT debate and it 
does provide an opportunity. 
   I would agree with Jason and others that if you are looking for a 
new forum and do not want to raise rates right now, the carbon tax 
idea, or raising the gas tax, I know that is not popular. But 
environmentally friendly taxation is another way that you might be able 
to get into a revenue debate that has ancillary good effects for the 
long-term of the environment. 
   To top it off, no pun intended, I would endorse Jason's idea also of 
imposing a top rate. A lot of the revenue boost that we are getting 
right now seems to be coming from upper income, more income being into 
the upper range. 
   I think reimposing a higher, slightly higher, or going back to the 
1990's top rate, would bring in some needed revenues. I cannot imagine 
it would do too much to damage the economy. But that is not tax reform. 
That is just a good old fashioned tax increase. 
   But I think the more opportunity areas are to really get into the 
tax expenditure debate, the tax gap issue, and the possibly of 
environmentally friendly taxes. 
   Chairman CONRAD. All right. Anybody with a closing thought? Anybody 
that wants to have something that they wanted to contribute that we 
have not had a chance to get on the table? Dr. Minarik? 
   Mr. MINARIK. Just one thought, Mr. Chairman. To a certain extent 
when we think about taxes in this connection, realistically speaking, 
and I went into this in my written statement but did not get there, you 
can tax me now or you can tax me later. But one time or another you are 
going to do it. 
   If you do not do what you have to do to keep budget deficits under 
control and ideally run surpluses for a while before the retirement of 
the baby boom starts, if you pay the taxes later, you are going to pay 
them with interest. So you might as well stay current if you can do 
that. 
   Another observation, thinking about interest, you hear a lot of 
people say that they are suspicious of Government because they feel 
like they pay taxes and they do not get anything in return. Well, if 
you are paying taxes to pay interest on the debt, that is literally 
true. You are not getting anything in return. 
   And the longer you allow deficits to run, the larger your deficits 
get, the more taxes our succeeding generations are going to have to pay 
just to keep the Acme Collection Agency from backing up the truck to 
the White House to collect the furniture. That is an important, I 
think, piece of reality that we have to keep in mind. 
   Chairman CONRAD. Dr. Butler. 
   Mr. BUTLER. I would just like to add that we have not actually spent 
any time talking about the budget process itself, in terms of how to 
force action on these issues. I suppose this is almost a question to 
you, actually. 
   I want to stress of the importance that I feel, and I think all of 
us probably feel, of disclosure of the full scale of the unfunded 
obligations of the Federal Government. It is something, of course, that 
Comptroller Walker is very concerned about, as we are, and supports 
taking active steps to do that. 
   And also the notion of saying that the entitlement spending should 
not just be on automatic pilot but should be budgeted in a serious way 
to force serious discussions about the relative balance of expenditures 
in that area, expenditures in other parts of the Federal Government, 
 and revenues. That it should be done in an explicit way rather, as I 
pointed out in my testimony--
   Chairman CONRAD. Indirect. 
   Mr. BUTLER. Automatic preemption of some big chunks of spending is 
the problem we are talking about, which we do have to look at and 
consider. Yet every day we are trying to find ways of paying for our 
troops in Iraq. 
   Mr. BIXBY. I just would want to emphasize something that I mentioned 
at the beginning and Dr. Butler mentioned it as well, which is I think 
this is an issue that really needs more public attention, and of course 
you   are doing everything you can on the committee to draw attention 
to it with this series of hearings. But a major public education, 
public engagement effort is needed on this. We are doing this Fiscal 
Wake-Up Tour, all of us. Jason has not been out on the tour yet, but he 
has volunteered for it and the rest of us have been out on this. 
   I would invite members of the committee to join us in their home 
States and maybe do some home and home series, as what I have thought 
about. Maybe a Republican, say for example Senator Gregg, and yourself, 
cosponsoring one in North Dakota and one in New Hampshire and drawing 
some public attention to this issue. 
   What we find on the Fiscal Wake-Up Tour is that people love to hear 
a discussion like we have had today, people exchanging ideas, not name 
calling, not pointing fingers at one another or casting blame, but 
talking about a problem, agreeing on the size of the problem, agreeing 
that there are no easy options and sort of debating what the tradeoffs 
are. Facing the magnitude of the problem and the nature of the 
tradeoffs and getting everybody to understand that is really, really 
important. That is what we try to do in the Fiscal Wake-Up Tour and it 
has been getting some attention. 
   Anything that we can do--because we think we are helping you. This is 
helping you and Senator Gregg and all of the members of the committee 
explain the problem to the public and perhaps to some of your 
colleagues. 
   Chairman CONRAD. Let me just say, obviously if the public does not 
understand, there is going to be no sense of urgency and no pressure on 
our colleagues or the White House to act. I think everybody in this 
room knows, certainly everybody on this panel knows, this is a 
situation that is unsustainable. It just is. And the faster we deal 
with it the better, the less draconian, the solutions will have to be. 
   It is extremely difficult to get a sense of urgency when the roof is 
not caving in. You have relatively good economic news, deficits are 
going down somewhat. Of course, nobody mentions the debt is going up. 
It is very hard, and I guess it is deep in human nature, to put off 
making unpleasant choices when there is no crisis. 
   The problem is by waiting, by failing to act, we make the crisis to 
come worse. That has been the overwhelming testimony before this 
committee. It is as clear as a bell. I do not care what projection you 
use. Anybody who thinks this is a matter of projections, fundamentally 
it is not. Because the baby boom generation is not a protection. They 
have been born. They are alive today. They are going to retire. They 
are going to start retiring soon. 
   And it fundamentally changes what we have had as an experience in 
the past. I think that is one reason it is very hard for our colleagues 
to get their minds around this. It is different than past experience. 
   And so I think an awful lot of people are kind of hoping against 
hope this goes away. It is not going to go away. You can say when is it 
going to really start crimping? You can debate that. But the fact is we 
are on an unsustainable course. 
   You have helped us, I hope, make that more plain today. And for that 
we are very grateful. I thank this panel and we will stand in 
adjournment. 
   [Whereupon, at 11:52 a.m., the committee was adjourned.] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]











                                               S. HRG. 110-162, Vol. II 

                      CONCURRENT RESOLUTION ON THE BUDGET 
                               FOR FISCAL YEAR 2008 
=======================================================================

                                    HEARINGS
 
                                   BEFORE THE 

                             COMMITTEE ON THE BUDGET 

                               UNITED STATES SENATE

                         
                              ONE HUNDRED TENTH CONGRESS 
                                      FIRST SESSION 
                                        ---------

           February 1, 2007-THE CURRENT ACCOUNT DEFICIT AND THE U.S. 

                                   FOREIGN DEBT
 

                             February 6, 2007-WAR COSTS
 

             February 7, 2007-THE PRESIDENT'S FISCAL YEAR 2008 BUDGET 

                                      PROPOSAL
 

           February 8, 2007-THE PRESIDENT'S FISCAL YEAR 2008 BUDGET 
                                  AND REVENUE PROPOSALS 

           February 13, 2007-THE PRESIDENT'S FISCAL YEAR 2008 BUDGETARY 
             PROPOSALS FOR THE DEPARTMENT OF HEALTH AND HUMAN SERVICES 

           February 14, 2007-THE PRESIDENT'S FISCAL YEAR 2008 BUDGET 

                              PROPOSALS ON TAX COMPLIANCE
 

           March 1, 2007-THE PRESIDENT'S DEFENSE BUDGET REQUEST FOR 

                            FISCAL YEAR 2008 AND WAR COSTS
 

                                    ------- 
                     U.S. GOVERNMENT PRINTING OFFICE 
34-649 PDF                 WASHINGTON DC:  2007 
---------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing 
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DC area (202) 512-1800  Fax: (202) 512-2104 Mail Stop IDCC, 
Washington, DC 20402-0001 



                         







                           COMMITTEE ON THE BUDGET 


                          KENT CONRAD, North Dakota, Chairman
 

PATTY MURRAY, Washington              JUDD GREGG, New Hampshire 
RON WYDEN, Oregon                     PETE V. DOMENICI, New Mexico 
RUSSELL D. FEINGOLD, Wisconsin        CHARLES E. GRASSLEY, Iowa  
ROBERT C. BYRD, West Virginia         WAYNE ALLARD, Colorado 
BILL NELSON, Florida                  MICHAEL ENZI, Wyoming 
DEBBIE STABENOW, Michigan             JEFF SESSIONS, Alabama 
ROBERT MENENDEZ, New Jersey           JIM BUNNING, Kentucky 
FRANK R. LAUTENBERG, New Jersey       MIKE CRAPO, Idaho 
BENJAMIN L. CARDIN, Maryland          JOHN ENSIGN, Neveda 
BERNARD SANDERS, Vermont              JOHN CORNYN, Texas 
SHELDON WHITEHOUSE, Rhode Island      LINDSEY O. GRAHAM, South Carolina 

                  MARY ANN NAYLOR, Majority Staff Director
 
                       SCOTT B. GUDES, Staff Director
 












                               C O N T E N T S 
                                   -------- 
                                   HEARINGS 

                                                                   Page 
February 1, 2007--The Current Account Deficit and the 
  U.S. Foreign Debt ................................................. 1 
February 6, 2007--War Costs ........................................ 79 
February 7, 2007--The President's Fiscal Year 2008 
  Budget Proposal ................................................. 145 
February 8, 2007--The President's Fiscal Year 2008 Budget 
  and Revenue Proposals ........................................... 243 
February 13, 2007--The President's Fiscal Year 2008 Budgetary 
  Proposals for the Department of Health and Human Service ........ 297 
February 14, 2007--The President's Fiscal Year 2008 Budget 
Proposals on Tax Compliance ....................................... 363 
March 1, 2007--The President's Defense Budget Request for Fiscal 
  Year 2008 and War Costs ......................................... 441 

                          STATEMENTS BY COMMITTEE MEMBERS 

Chairman Conrad......................... 1, 79, 145, 243, 297, 363, 441
 
Ranking Member Gregg................... 63, 89, 191, 254, 307, 374, 451
 
Senator Allard .................................................... 160
 
Senator Bunning .............................................. 229, 348
 
Senator Enzi ...................................................... 205
 
Senator Feingold ............................................. 226, 346
 
Senator Grassley .................................................. 405
 

                                WITNESSES 

Adams, Gordon, Dr.; Fellow, Woodrow Wilson International Center 
  for Scholars................................................ 102, 107 
Bergsten, Fred C., Dr.; Director, Peterson Institute for 
  International Economics....................................... 15, 22 
Cline, William, Dr.; Senior Fellow, Peterson Institute for 
  International Economics....................................... 32, 36 
England, Gordon, Hon.; Deputy Secretary, 
  Department of Defense....................................... 453, 455 
Everson, Mark W., Hon.; Commissioner, Internal Revenue Service, 
  Department of the Treasury.................................. 376, 378 
Giambastiani, Edmund P., Jr., Adm.; Vice Chairman, Joint Chiefs 
  of Staff, Department of Defense ................................. 453 
Gilmore, Michael J.; Assistant Director for National Security, 
  Congressional Budget Office ................................ 117, 120 
Jonas, Tina, Ms.; Under Secretary of Defense (Comptroller) 
  Department of Defense ........................................... 453 
Kosiak, Steven M.; Vice President for Budget Studies, Center for 
  Strategic and Budgetary Assessments........................... 90, 93 
Leavitt, Mike, Hon.; Secretary, Department of Health and Human 
  Services ................................................... 309, 312 
Malpass, David R.; Chief Global Economist, 
  Bear Stearns ................................................. 44, 48 
Paulson, Henry M., Jr., Hon.; Secretary, 
  Department of the Treasury.................................. 261, 264 
Portman, Robert J., Hon.; Director, Office of Management and 
  Budget ..................................................... 162, 171
 


                                                                   Page 
                            QUESTIONS AND ANSWERS 

Questions and Answers.......................... 230, 292, 349, 432, 489
 

                  ADDITIONAL MATERIALS AND CHARTS SUBMITTED 


Testimony, charts, and graphics submitted ......................... 427
 









                     THE CURRENT ACCOUNT DEFICIT AND THE 
                              U.S. FOREIGN DEBT 
                                    ------ 
                            THURSDAY, FEBRUARY 1, 2007 

                                                   U.S. SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:06 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Cardin, Sanders, Whitehouse, and Gregg. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

               OPENING STATEMENT OF CHAIRMAN KENT CONRAD 
  Chairman CONRAD. I will bring the hearing to order. 
  Senator Gregg has indicated he has been called into another meeting 
momentarily, but he will be here shortly and other members are on their 
way, as well. 
   I had one of our colleagues who is on the committee come to me 
yesterday and said you know, we are just having kind of a crash landing 
here with the early days of the session. He said he had three hearings 
simultaneously this morning and wanted to know if we could defer ours. 
I said no, I do not think that will work. 
   That is happening to us, but other members will come as they are 
available from other hearings. 
   Given the backlog of work from the last Congress, usually we start 
out with a little more calm, but not this year. So it is what it is. 
   I want to particularly welcome our witnesses here today. Dr. Fred 
Bergsten is somebody who has testified before this committee before, 
and we are delighted to have him back, the Director of the Peterson 
Institute for International Economics; Dr. William Cline, Senior Fellow 
at the Peterson Institute; and David Malpass, Chief Global Economist at 
Bear Stearns. Welcome to you all. We deeply appreciate you taking your 
time, extremely valuable time, to come before this committee and help 
us try to make the case of the importance of dealing with these 
long-term fiscal imbalances. 
   As you know, Senator Gregg and I have been urging our colleagues to 
develop a process by which we would produce a plan, a bipartisan plan, 
to address these long-term fiscal imbalances. We believe it is very 
important. 
   Today's hearings focus on the danger of the twin deficits, that is 
the Federal budget deficit and the trade deficit. Both of these 
deficits pose a serious threat to our Nation's long-term economic 
security. 
   Although the U.S. trade deficit has fallen recently, we can still 
see that the trade deficit in 2006 will exceed $700 billion. 

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   At the same time, our annual budget deficits are contributing to the 
wall of debt that we now face. At the end of 2001, our gross Federal 
debt stood at $5.8 trillion. At the end of this year CBO tells us, the 
Congressional Budget Office, tells us it will be $9 trillion. And if we 
continue current policies, gross debt will reach over $12 trillion by 
2012. 

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   I might say this is at the worst possible time, right before the 
baby boom generation retires. 
   We are having a very difficult time. Let me be very frank, we are 
having a very difficult time persuading our colleagues and the 
Administration of the need for urgent action. In a way, I think people 
are being lulled to sleep by the somewhat modest reduction in the 
deficit. While the deficit has shown some relatively slight 
improvement, the debt continues to mount in a way that is really 
unfavorable over the long-term, especially in light of the demographics 
of the country. That is what I think we are having a hard time getting 
people to fully grasp. 
   This demographic tsunami that is coming at us is unlike what we have 
faced in the past, and so I think it is hard for people to get their 
minds around that. 
   Over the long term, we can see the Nation's gross debt will continue 
to explode if all the tax cuts that the President has supported are 
extended without offset. In fact, according to the Center on Budget and 
Policy Priorities, it will more than double our debt level as a share 
of GDP by 2050 if all of the tax cuts are extended without offsets. 
   This chart shows how the debt grows, in the case of the tax cuts 
expiring or being offset. That is the green part of this slide. That is 
what happens to the debt if the tax cuts expire or are offset. That is 
the green part of this. 

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   The red is what happens to additional debt if the tax cuts are 
extended without offset. As much as I would love to support every tax 
cut and every spending program, you know, as a politician there is 
nothing better than being for every tax cut and every spending program. 
The problem is we cannot continue to do this. We cannot continue to do 
this. 
   Let me go to the next slide, if we can. The result of all of this is 
we are becoming increasingly dependent on the kindness of strangers. We 
are building up foreign holdings of our debt at a dramatic rate. It 
took 42 presidents, all of the presidents pictured here, 224 years to 
run up $1 trillion of debt held externally. This president, on his own, 
has more than doubled that amount in 6 years. This is an absolutely 
unsustainable course. 


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   And here are the top foreign holders of our national debt. We owe 
Japan now more than $600 billion. We owe China more than $300 billion, 
the United Kingdom more than $200 billion, the oil exporters almost 
$100 billion. And my favorite, the Caribbean banking centers. We owe 
the Caribbean banking centers over $60 billion. 

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   We are now by far and away the world's largest borrower. In 2005, 
the United States was responsible for 65 percent of all world borrowing 
by countries, 10 times as much as the next largest borrower. We may be 
starting to see the ramifications of all of this debt. 

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   Last September the Wall Street Journal reported that the World 
Economic Forum downgraded the United States from the most competitive 
economy in the world to the sixth most competitive. They stated, 
''serial budget deficits in the United States have led to rising public 
debt, which means an increasing portion of Government spending goes 
toward debt service. That means less money is available for spending on 
infrastructure, schools or other investments that could boost 
productivity. Heavy Government borrowing, which means competing for 
money and financial markets with the private sector, also tends to 
drive up businesses' borrowing costs.'' 

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   In testimony before this committee last month the Chairman of the 
Federal Reserve, Chairman Bernanke, emphasized the dangers of this 
growing debt. He said ultimately this expansion of debt would spark a 
fiscal crisis which could be addressed only by very sharp spending cuts 
or tax increases or both. The effects on the U.S. economy, he said, 
would be severe. High rates of Government borrowing would drain funds 
away from private capital formation and thus slow the growth of real 
incomes and living standards over time. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Our increasing reliance on foreign debt poses an added threat to the 
economy. Here is what the head of the Government Accountability Office 
told this committee last month. ''When, not if--when--foreign investors 
decide as a matter of mere prudence and diversification they are not 
going to expose themselves as much to U.S. debt, then interest rates 
will rise, and that will start a compounding effect. And so what is 
important is that we act so that they do not take that step.'' 

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   We have already seen the potential impact on our economy from the 
investment decisions made by foreign holders of our debt. Here is a 
Financial Times article from last November on the value of the dollar 
falling after a comment from a Chinese bank official on the need for 
China to diversify its foreign exchange reserves. The paper stated, and 
I quote, ''The dollar was sent tumbling on Thursday after the Governor 
of the People's Bank of China said the country was considering lots of 
instruments to diversify its foreign exchange reserves.'' Just that 
comment sent the dollar down. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   I hope very much that colleagues are paying attention. In fact, the 
dollar's value is already down considerably, more than 30 percent 
against the euro, since 2002, at least in part from market fears about 
our increasing Federal indebtedness. We simply have to get hold of this 
trajectory on deficit and debt. There really is no alternative. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   We have now been warned in this committee by the head of the 
Government Accountability Office. We have been warned by the head of 
the Federal Reserve. We have been warned by the head of the 
Congressional Budget Office. We have been warned just yesterday by the 
former head of the Congressional Budget Office and by three other 
distinguished panelists, including the Concord Coalition which is known 
for their interest in fiscal responsibility. Warned by the Heritage 
Foundation, one of their top economists, that we are on a course that 
is unsustainable. Warned by the head of the Hamilton Project, which is 
overseen, of course, by former Secretary of the Treasury Bob Rubin. 
   We have been warned and warned and warned. The question is, is there 
a will to act? 
   I would submit the first thing we have to do is submit a budget that 
is balanced by 2012, and at the same time engage in a much larger 
effort, a bipartisan effort, to produce a proposal to address these 
long-term fiscal imbalances. That is where the real danger lies. 
   With that I want to call on the witnesses, and I again welcome you 
to the committee. I would ask you to proceed with your testimony. 
Dr. Bergsten, why don't we begin with you. 

               STATEMENT OF C. FRED BERGSTEN, DIRECTOR, PETERSON 
                      INSTITUTE FOR INTERNATIONAL ECONOMIC 

   Mr. BERGSTEN. Mr. Chairman, you are about to get another strong 
warning. 
   I am delighted to appear before the committee again. I agree with 
virtually everything you have said in your opening remarks. I deeply 
applaud and admire your efforts to forge an action plan to deal with 
the budget problem. I want to suggest in my testimony today that the 
international dimension of the issue may, in fact, most likely trigger 
a crisis that would force action in the absence of the kind of 
constructive and preemptive steps you want to take. 
   I start with my punch line, which is that the huge and growing 
international trade and current account imbalances, which of course 
center on the U.S. external deficits and debtor position that you have 
described, represent the single greatest threat to the continued 
prosperity and stability of both the U.S. and world economies. They 
could, at virtually any time, trigger a large and disorderly decline in 
the exchange rate of the dollar, which would initiate sharp increases 
in U.S. inflation and interest rates, bringing on at a minimum 
stagflation like we saw in the 1970's but quite possibly a deep 
recession. 
   Even in the absence of such a crisis--and that is a critical 
point--continued failure to address the imbalances constructively and 
preemptively,  which you are trying to do, will inevitably lead to a 
costly and perhaps wrenching adjustment of the U.S. and world economies 
anyway. They could also lead to a disruption of U.S. trade policy, 
which is very hard to conduct in a sensible way with these huge 
international debts and deficits. That would threaten the openness of 
the global trading system. This is not our main topic today but is an 
element of this. 
   The only effective U.S. policy response to the problem, and I will 
describe that in a minute, is a conversion of present U.S., and as you 
said, particularly prospective U.S. budget deficits into modest 
surpluses, as the United States had in 1998 to 2001. You just suggested 
a goal of eliminating the deficit. I suggest that the U.S. should aim 
for modest surpluses. 
   The United States should in fact be running modest surpluses right 
now, because with the economy so strong in the last few years this 
would have been the ideal time to run a surplus. The strength of the 
economy has improved the budget and, as you mentioned, lulled some 
people to sleep about the need to deal with the underlying structural 
elements in it. 
   But actually at a time like this, the United States should take no 
comfort even from a modest deficit. It should be running surpluses of 1 
or 2 percent of GDP in light of the strength of the economy. That is 
what then positions us for the inevitable slowdown, as well as the 
structural deterioration in the fundamentals that you have talked 
about. So anybody who is complacent today is really barking up the 
wrong tree. 
   The end of my punch line is that the possibility of a sharp dollar 
fall is, in fact, the greatest short-term risk that emanates from the 
budget deficits and provides the most compelling reason for urgent 
action on them. 
   Let me quickly tick off a few facts. The U.S. merchandise trade and 
current account deficits exceeded $850 billion last year and exceeded 
$900 billion in a couple of quarters at an annual rate, including the 
last one for which we have full data. It is now almost 7 percent of the 
economy, which is more than double the modern record the United States 
had back in the 1980's, after which the dollar dropped by 50 percent 
over 3 years against the other major currencies. 
   The U.S. external deficit has risen by an annual average of $100 
billion for the past 4 years and almost that much for the last 10 
years. In short, it is on a trajectory very much like the one you 
showed on the budget deficit. In fact, the two are quite parallel. That 
trajectory as well as the levels of the imbalances are, in my view, 
totally unsustainable. 
   At these present levels, United States current account deficits and 
external debt pose what I would regard as unacceptable risk to the 
United States economy and United States foreign policy. A country that 
spends more than it earns has to finance its deficit, just like an 
individual who spends more than he or she earns. So the United States 
has to attract foreign capital inflows of about $4 billion every 
working day to finance the current account deficit. In addition, U.S. 
companies and individuals make a lot of foreign investments and the 
United States has to offset those by capital inflows. The bottom line 
is that the United States has to attract about $8 billion of foreign 
capital every working day to keep its domestic economy afloat. 
   The stunning fact is that a trigger for a crisis would not 
necessarily be a drawdown of existing foreign dollar holdings, though 
that would make it much worse. All that is needed to trigger a big 
problem is a reduction in the inflow from the current $8 billion to say 
$4 billion or $5 billion. That would still be a lot of foreign 
investment in the United States It is not as if the world has to give 
up on the United States totally. But if the amount of annual inflow 
drops from the current roughly $2 trillion to half that or less, still 
a huge amount of foreign investment, that would trigger a substantial 
deterioration of the situation, the dollar would go down, et cetera, as 
I will describe. So the situation is really very precarious. 
   As a result of all of these deficits, U.S. net foreign debt reached 
$2.7 trillion at the end of 2005. An even more important number than 
U.S. net foreign debt, which you showed in one of your charts, may be 
U.S. gross foreign debt. Foreign entities, mainly private but some 
official, now hold about $14 trillion of dollar denominated assets in 
the United States. Almost all of it could actually be disinvested at 
any point in time. That could lead to a very sharp and indeed 
precipitous fall in the dollar, which would represent a free fall and a 
crisis. 
   So even though we focus on the net debt of about $3 trillion, which 
is big enough, the fact is the United States could not mobilize our 
private foreign financial assets to deal with a crisis. And so we 
really have to look at the gross foreign debt, which is now $14 
trillion or more. 
   The major risk that the imbalances pose would be an elimination or 
reversal, or even sharp decline, of the very large net capital inflows. 
A cutback in the foreign capital inflow would immediately lead to a 
decline, perhaps very large and rapid, of the dollar exchange rate. 
That would push up the price of imported goods and services and the 
domestic products that compete with them, particularly now when the 
economy is close to full employment and there is, not much slack to 
take account of that. 
   Interest rates would rise by as much as inflation and probably by 
much more as the Fed had to raise rates to try to limit the decline of 
the dollar and its inflationary effect. The equity and housing markets 
would inevitably fall as a result. The economy would slow and perhaps 
drop into recession. 
   The operational question is always how much and when? One cannot give  
precise quantitative answers to that. But I suggest several reasonably 
reliable relationships that one can keep in mind. 
   Every decline of 10 percent in the average exchange rate of the 
dollar tends to increase United States inflation by about 1 percent, 
especially when the economy is at full employment like now and there is 
no slack to absorb that effect. 
   According to our calculations, and Bill Cline will elaborate on 
this, the dollar is still overvalued by at least 20 percent, maybe 
more. And that is calculated with a goal of simply cutting the U.S. 
current account deficit in half from where it is now. To eliminate the 
current account deficit and the buildup of foreign debt, it would have 
to do twice as much. We calculate that if the United States cut the 
current account deficit to say 3 percent of GDP-- 
   Chairman CONRAD. Can I stop you on this point, because I really want 
this point not to be lost. Would you just repeat what you said with 
respect to what the dollar would have to decline in value in order to 
potentially address what we face here? 
   Mr. BERGSTEN. Yes. The first part of that should be the goal of the 
adjustment process. You have set a goal of eliminating the budget 
deficit. I say it ought to be a small surplus. On the external side-- 
   Chairman CONRAD. Actually, we produce--under the budget I will 
propose, we do produce a small surplus. 
   Mr. BERGSTEN. That would be better yet. 
   Our analysis, which we have looked at very carefully, half a dozen 
of different senior fellows at our institute, what current account 
position would tend to be sustainable over time? 
   We do not believe the United States has to totally eliminate the 
current account deficit. We believe cutting it to about 3 percent of 
GDP, which is more than half from where it is now, would be sufficient. 
The reason for that, and Bill has analyzed this in great depth in his 
latest book called the United States as a Debtor Nation, is that if 
United States could level off the current account deficit at 3 percent, 
then the ratio of U.S. foreign debt to U.S. GDP would stabilize. 
   Chairman CONRAD. Stop growing. 
   Mr. BERGSTEN. It would stabilize at a riskily high level, around 50 
percent of GDP. 
   Chairman CONRAD. Isn't that a key here-- 
   Mr. BERGSTEN. Absolutely. 
   Chairman CONRAD [continuing]. Is that we stop-- 
   Mr. BERGSTEN. Stop the buildup of the debt/GDP ratio. 
   Chairman CONRAD. This is one of the goals that I am emphasizing to 
my colleagues, is we have to turn these trend lines. Right now the debt 
is just up, up and away, both in real and nominal terms, as a share of 
GDP. And what we have to do is stop that growth. You would agree with 
that as a-- 
   Mr. BERGSTEN. Yes, and bringing the external dimension into play. We 
have looked at the history of similar positions for the United States 
and other countries and tried to make some judgments based on the 
historical record of what is a relatively safe position. What does look 
like being sustainable if you could achieve it? 
   Chairman CONRAD. And what would that target be? Could you give that 
to us in GDP terms? 
   Mr. BERGSTEN. Yes. The ratio of United States net foreign debt to 
GDP that we think would be barely sustainable over time is about 50 
percent. 
   Chairman CONRAD. Foreign debt to GDP. 
   Mr. BERGSTEN. The number is now about 20 to 25 percent. Given the 
current trajectory, there is no way you could level it off before you 
got to 50 percent. But if we took effective action now to start 
bringing the current account deficit down over the next 5 years, as you 
phase in your budget correction, the dollar could come down in a 
gradual and orderly way. Over a 5-year period, we believe the external 
deficit would come down from the current 7 percent of GDP to about 3 
percent. 
   Chairman CONRAD. Which you think is sustainable. 
   Mr. BERGSTEN. If you maintained fiscal rectitude and the exchange 
rate did not soar and get overvalued again, then you could level off at 
that ratio. We think that would be sustainable. 
   Again, that is risky, 50 percent is high by historical standards. 
But given all of the history and our analysis, it is our judgment that 
that probably would be OK. 
   If you took a more conservative view and said you had to get the 
ratio down further or had to eliminate the current account deficit, 
then of course you would need much bigger adjustment both on the 
domestic side and in terms of the exchange rate. 
   Chairman CONRAD. You said earlier, and Senator Gregg is with us now, 
you said something that I think is very important. You indicated you 
believe the dollar is somewhere in the range of 20 percent overvalued. 
Is that correct? Did I hear you correctly? 
   Mr. BERGSTEN. Yes. Again, overvalued in terms of producing the kind 
of current account level and therefore-- 
   Chairman CONRAD. A sustainable current account level. 
   Mr. BERGSTEN. That is right. 
   Chairman CONRAD. Let me just say, other top economists and 
policymakers have given me that same number. 
   Then you went further and you said--you referenced a 40 percent 
change in the dollar. I took it to mean that that would be what would 
be necessary to--I do not know if that would eliminate the trade 
imbalance. 
   Mr. BERGSTEN. That number would tend to eliminate the full current 
account deficit if you took the view that any further buildup of our 
foreign debt was too risky and you therefore wanted to totally 
eliminate the current account deficit. You would have to roughly double 
all of the numbers that I have been using because, instead of cutting 
the deficit, in half you would be going all the way to zero. 
   Chairman CONRAD. Let me just say, that is precisely what other top 
economists and policymakers have told me, those two numbers, 20 percent 
and 40 percent. If that does not get our colleagues' attention I do not 
know--you begin to wonder what will. 
   Mr. BERGSTEN. You would hope. A crucial variable, and I talk about 
it in my statement but we can handle it any way you want, is the 
following: as part of this adjustment, which I believe is inevitable, 
that the markets will force it on is at sometime if we do not preempt 
and do it in a constructive and orderly way ourselves. 
   As part of the adjustment, the dollar is going to have to come down 
by 20 to 40 percent. The real issue is whether it comes down in a 
gradual and orderly way, as in fact it has been doing over the last 5 
years. Whether at some point confidence in our fiscal and other 
policies collapses and you get a free fall, which we have had 
historically--it in the late 1970's and mid-1980's--it is not a 
theoretical proposition. We know empirically that it can happen and we 
have actually had big declines of the dollar about once per decade over 
the last 40 years. 
   Chairman CONRAD. And so what? So what if we had a decline in the 
dollar? 
   Mr. BERGSTEN. Then you get three very clear effects. One is 
inflationary pressure, particularly if it occurs when the economy is 
close to full employment and full capacity utilization like the United 
States is now. You have no slack in the economy. The decline in the 
dollar is going to push up prices of imported products in the first 
instance, but through them the domestic products that imports compete 
with. So inflation goes up. I give some numbers in my statement. If the 
dollar declined even 20 percent, you would expect an increase of 2 
percentage points or more in inflation. That would roughly double the 
current inflation level. That is step one. 
   Step two is that interest rates go up. Nominal interest rates, of 
course, go up with inflation. So that is a minimum effect. But if the 
Federal Reserve fears that the markets are going to keep pushing the 
dollar down more, and therefore generating even more inflation, then 
the Federal Reserve has to try to preempt that with higher interest 
rates. And so interest rates could go up from the current level of 5 
percent, both short and long rates, at least to 7 or 8 percent. We have 
run models where interest rates go into double digits, at least for 
temporary periods, as a result of this kind of correction. 
   Again, it underlines the importance, Mr. Chairman and Senator Gregg, 
of your budget action. If you take the view, as I do, that these 
adjustments in the international position of the United States are 
inevitable, unless all economic history were repealed, they are going 
to happen. The question is how they happen. 
   Do they happen in an orderly and constructive way like preemptive 
action on the budget? Or do we just sit back and let it hit us? In 
which case the big effect could be a skyrocketing of inflation and 
interest rates. That chokes off private investment, which we need for 
long-term growth, and even cuts into consumer demand. A correction of 
the Federal budget position, which the United States needs for lots of 
other reasons anyway, even excluding the international side, is by far 
the more constructive way to do it. 
   If you start with my premise that adjustment is inevitable, you have 
a choice between the constructive preemptive approach and the ''simply 
sit back and let it clobber you'' approach. 
   In the constructive approach, you work the budget deficit down over 
a 5-year period, aim for a gradual but steady decline in the external 
deficit and the exchange rate of the dollar, which probably can be 
maneuvered in kind of soft landing terms. 
   If, by contrast, you do nothing, and let the budget deficit soar, 
which incidentally itself might trigger a free fall of the dollar 
because markets lose confidence, then the adjustment takes place 
through a skyrocketing of interest rates, maybe to double digits. So 
instead of tightening the fiscal side, you put it all on the financial 
markets and the Federal Reserve, interest rates soar, housing tanks, 
investment tanks, the stock market is tanked, and you wind up with an 
incredibly worse outcome. 
   Some people think the deluge can be avoided forever. You said it on 
the budget. Some people take that line on the international side, and 
they point to the fact, admittedly, that I and others have been 
expressing this concern for some time. So have you, Mr. Chairman. And 
they say the rest of the world is financing us and the rest of the 
world will be happy to keep financing us. 
   My point is that it is now up to $8 billion a day. We have $14 
trillion of dollar holdings around the world, which at any point could 
be cut into, and it would be the most reckless stance of national 
policy to just assume that this can go on forever at such levels 
without triggering a deluge that would be disastrous for the economy. 
   And so you have to conclude that, it is not a matter of if, but 
when. I would add, when and how through constructive preemptive steps 
or through just letting it hit you and then almost certainly it would 
be higher inflation and higher interest rates. 
   I speak about this with some feeling, Mr. Chairman. I was running 
the international part of the Treasury Department in the late 1970's 
when we had the closest thing to a hard landing. There were a lot of 
other things involved like oil shocks. It was not just the dollar. 
   But the dollar plummeted. The United States needed a $30 billion 
rescue package for the dollar and drew on the IMF. The Federal Reserve 
had to raise interest rates one full percentage point, the first time 
in its history. And the United States had to cut the budget deficit 
substantially. 
   External uses have forced U.S. fiscal policy to change three times 
in the last period. In the late 1960's, President Johnson finally got 
his Vietnam War tax surcharge because of a succession of sterling and 
gold crises, which brought huge pressure to bear on the dollar. 
Secretary of Treasury Joe Fowler at the time said that Wilbur Mills and 
the Ways and Means Committee and Congress were finally convinced to 
finance the Vietnam War only because of the external crises. 
   It happened again when I was in the Treasury in the late 1970's. 
There had been a big debate within the Carter Administration. We in the 
Treasury had been arguing for fiscal restraint right from the start. 
But when the dollar collapsed in 1979, it was clear it had to be done 
and Congress went along.  
   To indicate the horrors that can result--people forget now because 
it is quite a long time ago--in the late 1970's, the United States had 
three consecutive years of double-digit inflation, interest rates above 
20 percent, and the deepest recession in the second half of the 20th 
century. A big part of that was a collapse of the dollar. 
   And then, just to show that it is bipartisan, in the mid-1980's, 
when the dollar had become hugely overvalued, Jim Baker worked out the 
Plaza Agreement to negotiate a big decline in the dollar, between 30 
and 50 percent depending on how you calculate it. To get that decline, 
and then to stabilize the dollar at the lower level, the United States 
had to accept the demands of the rest of the world to take some fiscal 
action to begin putting its own house in order. In 1986 and 1987 there 
was, temporarily it turned out, a substantial reduction in the budget 
deficit. 
   The point is that even fiscal policy itself can be forced into an 
unhappy and precipitous adjustment if you do not take preemptive action 
in not taken. 
   Chairman CONRAD. Let me just stop you, if I can, on that point and 
say that is the message. I hope colleagues are listening. 
   [The prepared statement of Mr. Bergsten follows:] 

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   Chairman CONRAD. Let me go to Dr. Cline, and then we will go to 
Malpass and then open to colleagues for questions. 
Dr. CLINE. 

                 STATEMENT OF WILLIAM CLINE, SENIOR FELLOW, PETERSON 
                         INSTITUTE FOR INTERNATIONAL ECONOMICS 

   Mr. CLINE. Thank you very much, Mr. Chairman. 
   It is an honor for me to testify before this committee. I, too, 
strongly agree with your introductory remarks. 
   The United States has gone from being the world's largest creditor 
nation to its largest debtor nation. In 1971 to 1975 the average net 
foreign assets were 11 percent of United States GDP. At the end of 
2005, we had net foreign liabilities of more than 20 percent of GDP. 
The cumulative large current account deficits, of course, were the 
proximate cause. Last year our current account deficit reached almost 7 
percent of GDP or about twice the previous peak in 1987. 
   The deficit was up from 1.7 percent of GDP in 1997. This was closely 
driven or heavily driven by the 28 percent real appreciation of the 
dollar from 1995 to 2002. That, of course, made United States exporters 
less competitive and made imports more attractive. 
   There has been some dollar correction. The dollar has come down 13 
percent from 2002 to 2006 on a real trade-weighted basis. But I 
believe, as my colleague Fred Bergsten has said, that there is a long 
ways to go. 
   The adverse trend in United States debt has occurred--external 
debt--despite two very strong unique advantages. The first advantage is 
that the United States has a higher return on its direct investment 
abroad than foreign holders of direct investment in the United States 
get. 
   That difference is about 4.5 percent. 
   The second unique advantage is that unlike Argentina, who owed its 
debt in foreign currency, we owe our debt to the rest of the world in 
our own currency. We have assets abroad in foreign currency. So every 
time the dollar goes down, we have a windfall gain in the valuation of 
our net position. 
   Despite these advantages, we have had this adverse trend. 
   Fred has outlined the near-term hazards of the situation. I would 
like to focus on the longer-term burden, as well as the link to fiscal 
policy. 
   On the long-term burden. Even if the current account were to 
stabilize at 7 percent of GDP, then after about 20 years the net 
foreign debt would be about 100 percent of GDP. But we cannot actually 
expect it to be that favorable under current trends. With the dollar in 
real terms where it is now, the baseline that I calculate is that the 
current account deficit will reach 14 percent of GDP at the end of two 
decades and net foreign liabilities would reach 140 percent of GDP. 
   One of the main drivers of this is the fact that we are now 
decisively swinging into negative balances on our capital earnings 
despite the difference in the rate of return. Why? Because we have more 
foreign debt. 
   And then second, imports are about 50 percent larger than exports, 
so an equal percentage growth on both sides just keeps widening that 
gap. 
   Now the danger, it seems to me, is that there is a threshold beyond 
which United States foreign debt should not be allowed to rise. For 
developing countries, the critical debt crisis threshold is about 40 
percent of GDP. The United States economy is obviously stronger than 
developing countries, but the United States has a lot of international 
obligations, a lot of impact on the international economy. I do not 
think it is prudent for the United States to buildup net foreign debt 
that exceeds 50 percent of GDP. This is the same threshold that a 
number of other experts who have analyzed this question tend to arrive 
at. 
   So we are not on a sustainable path. The choice is basically between 
an earlier smoother adjustment and a later painful adjustment. 
   In my model simulations, if we try to stay within a 50 percent 
ceiling for net foreign debt by the end of 20 years, if we have early 
adjustment, cutting the current account deficit to 3 percent over 3 
years, then you have a much smoother phasing in of the belt tightening. 
If instead we wait for 10 years, then the gap will be so large that you 
would have to cut consumption and investment by something like 13 
percent from the baseline in order to get within a path that would get 
you back to that ceiling of 50 percent. 
   We need the exchange rate to move to do that. It is critical to get 
China and other Asian economies to stop intervening in the currency 
markets and piling up mountains of reserves in order for that to occur. 
It also looks increasingly likely that we will need to have a 
coordinated intervention to reverse the inappropriate recent decline of 
the yen. After all, there was intervention to reverse the decline of 
the euro some years ago. We will have to make the exchange rate 
adjustment. 
   But let me turn to the fiscal adjustment. Fiscal policy is relevant 
because by national accounts identities, our trade deficit is the 
result of our excess use of resources above our resources available at 
home. Now that also means it is the excess of investment over saving. 
And Government dissaving is eroding our national saving. 
   The fact is that from the average of 1997 to 2000 the fiscal 
accounts deteriorated by about 4 percent of GDP. The current account 
deteriorated by about 3 percent of GDP. So we can see the handwriting 
on the wall, that this contraction in the domestic saving that is 
caused by Government dissaving is a major factor. Obviously there are 
other factors. Private household saving has declined with the stock 
market boom and then the housing boom, so that people did not feel they 
needed to save as much out of current income. But we cannot count on 
how soon that will reverse. 
   And if there is anything we have learned, is that the only way to 
affect saving is through affecting Government saving. We do not have 
policies that can affect private saving in any reliable way. 
   So the second component of an adjustment process has to be fiscal 
adjustment that complements the exchange rate adjustment. And that is 
especially important because of the long-term challenges of Medicare 
and Medicaid, in particular, and also Social Security. 
   So I agree, I think we need a swing in the fiscal accounts from 
about a 2 percent deficit, and if you look at the CBO projections, it 
is 2 percent if you make realistic assumptions about the discretionary 
spending, the alternative minimum tax, if you also extend the tax cuts. 
We need to squeeze that or reverse that to about a 1 percent surplus, 
which ironically is what the CBO baseline is doing. If we could 
actually reach the CBO baseline, we would be home free. 
   So with that, I would simply say there are many reasons that we need 
to get the fiscal adjustment in its own right, but I think a strong 
reason for doing so, in addition, is a need to get our external house 
in order. 
   Thank you. 
   [The prepared statement of Mr. Cline follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Chairman CONRAD. Thank you very much for that important testimony. 
   Mr. Malpass, thank you very much for being here. We appreciate your 
taking your time to contribute to the work of the committee. 

              STATEMENT OF DAVID MALPASS, CHIEF GLOBAL ECONOMIST, 
                             BEAR STEARNS 
   
   Mr. MALPASS. Thank you, Mr. Chairman and Senator Gregg. It is a 
pleasure to be here. Thank you for the invitation. 
   I surmise that I am here, in part, to take a different point of 
view, which I will try to launch into here. 
   I listened with great interest to Fred's recounting of some of the 
historical hard times that we have had related to dollar weakness and 
inflation, and I think we probably all share an interest in not going 
back to that. 
   In recent years, the good news is that United States growth has been 
faster and steadier than most expectations. Even so, there is a 
frequent view that the United States is on the wrong economic path. And 
that is primarily where I want to take a different point of view. 
   People have been talking for several years now about us heading into 
a slowdown or a recession, in part due to the trade deficit. Instead, 
the United States has enjoyed a strong multiyear expansion. Growth in 
2006 was faster than in 2005, despite the view that things were hard. 
And 2007 looks equally robust to me. 
   If that is the case, we will end up with having 5 years in a row 
with over 3 percent real growth, a very strong economic performance. 
Rather than the trade deficit slowing the economy or causing higher 
interest rates the rising trade deficit and the net foreign debt, have 
coincided with strong growth, profits, and job creation for the United 
States economy. Unemployment has fallen to 4.5 percent. The fourth 
quarter of 2006 saw a net 1 million new jobs created in the United 
States, again associated or coinciding with a large trade deficit. 
I will go through some of the graphs in my written testimony. The 
unemployment rate has fallen steadily and that has been one of the 
sources of strength for the United States economy. 
   I am expecting some inflation problems because of the weaker dollar, 
and I agreed with Fred's concerns over dollar weakness generating 
inflation. In 2005, we already saw the United States economy get to 4.7 
percent CPI inflation. So we have already had some experience with 
severe inflation in this expansion. 
   The fiscal situation is worth pointing out. The debt to GDP ratio is 
already falling at a relatively brisk clip. We are down to 37 percent 
of debt to GDP. The fiscal deficit has fallen to an expected 1.5 
percent of GDP in fiscal 2007 and CBO projects a surplus in the near 
term. 
   Turning to the trade deficit, I will go through briefly some of my 
thoughts in this area. First and most importantly it is normal for the 
United States to run a trade deficit. With the exceptions of war time 
and recessions, the United States has usually been running a trade 
deficit. One exception was after World War II when the United States 
was helping rebuild Europe and Japan and there was a capital outflow. 
   But for most of our economic history, it has run a trade deficit. 
Countries with trade deficits often produce more growth and jobs than 
countries with trade surpluses. We have only to look at Japan, with its 
large trade surplus and difficulty creating jobs, the European Union in 
that same condition running a trade surplus, having difficulty creating 
jobs, to see that point. 
   The trade deficit is large as a share of GDP right now, in part 
because the differentials that drive it are large. The differentials 
driving the trade deficit include the growth differential. Between 1992 
and 2006, the United States grew 110 percent, whereas the rest of the 
world grew roughly 95 percent. So there was a big expansion of the 
United States relative to the rest of the world. This causes our 
imports to go up more than our exports. That is part of the trade 
deficit. 
   A second driver for the trade deficit is the demographic 
differential. There has widened out now an unprecedented gap between 
United States demographics and those of Europe and Japan in terms of 
aging. To dramatize it, think of Japan, where the under-60 population 
is expected to decline 3 to 4 percent every 5 years for the next 
generation. They have fewer and fewer people needing capital and they 
have an urgent need for capital abroad. Thus, a powerful driver for the 
trade deficit is the demographic differential. The United States alone 
among the major industrialized countries has a growing population of 
people under 60 that need capital and need goods. And that is going to 
go on for the next 50 years. It is not going to shift. And I am 
expecting the trade deficit to be with us for a long time. 
   The third strong factor creating this particularly wide trade 
deficit that we have now is the investment differential. The United 
States invested $842 billion more than national savings in 2005. In 
contrast, foreigners invested $670 billion less than their savings. So 
the lack of an attractive investment climate abroad urges foreigners to 
put their money into the United States, where they get a better return 
on investment. There is data in my statement showing the higher returns 
offered in the United States and the attractiveness to the United 
States for that foreign investment. 
   Now an important point in this is how can this be normal, to--as 
Fred put it--spend more than we produce? Actually, that is a very normal 
condition in economic theory and practice. Growth companies do that all 
the time. Most corporations are spending more than they produce. The 
difference is the increase in their debt. And if you stop that increase 
in debt, the company would not be able to grow. The United States is 
doing the normal thing, spending more than we produce, and funding the 
gap with capital in the same way that a corporation does with a bond 
offering. 
   So as you think about the trade deficit, remember that each time a 
corporation in the United States does a bond offering, that is causing 
it to spend more than it produces, invest more than it saves, and some 
of that is the trade deficit and the capital inflow that we are running 
from abroad. 
   Regarding the sustainability of the foreign debt, in the 12 months 
through November 2006, the latest data, foreigners increased their net 
holdings of longer-term maturity debt in the United States by $860 
billion. No signs of difficulty for the United States in financing the 
trade deficit anymore than a corporation issuing bonds. It fuels 
growth, controls whether it has a sustainable process of investment 
taking place in the corporation, and takes on more debt, perhaps 
perpetually. 
   The idea that somehow the United States has to stop this process is 
not consistent with what a normal leveraging process is, whether for 
countries or for companies. 
   Just as with corporate borrowing, the United States needs to 
maintain the quality of its new investments, whether funded by United 
States or foreign capital. I think the focus should be on the quality 
 of investment taking place in the United States We know we are 
borrowing from foreigners, usually at low interest rates. The issue: is 
are we using that capital wisely to build a growing economy? 
Yesterday's data showed that we were. In a nominal GDP basis, we are 
running 6 percent nominal growth year after year versus lower borrowing 
costs, which is a very powerful positive leverage that the United 
States is enjoying. 
   The argument that foreign funding will dry up has been made since 
1984-1985. In fact, I was a staffer for the Senate Budget Committee in 
the previous Congressional focus on the twin deficits. I do not know if 
Fred testified in those hearings in 1984-1985, but there was a big 
concern about foreigners withdrawing their funds from the United States 
in that situation. And I think, it ended up without that being a 
particularly sensitive part of the United States economic equation. 
   One of the reasons for that is foreigners own a small and declining 
portion of overall United States assets. The data that we have 
discussed so far has been the foreign debt relative to United States 
GDP. I think a better measure is to look at the foreign debt relative 
to United States assets. United States assets have been growing very 
fast and, in reality, foreigners are losing share of the rapidly 
growing United States asset base in part because they are not investing 
enough into the United States economy. 
   As we talk about trade deficit numbers, remember that the data is 
quite suspect in many areas. For example, when a United States company 
produces something abroad, ships it to the United States, makes a 
profit on it, we count that as part of our trade deficit even though it 
is coming from a United States company. 
   A second problem with the data is that on a global basis exports and 
imports do not add up. One of the primary reasons is that United States 
exports are not counted very well. We do a really good job of counting 
all of our imports of goods and services but not nearly as good a job 
counting the exports. Most people looking at this think that our actual 
trade deficit is much smaller than the numbers being reported. 
   As we think about the risks of the trade deficit, then I will name 
three issues. One is we want to have the investment that is taking 
place in the United States be profitable. That is true whether it is 
from foreign capital or our own capital. 
   Second, protectionism, is not the right approach even if you do end 
up thinking that there is a concern with having the trade deficit 
itself. 
   Third, a weak dollar policy, in my mind, will not solve the trade 
deficit at all. It encourages capital flight from the United States and 
makes our overall economic situation worse. 
   What can be done to reduce the trade deficit? The primary burden, I 
think, should be on the trade surplus capital outflow countries. 
Remember those countries running a trade surplus are shipping capital 
to the United States because we have young people. How can they change 
to make it more attractive for that capital to stay at home? Probably 
more population growth, more productivity growth, and a more attractive 
investment climate. 
   As you are thinking about the problems of the trade deficit, the 
primary thing to be focused on is how can foreign growth and investment 
climates be enhanced. 
   I am a critic, in some ways, of our international economic policy. I 
do not think the United States does a good job at all in making clear 
to the rest of the world that we would like them to grow faster and 
invest more in their own countries. 
   A tax cut in Japan would make a lot of sense. Japan needs 
desperately to boost its investment and consumption and its tax rates 
are too high to contribute to that right now. And I think the United 
States should more aggressively promote prosperity abroad as part of 
the response to our trade deficit. 
   In conclusion, rather than an unsustainable situation with the trade 
deficit and the net foreign debt--it has been called that for 25 years 
with no real evidence of it being unsustainable--I think the trade 
deficit will continue as long as the United States grows faster than 
our trading partners and it will contract when we do not. It comes down 
to the growth rate differential that we have and it is unlikely to be 
narrowing. 
   Thank you. 
   [The prepared statement of Mr. Malpass follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Chairman CONRAD. Thank you. 
   Let me start, if I can, with you, Mr. Malpass. We are talking here 
about twin deficits. Trade deficit, you have really focused on that. We 
are also talking about budget deficit and we are talking about the 
long-term fiscal challenges facing the country, because that is the 
distinctive purview of this committee and responsibility to our 
colleagues. 
   With everything that you have said, do you have any concern about 
the long-term fiscal situation of the country with respect to the 
budget deficits and the retirement of the baby boom generation and what 
we see it as the long-term fiscal outlook? 
   Mr. MALPASS. I think in the long run it is hard to project deficits. 
One thing we find is that they are very sensitive to growth rate 
assumptions. Since I tend to have a pretty optimistic view of the 
United States future, I think that we will find ways to meet most all 
of the commitments of the Government. 
   The problem, though, becomes when the Government makes expansive 
commitments, and those are presenting challenges now, particularly in 
the Medicare realm. We have made a big promise to the elderly about a 
broad, sweeping, robust, very generous health care program. That is 
going to be incumbent on the United States then to have a flexible, 
liberal, small-business-oriented growth environment and just keep 
growing 3 percent a year, as we have been these last 5 years. 
   Chairman CONRAD. I would say this with respect to Social Security, 
if the economy grows in the next 20 years as it has in the previous 20 
years, 80 percent of the projected Social Security shortfall 
disappears. So I think that should be something that colleagues keep in 
mind as we talk about Social Security. 
   That is not the case with respect to Medicare. With respect to 
Medicare, the long-term projected shortfall is seven times the 
projected shortfall in Social Security. And in my judgment, when I look 
at the numbers to try to pierce the veil, I think that is the 800-pound 
gorilla here. And that has the potential to swamp the boat. 
   Your reference to Medicare, perhaps we are on the same wavelength 
with respect to that long-term challenge. 
   Mr. MALPASS. Yes. I think there is a big modeling issue. If current 
trends continue, there is a big Medicare problem. 
   If you look at the assumptions underlying the Medicare Trustees 
reports and so on, one thing that is notable is that they assume that 
the real rate of growth of medical services will continue. Meaning that 
people will go to the doctor more and more often, they will use more 
and more services apart from their age. One of the ways that we can see 
a little more daylight on the Medicare side is if we think that the 
systems will become more productive and that people may become satiated 
with their use of some of the medical services over time. 
   Chairman CONRAD. OK. 
   Let me turn to our other witnesses, Dr. Bergsten and Dr. Cline. 
   And ask them, you have listened now to Mr. Malpass. Anything that he 
said that you would want to take issue with or have a different point 
of view. 
   Mr. BERGSTEN. Yes, I have several things, but two big ones at the 
start. 
   David said that it is natural for the United States to run a trade 
deficit.   As I said in my testimony, I do not disagree with that. The 
issue is how big. I suggested that if we cut it to roughly 3 percent of 
GDP, I would be modestly confident that we would be able to sustain it. 
That is because, as we said before, it would level off the ratio of net 
foreign debt to GDP and keep it from escalating forever. 
   So the difference between us is really over magnitudes, not signs. 
And I am not saying we should try to run a trade surplus. 
   Second, it is just wrong to day, as he said right at the end, that 
there has been no real evidence of unsustainability for over 20 years. 
Why did Jim Baker call the Plaza Agreement 1 year after the time period 
David cited, 1985? Jim Baker called the G-7 together and insisted that 
they cooperate with the United States in a huge adjustment of our 
external imbalance. 
   There were two reasons for that. The most immediate was that 
Congress was about to go protectionist in a big way. My friends on the 
Ways and Means Committee at the time said that if the Smoot-Hawley 
tariff itself had come to the floor in 1985, it would have passed 
overwhelmingly. 
   That was because Reaganomics--and I am not being political, I am 
trying to be analytical--big fiscal deficits and very high interest 
rates pushed the dollar to such high levels that the United States 
shifted from being the world's biggest creditor to the world's biggest 
debtor. Not only was there a risk to our international financial 
position but also there was a domestic political unsustainability 
because of the adverse effect on manufacturing, agriculture, and many 
other parts of the economy. 
   And so Jim Baker literally insisted, from a United States interest 
standpoint, that the world agree to a huge decline in the dollar. The 
rest of the world said it would do so only if the United State did 
something about the budget and that, in fact, was a partial component 
of the solution. 
   But that immediately showed the unsustainability. Again in the early 
1990's, the dollar--people forget this--fell to its all-time record 
lows in 1994 and 1995, when Bob Rubin was Secretary of the Treasury 
talking about the strong dollar, again because the imbalances were 
rising and there were doubts about the U.S. position. 
   So there have been big fluctuations in our international position. 
David did not say this, and I do not want to put words in his mouth, 
but I think he implied that there has been a steady increase in 
external imbalances, external debt and the like, indicating that all of 
this is OK. That has not been the case at all. There have been very 
large fluctuations. After the dollar came down and the budget was 
corrected at least a bit in the late 1980's, United States current 
account deficit basically disappeared in the early 1990's. And then it 
started a rising trend again. 
   But over the last 5 years, as both Bill Cline and I indicated, the 
dollar has again been coming down. Fortunately it has been gradual and 
orderly. But again, it is an indicated that even though the foreign 
capital continues to come in, they want a better price. They want to be 
able to buy the dollar cheaper. 
   Chairman CONRAD. Let me just stop you there and say that we have 
gone over my time. I want to turn it over to Senator Gregg. 
   But I did want to say to Mr. Malpass, when you are talking about 
debt to GDP coming down, you are talking about publicly held debt. And 
remember, that is the baseline. When we add back the things that are 
left out of the baseline, we get a different picture emerge. 
   And certainly on gross debt, on gross debt quite a different picture 
emerges. And that is where we are concerned, I can say Senator Gregg 
and I and other members of this committee, especially given the fact we 
have this baby boom generation coming. That is where we think we have 
to make an adjustment. 
   Senator GREGG. 
   Senator GREGG. Thank you. This has been a very interesting panel. 
   And I think what it shows is that the trade imbalance is an 
extremely complex issue. Unfortunately, it tends to get, in the 
political arena, simplified into catch phrases, and as a result becomes 
a short commercial. And it is not. It is something that has so many 
moving parts that it takes you three folks quite a while to explain 
them, and I am sure you could have gone on for much longer. 
   But to some extent I have always thought it came back to the basic 
Adam Smith theory that it is not the dollar that is important. It is 
the productivity under the dollar that is important. The dollar is just 
a representative item. It is a piece of paper. It means nothing unless 
there is productivity under that dollar. 
   I guess my question is isn't the trade imbalance a reflection of the 
fact, to a large extent, that the world sees our economy as the place 
to put their money to get the best return? 
   I would ask you all to react to that. 
   Mr. CLINE. I wonder if I might respond to that, Mr. Chairman. It is 
certainly the case that the attraction of our capital market is a major 
source of the strength of the dollar. I think, though the case has been 
exaggerated, there is this argument out there that there is a global 
saving glut because Asia and Latin America had their crises and their 
investment rate went down. The Chairman of the Federal Reserve, Ben 
Bernanke, has made this argument on other occasions. 
   When I parse that particular argument, I get a much smaller effect, 
only about 0.7 percent of United States GDP is our fair share of that 
excess savings. But we have had a widening of our current account 
deficit by 4 or 5 percent of GDP. 
   To me it is a much more obvious smoking gun to look at the decline 
in Government saving, as I say, a decline of something like 5 
percentage points of GDP in the critical period. 
   Now David was saying that well you know, isn't it wonderful that the 
rest of the world that does not have anything profitable to do with its 
money is sending it here where we are very creative and we have good 
investment. If you look at net private investment in 1994 it was 7 
percent of GDP. In 2004 it was 7 percent of GDP. 
   So it is a misleading argument to say that the reason we have this 
large increase in our current account deficit is that we have had this 
huge increase in private investment. It is, I think, rather clear that 
part of the problem is the decline in Government saving. 
   But that being said, I am a little bit concerned with precisely what 
you say, that we will be given enough rope by the foreigners precisely 
because our capital market is attractive, to well and truly hang 
ourselves. And what I am really asking is what does a logical 
consistent picture look like over a long period of time? 
   I challenge Dr. Malpass to tell us what his ceiling safe level is 
for foreign debt relative to GDP? And it has to obey the following 
rule: the long-term rate of foreign debt to GDP equals the current 
account deficit as a percent of GDP--right now 7 percent--divided by 
the nominal growth rate. That is 6 percent. So right now our eventual 
stabilization is 110 percent of GDP. 
   That is why we think it needs to come down to 3 percent so it will 
stabilize at 50 percent. 
   But those who argue that there is no problem have one of two things. 
They think the sky is the limit in terms of foreign debt for the United 
States, unlike all the rest of the world, A. Or B, they count on this 
thing naturally turning around at a comfortable time when we do not 
really have to do anything about it. I am not sure that that is a 
prudent approach. 
   Senator GREGG. I do not think my point was that there is no problem. 
My point was that correcting the problem may create issues which are 
going to undermine the economy and the productivity of the economy if 
you inflate the dollar, reduce the value of the dollar arbitrarily, or 
create other mechanisms that essentially make America less attractive 
as a place to put capital, because capital is the essence of growth and 
jobs. 
   Mr. BERGSTEN. Could I perhaps respond to that? I think it is not 
only a fair but critically important question. But I actually would 
come out the other way, depending on how the adjustment takes place, 
going back to some of the dialog we had earlier on. If the dollar went 
into free fall, if it triggered a prolonged period of United States 
inflation, you would be right. And I have argued that that is the 
ultimate thing we want to avoid, and that is why we should take 
preemptive action. 
   I think the alternative correction paths are between preemptive 
adjustment, mainly by gradually reducing the budget deficit and keeping 
the pressure off interest rates and inflation, and at some inevitable 
point getting a very sharp fall of the dollar that pushes interest 
rates up to a level that would reduce our level of investment, and 
therefore reduce our productivity growth, which would be very damaging 
to the economy indeed. 
   So I agree with you, but the way we manage the adjustment of the 
external imbalance could have a decisive effect on the outcome. And I 
would opt strongly for trying to preempt a dollar crash, a run-up in 
inflation, a soaring of interest rates where the burden of working out 
the adjustment would fall on the Federal Reserve and monetary policy 
and higher interest rates. 
   In a way it is back to the simple point of increasing budget 
deficits, putting pressure on the financial markets, raising interest 
rates, and such. 
   We have been relieved of that dilemma by the foreigners. As Bill 
Cline said, we have not gotten crowding out of private investment from 
our budget deficits because the foreigners have come in and financed 
the difference. And if you think that can go on forever at almost any 
level, then you sit back and enjoy it. And there is no doubt it is 
enjoyable while it happens. It is like drawing on your credit card if 
nobody sends you monthly bills. 
   So as long as it persists it is enjoyable and, of course, it is 
politically difficult to take any of the steps to correct it. And so 
the tendency is to just sit back and enjoy. 
   But as I said in my testimony, unless all laws of economic history 
are repealed, you cannot count on it and it literally could hit you 
just at the most unhappy and politically inconvenient time. 
   Senator GREGG. You want to comment on this, Mr. Malpass? 
   Mr. MALPASS. This is an interesting discussion. I agreed with your 
point that productivity in the United States, I think in terms of the 
quality of investment, is a key determinant of whether this goes well 
or not. Throughout its economic history the United States has tended 
to borrow money from foreigners and make a profit on that in the same 
way that a corporation does. A corporation issues bonds and tries to 
make enough extra to pay the interest on the bond, then roll it over 
and keep the process going. It gets older and older as a corporation 
and gets bigger and bigger. And that is basically how the United States 
has run since colonial times in terms of bringing in foreign capital to 
the United States and making a profit on it. 
   It is easy to look at the buildup of our debt. But it is important 
to then also look at the buildup of our assets. As we use foreign 
capital, we compound our assets. We have a multiplier effect going on 
in the United States economy. It makes the process sustainable. 
   The final point I will mention to you then is the demographics. This 
is at an extreme right now because we are at this massive crunch point 
where the populations in Japan and Europe are already declining. And in 
China within a decade, the population will roll over and begin to 
decline at a time when the United States population is growing rapidly. 
It is magnifying the normal historical behavior of the United States to 
borrow foreign money. We are doing it more than ever before because we 
are growing relative to the foreign economies. 
   Add to that the quality of the investment climate. We are in a world 
climate which is particularly favorable to what the United States does. 
Mr. BERGSTEN. David just said the United States has been doing this 
since colonial times. Not right. 
   As recently as 25 years ago, as Bill Cline mentioned in his 
statement, the United States was the world's largest creditor country. 
We had built up a huge net foreign asset position. For over 50 years, 
from roughly the start of the 20th century, at least World War I, until 
literally 1980, the United States increased its net asset position. 
Indeed, the previous big trade deficits in the 1980's were running down 
the asset position built up in the previous 50 years. 
   One reason it is more precarious now is that we are running these 
big deficits on top of already having the world's No. 1 debtor 
position. We do not have a cushion now. We used up the cushion in the 
last big run up. 
   We built up net assets for a long time. We were the world's largest 
creditor country. That came to be viewed as a natural thing because we 
were a rich country and we exported capital to the rest of the world. 
Now it has all gone topsy-turvy. 
   Second, David keeps making this comparison with companies floating 
bonds.   Well yes, but not without limit. No prudent company just says 
it will take whatever amount of money the capital markets gives me, and 
find some way to use it but not worry about the buildup of its debt. 
   They do a very careful corporate plan, have a financial strategy, 
and have a finite amount they want to borrow. They do not just borrow 
without any limit and let it go on a trajectory that gets more and more 
explosive. 
   Third, David made the correct point that how you use the funds is 
critical. But, look at the increase in U.S. external borrowing over the 
last five or 6 years. What has it financed? As Bill Cline just said, 
not an increase in private investment. An increase in the Government 
budget deficit, which went from surplus as recently as 2001 to deficit 
now, and more domestic consumption. The numbers today indicate that the 
United State private saving rate for 2006 was minus one, the first time 
since 1933. 
   So what has the big foreign borrowing financed? A big increase in 
U.S. capital stock and investment? No. A big increase in domestic 
consumption and an increase in the Federal budget deficit. And those 
things, to put it mildly, are not self-financing of the imbalance for 
the future. 
   Chairman CONRAD. Senator Cardin. 
   Senator CARDIN. Thank you very much, Mr. Chairman. 
   Let me thank all of our panelists. I found this discussion to be 
very, very helpful. And I certainly concur with the predominant view 
that our trade imbalance is a matter of concern and that it is not 
sustainable. 
   And I agree that we should be taking constructive preemptive steps. 
   I was proud of the work that we did under President Clinton to bring 
the budget into balance. It was not easy, but we got it done. It had a 
very positive impact on the economy, and yet within a very short period 
of time we have returned to a situation of uncontrolled deficits, and 
it is very frustrating. 
   I am always amazed that economists rarely will mention enforcing our 
trade rules as a way of fixing our trade imbalance back into balance. 
And I preface that with the fact that I have voted for most of the 
trade agreements, including the most controversial ones with Mexico and 
China. I strongly believe that it is in our national interest to 
enforce our trade rules, and I do not see how anyone can justify 
China's practices of tying its currency to ours and say that that is 
not manipulation and it is not adversely affecting the fair exchange 
between our currencies. China has a reputation for not honoring our 
intellectual property issues. That has an impact on American's 
opportunity to penetrate the Chinese market. 
   I mentioned China because that is obviously the largest imbalance we 
have. I could be talking about Europe and its nationa's practices. And 
I find that America has the most open markets, which I support. 
   But why aren't we talking about enforcing trade policies and as a 
method of resolving our trade imbalances? 
   Mr. BERGSTEN. Senator, I totally agree with that. In fact, I spent 2 
hours before the Senate Banking Committee yesterday on precisely the 
China exchange rate issue. Secretary Paulson testified and tried to 
defend the continued failure of the Administration to achieve necessary 
adjustment of the Chinese exchange rate. China is now the world's 
biggest surplus country, with a global surplus last year of $250 
billion, 10 percent of its GDP. And the reason, as you say, is that 
they intervened to the tune of $15 billion to $20 billion per month to 
keep their currency from rising. 
   So I absolutely agree. When we talk about getting the dollar down in 
a gradual and orderly way, its most critical component on the other 
side--of course the surplus countries whose currencies need to go 
up--is China, not only because China is the biggest surplus country 
but, also because when they hold their currency down against the 
dollar, it prompts all of the other Asian currencies to hold their 
currencies down against the dollar too, because the other Asians do not 
want to lose competitive position against China. So they take half the 
world, and the biggest surplus part of the world, out of the adjustment 
process. 
Therefore, I am for very tough action and testified yesterday that 
while there are still some multilateral steps we can try, there may be 
some unilateral steps the United States has to take to get the Chinese 
exchange rate to move, and to move by a lot. 
   My estimate is the Chinese exchange rate needs to go up about 40 
percent against the dollar. That would be only 20 percent in terms of 
its average because other currencies would go up with it. But it needs 
to go up a big amount. 
   Without that, you are absolutely right, we will not get the kind of 
adjustment we need. 
   The other steps, in terms of enforcing trade laws, are essential, 
including to maintain an open policy, which I strongly support. 
   Most of the others will not generate big numbers in terms of 
reducing the trade deficit. If we got all of the intellectual property 
enforcement we wanted, we would get a few billion dollars of extra 
exports, which would be useful, and it is important and we should make 
every effort to do it. 
   Senator CARDIN. It is very important for those people who work in 
jobs that otherwise are going to be eliminated. 
   Mr. BERGSTEN. Absolutely. There are all sorts of reasons to do it. 
I fully agree with that as well, only to say that any of those specific 
trade policy measures, while they are essential, will have much less 
impact on the trade imbalances, the big trade deficit, than moving the 
exchange rates and relative growth rates and some of the other things 
we have talked about. 
   Senator CARDIN. I want to give our other two witnesses a chance to 
respond. 
   Mr. MALPASS. Thank you, Senator. 
   I agree with your point about enforcing our rules. And I agree with 
the way Fred phrased it, that we need to keep our market open and that 
the rules will have a positive effect, but on the margins compared to 
the magnitude of the trade deficit. 
   I am thinking it is driven by the fast growth rate of the United 
States, the attractive investment climate, and the demographic 
differentials. So it is going to be hard to address through the rule-- 
   Senator CARDIN. I just want to make one point. We have been told 
that often the decisions by foreign-owned banks to purchase United 
States dollars are not because America is a good investment. Rather, it 
is because they want to make sure the market remains open and that they 
can penetrate it with products the way they do now, and because they 
have the luxury to be able to buy dollars and the capacity to do it. 
But it is not because of the return, it is more because of the impact 
of their investment on stability of the United States dollar. 
   Mr. MALPASS. Yes, I think central bank intervention is along those 
lines. They are often buying instruments that are the lowest yielding 
within the United States economy. They are not particularly driven by 
yield but by the effect on their own currency. 
   I have some thoughts about the manipulation side of this issue. 
China is maintaining a currency peg and has for a long time. So has 
Hong Kong, as you know, using the same techniques. But it extends more 
broadly. Brazil, each day this year so far, has been intervening in 
markets to keep the real from strengthening. Japan, over the years, has 
built up some $800 billion of United States treasury deposits, in part 
for the purpose of keeping their currency from strengthening. Russia, 
of course, is maintaining the same policy. 
   While we have tended to single out China as breaking the rules, it 
is actually a widespread common behavior by foreign central banks to do 
this. 
   The mushrooming of this intervention process has coincided with the 
very low interest rates that the United States has been running. Part 
of what the other countries are trying to do is not have their rates as 
low as the United States because they are afraid of overlending within 
their own economies. 
   The United States had a 1 percent interest rate in 2004, at a time 
when the economy was growing fast. That is part of the reason the 
foreign countries are having to buy up so many dollars. We were putting 
out a lot of dollars in that period. 
   Mr. BERGSTEN. To put a fine edge on it, most of the private foreign 
investment in the dollar, which is still by far the larger part of it, 
is probably motivated by financial return and economic considerations. 
But David put it very nicely, the buildup by foreign central banks is 
very much driven by their mercantilist interest. 
   To put a sharp edge on it, the China and other countries are buying 
dollars through their official entities as a means of subsidizing their 
exports and their jobs, and it is part of their development strategies. 
They know they are going to take a capital loss because they know the 
dollar will go down at some point. They never mark to market so they 
will not be held accountable for that. They have not suffered any 
international reaction either. So it is a wonderful policy tool. 
   But you are right to flag the point. It is not because of some 
wonderful financial attraction of the dollar, it is because of the 
export subsidy policies of the other countries. 
   Senator CARDIN. Mr. Cline, my time is up, so if you could be brief 
it would be helpful. 
   Mr. CLINE. Just to make the point that the subsidized currency as a 
form of unfair trade is a much murkier area in terms of protection than 
good old fashion quotas and tariffs. Whatever we do, I think it is 
important we try to stay within the WTO/IMF framework. 
   I can see, if the Chinese do not eventually change, the case for 
taking a countervailing duty case to the WTO on grounds that the 
practice is a subsidy to exports that ''frustrates the intent of this 
agreement'' which is language that is right in the GATT when it refers 
to exchange rates. 
   I was interested that Fed Chairman Bernanke called it a subsidy, 
that is a very loaded word which I am sure many people immediately 
sensed. 
   So sooner or later this new area of unfair trade may have to be 
addressed. We hopefully can get changes without going down that route. 
If we do go down that route, I think it would be important to try to 
stay within the IMF/WTO-- 
   Senator CARDIN. I would agree with you, but I would tell you, we 
have run out of patience. It is time for action. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator Cardin. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Would you gentlemen be good enough to give me some historic context 
on where you think our present current account deficit is vis-a-vis 
other moments in our history where we have run significant current 
account deficits? Mr. Cline? 
   Mr. CLINE. Yes, I have a chart-- 
   Senator WHITEHOUSE. Dr. Cline, my apologies. 
   Mr. CLINE. I have a chart on page two of my book which shows United 
States current account balances as a percent of GDP from 1869 to 2004. 
We were in deficit from 1869 to about 1877. Then we were more or less 
in balance through 1914. Then we were in surplus from 1914 until 1979, 
with the occasional exception. The surplus was 6 percent of GDP in 
1917. It would seem to be an average about 1 to 2 percent of GDP during 
that extended period. 
   We only began this period of secular deficits in basically the 
1980's. We have had two cycles. We had the big cycle with the 
overvaluation of the dollar in 1983-1984. Then there was a correction 
by 1990 and we were back to balance in 1990. And then we have had this 
second cycle, which has shown a steady widening to 7 percent. 
   Senator WHITEHOUSE. So fair to say that from the point of view of 
history, at least since the Civil War, we are running the biggest 
current account deficit we ever have by a significant margin? 
   Mr. CLINE. That is unambiguously true. 
   Senator WHITEHOUSE. With respect to how that corrects, you have 
talked about the hard landing scenario and the soft landing scenario. 
There was an article some time ago that I remember, I think it was 
written by James Fallows, that was in the form of a memo to the 
president looking backward on the consequences of a hard landing. Do 
any of you remember that article? It was in Atlantic or Harpers, one of 
those magazines. No? 
   In terms of the brutal correction that Dr. Bergsten referred to as a 
potentiality, in terms of the likelihood of whether we are going to 
have a hard or a soft landing, how would you advise us at present that 
likelihood shakes out? Is it a 1 percent chance of a hard landing or a 
brutal correction? Is it kind of 50/50 now? What is your educated 
guesstimate on what the likelihood of is of the brutal correction 
versus the soft landing? 
   Mr. BERGSTEN. I still think it is better than 50/50 that we can 
achieve a soft landing because the economy is basically strong and 
there is not such a huge attraction for capital in Europe or Japan, 
including for some of the reasons David Malpass said. 
   And if the dollar did start to go into a free fall, the G-7 and the 
Asian countries, I think, would come into the market with official 
intervention to try to slow it down. Neither we nor they would want to 
see a crash. So there are defenses against it, and I think that is the 
more likely case. 
   However, that is premised on our not doing something ourselves that 
would trigger a substantial loss of confidence in the dollar and our 
economy, such as a renewed explosion of budget deficits. The issue we 
are talking about here has the potential to move in either direction. 
Now all sorts of other things could happen. If the world lost 
confidence in the Federal Reserve, which again I do not anticipate, but 
if that were to happen; if for whatever reason--higher energy prices or 
the dollar decline itself--United States inflation were to crank up. 
David Malpass shared some of the concerns about inflation perking 
up--if all that were to be seen as likely and being sustained, then 
that would erode a lot of foreign confidence in the dollar. 
   If the other key surplus countries like China took the advice to 
shift the focus of their own growth strategy away from relying on 
exports to relying on domestic demand, they would not need to subsidize 
their exports so much. So that buildup of foreign official holdings 
would decline. 
   In short, there are a lot of possibilities for converting it from 
what I still think is more likely, which is a soft landing, to a hard 
landing for us to be complacent and fail to take preemptive action. 

   Senator WHITEHOUSE. I guess the last question on this, to what 
extend do you all believe that the prospect of a hard landing is one 
that could strategically be triggered by an outside economy or an 
outside government, for instance China? And to what extent do you think 
the threat of that is realistic in the foreign policy perspective? Are 
we vulnerable to that. Or are the checks and balances that you referred 
to such that there really is not anything that a government could 
realistically do to trigger a hard collapse if very adverse 
relationships began to develop and they were using it as a strategic 
vehicle? 
   Mr. BERGSTEN. They certainly could do it. They certainly have the 
wherewithal to do it. 
   Senator WHITEHOUSE. And consequently, the wherewithal to threaten 
seriously. 
   Mr. BERGSTEN. Right, so it is not idle to worry about it. However, 
that is one of the things I worry about least, because it is hard to 
see what the motivation for any foreign country, be it an ally like 
Japan or a potential adversary like China, to drive down the exchange 
rate of the dollar. Yes, they could do us some damage, but they do 
themselves a lot of damage, too. They would trash the value of their 
remaining horde of dollars. More importantly, they would drive down the 
dollar against their own currency, hurting their export competitiveness 
and their subsidy. 
   Central banks, who hold these dollars in virtually every country 
around the world, have a fundamental mission of avoiding financial 
disruption for their own countries and for the world. So it is very 
hard to see the scenario under which any of them would do it. But they 
do have the wherewithal. 
   And I will go back to what Senator Conrad said at the start, rumors 
of such action can destabilize markets. The big dollar decline in the 
1970's was triggered in part by rumors that Kuwait was going to sell 
$100 million of its dollar holdings. We never found out if they did it, 
or even thought about it, but rumors thereof are important. 
   And the chairman showed an FT article that noted that even some talk 
in that direction by Chinese officials could bring the dollar down. 
   When people say the dollar fell sharply as a result, usually it is 1 
or 2 percent. It is not very serious. And since we need a somewhat 
lower dollar for competitive reasons anyway, I do not worry about that. 
But it is true that such rumors could trigger market sentiments, which, 
if they snowballed into the private investors, could start the free 
fall and hard landing I talked about. 
   But if you ask analytically where significant downward pressure on 
the dollar most would come from, my view is overwhelmingly from the 
foreign private investors, not the foreign officials. If the foreign 
private investors lost confidence in the dollar for the reasons I was 
suggesting, then you could get the big dollar decline. There has been a 
big dollar decline once a decade for the last four decades. And it has 
always been triggered by private foreign investors. 
   Senator WHITEHOUSE. Because they do not have the export 
externalities, if you will. 
   Mr. BERGSTEN. Exactly. And so they decide that, the euro looks 
better. 
   I mentioned one point in my testimony that I have not had a chance 
to mention orally, and it is important. The creation of the euro is a 
big structural change in the world financial situation. One reason it 
has been easy for the United States to finance its deficits for the 
last 25 years since it has been running deficits is the dominance of 
the dollar in world finance. And the reason the dollar has been 
dominant in world finance for a century is that it really has had no 
competition. There has been no other currency based on an economy 
anywhere near our size or with financial markets anywhere our size. 
   That has all changed with the creation of the euro, which is based 
on an economy almost as big as ours, with more trade and more financial 
reserves. So there are now two global currencies. In fact, in the last 
couple of years there has been more flotation of bonds in euros than in 
dollars; more euro currency is now held around the world than dollar 
currency. 
   The potential therefore to move out of the dollar elsewhere or just 
to put those new investments every year into another currency is now 
very different than it has been for the whole earlier period of our 
external imbalances. 
   The role of the euro is steadily creeping up vis-a-vis the dollar, 
taking more market share from the dollar in world finance. And that 
pace could accelerate very sharply if people, for whatever reason, lost 
confidence in the United States and/or if the Europeans started doing 
better. If in Europe productivity picked up like it did in the United 
States in the mid-90's, and there is no reason it should not happen at 
some point, then you could see a big flood of investment going into the 
euro. A lot of that investment would come out of the dollar or at least 
would prevent new investment in the dollar. And then you could get--a 
sharp enough decline in the dollar to cause us real trouble and propel 
a hard landing. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Chairman CONRAD. I thank the Senator. 
   One thing I would just like to mention is well, we have been advised 
now there will be three votes at 11:55 and I want to make certain that 
Senator Sanders has the time that he deserves with the panel. 
   One other observation I would make, to take this back to a budget 
context, because we have kind of veered off into mostly talking about 
the trade imbalance, which is critically important. It is the two of 
them in combination that I think has to concern us. 
   And in the budget context, the thing that we have to be most 
concerned is the dissavings by the United States created by large 
increases in the Federal debt and this tremendous run-up that we 
forecast with the retirement of the baby boom generation. 
   And it is, as you said earlier in your testimony, Dr. Bergsten, it 
is that effect that we have to be concerned about in terms of this 
committee's jurisdiction and we have to focus on. 
   I think even Mr. Malpass would agree that is a place where we have a 
special responsibility. 
   Senator SANDERS. 
   Senator SANDERS. Mr. Chairman, I apologize for being late and I 
welcome our panelists. I am sorry but I have not figured out yet, as a 
new senator, how to be in four places at exactly the same time. So I do 
apologize. 
   This issue that you are discussing, actually, is one that I consider 
to be of enormous importance and of great interest to me. 
   I would like to make a brief presentation and then I would like to 
ask you a kind of dumb bunny question, if I might. My presentation is 
this: it seems to me at least, as somebody who had been in the House of 
Representatives for 16 years, was there in the beginning of NAFTA and 
that debate, that corporate America and the corporate media was very 
solidly and is very solidly behind unfettered free trade. We were told 
from the beginning of NAFTA and PNTR with China that this is really 
going to be a good thing for American, in the sense of creating good 
paying jobs in this country, reducing our trade deficit, dealing with 
immigration, et cetera, et cetera. 
   It seems to me that the evidence is quite overwhelming that what we 
were told by corporate America and by Presidents Reagan, Bush I, 
Clinton, Bush II, was going to happen, in fact has not happened. That 
the reality is not only that today we have a trade deficit of over $800 
billion, of great concern to everybody, we have lost 3 million good 
paying manufacturing jobs. 
   Mr. Chairman, I do not know about North Dakota but in the State of 
Vermont in the last 10 years one new company has come into our State 
which is providing very good paying jobs. One new company in 10 years. 
I do not know how different it is in North Dakota. 
   I was in China 5 years ago and, as all of you know, China is 
exploding. You cannot walk into a town without seeing a huge amount of 
building activity and so forth and so on. In my State, a small State, 
not a manufacturing State, we have lost 20 percent of our manufacturing 
jobs in the last 5 years. One out of five of our jobs. 
   We are losing good paying jobs. Most of the new jobs that are being 
created pay lower wages than the jobs that we are losing. We are 
running up a huge trade deficit. There is speculation, for example, 
that the automobile industry in the United States may be in China in 20 
years. 
   My dumb bunny question is in the midst of all of that reality of the 
decline of the middle class, the increase in poverty, the loss of good 
paying jobs, the growth of our trade deficit, why is anybody continuing 
to defend our current trade policies? And why are people not saying 
excuse me, it is not worked, we need to rethink them very 
fundamentally? Dr. Bergsten? 
   Mr. BERGSTEN. The huge trade and current account deficits cannot 
really be attributed to trade agreements. They can be attributed to 
these big macroeconomic imbalances that we talked about, including the 
exchange rates. 
   I spent 2 hours before the Senate Banking Committee yesterday 
talking about the Chinese exchange rate and laying out a very 
aggressive program for attacking it, including with unilateral U. S. 
action if needed, because that exacerbates the problem so enormously. 
Senator SANDERS. But let me ask you this, and I share that concern. But 
if you are an employer in North Dakota or in Vermont and you can move 
to China and hire people, hard-working good people, at 50 cents an 
hour, you do not have to worry about unions, you do not have to worry 
about environmental protection, why would you not do that? 
   Mr. BERGSTEN. The reason you would not is because the productivity 
of those Chinese workers is, in most cases, equally lower than their 
wages. 
   Senator SANDERS. I do not believe that. 
   Mr. BERGSTEN. In the aggregate it is true. But, I will grant you in 
some sectors it is not true, and that incentive exists in some sectors. 
Senator SANDERS. The people who run companies like General Electric are 
not dummies. When you have the CEO of General Electric saying that he 
sees the future of GE in China, or when you see white collar companies, 
information technology companies, moving as fast as they can to India, 
I understand the productivity in the United States is going to be 
higher in China. But if I am paying somebody 50 cents an hour, as 
opposed to $15 an hour or $20 an hour, I could compensate for that. If 
you work half as effectively I still make a lot more money. And the 
proof is in the pudding. 
   Mr. Chairman, how many new plants have been built in North Dakota in 
the last 10 years? 
   Chairman CONRAD. I do not know how many new plants. We do not 
have--we are very different, on almost any national metric, North 
Dakota is different. 
   [Laughter.] 
   Chairman CONRAD. We have had an increase in manufacturing in North 
Dakota but that is an unusual set of circumstances that relates to--you 
know, most people do not think of North Dakota as an energy state, but 
we are. So that changes things. 
   Senator SANDERS. But in Vermont, and I think in the Northeast, what 
I am telling you is truth. There has been one major plant that has come 
in. 
   My point gentlemen, and I would love to hear other discussion on it, 
is I think what has been distorted is you have--I remember, Mr. 
Chairman, because I was here for the NAFTA debate, every major 
newspaper in America editorial, down to the Toledo Blade, supported 
NAFTA. And I do not know how much change there has been in mentality. 
But I think if you look at it objectively, it is very hard to defend 
from the standpoint of the middle class or working families of this 
country, our current trade policy. I think more and more Members of 
Congress are beginning to understand it. Certainly the American worker 
understands that. 
   But other discussion on why, at this point, somebody should say 
oops, we made a mistake. We have to rethinking this. And not just blue 
collar. I worry about white collar information technology jobs, as 
well. 
   Any other comments, I would appreciate it. 
   Mr. CLINE. If I might, I think it is fairly important to remember 
that Americans, the modest income households in this country also get a 
tremendous benefit from the availability of goods at bargain prices. 
Their real incomes would be considerably lower if we had protection 
like we used to, sky-high protection on apparel, for example. 
   But I fully agree with my colleague, Fred Bergsten, that these huge 
widening trade deficits have much more to do with our macroeconomic 
policy, our fiscal policy, with exchange rates than they have to do 
with any massive change in our trade policy. 
   There are other industrial economies, Europe is not in a situation 
of big trade deficits because of low-wage foreign competition--your way 
of looking at it, which is an understandable initial approach. But if 
you parse it through, it seems to me it would imply that, of course, 
Europe and Japan would have tremendous deficits because they, too, have 
industrial country wages, in many cases higher than our wages. And 
neither can they compete with China. 
   Well, we know that is not true. Europe actually had a surplus. It is 
about in trade balance. Japan has a huge surplus. 
   I think you have your finger on the right concern, that the external 
sector is making life harder for American manufacturing than it need 
be. But I do not explain that because of NAFTA, and I do not explain it 
because of low wages in China. I do attribute to the constellation of 
macro policies that have led us to where we have the largest external 
deficit in our history. 
   Senator SANDERS. My last question, and thank you for the time, Mr. 
Chairman, is worker productivity in the United States has risen quite 
rapidly. And yet in the last 6 years real wages or median family income 
has gone down, workers are working, in many cases, longer hours for low 
wages, poverty has increased substantially. Why? And how can that not 
have something to do with our trade policies? 
   Mr. CLINE. If my colleagues will forgive me, let me address that, 
too. Because I did a book in 1997 called Trade and Income Distribution. 
And it tried to parse out what was the role of trade and other factors 
in the rising wage differential between skilled and unskilled workers. 
And that had been going on since the 1970's. 
   My conclusion was that we should have expected that wage 
differential to decline because we had a huge increase in the supply of 
skilled workers from universities cranking out graduates. Instead, it 
increased. 
   So there must have been large unequalizing forces. And the bulk of 
the unequalizing force seems to come from technological change that 
shifted out the demand for skilled workers more than the supply had 
shifted out. 
   My calculations did show some modest further contribution from open 
trade, but it was much less important, far less important, than the 
technological change. And also, a very substantial contribution from 
the erosion of the real minimum wage and from the erosion of unions, 
de-unionization in the country. 
   So I think there are a number of factors that have given us this 
uncomfortable period of a widening of the income disparities. I think 
it is wrong, though, to think that trade is the most important of 
those. 
   And I would reiterate that trade protection hurts the consumers who 
are buying a lot of goods that are imported at prices that otherwise 
would not be available. 
   Senator SANDERS. I do understand that, but I have a real fear that 
a great nation is not going to be a nation where millions of low-wage 
workers go to Wal-Mart. I do certainly agree with you. You can buy 
products very, very reasonably at Wal-Marts and other stores, no 
question about it. 
   But that is not, I hope, what the future of American is, that we 
have workers who are working at low wages who survive by buying cheap 
labor made by people who make 30 cents an hour abroad. I would have a 
different vision for America. 
   Yes, sir. 
   Mr. MALPASS. Thank you, Senator Sanders. 
   I wanted to underscore Fred and Bill's points, and would agree with 
those in diverting the attention from the trade agreements into the 
macro climate. 
   I do not think it is a fair characterization to describe the United 
States as headed in the direction that you are saying. This is a 
vibrant economy that is growing fast, that is creating a lot of well 
paying new jobs. 
   The challenge is the amount of change going on in the United States 
Each quarter there is a tremendous number of Americans that leave a job 
and go to a new job. 
   One of the things happening has been a migration from New England to 
the South. I am from New York State. New York State is losing 
population each year, and quite dramatically, at a time when the rest 
of the country is adding population. That creates particular strains. 
   We can think in terms of transition assistance for people migrating 
to different parts of the country or different types of jobs. I think 
that we have to put some of these concerns into the overall 
manufacturing transition of the United States economy to services. In 
many ways, the United States is ahead of the rest of the world in doing 
the products of the future rather than products--you mentioned 
automobiles--the products that were invented a long time ago. 
   One final point-- 
   Senator SANDERS. I am not quite clear on what that means. 
Manufacturing jobs are in decline in the United States; is that 
correct? 
   Mr. MALPASS. Yes. That decline has actually been a straight-line 
process for 50 years. 
   Senator SANDERS. And the new jobs, service industry jobs--I am not 
an economist, but my impression is--pay substantially less than 
manufacturing jobs? 
   Mr. MALPASS. No, I do not think that is correct. 
   Senator SANDERS. Service industry jobs, working at Wal-Marts does 
not pay less than working at General Motors? 
   Mr. MALPASS. That would be correct. 
   Mr. BERGSTEN. Working at Goldman Sachs. 
   Senator SANDERS. Goldman Sachs is a service industry jobs? 
   Mr. MALPASS. On average, services jobs pay more than manufacturing 
jobs. 
   Senator SANDERS. Waiters and waitresses? I mean, I guess the problem 
is working at Goldman Sachs they are going to get a $50 billion bonus. 
Do we equate that in the same category as working at McDonald's, does 
not make a lot of sense to me. 
   Mr. BERGSTEN. No, but workers in the big services 
sectors--hospitals, health care, education, teachers, administrators, 
and government employees. Those are the big parts of the services 
sector. 
And even some retail and wholesale trade jobs actually pay pretty well. 
You are right, of course: A hamburger flipper or a low-wage janitor are 
services jobs as well. But so are some apparel and footwear workers, 
who to the extent that they still exist get very low wages as well. But 
services, on average, do pay higher than manufacturing jobs. And that 
is fortunate, since that is 80 percent of the work force now. 
   Mr. MALPASS. May I add one more point? You raised the median income 
issue. 
   We have gone through a remarkable 10-year period with the swing in 
the value of the dollar. Some portion of the median income weakness of 
these last 5 years has been related to this. As the dollar weakened in 
2001, 2002, and 2003, with low United States interest rates, commodity 
prices went up a lot. Wages are just now beginning to go up as much. 
   There is a timing cycle that is adding to this sense of the median 
wage being weak. The first prices to adjust, after a big devaluation of 
the dollar as we have gone through, are for things that are not so much 
produced in the United States That is going to have a negative effect 
on the median wage until workers catch up, which is the process we are 
in now. 
   Chairman CONRAD. Can I just say-- 
   Senator SANDERS. Do we have a vote? 
   Chairman CONRAD. Yes, the vote has started, and we are probably 3 
minutes into the vote. I would say to my colleague, we would give Mr. 
Bergsten a chance to respond and then if you would have a final 
question. 
   Mr. BERGSTEN. To be clear, we as a country do a lousy job equipping 
our lower-skilled, lower-educated, lower-income people to compete in a 
globalized economy. We have done intense studies of globalization's 
effect on the United States economy. We conclude that the United States 
economy as a whole is today $1 trillion per year richer than it would 
otherwise be as a result of our integration into the world economy and 
globalization. That is $10,000 per household. 
   However, it does add to the unequal income distribution. And 
therefore, there is a cardinal need for the country to do a much better 
job in K-12 education, in training programs, and in transitional safety 
net assistance to help the losers, which there clearly are as part of 
the process, to reap some of the benefits. 
   We gain $1 trillion a year. We spend $1 billion a year on trade 
assistance. 
   Senator SANDERS. My constituents do not gain part of that. Most of 
that or much of that $1 trillion goes to people very much on the top. 
   Mr. BERGSTEN. That may be for the next debate, but as Bill Cline 
said, a lot of it goes to low-income people because of those cheaper 
goods at Wal-Mart. 
   Chairman CONRAD. Let me just put a final question to you. 
   In terms of the responsibility in this committee, and I would just 
ask you to respond briefly, do you believe it is important that we work 
to address especially these long-term fiscal imbalances that we 
confront? 
   I would start with you, Mr. Bergsten. 
   Mr. BERGSTEN. It is imperative that you fashion and implement soon a 
decisive answer to the long-run fiscal problems. In addition to all the 
domestic problems it would cause, we would almost surely be triggering 
at some point--sooner rather than later--an external crisis that would 
be enormously damaging to the United States economy, United States 
foreign policy, and all of the objectives that you and the committee, 
but Congress more broadly, are pursuing. 
   Chairman CONRAD. Dr. Cline? 
   Mr. CLINE. Yes. I think it is critical. Some of the numbers are just 
mind-boggling in terms of the rise of Medicare and Medicaid as a 
percent of GDP. It is a rise from 4 percent of GDP to 12 percent of GDP 
or something like that. That is critical. 
   I would also underscore that I think even in the shorter term, three 
or four or 5 years, it is highly desirable to move from our 2 percent 
of GDP realistic deficit to something like a 1 percent surplus. 
   Chairman CONRAD. Mr. Malpass? 
   Mr. MALPASS. Mr. Chairman, and I agreed with your point that it is 
imperative that we do things. I will list four. One is be very cautious 
of new entitlements. They kind of creep up decade after decade. Also, 
be cautious of expanded entitlements. They quietly gather more reach. 
   With regard to Medicare, pay particular attention to possible 
efficiencies within Medicare. 
   And then fourthly, a glaring need is tax reform. We have a tax 
system that does not work, and there is no real plan to begin to fix 
that. 
   Chairman CONRAD. Let me just say that is one of the things Senator 
Gregg and I have tried to put on the agenda here, is a procedure that 
would involve eight Democrats, eight Republicans. They would be given 
the responsibility to come up with a plan that would involve both the 
long-term imbalances and tax reform and revenue issues and come back 
with a plan that would take a super majority of that committee to 
report, and it would take a super majority here to pass on a fast-track 
basis. 
   That is what we are trying to advance here. And that is a challenge 
in and of itself. 
   We are well into this vote. I just want to conclude by thanking this 
really distinguished panel. You have been, I think, especially 
interesting to the committee. 
   Thank you very much. 
   [Whereupon, at 12:06 p.m., the committee was concluded.] 


                 HEARING TO CONSIDER WAR COSTS 

                            ---------           

                    TUESDAY, FEBRUARY 6, 2007 

                                           UNITED STATES SENATE,
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:08 a.m., in room 
SD-608, Senate Dirksen Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Murray, Wyden, Stabenow, Menendez, Cardin, 
 Sanders, Whitehouse, Gregg, Domenici, and Allard. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

            OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. I would bring the hearing to order. 
   I would like to welcome everyone to today's Budget Committee hearing 
on war costs. I would like to particularly welcome our witnesses. Dr. 
Gordon Adams, a Fellow at the Woodrow Wilson International Center for 
Scholars, and a former Associate Director of the Office of Management 
and Budget for National Security. Welcome, Dr. Adams. 
   Dr. Michael Gilmore, the Assistant Director of the Congressional 
Budget Office and the head of CBO's National Security Division, 
somebody who is very respected on these issues. We are glad to have you 
here. 
   And Steve Kosiak, the Director of Defense Budget Studies at the 
Center for Strategic and Budgetary Assessments. 
   Thank you all for your contribution to the work of the committee. 
   I want to indicate that, in addition to today's hearing, next 
Thursday we expect to hear from the Secretary of Defense, Mr. Gates, on 
the question of war costs, as well as the overall defense budget. 
   The Administration has been financing this war not through the 
regular budget process but, as you know, through a series of 
supplemental appropriations bills. We very much believe that these war 
costs ought to be considered in the regular budget process so they get 
the oversight that they deserve. 
   To do the war funding the way the Administration has been doing it 
avoids accountability and oversight. When we are spending over $10 
billion a month, we think it is critically important that Congress 
conduct its oversight responsibilities. 
   Let me be clear, we will provide our troops with everything they 
need for as long as they are in harm's way. I want to be crystal clear 
on that point. We will stand shoulder to shoulder with those who are 
supporting the resources that are necessary for our troops in the 
field. That is a responsibility that all of us on this committee 
recognize. 
   But we will also conduct the oversight that has been lacking because 
these provisions have not been in a budget request. 
   I want to, at this moment, commend my colleague who chaired this 
committee previously for his vigorous insistence that these costs be 
included in a budget. Senator Gregg was a leader on this matter, is a 
leader on that matter, and I want to commend him for it. 
   The fact is that the Bush Administration has not shown, in its 
previous budgets, the full cost of the war. At one point at the 
beginning of the war the head of the Bush Administration's USAID said, 
and I quote, ''That is correct, $1.7 billion is the limit on 
reconstruction for Iraq. In terms of the American taxpayer 
contribution, that is it for the United States The rest of the 
rebuilding will be done by other countries and Iraqi oil revenues.'' 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   He could not have been more off the mark. We have already committed 
$28 billion for Iraqi reconstruction, and that does not count the money 
for their security forces. 
   At another point, in testimony before the Congress, the Deputy 
Defense Secretary, Mr. Wolfowitz, said this ''The oil revenues of Iraq 
could bring between $50 billion and $100 billion over the course of the 
next two or 3 years. We are dealing with a country that can really 
finance its own reconstruction, and relatively soon.'' That prediction 
was also wrong. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Secretary of Defense Rumsfeld was even more dismissive of 
predictions that the war could be costly. Here is the transcript of an 
interview on This Week With George Stephanopoulos. 
   Stephanopoulos: What should the public know right now about what a 
war with Iraq would look like and what it would cost? Secretary 
RUMSFELD. The Office of Management and Budget estimated it would be 
something under $50 billion. 
   Stephanopoulos: Outside estimates say up to $300 billion. Rumsfeld: 
Baloney. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   It was not baloney. We now know that the $300 billion estimate does 
not cover the cost of the war this far. In fact, it was far below the 
cost of the war to this juncture. 
   Including the requests in the President's budget released yesterday, 
the Administration has now asked for a total of over $520 billion in 
emergency funding on top of the regular defense budget. That is more 
than 10 times the Administration's original war cost estimate. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   To put this cost in perspective, the Iraq war is now approaching the 
cost of the Vietnam War. In 12 years of major involvement in Vietnam, 
we spent $650 billion in today's dollars. Less than 4 years after the 
invasion of Iraq, we are now considering a request that will bring the 
total cost of the Iraq war to more than $500 billion. And that is 
without including the $50 billion placeholder the President included in 
his budget for war costs in 2009. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   If we add Iraq and Afghanistan costs together, we are already well 
above the cost of the Vietnam War. Unfortunately, Iraq has diverted 
resources from our effort in Afghanistan. The news from Afghanistan has 
been troubling and disturbing. The situation there looked like it was 
improving a few years ago but now has deteriorated. We, I think, all 
understand the absolute necessity of prevailing in Afghanistan. 

   The budget also reflects these wrong priorities. Between what we 
have spent and what the Administration has requested, Iraq has received 
$3 for every dollar in Afghanistan. That is despite the fact that it 
was Osama bin Laden, based in Afghanistan, who attacked the United 
States and not Iraq, led by Saddam Hussein. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   The Bush Administration's cost estimate on the buildup, the further 
buildup that he is calling for in Iraq, has also been subject to 
question. The Administration has indicated to us that the cost of the 
escalation in Iraq would be $5.6 billion. Yet last week the 
Congressional Budget Office informed the committees that the surge 
would actually cost $9 to $27 billion, depending on the duration of the 
escalation because the Administration was not fully accounting for the 
cost of all of the support troops needed. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   In addition to questions about the number of support troops needed 
for the President's plan, there are also questions about whether our 
troops lack the equipment needed to get their job done. Here was a 
Washington Post headline last week ''Equipment for added troops is 
lacking: new Iraq forces must make do, officials say.'' 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   That is a serious matter. We should not be sending our troops into 
harm's way without the equipment that they need. I see no indication 
that the President's plan will cover the costs, his budget plan will 
cover the costs that CBO has alerted us to. 
   I look forward to hearing our witnesses thoughts on the costs of the 
President's proposals and look forward to the chance for questions from 
the panel. 
   With that, I turn to my colleague, Senator Gregg. 

        OPENING STATEMENT OF SENATOR JUDD GREGG 
   
   Senator GREGG. Thank you, Senator Conrad. And I do think this is a 
very appropriate hearing. I wish we had someone from the Defense 
Department testifying, but I know it is difficult to get them to come 
to the Budget Committee, having been chairman and requested that a 
number of times. 
   I appreciate the Senator's comment that the troops in the field will 
get the support they need. Obviously, I believe that is the correct 
policy. I know the Senator is very sincere in his belief in that. I 
just wish the Majority Leader were equally sincere and would allow us a 
vote on that specific language this week, which appears to be something 
the Majority Leader is now going to allow us to do. That is a fairly 
reasoned position. But the troops in the field should be supported. But 
as of right now, the Majority Leader takes the position that the 
amendment should not be allowed to the floor as one of the three things 
we vote on or four things we vote on this week. Very strange in my 
opinion, inconsistent to say the least. 
   On this next issue, however, of budgeting for troops and our costs, 
I do agree with the Chairman. We have very serious concerns about the 
way the Administration has brought forward their budget. I will begin 
by congratulating them for at least including this year what they 
project as the full cost in 2008. I thank Director Portman for 
insisting on that. I do not think the Pentagon would not have done it 
without the Director's insistance. 
   However, once again they have designated it as an emergency. This is 
unacceptable. It is very clear, after 5 years of war, that it is not an 
emergency, that it is something that we have to do. We have to fight 
this war and we have to make sure our troops that go into this battle 
are fully supported with the resources they need. And it should go 
through the regular order. Because we have seen in a couple of the 
other supplementals that have been sent up that things which were not 
war fighting have been included. And it has been represented, at least 
in press reports, that that may occur again, such as the repositioning 
of the Army and aircraft would be purchased for the out years, and even 
boats that do not deal with the immediate issue of fighting the war. 
   So I do think this language should have the emergency designation 
stripped from it, and it should go forward as a sidecar. That is the 
way I would describe it. I do not want it folded into the core budget 
because I do not want, two or 3 years from now when the war does wind 
down and we are out of Iraq, which we all hope will happen, I do not 
want the defense base to have grown by the amount of the war cost. And 
then we have to go back in and pick the money out in order to get the 
defense repostured at its proper level. 
   I believe we should have a base budget for the Defense Department 
and we should have what I call a sidecar for fighting the war. But it 
should not be an emergency event, it should go through the authorizing 
process. 
   I will be interested in the proposal that comes forward from our 
Democratic colleagues, as they are now responsible for the reins of 
Government, and specifically the budget. As we all know, the budget is 
not signed by the president, it is truly a work of the Congress, about 
how you are going to handle these war costs. 
   My own view is you need to put more in for 2009. I think the White 
House and the Administration has grossly underrepresented that number 
with a $50 billion plug. That is not anywhere near what the 2009 cost 
is going to be. A more correct number is probably going to be on what 
the historic average is, somewhere around $90 billion or $100 billion. 
But it will be interesting. You have a difficult task, and I will be 
happy with you on that. 
   But I do think we should get this number right and we should give 
the military the dollars they need to make sure the men and women who 
are in the field are properly supported. And we should do it in the 
regular order, not outside the regular order. 
   I thank you for having this hearing. 
   Chairman CONRAD. I thank Senator Gregg for those observations. 
   We will now go to the witnesses, and we have asked each of them to 
limit their remarks to five to 7 minutes so there are sufficient time 
for questions by colleagues. 
   We will start with Steven Kosiak, the Director of Budget Studies, 
the Center for Strategic and Budgetary Assessments. 
   Welcome, Mr. Kosiak, and please proceed with your testimony. 

              STATEMENT OF STEVEN M. KOSIAK, VICE PRESIDENT FOR 
                  BUDGET STUDIES, CENTER FOR STRATEGIC AND 
                             BUDGETARY ASSESSMENT 

   Mr. KOSIAK. Thank you. 
   First I want to thank Chairman Conrad and the rest of the committee 
for inviting me to testify this morning on this very important subject. 
In my testimony, I want to make four points related to the costs and 
funding for the global war on terror, or the GWOT. My first point is a 
simple one, and that is that the GWOT has proven to be very costly, and 
those costs have grown substantially over time. 
   All together, the money that's been appropriated so far through 
2007, is $502 billion for the GWOT, and that includes--you can get 
somewhat different estimates--something like $345 to $375 billion for 
Iraq, $100 billion for Afghanistan, and $25 to $55 billion for a 
variety of other programs and activities. 
   Yesterday, the Administration requested another $93 billion for 2007 
and $142 billion for 2008. 
   Assuming these two measures are enacted, total funding for the GWOT 
would rise to about $737 billion through the end of next year. That 
would make the GWOT more expensive than either the war in Vietnam or 
the war in Korea. 
   GWOT funding is not only high today, it has been growing 
significantly over time. Back in 2001, when we first sent troops into 
Afghanistan, the budget was about $14 billion. In 2003, after we sent 
large forces into Iraq, the budget jumped to about $88 billion. In its 
most recent request, if you add together what's already been provided 
by Congress in 2007 with the new request, it would amount to about $163 
billion. That is roughly a doubling of GWOT costs in just the past 4 
years. 
   The second point I would like to make is that it is unclear why the 
GWOT has proven to be so expensive and why there has been such 
significant cost growth in recent years. 
   Chairman CONRAD. Mr. Kosiak, when you refer to GWOT, just for those 
who are listening, you are referring, I assume, to the global war on 
terror? 
   Mr. KOSIAK. Yes, yes. 
   Chairman CONRAD. That is kind of the shorthand here in Washington, 
but those who are listening in might not be able to translate that. 
   Mr. KOSIAK. Good point. 
   If you look at the estimates of the cost of conducting military 
operations in Iraq and Afghanistan, those have grow significantly over 
time, and this is true even if you adjust for changes in force 
structure, and in force levels that have occurred. 
   In September 2002, CBO estimated that based on the cost of past 
conflicts like Desert Storm/Desert Shield and operations in Bosnia and 
Kosovo, sustaining an occupation force consisting of 75,000 to 200,000 
United States troops in Iraq would cost something like $20 to $50 
billion a year. And that works out to about $250,000 per troop. 
   CBO's high-end estimate of the number of troops required turned out 
to be fairly close to the mark, but its per troop cost estimate turned 
out to be far too low. 
   In 2004, CBO released another estimate. In this case, the costs per 
troop work out to something like $320,000 per troop. In its most recent 
2006 estimate, CBO increased its estimate of funding for the global war 
on terror once more. This time the costs per troop work out to 
something like $540,000 per troop. 
   This is more than twice what CBO estimated in 2002 prior to the war 
in Iraq, and nearly 30 percent higher than what they were projecting 
just a few years ago in 2005. 
   If this cost growth in CBO's analysis were based on data they had 
gotten from DOD, rigorous detailed cost data, then this cost growth 
might not be so troubling. But that is not really what it is based on. 
CBO's latest estimate is basically a simple extrapolation of enacted 
appropriations from 2006 adjusted for inflation and changes in force 
levels. It is not a truly independent estimate of the cost of military 
operations in Iraq or Afghanistan or other activities related to the 
global war on terror. 
   This cost growth might also be less troubling if it were clearly 
linked to changes in OPTEMPO or changes in the amount of equipment that 
needs to be replaced and repaired, or the inclusion of costs related to 
training and equipping Iraq and Afghan security forces. But even taking 
these factors into account, much of the growth I have described is left 
basically unexplained. 
   I want to make clear that nothing I am saying here should be taken 
as a criticism of the Congressional Budget Office. The problem is that 
CBO has not been provided with the kind of data it needs to do these 
kinds of estimates, either to do independent estimates of GWOT costs or 
to verify the accuracy of DOD's estimates of GWOT costs, as well as 
funding requirements. 
   It has also made it very difficult to project future funding 
requirements with any level of confidence. This is a point that CBO has 
made on multiple occasions over the past year and going back at least, 
I think, as far as 2004. 
   The third point I would like to make is that an increasing share of 
funding for the global war on terror appears to be going to programs 
and activities that are, at best, only indirectly related to the 
military operations in Iraq or Afghanistan. This may be part of the 
explanation for this cost growth that we have seen in recent years. 
There has always had some funding in these supplementals that has been 
unrelated or only loosely related to the wars in Iraq and Afghanistan. 
The most obvious example of that is funding for the Army's modularity 
program. But it is unclear just how much money funding in these past 
supplementals was in this category. 
   Whatever has been true in the past though, it seems likely that in 
the future more of this kind of funding is going to be included in the 
GWOT, in the global war on terror appropriations. In part, this is 
because in October of 2006, Deputy Secretary of Defense Gordon England 
sent the services a new guidance, telling them that they should not 
feel that they have to limit their requests for supplemental funding 
for the global war on terror to programs and activities closely related 
to the operations in Iraq and Afghanistan, but should feel free to 
include, with a few caveats, funding for a broad range of other 
programs and activities that fit within the broader global war on 
terror. 
   Unfortunately, in my view, this basically removed any principal 
distinction for the services between what they should include in base 
budgets, long-term budgets, and what they should include in special 
global war on terror appropriations. 
   The most significant problem with this approach is that this 
guidance basically tells the services that they do not need to find 
room in their regular baseline budgets for fully covering the costs of 
their long-term force structure readiness and modernization plans. The 
services already have a serious and persistent problem in coming up 
with and presenting long-term plans that actually fit within realistic 
projections of what level of funding is going to be available. This 
change will only make the matter worse and, in the end, the services 
will have inevitably suffered the most from this weakening of their 
planning and budgeting process. 
   The fourth and final point I want to make is just that we really do 
need to improve our understanding of these costs. If we are going to 
appropriately and effectively budget for the global war on terror in 
the future and if we are going to appropriately budget for the 
service's long-term force readiness and modernization plans. It is not 
just a question of getting the global war on terror right, it is 
getting their long-term plans right. 
   CBO has done the best that they can do with the data available, but 
that data has not been very good. And I think CBO could do a much 
better job, and other analysts could do a much better job, if the 
Department of Defense would provide more rigorous data, and more 
detailed and more timely data. 
   At present, at this point I cannot say whether that data has been 
provided in the most recent budget request or whether it will be 
provided in the coming weeks. But if it is not provided, then I think 
Congress needs to once again pressure the Administration to provide 
better data. 
   With that, I will end my comments and again, thank the committee for 
inviting me here this morning. 
   [The prepared statement of Mr. Kosiak follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 


   Chairman CONRAD. Thank you for your testimony. Now we will turn to 
Dr. Gordon Adams, a Fellow at the Woodrow Wilson International Center 
for Scholars and a former Associate Director of the Office of 
Management and Budget for National Security. 
   Welcome, Dr. Adams. 

                    STATEMENT OF GORDON ADAMS, FELLOW, 
                       WOODROW WILSON INTERNATIONAL 
                           CENTER FOR SCHOLARS 

   Mr. ADAMS. Thank you, Mr. Chairman and ranking member. Thank you for 
holding this hearing. 
   I think it is a very timely and important matter you are dealing 
with here today and it is not going to stop here. It is a matter that 
you are going to have to deal with, sadly, for sometime to come. 
   I also want to commend both you Mr. Chairman, and the ranking 
member, for stepping up to this issue over the past year, addressing 
yourselves directly to the Department of Defense and the Administration 
and urging legislating the expectation that budget expenditures for the 
global war on terror, and Iraq will be brought forth as part of the 
regular budget. I will make a comment about that in a moment in terms 
of the current budget request. 
   I want to talk about a couple of areas this morning, but let me 
start by saying that spending on the global war on terror, roughly 80 
percent of which is for the conflict in Iraq, is consuming a rapidly 
rising share of defense spending and of the overall budget. If you take 
all of the requests for the global war on terror together, over the 
next 18 months we will be increasing spending for the global war on 
terror by 50 percent over all prior spending for the global war on 
terror. So it is a very rapid slope upwards. 
   I want to talk about two areas briefly this morning. One of them 
concerns defense programs and it will reinforce some of the points that 
Steve Kosiak has just made, about the integrity of the defense budget 
process and the quality of the justification for this spending. And I 
want to mention briefly the budget implications of the Administration's 
proposal to expand the size of United States ground forces overall for 
the long war on terrorism. 
   The second area I want to mention, which we do not talk so much 
about, is international affairs spending which is also, a concern of 
this committee. I want to talk a bit about the adequacy of our 
estimating and budgeting for Iraqi security assistance and economic 
reconstruction, and about the issue of the relationship between Defense 
and the State Department and AID with respect to the delivery of these 
kinds of programs. 
   First off, defense. As Steve Kosiak has said, this war is getting 
increasingly expensive and it is, as the Chairman has said, being 
funded largely through emergency supplemental or bridge funding. 
   What is interesting is if you go back and look at the overall share 
of total resources available to the Department of Defense over the last 
eight budget years, there has been a very sharp increase in the share 
of the total resources coming through emergency and bridge funding 
supplementals. That share has risen from something like 6 percent in 
fiscal year 2001 to 21 percent in 2006 to, if you accept the 
President's current request, 27 percent in 2007, and 23 percent in 
2008, with more likely on the way. 
   In other words, about a quarter of the total resources available to 
the Department of Defense right now are coming through these emergency 
supplementals and bridge funding for the global war on terror. 
   What this has meant, in effect, is that the Defense Department has 
been conducting two parallel budget processes. One process that is, the 
PPBES, the normal programming planning, programming budgeting and 
execution system. And the other is the emergency supplemental and 
emergency bridge funding requests. 
   These latter are out of phase with the normal budget cycle in the 
Department of Defense and tend to be given much less scrutiny of the 
kind that is given to the normal budget in the PPBES system. 
   The Administration has decided it will comply with the language of 
Section 1008 of the Authorization Act and send up with its fiscal 2008 
budget the fiscal 2008 request it has in mind for the global war on 
terror. That is a good thing and I commend them for taking that step. I 
think Director Portman deserves a lot of credit for pushing that very 
hard. 
   On the other hand, this spending was still prepared outside the 
normal budget process in the Department of Defense. The guidance for 
the FY 2007 supplemental and the guidance for FY 2008 both came out 
long after the PPBES system had been dealing with scrutiny of the 
Defense Department's regular budget. So it still does not get the same 
kind of scrutiny. 
   That dual process has had a corrupting effect on the normal Pentagon 
PPBES system, because the Department tends to treat these two budgets 
as fungible. Steve Kosiak has talked about programs that show up in the 
emergency supplementals that are really longer-term, such as long-term 
delivery of aircraft, helicopters, and long-term planning for forces. 
But they show up in the emergency supplemental request. 
  Operations and maintenance funding, in general, is fungible between 
the resources provided for the war and the resources provided for the 
normal operations of the Department of Defense, outside the conduct of 
the global war on terror. 
   So, to reinforce the points that both of you have made, there needs 
to be a clearer separation between the two. Gordon England's guidance 
to the services to prepare the FY 2007 second supplemental muddied the 
waters even further by allowing items related to the long war to be 
included in the emergency supplemental. 
   Let me address my second point briefly, and that is the expansion of 
the Army and the Marine Corps, which is also included in the 
President's budget. This is relatively unrelated to Iraq, maybe even to 
Afghanistan, because troops that are needed under that process are 
likely not to be available in time to solve the stressful rotation 
problems there. 
   But here, too, there is a budgetary problem. Aside from the question 
of whether such an expansion is justified, which I have written about 
in other contexts, the emergency supplemental for FY 2007 includes $1.2 
billion for this force expansion. So it is put on an emergency basis, 
though it is not an emergency program. In timing terms, this may get it 
going but, it is in the wrong place in the budget. There is $12 billion 
in the 2008 budget for this process. 
   As a budgetary matter this force expansion has grave implications 
for the defense budget and for the overall Federal budget and for your 
work. Forces in the end drive budgets. This will be an expensive 
proposition. Press reports now say that it will cost as much as $117 
billion and it may lay $15 to $20 billion a year against each annual 
budget to accommodate the future costs. 
   Forces drive defuse budgets, and we have had a ''consumption 
driven'' buildup over the past 6 years that will further drive the 
defuse budget. We will have a lot of people who will require a lot of 
training, who will require a lot of equipment. 
   This is a problem if defense budgets turn around and start to come 
down because there will need to be bill payers. And some of that bill 
paying may happen inside the defense budget itself. That will have a 
potentially dramatic impact on the acquisition of technology and new 
equipment in the services as procurement budgets become the bill payer 
for expanded force size. 
   And it may, as well, be a problem for the Federal budget as a whole. 
In the President's budget, submitted yesterday, something like 56.2 
percent of all discretionary spending, was committed to what is called 
''security spending''. A useful concept actually, defense, homeland 
security throughout the Government, and Function 150 (international 
affairs). By 2008, that security share would rise to 60 percent, and it 
would be 65 percent if one fully included the costs of the global war 
on terror. 
   In other words, about two-thirds of Federal discretionary spending 
by 2008 would be committed to security issues. And the Administration 
has been quite up front about the priority that they put on those 
expenditures. That is likely to make your job considerably difficult, 
year by year, as those programs consume larger and larger shares of  
discretionary spending. 
   Finally, let me turn to the two implications, I want to mention for 
the international affairs account. We do not talk about it much and yet 
arguably the critical contribution that diplomacy and foreign 
assistance make to our national security obligates us to focus on those 
tools of statecraft that reinforce, supplement, may even make 
unnecessary certain military operations. 
   In the global war on terror related budgets, there are $6.3 billion 
worth of global war on terror-related nondefense programs in the 2007 
emergency supplemental and another $3.5 billion in the fiscal year 2008 
emergency part of the budget. And of this, 95 percent is in 
international affairs. 
   I want to make two points about this. Point No. 1: we are not doing 
a very good job of estimating the fiscal needs involved here. As the 
Special Inspector General for Iraq Reconstruction has pointed out in 
his latest quarterly report, the United States has comitted over $38 
billion to security assistance and foreign assistance in Iraq since the 
war began. 
   That understates, however, the level of the resources committed to 
these purposes. Over $50 billion of Iraqi government funds, some seized 
funds, some budgeted over the past 2 years, have gone to the same 
purpose. And there is $15 billion worth of international funds coming 
in quite slowly, that have been committed, for this purpose. 
   Put another way, the total commitments and expenditures on Iraqi 
reconstruction and security assistance since the war began come to over 
$100 billion. Not $20 billion, not $38 billion, but over $100 billion. 
   We have not done a very good job of estimating that cost. Even the 
international community has not done a very good job, since the 2003 
World Bank/UN estimate of the costs of reconstruction in Iraq was $55 
billion, or just a little over half of what has been comitted. 
   There is another $18 billion worth of security assistance and 
economic reconstruction assistance in the 2008 budget request. So that 
cost is going up. 
   Senator DOMENICI. Mr. Chairman, might he go back 2 minutes and 
repeat what he has just said? 
   Mr. ADAMS. I am happy to, Senator. Where do you want me to pick up? 
   Senator DOMENICI. Do you know where you talked about this last set 
of estimates being out of--
   Mr. ADAMS. The reconstruction and security assistance estimates. 
   Senator DOMENICI. It is much bigger, and I did not understand what 
that was. 
   Mr. ADAMS. Absolutely. The Special Inspector General for Iraq 
Reconstruction, Stuart Bowen, estimated in his last quarterly report, 
that the United States has committed over $38 billion to security 
assistance and economic reconstruction assistance in Iraq. 
   Iraqi government funds have amounted to over $50 billion. Some of it 
is funding that we retained control over because it was seized in 
oil-for-food assets. Some are assets they have budgeted through their 
own capital budget for economic reconstruction. 
   And third, there is about $15 billion worth of international 
community--World Bank, International Monetary Fund, European Union, 
Japan, Britain and other countries--commitment to Iraqi reconstruction. 
The total is $104 billion. That is setting aside the $18 billion 
requested for fiscal year 2008 in the President's budget, which would 
be in addition. 
   Is that clear? 
   Senator DOMENICI. Thank you, Mr. Chairman. 
   Mr. ADAMS. Finally, the last question I want to deal with, Mr. 
Chairman, is the question of responsibilities for these programs. Iraq 
and Afghanistan have been a test bed for a different way of delivering 
foreign and security assistance by the United States Government. It is 
a test bed for a concept that has the Defense Department increasingly 
assuming responsibilities for security assistance and foreign 
assistance delivery. This includes a major training and equipping 
program in Iraq and Afghanistan, not dissimilar to what we might have 
done under foreign military financing, but we are now doing directly 
through Department of Defense funding. 
   They are seeking to globalize that training and equipping program in 
order to stabilize and restore authority to ungoverned areas and 
prevent terrorist havens elsewhere. 
   Second, the Commander's Emergency Response Program, (CERP), has 
become a billion-dollar item in the fiscal 2008 budget request. It is 
for local rapid delivery of what is, in effect, economic and 
reconstruction assistance. The Pentagon seeks to globalize that 
program, as well. 
   And two new fellowship programs, a counterterrorism fellowship 
program and a stability operations fellowship program, both of which 
are operated independently of the International Military Education and 
Training Program, (IMET). And budgetary support, because through 
Pentagon funding and emergencies we are, in effect, reimbursing the 
Pakistani government and other governments for their support with the 
global war on terror. 
   The argument is that the Defense Department itself has the skills, 
the logistics, the equipment, the budget, the direct contacts to do 
this in an effective and efficient and agile way and the State 
Department and AID do not. They lack the budget, cannot raise it, do 
not have the training, do not focus on these issues. 
   As a consequence, we are walking down a road without really 
evaluating where we are going. The consequence for the State Department 
is that as we charge Defense more and more with foreign and security 
assistance responsibilities, we begin to disempower the State 
Department and AID to oversee policy and to supervise and implement 
such programs. 
   And the consequences for the Defense Department are that we 
increasingly are putting our men and women in uniform into the job of 
security and foreign assistance providers, which diverts them from 
their core military mission. 
   In effect, we may be underfunding and disempowering our diplomacy 
and foreign assistance, and, at the same time, distracting the military 
from their core mission. 
   So I urge you, when you talk with other witnesses both from the 
State Department and AID, and from the Defense Department, that you 
raise these issues about the balance and integration of our security 
assistance and foreign assistance efforts. 
   Thank you, Mr. Chairman. 
   [The prepared statement of Mr. Adams follows:] 

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   Chairman CONRAD. Thank you, Dr. Adams. 
   Now we will turn to Dr. Gilmore, the Assistant Director of the 
Congressional Budget Office and the head of CBO's National Security 
Division. 
   Welcome, Dr. Gilmore. 

                    STATEMENT OF J. MICHAEL GILMORE, 
                           ASSISTANT DIRECTOR FOR 
                 NATIONAL SECURITY, CONGRESSIONAL BUDGET OFFICE 

   Mr. GILMORE. Mr. Chairman, Senator Gregg, members of the committee, 
I appreciate the opportunity to appear here today to discuss Iraq war 
costs. My remarks will focus on the estimate of the cost of 
implementing the President's plan to increase forces in Iraq that CBO 
released last week. 
   At the request of the House Budget and Armed Services Committees, 
CBO has estimated the costs of that plan, in which CBO models the 
maximum increase in forces to span 4 months, namely from May through 
August, as well as two other scenarios increasing the span of that 
surge to 12 months and 24 months. 
   CBO estimates that the incremental costs, that is over and above the 
costs of the previously planned operations which would have sustained 
15 brigade combat teams in Iraqi, of the President's plan would range 
from $9 billion to $13 billion through fiscal year 2009, with $7 
million to $9 billion of that cost occurring in fiscal 2007. I will 
discuss the reasons for that range in just a minute. 
   If that increase in forces were extended to last 12 months, CBO 
estimates that costs through fiscal year 2009 would range from $20 
billion to $27 billion. 
   Now CBO's estimates depend critically on the answers to three 
questions. How many additional troops will actually be deployed? How 
long will the deployments last? And what are the additional costs 
associated with incremental troop deployments? The rest of my remarks 
will focus on those three points. 
   The President announced his plan on January 11th, indicating it 
would comprise about 20,000 troops. The Administration has now 
confirmed that that figure referred only to the number of troops in the 
brigade combat teams to be deployed, not to the additional support 
troops that might be needed. All major military operations involve 
support units in the theater other than those included in the combat 
brigades. That is support at echelons above brigade and echelons above 
division. 
   Historical experience, including experience with Operation Iraqi 
Freedom, shows that substantial numbers of such support troops always 
accompany combat brigades deployed to conduct combat operations. 
Support functions performed outside the brigades include almost all 
logistics, higher-level headquarters, military police, military 
intelligence, signals-meaning communications-engineers, medical and 
other services. Providing the needed level of these services is 
essential to conducting an effective combat operation. 
   The number of support troops necessary to perform these tasks 
increases when the number of combat troops expands and, in particular, 
Army planning often assumes the need for these services increases in 
direct proportion to the number of combat troops in the theater. It is 
worth noting that it is difficult to rely on contractors to perform all 
of these services, particularly in combat zones. 
   The Army plans to, and has structured its force to, and historically 
has deployed one to two support personnel per combat person. Based on 
historical deployment data from DOD for Operation Iraqi Freedom, CBO's 
higher cost estimate assumes about 5,500 additional support personnel 
deployed to the theater per 4,000 person combat brigade. Those are 
average figures. Obviously, the composition of individual brigades 
differs. That is the average support-to-combat ratio for such 
deployments in Operation Iraqi Freedom since September 2003. 
   In that case, building the 20 combat brigades in theater will raise 
ground force levels from about 142,000 currently--and that is in the 
entire Iraq theater, including Kuwait and other areas--to 190,000 by 
May, an increase of about 48,000. 
   CBO's lower cost estimates assume that about 3,000 additional 
support personnel deploy to the theater per 4,000 person combat 
brigade. That number is consistent with the lowest support-to-combat 
ratio achieved in the Iraqi theater overall during the larger 18 
brigade deployments that have occurred since September 2003. In that 
case, bringing the 20 combat brigades in theater will raise ground 
force levels from about 142,000 currently to 177,000 by May, an 
increase of about 35,000. 
   Now to put CBO's estimates in context, consider what happened during 
the increase in forces executed by DOD during the January 2005 
parliamentary elections in Iraq. There were about 16 brigades and 
137,000 ground forces deployed in the Iraq theater at the end of 
September 2004. Deployments increased to 20 brigades and about 189,000 
personnel by the end of December 2004. Forces then fell to 17 brigades 
and about 165,000 personnel by the end of March 2005. Throughout that 6 
month period the average increase or decrease in personnel averaged 
9,200 per brigade, consistent with CBO's higher estimate. 
   And on November 17th, 2006, just last fall, DOD announced units for 
the upcoming Operation Iraqi Freedom rotation, including five brigade 
combat teams and a division headquarters comprising 20,000 personnel, 
an average of 4,000 per brigade combat team, as well as 37,000 support 
personnel. That was in the announcement. All told an average of 11,040 
personnel deployed per brigade. Those are the support personnel DOD 
identified as needed in theater to service the brigades whose 
deployment is now being accelerated. 
   The Administration has recently suggested the possibility of much 
lower levels of support troops than those incorporated in CBO's 
analysis, stating that only 10 percent to 15 percent of CBO's estimates 
would be needed. Assuming that those percentages refer to CBO's high 
case estimate of 28,000 support personnel, that would imply that DOD 
plans to deploy about 4,700 total personnel per newly deploying 
brigade. This would result in support-to-combat ratios in the overall 
Iraq theater during the upcoming increase significantly lower than any 
indicated in the OIF deployment available to CBO. 
   CBO has not explored the implications of conducting such a 
historically anomalous deployment in which the number of troops in 
combat brigades theater-wide would increase by 33 percent with a 
corresponding increase in higher echelon support personnel of 4 
percent. 
   As I indicated previously, the length of the maximum increase in 
force levels analyzed by CBO spanned four to 24 months. Costs for 
increases of different durations are roughly proportional to the total 
length of those increases, including the 3-month buildup and ramp down 
period CBO assumed. Thus, through 2009 the 24 month increase, spanning 
30 total months, would cost three or four times more than the 4-month 
increase, spanning 10 total months. 
   All of the force increases CBO considered would require that DOD's 
goals for the use of its active and reserve forces be exceeded by more 
than they have been over the past year. CBO has not yet analyzed the 
implications of those increased levels of stress on our forces. 
   Now as Steven Kosiak mentioned, we find estimating the cost of the 
wars in Iraq and Afghanistan difficult and have routinely 
underestimated the costs relative to the Administration's requests. 
Estimation is difficult for all of the reasons Steve mentioned, because 
thus far the available cost reporting and budget justification 
information have lacked sufficient detail to prevent robust cost 
estimating relationships to be developed. And some of the support 
material that I reviewed last night that accompanies the President's 
budget submission, the supplemental submission, and the new budget lack 
the kind of detail that we would need still, although there may be more 
details coming. 
   Thank you, and I look forward to your questions. 
   [The prepared statement of Mr. Gilmore follows:] 

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   Chairman CONRAD. Thank you, Dr. Gilmore, for that testimony. 
   Let me just indicate that we have a pattern here of the 
Administration hiding the ball from the Congress and the American 
people on the cost of this war. It started at the beginning and it has 
continued right through. Until last year they told us in every one of 
their budget submissions there was not going to be any cost to the war. 
Last year they told us it was going to cost $50 billion and we are at 
$163 billion and counting. 
   Now you tell us, Dr. Gilmore, that the so-called surge or the 
escalation which the Administration has told us is going to cost $5.6 
billion, you have told us that if it lasts a year the more likely cost 
is $20 to $27 billion. 
   Have I got that right? That your estimate for a year-long additional 
deployment as called for in the President's plan would be in the range 
of $20 to $27 billion? 
   Mr. GILMORE. If the increase were extended to 12 months, including 3 
month buildup and 3 month ramp down, the total cost through 2009 that 
we estimate would be $20 to $27 billion. 
   Now for our understanding of what the President's plan calls for at 
this point, which is a buildup hitting about 20 brigades in theater in 
May, extending through August, and then a ramp down, the total costs 
through 2009 would be $9 billion to $13 billion, and in fiscal year 
2007 would be $7 billion to $9 billion, depending on the level of 
support forces. 
   Chairman CONRAD. Let me just say, the President has told us 
consistently that he is opposed to a timeline. It all sounds like a 
timeline to me. For 2008, he is calling for $140 billion; for 2009, $50 
billion; in 2010, no money. If that is not a timeline, I do not know 
what a timeline is. 
   And with respect to the escalation, the President is saying it is 
going to cost $5.6 billion. If that is accurate, what could we conclude 
would be the amount of time that this escalation would last? Based on 
history of what these troop levels cost. 
   Mr. GILMORE. Well, $5.6 billion would be a shorter increase in 
forces than the 4-month increase that we have estimated. Now, we have 
seen none of the detail behind that $5.6 billion. I have heard that $2 
to $3 billion of it is associated with the naval forces, the deployment 
of the additional carrier to the Persian Gulf and then covering for 
what that carrier would have done in the Western Pacific by having the 
Ronald Reagan sail and pick up the Kitty Hawk Air Wing. 
   Chairman CONRAD. That would make the estimate even further off then. 
   Mr. GILMORE. Yes. 
   Chairman CONRAD. Because your estimate does not include naval costs. 
   Mr. GILMORE. Our estimate excludes naval costs. So if it were $2 
billion, if it were really $2 to $3 billion, then it would be a surge 
that would compose a length a third of the one that we have looked at. 
   Chairman CONRAD. One third of how long? 
   Mr. GILMORE. It would just be a month or two, according to our 
estimates which, of course, the Department disputes. 
   Chairman CONRAD. When you hear the Department say they are going to 
do this but they are only going to have a troop level over and above 
the combat troops that are deployed of 10 or 15 percent in terms of the 
cost, what is your reaction to that based on your professional 
experience? 
   Mr. GILMORE. I don't understand it. 
   Chairman CONRAD. Do you believe it? 
   Mr. GILMORE. As I said, I do not understand it. We have asked for 
additional information. In fact, we met with the Army on January 25th. 
Unofficially, we received information which is consistent with the 
estimates that we made in terms of the number of support forces, but 
obviously Secretary Gates is disputing that. 
   I can only point out again that our estimate is based on our 
understanding of Army planning, we do understand that, and on 
historical experience, and I am not talking about ancient historical 
experience. I am talking about recent historical experience. I went 
through the force levels that occurred during the increase in forces to 
cover the parliamentary elections. At that point they had 20 brigades 
in theater, 189,000 forces. Our estimate would be 190,000 troops in the 
theater. Our higher estimate would be 190,000 troops in the theater 
beginning in May, when they hit 20 brigades. 
   As far as I understand what the Administration is saying at this 
point, they would say that there would be 160,000 to 166,000 troops in 
theater in May. 
   And that is just absolutely inconsistent with Army planning, what we 
know of Army planning, and what the Administration has executed in the 
past and what the Administration announced last November in terms of 
the needed support package for the forces that are going to be part of 
the rotation. 
   Chairman CONRAD. Let me just say that in looking at this, it seems 
to me that the Administration's claim is just not credible. It is not 
credible based on what the history has been, not only in this conflict 
but other conflicts. It is not credible with respect to what we have 
seen in Iraq. 
   Senator GREGG. 
   Senator GREGG. Thank you, Mr. Chairman. 
   It appears we went through a surge in 2004 that was actually larger 
than what the President has proposed in 2007; is that correct? 
   Mr. GILMORE. It was a surge of about the same size, as far as we 
understand. It was up to 20 brigades. It hit 20 brigades in January and 
then it ramped down by March, so it was actually a bit of a shorter 
surge. 
   Senator GREGG. So we have been through this exercise before. 
   Mr. GILMORE. Correct. 
   Senator GREGG. The issue which you raise, Mr. Kosiak, of the 
supplemental being used to fund the base, can you document your view on 
that, that the supplementals have been used to fund the base, and that 
the supplemental that we are going to get, I presume in February, will 
be used to fund the base? Can you document that in the specifics? 
   And can you highlight and get us a paper to that effect? And pending 
your doing that, in specifics, could you sort of highlight what you see 
as some of the costs that have been in past supplementals and that you 
would see coming in the future supplementals, other than the Army 
modularity issue, which we are all familiar with, that you think are 
base issues versus war fighting issues? 
   Mr. KOSIAK. That is an excellent question and it is hard to do that. 
I will try to answer it partly at least. 
   Because of the justification materials, problems with the 
justification materials, it is hard to tell, it is harder to tell than 
it might otherwise be. But I think there are a couple of reasons to 
suspect that this is going on. 
   One is that if you look at the Administration's request, if you look 
at the level of funding that was provided in 2006 for military 
operations, about $116 billion for the Department of Defense, and 
compare that with the $163 billion projected for this year, that I 
think raises questions as to why costs have grown that much, because it 
would not be explained simply by an increase in the number of troops. 
   Also, if you look at OMB's own estimates of what the costs were 
going to be for 2007, up until as late as August of 2006, they were 
estimating total cost for the global war on terror in 2007 of $110 
billion versus $163 billion. 
   There are also, if you look at some of the programs like the Joint 
Strike Fighter, it seems to me programs that really belong in the 
Department's long-term plans not in their short-term special global war 
on terror funding, which is sort of emergency funding. 
   Also, if you look at their funding totals in the 2007 supplemental 
and for 2008, they include I think for 2007 the total amount of funding 
provided for reconstitution or what had been called reset, is about $37 
billion. That seems substantially higher than what they were estimating 
a short time ago. 
   My understanding was that the Army and Marine Corps basically said 
that the $23 billion that was provided in the 2007 regular 
appropriations, the $70 billion that Congress provided in 2007 in their 
bridge fund, that the $23 billion in that that was for reconstitution 
was what they needed. So to get an additional chunk of money to bring 
it up to about $37 billion for 2007 just raises, I think, my suspicion. 
And then finally, go back to the memo by Gordon England, which invites 
this to happen. 
   But it is hard to pinpoint particular programs. 
   Senator GREGG. I appreciate that brief thumbnail review of it, but 
do you think you could do a little more extensive review and get it to 
us? 
   Mr. KOSIAK. Yes, I would certainly be happy to try to do that. 
   Senator GREGG. I understand O&M costs are fungible, but I would be 
interested to know what percentage of the O&M costs that we are hearing 
is war fighting is really not war fighting, it is simply base operation 
activity. So I thank you for that. 
   This whole issue of developing the emergency, I think it was Dr. 
Adams who said that when the Pentagon develops their emergency 
supplemental request they do it outside their own budget criteria. I 
have always thought the biggest problem is that it gets outside our 
budget criteria. But I had not thought of it, in the terms that it 
actually goes outside of the Pentagon's criteria. 
   What is the practical effect of it skipping the Pentagon's budget 
criteria internally? I know what the practical effect is here, it does 
not go through the authorizing committee and the appropriating 
committee ends up looking at it with about a 48-hour window. 
   But what is the practical effect for this occurring at the Pentagon 
level? 
   Mr. ADAMS. There are a couple of effects. Emergency supplementals 
are developed with a timing that puts them outside the normal PPBES 
cycle in the Department of Defense. They generally happen when, as 
Deputy Secretary Gordon England did in late October, the Deputy 
Secretary sends guidance to the services and says come back within this 
given timeframe with the programs and data you will require to go into 
the fiscal year 2007 second supplemental. 
   Anything that is in that response has not gone through the scrub of 
PPBES, where there is an orderly process of looking at all these 
requirements, determining whether they are absolutely needed, winnowing 
out things that are not necessary, trading them off against other 
programs in the budget cycle when you know you have a funding limit. 
   Without that funding limit, the temptation is to do what Steve 
Kosiak was talking about, put things into that budget that you were not 
able to obtain through the normal PPBES cycle. 
   That is most clear with hardware programs like the F-35. Because of 
the fungibility of O&M, it is harder to sort out what goes to war costs 
and which does not. The Pentagon does not give us data to help us do 
that. 
   So in part, the problem is that things that should be in the normal 
budget process get hived over into a supplemental process that is not 
going through the same kind of scrub and the same kind of tradeoffs. 
   The consequence of that for those who work the PPBES process in the 
Department of Defense is that they never quite know what is in and what 
is out, what they are being asked to scrutinize, what they are not 
being asked to scrutinize. This has a dispiriting effect on the job 
that they do in the PPBES cycle. 
   If their job is to say A is more important that B, that hardware 
program is more important than this alteration in the force structure, 
or pay or benefits or whatever one proposes, and they are told do not 
worry about it, we will go over to the supplemental to get it fixed, 
then the integrity of their own process is called into question. 
   So it has that kind of effect on their process, the dual process 
they have there. 
   Senator GREGG. Thank you, very much. 
   Chairman CONRAD. Senator Murray. 
   Senator MURRAY. Thank you very much, Mr. Chairman. 
   I think this hearing is very important and it is critical that we 
get, finally, the facts on the cost of this war so we can hold this 
Administration accountable and, from my point of view, change the 
direction we are going in Iraq. 
   Listening to your opening statement, Mr. Chairman, it was stunning 
to remember what we have been told about the cost of this war. I 
remember in 2003 when the White House Budget Director said the war 
would cost $60 billion, and now what are we, six times past that? 
   I remember Defense Secretary Paul Wolfowitz telling us that Iraq 
would finance its own reconstruction. I remember Vice President Cheney, 
back in 2003, saying Iraqi oil would cover the costs of reconstruction. 
Obviously none of that has come true. 
   And at the same time we are paying for this all off budget, in a 
supplemental, which really hides the true cost of the war. 
   So this, I think, is really essential that we have this hearing and 
have an understanding so we can make critical decisions about the 
future. 
   I am sorry Senator Gregg left. I did want to respond to one thing he 
said in his opening statement. I am deeply troubled that the Republican 
leadership did not allow us to go to a floor debate on the surge in 
Iraq. Senator Gregg mentioned his amendment as part of that. 
   It is the fact, my colleagues should know, that Senator Reid has 
offered, on more than one occasion, a vote on the Gregg Amendment up 
or down, along with several other resolutions. His amendment really 
talks about the cost of war, which is a debate we are going to have 
on the budget and on the supplemental and I am sure many other things. 
The point of the debate that we want to have is about the surge. And 
critically to this budget hearing, we need to know how much that is 
going to cost. I am deeply concerned that we are going to be sending 
our troops overseas without a vote of the Senate, without a discussion 
in the Senate, and they will not have the equipment and the supplies 
they need because we have not adequately budgeted for it. And I think 
that should be of deep concern to every one of us in this committee and 
in this country. 
   I would say, as the Senator representing Washington State, that has 
striker brigades going over, these are families that we are responsible 
for. 
   So I am troubled, Dr. Gilmore, when I heard your statements about 
CBO's estimates versus what the Administration is saying, that this is 
48,000 troops. I understand that Secretary Gates said that the support 
troops would only number 10 to 15 percent of the CBO estimate. I would 
like to know who is right and who is wrong? Can you fill us in? 
   Mr. GILMORE. As I said earlier, I do not understand the basis for 
what the Secretary said. As I said, we have asked the Army about this 
and received some information. We will meet with them again and perhaps 
receive some more. 
   I can only just say again that our estimate is based on recent 
historical experience and what we understand of Army planning. We would 
have, in our higher estimate, force levels of about 190,000 in theater 
and 20 brigades. That is consistent with what happened in January 2005. 
Senator MURRAY. Which is the surge that Senator Gregg was talking 
about? 
   Mr. GILMORE. Correct. And it is consistent with what we know of Army 
planning, which is that they deploy one to two support people for every 
person in a combat brigade. 
   So I do not know what more to say. I am just trying to explain to 
you why we think our estimates are reasonable and what the basis for 
them is. We have asked for information from the Department about the 
basis for what they apparently are saying they are going to do and we 
have not received it. We are anxious to receive it. 
   If they do do that, if they do deploy with that smaller number of 
support forces, then it would be inconsistent with what we understand 
of Army planning, certainly inconsistent with the history of these 
deployments, and I think that it would then mean that the 
Administration is willing to accept risks that they are not normally 
willing to accept in order to execute this deployment. 
   There can be good reasons for that. 
   Senator MURRAY. That is deeply disconcerting. Without a vote or a 
discussion or debate in the Senate, the President has been given the 
green light to move forward with the surge. And from what I hear you 
saying to us, not making sure that our troops that are going to then be 
on the ground have the support, the supplies, the equipment, and the 
training that they need. 
   And to this Senator, that is very, very troubling. It seems to me 
that what we have is the Bush Administration just trying to minimize 
the number of troops that will be required so we do not question it. 
Maybe our other witnesses would like to comment on why they think there 
is such a discrepancy between what we are being told this will cost by 
CBO and what we are being told it will cost by the Administration. 
   Mr. ADAMS. Senator, I know no more than Mike Gilmore, having not 
directly pursued the Pentagon myself, and I know they have pursued the 
Pentagon assiduously to try to get data on what explains this 
discrepancy. I would be making assumptions. 
   One assumption might be they think existing support in field is 
adequate to cover the increment of troops that they are sending, which 
does not sound true to historical practice in the Pentagon. 
   Senator MURRAY. Nor does it sound true to my ears, just as an 
observer. If you are going to keep Stryker brigades on the ground 
longer, they are going to be still using their equipment. If you 
send over other brigades earlier that they are supposed to, they are 
going to need equipment. So you do not have duplicate equipment. 
   It does not make sense to me. 
   Mr. ADAMS. I think you are right, Senator, they will need the 
support. I am not sure that the support in the field is going to be 
adequate for what they require. But I do not have independent knowledge 
of what has moved them to this particular judgment. 
   Senator MURRAY. Medical officers, people capable of helping them 
in the field? This is really disconcerting. 
   Mr. ADAMS. There is a history of now, since 2003, of both 
underestimating the cost and underestimating the requirement. I worry 
that we may be in another situation where that is the case, that we 
have understated for reasons that I cannot describe, perhaps just not 
worry too much about the impact. The consequence of this, of course, 
is it takes longer and it is a lot tougher job to do. 
   Senator MURRAY. Mr. Kosiak? 
   Mr. KOSIAK. I would just say that I think CBO did the analysis the 
only way you could do the analysis and it is up to the Pentagon, I 
think, to explain why that does not make sense. 
   Chairman CONRAD. Thanks, Senator. 
   Just for the record, I would like to make sure that we get it very 
clear that the support personnel that you are talking about are 
logistics, police, intelligence, engineers, communications, medical. 
   What other support personnel, Dr. Gilmore, are we talking about 
here? 
   Mr. GILMORE. Those are the ones that I highlighted in my verbal 
remarks. 
   Chairman CONRAD. So we are talking about, we just now have a-- 
   Mr. GILMORE. These are all support personnel outside the brigades. 
The Pentagon likes to make the point that the new brigade combat teams 
have support integrated within them, and that is true. 
   Chairman CONRAD. That has been the case in the previous surge, is it 
not? 
   Mr. GILMORE. Yes. In the previous surge, not as many of the brigade 
teams were modular. But even in the Army before it was modularized, 
when they deployed brigade combat teams, they would pull the support 
down from division and then it would be incorporated as part of the 
brigade combat teams and deployed. Now it is integrated. 
   But that is not the support we are talking about. That support is 
there to receive things from higher echelons. And the support we are 
talking about is that support at higher echelons. 
   Chairman CONRAD. Is there any possibility that they are using 
contractors for these purposes? 
   Mr. GILMORE. They certainly do use contractors for things like 
feeding and housing and that sort of thing. We did a study back in late 
2004 of the costs of what is still called the Logistics Civil 
Augmentation Program that at that time was being executed by KBR. At 
that time they had a substantial presence in the theater of over 38,000 
people. That was just that contractor element. 
   And the costs were about $5 billion a year. From what I have seen of 
the budget justification material, that has risen to about $6 billion a 
year. The Pentagon likes to make the point that the theater is mature 
and perhaps because of the support that is there and all the 
contractors that are there we do not need as many support forces to 
accompany the units in this surge. 
   I would just simply point out that at least the so-called LogCAP, 
Logistics Civil Augmentation Program contractors were there in force in 
2004 when the increase was executed during the parliamentary elections. 
And the level that they are funding those kinds of activities now is 
about the same as they were funding them then. 
   Chairman CONRAD. We have a real discrepancy and it has been 
repeated. I have just been handed a news account that the Secretary has 
repeated that they will add as many as 3,000 troops to the 21,500 and 
we think the number is going to be around 21,500. Secretary Gates told 
a Senate panel that it would not be more than 10 percent more, 10 to 15 
percent more, which directly contradicts the estimates that you have 
provided, which been based, as I take it, on what has happened 
historically. 
   Senator ALLARD. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   We have heard testimony here where the cost has not related to the 
number of troops that get deployed, particularly when we are looking at 
a cost per troop basis. Has there been any attempt to analyze it as it 
might relate to the level of arrests and occurrences of violence and 
everything within Iraq or other countries? We have had surges, you 
understand, where we have had increased violence in these various 
countries. I am wondering does anybody suspect any correlation to the 
level of violence? 
   Mr. KOSIAK. My understanding is that according to Department of 
Defense reports, that only about 10 percent of the costs for the global 
war on terror are those kind of costs that vary with operational tempo, 
which is what I think you are getting at, the more intense military 
operations. So that having these more intense military operations, most 
of the costs are really driven by the number of troops that are 
deployed and all the sustainment costs, reserve activation, things like 
that. Actual operational tempo doesn't tend to have that big an impact. 
That may well have had some impact, but I think we need--and maybe it 
has a bigger impact. But we do not have the data from DOD to have that 
verified, I think. 
   Senator ALLARD. You know, when we started this conflict, we did not 
have enough body armor. And so a big effort was made for body armor. It 
was sort of delayed because the manufacturers could not keep up with 
demand. And I assume that when they have to go and on a short-term 
basis ramp up their manufacturing lines or what not, I suppose they do 
not do that on the cheap because they have to recover the costs 
quicker. 
   Then after that, we had issues about the Humvees having to reinforce 
the underside. We see the same phenomenon there. And then we see the 
striker, for example, vehicle. That vehicle is a very modern kind of a 
vehicle, loaded with technology. 
   How much of a factor have these things played in trying to make our 
environment more secure, make the soldier more secure on the ground in 
Iraq? Has there been any effort to analyze that? 
   Mr. KOSIAK. I guess the only thing I would add is that even if you 
look at these numbers and you take out the amount that has gone to 
procurement and reconstitution or reset, you still see--it is not as 
large a trend. I think that explains part of it. 
   But even when you take that out of the initial cost estimates and 
the later cost estimates, you still see a significant growth in costs. 
There presumably are answers to this, and I am not suggesting that all 
of this is nefarious on the part of the Pentagon, by any means. 
   The bottom line is the data we have does not provide us with a real 
handle on what is driving those costs. And so it makes it very 
difficult to look at DOD's justification details and figure out is this 
the right amount of funding? And also very difficult to look forward 
and try to guesstimate about how much we are going to need in the 
future. 
   Senator ALLARD. We have made an effort to bring some accountability 
to the process by making this part of the regular budget request. It 
has been going on for a while to see that, where we can look back and 
make some analysis there and what we are going to do there and build in 
inflation and what not. Probably do a little better job of that. And 
that means that we will have more oversight, I think, if we go through 
the regular process from the various committees, authorization and 
appropriation both. 
   One of the things that happens over time, I think, is that the base 
can get built artificially high during times of conflict. We have tried 
to manage this by setting up an emergency fund and then going back and 
providing that. 
   Anybody have any thought on how we manage a fund like that? The war 
is not going to go forever yet there will be a build in to the base 
there. And when that does drop down, how do we manage those 
appropriations? Or do you just think it is the best thing for the 
Congress to look at on a year-to-year basis and say well, our 
priorities have changed, we shift dollars, or we cut back on spending? 
How do we deal with that? 
   Mr. ADAMS. I think the first step, Senator, is one that the 
Department of Defense has at least opened the door to by providing a 
much larger volume of justification for the supplemental requests, for 
the war than they have provided in the past. 
   Senator ALLARD. So we are getting more detail on the requests now. 
   Mr. ADAMS. A first step has been taken. I have had a chance to 
glance through some of that. I have to share, to some degree, Mike 
Gilmore's view that it is not quite clear that there is enough there to 
really tell what this is going to cost, but it is a lot more than we 
have had. That is two very thick documents, at this point, worth of 
justification and they have said they will deliver even more 
justification than that. 
   So step one, I think, is for this committee and the other committees 
responsible to take that documentation on board and scrub it very, very 
hard to make sure that the right things are in place for the right 
reasons. 
   You will find things that are going to demand very close scrutiny. 
One that is of interest to me is the rather large and rapidly growing 
investment that we have in continuing what is the major source of 
casualties of our troops in Iraq, and that is IEDs. There is now an 
enormously expensive $6 billion request for the IED Center that is 
looking at technologies and ways to combat the IED threat in Iraq and 
Afghanistan. 
   Given the volume of that expenditure, it is worth taking a look at 
now, what they are producing, whether they are producing results, how 
they are being tested on the ground, whether they are working, whether 
they are in fact reducing casualties and reducing fatalities in Iraq. 
So there are bits and pieces now that you can pull out and say all 
right, give us a witness on this, give us some documentation, give us a 
bit more. 
   In a broader sense, the concept of creating a kind of ''sidecar'', 
which is what Senator Gregg was referring to, for war costs is a good 
idea. It will help you deal with some of the very knotty issues, about 
what is appropriate to the war and what is not appropriate to the war. 
One of the big areas that you are going to need to look at is this 
reset issue, with $37 billion in the request. You really need to go 
into that reset program and say all right, which of these are really 
contributing long-term hardware capabilities for the long-term 
operations of the United States military? And which are reset costs 
that involve taking equipment that suffered severe damage from either 
the weather, operations on the ground, or combat and fixing it so it is 
re-usable? 
   There is a gray area in there. If you buy a new and improved Abrams 
tank or a new and improved infantry fighting vehicle, have you really 
bought it because you intend to deploy it for the war? Or are you 
buying it because it is next in line, it is the next program that you 
need to reset the force, to equip an expanded force? 
   So pushing very hard to get those details separated out and worry 
the troubled gray areas in hardware, in O&M, is a very important first 
step to answering your question. 
   Senator ALLARD. And replacement costs are a problem when you are in 
such a harsh environment. 
   Mr. ADAMS. Absolutely. 
   Senator ALLARD. All the sand and everything, your depreciation on 
the vehicle is so much-- 
   Mr. ADAMS. Clear wear and tear on the equipment. 
   Senator ALLARD. If I might, just one other thing, on benefits to the 
people who serve over there, have you looked at that at all? There are 
going to be veterans and there will be veterans benefits. And I guess 
this could be attributed to the costs. I wonder if you have tried to 
extrapolate that in as a long-term cost, medical care and what not? 
   Mr. ADAMS. Some of the work that I have seen has been done at CBO. 
   And there is some that the CRS has done. And there is some that 
Professor Linda Bilmes at Harvard has also done. There is a very broad 
range of what those costs may be; CBO's is on the low end of the range, 
as I understand it. 
   Mr. GILMORE. It is about $1 billion a year. 
   Mr. ADAMS. Bilmes's is a very high end, $300 to $600 billion over 
the lifetime of the veterans affected. 
   That is an issue that is very much worth looking at long-term 
because the implications of that in budgetary terms are very, very 
large. 
   Senator ALLARD. Thank you. 
   Chairman CONRAD. I thank the Senator. 
   Let me just indicate that I have just been notified that Secretary 
Gates now, who was scheduled to come before the committee next Thursday 
will not come before the committee next Thursday. 
   I just say that I find that very disappointing. We have serious 
issues that have been raised and for the Secretary to now change what 
was a commitment to this committee is just unacceptable to the 
committee. I just want to make that very clear. 
   This is an overwhelming driving element to this budget. And for the 
Secretary, who was scheduled to come here next Thursday, this morning 
to tell us now he will not come, I just find unacceptable. 
   Senator SANDERS. Mr. Chairman, just a point on this. 
   It is not just unacceptable. This is a huge amount of money that 
impacts education, health care, every aspect of our life. 
   I would hope that this committee acts in a very strong way. Why 
should we give consideration to a budget when they refuse to send 
analysts up here to defend the budget or the Secretary to tell us why 
they need it? 
   Chairman CONRAD. I think it is very clear this committee, I think on 
a bipartisan basis, will be very disappointed, in the least. And I just 
find it unacceptable that the Secretary had committed to coming before 
this committee next Thursday to talk about what is absolutely central 
to the deliberations on the budget. And now the Secretary does not want 
to come. 
   Senator STABENOW. 
   Senator STABENOW. Thank you, Mr. Chairman, and I share not only the 
frustration but I would say outrage at what I have seen and heard. And 
if we are not even going to have the opportunity to talk to the 
Secretary, that is a very concerning thing. 
   I also think though, and to use one of the Chairman's charts to 
re-emphasize again how incredibly off they have been. I really 
question, with all of these numbers, whether we can believe at this 
point. We have not seen anything that was accurate that we could 
believe. 
On the Sunday talk show, when Secretary Rumsfeld was asked what should 
the public know right now about a war with Iraq, what it would look 
like and what the cost would be, and he said the Office of Management 
and Budget estimated it would be something under $50 billion. It was 
said outside estimates say up to $300 billion, and he said baloney. 
I would suggest that we are choking on that baloney, Mr. Chairman, the 
American people and the tradeoffs that we have had to make and the 
costs for our grandchildren and great-grandchildren for decades to come 
is extraordinary. It is hard to know where to begin on this, looking at 
all these numbers. 
   One thing, and then I have a couple of questions, let me just put in 
perspective in terms of choices. We are struggling, in the budget, to 
find a way to provide health insurance for every child in this country 
that does not have health insurance. I think everyone would agree, I 
think the American people would say, we ought to be starting from a 
premise that every child is uninsured ought to be able to get health 
care. Every parent ought to know that their children can have health 
care coverage. 
   That would cost $12 billion a year. That is a little bit more, not 
much, than 1 month in Iraq. So all of these numbers do have 
consequences, as we know, and I know the Chairman knows more that 
anybody else, stunning, stunning consequences when we are looking at 
over $500 billion. We are upwards now, Mr. Kosiak was saying, $737 
billion overall in the global war on terror. 
   We certainly know that there are costs and that we need to address 
it, no question. But this is stunning to me. 
   The question I would have that relates to military preparedness. 
Those of us who did not support proceeding with this war have voted for 
the budget every year, which I have. It is because I do not want to 
send people to war and not let them know that we intend to have them 
have the equipment they need, have the training they need, and to have 
all of the support services they need so they can complete the mission, 
they can be successful, and they can come home safely. 
   I am astounded, Mr. Chairman, when you show a chart that says, 
again, that we are being told people do not have the equipment they 
need. That is the No. 1 question I want to ask the Secretary. 
   And I guess I would ask our panel, I am very grateful for all of 
your information. And I know it is job just to analyze and provide the 
information. But when we look at the fiscal year 2006 base budget, 
which was $410 billion for Department of Defense, this year we gave 
them a $29 billion increase when we look at base budget. 
   Next year they asking for $42 billion base budget, which is about a 
9.6 percent increase in the base budget, which does not include Iraq, 
Afghanistan, or any of the costs that have been called emergency costs. 
Why can't we provide people with equipment? Have you looked at any of 
the analysis? Have you broken it down at all in terms of the amount of 
dollars going for the equipment and support for our troops? Where is 
this going, Mr. Chairman? Where is the money going? It is not that we 
are cutting their budget. We are increasing their budget, almost a 10 
percent increase for next year. 
   I am wondering if any of the panelists could speak to where the 
dollars are going that relate to making sure our troops have the 
equipment they need. 
   Mr. GILMORE. Well, about 60 percent of that base budget is for 
peacetime operations and maintenance and pay for military personnel. 
The other 40 percent is for researching new equipment, designing new 
equipment, and then buying new equipment, about $100 billion in 
procurement. 
   That procurement is mostly for new systems. And those systems such 
as, for example, the Joint Strike Fighter and Future Combat System when 
it starts being procured, they tend to enter the force very slowly and 
they are not really, for the most part they are not really relevant to 
supplying the troops in the field right now with equipment. 
   Those costs, the costs to repair that equipment and replace it have 
been in the supplementals primarily. And those costs have been growing 
very rapidly, as Steve Kosiak mentioned. In fact, in 2007, I think 
there is going to be about $32 billion for Army procurement in the 
supplemental and the bridge, and that compares with about $15 billion 
for Army procurement for these future systems in the base budget. 
   So the base budget is really funding, at least in terms of equipping 
troops, is funding the acquisition of these next-generation systems 
that are coming into the force relatively slowly. And so when you have 
troops in the field who are using equipment now and damaging it in the 
harsh environments, that money to handle those problems and replace 
that equipment has all been in the supplementals. 
   Senator STABENOW. So Dr. Gilmore, you are basically saying none of 
the Department of Defense base budget goes for making sure our troops 
currently have the equipment that they need; is that correct? 
   Mr. GILMORE. No, that is not really correct at all. That is not 
really what I meant to say. 
   The base budget funds the peacetime operations and the procurement 
of the next generation of systems. There is also, of course, there has 
been historically money in there for upgrading existing systems to keep 
them current. But a lot of that funding has migrated to the 
supplementals now, because there is a lot of equipment in Iraq that is 
being used. When they bring it back, they do not just repair it, they 
upgrade it. 
   So it is a mix of the two. But when you look at the investment 
program, it is mostly future looking, forward-looking, whereas the 
money in the supplementals is covering the costs of the damage and 
wearing out of the equipment in theater today. 
   Mr. ADAMS. Senator, if I could make just two points to supplement 
what Mike Gilmore has been saying, I think there are a couple of 
elements that need to be taken into consideration. One is that in the 
early emergency supplementals for the war, most of the money is going 
for supplemental pays and especially operations and maintenance. There 
is usually very little funding there for the acquisition of equipment. 
   So you have a gap between the technology modernization Dr. Gilmore 
is talking about and a recognition that you require some kinds of 
procurement and R&D work going on immediately because of the 
requirements of the troops in the field. 
   The other element is that when you see that gap what it often means, 
and it clearly meant it here, is very poor anticipation of what you 
thought you were going to run into. That is a broader characteristic of 
our planning for this conflict. But in this particular case, not 
anticipating body armor requirements, not anticipating up-armored 
Humvee capabilities, not anticipating the threat from IEDs in the 
field, have all led to a ''scramble'' effect--let's hurry up and find a 
program. 
   And of course, those things take time. When you put those programs 
in place, you have to put the acquisition system in place, as Senator 
Allard was saying. You have to find out what the technologies are that 
you need to combat IEDs. And so you are behind the curve. 
   So poor anticipation is part of this problem, as well. 
   Senator STABENOW. Thank you, Mr. Chairman. 
   I would just say in conclusion, if I might, that basically what you 
are saying is that we, because of the lack of understanding of what we 
were putting our men and women into, in terms of the situation and so 
on, and not planning and preparing and so on, we sent people into a 
situation without the equipment that they needed. And I think that adds 
insult to injury with all of this. 
   Thank you. 
   Chairman CONRAD. Senator Menendez. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   Mr. Chairman, I appreciate your Midwestern demeanor. But I have to 
be honest with you. I think and I hope the Chair will either author a 
joint letter or have a vote of this committee, that I hope would be a 
bipartisan vote, to demand the Secretary to come here. 
   This saddles the Nation's future. Iraq, our expenditures, saddles 
the Nation's future. And to not have the Secretary come here to make 
the case, whatever case that might be, about something that saddles the 
Nation's future, blows my mind. 
   So I hope and I would urge the Chair to do that, and I would be 
happy to join him in that effort. 
   Let me get past maybe the politeness of budget speak. First, I 
appreciate you having this hearing. But I want to start with a 
reference point that is not about money. It is about lives, 3,084 
American lives. That is invaluable. There is no cost that can be 
associated with it. Twenty-three thousand men and women, sons and 
daughters of America, who are wounded in ways that affect their lives 
forever. And the costs, staggering. We have not included in this 
equation. 
   We spend about $8 billion a month in Iraq. We spend a $2 billion a 
week in Iraq. We spent $280 million every day in Iraq. We spend $11.5 
million every hour in Iraq. 
   And we cannot get the Secretary of Defense to come here and justify 
that. That is outrageous. 
   But then again, I am not surprised, Mr. Chairman. This 
Administration has lied to the Congress and to the American people from 
the very beginning. They lied to us about weapons of mass destruction. 
There are none. They lied to us when the President landed on the 
aircraft carrier and said mission accomplished. Well, we are far away 
from that. 
   Lied to us when we were told we were going to be liberators and 
greeted as such. Lied to us when victory was just around the corner. 
Lied to us went in 2003 there were press reports where the 
Administration was downplaying the question of how much this war was 
going to cost, downplaying then $50 billion or $60 billion. 
   Now we have the escalation, and the escalation easily, as we have 
heard today, could very well be triple the projection. 
   Then, when we look at how much money we are spending, we had the 
Inspector General that this Administration wanted to eliminate, new 
report: waste and fraud in Iraq rebuilding projects. Cannot account for 
so many things, including $36 million in weapons that we cannot even 
account for. And we want more. 
   And we want a justification and say we want to give our troops 
everything in the field. Yes, but how can we know that they are even 
getting it. 
   And then we have another Business Week, military equipment, missing 
in action. New defense audit says the Pentagon has failed to properly 
equip soldiers in Iraq. Those that are there, before we send anybody. 
   Mr. Chairman, it is beyond belief. I appreciate all of witnesses' 
testimony. I just want to ask Dr. Gilmore, as it relates to some of 
what you said. You said the words it would be a historical--I think 
this is what you said-anomaly. That is a nice way to say they would be 
totally out of line with how much support personnel would be added per 
the troops that would presently be added in the field. 
   Is that basically what you are saying? 
   Mr. GILMORE. It would be out of--what the Secretary seems to be 
claiming, would be inconsistent what we know of Army planning and also 
what they have done in terms of the deployments in Operation Iraqi 
Freedom. 
   Senator MENENDEZ. And you said that means, I can only believe that 
means that they are willing to accept risks that they have not been 
willing to accept before. 
   What type of risks are associated with that? 
   Mr. GILMORE. It is the risks that they will not able to fully 
support the operational tempo that they will want to engage in, that 
they will have to constrain the operations of the forces in ways that 
they might not, they may not desire, otherwise desire. 
   But of course, this is all just speculation on my part. It is 
dangerous for me to speculate. 
   I think the simplest thing for me to say is I do not understand what 
the Secretary is proposing, and I have explained why I do not 
understand it based on what they have done and what we know they plan 
to do. 
   Senator MENENDEZ. I do not think it is so speculative if you have 
Army planning that says we generally provide X support personnel for 
the number of troops deployed, if that is your standard operating. Then 
you have a historical reality in Iraq. And then you deviate from that 
substantially. Something significantly is wrong. 
   My last question is in this escalation that they are talking about, 
you say that that means they would have a downturn in August; is that 
correct? 
   Mr. GILMORE. That is the way we modeled it based on what we have 
heard. 
   Senator MENENDEZ. Mr. Chairman, every briefing we have received says 
that they will finally be at full force in May. 
   That means in 2 months we are going to do everything we need to do? 
We are going to secure Baghdad and we are going to start down-forcing 
in August? 
   You know the part of the Nation that I come from, we were born, but 
not yesterday. And the bottom line is this is outrageous. No one can 
believe the Administration, as you so aptly said, has been unwilling to 
except timelines for anything. And yet for this purpose, in order to 
hide the real costs of the escalation, we are going to have timeline 
that suggests that in August we are going to actually reduce forces. It 
is just not going to happen. 
   Mr. Chairman, we need the Secretary of Defense here. We need 
answers. This is overarching. 
   Chairman CONRAD. Let me just say that the President said, as 
recently as yesterday, no timeline. It seems to me very clear there is 
a timeline associated with this, when you overlay the budget numbers 
with what he said. 
   Let me just say, the discrepancy between the testimony of the 
witnesses today and what the Administration is telling us is so stark 
that I understand why the Secretary does not want to come up here and 
testify. But that just is not acceptable. 
   We have gone through this war for 4 years and no Secretary of 
Defense has come before this committee to testify. I think it is 
abundantly clear why not, because they have played hide the ball with 
this committee, with the Congress of the United States, with the people 
of this country on the true cost of this war. 
   It is no longer arguable. It is very clear. 
   I am going to ask this committee, I am going to circulate a letter 
and ask, on a bipartisan basis, that we write to the Secretary, 
insisting that he hold to his commitment, his previous commitment, to 
come before this committee next week. 
   Let me just say, at the same time, I am researching sterner measures 
and we will not go further with that now until we find out what that 
research discloses. But it is not acceptable to this committee to have 
the Secretary of Defense refuse to come before this committee and 
defend these numbers. 
   Senator SANDERS. 
   Senator SANDERS. I am glad to hear that, Mr. Chairman. I want to go 
on record as concurring with the Senator Menendez. 
   But frankly, I am not surprised that they are not here. I do not 
blame them. If I had their record of distorting the costs of this war, 
if I had their record of how they misled the American people into this 
war, if I had their record in terms of being as unprepared as they were 
to fight this war, I also would not want to come before the United 
States Congress or this Budget Committee. 
   But I do have to say, Mr. Chairman, the fault is not totally with 
them. The fault is with us. We have abdicated our constitutional 
responsibilities on this issue. We do not have to beg them to continue 
to come. If they do not want to come, I tell you what I think the 
assumption is. The assumption is that cannot defend their figures 
because they are dishonest figures. They are not accurate. And I think 
that you should say to them, and I would hope the letter would suggest, 
that we assume that you have overstated overstated what you need. We 
have going to significantly underfund your request unless you tell us 
otherwise. 
   If you do not have the courtesy to come before this committee, we 
will not take you seriously. 
   So I am not just blaming them. I am blaming us. And that gets back 
to the whole broader issue of how we bring our troops home as soon as 
possible and the need to begin to use the power of the purse to do 
that. 
   Mr. Chairman, I just received a letter from Vermont and I have the 
feeling that every member of this committee has received similar 
letters. This is an article from a newspaper in Central Vermont dealing 
with a school board meeting of a very small high school in Plainfield, 
Vermont, Plainfield and Marshfield, Vermont. 
   And I quote a young person, a kid in the school. The kid says ''The 
changes in the school budget, the cuts in the school budget, scare me 
more than I could have ever expected. I cannot imagine getting an 
education at Twinfield High School without the honors English class I 
took my junior year and many other scholastic programs that are being 
compromised.'' 
   In other words, in Central Vermont, all over my State, all over 
America, kids are not getting the education that they need. They cannot 
afford to go to college. Our child care and Head Start programs grossly 
underfunded. 
   And yet the Department of Defense comes in with huge budgets to 
fight a war that we never should have fought in the first place. 
   I think, Mr. Chairman--
   Chairman CONRAD. Let me be clear to the audience the rules of the 
Senate. There can be no expression by the audience during the 
functioning of this committee. 
   If anybody violates those rules, they will be removed from the 
hearing room. Let me just make clear, that it is rule of the Senate and 
it will be enforced in this committee. 
   The Senator may proceed. 
   Senator SANDERS. I just find it a very tragic that when our children 
need support so that we can end the shame of having the highest rate of 
childhood poverty in the industrialized world, there is no money for 
them. 
   Senator Allard mentioned a few moments ago about the situation of 
our veterans. I know in Vermont, I do not know about Colorado, there 
are waiting lists, waiting lines for veterans to get into VA hospitals. 
Somehow, we do not have enough money to take care of our veterans. We 
have 47 million Americans who have no health insurance. The problems 
facing the middle-class and working families of this country are 
enormous. 
   And somehow when we need money to fund those needs, we do not have 
the money. But when the President comes in with a huge military budget 
to continue a war that should never have been fought in the first 
place, apparently this Congress is giving that serious consideration. 
   I think that that is wrong. I think, Mr. Chairman, we should use 
this Budget Committee to rethink our national priorities. I think we 
should use this Budget Committee to begin the process of beginning our 
troops home as soon as we possibly can. 
   Thank you very much, Mr. Chairman. 
   Chairman CONRAD. I thank the senator. 
   Let me just indicate that we will be circulating a letter to 
committee members with respect to asking once again that the Secretary 
come before this committee. He had previously committed to do so. I 
think it is essential, given the extraordinary costs associated with 
these requests the Administration has made, that the Secretary himself 
come before this committee. I do not think that is an unreasonable 
request. He had previously agreed to do so. It is just unacceptable for 
him to back out. 
   I can tell you, for too long the Secretaries of Defense have been 
bucking this to somebody else. This committee, I think, deserves to 
hear from the Secretary of Defense. The discrepancy between what he is 
saying the cost will be and the professional testimony of the 
nonpartisan Congressional Budget Office about what this cost will be 
are so sharply different that we simply must insist that the Secretary 
of Defense come before this committee and explain his intentions. 
   That is something we are going to insist on. I hope that message is 
received. 
   I again want to thank the witnesses and we appreciate very much your 
participation in this hearing. 
   [Whereupon, at 11:47 a.m., the committee was adjourned.] 


                  THE PRESIDENT'S FISCAL YEAR 2008 BUDGET 
                                  PROPOSAL 
                                   ------
                          WEDNESDAY, FEBRUARY 7, 2007 

                                           UNITED STATES SENATE,
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:05 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Murray, Wyden, Feingold, Menendez, 
Sanders, Whitehouse, Gregg, Allard, Enzi, Bunning, Crapo, and 
Ensign. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

             OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. We will bring the hearing to order. 
   Let me indicate that Senator Gregg, of course, because of events on 
the floor, will be there for at least some part of the morning. Senator 
Allard will be filling in ably for him, and we appreciate his doing 
that, in light of the events that have developed over the last 24 
hours. 
   We want to welcome Director Portman, the head of the Office of 
Management and Budget, to the Senate Budget Committee. I am 
appreciative that the Director has taken his time to be here and that 
we can have a discussion on these critically important issues facing 
the country. 
   I have high regard for Director Portman, both personally and 
professionally, and we very much appreciate his public service and look 
forward to his testimony today. 
   Let me just start with concerns we have about the budget, and these 
are things that we can discuss during the hearing. As we look at the 
budget we see a number of things that are left out, full Iraq war costs 
beyond 2008. In saying that, I also want to acknowledge and commend 
Director Portman for pressing to get at least a realistic war cost put 
in for 2008. I do not think that would have happened without his 
pressing the issue, and we appreciate it. It was certainly a step in 
the right direction. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   We also note that while this is a 5-year budget there is only money 
for alternative minimum tax reform for the 1-year, so it leaves out 
detail past that for the alternative minimum tax. 
   It also leaves out, the budget leaves out discretionary spending 
levels beyond 2008. So this is a 5-year budget, but we only have 
discretionary spending details for the 1-year. 
   Let me go to the next--one of the, I think, serious issues that we 
have to confront as a Congress and a country is the revenue side of the 
equation. Our friends on the other side only want to focus on the 
spending, and while I would completely agree we have to be disciplined 
on the spending side I think we also have to look to the revenue side 
of the equation. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Our friends on the other side of the aisle point to the rapid 
revenue growth of the last several years, and indeed there has been 
rapid revenue growth the last several years. But they neglect to 
mention what happened before then. They neglect to mention that we have 
had revenue stagnation for 6 years. In fact, revenue went down after 
the last peak we had in 2000, where we had revenue of just over $2 
trillion, revenue was below that for 2001, below for 2002, 2003, 2004, 
2005. Only in 2006, on a real revenue basis, did we get back to the 
revenue of 2000. 
   Let's go to the next slide, if we can. So revenue was down but 
spending was up. In fact, under the Administration's spending plan, the 
spending side of the equation increased by 40 percent. So revenue was 
down, spending was up. The consequence is the debt exploded. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Let me have that slide, if we can. Here is what happened to the debt 
of the country. We have a $3 trillion increase in debt during this 
Administration. And over the next 5 years we are anticipating, if the 
President's policies are adopted, another $3 trillion of debt. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Let's go to the next slide. 
   The President, in this budget, advocates a number of spending cuts. 
But he also advocates additional tax cuts, making the current tax cuts 
permanent. And with the other omitted items, if we look at the 10-year 
outlook rather than just the 5-year outlook--because the 5-year outlook 
we see some improvement. But then if we put back the omitted items, we 
see the fiscal condition turning back on us, back into deeper deficits 
and more debt. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Let's go to the next slide. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Perhaps most serious, and I think all of us share the understanding 
of our long-term situation is unsustainable. And when I look at the 
President's budget, he makes that situation worse because, in making 
the tax cuts permanent, the cost of those tax cuts explode at the very 
time the trust funds of Social Security and Medicare go cash negative. 
And the combined effect of all of this is to take us right over the 
cliff. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   That cannot be the fiscal future of the country. Let's go to the 
next slide. 
   This next chart shows what happens if the tax cuts expire or are 
offset. That is the green part of this bar. If they are not paid for, 
if they are not offset, here is what happens to the trajectory, the 
fiscal trajectory of the country. It is a trajectory of rapidly rising 
deficit and debt, and at the worst time, right when the baby boomers 
are retiring. 


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Let's go to the next slide. 
   I look at the President's budget and he has savings in Medicare 
and Medicaid which, over a 10-year period would equal $280 billion. But 
the cost of the President's tax cuts during that same time are $2 
trillion, $2 trillion when we add debt service into it. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   And then there are the question of priorities. We look at the 
President's budget. For 2008 the cost of tax cuts for those earning 
over $1 million a year for that year alone is $55 billion. The 
President says cut education $2.3 billion. These are not priorities 
that on our side we share. We do not think that is the proper balance 
for the country. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   We see the same thing with respect to the COPS program. The 
President's budget proposes cutting the COPS program 94 percent. It 
would take $520 million to restore the COPS program for 2008. Again, 
that same year the President is advocating continuing tax cuts for 
those who earn over $1 million a year of $55 billion, 100 times as 
much. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Let's go to the final slide, if we could. 
   LIHEAP, low income heating assistance, the President's budget 
proposes cutting that nearly 20 percent. It would take $420 million to 
restore it. Again, the comparison is the tax cuts for those earning 
over $1 million a year. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   I would say this is especially sensitive in my home State. The other 
day it was 46 below in North Dakota. We have a real understanding of 
the need for heating. 
   This is what Chairman Bernanke told us. And what I want to focus on 
in my time is the long-term outlook because we have differences on this 
5-year budget. Those are differences I believe we could bridge. I am 
far more concerned about where this is all headed in the long-term. 
This is what Chairman Bernanke told us: one might look at these 
projections and say they are about 2030 and 2040, we really do not have 
to start worrying about them now. But in fact, he said, the longer we 
wait the more severe, the more draconian, the more difficult the 
adjustments are going to be. I think the time to start, he said, is 
about 10 years ago. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   That puts this discussion where I think it needs to be. 

   With that, I call on Senator Allard. 


                  OPENING STATEMENT OF SENATOR ALLARD 
   
   Senator ALLARD. Good morning, Ambassador Portman. 
   I would like to welcome you to the committee on behalf of Senator 
Judd Gregg and myself. As was explained, Senator Gregg is tied up on 
the floor of the Senate. We anticipate him joining the committee later 
on. 
   Mr. Chairman I wonder if I might provide a further explanation of 
the first chart that you pulled up. Do you mind if we used your first 
chart there? 
   Chairman CONRAD. I do not mind at all. 
   Senator ALLARD. Thank you. 
   It would be the first chart that he pulled up. 
   What I would like to point out on that chart, he talked about the 
problem with the first 6 years. But if you remember, 2001 is when we 
had 9/11, and then shortly after that we had the technology bubble 
break, the Internet bubble, however you want to describe it. 
   And 2003 is when we passed the economic growth package that was 
signed by the President. Look what has happened to revenues after that 
economic growth package. Every year after that they have increased. I 
just thought that we needed to have that further explanation. 
   Chairman CONRAD. Let me just say, the first and biggest round of tax 
cuts were passed in 2001, and you can see revenue went down. 
   Senator ALLARD. Well, 2001 related--we dealt mainly with 9/11. We 
got to 2003 is when we passed the economic growth package. 
   Chairman CONRAD. No, no, no, 2001, let's be factually accurate with 
people. If you are going to use my chart, let's be factually accurate. 
   The biggest tax cuts were in 2001. You see, you put those tax cuts 
in effect--in fact, your side told me you are underestimating, Senator, 
the effect on growth. We are going to have much more revenue. 
   Well let's see. We did not have more, we had less revenue in 2002, 
less revenue in 2003, less revenue in 2004, less revenue in 2005. 
   Senator ALLARD. Let me make this point, if I might. In 2003 that 
economic growth package that we passed was a growth stimulant package. 
Those cut tax cuts were designed to encourage the economy to grow, and 
they have been successful. 
   Now we have had discussions in the past that not all tax cuts 
stimulate the economy equally. There are some that do more than others. 
And I just wanted to make a point that those we had in the 2003 package 
has made a difference, and I think that chart reflects it. 
   I do want to go ahead and make some formal comments on behalf of 
this side of the aisle. 
   This, of course, is an annual exercise in that once a year the 
President submits and Congress receives a comprehensive budget for the 
United States Government. And every year there will be people who 
criticize and say the budget is dead on arrival. 
   And yet, regardless of who controls the White House and who controls 
the houses of Congress, the legislative branch pivots off the 
President's budget and is largely reactive. 
   The President's budget, regardless of which president and which OMB 
draft, becomes the memo for the meeting and drives all other action. 
   This fiscal year 2008 budget proposes some notable changes and 
reforms. First, it is clear that the President's economic policies have 
been a major success and have led to recovery from the recession caused 
by 9/11 attacks and the burst of the Internet bubble. The economy is 
growing at 3.5 percent and is now in its fifth consecutive year of 
expansion. 
   Since 2003, over 7 million new jobs have been created. The 
President's policies of holding down taxes and stimulating private 
sector growth resulted in a continuing rise in Federal revenue 
collections. Federal revenue collections are over their historic 
average, and just last month once again showed that everyone's 
estimates--that is OMB's, CBO's, and outside experts, have been too 
cautious. For the first 4 months of this year tax collections were over 
9 percent above this same period last year. 
   The President's budget gives priority to keeping taxes fair and low 
and by allowing Americans to retain their hard-earned money. The 
President's tax policies have been a major success and this budget 
keeps tax relief in place and proposes additional changes such as 
ensuring that American companies invest in research and development to 
improve our economic competitiveness. 
   Second, the budget includes an annual estimate in 2008 for the cost 
of the global war on terror and support of our American men and women 
in Iraq and Afghanistan. Thank you, Director Portman, for listening to 
the Congress and including a requirement that we can now review. 
   In fact, the 2008 President's budget clearly and unequivocally puts 
a priority on defending our Nation. This is the core duty of our 
Federal Government. The President's budget supports our military 
personnel and grows our force structure. It provides ample operation 
and maintenance resources so as to not allow a hollow military to 
reoccur. It provides for procurement of modern weapons systems and 
research and development to stay ahead of any threat or foe. 
   Third, the budget tackles the long-term entitlement bow wave that 
threatens to undermine our economy and our children's future. The 
budget goes in specific programmatic detail and makes program 
adjustments to rein in some of the uncontrolled growth of mandatory 
programs, $61 billion in net mandatory program savings are proposed. 
And fourth, the budget continues overall spending discipline, 
especially for non-security programs. 
   I thank the Chairman and I yield my time. 
   Chairman CONRAD. Thank you, Senator Allard. 
   We will go now to Director Portman or Ambassador Portman, both 
titles apply. Welcome to the committee. 
  
                   STATEMENT OF HON. ROBERT J. PORTMAN, DIRECTOR, 

                         OFFICE OF MANAGEMENT AND BUDGET 


   Mr. PORTMAN. Thank you, Mr. Chairman, very much. And I want to also 
thank other members of the committee who are here this morning, 
including Senator Allard. Thank you for filling in. And to Senator 
Murray, Senator Bunning, Senator Feingold, Senator Sanders. 
   I look forward to the opportunity to engage in some of the issues 
that were raised by the Chairman and ranking member this morning, 
including that chart, which we will see again, I am sure, and I do have 
some comments about that. 
   It is good to be before the committee again and have the chance to 
talk about this budget. As Senator Allard said, it is our fiscal year 
2008 budget. It is a 5-year budget building on the reduction of the 
deficits over the last 2 years of $165 billion. The President's 5-year 
2008 budget continues to reduce the deficit every year and achieves 
balance by 2012. 
   We do so while keeping taxes low, but also meeting our Nation's 
priorities. Although we will have differences on how to achieve 
balance, as Chairman Conrad said, I believe we have an opportunity to 
bridge our differences with regard to the short-term outlook. And our 
sincere hope is that this budget helps provide the basis for us to work 
together across party lines to achieve balance in the short-term, but 
also to prepare us better for the long-term. Because I agree with what 
Chairman Conrad said with regard to our more difficult fiscal 
challenge. 
   I believe this is a realistic budget. Instead of painting a rosy 
scenario on revenues, I believe it is cautious. We can talk more about 
that in a moment. 
   We have also responded, as Senator Allard and Senator Conrad 
acknowledged, to congressional concerns about showing more war costs. 
For the first, we have included these supplementals in the budget, as 
you know. We have done it in a more transparent way. All of these war 
costs, by the way, are calculated as part of the reduction in the 
deficit every year and the balanced budget in 2012. 
   We have changed our projections a little bit from past years. We 
have gone from a freeze, or some years a cut, to a slight increase in 
non-security discretionary spending. And we have done that throughout 
the budget window. 
   It is consistent with what Congress and the President have actually 
enacted for the past few years, by the way. It is below inflation. It 
is 1 percent. It is also, by the way, just about where we are on the 
continuing resolution this year. 
   You will also see we have eliminated some policies that show budget 
savings but are unlikely to materialize because of congressional 
opposition. One that I have heard from members of the committee about 
is the TSA user fee, as an example, which is $1 billion. We did not 
include that in the budget this year. 
   I have had a lot of conversations with Chairman Conrad and Senator 
Gregg, and others on this committee, about our biggest fiscal 
challenge. And it is this unsustainable growth in the entitlement 
programs, important programs, Medicare, Social Security, Medicaid. I 
will address this further in a moment but the progress we are making in 
getting our fiscal house in order in the short term must not distract 
us from this longer-term challenge. 
   In this budget, as you will see, we have proposed some sensible 
reforms, primarily in Medicare, that are less than a 1 percent 
reduction in the annual rate of growth over the 5-year period and over 
the 10-year period, but they do represent an important step in 
beginning to reduce the unsustainable growth in these critical 
programs. 
   I hope we will be able to begin addressing these unfunded 
obligations through the budget process. I also believe that Senator 
Conrad and Senator Gregg's idea of a bipartisan working group has 
promise, and I commend them for their personal commitment to addressing 
these broader entitlement challenges. 
   While restraining spending overall, the President's budget also 
provides resources for key priorities. As Senator Allard said, it 
increases funding for national security to combat terrorism and protect 
the homeland. It includes new policies to address issues of concerns to 
America's families including educating our children, access to 
affordable health care and reducing energy costs. On the whole we have 
attempted to give you a credible and more realistic plan to try to 
maximize our chances of working together to achieve balance over 5 
years. 
   Over the past 2 years we have been able to reduce the deficit by 
about $165 billion. We have been able to do it for two primary reasons. 
One is a strong economy. We have been blessed with a strong economy 
that has generated record revenues the last couple of years. 
   Second, we have done a little better job of restraining spending, 
and Congress deserves some credit for that, especially in the 
non-security spending, keeping it under inflation for the past 3 years. 
I talk about that a lot publicly. The press very seldom pick up on that 
point, but it happens to be true. 
   It is exactly these elements, the solid economy and reasonable 
restraint on spending, that can now lead us to balance, working 
together. 
   As you can see from this first chart, because I will have a few of 
my charts, too--not as many as Senator Conrad. I am building up. Maybe 
next time I come before you I will have as many. 
   The budget reduces the deficit every year and results in a surplus 
in 2012. In fiscal year 2007, this year, we project the deficit will 
decline  to $244 billion, which is a reduction, by the way, of $95 
billion since our last estimate in July of 2006. 
   The deficit in 2008 falls again to $239 billion. As you will see 
from this chart, the 2008 deficit is 1.6 percent of our economy which I 
believe is the key measurement of the deficit, percent of GDP, because 
it shows the impact of Government borrowing on economic activity. This 
projected 2008 deficit, by the way, is lower than 18 of the past 25 
years as a percent of our economy. 
   The deficit then continues to decline each year, both in nominal 
terms and as a percent of the economy, until we reach a budget surplus 
of $61 billion in 2012. 
   You will recall that 3 years ago the President established this goal 
of cutting the deficit in half from its then projected height in 2004. 
At the time, a lot expressed skepticism that this goal could be met, 
including some members of this committee. But it was achieved. We 
achieved that goal together. We achieved it back in September, 3 years 
ahead of schedule. We will now build on that success and again work 
with this committee and others to come to balance over a 5-year period. 
   To keep the economy vibrant, we need to continue the pro-growth 
economic policies that have been in place and help fuel the economy, 
and therefore the revenues. The 2008 budget continues to support 
growth, innovation and investment by making permanent the tax relief 
that was talked about earlier that would otherwise expire in 2010. As 
you can see from this chart, and it is a very interesting chart to 
respond maybe to one earlier-- 
   You might want to just hold it up. Senator Conrad has his held up. I 
kind of like that. 
   [Laughter.] 
   Mr. PORTMAN. Since the tax relief took effect in 2003, you see in 
2001 there was a big reduction in revenues. That was not because of the 
tax relief. Primarily it was because of the recession. When there is a 
recession, our revenues go down. 
   Senator Allard is right, 9/11 hit, the bubble burst in the stock 
market and so on, but when you have a recession this is what happens. 
It was the most shallow and shortest recession we have had in our 
recent history, but we did have a recession and revenues go down. 
   The 2001 tax relief was fully implemented in 2003. In 2003 there was 
additional tax relief, as you know, on the investment side, primarily 
capital gains relief, dividend relief. Amazing correlation there, you 
see between the 2003 full implementation of the tax cuts and the change 
in business investment, which is the green line, and the change in 
jobs, which is the purple line. Dramatic increase in jobs, 7.4 million 
new jobs since that time, a big increase in business investment, 
productivity, and paychecks are growing. 
   This is what we want to be sure continues. 
   After 2003, the economy not only strengthened, but Federal revenues 
also surged, as I said earlier, in fact hitting record revenue levels. 
The President's 2008 budget uses 5-year economic projections that are 
in line with those of outside experts. As you can see from this chart, 
we assume GDP growth will average about 3 percent over the budget 
window. The first quarter of this year, as you know, was 3.5 percent, 
just reported last week. 
   But our projections over that 5 years closely track those of the 
so-called Blue Chip projections, which is a compilation of various 
outside forecasters. This year we have a 2.7 percent projection. I said 
earlier I believe our revenues are cautious. So is our GDP growth, 2.7 
is relatively low. Most outside forecasters are now well above 2.7, 
partly again from the information that we have received since our 
budget was put together. 
   As you can see from this next chart, with solid economic growth our 
total receipts are now 18.5 percent of our economy. That is slightly 
above the historical average of 18.3 percent as a share of the economy. 
We project receipts remain at or above this historical average, by the 
way, for the 5-year period. 
   So the notion that we are under-taxed relevant to again our history 
is just not accurate. In fact, we are already over the historical 
average. Yes, we dipped down in 2001 and 2002. That is absolutely 
right. But we are back up, not just to the historical average but a 
little above it. And our projections are we stay there during this 
entire 5-year period. 
   I termed our revenue forecast as being cautious for this fiscal 
year. Our forecast for this fiscal year is 5.5 percent growth in 
revenues. And then, over the 5-year period our average is 5.4 percent 
per year for 5 years. 
   This is, of course, below the 40-year historical average, which is 
7.6 percent. It is also well below the dramatic 11.8 percent increase 
of last year and 14.5 percent increase of the year before. 
   That is one reason I call it cautious, but in fact it is below the 
actual first quarter numbers that are now in, which is 8.2 percent in 
the first quarter. As some of you know, CBO reported yesterday on some 
January figures that are even higher than that of the first month of 
the next quarter. 
   As in the past, our revenue projections are being produced by the 
career professionals at the Office of Tax Analysis at the Department of 
Treasury. We have chosen to use them. You do not require us to, but we 
have chosen to use those projections. 
   I will also say, as was the case in the past 2 years, we may well 
find that our revenue projections are low, and thus our 2007 deficit 
projection is high. I want to say that now because I remember what 
happened last July when we came out with our reduced projection of the 
deficit. And people said gee, you lowered expectations when you put the 
budget out. 
   I am not trying to lower expectations. I am giving you what our tax 
professionals are saying, career professionals. I think they are very 
cautious. I think that is just where we have been the last 2 years and 
we are likely to be there again this summer when we do our mid-session 
review. 
   Even with his cautious forecast on revenues, the budget demonstrates 
we can achieve balance by 2012 and do it without raising taxes. In 
addition, we plan to more effectively and efficiently collect the taxes 
owed through an unprecedented effort to close the tax gap. This is 
something that Chairman Conrad and others have talked about a lot. 
   It is a problem. And we approach the problem in two ways. First, we 
improve the effectiveness of IRS's activities with a $410 million 
package of new initiatives to enhance enforcement and taxpayer service 
and to improve IRS technology, all focused on compliance. 
   Second--and by the way, relying on standard conventions, we do not 
show any additional receipts from this. We do not score these 
additional resources to the IRS in our budget. That is the way CBO has 
traditionally done it, that is the way we have traditionally done it. 
This is increased compliance. I believe it will result in increased 
revenues. We can talk more about what some of those figures might be, 
but it is not in our forecast. 
   Second, we include in the budget 16 carefully targeted tax law 
changes that promote compliance while maintaining that critical balance 
between taxpayers and taxpayers' rights on the one hand, and our shared 
interest in collecting the taxes due. 
   These changes in the legislative side are estimated to raise $29 
billion over a 10-year period, which as those of you know who follow 
this tax gap is a relatively small part of the tax gap, but it is 
scored in our budget as raising revenue because these are specific 
legislative changes. 
   As noted, the 2008 budget proposes to hold the rate of growth for 
non-security to 1 percent. Again, we think that is fiscally prudent and 
also realistic. Congress and the President have done a better job at 
that. You all have done a better job on the non-security side of 
domestic discretionary spending. In fact, the growth over the last 3 
years is about 1 percent. It is about 1.2 percent the last 3 years on 
average, including this year. 
   Again this year, the House just passed a continuing resolution that 
you all are going to look at, I understand this week and next week, 
that is at about the same level. We believe we can address our Nation's 
top priorities at this level of funding. You have shown we can do it 
and our budget does just that. 
   Within discretionary spending, the Administration closely examines 
programs to determine whether it is a priority or not, whether it is 
effective, whether it is producing intended results. Based on these 
thorough reviews the budget proposes to terminate or reduce 141 
discretionary spending programs which save about $12 billion. These 
reforms will help us reduce the deficit, but it channels resources to 
higher priorities and more effective programs. 
   We are able to make these judgments as to how taxpayer dollars are 
spent, in part, because of tools that we have developed working with 
this committee, the Homeland Security Committee and others on the 
President's Management Agenda. I encourage you to look at our analysis 
of these programs. 
   Last year to ensure greater Government accountability, we launched 
this new website called ExpectMore.gov. This site includes information 
for taxpayers on the programs that have been assessed for effectiveness 
using what we call the PART, Program Assessment Rating Tool. With this 
website, Congress and the public now have an unprecedented view into 
our Federal programs, which ones work, which ones do not, and what we 
are doing to try to improve them. It is another way we are providing 
greater transparency, holding ourselves accountable and demanding 
results. 
   The new and improved version of this website was launched yesterday. 
We now have program level information about the performance of nearly 
1,000 Federal programs representing 96 percent of Federal Government 
spending, about $2.5 trillion of spending. I urge members, I urge their 
staff, I urge any viewers that might be watching, to checkout 
ExpectMore.gov. It is an interesting view into your Federal Government 
and how we made some of our decisions. 
   The President's 2008 budget also outlines a comprehensive series of 
budget reforms that will help improve fiscal restraint, transparency 
and accountability. This committee has taken the lead on a number of 
these. 
   Legislative line item veto is, of course, one. I commend Senator 
Gregg for his efforts recently in leading a bipartisan effort that 
resulted in a close vote, but a majority vote, of the Senate to move 
the legislative line item veto through the Senate. The House actually 
passed such a bill last year, as you know, by a 247 to 172 margin, so a 
bipartisan effort in the House. By allowing Congress to take a second 
look at legislation through the process, I think it will help. I think 
we can work together to help reduce unwarranted earmarks or other 
wasteful and unnecessary spending. 
   I also think it is complementary to the key reforms to the 
earmarking process that you all have just been through. The President 
has some additional ideas there to take earmarks out of report 
language, put them in statutory language so you actually vote on them, 
and so you have an opportunity to strike those you think are 
inappropriate. The President also believes we ought to reduce those 
earmarks by half. 
   Our budget also proposes discretionary spending caps. In effect this 
expands PAYGO from no new spending in the mandatory side unless it is 
paid for, to the discretionary side as well. We also have additional 
proposals with regard to mandatory spending. They are specific, as I 
mentioned earlier, but also some process reforms that get to not just 
new spending in mandatories but the existing problem that we talked 
about earlier. 
   Our budget shows how we can work with you to achieve a balanced 
budget by 2012, but that accomplishment will be short lived without 
addressing what Senator Conrad has talked about, which is the long-term 
challenge, the unsustainable growth in the entitlements. 
   As you can see from this chart, mandatory spending is overwhelming 
the rest of the budget. In the space of four decades, we have gone from 
about 26 percent of our budget to over half of our budget devoted to 
these programs, and it continues to grow. 
   As the next chart shows, the trends are just not sustainable. 
Senator Conrad has a good chart where he talks about that, as well. 
Under this chart what you will see is that by 2040 spending on these 
three programs and the debt that is attributable to those programs 
crowds out all other Federal spending. So there would be no spending 
for education or homeland security or defense. 
   It seems to me that there is now nearly universal bipartisan 
agreement that the unchecked growth of these programs does provide real 
long-term threats to beneficiaries, to our Federal budget, to our 
economy. 
   We now face, by the way, a $32 trillion unfunded obligation in 
Medicare alone. That is over a 75-year period. 
   Our choices are pretty stark: massive benefit cuts, enormous 
deficits, or huge tax increases. Unless we act. And we can act. And we 
can act to make relatively small changes in these programs now to avoid 
that happening. 
   The balanced budget is important, in part, because it positions our 
country better to address these looming fiscal challenges. But our 
5-year budget proposal also makes an important down payment toward 
sensible reform of these mandatory programs, reducing spending growth 
by $96 billion over 5 years. 
   Again these reforms are primarily in the Medicare program, but also 
in Medicaid and other programs. The proposals are similar in character 
to those this Administration has offered in the past, also to what the 
previous administration has offered, also to what a lot of Members of 
Congress have offered, and what we did together back in the 1990's. 
To put these reforms in some context, you can see from this chart, the 
size of our budget proposal is a lot smaller than what we did on a 
bipartisan basis with divided government back in 1997, the last time we 
attempted to achieve balance together. 
   Although an important first step, the savings in this proposal, as 
you see here, would only reduce the unsustainable annual growth rates 
of mandatory spending by less than 1 percent. Back in 1997, it was 2.8 
percent. 
   What we are proposing is also less than what we did in 1990 with 
OBRA and 1993 with OBRA, and some of you were involved in those 
efforts. 
   Specifically, over 10 years the annual rate of growth in Medicare 
would be reduced under our proposals from a projected 7.4 percent 
annual growth to 6.7 percent annual growth. So it is still a very 
healthy increase. Of course, more than double inflation, maybe triple, 
and considerably higher than domestic spending. 
   However, while these proposals deliver relatively small savings in 
the short-term, the effects that build over time are more substantial. 
The challenges that we face are great and the changes that we are 
proposing are relatively small compared to the challenge in the first 
five and 10 years, but over time they do help reduce the unfunded 
obligation of the program, by about 25 percent actually over the 
75-year analysis of the unfunded obligation. 
   Frankly, under our policies, we can achieve a balanced budget within 
this 5-year window without any of these mandatory changes. So the 
budget we are giving you today, the proposals you see, we can get to 
balance, we can show you how we can get to balance with a surplus in 
2012 without making any of these changes on the mandatory side. That 
would be the wrong thing to do. We would only be digging a deeper hole 
by ignoring it for another year. 
   Balance is not coming at the expense of our Nation's commitment to 
seniors and low-income Americans. Quite the opposite. We have to begin 
to reform these programs now in order to protect these commitments in 
the long-term. Addressing entitlement spending is the right thing to do 
because small changes now can have a bigger impact later. I urge the 
committee to take a careful look at these specific proposals but also 
the general issue that the Chairman and others have raised. 
   As we restrain spending, we are also investing in our Nation's 
highest priorities, combating terrorism, protecting the homeland, 
addressing pocketbook issues that affect the standard of living of 
American families. We have talked about the fact that the budget 
supports our troops, fighting terrorism abroad. It also invests 
substantial resources to maintain high levels of military readiness in 
our DOD base budget and to continue transforming our military to meet 
the challenges of the new century. 
   I want to make this point clear, the cost of the war is reflected in 
the Administration's deficit projections. In fact, again there has been 
a $165 billion reduction in our deficit the last 2 years, even 
including substantial war costs. 
   As noted earlier, the Administration supports greater transparency 
and accountability in the war costs for Iraq, Afghanistan and the 
global war on terrorism generally, and this budget does improve the 
timeliness and specificity of the information provided to you. 
   With the 2008 budget, we go further than we have in the past. We 
show full costs of the war through the remainder of the President's 
term. We provide full costs for 2007 and 2008 for the first time, 
including account level detail of our request and also justifications. 
Specifically, we are requesting additional resources of $99 billion for 
2007 for Iraq, Afghanistan, the global war on terror; $145 billion for 
2008; and an allowance of 50 billion for anticipated war costs in 2009. 
   The Administration welcomes more oversight of our war spending and 
we hope these details we are providing with this budget this week will 
help you more fully understand our war-related requests. 
   This is a good faith effort. It is a good faith effort on our part 
to be as transparent as possible in what we anticipate the needs will 
be as far out as we can reasonably project. 
   Mr. Chairman, there is a lot more to talk about in this budget but I 
will leave it for the dialog with members of this distinguished 
committee. I will say, in concluding, that the budget before you shows 
that we can reduce the deficit every year. We can achieve balance by 
2012 by keeping the economy strong and imposing sensible and realistic 
spending restraint. We are committed to working with all members of 
this committee to ensure that our fiscal house is in order for the time 
that all of us will be in office, but also for the future. 
   I am optimistic that we can do it. I think we can do it across party 
lines, as the American people expect, and as the American people 
deserve. 
   Thank you, Mr. Chairman. I look forward to your questions. 
   [The prepared statement of Mr. Portman follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Chairman CONRAD. Thank you, Director Portman. 
   Let me address a couple of the things that you have talked about. 
You talked about the deficit as being in comparison to previous 
deficits. 
   The problem, of course, it is very difficult to compare now because 
we have such large temporary surpluses, especially in Social Security, 
that are not counted in your deficit calculation but that are added to 
the debt. 
   For last year, the reported deficit was $248 billion. But the gross 
debt of the country increased by $546 billion. So when the assertions 
are made that the deficit was less than 2 percent of GDP, the fact is 
the debt of the country increased by more than 4 percent of GDP. And 
the biggest difference is the Social Security funds that are in 
temporary surpluses that are being used to pay the operating costs of 
the Federal Government. 
   In the private sector, if anybody tried to do this, if anybody tried 
to take the retirement funds of their employees and pay operating 
expenses, they would be headed for a Federal institution. But it would 
not be the Congress of the United States and it would not be the White 
House. They would be headed to the big house, because that is a 
violation of Federal law. 
   So I hear this over and over, that our deficit as a share of GDP is 
manageable. Nobody is talking about the debt. This debt is being run up 
at the worst possible time, before the baby boomers retire. 
   The second point that you made that I want to respond to is the 
correlation you have made between the tax cuts and the economic 
recovery. I would point out that if you compared it to the Clinton 
years, you would see a similar pattern, actually an even better pattern 
of both job creation and economic growth. And that was after a tax 
increase. 
   So I do not know if you would now say well, it was the tax increase 
that drove those remarkable economic results of the Clinton years, that 
showed the strongest economic growth in the Nation's history, showed 
the strongest business expansion in the Nation's history, the lowest 
unemployment in 30 years, the lowest inflation in 30 years, after a tax 
increase. 
   It reminds me very much of the story of the elderly woman who was on 
her porch and it was a very hot day, the pavement was melting. And she 
fainted. And her nephew concluded that it must be the melting pavement 
that had caused her to faint. 
   I think you are attributing the economic growth to the wrong cause. 
I think it is the recovery. And we see, in every recovery revenue 
growth, jobs expand. And we have seen it, we saw in the Clinton years 
after a tax increase. 
   Let me just say, this recovery is running on revenue. We went back 
and looked at all of the recoveries since World War II. This is by far 
the weakest. This recovery on revenue is running $127 billion behind 
the average of the nine major recoveries since World War II. 
   On job creation, let us go to that next slide. On job creation, this 
recovery is running 6.5 million private sector jobs behind the typical 
recovery since World War II. 
   So I think the analysis here of what is causing what is just 
misplaced. 
   And the longer-term implication of the President's plan is to dig 
the whole much deeper. The President's plan, that says we are going to 
extend all of the tax cuts at a cost of $2 trillion over 10 years, 
dwarfs the savings that the President has called for on the mandatory 
side. 
   I indicated your savings on the mandatory side, $280 billion over 10 
years, is absolutely dwarfed by the tax cuts. So you wind up in a worse 
position. 
   Let's go to where we might agree, because there are places that you 
and I agree. The place we agree is our long-term prognosis on the need 
to face up to the fiscal imbalances. We have tried, Senator Gregg and 
I, to bring both sides to the table to devise a solution. To me, the 
only way that happens is if both sides are prepared to compromise. 
   You have said everything is on the table. What do you mean by that? 
   Mr. PORTMAN. Thank you, Mr. Chairman, and welcome to Senator Gregg. 
I talked about you and Chairman Conrad talked about you, so it is good 
you are here to defend yourself. 
   First of all, I agree with you. I think it is incredibly important 
that we, as public officials on both sides of Pennsylvania Avenue, and 
both sides of the aisle, acknowledged the problem. I commended you for 
that in my testimony and you and I have talked about that a number of 
times. Because the long-term unobligated--the long-term liabilities and 
obligations that are currently unfunded is really the fiscal challenge 
we face. 
   We are doing a much better job in getting our fiscal house in order 
short-term. And what the President has said recently is not only a 
specific proposal for a bipartisan commission to deal with the 
entitlement challenge, but he has said that there should be no 
preconditions, meaning that, in fact, everything should be on the 
table. 
   He has also, as you know, shown some political courage in taking on 
some of these specific issues. We do it again in this budget. I have 
laid out for you what we think are sensible and reasonable changes in 
some of the programs that create the biggest challenge longer term. 
We talked about the $32 trillion unfunded obligation in Medicare. The 
President has also been way out front on the issue of Social Security 
and, as you know, we were not successful in getting Congress to take up 
those reforms. But he continues to believe that this is the biggest 
fiscal challenge that we face and we should address it and we should do 
so in a bipartisan way. 
   Chairman CONRAD. Let me just followup and ask you, if I can, this 
question: when you say no preconditions, does that mean that you can 
foresee a resolution that includes both additional revenue as well as 
reduction in expenses for the long-term entitlements? 
   Mr. PORTMAN. I think it is critical we not pre-judge at this point 
where we are going to end up in the long-term, because in that case-- 
   Chairman CONRAD. I am not asking for a conclusion. I am asking 
though, when your side says there is no preconditions--because you say 
this, Secretary Paulson says it. But then I see the President and the 
Vice President, when they are interview publicly, slam the door in 
terms of revenue. 
   So we need to know, if there is really going to be a serious 
discussion, it cannot be a circumstance in which one side, clearly 
Democrats are the preeminent defenders of Medicare and Social Security. 
Republicans are the preeminent defenders of tax cuts. That is the 
reality. 
   So the question is are both sides to compromise? Are both sides to 
give ground here? Or is only one side to give ground? 
   Mr. PORTMAN. I would take issue with your premise that Republicans 
who are trying to be sure these programs are around for future 
beneficiaries are not defenders of Medicare and Medicaid and Social 
Security. It is precisely because we think these programs are so 
important that we are willing to take what are politically difficult 
steps to try to ensure the commitment is there for future generations. 
   I think that is the responsible thing to do. 
   Chairman CONRAD. I would just say the problem is you are cooking a 
fiscal stew that is going to guarantee that there have to be more 
draconian cuts because you are using Social Security--we can get into 
that debate. I had hoped to try to reach conclusion on is there a 
serious chance for a discussion on the longer-term. 
   But look--
   Mr. PORTMAN. There is absolutely, absolutely a serious change. But I 
would not-- 
   Chairman CONRAD. The fiscal reality is the President has run up the 
debt $3 trillion. That threatens Social Security and Medicare. It 
threatens Social Security to take $180 or $190 billion of Social 
Security money and use it, instead of paying down debt or prepaying the 
liability, to use it to pay the operating expenses of the Government. 
But that is the President's fiscal plan every year for the next 10 
years. 
   That makes the long-term solvency of Social Security more difficult. 
   Mr. PORTMAN. The issue on Social Security is that we need to reform 
the program so that it is able to sustain itself over time. I totally 
agree with you on the way you were calculating various approaches to 
looking at the deficit or even the long-term debt. We should have all 
that information. All of that is provided, by the way, in this 
financial report of the United States that I sent to you all 
personally. It is up on our website. I encourage every American to look 
at it. You can look at the debt and the deficit in a number of 
different ways. 
   Chairman CONRAD. So is revenue on the table? If there is a 
discussion, if we come together for a negotiation, is revenue on the 
table as far as the Administration is concerned? 
   Mr. PORTMAN. Again, I do not know how I can be more clear, but what 
the President has said recently--and this is not, again, something that 
was being said a year ago or even 6 months ago. And I think we should 
note that we have a long-standing view, and I have laid it out in our 
budget very clearly why we believe that we do not need additional 
revenues to get to a balance in 2012. I have shown you what the percent 
of the revenue is as to the economy, which is the burden on the 
economy, how it grows and does not go down--
   Chairman CONRAD. But I am talking Beyond--as you know, I am talking 
beyond 2012. 
   Mr. PORTMAN. Our long-term figures show the same thing, which is we 
do not fall below that historic average. The question is what should 
the burden be on this economy? Do we want to risk the 7.4 million new 
jobs we have created since 2003, the economic recovery that has enabled 
us to generate those revenues. 
   Chairman CONRAD. Director Portman, you are doing exactly what I 
feared-- 
   Mr. PORTMAN. No, no, but this is nothing new. 
   Chairman CONRAD [continuing]. Which is that this is all going to be 
done-- 
   Mr. PORTMAN. This is our policy view. 
   Chairman CONRAD. What I am hearing from you is exactly what I hear 
publicly from the President and the Vice President, that this is only 
going to be done on the cost-cutting side, which clearly has to be 
done, but nothing on the revenue side. If that is what you postulate, 
then there will not be a conclusion because then you are only asking 
one side fundamentally to compromise. If both sides are not prepared to 
compromise, there will not be a resolution during this administration. 
And that would be a tragedy. 
   Mr. PORTMAN. What I am saying is we should have the discussion with 
no preconditions on either side. 
   Chairman CONRAD. Senator Gregg. 
   Senator GREGG. This is the gravamen, to use a legal term, of the 
fiscal year issue of this Nation, which is how we handle the long-term 
entitlement costs and the fact that those costs exceed significantly 
revenues, and the fact that you cannot tax your way out of this problem 
because the burden of these costs is accelerating at a point that they 
could easily absorb not only the entire Federal budget but well beyond 
the Federal budget, maybe as much as 30 percent of gross national 
product. Today, of course, the Federal Government only--that is three 
programs, 30 percent of gross national product. 
   I want to congratulate you, though, for--I had hoped we would reach 
a resolution that would allow us to sit down and set up a process which 
would lead to a policy which would take a global response and would 
address the entitlements, the major entitlements, primarily the health 
care entitlements and Social Security, and would also have to address 
revenue side. We are not going to get there without looking at both 
pictures, but the majority of the effort has to be on the benefit side. 
   But it does not appear that the climate is going to allow that for a 
variety of reasons. I do not think the blame lies at the White House 
entirely, although some comments were not constructive. I think there 
is also a problem with some skittishness on the other side of the 
aisle, relative to making what would be a very courageous act of 
actually addressing the benefit structure of these programs. 
   But I do want to congratulate you folks for putting forward a major 
step in the area independent of a global settlement with your proposal 
on Medicare which, as we know, Medicare has approximately a $35 to $40 
trillion--that is with a T--unfunded liability over its actuarial life, 
the actuarial life being essentially the retirement of the baby boom 
generation. 
   That liability is so huge that it will essentially bankrupt our 
children's capacity to have a decent lifestyle. Our children will not 
be able to afford that system. And they well be left with a lifestyle 
much less of quality than what our generation has had, and our 
generation will have done an incredible unfairness to our children by 
leaving them with this debt and putting this debt on them. 
   We have to address that. Now I would hope for a global settlement 
but we are not going to get there, it appears, because the parties are 
backing away. 
   But least you have come forward with a proposal which reduces 
significantly that number. As I understand your proposal, which 
represents about $90 billion over 5 years, translates into about $8 
trillion over the actuarial life, which is about 25 percent of the 
problem. That is a huge step. 
   As I also understand your proposal, it does not address--it does not 
reduce benefits to beneficiaries. It calculates more accurately the 
reimbursement inflation rate for hospitals and for provider groups, 
which should be gone. And it also says that Bill Gates's father and 
other people who are fairly wealthy, very wealthy, should not be 
subsidized by working Americans who are working at restaurants and gas 
stations across this country, and their doctors' cost and their drug 
costs. And those two items primarily are the drivers of this very 
dramatic reduction in the out-year liability. 
   I guess I have two questions for you. First, is that an accurate 
description of what you are doing? I am sorry that I was not earlier, 
maybe you have already gone through this. There was some issue on the 
floor that has drawn me away on occasion. 
   And second, I would hope that if that is true, that at least our 
colleagues on the other side the aisle, when they draw up their budget, 
would at least take this element of the major reform effort, which is a 
significant element, and run with that one. 
   Mr. PORTMAN. I appreciate the fact that you have described it well, 
and better than I did in my testimony, because you have talked about 
what the impact is on beneficiaries. You are right, for the vast 
majority of Medicare beneficiaries there is not only no impact, it is a 
positive impact in the sense that their premiums will go down. Because 
as you know, in Part B they pay 25 percent of the premium. 
   Senator GREGG. And the system will be made more solvent. 
   Mr. PORTMAN. And the system is made more solvent, which is the 
ultimate benefit to all of us, to be able to protect these programs 
over time. For higher income seniors there is more means testing. I am 
told I should use the word income relating. But what it means is-- 
   Senator GREGG. No, we are just going to make high-income seniors pay 
the fair cost of what we are giving them. That is reasonable. 
   Mr. PORTMAN. It is 5.6 percent of seniors. Again, every other 
beneficiary will see a reduction in their premiums, not an increase, a 
reduction. But for 5.6 percent of seniors there will be less of a 
Federal subsidy under Part B and under Part D for the premiums. But it 
is 5.6 percent of seniors. It is actually 2.7 percent of seniors in 
Part D. 
   Senator GREGG. What percent of that $8 trillion is tied to the 
adjustment of premiums for high-income seniors? 
   Mr. PORTMAN. About half, over time. 
   Senator GREGG. And the other half is to get the COLA right for 
reimbursement; is that correct? 
   Mr. PORTMAN. That is correct, what we believe is an appropriate 
reimbursement for the providers, clinics, labs, hospitals. 
   Senator GREGG. I do not think either of those should be 
controversial. I mean, obviously the provider groups are going to go 
crazy. But a fair reimbursement rate is a fair reimbursement rate, and 
having high-income seniors pay a much higher percentage of the cost of 
their premium is a reasonable thing. 
   I would hope that as our Democratic colleagues develop their budget, 
they would consider putting that in there, too, so we would have it in 
both budgets and there would be consensus. 
   Thank you. 
   Mr. PORTMAN. Thank you, Senator. 
   Chairman CONRAD. I would just say for me, I voted to do that. One 
night in the Finance Committee a number of years ago, a group of us 
just got so tired of this stale debate that we did a whole series of 
things. And it actually passed the Finance Committee overwhelmingly on 
a bipartisan vote. And when we told our other colleagues about it, they 
retreated. But we were prepared-- 
   Senator GREGG. I think we should give the Finance Committee another 
opportunity to do that. 
   Chairman CONRAD. That may be a very positive idea. 
   Senator SANDERS. 
   Senator SANDERS. Thank you very much, Mr. Chairman. 
   Rob, how are you? 
   I look at the world a little bit differently than you do and a 
little bit differently than some of my colleagues. Let me tell you the 
world that I look at. 
   Since the Bush Administration has been in office, and I did not hear 
you mention this word once, poverty has increased by 5 million 
Americans. Is that an issue that maybe we might want to be talking 
about? 
   Not only does the United States have the highest rate of poverty of 
any major country in the industrialized world, but I think more 
outrageously we have by far the highest rate of childhood poverty, way 
above what Europe and Scandinavia does. I do not hear one word coming 
out of the Administration on that issue, 37 million Americans living in 
poverty today. 
   Median income for working-age families has declined for 5 years in a 
row while the price of health care, housing, energy and college tuition 
has skyrocketed. 
   Meanwhile, and this is an issue that we have to place on the table 
as well, while poverty is increasing and while millions of Americans 
are working longer hours for lower wages, the people on top have never 
had it so good. You cannot just look at an economy and say everything 
is going well. Well, it is not. Poverty is increasing, middle class is 
shrinking, people on top have never had it so good, not since the 
1920's. 
   According to Forbes Magazine, the collective net worth of the 
wealthiest 400 Americans increased by $120 billion last year, to $1.25 
trillion. The 400 wealthiest Americans are worth $1.25 trillion. At the 
same time, 37 million Americans are mired in poverty and 47 million 
Americans have no health insurance. 
   That is the reality that I see, and maybe that is the reality every 
now and then this committee might want to talk about, just 
occasionally. 
   Now a budget is a reflection our values. It tells us what we believe 
and where we want to go. The way I see the budget being presented is at 
a time when the wealthiest people have never had it so good, what you 
do is suggest that we maintain huge tax breaks for millionaires and 
billionaires. It does not seem fair to me. It does not seem right to 
me. 
   Meanwhile, while poverty is increasing and millions of Americans are 
really struggling just to keep their heads above water, what I see, as 
the chairman indicated, Vermont may not be as cold as North Dakota, it 
gets pretty cold in Vermont, it gets pretty cold in New Hampshire. 
LIHEAP, 40 percent of whose participants are seniors, will be cut. The 
Commodity Supplemental Food Program, which provides a package of 
groceries to low income seniors once a month, is cut. Community Service 
Block Grants, which provide the infrastructure for the delivery of 
services to low-income people, is cut. 
   Now we talk about a war budget and the war in Iraq, and yet in my 
State, and almost all over this country, veterans today are on waiting 
lists. And what you propose in your budget is to raise fees on veterans 
for their health care by $355 million in 2008, the result of which will 
be driving, which is the purpose, hundreds of thousands of veterans off 
of VA health care. 
   Now maybe some people think that is a way to say thank you to the 
people who have put their lives on the line defending our country. I 
personally do not. 
   When we have the highest rate of childhood poverty, you are 
proposing cutting back on Head Start and child care. 
   Now Rob, I do not know what goes on other parts of the country, but 
I will tell you that in Vermont, child care is a disaster. It is very 
hard for families to find affordable quality child care. And you are 
cutting back on that. 
   Question: at a time when we are seeing an escalation of millionaires 
and billionaires at the same time as we are seeing a huge increase in 
poverty and a decline in the standard of living of millions of American 
workers, do you really think it is appropriate to cut back on programs 
for low-income people and maintain tax breaks for millionaires? 
A pretty simple. 
   Mr. PORTMAN. Senator Sanders, I thank you for your question and I 
know we are going to have differences in our views or approaches. But 
just, if I could, tell you a little bit about what we are looking at 
now in terms of the economy, where it is relative to where it was maybe 
a few years ago in terms of what you were talking about, working 
families and their paychecks. 
   Senator Conrad talked about the fact that recoveries typically 
involve not just an increase in revenues, but they also involve, I will 
say, an increase in wages. If you look at what is happening today and 
in the last year in particular, we have seen real wages going up. We 
did not see that early in the recovery. By the way, we DID not see that 
in the recovery in the 1990's either. In fact, we are ahead of the 
1990's recovery in terms of from the recession until now how much wages 
have gone up. Talking about real wages, after inflation. And we are 
able to show that now. And thank goodness, and it is a great thing for 
working families. 
   So over the last 12 months, we have seen a change in that, partly 
frankly because energy prices have gone down some. But mostly it is 
because, as with the recoveries over the last four decades, wage growth 
tends to follow the productivity growth, the GDP growth, and it is now 
happening and it is kicking in. And working families and people who 
punch a time clock around this country every day are now seeing the 
benefits of the better economy. That is a good thing. And that is 
affecting some of the income inequality issues that you raise. 
   I can give you all of the data on that that we have now got from 
Treasury and from the Labor Department and so on, but that is good 
news. And it was not true a year ago. 
   Senator SANDERS. If I could, my time is limited and I do not mean to 
be rude. 
   Child care, a horrendous situation, I think, all over this country. 
I do not know if you acknowledge that or not, affordable child care 
hard to come by almost any place. And yet you guys are cutting back on 
child care, you are cutting back on Head Start. 
   Explain to me why you think that is a right thing to do within the 
context of our country, having the highest rate of childhood poverty? 
   Mr. PORTMAN. Let me get the Head Start numbers. 
   I have a little bit of a challenge here because, as you know, 
Congress is about to pass a new Head Start provision, or the Senate I 
think is poised to pass something. The House has passed in the last 
week, new numbers. 
   Our number is based on the expected changes. The 2007 request would 
have been a slight increase. The number I have now in front of me on, 
at least what the House passed and what I assume you all will pass, is 
our request is actually an increase of 1.45 percent. 
   Senator SANDERS. We see it as a reduction from the continuing 
resolution. That is the numbers that I have. 
   Mr. PORTMAN. I have all of the numbers. We can share these with you. 
But it takes me a minute because this H.J. Res., which is the new 
long-term CR, changes the numbers somewhat. You are providing-- 
   Senator SANDERS. Tell me about the-- 
   Mr. PORTMAN. Can I talk about the fees just for a second, because it 
is a very important issue. 
   Chairman CONRAD. We need to close this out because the Senator's 
time has expired. 
   Mr. PORTMAN. I am happy to get with you afterwards, but we think we 
have a good policy here, a big increase again, 7.6 percent in the 
veterans budget, 7.4 percent increase in medical care for our veterans 
this year, building on the increases we have had of 64 percent since 
2001. 
   Chairman CONRAD. Senator Allard. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   We had some discussion about the debt, as opposed to the deficit, 
and how Social Security plays into that. Is there some way that we can 
change our debt problem without changing the law pertaining to Social 
Security and the transfers of dollars from Social Security to the 
general fund? I do not see how that happens. 
   Mr. PORTMAN. No, it would require legislation. 
   The point I was making earlier was that I agree the Chairman in the 
sense that we ought to look at our deficit and our debt in various 
ways. One is the unified budget. That is how we have done it since 
1967. That is how this committee will, I assume, propose your own 
budget. It will not include the surpluses in Social Security. 
   That is how the CBO does it, the non-partisan Congressional Budget 
Office. That is how the Clinton Administration did it. That is how we 
do it. 
   My point was I think it is helpful, frankly, to look at it another 
way, which is to look at not just our net operating costs, which would 
include our real liabilities like veterans or military retirees or 
Government retirees--which by the way, again, is here. You can look at 
the net operating cost of the Government as well as our unified budget. 
   Also, I think it is helpful to look at it in terms of what are our 
unfunded obligations, which would include Social Security and Medicare? 
   But the point, Senator Allard, that you made and that I am trying to 
make, is at a minimum we should agree to get to balance on a unified 
basis. The unified budget that we all have been using since 1967 is all 
money in and all money out. So all fees, all payroll taxes, all income 
taxes into the Government, and then all the money we pay out. At a 
minimum, let's get to balance on that basis. And that will require some 
spending restraint. 
   On the other hand, if you look at what Congress has done the last 
couple of years, we are on track to be able to achieve that, as long as 
the economy continues to grow. That is why keeping the tax relief in 
place is so important. 
   The one thing I did not get a chance to do, in responding to Senator 
Sanders' comments, is to say that one reason we feel so strongly about 
the tax relief staying in place is because of this correlation we see 
between its implementation in 2003 and the growth in jobs and 
productivity and investment. But also because if you reduce the 
existing tax relief that is in place, it will be a tax increase on 
America's families. 
   Or if you are focused more on the economic impact overall, you have 
to acknowledge that it is a big increases in taxes on America's small 
businesses, which are creating so much of the economic activity and new 
job growth. More than half of the new jobs are being created by small 
businesses, 90 percent of whom filed their taxes through the individual 
tax system. 
   So if you raise people's taxes, Mr. Sanders talked about going after 
the wealthy individuals. Well, you are also going after America's 
businesses. In fact, it is the more profitable small businesses that, 
of course, are generating more jobs, expanding their plant and 
equipment and people. And 75 percent of those small businesses have 
income in these top two brackets that we are talking about. 
   So this is a very important part of the President's tax relief, as 
well. 
   Of course, on the capital gains side, on the dividend relief side 
that you supported so strongly, Mr. Allard, very important to encourage 
investment to keep that moving forward. 
   Chairman Conrad talked about the difference between this recovery 
and the last recovery. He noted that there were tax increases in the 
early 1990's. That is true. But when the economy really took off in the 
late 1990's, including 1997 when we came together as Republicans and 
Democrats, we actually cut taxes. 
   Senator Bunning was on the Ways and Means Committee there at that 
time and he helped do that. It was on capital gains. And it resulted in 
new revenues in capital gains that were beyond anybody's expectations. 
It helped us, as you know, get to balance in the late 1990's sooner 
than anybody thought we could. 
   We had a 5-year balanced budget then, as we are proposing now. We 
actually got there a couple of years early, partly because of those 
capital gains receipts that came in because of a tax cut in 1997. 
   Senator ALLARD. I want to make an additional point here, my time is 
running out here. I just put a chart up on the screen there to the 
right which shows high income taxpayers bear a greater burden under 
Bush. If you compare the Clinton Administration, it is 81.2 percent. If 
you compare the Bush Administration, who brought in tax cuts, we see it 
goes up to 84.9 percent. 
   So in real figures what is happening in revenues coming into the 
Federal Government, we see a greater proportion of that coming from the 
high income taxpayer. 
   Mr. PORTMAN. That is a fair point and it is accurate. After all the 
Bush tax cuts are implemented, the top 10 percent pays about 66 percent 
of the burden rather than 64 percent of the burden, and that would be 
consistent with your chart. 
   That is because of the refundable nature of the child tax credit, as 
you know, the expansion of the 10 percent bracket. Also the way the 
marriage penalty works. As you know, 4 to 5 million taxpayers do not 
pay any Federal income tax now who did previously, who are lower income 
Americans who benefit from the tax relief. 
   So you are right to point that out. The point I was making is 
another aspect of it, which is among those higher income taxpayers a 
lot of them are small businesses. Because of the way our tax system 
works small businesses, for the most part, are in the individual tax 
system, not in the corporate tax system. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator Allard. 
   Senator MENENDEZ. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   Director, it is good to see you. I enjoyed my time in service in the 
House with you. 
   Let me start off by saying that in 2003 a different White House 
Budget Director told the Congress that the war in Iraq would maybe hit 
$50 or $60 billion at most. We have spent seven times that much. So I 
want to look at the present request by the Administration in this 
budget on Iraq. 
   As I understand it, the President is asking for about $179 billion 
for Iraq in 2007 and 2008; is that correct? 
   Mr. PORTMAN. That is correct, Senator. It is $170 billion roughly 
total, a little less than that, but about $170 billion for 2007 when 
you add the bridge that you all passed back in October. And then it is, 
for 2008, another roughly $145 billion, about $141 billion on the DOD 
side, and $145 billion total for Iraq, Afghanistan, global war on 
terror for 2008. 
   Senator MENENDEZ. One of the things I would hope that you would make 
more clear in the future, you have to be a CPA/rocket scientist to go 
through the way--instead of very clearly saying here is how much we want 
for the war in Iraq, here is how much we want for Afghanistan, the 
Administration mixes it in such a way. It should not have to take a 
rocket scientist to figure it out. 
   But having figured it out, isn't it a fact that these numbers, CBO 
has told the Congress that they see the escalation of the war costing 
much more than that. And it is either oversight or deceit by the 
Administration not to have an extrapolation of the facts that there is 
going to be a lot of support personnel in addition to the actual troop 
deployment that is necessary. And that does not seem to be factored in 
in this budget. 
   Mr. PORTMAN. I am glad you asked that question. It is neither 
oversight or deceit. It is a different plan. I spoke to the director 
CBO, for whom I have a lot of respect, I know you know him well, Peter 
Orszag, about this. I just wish they had called us because they assume 
that this goes into 2008. First, we do not. It is a different policy. 
You can hold us accountable for our policy, but our policy is this is a 
fiscal 2007, not a fiscal 2008/fiscal 2009 exercise. 
   Senator MENENDEZ. So the Administration is going to deviate totally 
away from the military standard operating procedure for the purposes of 
support personnel? It is going to move totally away-- 
   Mr. PORTMAN. That is another issue. 
   Senator MENENDEZ [continuing]. From its historical realities. And 
you are not going to come back to us for a supplemental this year; 
right? 
   Mr. PORTMAN. That is another issue and I should have addressed that 
earlier. On the plan that the President has laid out for increased 
brigades he is assuming, and this is our plan, that we will extend the 
deployment of many troops who are in Iraq now. The CBO assumed that we 
would be sending reinforcements in that were brigades from the United 
States or other bases. So it is just a different plan. 
   The support troops that you are talking would also, under our plan, 
many of whom would be in Iraq now or in the theater, they would be 
extended, as well. 
   Senator MENENDEZ. So you are going to send 22,000 troops more and 
not send virtually any more support troops for those 22,000? 
   Mr. PORTMAN. No, we have built into our estimate, which is $5.6 
billion, the support troops necessary to support the additional 
brigades. 
   Senator MENENDEZ. So you are not going to come back to us for a 
supplemental? 
   Mr. PORTMAN. Well, we will see what happens on the ground. With 
regard to the particular issue of what we are doing on the additional 
brigades, the reinforcements in this new plan, we have our full costs 
in the fiscal year 2007 supplemental. 
   Senator MENENDEZ. How do you go in 2009 to $50 billion? How do you 
go from $170 billion, especially with the President's escalation of the 
war, and then tell the Congress that in 2009 you are going to have $50 
billion? 
   Mr. PORTMAN. It is not an estimate of full war costs in 2009. You 
are correct. 
   Senator MENENDEZ. So it is going to be a lot more than that. 
   Mr. PORTMAN. I do not know. Nor does anybody on this committee. 
   Senator MENENDEZ. How can you talk about a balanced budget when you 
are throwing out a figure that is clearly underfunded from its present 
reality? 
   Mr. PORTMAN. If the President's plan works as we believe it will, 
and as I know Americans hope it will, which is that it will result in 
less of a commitment by our country to Iraq because we will be able to 
quell some of the sectarian violence that has flared-- 
   Senator MENENDEZ. Two-thirds less? Two-thirds less in 1 year? 
   Mr. PORTMAN. No, I am talking about 2007 now. We are in 2007 now and 
that is the funding that provides for the increased reinforcements in 
2007. 
   In 2008, we actually provide, and this may make you feel better 
about things, a straight line. In other words, in 2008, we do not 
assume, for purposes of our budget, that there will be a decrease in 
our activity. We hope and expect there will be, but to be prudent in 
2008 it is just a straight line. 
   Senator MENENDEZ. What will have you come back here for a 
supplemental? What facts will change on the ground that will have you 
come back here for a supplemental? 
   We had testimony here by a panel of experts that say they believe 
that notwithstanding what you have put in the budget, you are going to 
be coming back for a supplemental. What would be the factors that you 
might have that you will have to come for a supplemental? 
   Mr. PORTMAN. Changed circumstances on the ground, and it can go 
either way, honestly. What we have provided is, I think, a prudent 2007 
and 2008 estimate. And 2007-2008, by the way, are being provided to you 
for the first time at the account level, breaking out Afghanistan. I 
agree with you that in the past we have not provided the kind of 
transparency that is most helpful to Congress for oversight. 
   These two boxes, that I will not make somebody put on the table, 
include the justifications. So it is not just the account level, which 
we have not provided previously with the budget, but it is all the 
justifications now, not justifications to come later. 
   It will not take a rocket scientist to look through it. It will take 
some time because there is a lot of detail there. And we are saying for 
2007, we believe this to be our full cost. You can look at our 
assumptions. You can look at our request for 2008, which is something 
that is difficult for military planners to do because much of this 
money will not be spent for 18 months or 2 years or more. We are 
basically giving you a straight line from 2007 in terms of military 
operations. 
   Now again, we believe that we will be able to see some success with 
the reinforcements that will not make that necessary. But out of 
prudence, we are providing that. 
   I just want you to be aware of that. There is no opportunity for 
members of this committee or for war planners at the Pentagon to have a 
window into exactly what is going to happen. Nobody has a crystal ball. 
So that is why I cannot answer your question as to whether there might 
be another supplemental request sometime in the future. I just do not 
know. 
   But I do think that by providing more information to you and giving 
it to you in a more transparent way with all of the justifications and 
account level detail, we are being more responsive to the concerns that 
have been raised. 
   Senator MENENDEZ. Mr. Chairman, I just want to close by saying that 
I am concerned that we do not have the full figures here, that we will 
end up with a supplemental. And supplemental is deficit funding at the 
end of the day. That is how the Administration has largely funded this 
war. 
   Thank you. 
   Chairman CONRAD. Senator Bunning. 
   Senator BUNNING. Thank you, Mr. Chairman. 
   Director Portman, I am concerned about the rate of growth of our 
entitlement programs. You are also, particularly Medicare and Medicaid. 
   The President's budget takes steps to slow the rate of growth in 
these   programs. In other words, we are not cutting but the growth 
rate is slowed. For example, in Medicare the President has proposed 
reducing the growth rate in the program from 6.5 to 5.6 over 5 years. 
In Medicaid the rate of growth is reduced from 7.3 to 7.1. 
   And I looked at it over a period of 75 years. Out-years are 
particularly a concern to my 35 grandkids and my four greatgrandkids. 
If we do what is proposed to be done, the Medicare unfunded 75-year 
unfunded liability is reduced by 25 percent or $8 trillion. I think 
that is very important. 
   Is that the reason that we are biting the apple now, not reducing 
any benefits, but if we do not take that reduction in increase now that 
the out-years just get worse and worse as we go down the pike? 
   Mr. PORTMAN. Yes, you are absolutely right. We talked about this a 
little bit earlier, but by making relatively small changes now that are 
sensible policy changes, we can have a significant impact in the 
out-years. 
   I will also tell you this is not enough to address the problems that 
Senator Gregg and Chairman Conrad discussed earlier. In other words, we 
will need, as a Congress and as an administration, to sit down and work 
out even further sensible reforms to not just Medicare but also 
Medicaid and Social Security. 
   On your numbers, you are absolutely right. Over the 10-year period, 
by the way, the Medicare growth is 7.4 percent under current 
projections. The implementation of all of these proposals we have on 
Medicare takes it to 6.7 percent. So it is less than a percentage point 
decrease in the rate of growth over the 10-year period, as well as the 
5-year period that you mentioned. 
   On Medicaid, the 10-year number is 7.4 percent under current law 
annual increase, and all of our proposals on Medicaid, which again we 
believe are all good policy, takes it to 7.6 percent, 0.1 percent. 
I would say that is the least-- 
   Senator BUNNING. Out-year projections, am I correct on the out-year 
predictions? 
   Mr. PORTMAN. Yes, you are, sir. You are correct. In the out-years it 
has a greater impact. In the out-years the $32 trillion unfunded 
liability in Medicare over the 75-year period that was talked about 
earlier would be reduced by roughly 25 percent or $8 trillion under the 
full implementation of these Medicare proposals because the savings 
grow over time. 
   Senator BUNNING. I have to get back to Social Security because you 
were on my subcommittee over in the House, as chairman and he was a 
member of my subcommittee in the House on Social Security. 
   How many times did I say we have to change the law if we want to 
change the unified budget? Because the law requires exactly what we do 
with our money when we take it in in Social Security. 
   I do not know how many people up here at this forum or this table, 
this wonderful Budget committee I sit on now, are willing to change the 
law and do something else with the receipts of the Social Security 
funds. 
   But if we are going to change that then the unified budget would 
look different? Is that correct? 
   Mr. PORTMAN. That is true. Under current law there is a requirement 
that they be invested in treasuries. 
   Senator BUNNING. And what do we do the other money that is invested 
in treasuries? In other words, the money that the Treasury sells out on 
a monthly or bimonthly or quarterly or whatever, the 5-year notes, the 
2-year notes, the 10-year notes, the 30-year bonds. What do we do with 
that money? 
   Mr. PORTMAN. It is used to help finance our debt. 
   Senator BUNNING. Yes. 
   Mr. PORTMAN. I will say there is a big distinction between publicly 
traded debt, which is the debt that we offer to the public, and 
so-called internal debt. 
   What you are talking about is the importance of looking at both of 
those. The internal debt is the obligations that we have to Social 
Security and beneficiaries over time, now in a surplus. But in 10 short 
years, as you know, the line crosses. In a sense, we do not have the 
payroll taxes coming in to afford the-- 
   Senator BUNNING. No, we go into the interest and in about 2046, if 
we do not do something dramatic, we will be paying 75 percent of the 
benefits that we now are obligated to pay under current law. 
   Mr. PORTMAN. But in 10 short years that surplus is no longer there. 
   Senator BUNNING. That is correct, we are into the interest. 
   Thank you very much. 
   Mr. PORTMAN. Thank you, Senator Bunning. 
   Chairman CONRAD. Thank you, Senator Bunning. 
   Senator CRAPO. 
   Senator CRAPO. Thank you very much, Mr. Chairman. And Mr. Portman, 
we appreciate you being here. 
   I look back with fondness on the time we served in the House 
together, as well, on a number of these critical issues where we 
struggled then to try to find solutions to develop a path forward. 
   But I want to pursue with you a little further the same line of 
questioning that you have gone through here with Senator Gregg and 
Senator Bunning, the 75-year outlook on our entitlements. 
   I understand that we have gone over the numbers several times, that 
you are proposing about a $90 billion reduction in the first 5 years, 
in the 5-years of this budget, but that that $90 billion reduction will 
translate into approximately $8 trillion of savings over the next 75 
years of the entitlement programs that we are talking about; correct? 
   Mr. PORTMAN. That is correct. 
   Senator CRAPO. Could you give us a little more detail about how that 
$90 billion is proposed to be achieved in terms of the savings? 
   Mr. PORTMAN. Thank you for asking. I had an opportunity with Senator 
Gregg to talk about this a little bit earlier. But in the first five 
and 10 years, the majority of the Medicare savings do come from what we 
believe are changing the payment from what it currently is projected to 
be to providers to what we think is a more appropriate payment. That 
number is on the market basket, which is the biggest part of it, a 0.65 
percent reduction. We come at that number in part from analysis that 
has been done by outside groups and experts. But also it happens to be 
about half of the productivity gain that is expected. 
   In other words, through efficiencies and more productivity, we would 
expect about twice that amount. So we think the 0.65 percent is 
reasonable, again also based on what many experts have given us in 
terms of the actual health care provider community and what would be an 
appropriate level. So we think it is good policy and in the first five 
or 10 years it is the majority of the relatively small savings relative 
to the growth of the program we talked about. 
   Over the longer haul, it is shifted somewhat more to the means 
testing side so it becomes, I believe, nearly half of the savings over 
time is telling those individuals who make over $80,000 a year or as a 
couple over $160,000 a year that the Federal Government will continue 
to provide a subsidy for their premiums under both Part B and Part D, 
but a little less of a premium subsidy from the Federal Government. 
   That is the proposal that Senator Conrad talked about the Finance 
Committee has taken up in the past, maybe the distant past now, and we 
think is also a crucial element to a comprehensive plan to looking at 
our entitlement problem. 
   I will also say we have not talked as much about Social Security. I 
know you have a strong interest in that and you have been out front on 
some specific proposals in that regard. The 75-year projection on the 
Social Security unfunded obligation is $15 trillion. So less we only 
focus on the Medicare $32 trillion, there is also a big unfunded 
obligation in our Social Security program. 
   Senator CRAPO. And we still need to deal with that, which is not 
done in this budget proposal. 
   Mr. PORTMAN. No, it is not. 
   Senator CRAPO. Back to the details you were just talking about, if 
I understand them correctly then, with the exception of those 
reductions or changes in the benefit structure for the more wealthy 
citizens, there is not a proposed change to the benefit structure of 
the Medicare or Medicaid system? 
   Mr. PORTMAN. That is correct. For those Medicare beneficiaries who 
are not part of what is now 5.6 percent of beneficiaries under Part B 
or 2.7 percent of beneficiaries under Part D who would be subject to 
some of this slight reduction in the Federal subsidy on premiums, for 
the rest of Medicare beneficiaries, meaning the vast majority of 
beneficiaries, the impact is a slight reduction in their premiums. 
Why? Because they pay 25 percent under Part B, as you know, of the 
premium, the Federal Government pays 75 percent. And they are going to 
see a little lower premium as a result of these changes that we have 
proposed on the provider side. 
   So for most beneficiaries, the difference will be that they will see 
a slightly lower premium. 
   Senator CRAPO. So the message there with regard to the beneficiaries 
is that the proposals you are making will actually have a slight 
reduction, except for the small number we talked about at the higher 
end, and that they could look for about a 25 percent reduction in the 
long-term issue that we have. 
   Mr. PORTMAN. That Is correct. 
   Senator CRAPO. Let us look at the provider side. Are the proposed 
reductions on the provider side going to cause a problem in terms of 
providers being able to effectively work in a market that we are 
seeking to have them work in to provide these benefits? 
   Mr. PORTMAN. That is a fair question and, again, we have done our 
own analysis. You will do more analysis in the Finance Committee and 
here on this committee. Our belief is that we can continue to provide 
the kind of care that is currently available because we think, again, 
the 0.65 percent reduction is a fair reduction. It right-sizes, in 
effect, what the payments have been. 
   It is also very similar, as you know, to proposals that this 
Administration has made in the past. The Clinton Administration made 
proposals of a similar character, but before us. On a bipartisan basis 
in 1997, we did a lot more in terms of the market basket. Instead of 
0.65 in 1997 the number was 2.7 percent as compared to 0.65 percent, 
which is the chart I showed earlier. Either in nominal terms or as a 
percent of the program, we have done more as a Congress previously when 
we have tried to work together to get to a balanced budget. 
   We also did more in 1993 and 1990 with the OBRA reforms to try to 
get at a growing deficit. 
   I know it is not going to be easy. Politically, it never is. But I 
do believe that this is the appropriate policy approach. I also believe 
that it is a first and important step toward dealing with this unfunded 
obligation that Senator Gregg and Senator Conrad talked about. 
   Senator CRAPO. Thank you, and our time is up. 
   I just want to thank you for paying attention to that, because I did 
note, and we all in America noted, that the President has proposed a 
budget that moves to balance in the year 2012. And I would expect that 
any other budgets that this committee may come up with will also 
balance, because we have the dynamic in the short term, the five to 
10-year range term, to be able to do that. 
   But the real looming liabilities out there, those unfunded 
liabilities that are going to start driving deficits in the future and 
driving debt in the future have to be paid attention to. 
   And I appreciate the fact that while submitting a 5-year budget that 
balances, the President also has made proposals for how we will start 
dealing with the long-term liabilities that are such a giant issue for 
our country. 
   So thank you very much. 
   Chairman CONRAD. Thank you, Senator. 
   Senator ENZI. 
   Senator ENZI. Thank you, Mr. Chairman, and I want to thank the 
Director for his fine presentation and his capability for answering our 
questions. 
   The Higher Education Act is going to be up for reauthorization this 
year, and I do want to work with the Administration through that 
reauthorization process and support many of your spending initiatives, 
particularly the increase in the maximum Pell Grant award. But I do 
feel that it has to be responsibly paid for. And I am sure several of 
us have some concerns about mandatory savings being used for 
discretionary spending. 
   And rather than have you give me the details right now on how that 
proposal is going to work, I am going to submit that question in 
writing for you because I think it is more than what we can do in the 
time limit here. 
   But I am drastically interested in that. 
   I would also ask unanimous consent that a full statement be put in 
the record. 
   Chairman CONRAD. Without objection. 
   [The prepared statement of Senator Enzi follows:] 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
 

   Now I see them in the budget, there are some premium increases that 
are being proposed. We put some premium increases in the legislation 
last year and now there are some being proposed for this fiscal year. 
Again, I will cement that in writing to see why you are proposing them 
and we need a lot more detail on that. 
   To actually get to a question, another thing that the HELP Committee 
is working on is sufficient funding for the FDA to carry out its 
important mission. I did notice in the President's budget request that 
there are three new user fees that will be required. These new user 
fees totaled $53 million. What I noted was that they have not been 
authorized through legislation, and that is close to half of the 
proposed increase for the FDA budget. 
   So it has been typical that the industry would negotiate new 
agreements, fees, and goals and then set it to Congress and then we 
would do something with it. Has the Administration discussed these 
fees, particularly with the proposed generic users in the affected 
industry? 
   Mr. PORTMAN. [Nodding affirmatively.] 
   Senator ENZI. You are nodding your head so I will not ask if not, 
why not? But are they receptive? 
   Mr. PORTMAN. You note there is an increase in the FDA funding and 
that is because we want to assure FDA has the resources to be able to 
even accelerate some of the approvals that are so important. 
   We have worked with not just the generic community, but the users in 
general. And I believe that you will find that certain fees are viewed 
as acceptable so long as they go back in the system. I will let you do 
your independent analysis of that, but we have spent the time to talk 
to some of the users to be sure they understand why we are making these 
increases that they have asked for, but also to talk about to what 
extent fees should be part of it. 
   I think you will find again, as long as the resources are devoted 
back to the FDA process, that there is more receptivity to it. 
   Senator ENZI. I appreciate the emphasis, too. 
   I did notice that the budget included, and these are really small 
amounts compared to the whole budget, but $30 million for the African 
Development Foundation. That group is doing such spectacular work at 
actually getting the money to the people not to the governments and 
having it absorbed there, but to the people. And they are getting the 
governments to match whatever we do, which I think has a tremendous 
impact for the United States and much greater impact than some of the 
ones we are spending billions on. So I really appreciate that emphasis. 
   Something of more immediate concern for me though is we passed the 
Surface Mining Control and Reclamation Act amendment last year. That is 
abandoned mine land money. That implementation is very important to the 
State of Wyoming. And I want to ask that you keep me in the loop on 
that, and the budget does not detail where you are in the 
implementation process. You may not know that, again compared to the 
whole budget it is a very significant amount. But for Wyoming it is a 
huge amount. So I would like to know where that is. 
   Also the coal-to-liquids technology, I think that will play a huge 
role in the future of energy for this country. The President placed 
quite an emphasis on it. And I would like to know if the Administration 
plans to help move forward with that development of coal-to-liquid 
technologies as part of the loan guarantee program, and if we are ever 
going to get that in place? 
   Again a question you may not be able to answer here but if you would 
find the answer for me. 
   I have some other questions of a similar nature that I would like to 
put in there because that can make a huge difference in where we go 
with policy. And Wyoming, with its huge coal reserves, is ready to step 
forward and change a lot of that coal into diesel fuel, which would 
allow the refineries in this country to concentrate on gasoline. 
   It is also low sulfur coal, so it meets the criteria for low sulfur 
diesel. So we want to know where those funds are, as well. 
   Again, I thank you for being here? My time has expired. 
   Mr. PORTMAN. Thank you, sir. We will get back to you on every one of 
those issues. And I want to thank you for working with us on so many 
these issues, the pension reform last year, the education issues. 
   I appreciate your working with us on increasing funding for Pell 
Grants to help low income families be sure they can afford the cost of 
college. We have about a 40 percent increase compared to 2006, about a 
30 percent increase even above what Congress has just increased--at 
least on the House side--in the long-term continuing resolution there. 
And then, as you know, we have K through 12 funding increases, about $1 
billion over 2006, and actually about $700 million over again the 
long-term continuing resolution, which provided more funding for K 
through 12. And then a $1 billion increase in NCLB. 
   The focus there is again on lower income students and the schools 
that serve them. Therefore, there is a $1.1 billion increase in the 
budget, as you know, in Title I. 
   So we look forward to working with you. We are prioritizing within 
our resources. 
   And I know that you have a strong interest in the PBGC. The reason 
that we have reproposed--none of these are new proposals, as you 
know--some of our reforms in PBGC is we still see an unfunded liability 
there. We still see a gap. It is to try to deal with that solvency 
issue. 
   But we look forward to working with you on that, and congratulate 
you on a good step with the Pension Reform Act, which you and other of 
your colleagues worked on last year. 
   Senator ENZI. Thank you. And we did have a great bipartisan meeting 
this morning of people interested in education on the committee. In 
fact, that was almost everybody on the committee. We met with Secretary 
Spellings and found some good ways to make good use of the money that 
you put in there, and probably a couple of other reorganizations of the 
budget too. 
   Thank you. 
   Chairman CONRAD. Senator Wyden. 
   Senator WYDEN. Director Portman, welcome. 
   People in my part of the country feel betrayed this morning. As you 
know, the Federal Government owns more than half of our land. God 
blessed us with an awful lot of trees. And, historically when those 
trees were cut, we would get in the form of timber receipts money for 
our schools and roads. 
   I wrote a law in 2000 that gave us some semblance of stability. That 
law has now expired. We have been trying to get the Administration to 
put forward a proposal that at least has a pulse around here in terms 
of actually going forward and winning support. 
   As you know, the Administration has recycled the proposal from last 
time to, in effect, sell off the crown jewels of this country, our 
national treasures and our forest land, to pay for this program. 
   Not one single member of the Senate, Director Portman, not one, not 
on the Republican side, not on the Democratic side, has been willing to 
support this in the past. This is a proposal that does not have a 
pulse. 
   Now we have closures in the rural part of my State. We are hearing 
that schools may shut down and we have a real question about whether 
rural counties in Oregon even going to survive. That is what this is 
about. 
   I would like to know when we are going to get a proposal from the 
Administration that really has a prospect of winning bipartisan support 
here in the Senate? When you advance a proposal that cannot get even 
one Senator, even one, that is betraying our part of the United States. 
We have nowhere to turn in these rural counties where the Federal 
Government owns 58 or 60 percent of the land. 
   I think you know me pretty well. I am interested in working with you 
on a bipartisan basis. We are trying to do that in health care. We are 
trying to do that in a variety of areas. 
   But this is unacceptable. Senator Baucus and I have even given you 
alternatives. So it is not a question of the Administration not seeing 
any alternatives. 
   When are you going to give us a proposal that has a chance of 
winning some measure of support here in the Senate? 
   Mr. PORTMAN. I can tell you are not very enthusiastic about-- 
   Senator WYDEN. There will be a strong message to follow. 
   Mr. PORTMAN. This is a new proposal. As you know, it is not the same 
proposal from last year. It is a new proposal, frankly, because of 
meetings that I had with you and some other members, but primarily a 
conversation we had about 9 months ago when I first came on the job. 
And it is quite different. 
   I thought you might be more interested in it than you appear to be, 
because it does not say that there is going to be a sale of what we 
view as excess Federal lands and then have that money all go into the 
rural schools. 
   Senator WYDEN. What is new about it? 
   Mr. PORTMAN. It says that half of that funding can now go back into 
acquisition of more important lands that States want to acquire for 
public use. 
   So it was an attempt on our part to provide $400 million more than 
last year for the very schools you are concerned about, and do it in a 
way that actually we thought would be a lot more attractive not just 
you but, as you say, to your colleagues to be able to work through it. 
So let's sit down again. This proposal, we may not have explained it to 
you properly yet. We will do that in person. Half of the land sales, 
again, go to county payments and half will go for national forest 
acquisition in the States. 
   The counties benefit because they get four additional years of 
payments and the States receive a big environmental benefit because 
they get to exchange land that has very low environmental value for 
lands that have high environmental value. It seemed to us that that 
made sense. 
   The parcels to be sold have already been identified as suitable for 
sale or exchange because they are isolated land or they are difficult 
or inefficient to manage. The lands with higher environmental value 
will not be offered for sale. Acquisitions would focus on parcels that 
enhance the environmental integrity of our national forest. That is a 
change from last year. 
   So we will continue to work with you on it. We want to see an 
extension. We want to see that it is paid for by some mutually 
agreeable offsets. We think we have a better proposal this year for 
purposes of passage. 
   Senator WYDEN. You are a hiker and an outdoorsman. I can tell you 
when you are talking about selling off lands within the Mt. Hood 
National Forest-- 
   Mr. PORTMAN. And buying more important plans for Mt. Hood or other 
important parks or Forest Service system, so it is not the old 
proposal. It is a new proposal. 
   Senator WYDEN. But it essentially involves something which is going 
to be a full employment program for lawyers. You are not going to get 
any support here. There is going to be lots and lots of litigation 
while schools, law enforcement, and other essential services close. 
   My biggest regret with this program is I wish I had kept my hold on 
every one of those Administration appointees. I took it off last year 
because I thought the Administration was going to work with us in a 
good faith. I think these counties now, we have Curry County, Grant 
County, a whole host of them that are looking at closing. There is a 
real question about whether they are going to survive. I hope that and 
I, in fact, challenge you to find somebody here in the Senate who is 
going to support this new proposal. Because it is not new. It is 
essentially a recycled version of what we had before. It will get no 
more support. 
   That is why we are going to be sitting here again while all these 
schools are closing. That is unacceptable to me. 
   Thank you, Mr. Chairman. 
   Mr. PORTMAN. Thank you, Senator. 
   Chairman CONRAD. Director Portman, you said that you have balanced 
the budget without any tax increase. Isn't that the case? Didn't you 
testify that you-- 
   Mr. PORTMAN. While permanently extending the President's tax cuts. I 
will look back at my testimony to see how I described it. I said we do 
so while keeping taxes low and meeting our Nation's priorities. I 
talked earlier about the fact that we believe the tax cuts ought to be 
extended, and we extend them permanently in the budget. 
   Chairman CONRAD. Are there any tax increases included in your 
proposal? 
   Mr. PORTMAN. Net, there is a lot of tax relief, I think about $600 
billion net. But there are tax-- 
   Chairman CONRAD. But are there any tax increases? 
   Mr. PORTMAN [continuing]. Increases and tax relief throughout the 
budget, as always. 
   Chairman CONRAD. Where would be the biggest tax increases that are 
in the budget proposal? 
   Mr. PORTMAN. Probably fees. We talked about the FDA fee earlier. 
   Chairman CONRAD. Don't you have a large tax increase built in here 
for the alternative minimum tax? 
   Mr. PORTMAN. Well, it will be viewed as a tax increase by middle 
income Americans if we do not do something to reform it. 
   Chairman CONRAD. But you have only reformed it-- 
   Mr. PORTMAN. It is current law, as you know. You and I have talked 
about this. 
   Chairman CONRAD. But you have reformed it for 1 year but you have 
not reformed it for 5 years. 
   We just got numbers. This is the question I want to ask you. We just 
got, from the Tax Policy Center at Treasury, that this is the 
alternative minimum tax revenues contained in your budget. This will be 
felt by people as a huge tax increase, as you know, because they are 
not paying these taxes now. 
   Mr. PORTMAN. That is why we need to reform it. I agree with you. 
   Chairman CONRAD. But you have a 5-year budget here and you reform 
for 1 year. So this is what they are telling us is the effect. That is 
a $500 billion tax increase. To be precise, $499 billion. 
   So when this Administration says, when I hear the President say 
there is no revenue increase, there is a revenue increase. People out 
there are about to experience, those primarily in the $100,000 to 
$200,000 income range, are going to find they are going to be in for a 
big surprise here. They thought they were getting tax cuts. All the 
talk is tax cut, tax cut, tax cut. The effect of the alternative 
minimum tax, as you know, is to explode the number of people who will 
be swept into the alternative minimum tax, approaching 30 million 
people a year by the end of this period. 
   So at least some of what I have heard, not from you--I want to make 
clear--but from others in the Administration, I think, misrepresents the 
plan. The fact is to balance, you have substantial expansion of 
revenues in the alternative minimum tax. 
   Let me go back to the question I asked before. 
   And now I see Senator Murray has arrived, so I will defer--oh and 
Senator Whitehouse, as well. Senator Murray had been here earlier, as 
had Senator Whitehouse. But Senator Murray had been here first, so we 
will go to Senator Murray, but then I want to come back to this. 
   Mr. PORTMAN. I would like to talk to you about it. 
   Chairman CONRAD. And we will have a chance. I will not leave you 
hanging out there without a chance. 
   Senator MURRAY. 
   Senator MURRAY. Thank you very much, Mr. Chairman. 
   I apologize for having to leave and come back. It is a busy day 
here. But I did want to come back. You have been asked a lot of broad 
questions and I want to go back to the Chairman's opening remarks and 
share with him my concern about the priorities in the budget. We will 
have more discussion about that. 
   I wanted to address a couple of regional issues really quickly and 
then go to the broader picture. The first one is about BPA. We are 
again dealing with a proposal from OMB that is going to take funds out 
of the Northwest economy and direct them to the United States Treasury. 
This is not the first time we have been down this road. It is just the 
latest in a series of proposals to circumvent our regional process and 
impose a rate increase on BPA customers that would have a huge impact.  
   We have been down this road before on a bipartisan basis. We have 
defeated it. We will again and it will leave a $91 million hole in your 
budget. 
   So instead of doing this every year, I would just like to ask you 
today, can I get a commitment from you that we can have a real 
discussion on this rather than just having a budget battle that you 
know you are going to send over here and it is going to be defeated? 
   Mr. PORTMAN. Well, you and I have talked about this in an earlier 
meeting and I do think, if you look at this proposal, it is different 
than last year's proposal. 
   Senator MURRAY. They all are, every year there is nuances. But it is 
the same. 
   Mr. PORTMAN. This one drops altogether the debt clarity proposal 
that BPA was very concerned about, which has been in our budgets in the 
past. We think it is a significant compromise. So does BPA. 
   We also, at you are urging--and I think you were right about 
this--we engaged directly with BPA rather than coming up with our 
proposal without dialog with them. We have had a lot of dialog with 
them. 
   We still do have a fundamental difference that we apply not just to 
BPA, as you know, but across the Federal Government that when you have 
these kinds of revenues coming in--and the net secondary revenues have 
been about $500 million per year--that they ought to pay down some of 
their debt. It is not putting it into the Treasury. It is paying down 
some of their debt. 
   Senator MURRAY. Which they do a regular basis and they keep that 
commitment without putting our ratepayers responsible for paying off 
money at the national debt level. So we will have discussions again but 
I just want you to know, working with senators from Idaho and in the 
region, Oregon, this is not going to go anywhere again. And it is going 
to leave a $91 million hole in the budget. 
   I want to ask another really important home issue. As you know, 
Washington State, my home State, is home to the Hanford site and the 
Pacific Northwest National Lab. Both of those were born out of the 
Manhattan Project, both very crucial. 
   I think you know, as well, DOE is right now in the process of 
cleaning up that site. And we have a unique situation of a national 
laboratory with facilities in the middle of a cleanup site. 
   In these facilities PNNL conducts a lot of really important work for 
issues ranging from national security to environmental remediation. We 
have to make accommodations to continue the cleanup of the Hanford site 
and still preserve those research facilities. 
   For the past couple years, I have been working very closely with the 
Department of Energy and with the Department of Homeland Security in 
support of a plan to do that. But in the 2008 budget, you do not allow 
that plan to go forward. 
   This is a project that relies on third-party financing. It has been 
very carefully worked out with all parties involved. My understanding 
is now that OMB is not going to allow that third-party financing 
package to move forward. 
   I would like to know from you when OMB is going to allow that to 
happen? 
   Mr. PORTMAN. I apologize, I do not know the answer to that this 
morning, and I will get back to you on it. I do know what the numbers 
are for Hanford which, as you know, is $690 million. 
   Senator MURRAY. I know the Hanford numbers and I appreciate the Vit 
plant. We have some concerns, HAMMER was not funded, and things like 
that. 
   But the critical issue for us right now is this very important 
research facility that is in the middle of a cleanup site that we 
cannot preserve its ability to continue to do important critical 
national research unless we are able to move forward on this. 
   Mr. PORTMAN. Is this the Army Corps issue? 
   Senator MURRAY. No, it is not. It has to do with PNNL, a research 
facility, located in the middle of a cleanup site. And in order to 
continue the clean up, the facility has to either be changed or moved, 
and we need to make sure that the third-party financing moves forward. 
For some reason, OMB is the one party out here saying they are not 
going to allow that to move forward, and it is going to either lose 
critical, critical research for the Nation, or it is going to cause 
clean up not to occur. 
   So if you can get back to me on that, I would appreciate it. 
   Mr. PORTMAN. I appreciate that, Senator. I will get back to you on 
it. 
   Senator MURRAY. And then in my last 10 seconds a broader topic, 
veterans. 
   We have gone back and forth with inaccurate projections from the VA 
on how much they need to cover the cost of veterans. As you know, we 
went through a very bad situation a couple of years ago where they did 
not tell us what they needed and ended up billions of dollars short 
that we had to make up in a supplemental. 
   It was not just us complaining. The GAO did a report. And what they 
told us was pretty shocking. The GAO told us that the VA had misled 
Congress, that they concealed funding problems, that they based their 
projections on inaccurate models, and that they did not adequately plan 
for the impact of service members from Iraq and Afghanistan. 
   Now we have an ongoing war. The President is now asking to send more 
troops over, 48,000. And we are getting a budget from you that many of 
us are deeply concerned is based on flawed numbers. 
   How can you expect us to have confidence in the number you have 
projected when the history tells us that we are not being told the 
truth about the cost to the VA because of the war in Iraq and numerous 
other costs that are coming at them? 
   Mr. PORTMAN. First of all, I think you will be, I hope you will be 
pleased with the budget because it is a big increase again, 83 percent 
increase, as you know, over the life of this Administration for VA 
health care. 
   Senator MURRAY. Because we beat you up over it. 
   Mr. PORTMAN. Well, we worked with Congress on those issues over the 
years, including when I was in Congress. But it is a $6.1 billion 
increase in VA health care this year. I am sorry, in VA overall, $2.5 
billion for health care. That is a 7.4 percent increase on health care 
fraud. We will give you total transparency and let you know how we 
are-- 
   Senator MURRAY. I will have my staff get you the numbers, but what 
we are seeing is that the VA is basing their projections on the number 
of Iraqi and Afghani soldiers coming back on fewer than they saw last 
year, when we know more soldiers are going to come into the system. 
   Mr. PORTMAN. As you know, we are using the new model. We believe 
that the concern that you raise, which is a legitimate one, has been 
fixed in this model. We will share all of that with you. 
   The new model does have an additional obligation on behalf of the VA 
on health care side, and it is fully funded in the budget. So we will 
provide you with all that. 
   Senator MURRAY. We will look forward to seeing all of that. 
   Mr. PORTMAN. It is based on the new model. 
   Senator MURRAY. But again, remember, it is not just us that have not 
been happy with this. The reports that come back that show us that we 
have been misled and inaccurate models continue to really concern all 
of us. 
   We need to make sure we have adequate funding in the budget that we 
pass out of Congress to care for the men and women who are protecting 
us, no matter whether we agree with the President or not. And we take 
that responsibility very seriously. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. I thank the Senator. 
   I thank her very much for raising, once again, the issue of 
veterans. She has been extremely diligent on this subject and has been 
a very strong advocate for our Nation's veterans, not only in the 
public councils of this committee but in the private counsels of this 
committee, for a very long period. So she comes to this with 
credibility. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Ambassador, how are you? 
   Mr. PORTMAN. Well, thank you. Sorry I did not acknowledge you 
earlier. We have not had the chance to meet before. 
   Senator WHITEHOUSE. I had to go to another meeting. 
   My first question or I guess comment to you has to do with what I 
heard you saying as I was going out the door, which I think was that 
unless we do something about the entitlement costs, we are looking at 
benefit cuts, we are looking at tax increases or we are looking at 
massive debt explosions. 
   I would just urge you to add, in your list of ways to cope with the 
forecast, particularly health care problems we have coming, that 
reforming the way in which the health care system operates is, 
absolutely critical. It makes me crazy when I hear people say well, we 
can only do this with benefit cuts or tax increases or massive debt, 
because I see a health care system that is so wasteful, so badly 
designed, so disgracefully counterproductive in so many different ways. 
And then to just sit there and say, well, we are going to leave that 
alone but we are going to cut people's benefits so that we do not have 
to go to the trouble of fixing it. 
   Mr. PORTMAN. You are absolutely right. Maybe you did not hear as you 
went out, unless we make reforms--and I think that is obviously the 
better alternative. 
   Senator WHITEHOUSE. Good. 
   Mr. PORTMAN. You are right on health care. 
   Senator WHITEHOUSE. Keep that in your focus because it would be a 
national disgrace if we had to cut people's health care. 
   Mr. PORTMAN. I think that is a good point. I did not make that point 
clearly enough, that so much of what drives, as you know, the Medicare 
and Medicaid numbers is the inflation in health care. And until you get 
at that problem, it is difficult to get at that larger problem that we 
have with our obligations going forward. 
   Senator WHITEHOUSE. The other thing I wanted to talk with you about 
is I am new to this committee and I am sort of working my way down into 
the details. But starting at a very macro level, I see major economic 
shifts happening in our economy that are the result of the, to use the 
popular word, flattening of the world economy, creating big-time 
winners and losers in the American economy, very often perhaps even 
usually, through no particular fault or no particular achievement of 
their own. They just happened to be in the right place as the economy 
shifted or caught in the wrong place as the economy shifted. 
   I see that playing out in the statistics that we all see about the 
evaporation of the middle class, the increasing income gap between rich 
and poor, the fact that CEOs make 400 times now the average worker 
salary and it used to be 40 just a couple of decades ago; that we are 
headed for what I consider to be considerable social/ political/
economic problems if we do not do something about this. 
   And I would like your comment on whether you think that this is a 
sustainable course. Or alternatively, are there actually social and 
political consequences to allowing our country to turn into that sort 
of an almost economic royalist economy, to use a friend's phraseology? 
And if there really are problems coming at us on that, what should we 
be doing about it? 
   Because it strikes me that this Administration's tax policy has 
compounded the problem by making the people who are the winners, as a 
result of this really secular shift, even bigger winners and throwing 
the people who are the losers under this economy even further under the 
bus. 
   Mr. PORTMAN. I think you raise a really interesting question about 
what the impact of the global economy is on winners and users. You are 
absolutely right, the pace of change is increasingly fast, too. So it 
is hard for us almost to get ahead of it sometimes. And a lot of it, as 
you say, is not driven by Government, it is driven by market forces 
beyond Government. 
   As you know, I was the Trade Representative before this job so I was 
more familiar with some of those market forces. They are both a 
challenge and a huge opportunity. 
   As other countries grow and prosper, it does not hurt us. It can 
actually help us because it expands markets for service providers in 
your State, farmers, manufacturers and so on. 
   Senator WHITEHOUSE. I am thinking less internationally than 
domestically. 
   Mr. PORTMAN. Absolutely, and my point is that it affects our economy 
a lot and there are winners and losers. 
   I think the tax policy, and we talked about this earlier when you 
were out at your other responsibilities, but we talked about the fact 
that if you put all the President's tax policies from 2001 and 2003 
together, the upper income Americans are actually paying a bigger part 
of the burden. 
   Now admittedly, they are always paying a bigger part of the burden. 
And so when you do tax relief across the board, give everybody tax 
relief, they got tax relief. And more significant tax relief if they 
were paying more taxes. 
   But the burden is now, for the top 10 percent for instance, you are 
talking about 66 percent of our income taxes. It was about 64 percent. 
About four or five million Americans are off the rolls altogether who 
are lower income Americans because of the refundable nature of the 
child credit, 10 percent bracket expanding, marriage penalty and so on. 
So I do not think the tax relief has had that impact. In fact, arguably 
it has shifted the burden more to the upper income Americans. 
   Senator WHITEHOUSE. It certainly has not offset it, as we can see 
from the-- 
   Mr. PORTMAN. What would have happened otherwise is something we can 
look at. We can maybe get you some data on that. 
   But in terms of wage growth, which is key to this, it has taken a 
while in this recovery to see real wage growth, partly because 
inflation was relatively high the last couple of years. But we are now 
seeing real wage growth, which is a difference. Within the last year we 
have particularly seen some market increases in hourly wage growth, 
which is again addressing some of this income inequality issue you are 
talking about. 
   I said earlier it is happening a little sooner than it did in the 
last recovery, in the 1990's. The wage growth now is higher as a 
percent than it was at this point in our recovery in the 1990's. But it 
always takes a while to catch up with productivity growth and GDP 
growth. 
   And finally in this budget, and you may not like all of aspects of 
the budget, but I do want focus-- 
   Senator WHITEHOUSE. Nobody has ever liked all aspects of any budget 
anywhere. 
   Mr. PORTMAN. I do hope you will focus on the American 
Competitiveness Initiative, because it is trying to get at this very 
issue you address, which is a rapidly changing global economy that 
challenges us to be more competitive than ever in order for America to 
keep our edge. 
   Right now we are the envy of the world. We are growing faster than 
any of the other G-7 countries. So the major developed countries in the 
world are looking at us saying why do you have lower unemployment than 
we do? Why do you have faster growth? I think it goes to our 
entrepreneurial and innovative nature as Americans. But we need to do 
more as Government to encourage that. 
   So if you will look in the budget, for instance, we have additional 
resources for research. We make a commitment to double that over time. 
   We have that again in our budget this year, as we did last year. 
   Congress, on a bipartisan basis, has been very supportive of that. 
But it includes everything from the research and experimentation tax 
credit, the R&D tax credit it used to be called, which I know is 
important to your State, but also increases in funding for research 
about American competitiveness, engineering, math, science and so on. 
   So that is part of the response, I think, that you will see in this 
budget that we, as a Government, ought to be focused on to address the 
challenge that you rightly raise. 
   Senator WHITEHOUSE. But in terms of the dislocation of people who 
are the losers and the economic shift when having to compete with very 
low-wage workers in India, Indonesia or China or wherever, in terms of 
the concern that I just see so deeply in Rhode Island as I travel 
around, is people really are very, very concerned about their economic 
futures. And for the first time in their lives, worried that things do 
not look so good for them and starting to lose their own optimism. 
   For those people, the message is just hang in there and wait for the 
economic forces that will ultimately drive wage growth to come to 
fruition? 
   Mr. PORTMAN. No, again if you look at our budget, which your 
colleague Senator Sanders said is a reflection of policy and how we 
view what the Governmental's role ought to be. Not only do we have 
these increases in funding for competitiveness, which directly 
addresses some of the issues you raised in the global economy. 
   But the reason we have increases in funding in unprecedented levels 
for K through 12 education is that we see an incredible correlation 
between education level and that wage gap you talked about and the 
sense of insecurity that many people feel as a result of, in part, the 
global economy. 
   By the way, it is not just the global economy. It is our own 
economy, because our own economy is increasingly competitive. 
   We also have resources devoted more toward lower income students 
within that mix, about a $1 billion increase in Title I here, because 
those tend to be some of our lower performing schools that would be 
eligible for Title I. 
   And then of course, the Pell Grant increase that you know about that 
you all, I think, are going to vote on soon. We increase that even 
more. We would have about a 40 percent increase, after you finished 
increasing it--which we had not expected frankly--for 2007, it will be 
about a 30 percent increase. But, Pell again focuses more on ensuring 
that some of those folks who may feel that they are not enjoying all of 
the benefits of a good economy, at least have more of an ability to be 
able to afford the higher cost of higher education. 
   So there are some things in our education part of the budget and the 
competitiveness part of the budget. Health care, of course as you know, 
in your State is a huge issue. We have the focus on health care and the 
uninsured and the cost of health care, which you talked about earlier. 
Also energy, in the budget reflective of what the President talked 
about in terms of energy, that our kitchen table issues that I think 
add to that insecurity. 
   So we have some proposals here. I know that you will have others. 
   Senator WHITEHOUSE. Good. I have exceeded my time. Mr. Chairman, my 
clock in front of me is broken, which I think gives me a bye on any 
time restrictions. 
   Chairman CONRAD. You did very well. 
   Senator WHITEHOUSE. I apologize, Mr. Chairman. 
   For the record, Pell of Rhode Island. 
   Chairman CONRAD. No apology required. We knew that it was not 
working. 
   The first thing I want to ask you is, Ambassador Portman, Director 
Portman, will the Iraq war be over by 2010? 
   Mr. PORTMAN. I do not know. 
   Chairman CONRAD. The budget says that we do know. The budget says 
there is no money in 2010. 
   Mr. PORTMAN. As I said earlier in the response to Mr. Menendez's 
question, we are showing more war costs, as you have acknowledged, and 
I thank you for that. And we are showing it in greater detail than we 
ever have before. We are also showing for 2008 a substantial commitment 
that is, as I said, effectively a straight line commitment. Secretary 
Gates, who has been testifying this week-- 
   Chairman CONRAD. That would be for 2008-- 
   Mr. PORTMAN. That is for 2008. 
   Chairman CONRAD. But then a very sharp reduction for 2009. The 
President has told us repeatedly there is no timeline. But when I look 
in his budget, there appears to be a timeline, that the war will 
deescalate, will dramatically be reduced in activity in 2009. That is 
what the budget says. It is going to go from $145 billion down to $50 
billion. That is a dramatic reduction. And then no spending at all in 
2010. 
   And so it looks to me like, at least with respect to the budget, 
there is a timeline. 
   Mr. PORTMAN. We will have to see how it goes. Our hope is that the 
2008 supplemental request, which as you acknowledged earlier we have 
never presented to Congress before, and we have never presented the 
next year, will end up being high. That is our hope. 
   Chairman CONRAD. I say, I give you credit. I especially give you 
personally credit for getting in the 2008 budget something that is far 
closer to realistic, I believe. But I look in those out-years. When we 
talk about this budget balancing, I know that that is the assertion. 
But when I look at the war spending, when I look at the alternative 
minimum tax, those are big moving parts. 
   Mr. PORTMAN. Can I make one comment on defense that I know you will 
appreciate? I am not sure that I can explain this properly, but I will 
try. 
   If you look at our 2008 request, you not only see a substantial 
commitment to the global war on terror through emergency supplemental 
spending, which is part of the budget but supplemental to the base 
budget, you will also see in the Department of Defense and in the 
Department of State substantial double-digit increases in funding. 
   There is a reason for that, and it relates to the global war on 
terror and readiness concerns that have been expressed in this Congress 
on both sides of the aisle. 
   I am not suggesting that that increase in the base is going to solve 
every problem. Our international situation will change and we will see 
what our needs are. 
   But I will say that in terms of your concern about what numbers do 
you show in the budget, to have an 11 percent increase in the base 
funding for defense and have that fully funded within our declining 
deficit for 2008, and to have an over 12 percent increase in State's 
budget, much of which is security-related and GWOT-related, does show a 
commitment on resources that we have not shown previously and is part 
of our deficit calculation. 
   And I hope you will note that those are made part of the base, not 
supplemental. And that was also part of our intent this year, was to 
provide more in the base to show what we think those costs are. 
   Chairman CONRAD. And we appreciate that, and I have tried to 
acknowledge that, both publicly and privately. 
   Let me just talk about several other issues. There has been mention 
of Social Security and it would take a law change to do something 
different on Social Security. No it would not. It would not take any 
law change. 
   If we were not running these massive fiscal deficits the money in 
Social Security would be used to pay down debt. That is a huge 
difference. If we were paying down this debt instead of adding to the 
debt, that would be in line with what the intention was when Social 
Security was changed to prepare for the retirement of the baby boom 
generation. 
   They increased the taxes on Social Security for a purpose, and it 
was to make it solvent long-term. And it was decided to either pay down 
debt so that we were better prepared for the retirement of the baby 
boom generation or be able to prepay the liability. Neither of those 
things are happening. 
   Instead, Social Security money that is in temporary surplus is being 
used to pay operating expenses. Now to suggest that some law has to be 
changed to change that trajectory is just not correct. 
   With respect to the assertion I have heard repeatedly that the tax 
code has been made more progressive, I listened to you very carefully 
and you talked about the income taxes. If you look at payroll taxes and 
income taxes, and remember the vast majority of Americans pay more in 
payroll taxes than they pay in income taxes, you get a very different 
answer. No. 1. 
   No. 2, it is not surprising on the income tax side that higher 
income people pay more because their incomes have grown much more 
rapidly than the rest of the American population. So of course their 
taxes have grown, even though they have had a disproportionate benefit 
from the tax cuts. 
   We indicated in one chart that for 2008 alone those earning over $1 
million a year, the cost of their tax cuts is $55 billion for that 1 
year alone. 
   That takes me to the thing I really want to talk to you about, which 
is long-term we agree the debt of the country will explode absent our 
action. To your credit, you have come forward with a proposal on 
long-term entitlements, especially in the health care accounts, in this 
budget submission.  
   What I fault you for is at the same time you have come forward with 
massive additional tax cuts by making permanent all of the tax cuts 
previously enacted. In fact, the weight of those tax cuts, the cost of 
them, far outstrip the savings that you have from cutting Medicare and 
Medicaid, or at least reducing the growth in those accounts. 
   That is just not a balanced approach. It is just not balanced. And 
that is the only conceivable way that there is a long-term resolution 
is if we have savings out of the long-term entitlements and that will 
have to bear a disproportionate part of the load. I do not dispute 
that. 
   But to suggest we do not need revenue to lessen the impact on the 
least fortunate among us, especially our revenue from the most 
fortunate among us--and I include myself in that category--is just 
divorced from reality. It is just divorced from reality. 
   And there is no way there is going to be a long-term settlement 
between Republicans and Democrats absent both sides, both sides 
compromising on their cherished positions. The fact is Democrats do not 
want to cut or reduce Medicare or the other entitlements. They do not. 
Republicans do not want to abandon any tax cut. You know what? It takes 
two to agree. It takes both sides to demonstrate a willingness to break 
from their fixed position. 
   And what I am asking you again today is is your side willing to 
break from their fixed position in which they say not only no tax 
increases, no additional revenue, but an insistence on more tax cuts? 
   Mr. PORTMAN. Interesting that we were accused of massive tax cuts 
and massive tax increases all in the same 45 minute period. 
   Chairman CONRAD. We are talking two different periods, aren't we? We 
are talking the near-term and the long-term. 
   Mr. PORTMAN. No, I am talking about the chart that you held up 
saying that we-- 
   Chairman CONRAD. That was for 5 years. Now I am talking, as you 
know, I am talking about the long-term beyond the 2012 period. 
   Mr. PORTMAN. I am talking about your long-term chart on your AMT 
chart, saying that we had massive tax increases. 
   Chairman CONRAD. That was for 5 years. That is the 5-year budget. 
Now I am talking about the long-term. 
   Mr. PORTMAN. The savings over the long-term, I do think that it will 
be difficult politically, as you say, but I also think that there is 
greater acknowledgment and recognition of it, partly because of your 
efforts and others. 
   I also think, and I was very interested to hear what Senator 
Whitehouse said about the cost of health care relating to that, because 
it does. So it is reform, but it is also reform that can be outside 
these systems on health care generally, because that drives so many of 
the costs now in Medicare and Medicaid, which is our biggest unfunded 
obligation. 
   On the revenue side, we have gone through this today in various 
ways. I will just say that we will be able to show you in this budget 
short-term but also longer-term that going at roughly our historical 
level of revenues and somewhat above, because that is where we are in 
our budget--and this may not be something that all economists who might 
represent views closer to my side of the aisle are happy about. In 
fact, I know they are not. In fact, some of them talk to me about this. 
   As a percent of our economy, our tax burden-- 
   Chairman CONRAD. Quit talking to them. 
   Mr. PORTMAN [continuing]. Is greater today than it has been 
historically, and far greater than it was, as you know, a few years 
ago. 
   But we have an opportunity, I think, to come together because of the 
increasing recognition of the problem, because of some solutions that 
are now out there being talked about, including some that we have. 
   Chairman CONRAD. Does your budget, long-term, solve the debt crisis 
that is looming over us? Does it solve it? 
   Mr. PORTMAN. No, it does not. 
   Chairman CONRAD. That is the point. Let's be direct with each other. 
You know and I know-- 
   Mr. PORTMAN.--But it-- 
   Chairman CONRAD [continuing]. It does not deal with it. And the only 
way we are going to deal with it is if the two sides get together and 
there is a compromise on both sides. 
   And the question I keep putting to you is your prepared to really 
compromise? 
   Mr. PORTMAN. We are prepared to engage in the debate and the 
dialog-- 
   Chairman CONRAD. No, no, that is not what I asked. We can debate. 
That is not getting us anywhere. The only way we are going to get 
somewhere is to actually compromise. 
   Mr. PORTMAN. Mr. Chairman, with all due respect, if I put you on the 
spot as to what you think the conclusion of a dialog would be-- 
   Chairman CONRAD. I have said-- 
   Mr. PORTMAN [continuing]. On your side, I think you would-- 
   Chairman CONRAD. That is what the problem here. I have said I am 
prepared-- 
   Mr. PORTMAN. I think you would not think that is very productive. 
   Chairman CONRAD [continuing]. To get savings out of long-term 
entitlement programs. 
   What I do not hear from your side ever is that you are prepared to 
do something on the revenue side of this equation, other than you want 
more tax cuts. You talk about divorced from reality, that is it. 
   Mr. PORTMAN. We are not talking about more tax cuts, just to be 
clear. 
   Chairman CONRAD. You are talking about making all the tax cuts 
permanent-- 
   Mr. PORTMAN. That is talking about extending the-- 
   Chairman CONRAD [continuing]. That have a cost of nearly $2 trillion 
over the next 10 years. 
   Mr. PORTMAN. Extending the existing tax relief. 
   Chairman CONRAD. But the law does not extend the existing tax 
relief. You are coming here asking to change the law to make all the 
tax cuts permanent, including ones that go overwhelmingly to the most 
advantaged and the wealthiest among us and with no--and at the same 
time saying we have to cut things that help the people who are the 
least among us. 
   I have to say to you, I do not know of any religion that teaches let 
us take from the least to give to those who have the most. 
   Mr. PORTMAN. Again, if you look at the tax relief that we are 
attempting to extend, in our view this is not only, factually speaking, 
a more progressive system than it was previously. In other words, the 
top end is paying a higher burden of taxation thanks to the--and by the 
way, on the payroll taxes, we have changed nothing. So whatever the 
policy was in the previous administration and previous Congresses, we 
have continued. 
   With regard to the importance of this tax relief to the economy, we 
feel very strongly that it would be exactly the wrong thing to do right 
now to abandon the tax relief which we think has been critical to the 
robust economy that has put us in a position to even talk about 
balancing the budget. 
   In going forward, Senator, let's be honest, we are not going to be 
able, as Senator Gregg has said well, to tax our way to a solution 
here. 
   Chairman CONRAD. And we are not able to cut our way, either. The 
hard reality is you guys have come up here with this line every year 
and the debt just keeps getting bigger. 
   Mr. PORTMAN. Let me finish. Part of-- 
   Chairman CONRAD. Look, it has not worked on your side. You promised 
us in this Administration that the debt would not increase, that in 
fact the President told us he have maximum pay down of the debt. And 
the fact is the debt has exploded. Now it has not worked, sir. 
   And what I am saying to you, unless there is a serious--serious 
now--I mean we can play these political games all day and all night. 
And I am disappointed. Because I hoped that this year, with what is so 
clear in terms of the threat facing this country, that there would be 
a chance to work together to do what we all honestly know needs to be 
done which is to work on both, on both the spending side of the 
equation and the revenue. 
   And the idea that it is just going to be on the spending side and 
you are going to have more tax cuts, that is not real. That is not 
serious. That is not good faith. 
   Mr. PORTMAN. If I could just finish my point for a second on the 
importance of the economy side and therefore the revenue side, we have 
made progress the last couple of years. The reason I mentioned, we have 
reduced the deficit by $165 billion in the last 2 years is to show that 
there is a model here and that is the reason we are-- 
   Chairman CONRAD. How much did the debt go up in the last 2 years? 
The debt went up-- 
   Mr. PORTMAN. Let me answer. 
   Chairman CONRAD [continuing]. Approaching $1 trillion in the last 2 
years. 
   Mr. PORTMAN. Let me answer. The way economists on the right, on the 
left, or nonpartisan would react to that question is they would say 
what matters about the debt is our debt as a percentage of our economy 
because that is what affects the markets, that is what affects our 
economy and that is how people look at it. 
   Chairman CONRAD. Agreed. And it is going up. 
   Mr. PORTMAN. And as a percent of our economy, it is going down-- 
   Chairman CONRAD. No, gross debt, gross debt in the United States is 
going up. 
   Mr. PORTMAN. Publicly traded debt has gone down as a percent of the 
economy-- 
   Chairman CONRAD. Gross debt is what we are going to have to pay 
back. And the gross debt is doing up. 
   Mr. PORTMAN. That is another discussion. 
   Chairman CONRAD. What used to be-- 
   Mr. PORTMAN. But if you look at the publicly-- 
   Chairman CONRAD. No, no, let's have that discussion. 
   Mr. PORTMAN [continuing]. Traded debt, because that is the issue 
here, it has gone down the last couple of years. Why? Because our 
economy is growing at about 3 percent. Our deficit is growing at about 
1.8 percent. 
   Chairman CONRAD. What does that leave out? What does that leave out? 
   Mr. PORTMAN. That means we actually have-- 
   Chairman CONRAD. That leaves all of the money you are taking from 
every trust fund in sight-- 
   Mr. PORTMAN. No. 
   Chairman CONRAD [continuing]. To float this boat, that is going to 
have to be paid back. 
   Mr. PORTMAN. It is publicly traded debt. And at the end of the 12 
years-- 
   Chairman CONRAD. But the gross debt is all of the money that we owe. 
And the gross debt under your plan, when you put back the things you 
have left out, is growing faster than the economy. The gross debt of 
the United States has grown enormously in the last 6 years. Do you 
disagree with that? 
   Mr. PORTMAN. I do not disagree that the internal debt, if you 
include that, if you think we should not be reforming any of these 
programs, and you look at that-- 
   Chairman CONRAD. Did the gross debt of the United States-- 
   Mr. PORTMAN [continuing]. As an unfunded-- 
   Chairman CONRAD [continuing]. Over the last 6 years as a share of 
the economy? 
   Mr. PORTMAN. When you include internal debt. 
   But when you deal with the publicly traded debt, which again is 
what-- 
   Chairman CONRAD. Do you know what? 
   Mr. PORTMAN [continuing]. Affects our economy, it has actually gone 
down because we are making progress. 
   Chairman CONRAD. But what affects the budget is all of the debt. 
   Mr. PORTMAN. That is because of two things, a little better 
restraint on spending and a strong economy, which has record revenues. 
My only point is as you get into this discussion on revenues, we have 
to keep in mind that we are not going to be able, as Senator Gregg said 
and you have acknowledged, tax our way through this. We are going to 
have to make some changes, as you say-- 
   Chairman CONRAD. And we cannot tax cut our way through it, either. 
   Mr. PORTMAN. But we also need to rely on a strong economy. We cannot 
grow our way out of the problem. I am not saying that. But it is a 
critical element-- 
   Chairman CONRAD. Let me ask you this: do tax cuts-- 
   Mr. PORTMAN [continuing]. A critical element to dealing with the 
long-term problem is to keeping a strong economy. 
   Chairman CONRAD. Do tax cuts pay for themselves? 
   Mr. PORTMAN. Some do and some do not. It depends on the tax cuts 
and-- 
   Chairman CONRAD. No, no, no. No tax Cuts--According to the Treasury 
Department of this Administration, no tax cuts pay for themselves. 
   Mr. PORTMAN. Certainly the 1997 capital gains did. 
   Chairman CONRAD. No. 
   Mr. PORTMAN. Certainly-- 
   Chairman CONRAD. No. 
   Mr. PORTMAN. Certainly it did. 
   Mr. PORTMAN. No. Mr. Mankiw, are you familiar with Mr. Mankiw? 
   Mr. PORTMAN. I am familiar with Mr. Mankiw. 
   Chairman CONRAD. Is he part of the Republican administration? 
   Mr. PORTMAN. Yes. He was. 
   Chairman CONRAD. What does he say? He says at most the tax cuts paid 
for 50 percent. Those are the capital tax cuts that you are referring 
to paid for half. So if you have $100 billion tax cut, you added $50 
billion to the deficit. That is his finding. 
   On those that are not capital tax cuts, he says they only pay for 17 
percent of them. So if you have $100 billion tax cut, you get back $17 
billion in increased economic activity, you add to the debt $83 
billion. 
   The proof is in the pudding. 
   Mr. PORTMAN. It depends on the timing. 
   Chairman CONRAD. We have had this experiment going on and all that 
has happened is the debt of this country has exploded at the worst 
possible time, before the baby boomers retire. 
   Mr. PORTMAN. You and I can have this discussion in detail-- 
   Chairman CONRAD. The Treasury Department--that was Mr. Mankiw. 
   Mr. PORTMAN [continuing]. But if you look at the timing-- 
   Chairman CONRAD. Let me tell you what the Treasury Department has 
concluded. 
   Mr. PORTMAN [continuing]. And the type of tax cut, it can indeed 
have a salutary effect on revenues. We have seen it. The last 2 years 
we have had revenue increases because of a robust economy. 
   Chairman CONRAD. So are you saying tax cuts pay for themselves? 
   Mr. PORTMAN. No, I explicitly did not say that. What I said was it 
depends on the tax cut-- 
   Chairman CONRAD. Well, that is a very important distinction. 
   Mr. PORTMAN [continuing]. And the timing of the tax cut. And I think 
it is a big risk right now, when we have an economy that again is 
hitting on all cylinders in terms of employment, wage growth now, 
GDP--3.5 percent GDP in the first quarter of this year, which no one 
expected frankly. Ours was 2.7 percent. 
   Chairman CONRAD. And we are adding $500 billion to the debt. 
   Mr. PORTMAN. No, we need to be sure that we continue-- 
   Chairman CONRAD. And we are financing the debt-- 
   Mr. PORTMAN [continuing]. To have that economy growing so that 
Americans can have better jobs, but also so that we can have this 
revenue coming in to be able to keep reducing the deficit, as we have 
done the last 2 years. That is a fact. 
   Chairman CONRAD. Unfortunately, the debt-- 
   Mr. PORTMAN. And getting the surplus under the unified budget is the 
first good step, and I look forward to working with you on your budget 
and our budget to get there. 
   Chairman CONRAD. Let me just say, the debt has exploded. And the 
debt of this country has exploded at the worst possible time, before 
the baby boomers retire. And the plan the President has put forward 
does not fundamentally address where we are headed. 
   I just say this to you, we have an opportunity here to work 
together. But the only way I know in human relations for there to be 
resolution between parties who have different views is for both sides 
to compromise. And unfortunately, I see virtually none on your side. 
And I regret that more than I can say. 
   [Whereupon, at 12:33 p.m., the committee was adjourned.] 

                        PREPARED STATEMENTS 

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                   ANSWERS TO QUESTIONS SUBMITTED 

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                 THE PRESIDENT'S FISCAL YEAR 2008 BUDGET 
                         AND REVENUE PROPOSALS 
                               -------

                                  THURSDAY, FEBRUARY 8, 2007 

                                           UNITED STATES SENATE,
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:06 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Nelson, Menendez, Cardin, Sanders, 
Whitehouse, Gregg, Domenici, Bunning, and Crapo. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

                OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. The hearing will come to order. 
   We apologize for being somewhat tardy in beginning this hearing. We 
try to start these hearings on time every morning and I think we have 
succeeded every morning. But we wanted to have an informal discussion 
with the Secretary and see if we could not have a constructive 
discussion about things in a way forward. 
   I want to welcome the Secretary to the committee and say that we 
have enjoyed our discussions with him since he has come into this 
office. We see him as a very constructive player and want to 
acknowledge that publicly. 
   Let me just begin by talking about the revenue. The Secretary of 
Treasury, of course, as the preeminent responsibility in the 
administration on the revenue side of the equation. Let me just talk 
about it. 
   You saw this the other day in the Finance Committee. It is true that 
we have had good revenue growth the last several years. But if one 
looks back on a comparison basis to 2000, and these are real revenues 
adjusted for inflation, you see it took until 2006 to get back to the 
revenue we had in 2000. 

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   On the other hand, spending has gone up by 40 percent and the result 
of this combination, revenue down and spending up, has been to explode 
the deficit and the debt. 

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   We can see we have had an increase of the debt from $5.8 trillion at 
the end of the first year of this Administration to $9 trillion 
projected at the end of this year, which is exactly what you would 
expect. If you cannot pay your bills in the first place, and you cut 
revenue and raise spending, the imbalances grow. 

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   One of the results of this is we have become increasingly dependent 
on what I call the kindness of strangers. We are increasingly borrowing 
this money from abroad. As this chart shows, it took 42 presidents 224 
years to run up $1 trillion dollars of United States debt held abroad. 
That is now more than doubled in the last 6 years. 

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   This chart shows if you make the President's tax cuts permanent at 
the very time the trust funds go cash negative, the cost of the tax 
cuts explode, and it takes is right over a cliff. That is, if we extend 
these tax cuts without paying for them. 

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   You know, I like tax cuts as much as anyone and I have been a great 
beneficiary of these tax cuts, personally. But we face a situation with 
this demographic change that-we face a demographic change that is going 
to require us to do a lot of things we would prefer not doing. That 
means we have to have savings out of the entitlements. I believe, as 
part of a package, it means we are also going to have to find more 
revenue. 
   Let me be swift to say I think the first place we ought to look for 
revenue is not a tax increase. The first place we ought to look is this 
burgeoning tax gap, $350 billion a year. 

   This chart shows what happens if the tax cuts are extended without 
paying for them, without offsetting them, and the debt in the out-years 
explodes. Every single witness before this committee has acknowledged 
we have a very serious long-term problem and an unsustainable budget condition. 

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   This is the question of whether tax cuts pay for themselves. We have 
heard a lot of discussion from people that suggest that tax cuts pay 
for themselves, perhaps more than pay for themselves. This is the 
Chairman of the Federal Reserve saying I do not think that, as a 
general rule, tax cuts pay for themselves. 

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   And he is not alone in that judgment. This is former Chairman Alan 
Greenspan who said it is very rare and very few economists believe that 
you can cut taxes and you will get the same amount of revenues. 

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   The former Chairman of President Bush's Council of Economic 
Advisers, Dr. Mankiw, wrote in his introductory college economics 
textbook there is no credible evidence that tax revenues rise in the 
face of lower tax rates. And economists claiming tax cuts pay for 
themselves is like a snake oil salesman who is trying to sell a miracle 
cure. 

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   The fact is that even with the recent revenue improvement, real 
revenues are still lagging behind what they would be in a typical 
recovery. We have looked at the nine previous recoveries, major 
recoveries, since World War II, and we see in this recovery revenue 
still lagging behind the average of the nine previous recoveries, and 
by a substantial margin. 

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   We see the same thing when it comes to jobs. We do not need to put 
up that. 
   As I noted earlier, what is really missing from this budget and from 
our discussions is a commitment to tackle these long-term fiscal 
imbalances. Let me just say, we have had the head of the General 
Accounting Office tell us we are in an unsustainable situation. We have 
had the Chairman of the Federal Reserve. We have had the head of the 
CBO. We have had a parade of witnesses here, from every philosophical 
stripe, tell us we have a serious long-term problem. That is really 
what I would like to focus on today, to see if we cannot find a method 
or a means to get us to a discussion about how we begin to resolve 
these long-term imbalances. 
   I believe, I know you do, Mr. Secretary, that it would be entirely 
in the country's interest if we were able to find a way to take steps, 
the beginning steps, of reducing these long-term fiscal imbalances. 
   Again, I thank you for being here and I now ask Senator Gregg for 
his remarks. 

                 OPENING STATEMENT OF SENATOR JUDD GREGG 

   Senator GREGG. Thank you, Mr. Chairman, and I also wish to welcome 
the Secretary of the Treasury, who has already, in his short tenure, 
been a very constructive force, in my opinion, for trying to move 
forward the debate and discussion as to how we resolve our long-term 
fiscal issues which, as the Chairman has appropriately and effectively 
alluded to, are the gravamen of the problems for our Nation as we move 
into the future relative to policies that do not involve terrorism. 
   If you are looking for the biggest problem we have, it is the fact 
that we are going to pass on to our children a Government they cannot 
afford because it will simply be far too expensive to support the 
entitlement programs for the baby boom generation. 
   But I also think that there has not been enough focus on how well 
things are doing right now in many places and in many ways. 
   We have now had 21 straight quarters of economic recovery in this 
country. That is good news. These are significant growth numbers, and 
they are continuing. 

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   As the result of this recovery, employment has expanded for 41 
straight months and we have added over 7 million jobs. That is a lot of 
people who have a much better lifestyle because they have a job that 
is, in most cases, a very good job and they are generating income. 

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   We have seen that the unemployment rate as a percentage is lower now 
than it has been in almost all of the prior major recoveries. So we are 
actually getting a larger amount of employment and we are getting a 
very strong recovery in this economy. 

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   Real wages are up over the Clinton years. That is a very important 
statistic. We are hearing a lot about wage gap and we are hearing a lot 
about the middle class being squeezed. But the fact that we have had an 
expansion now for over 5 years and an employment increase for over 41 
months and that those jobs are real wage benefits to working Americans, 
that shows that--that is good. That is what you want. You do not want 
the opposite, which is a negative situation. 

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   The growth in revenues has exceeded projections now in the last 4 
years. The fact is, revenues have not only exceeded projections, they 
have essentially blown through the projections from CBO and OMB during 
the last 4 years. And we have seen, in the last 3 years, the three 
largest years of increase in revenue growth in the history of our 
country. That is very significant as a reflection of the growth of the 
economy, of course, and more people having jobs. And again, this is 
another chart that reflects the fact that growth is exceeding the 
projected growth for the last 3 years. 

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   The Chairman says that cutting taxes does not generate more revenue. 
Well, we cut the capital gains rate and we generated a heck of a lot of 
revenue. It is just common sense. 
   It may be that economists tell you that cutting rates does not 
generate more revenue. But common sense tells you that when you cut the 
capital gains rate, you are going to generate some significant revenue 
because people who have locked up assets that they are not willing to 
sell because they do not want to pay that high tax rate, will start to 
sell those assets. And the ancillary effect, the unintended consequence 
effect, is that that revenue, once it is freed up, is then reinvested 
in much more productive capital activity, much more productive things. 
As a result you generate more economic activity, which creates more 
jobs, which is the bottom line we are aiming for, more jobs and a 
better economy. 

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   There is another point that should be made. The tax cuts which the 
President put in place generated this economic recovery which has gone 
on now for over 5 years, which has created over 7 million jobs, which 
has generate huge revenues to the Federal Treasury. Those revenues, by 
the way, today exceed the national averages. Traditionally, we get 18.2 
percent of gross national product as Federal revenues. Now we are up to 
almost 18.4 percent of gross national product as revenues. 
   By cutting the rates and putting a fair tax law into place, we've 
created an environment where people are willing to pay their taxes and 
go out and take risks, be entrepreneurs, create jobs and, as a result 
of doing that, create more revenues for the Federal Government. That 
created a better revenue stream for the Federal Government. 
   At the same time, the President's tax cuts have actually created a 
more progressive tax system, which is never talked about, regrettably, 
by folks on the other side of the aisle. They are always talking about 
how high income people are always getting a better tax benefit under 
this Administration. 
   Well in fact, high income people are paying a higher share of the 
income tax burden in America today, than they paid in the Clinton 
years. 85 percent of the tax burden today is being paid by the top 20 
percent of wage earners, of people with high income. Whereas under the 
Clinton years those 20 percent of high income individuals only paid 81 
percent of the income taxes. So we have the higher income people paying 
more in taxes as a percentage of what we collect. 

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   And I think the next chart shows that the low-income individuals in 
this country, who do not pay any income taxes who receive money back 
through the Earned Income Tax Credit, are actually receiving twice as 
much back today as they received during the Clinton years. 

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   So what we have is a tax law which is significantly more 
progressive, where the high income individuals are paying more of the 
tax burden, and low income individuals are getting more benefit from 
the tax law than during the Clinton years. 
   
   And at the same time, we are generating dramatically more revenues 
than we historically have generated, and especially in the last 3 years 
we are generating significant revenues. 
   The practical effect of that is the deficit is going down. It is 
going down not because we are spending less money, but because we are 
generating more revenues. We have an expanding economy. We are creating 
more jobs. And that is all good news. 
   I think we ought to talk about it a little bit, so that is why I 
took these few minutes to talk about it. 
   I appreciate the Secretary of Treasury being here. 
   Chairman CONRAD. Thank you, Senator Gregg. 
   Again, welcome, Secretary Paulson. Please proceed with your 
testimony. As you can see, we have an amicable committee here, but we 
do not always agree. 

               STATEMENT OF HON. HENRY M. PAULSON, JR., SECRETARY, 
                             DEPARTMENT OF TREASURY 
   
   Secretary PAULSON. Chairman Conrad, Senator Gregg, thank you very, 
very much. 
   I am going to make a brief statement for the record and then we will 
be ready to take your questions. 
   As you know, I am very pleased to be here today to provide an 
overview of the President's budget for fiscal year 2008. 
   


   As the Secretary of Treasury, my top priority is keeping America's 
economy strong for our workers, our families, and our businesses. And 
the President's budget supports that goal. 
   We start from a position of strength. Our economy appears to be 
transitioning from a period of above-trend growth to a sustained level 
of about 3 percent growth. More than 7.4 million jobs have been created 
since August of 2003. 
   Our unemployment rate is low, at 4.6 percent, and over the last 12 
months real wages have increased at 1.7 percent. Economic growth is 
finding its way into workers' paychecks as a result of low inflation. 
That means family budgets are going further. 
   Strong economic growth also benefits the Government's fiscal 
position. In the first quarter of fiscal year 2007, budget receipts 
totaled $574 billion, an increase of 8 percent over the same period in 
fiscal year 2006. As a result of increased revenue over the last 2 
years, we have brought the Federal budget deficit down to 1.8 percent 
of GDP. 
   The President has submitted a budget that reflects our strong 
economy and our Nation's priorities: continued job creation and wage 
growth, vigorous prosecution of the War on Terror, increased access to 
affordable health insurance, improved energy security, a strong fiscal 
position from which we can address the long-term challenges such as 
sustaining Social Security and Medicare for future generations. 
   This budget supports a strong economy by maintaining fiscal 
discipline. It maintains our current tax policy, which has helped our 
economy rebound from recession to its current robust health. With a 
steadily growing economy, tax revenues combined with fiscal discipline 
should bring the Federal budget into balance in 5 years. 
   In fact, we are submitting a budget that includes a surplus in 2012, 
which is achievable if we keep our economy growing. While no one has a 
crystal ball, our economic assumptions are close to the consensus of 
professional forecasters. 
   The President's budget addresses important domestic priorities. 
Health care is high on this list. Under current law, the tax subsidy 
for health insurance purchased through employers will average more than 
$300 billion a year over the next 10 years. For that large expenditure 
we get a system in which rising costs are a burden to families and 
businesses, and in which millions of people have no insurance at all. 
   The President's proposal would make health care more affordable and 
more accessible. It would give all taxpayers who buy health insurance, 
whether on their own or through their employer, and no matter what the 
cost of the plan, the same standard deduction for health insurance: 
$15,000 for a family or $7,500 for an individual. 
   The President's proposal would help hold down health care costs by 
removing the current tax bias that encourages overspending. Costs would 
become clearer, giving patients more power to make informed choices 
about their health care spending. The proposal would also jumpstart the 
individual insurance market, so consumers have more choices than are 
available today. Health care would become more consumer driven, more 
affordable, and more accessible for millions of Americans. 
   Energy security is another concern of the American people, and it is 
a priority addressed in the President's budget. President Bush has put 
forward an ambitious goal of reducing America's projected gasoline 
consumption by 20 percent over the next 10 years. We can achieve this 
goal by dramatically increasing the supply and use of alternative 
fuels, and improving fuel efficiency by reforming and increasing CAFE 
standards. The expanded fuel standards will provide entrepreneurs and 
investors a guaranteed demand for alternative fuels, which will 
accelerate private investment and technological development. 
   Reforming CAFE standards will allow us to increase the fuel economy 
of our automobiles as fast as technology allows. With a more diverse 
fuel supply and better fuel efficiency, we can make our economy less 
vulnerable to supply disruptions and confront climate change through 
technologies that reduce carbon dioxide emissions. 
   Finally, the President's budget, by emphasizing fiscal discipline 
and economic growth, lays the right foundation for dealing with 
entitlement reform, a challenge we all have a responsibility to 
address. 
   Strengthening Social Security and Medicare is the most important 
step we can take to ensure retirement security for our children and 
grandchildren, the long-term stability of the Federal budget, and the 
continued growth of the American economy. 
   I look forward to sitting down with Democrats and Republicans 
without preconditions and finding common ground in these critical 
issues. 
   Mr. Chairman, the President's budget priorities, a strong economy, 
national security, fiscal discipline, health care, energy innovation, 
and laying the groundwork for entitlement reform, are the right 
priorities for America and for the workers, businesses, and investors 
who drive our economy. 
   I am confident that working together we will keep our economy strong 
and chart a course for maintaining our global leadership in the years 
ahead. 
   Thank you for the opportunity to discuss this today, and I now 
welcome your questions. 
   Thank you. 
   [The prepared statement of Secretary Paulson follows:] 

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   Chairman CONRAD. Thank you, Mr. Secretary. Thank you, again, for 
your testimony and thank you for your service. 
   Let me go to one of your last statements, a discussion about going 
to the table without preconditions with respect to the challenges our 
country faces because, in large part, of this demographics tsunami that 
is coming at us of the baby boom generation. 
   When you say without preconditions, what does that mean to you? 
   Secretary PAULSON. Let me step back and say it was very clear in 
your charts that entitlement reform is the biggest issue. We had a good 
conversation yesterday at the House Budget Committee, and Chairman 
Spratt there showed some numbers. They disagreed with our assumptions, 
with our budget, and he said that we are wrong and that the deficit 
will be $145 billion based upon the numbers he is looking at in 2012. 
   I said that I very respectfully think that we can work toward, I 
believe, our numbers, and we can reduce and eliminate the deficit and 
have a surplus in 2012. 
   But the differences we are talking about are very small, $145 
billion in 2012 is 0.8 percent of our GDP. And so what we have staring 
us in our face, and the reason we all care about this, is because of 
the long-term problems. 
   So what it means to me is that we are not going to solve this unless 
we have a bipartisan solution. And so what I am trying to do, at the 
President's direction, is to take the politics out of this and to say, 
without prejudging outcomes, without trying to negotiate this in the 
public arena, let's bring people together and say any idea. Anything 
you want to talk about, I want to talk about. And we will take any idea 
seriously. 
   There is no doubt that the President feels the way he does about tax 
relief. You saw his ideas on Social Security reform over the last 
couple of years. He does not believe you need to increase taxes. He 
thinks personal accounts are a good idea. And other people feel very 
strongly on the other side. So the President has said let's start over. 
Let's have a clean sheet of paper. Let's come to the table without 
preconditions. 
   So to me that is really what it means. It means that people on both 
sides will present their ideas, and we will not do it in a public 
forum. We will do it in a way in which we can make progress and take 
some of the political rhetoric out of this. 
   Chairman CONRAD. I thank you for that. I think that is a very 
constructive statement. And I am absolutely persuaded that you come to 
this with sincerity and a conviction that we have an opportunity here, 
and really a responsibility, to try to make progress. So I welcome that 
statement. 
   I want to go back to the question, because it really is very central 
to this debate, whether or not tax cuts pay for themselves or generate 
more revenue than they lose. 
   Last summer the Treasury Department, and this was before you were 
there, the Treasury Department under your predecessor did a dynamic 
analysis of tax cuts. And here is what they concluded. Treasury's 
dynamic analysis of the President's tax relief indicates that making 
the tax relief permanent can be expected to increase the level of 
annual output by about 0.7 percent. 
   The Congressional Research Service then translated that into what it 
means in comparison to the cost of the tax reductions, and here is what 
the Congressional Research Service told us last summer. The base case 
estimates in the Treasury's dynamic analysis suggest that the induced 
effect on output, were the tax cuts to be extended, would lead to a 
revenue offset of 7 percent of the initial cost. 
   Now that is your own department's analysis. This was before you were 
in the department. I want to be fair, this was under the previous 
Secretary of the Treasury. 
   Let me go to the Washington Post article. Greg Mankiw, who I cited, 
who was a top official, was Chairman of the President's Council of 
Economic Advisers, has tested the notion that tax cuts pay for 
themselves. He is a very distinct economist, as you know, again 
Chairman of this President's Council of Economic Advisers. 
   He looked to the extent to which tax cuts stimulate extra growth and 
the extent to which the growth generates extra revenue. Here is his 
conclusion: even over the long-term, once you have allowed all of the 
extra growth to feed through into extra revenue, cuts in capital 
taxes--which Senator Gregg was referring to--juice the economy enough to 
recoup half of the lost revenue. This is the tax type that has the 
biggest payoff. Senator Gregg is right about that, taxes on capital 
have the biggest payoff. 
   They do enough to recoup half of the lost revenue. Cuts in income 
taxes deliver a boost that recoups 17 percent of the lost revenue. 
So $100 billion cut in taxes on capital widens the budget deficit by 
$50 billion. A $100 billion cut in income tax widens the budget deficit 
by $83 billion. That is Dr. Mankiw's conclusion. 
   We have our own Congressional Budget Office that did an analysis on 
what the effect of a 10 percent reduction in personal taxes and how 
much of that would be paid for by the cut. On the most of optimistic 
assumption it could muster, the CBO found the tax cuts would stimulate 
enough economic growth to replace 22 percent of the lost revenue in the 
first 5 years and 32 percent in the second five. On pessimistic 
assumptions, the growth effects of tax cuts did nothing to offset 
revenue loss. 
   In fact, in the most optimistic of these analyses, done by your own 
department, done by Dr. Mankiw, the former Chairman of Economic 
Advisers under President Bush, done by our own Congressional Budget 
Office, in no case did the tax cuts come close to paying for 
themselves, nowhere close. And these are under the most optimistic 
assumptions, the assumptions being that the tax cuts were financed by 
cuts in other Government spending. 
   As you know, these tax cuts are not financed by cuts in other 
Government spending. These tax cuts are financed by deficit spending. 
When you finance tax cuts with deficit spending, the conclusion of all 
of these analyses is that there is virtually no offset. 
   Now I would just ask you, do you agree with your department's 
analysis on tax cuts not paying for themselves, not coming close to 
paying for themselves? 
   Secretary PAULSON. Mr. Chairman, as I said when I answered the same 
question at the Senate Finance Committee and at my confirmation 
hearings, I have never argued that tax cuts pay for themselves 
entirely. In terms of getting into the details about how much, this is 
something I do not think we really can do with precision. 
   What I have said, which I really believe, is that I have seen it in 
the real world. I was in Wall Street when the bubble burst, the stock 
market bubble, when we went into a recession after 9/11. And I watched 
behavior change with these tax cuts. I have no doubt they created a 
foundation for growth. I do believe it is very hard for economists or 
anyone to evaluate behavioral changes. 
   One thing that I have used before as an example is to look at the 
upper rate. But that is really tax relief for a big part of small 
business, the Schedule C filers. You probably have known small 
businessmen. I have known small businessman all my life. 
   Chairman CONRAD. I come from a family of small businessmen. 
   Secretary PAULSON. What do you do if you are a small businessman?    
Oftentimes, every penny you save, you plow back into your business. 
So there is no doubt in my mind that we have an economy that is robust 
and that revenues are coming in well above the estimate. 
   One of the things I am trying to study and I am spending time 
trying to figure out is actually why we have been so wrong in 
estimating, underestimating the revenues. 
   Chairman CONRAD. Let me ask you this. My time has really passed. 
Your department has concluded, with a dynamic analysis, a dynamic 
analysis, that the base estimate of your department is that the tax 
cuts only pay for 7 percent of their cost. 
   Do you dispute that analysis? Or do you agree with it? Or do you 
want to back and review it? 
   Secretary PAULSON. I have to tell you, I have not read that 
analysis carefully or looked at it carefully. 
   Chairman CONRAD. I would just ask you if you would do that and get 
back to us and let us know do you agree with it, do you disagree with 
it, and the reasons. 
   Secretary PAULSON. I will do it, but I would speculate that I will 
get back to you and say it is a very inexact science. And I will 
probably come back and say I would never try to influence the way the 
great people at Treasury--very, very independent economists--are doing 
their analysis. 
   So I will understand what they have, but to me that is not critical 
to the discussion we are having today. But I will get back to you. 
   Chairman CONRAD. Let me just say, I think it is critical in the 
sense that we look to your department for professional guidance. And we 
need to have the best guidance we can on this issue, among many others. 
   Senator GREGG. 
   Senator GREGG. Thank you, Mr. Chairman. 
   Of course, the issue is not whether the tax cuts pay for themselves. 
That is a straw dog. The issue is whether or not you have a tax law 
which generates enough revenue to support the Government or whether you 
grow the Government to the point where you simply will never be able to 
catch up with the taxes because you will make it impossible for people 
to bear the burden of the taxes that they would be hit with. 
   Let me show you a chart which reflects this fact. If you just take 
the three major entitlement accounts, Medicare, Social Security and 
Medicaid, you will see that they presently are around 5 percent or 6 
percent of gross domestic product. But as the baby boomer generation 
retires, those accounts, as a percentage of the gross domestic product, 
grow radically. And by the year 2030, 2028, they absorb 20 percent of 
gross domestic product. The historical mean of what the Federal 
Government has spent is 20 percent of gross domestic product. 

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   And that just continues to grow. So historically, the amount of 
taxes which the Federal Government has taken, is about 18.2 percent, 
which would be a little bit below the 20 percent of spending. But the 
practical implications of this chart is that you cannot tax your way 
out of this problem unless you are willing to put a tax burden on the 
American worker which is so high that the younger people in this 
country will end up paying so much in taxes that their quality of life 
will drop dramatically and the productivity of the economy will 
probably drop dramatically. 
   But certainly the younger people, my children and your children and 
our children's children, will not be able to send their kids to 
college, will not be able to buy the house they want, because they will 
be paying taxes to support this burden of Government. 
   So the issue is not whether tax cuts pay for themselves. The issue 
is whether or not the tax law that you have in place generates enough 
revenue to support the Government, and at what level will the 
Government be set? How much is the Government going to take out of the 
economy? 
   Now today we know that the present law, the President's tax 
proposals are supporting an income to the Government that exceeds what 
the Government has historically received. We are getting about 18.4 
percent of gross domestic product in revenue, as versus the traditional 
revenue of about 18.2 percent. 
   So the tax cuts are working. They are generating a fair amount of 
revenue to the Federal Government. The problem is we are just spending 
a lot more than we are taking in. And we are going to spend even more 
in the future than we are taking in because of the retirement of the 
baby boomer generation. 
   So my question to you, Mr. Secretary, is independent of whether or 
not the tax cuts pay for themselves, is the tax burden that we have on 
the American people today a fair one? Or are they undertaxed? 
   Secretary PAULSON. I would say that I totally agree with your 
numbers. You look at the last 40 years, the last 50 years, the average 
has been 18.1 percent. And it is now 18.4 percent. You can look at that 
and then look at the fact that revenues are coming in, frankly, faster 
than any of us had expected, any of us on either side of the aisle had 
expected. 
   So I agree with your point. 
   Senator GREGG. The point that the Chairman has made that I do agree 
with--and we actually agree on quite a few things, and we very much 
agree on this point, and we consider it to be the essence of the 
problem--is that chart, which I just held up, shows that we are facing 
an explosion in costs for this Government that will be inordinate and 
historic and unsustainable. And everybody that has testified before us 
says that. 
   The question becomes you have to match revenues to expenditures in 
order to have a strong Government or come fairly close to that. In the 
out-years what percentage of the economy, and I have asked this of 
everybody who has testified, what percentage of the economy should the 
Federal Government take? Today it is taking 20 percent. Should it take 
22 percent, 23 percent, 24 percent? Is there a number at which, when 
the Federal Government starts to take that amount of the economy, the 
economy goes into a nonproductive spiral because the burden of the 
Government has become so high? 
   Secretary PAULSON. Senator, I do not know the answer to that 
question, and I will tell you why. It is because as I have looked at it 
and looked at the problem, the problem is so big in a number of years 
that I do not think we need to answer that question with great 
precision. We do not have to go too far out to know that we are going 
to be hitting a situation where there is either going to be no money 
left for any other discretionary spending, our taxes are going to be at 
the level where they stifle all of us, or we are going to be really 
hurting our children and our grandchildren in terms of their retirement 
security. 
   I know I am singing to the choir because I see both you and the 
Chairman nodding your head. As I look at this, I tell people I have no 
doubt that this country will solve this problem, this entitlement 
problem, at some time. The frustrating thing for all of us is the 
longer we wait, the more costly it will be, and the more difficult it 
will be. And the longer we wait, we are going to have to answer these 
questions you have asked with a lot more precision. I think we are not 
going to like the answers because there is clearly a level at which the 
taxes will really burden this economy and make us noncompetitive. 
   There is clearly a level at which we are not going to be able to 
have the amount of discretionary spending we need to take care of our 
other needs. 
   Senator GREGG. And the collateral point to that is that you 
obviously are going to have to do the majority of this on the spending 
side. 
   Secretary PAULSON. Right, yes. 
   Senator GREGG. Thank you. 
   Chairman CONRAD. The ranking member may be surprised by this. I 
happen to agree with him. We cannot tax increase our way to a solution 
of this problem. 
   I also believe, and the point I was trying to make, is you cannot 
tax cut your way to a solution to this problem. It is going to take a 
balanced, comprehensive approach. And I think most of it is going to 
have to be on the spending side of the equation, given the magnitude of 
the baby boom generation. 
   Senator SANDERS. 
   Senator SANDERS. Thank you very much, Mr. Chairman. 
   Mr. Secretary, let me take this discussion in a little different 
direction. Very often when we talk about the economy, we talk about the 
economy in a general sense. But the American people are not a general, 
they are real human beings who have real concerns. 
   What is your judgment on the fact that the United States has the 
most unequal distribution of wealth and income of any major country on 
earth? That we have, to our shame, by far the highest rate of childhood 
poverty of any industrialized nation, depending on the studies that you 
look at, between 18 percent and 20 percent? Should we be proud as 
Americans? 
   We hear people telling us how wonderful this economy is doing. Mr. 
Secretary, how wonderful is the economy doing when we have by far the 
highest rate of childhood poverty in the industrialized world, with 
some 20 percent of our children living in poverty? Can you tell me how 
that reflects on our economy? 
   Secretary PAULSON. Senator, first of all, in terms of your numbers, 
I have looked a good bit at income distribution. And what I have seen 
is a trend that I have seen in most parts of the world that has been 
going on for 30 years. In some countries it was more pernicious. And so 
when you look at what I saw going on in Mexico-- 
   Senator SANDERS. But we are not Mexico, sir. 
   Secretary PAULSON [continuing]. And China. 
   Senator SANDERS. We are not China. 
   I do not have a lot of time and I know that the Chairman will use 
his gavel. 
   Secretary PAULSON. Let me answer your question. 
   Senator SANDERS. In the United States, the wealthiest 1 percent own 
more  wealth than the bottom 90 percent. The gap between the rich and 
the poor is growing wider, and we have the highest rate of child-- 
forget China--in the industrialized world. What do you think about that? 
   Secretary PAULSON. I would say that what is going on right now is 
something that is happening all over the world. It has been happening 
here for 30 years. But what I think about it is that we are doing a 
lot, and we need to continue to do a lot. 
   Senator SANDERS. What are we doing? I do not have a lot of time. 
   Secretary PAULSON. OK, I will tell you-- 
   Senator SANDERS. Let me ask you a question and please give me an 
answer. I do not have an endless amount of time. 
   When we talk about childhood policy, one of the issues related to 
that is the disastrous situation with regard to child care and Head 
Start in this country. We underfund Head Start, huge numbers of 
families cannot get it. The budget that the President has just 
presented us would cut by $300,000, between 2006 and 2010, millions of 
children from getting child care. 
   Do you think that that is an effective way of dealing with childhood 
poverty? 
   Secretary PAULSON. To get back to your question of what are we doing 
about it, I will answer that very directly. What you have seen under 
this President is 5 million taxpayers taken off the Federal income tax 
rolls. So 5 million additional people do not pay taxes. 
   Senator SANDERS. But what else have we seen? You use the 5 million-- 
   Secretary PAULSON. And you have seen-- 
   Senator SANDERS. Sir, unless the Chairman wants to give me some 
additional time. 
   But we have also seen, more importantly, since President Bush has 
been in office, 5 million more Americans slipping into poverty. Can you 
tell me, is that a good thing, 5 million more Americans are poor today 
than before President Bush took office. 
   Secretary PAULSON. I would say to you, Senator, that I have focused 
a lot on income distribution. It is something I am very focused on. I 
think the No. 1 thing we can do for all Americans, rich or poor, and 
particularly for people at the low end and in the middle, is keep an 
economy growing, keep creating new jobs. They will all do better-- 
   Senator SANDERS. But sir, that is not the record. Since President 
Bush has been in office, almost all of the new income created has gone 
to the very wealthiest people and 5 million more Americans have slipped 
into poverty. Millions of people have lost good paying jobs and are 
working jobs for lower wages. How is that good news? 
   Secretary PAULSON. I would say to you that I do not agree with the 
numbers. 
   Senator SANDERS. You do not agree that 5 million Americans have 
slipped into poverty? 
   Secretary PAULSON. I have not heard that number. And I would just 
tell you, when you talk about the millions of Americans that are losing 
good jobs, I will say there are good jobs being created all of the 
time. And the thing I look at most carefully is what is happening to 
the average worker. 
   And I am very pleased that over the last year we have seen real 
increases in wages. 
   Senator SANDERS. In the last year. 
   Secretary PAULSON. In the last year. 
   Senator SANDERS. That is good, but President Bush has been in office 
for 6 years. 
   Secretary PAULSON. I would say that what we have seen in other 
recoveries, and it was very similar in the 1990's, is that if you can 
keep productivity high, keep creating new jobs, productivity will find 
its way into real wage increases. And we are making progress. 
   Senator SANDERS. I think, sir, you have a tough sell. What you are 
trying to do is convince the middle-class and working-class of this 
country that things are going well. They are not buying it, because 
they know that they cannot afford increasingly health care. And since 
President Bush has been in office 6 million Americans have lost their 
health insurance. 
   They know that more and more people are becoming poor. We see some 
young people here. Middle-class families know that they are finding it 
increasingly difficult to send their kids to college. We have lost 3 
million good paying manufacturing jobs. And while, in fact, we have 
seen in recent years a growth in new jobs, many of those jobs are 
paying lower wages and lower benefits than the jobs, in fact, that we 
are losing. 
   People are seeing folks on Wall Street ending up with $50 million 
bonuses while they are losing their pensions. They are losing their 
health care, when they retired, the health care benefits that they were 
promised. 
   So what you are seeing is a Nation in which the people on top are 
doing very, very well. The middle-class, in fact, is shrinking, not 
because of President Bush. This is a long-term trend. But right now a 
two-income family has less disposable income that a one-income family 
did 30 years ago. 
   I am not blaming this all on President Bush. It has a lot to do with 
trade policy. It has a lot to do with the lack of unionization in this 
country. 
   We will continue this discussion another time. Thank you very much, 
sir. 
   Secretary PAULSON. Actually, I thank you for your comments. I would 
like to talk with you some more, particularly about trade policy. 
   Senator SANDERS. I would love to do it. 
   Chairman CONRAD. Senator Domenici. 
   Senator DOMENICI. Thank you. 
   First, let me say to you, Secretary Paulson, I got a chance to meet 
you since you have been appointed and I have not had a formal 
opportunity. But the private one was very exciting for me because I 
thought that where you came from and what you worried about, based upon 
what you have written, that you are the right person for this job. 
   What a tough job we all have, and it is not all yours. But I would 
suggest a couple of things that I think I know from having served here 
for a long time. 
   One, there is just no way we are going to solve the deficit problem 
by continuing to attack almost singularly the appropriated accounts 
every year. It has now reached the point where we cannot produce a 
budget, in my opinion, of the President's level in that account, that 
big account, that can pass and be implemented throughout the year. I 
will start with that. Whomever that helps, I am not saying where I am 
voting. I am just saying each year that one is getting where it can 
less and less do the job. 
   I hope you will think that true because I think the conclusion is 
absolutely inevitable. 
   But that does not mean that our problem is still not that we must 
cut growth in Government. That is what we must do, instead of worrying 
so much about increasing taxes. We have to find a way to solve the 
problem of ever spiraling costs of Medicare, Social Security, and 
Medicaid, although Medicare is a different breed of program. 
   And I wanted to suggest to you that there is a bill called Senate 
Bill 355. I put that in with Senator Feinstein, and I would hope you 
would look at it. 
   The reason I put it in is because I have given up on Congress, even 
with leader president, I have given up that we will modify Medicare or 
Social Security in any significant way. And both are doable. But I do 
not think Congress will do it. 
   Therefore, this is for a bipartisan commission to recommend how to 
do it. And I truly believe if you could read it and give us your views, 
I think it can do the job. It has the right input, the right people, 
the right rules, and reports its results to the right people, who must 
act. 
   And I think that is a lot better than wringing our hands, that we 
must squeeze the appropriated accounts another time for $3 billion or 
$4 billion or $5 billion, when the debt is so much bigger and we know 
it--the deficit, excuse me, and we know it. 
   Having said that, just do you agree theoretically that what we have 
to do is what I said? Not my bill but-- 
   Secretary PAULSON. Senator, I do agree philosophically that the 
biggest issues we face are the long-term spending--Medicare and 
Medicaid--and other entitlements--Social Security. 
   Senator DOMENICI. I think it is good if you become a little bit more 
of an expert on them. You are a quick learn. Because you cannot just 
deal what the theoretical Treasury problems and help us solve our 
problems. 
   Let me tell you another one that is quick, but everybody is trying 
to come up with an idea on how to fix our global warming, that is some 
carbon containment so it does not get out there as we burn it. 
   I submit to you that everybody is looking for a law that will do it 
which will put all kinds of impacts on business and it will become just 
another master of bureaucracy on trying to collect carbon tax or 
whatever it is. Now just think with me for a minute. 
   The real problem is that we are not getting enough in investment or 
solution to new technology that takes the carbon out of the coal. 
Instead of trying to solve that, we are trying to change the law and 
burden business one way or another. 
   Question to you: what if we introduced a bill that said this bill 
has, as its purpose, the financing for the next decade of those who 
wish to invest in new technology that will direct itself at converting 
coal and getting the coal sequestered permanently in the process. 
   Would that not be just the same as passing one of these burdensome 
bills, if not better? 
   Secretary PAULSON. Senator, let me say it is a complicated topic. 
But I will tell you that technology has been very important to this 
president. And as I have looked at it and studied the issue, there is 
no doubt that coal is the backbone of power generation around the 
world. 
   In our strategic economic dialog with China, one of the things we 
talk about a lot is clean coal technology, the FutureGen project. So I 
do believe that in any solution we come up with, one important part of 
it should be new technology. Clean coal has to be a very big part of 
it. So I agree with you there. 
   Thank you. 
   Senator DOMENICI. Mr. Secretary, it seems like the Federal 
Government is going to have to push the technology. And I submit to you 
that a very big program of loan guarantees or the like for this kind of 
work on a 10-year basis will find the breakthroughs sooner than just 
insisting that we have a new law that takes away things from business. 
Secretary PAULSON. I do agree there is clearly a role for Government. 
And right now you will see we have a very rigorous approach to this, 
and we are funding, at the Federal level, clean coal technology. There 
is a lot of work being done on this. 
   I think it is actually quite encouraging, some of the progress. 
   Senator DOMENICI. Thank you, sir. Thank you, Mr. Chairman. 
   Chairman CONRAD. Senator Bunning. 
   Senator BUNNING. Thank you, Mr. Chairman. 
   Speaking about economists, as the Chairman did earlier, I can put 25 
economists in a room and ask them and give them exactly the same 
circumstances. And guess how many answers we will get? Twenty-five 
different answers. 
   Chairman CONRAD. Fifty. 
   Senator BUNNING. Fifty, that may be true, too. 
   Secretary PAULSON. That is right, on the one hand, and then on the 
other. Unless they are all one-armed economists. 
   Senator BUNNING. You are taking my time now, and I have not asked a 
question. 
   [Laughter.] 
   Senator BUNNING. Under the Bush Administration, we have increased 
earned income tax credit dramatically and we have doubled the child tax 
credit in the last 5 years. And there are 40 million senior citizens 
now getting prescription drugs that did not get them before the Bush 
Administration took office, just as a matter of fact, under 
prescription Medicare Part D. 
   Let me just ask you a couple of questions. Thank you for coming, 
first of all. 
   I was pleased that the President's budget calls for a repeal of the 
sunset of the marginal tax rate relief. I am very concerned about some 
proposals I have heard from Members of Congress to increase the 
marginal rates and the impact such proposals could have on our small 
businessmen and women. 
   Given the enormous number of jobs created by small business in this 
country, what effect could such a tax increase have on the strong job 
growth and overall economic strength that we have enjoyed in recent 
years? 
   Secretary PAULSON. I would just say to you that I would clearly not 
recommend a tax increase. I think that is why it is important to make 
this tax relief permanent. I think one of the positives, which you have 
pointed out Senator, which I do not think is generally understood, is 
when you look at that top bracket it applies to the individual Schedule 
C filers, which are-- 
   Senator BUNNING. And S-Corps, too. 
   Secretary PAULSON. Yes, and S-Corps, which are small businesses. 
   Senator BUNNING. Yes, which are all small businesses. 
   Secretary PAULSON. This is a marvelous thing, this American economy, 
just a marvelous thing. We all sit here and think we are doing things 
in Washington that are responsible for everything, but it is the 
American businessman, the American worker. And I do believe we need to 
look for ways to help them. I take your point, and I agree with it. 
   Senator BUNNING. Since our economy is extremely strong, and there 
are people that are debating whether it is or not, and our unemployment 
rate is very low at 4.6 percent, which historically over the 1960's, 
1970's, 1980's, and 1990's and into the 2000's, is at a historic low 
for a period of long-term. 
   Economic growth has averaged over 3 percent growth for more than 20 
straight quarters. Yet some Chicken Littles are trying to convince the 
American public that the sky is falling in, or else they are trying to 
ignore the fact that record performance of the economy was engineered 
by sound economic policies. 
   Do you believe that the policies put in place by the President and 
the Congress over the past 6 years have contributed to this remarkable 
growth of our economy? What would be the economic impact of reversing 
the President's tax relief or allowing the tax relief to expire? 
   Secretary PAULSON. I would say, Senator, I do believe, as I said 
earlier, that these economic policies--the tax relief--has been very 
important, provided a real foundation for growth, helped investor 
confidence, changed behavior, and made a very big difference. 
   I think all of us should feel fortunate that this expansion is 
continuing. It is stronger now than I believed it would be. So I would 
not-- 
   Senator BUNNING. I have one more question. 
   Secretary PAULSON. I am sorry. I would not recommend that we raise 
taxes. 
   Senator BUNNING. OK. 
   We talked about entitlements and the reduction in the rate of growth 
that has been put into the President's budget. It is less than 1 
percent in Medicare and less than 1 percent in Social Security or 
Medicaid and on down. 
   But when we project that reduction 75 years out, it saves $8 
trillion long-term. I would like your comment on that. 
   Secretary PAULSON. I think you have it. And so you look at Medicare, 
and what we are doing is putting some ideas on the table to reduce the 
trajectory of growth over 10 years from 7.4 percent to 
6.7 percent. You are right. You are dealing with such big numbers, just 
changing the rate of growth a small amount makes a big difference. 
   I can see you have studied these things very carefully, and I 
appreciate it. 
   Senator BUNNING. Thank you very much. 
   Chairman CONRAD. I heard you say, in response to Senator 
   Bunning, that you would not recommend a tax increase. Is that 
correct? 
   Secretary PAULSON. Correct. 
   Chairman CONRAD. I assume that you are saying that in reference to 
the extension of the 2001 and 2003 tax cuts that otherwise expire? 
   Secretary PAULSON. Yes. 
   Chairman CONRAD. But does not the President's budget have, in just 
the same way, a tax increase on the alternative minimum tax, since 
those provisions, under the President's budget, sunset after 1 year? 
The provisions to prevent a massive tax increase. 
   And so in the President's budget, and this is from the Tax Policy 
Center at Treasury, you have almost $500 billion of tax increase as you 
have defined it here. Is that not the case? 
   Secretary PAULSON. Yes, Mr. Chairman, let me address that. I think 
we are all agreed that we do not want the alternative minimum tax to go 
into effect without extending the current patch. As I have said before, 
it would be cruel and unintended, and it would be a real surprise to 
hit the middle class. 
   And so what we have done in the President's budget is put forward a 
budget where there is an additional year of relief. That is to give us 
time to work together to solve this problem. 
   Chairman CONRAD. But the President's budget would not balance 
without the revenue that flows from what you have defined here as a tax 
increase. 
   Secretary PAULSON. I would say that what we have seen now, I think 
for the last 6 years, is that this 1-year patch is what Congress has 
done. What we thought made most sense was to go ahead with that 1 year 
of additional relief, and then work together. And I am hopeful that we 
will work together and come up with a solution. 
   Chairman CONRAD. I appreciate that, but the reality is as you have 
defined tax increase, this is a tax increase. And it is a large one. It 
is $500 billion of revenue that, if you did not have in this budget, 
this budget would not balance. Is that not the case? 
   Secretary PAULSON. There is no doubt that if the alternative minimum 
tax went into effect without extending the patch, it would be a cruel 
tax increase. It would be an unintended one. 
   Chairman CONRAD. Because my time is fleeting, as well, let me ask 
you this if I could. Are there ways that we could increase revenue 
without increasing tax rates? 
   Secretary PAULSON. I would say obviously you can, by reducing 
spending. 
   Chairman CONRAD. No, I'm talking about on the revenue side now. 
   Secretary PAULSON. On the revenue side I do believe it is very 
interesting. When we looked at our budget, and when I did the analysis 
 and compared it with our projections, with the CBO projections, and 
others, it is just clear to me how dependent all of this is on a 
growing economy and keeping an economy strong. And that is really where 
the biggest sensitivity is. 
   Chairman CONRAD. Let me try to help you and suggest that-- 
   Secretary PAULSON. So I would say to you that I think the biggest 
way we increase revenue without increasing tax rates is through 
economic growth. 
   Chairman CONRAD. Without question. And what other ways? 
   What I am trying to lead you to is the tax gap. As I see it, and 
help me understand how you see it, the Revenue Service has told us 
before this committee that they now believe the tax gap, the difference 
between what is owed and what is paid is now $350 billion a year. And 
while the vast majority of us pay what we owe, I believe the vast 
majority of companies do as well, we have some number of individuals 
and companies who are not. Is that not a way of increasing revenue 
without a tax increase? 
   Secretary PAULSON. How much time do I have to respond to that? 
   Chairman CONRAD. Go ahead. 
   Secretary PAULSON. I am going to try to be brief, but this is one 
that I have thought about a lot because when I arrived here Chairman 
Baucus told me how serious he was about this. 
   I looked at the numbers, and the numbers are not as good as we would 
like. The last real serious estimating efforts were in 2001. Under my 
direction we are going to be taking a much more careful look this year. 
But the estimates, the number I would use was $290 billion, which was 
the net tax gap. I began looking at this the way all of us look at it, 
which is to say that it is outrageous to any of us who pay taxes that 
we all are paying more taxes because some people are free riding and 
are not paying anything. For some of them, it is done through intent, 
and for others, it may be because they inadvertently do not pay the 
taxes. 
   But as I looked at this, what I found, and we are working hard on 
this, is that the vast majority of the tax gap come from individual 
taxpayers, and it is the result of underreporting. You can look at it. 
There are some non-filers, and there is some underpayment. But the 
biggest piece is underreporting. 
   As you delve into that and you look at that, the majority of the 
underreporting comes from business income. So it is Schedule C, and a 
lot of it is small business and farmers who are under-reporting. 
   And then you say OK, so how do you get at that? The conventional 
wisdom was if we make the tax code simpler this will help shrink the 
tax gap. That is right, it will help shrink it. But frankly, to get at 
the big numbers and the biggest portion of it, we would have to make it 
more complicated because it means more reporting. 
   As I have looked at it, there are a number of things if we wanted to 
get it, we would have to do, which I think, frankly, none of us will 
want to do. That is because they would be the kinds of policies that 
will be very onerous. It would be the sorts of things like a lot of 
reporting, 1099s. I have used the example that if you hire a plumber, 
you would have to fill out the 1099, give him a coypy and send a copy 
to the IRS. Or on the family farm where the wife is selling eggs, going 
through the same procedure. 
   Another way to get at it, and I spent a bunch of time with our 
people on this, would be to have electronic receipts or credit card 
receipts for everything. Moving in that direction, moving away from the 
cash economy and having all of those receipts go to the IRS. 
   Or big withholding. I remember when Dan Rostenkowski had withholding 
on dividends and interest. There was big objection to that, and 
Congress repealed it. Well, you could have withholding on pension 
payments, on interest, on dividends. 
   And so as I have looked at it, what I have to say to you is that I 
would love to come up with ways to finance through the tax gap. We are 
going to be working hard on this. But it is not a pot of gold. I am 
just convinced that this is not a pot of gold that is going to finance 
the AMT or other things. 
   I wish I could tell you otherwise. We have 16 legislative proposals 
that have to do largely with reporting. I am urging Congress to pass 
those. And I understand why there may be some resistance, because even 
those-- 
   Chairman CONRAD. How much will that raise? 
   Secretary PAULSON. That will raise about $30 billion over 10 years. 
And even there, some of them are going to have a delayed effect. One of 
them, for instance, involves the securities industry and would require 
brokers to report the basis of securities. And there will be a lag 
effect because that proposal would go into effect, if it is passed, in 
2009 and would apply to securities that are bought after 2009 and then 
are sold thereafter. 
   But this is not going to be easy. We have what we think is an 
aggressive IRS budget. We would like to get that funded. I appreciate 
your support over the years in always funding the IRS in any of our 
efforts there, supporting the budget, and helping pass our legislative 
proposals. 
   Chairman CONRAD. Senator Gregg. 
   Senator GREGG. Thank you. 
   What you are saying is that most of the tax avoidance is a cash 
economy that is very hard to track without a lot of paper and a lot of 
bureaucracy. 
   Secretary PAULSON. Boy, I wish I could have said it that quickly and 
clearly. I am going to take lessons from you, Senator. 
   Senator GREGG. One of the things we have been talking about in this 
committee, and I think appropriately so, is the amount of ownership 
which we have of our debt by foreign holders and the fact that our 
debt, as a percentage of gross national product, has gone up. And it 
will go up radically if we have these numbers facing us. 
   And you are, unquestionably, the best expert we have ever had in the 
Government on the issue of debt since Mr. Rubin was serving, I suspect. 
You are probably even better than Mr. Rubin. 
   Secretary PAULSON. I would not say that. 
   Senator GREGG. Anyway, your expertise is unquestioned. 
I would just like to get out your thumbnail thoughts on having foreign 
ownership of debt? Is it worse than having American ownership of debt, 
our own debt? And at what point does foreign ownership of debt become a 
risk because they lose their confidence in us? Is that a potential that 
we should fear? And if it is, what would lead to that? 
   Secretary PAULSON. Thank you, Senator. Again, I have looked at this 
carefully. 
   First of all, we all should know why we have the foreign ownership 
of debt. We have a current account trade deficit. We also have an 
economy that is growing, and we really want to keep our economy 
growing. We are not saving, in this country, and we have very high 
savings rate in other countries. China has a 50-percent savings rate, 
for instance. And so it is very important that we have foreign 
ownership of debt. 
   And as I have looked at it, there is great diversity in the 
holdings--in foreign holdings, individuals, governments--great 
diversity. 
   I will give you a couple of numbers that are fresh in my mind 
because, as I testified before Senator Dodd's committee on China, I was 
asked these questions. We have roughly $4.4 billion of treasuries 
outstanding and held by the public. When you look at that, we have 
about $346 billion of them held by Chinese. That is 8 percent of the 
total. 
   Now some of those are held by individuals and some by the 
Government. We do not break that down publicly. But we have $500 
billion of our Treasury securities traded every day. So that is less 
than 1 day's trading volume. 
   Japan is the biggest holder when you look at individuals and the 
government. That is $650 billion roughly, a little bit more than a 
day's trading volume. 
   So as I look at this, there are many other things I am more 
concerned about than this. The key to all of this is to keep with 
policies that generate confidence in our economy, so that all holders 
of Treasuries, whether they are overseas or in the United States, buy 
Treasuries because they think it gives them the best risk-adjusted 
rate of return and because they have confidence in our economy. 
   The way I think about this is we need to work on these imbalances. 
It is going to take a number of years to work our way out of these 
imbalances. I am encouraged by the fact that with regard to the trade 
deficit, we have now had four quarters in a row where our exports are 
growing faster than our imports. This last year, our exports to China 
grew at 33 percent, our imports at 19 percent. Our exports added 1 
percent to our GDP in the fourth quarter. 
   So we are making progress but it is going to take a while as we work 
through these imbalances. And I do not believe the foreign holding of 
debt is a symptom. It is a natural outcome of the trade imbalance. 
Given the diversity of holdings, the liquidity of Treasuries, I am not 
particularly concerned about that problem. 
   Senator GREGG. I appreciate that explanation. 
   If I could just make one comment--I really do, those were very 
substantive thoughts. 
   But on the issue of how you do not have to increase rates to 
generate revenue, you mentioned expanding the economy obviously as the 
best. And the Chairman has mentioned collect taxes that are owed. 
   I would like to put the third item on the table, which is that you 
go back to the 1986 Tax Reform Act which is that you clean the code of 
deductions and you actually cut rates and generate more revenue. 
   Secretary PAULSON. Absolutely, simplification. You are absolutely 
right. 
   Senator GREGG. Thank you. 
   Chairman CONRAD. If I could just follow for one moment and then 
Senator Whitehouse is next. 
   If I could ask you any proposals you would have with respect to what 
Senator Gregg just raised, that is tax reform proposals, base 
broadening proposals that Treasury has worked on, that would be 
of interest to the committee. 
   Secretary PAULSON. Thank you very much, Mr. Chairman. 
   In light of the fact that there has been very major tax reform in 
2001 and 2003, and given how important this entitlements issue is, our 
major priority had been coming up with incremental tax reform, and a 
big effort in terms of this incremental reform is with a standard 
deduction for health care. 
   And I am quite interested and am doing work on tax reform. We will 
continue to do work on tax reform as it relates to competitiveness and 
base broadening, looking at the corporate sector, and what it takes in 
this century to be competitive. 
   And so you will see work as we go through the course of this year. 
   Chairman CONRAD. That would be very interesting and very helpful. 
   Secretary PAULSON. Thank you. 
   Chairman CONRAD. Senator Whitehouse. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. I see that my clock has 
been restored to working order so I am no longer operating in a time-- 
free zone down here. 
   Mr. Secretary, first of all welcome, pleasure to have you here. 
   I would like to touch base following a little bit on what Senator 
Sanders said. We see an expanding income gap between the rich and the 
poor, a dramatic one that goes back and is unmatched since robber baron 
days. It strikes me that it is not attributable to any particular fault 
collectively on the part of the middle class. Indeed, working folks 
seem to be producing at a higher level production than ever, or an 
increasing one anyway. It does not appear to be the result of any 
particular new level of achievement on the part of the wealthy and more 
fortunate members of our society. 
   It appears, rather, to be the product in significant measure of 
secular economic forces around the world, of the flattening economy, of 
new levels of competition for labor and so forth. 
   Secretary PAULSON. Technology. 
   Senator WHITEHOUSE. And technology. And it is having a really 
pronounced societal affect that is beginning, I think. I guess the 
question is where does that go? 
   I see huge risk of climate change from global warming creating 
enormous stresses. And the obvious solutions to it would appear to me 
to be price driven and likely to result in increases in fossil fuel, 
utility, heating oil, gas costs, all things that, as a portion of the 
household budget, are a larger portion for lower and middle-income 
families. 
   So as we solve that critical national and international problem, 
again, a second hit on these families on top of the secular drift that 
is taking place right now. On top of that I see tax, trade and budget 
policies of this country that accelerate that drift even further, 
supporting wealthy and corporate interests and cutting what are, in 
many cases, vital supports for working families. 
   And the three seem, to me, to be adding up to a kind of a perfect 
storm.   And I am interested in your thoughts on just how far you think 
we can go, as an American society, in terms of this increasing and 
potentially limitless discrepancy between the trajectory of wealthy 
families and the trajectory of working-class families before it creates 
social, political, economic, and really moral issues that change the 
face America presents to the world and change the way we look at each 
other? 
   And if you think it is serious, where in this budget do we find 
anything that helps? 
   Secretary PAULSON. Senator, thank you for that comment. It is very 
consistent with Senator Sanders' comment. 
   Senator WHITEHOUSE. It is a New England thing. 
   Secretary PAULSON. And I think, this is something that many of us 
are thinking about right now--the growing dispersion of income And what 
is causing it. 
   As I learned long ago, it is very interesting to know there is a 
problem. It is much more valuable to ask what do you do about it? 
But I do want to say one thing in terms of the cause. I really do 
believe that a very big part of what is going on is technology. Part 
of it is integration into the global economy. 
   The reason I mentioned that is because I do not hear anybody say, 
and I am sure you would not say, let us turn back technological growth, 
let us put that back. 
   Senator WHITEHOUSE. I think, actually sir, on a net basis it has 
been hugely positive. The problem is that some people are losers and 
some people are winners in that net forward and that itself becomes a 
problem at some point. 
   Secretary PAULSON. I agree. 
   And the reason I say that is because I feel the same way about 
trade. Your statement about technology I would make about trade, also. 
We have been net gainers. The reason I would say that is I think if we 
move toward protectionist policies, it would be very similar to try to 
pull back technological advancement, and it would hurt the very people 
we are trying to help. 
   Now having said that, I think a bit-- 
   Senator WHITEHOUSE. That still leaves the people who, because of the 
trade changes and because of the technological changes, are getting 
hurt. How do you help them? 
   Secretary PAULSON. I think there has to be a big focus on what we 
do. And I like the way you are approaching it, not in terms of class 
warfare, but how do we help the people on the bottom? How do we help 
the average worker? 
   I am just going to say what I said to Senator Sanders. First of all, 
I am not saying this alone is sufficient. But keeping this economy 
growing and keeping new jobs growing is essential, because whatever the 
issues, they are going to be greater if we do not have that, if we do 
not have the position of economic strength. 
   The more you study it, the more you see it really comes down, to a 
large extent, to education and training. It also involves thinking 
about how in this century we think just more precisely about it, 
practically about what we do there, and coming up with programs that 
also are more effective at dealing with the job losses and 
dislocations. 
   Because no matter what we are doing just generally, there is no 
doubt that trade does cost jobs. It does not cost net jobs, it adds 
jobs. But to those who lose their jobs-- 
   Senator WHITEHOUSE. That doesn't help the family who just lost their 
job. 
   Secretary PAULSON. To those that lose their jobs, we need to ask how 
do we deal with those specific situations because society overall is 
benefiting, and there is a higher standard of living because of it. 
   So I think you really are pressing on the issue that we are all 
going to have to deal with together over the next 10 years. I am sorry. 
   Senator WHITEHOUSE. No, no. I just wanted to get permission from the 
Chairman, because I have gone over my time, just to make one additional 
point. 
   Secretary PAULSON. I went over for you. I am sorry. 
   Senator WHITEHOUSE. No, no, that is fine. 
   Chairman CONRAD. Let me just stop you, if I can, at that point. Let 
me just say kind of my rule of thumb here is we have 5 minute rounds, 
but I try to give each Senator about a 2-minute additional bump. That 
is how I have operated here, as you can probably tell. 
   But we will have additional round. It really is Senator Sanders' 
turn, if we could. 
   Senator SANDERS. Senator Whitehouse, I will pick up where you left 
off. So you did not lose time, we are raising the same issues here. 
   It seems to me, Mr. Chairman and Mr. Secretary, that sometimes here 
in D.C. we get a little bit isolated from reality. You made a statement 
a moment ago, this is a paraphrase that ''this is a marvelous thing, 
this American economy'' roughly speaking. 
   Now I have to say I think that if millions of people all over 
America were listening to your statement, people who had fallen into 
poverty, people who today are working longer hours for lower wages than 
used to be the case, maybe one of the 6 million Americans who have lost 
their health insurance, maybe one of the millions of workers who were 
promised a pension but that pension was reneged, taken away from them, 
maybe a mother who is desperately seeking affordable child care in her 
community as she goes out to work 40 or 50 hours a week to earn enough 
money to take care of her family. 
   Do you know what she would say? Sir, what world are you living in? 
And that maybe, maybe we are hanging around with folks in the country 
clubs and CEOs of large corporations for whom this economy is a very, 
very marvelous thing, to use your word. But it is not a marvelous thing 
for the middle class. We have to get our act together. 
   The fact is, and I think all of the evidence suggests this, that the 
middle class is shrinking. When you and I were growing up the 
expectation was that one breadwinner in a family, usually the men back 
in those days, could work 40 hours a week and earn enough money to 
provide for the family. One person, 40 hours a week. 
   How many people, Mr. Chairman, do we know in America today, 
middle-class families, where one person is working 40 hours a week? 
Quite the contrary. The vast majority of middle-class families, husband 
and wife are working. And it is not uncommon for them to be working 
more than 40 hours a week. 
   In fact, in this marvelous economy that you are talking about, you 
may or may not know that in the United States our people work the 
longest hours than in any other industrialized country. I believe a few 
years we surpassed the Japanese, who also work very long hours. How is 
this a marvelous economy? 
   Now, my question to you, and I am a little bit blunter than my good 
friend from Rhode Island. I look at what is going on having to do a lot 
with one word, and that is greed. Frankly, I do not believe that the 
Bush Administration is trying to help all of the people. I do not 
believe that at all. I think you guys work day and night to help the 
people on top. And I think you have turned your backs on middle-income 
people, working people, and low-income people. 
   Sir, the United States is the only nation in the industrialized 
world that does not have a national health care program. The only one 
of any major country. In your judgment, should health care be a right 
of all people, as is the case in every other major country on earth? 
Secretary PAULSON. You know. I feel very strongly that we need to work 
toward a system where everyone has access to affordable health care. 
But to me that is not a nationalized program. 
   Senator SANDERS. Not nationalized. But every other country has said 
that, as a right of citizenship, people should have health care. We are 
the only one in the industrialized world that does not. And I am 
hearing you say that you do not think that that should be the case. 
   Let me ask you another question. We have heard a lot of discussion 
about Social Security. In my view, Medicare is a very serious problem. 
I do not think Social Security is. Right now Bill Gates and the 
wealthiest people in this country contribute into the Social Security 
system the same amount of money as somebody who makes $94,000 year, 
roughly speaking. 
   My understanding is that if you simply lift the cap and you said to 
the wealthiest people in this country, people who by and large their 
income has soared in recent years, if you lift that cap as we have done 
with Medicare and ask them to contribute proportionally into the 
system, we would not have a Social Security problem. 
   Now given the fact that the wealthiest people in this country have 
seen huge increases in their income in recent years, why should not 
they be asked to contribute more into the Social Security system so 
that we can solve that problem and make sure that Social Security is 
vibrant and strong for the next 75 years? 
   Secretary PAULSON. Senator, you could also do that by taking a 
progressive approach to benefits. 
   Senator SANDERS. Well, you could. 
   Secretary PAULSON. Of course you could. 
   Senator SANDERS. You could. But this, I think, would be the simpler 
way, if you want to keep Social Security as a universal system 
protecting all people. I frankly think that Bill Gates, not that he 
needs it, is entitled to Social Security, too. And once you start doing 
away with universality, you are going to eventually make it into a 
welfare program, which is not a good idea. 
   Secretary PAULSON. I did not suggest doing away with universality. I 
suggested progressivity. 
   Senator SANDERS. Should we ask, should we lift the cap and solve the 
Social Security problem by asking the wealthy to contribute more into 
the system? 
   Secretary PAULSON. That would not be my suggestion. 
   Senator SANDERS. Why? Don't you think it is fair that at a time when 
the wealthiest people have never had it so good, and the gap between 
the rich and the poor is growing wider, that simply lifting that cap 
can solve the problem? 
   Secretary PAULSON. I think you and I are not going to solve the 
situation right here at a public hearing. Maybe you will be one of 
those who comes to the table and that will be your idea.   
   Senator SANDERS. Let may go back to an issue that I feel very 
strongly about, that as the middle class declines and as you see 
husbands and wives out working, we see in the budget that the President 
submitted a program which would reduce the number of children receiving 
child care assistance by 300,000 at the same time as the budget 
provides $739 billion in tax breaks to households with incomes 
exceeding $1 million. 
   In addition, your budget asks veterans in this country to pay more 
for their health care. 
   Can you explain to me the morality of cutting back on child care, 
asking veterans to pay more for their health care at the same time as 
 we sustain huge tax breaks for billionaires? What is the morality of 
that? 
   Secretary PAULSON. I see you have a point of view, and I would 
suggest that when Secretary Leavitt is here and is talking about the 
health care program, maybe he can go into the details of that with you. 
Senator SANDERS. Just let me conclude, Mr. Chairman, and thank you for 
the extra time, we are not just talking about economics. We are talking 
about a moral perspective. We hear a lot about moral values. Let me be 
very clear. You do not give tax breaks to billionaires, ask veterans to 
pay more for their health cut and drive them off of health care, cut 
back on child care, cut back on Head Start. 
   To me those are not moral values. 
   Thank you, Mr. Chairman. 
   Secretary PAULSON. Can I just say one thing that I think you and I 
can agree on? When I said it is a marvelous economy, what I meant is 
this is an economy that makes it better for virtually everyone. Better 
than we would have if the economy, were a no growth or a slow growth 
economy. This is an economy that is a very strong economy in terms of 
jobs that are being created, inflation, et cetera. 
   I did not mean to suggest that there are not some people in this 
economy that we would all like to see do better. And so I am very aware 
of what is going on with income distribution, and I am very focused on 
the average worker and people at the bottom. 
   So I look forward to talking to you. 
   Senator SANDERS. I hope that we can continue this discussion. Thank 
you very much. 
   Chairman CONRAD. Senator Menendez. 
   Senator MENENDEZ. Thank you, Mr. Chairman. Thank you, Mr. Secretary, 
for your testimony. 
   I have one overarching question and then some specific questions. I 
read your testimony. But I have a problem in believing that we can tell 
the American people that we can afford $1.7 trillion in permanent tax 
cuts that will continue to benefit a disproportionate number of higher 
wealthy taxpayers, continue to fund the war at more than $8 billion a 
month with no real end in sight, ignore the exploding costs of a 
middle-class tax crisis under the AMT that we will almost certainly 
have to finance. 
   Looking at that and looking at continuing to deal with the AMT 
exemption every year, roughly $50 billion a year on average from now 
until 2012. 
   How do you do all of that, not offset the tax cuts? How is that 
fiscally responsible? Would you have run your former company that way? 
You would have? Would you have run your former company that way? 
   Secretary PAULSON. I would say that looking at a firm, there is an 
appropriate role for debt. And again, as I look at the fiscal 
situation--and you missed some of the discussion we had earlier, so I 
will repeat it--we have a situation today where our debt as a percent 
of GDP, is 1.8 percent. Looking over a period of time, that is within a 
range that I do not think would concern many-- 
   Chairman CONRAD. Mr. Secretary, might I just stop you for a moment, 
because I think you just misspoke. You said our debt is 1.8 percent. I 
think you meant to say our deficit. 

   Secretary PAULSON. Deficit, absolutely. I am sorry. Thank you. And 
so I look at it from that perspective, I was at the House Budget 
Committee yesterday and Chairman Spratt looked at our budget and said, 
I do not believe you are going to balance it in 2012. He said, I think 
that instead of having a surplus you are going to have a deficit, and 
it is going to be $145 billion with your policies. 
   I said that I think we will achieve a surplus or balanced budget. 
But if he is right, the deficit would be 0.8 percent of GDP. 
   The concern that all of us have, and the reason we have the fiscal 
concern, is because of what we see coming with the entitlement program. 
I think there was sort of a general agreement, before you had come in, 
that that is the issue. 
   And so if I were running a company and I was looking-- 
   Senator MENENDEZ. So the answer is yes? The answer is yes? Is that 
what you are telling me, this is how you would run your company? 
   Secretary PAULSON. I would say it is not a simple yes or no. I would 
say that a deficit of this level right now would not concern me. But if 
I was looking at accrued liabilities staring me in the face a number of 
years down the road, I would be very concerned. And I would ask how do 
we deal with it. 
   Senator MENENDEZ. Let me ask you about values because I think 
budgets are about values, both personally and nationally. 
   How is it that we can explain a value that we have $1.7 trillion in 
tax cuts, including those that would provide $160,000 break to 
millionaires in 2012 and not have an extension of the college tuition 
deductibility when we are more globally competitive than ever before? 
   Is that a value that make sense? 
   Secretary PAULSON. I would say that, as far as I know, the college 
tuition deduction is in the law now. 
   We did not put in the budget a proposal to extend it, but it is 
there thorough 2007? 
   Senator MENENDEZ. The deduction expires at the end of 2007. 
   Secretary PAULSON. We did not include an extension. 
   Senator MENENDEZ. You did not. So it is evidently not a value the 
Administration decides is a value. 
   Secretary PAULSON. I would say education is an important value. 
   Senator MENENDEZ. But not when we take away the single most 
significant way that average middle class and those struggling to get 
into the middle class have to help them fund their education. Yet, we 
have these tax cuts geared in such a way that clearly speak of a 
different set of values. 
   Let me ask you this, speaking of values. The overwhelming part of 
the tax paying base of this country is the middle class. How is it 
possible that if we make the tax cuts permanent, what is the cost of 
the long-term AMT relief? It is a lot more, is it not? 
   Secretary PAULSON. Yes. The long-term AMT relief is something that 
is very important to all of us. And it is a cruel and unintended tax. 
And we are very committed to coming up with a permanent solution there. 
Senator MENENDEZ. It seems to me, Mr. Chairman, and I see my time is up 
and I do not want to belabor it before my colleagues, that addressing 
the pretax cut AMT issue relief would be about $400 billion, compared 
to about $3 trillion of the cost of AMT relief with extending the tax 
cuts. 
   So I just do not believe, I have been here 15 years--not in the 
Senate but in the Congress--and I just do not believe that everything I 
hear is that we can have it all. It is like having a kid in a candy 
store. We can have it all, do not have to pay for it, do not have to be 
worried about any consequences, not going to affect the domestic 
discretionary spending, not going to hurt programs that help people 
achieve the goals in their lives and fulfill the American dream. 
   I am just bewildered by the Administration's testimony that 
constantly leads down that road. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Senator Cardin. 
   Senator CARDIN. Thank you, Mr. Chairman. 
   Mr. Secretary, it is a pleasure to have you before the committee. I 
think you are very much committed to trying to deal with the long-term 
budget problems that we have. Our chairman has held a series of 
hearings on the long-term challenges that we face, not just the 2008 
budget. I look forward to working with you. 
   But I just want to comment that there are several elements of this 
budget that make it more difficult for us to move in that direction. 
Senator Menendez mentioned the alternative minimum tax. We all agree we 
have to deal with it. Yet, the budget does not provide any relief 
beyond 2008. 
   And I mention that specifically because, you have said that we will 
bring it into the budget debate at some point. But the budget does talk 
about Social Security. That is an area that you and I have talked 
about, and I think it is important that we strengthen Social Security, 
and that we do this on a bipartisan basis. 
   But the budget includes, in 2012, the privatization of Social 
Security and diversion of funds. I do not think that is very helpful in 
trying to get a commitment to deal with Social Security. 
   I believe you strengthen Social Security by strengthening it. Adding 
additional burdens, such as privatization does in 2012, does not make 
it easier for us to deal with it. 
   Secretary PAULSON. Would you like me to respond to that? 
   Senator CARDIN. Absolutely. 
   Secretary PAULSON. Absolutely. 
First of all, let me say I know how committed you are to retirement 
security. I have appreciated our conversations and I look forward to 
having more of them. I also know you are very knowledgeable in this 
area. 
   With regard to the personal accounts, it should not surprise anyone 
that the President had a plan he put out. It was a plan, personal 
accounts were part of it. He thinks personal accounts are a good idea. 
So it should not surprise people that personal accounts are in the 
budget. 
   I hope you did notice that they were put off a number of years. And 
I hope you see an important signal in that. 
   But what the President has said, and what I have said, is we would 
really like people from both sides of the aisle to come together 
without any preconditions to talk about their ideas. 
   So again, it should not surprise people that one of ideas that the 
President will have is personal accounts. That does not mean that you 
are going to like it, that other people are going to like it. But 
again, as I have talked with people individually about it, although 
there has been some push back publicly, most people have said how can 
you tell people to come to the table and tell them that you cannot talk 
about one idea or another. All ideas should be welcomed, and we will 
work through it. 
   When you and I talked individually, I understand what you think 
about personal accounts. 
   Senator CARDIN. And it has not changed. 
   Let me assure you that I am interested in talking about supplemental 
accounts, and other ways that we can improve private savings and 
retirement, in addition to Social Security. I think that is important. 
I think we have a responsibility to strengthen Social Security, but we 
also have a responsibility to increase private savings and retirement 
in addition to Social Security. 
   We have heard over and over again, during our hearings on long-term 
budget issues, that we must increase savings rates, deal with national 
savings, and correct the trade imbalance through increasing national 
savings. 
   So when I have a chance to talk to the USTR about the trade 
imbalance, you are always mentioned. As the Secretary of Treasury, you 
have the responsibility for the currency issue with China. 
   And China cannot justify its currency practice. I must tell you, we 
are running out of patience in the United States Senate on this issue. 
I expect you will see some activity that will take place. 
   It would be far better if we could negotiate an orderly process for 
China to allow its currency to reach its appropriate market rate, 
rather than tying it to the United States dollar. 
   Secretary PAULSON. Senator, I have that message loud and clear. I 
testified before Senator Dodd's committee on January 31st, and I will 
be very brief in just saying to you that we have a process in place. I 
do believe the strategic economic dialog lets us speak with one voice 
on a regular basis to the decisionmakers of China, and that we are 
pressing for much greater flexibility and movement in their currency in 
the short term. And they have been moving it, and they have been moving 
it more quickly, but it is not nearly quickly enough. 
   But we are also working on some structural things they need to do to 
get to the point so we will not be having the debate about what is the 
appropriate level. They will have a market determined exchange rate. 
   And then what is really underlying your question are the imbalances. 
When you look at the imbalance in order to get at that, as important as 
currency is--what really gets at the imbalance are structural changes. 
And so, when we are not saving, and I know you understand this very 
well, and when they are saving at 50 percent, and they have an economy 
that does not have domestic-led consumption, but is led by exports, and 
we are growing, we are going to have these imbalances. 
   And so, again, we are working on some benchmarks and working toward 
progress on the kinds of intermediate-term and longer-term structural 
change they need to make to really open up their economy. 
   And to the extent they open up for more competition for United States 
products, more competition in the services area, and get some structural 
changes, that will make a big difference. 
   The one positive thing I mentioned before you came in, is that this 
year we reached the crossover point on exports. And every quarter for 
the last four quarters our exports have been growing faster than 
imports in this country. And this last year our exports to China grew 
33 percent, our imports 19 percent. And because exports grew faster 
than imports for our country they added a percentage point to our GDP 
in the fourth quarter. 
   So we are making progress. We have more to do. I have the message. 
You gave it to me when we talked to you personally. I have it here. I 
know what I need to do. We need to get some progress. 
   Senator CARDIN. I would just point out the urgency of this matter. 
Each month there are more and more United States companies that cannot 
compete with a 40 percent discount given to Chinese products and more 
American jobs are being lost. It is truly urgent. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator Cardin. 
   If I can go back to the question of what is in this budget with 
respect to tax increases, you had earlier stated in your testimony, in 
response to a question from Senator Bunning, you would not recommend a 
tax increase. We talked about the alternative minimum tax and you 
defined a tax increase as one where you failed to extend expiring tax 
provisions, with respect to the 2001 and 2003 tax cuts. AMT, that 
expiring provision, because you only handle it for 1 year in your 
budget, is a $500 billion tax increase contained in your budget. 
   I started looking at other tax provisions that you do not extend or 
extend for just a brief period of time: work opportunity and welfare to 
work credits, you only extend for 1 year in this budget. So you have 4 
years of a tax increase there. 
   State and local sales tax deduction in the budget presented by the 
President, not extended at all. Not even for 1 year. That is a whopper 
of a tax increase for people. 
   Deduction for qualified college tuition, that is not extended at 
all. And under your definition that would be a tax increase. That is a 
big tax increase for people who have kids in college. 
   Depreciation of leasehold improvements, something I have been very 
involved in, the Administration's budget does not extend that at all. 
That would be a big tax increase for business. 
   Indian employment tax credit is not extended at all. The renewable 
energy credit, the energy efficient building credit, the bio-diesel 
credit, the energy efficient home credit, the clean renewable energy 
bond, solar and fuel cell credits, none of them are extended in this 
budget. All of them, under your definition, are a tax increase. 
   So this budget that the President sent up here, the more time I have 
to examine it, is filled with tax increases by your definition, is it 
not? 
   Secretary PAULSON. Well no, I would not say that. Let me start with 
the big one and just say again, because Senator Cardin was not here 
when I said it before, what we did on AMT was put in an additional year 
of relief, the 1-year patch, which as you know has gone on for 6 years. 
 We have said that this is a tax that is unintended and cannot go into 
effect without extending the patch. 
   Chairman CONRAD. But you used the revenue to balance the budget, Mr. 
Secretary. 
   Secretary PAULSON. We want to work on it together. 
   Now with these others, I would not read anything into this. These 
expiration dates are set by Congress, they are not set by us. And we 
will have a chance-- 
   Chairman CONRAD. But Mr. Secretary, let us be frank now. Do not hurt 
your credibility here. Do not hurt your credibility. 
   You cannot, on the one hand, say if the 2001 and 2003 tax cuts that 
are going to sunset. And if we fail to do that you call it a tax 
increase. And then in all these other tax provisions that are set to 
sunset and you do not extend them in your budget, by simple definition, 
your definition, these are tax increases. 
   And this budget, as I have a chance to examine it, you have hundreds 
of billions of dollars of tax increase. At least you are using the 
revenue to balance. 
   Secretary PAULSON. I would say, Mr. Chairman, as I think about tax 
increases, there are a lot of fine points of the whole budget process 
that are rather Byzantine to me. But I would say to you, in terms of 
the taxes you are talking about, I have no doubt that if and when any 
of them expire and the tax goes up, the person that pays that tax will 
know it is a tax increase. 
   Chairman CONRAD. Well then, everyone of these, by your own 
definition, they have an awful lot of people who should be told the 
budget the President has sent up here is loaded with tax increases. 
   Secretary PAULSON. They have not expired yet. 
   Chairman CONRAD. You do not extend the state and local sales tax 
deduction for even a year. You do not extend the qualified college 
tuition for even a year, that deduction, or the renewable energy credit 
or all of the others I have listed. 
   So I would just say to you, if we are going to be frank with each 
other, if not extending the 2001 and 2003 credits constitutes a tax 
increase, then all of these others constitute a tax increase because 
the budget the President sent up your does not extend them. 
   Secretary PAULSON. I would say that they will be a tax increase when 
the taxes actually go up. 
   Chairman CONRAD. But the budget guides policy around here. And in 
the President's budget, he does not extend them. So the taxes are going 
to go up unless we take action. The President has used the revenue to 
balance his budget. 
   Let me just indicate, there is a vote that has now started. 
   Senator Whitehouse. 
   Secretary PAULSON. Shucks. 
   [Laughter.] 
   Chairman CONRAD. Mr. Secretary, you are saved by the bell. 
   Secretary PAULSON. You have ruined my morning. I wanted to go all 
the way to noon. 
   Chairman CONRAD. All right we will, first of all, thank you again 
for your appearance here. Thank you for your service to the country. 
And we will close the hearing. I understand the Secretary is leaving 
for a trip, as well, and we wish you well. 
   Secretary PAULSON. Thank you very much. 
   [Whereupon, at 11:57 a.m., the Committee was adjourned.] 

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                THE PRESIDENT'S FISCAL YEAR 2008 BUDGETARY 
                       PROPOSALS FOR THE DEPARTMENT OF 
                           HEALTH AND HUMAN SERVICES 
                                  --------
                          TUESDAY, FEBRUARY 13, 2007 

                                           UNITED STATES SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:07 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Feingold, Nelson, Menendez, Cardin, 
Whitehouse, Gregg, Allard, Bunning, Crapo, and Cornyn. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 
   Chairman CONRAD. 

                  OPENING STATEMENT OF CHAIRMAN KENT CONRAD 
  
   Chairman CONRAD. The hearing will come to order. 
   We thank everybody. Senator Gregg is on his way. 
   Secretary Leavitt and I have just had a chance to talk about some 
things that are important and some of those things we will talk about 
as the hearing progresses. 
   We especially want to welcome Secretary Leavitt to the committee. We 
thank him for his service. We thank him for his excellent leadership. 
And we very much appreciated the opportunity to work with him and have 
enjoyed the relationship. 
   This is an important hearing because our Nation's physical health is 
directly linked to our fiscal health and the challenge of Medicare and 
Medicaid and the other health accounts is among the most daunting that 
we face. I personally believe it really is the greatest challenge. It 
is the 800-pound gorilla. And together we have to find ways to address 
it, and the sooner the better. 
   We know that we face a demographic tsunami. We have this baby boom 
generation that is poised to retire. They are out there. This is no 
projection. They are alive. They are going to retire. They are going to 
be eligible for Social Security and Medicare. 
   This is a chart that shows what happens. It is unlike anything we 
have ever seen before, which I think is one reason we find it difficult 
to cope with. It is just not something in our experience. 
   We need to remember that Social Security is not the biggest budget 
challenge confronting us, although it is certainly part of the puzzle. 
But the biggest part, by far, is Medicare. We see the comparison here. 
The 75-year shortfall in Medicare, over $32 trillion, seven times as 
much as the projected shortfall in Social Security. 

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   The growing cost of Medicare and Medicaid is simply staggering. By 
2050, if nothing changes, more than 20 percent of our gross domestic 
product, 20 percent of our economy, will be spent on just these two 
programs. That is as much as now goes up for all of Government. So we 
are clearly on a course that is unsustainable if the current trend 
lines continue. 

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   This next chart from the Center on Budget and Policy Priorities 
shows that rising health care costs are by far the biggest factor 
driving Medicare cost growth. Demographic changes are a significant but 
secondary factor. So the biggest driver of all of this is rising health 
care costs. The demographics clearly play a role, an increasingly 
significant role. But the thing we have to remember is that it is 
underlying health care costs that are the biggest driver. 

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   The fact is that our health care system is not as efficient as we 
would like it to be. The United States is spending far more on health 
expenditures as a percentage of our gross domestic product as any other 
country in the developed world. Those are the leading economies in the 
world. For example, the United States, we are at 15.2 percent of gross 
domestic product. Back in 2003, these are the last international 
numbers, we are making an international comparison here, we know that 
our spending now has reached 16 percent of gross domestic product. 

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   The next highest country when this was done was Switzerland at 11 
percent of gross domestic product. That difference between 11 percent 
and 16 percent of gross domestic product is $800 billion in a year, 
$800 billion in a year. That would completely take care of not only our 
on-budget deficit but our off-budget deficit, as well. 
   Unfortunately, the budget before us does not deal with the 
underlying problem of the rapid growth in health care costs. Clearly, 
we are going to have to find savings in the entitlement accounts. The 
President's Medicare and Medicaid cuts will save $280 billion over the 
period 2008 to 2017. But those savings would be more than wiped out by 
the $2 trillion in tax cuts the President also proposes, tax cuts that 
are not paid for. 

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   If all of the 2001 and 2003 tax cuts are made permanent, the cost 
will explode at the very time the cash surpluses in Social Security and 
Medicare become deficits. In other words, the tax cuts will 
dramatically worsen an already serious situation. 

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   I am talking now about tax cuts that are not paid for. I would be 
delighted to be able to continue all of the tax cuts. I have been a 
significant beneficiary of those tax cuts, and many of my constituents 
have. But we have a very serious problem making things add up here. 
   I am not the only one who believes that changes to Medicare and 
Medicaid should be done in the context of overall health care reform. 
Here is what our new CBO Director told us in his recent testimony 
before the committee, and I quote, ''I think it is a mistake to look at 
containing costs just within the Federal programs themselves. The 
underlying driver of the cost growth--of the cost of those programs is 
the underlying rate of cost growth in the health sector as a whole. And 
tackling that problem is perhaps the fundamental fiscal challenge and 
important economic challenge facing the Nation.'' 

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   Let me just say I believe that. I endorse that. I think that is 
precisely what we have to face up to. 
   And we are delighted, Secretary Leavitt, that you are here today to 
discuss these issues and others. 
   Let me just conclude by going back to one of the things that I have 
returned to repeatedly, and my colleagues know it well, is this notion 
of those who are chronically ill. Because there 6 percent of the 
population, 6 percent of the beneficiaries are using half of the 
budget. When I went to business school they told us to focus on that, 
any time you find a statistic like that, where you have a small 
percentage of the population has a disproportionate share of the cost. 
That is really where we have to first focus our attention. We will have 
more chances to talk about what we might do in that area. 

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   Again, welcome, Mr. Secretary. And now I will turn to my colleague, 
Senator Gregg. 

              OPENING STATEMENT OF SENATOR GREGG 

   Senator GREGG. Thank you, Mr. Chairman. It is a pleasure to have the 
Secretary here to talk about the health care elements of the 
President's budget. 
   I obviously agree with the groundwork laid by the Chairman on the 
issue of the problem, which is the demographic shift in our population 
that we are going to have to support as a Nation and what the effect of 
that will be, and the fact that a large percentage of the issue is 
health care and how you deliver quality health care to 80 million 
retirees versus 35 million retirees and do it in a way that does not 
bankrupt the younger generations who are paying for it. 
   Where I think we depart ways, of course, is that I am willing to 
step forward, and I admire the Administration and respect the 
Administration for stepping forward with some specific proposals right 
now and not to play the verbal game of well, if we just did it on a 
global basis, if we just did this, if we just did that, we might be 
able to accomplish this or that. I think you have to have specific 
proposals. 
   The proposal the Administration has put forward is a legitimate 
specific proposal which would reduce the long-term unfunded liability 
of Medicare by almost 25 percent. That liability is approximately $32 
trillion. That is not a sustainable liability for us to pay for. 
   What the Administration has suggested is major changes in Medicare 
which do not affect beneficiaries, certainly do not affect poor 
beneficiaries or moderate income beneficiaries, but rather give us a 
better accounting of the costs of health care and reimburse on that 
better accounting system, and also require high income people to pay a 
fair price for the benefits they get from the Government. Specifically, 
Bill Gates's father should not have his Part B physician premium 
subsidized and he should not have his Part D drug premium subsidized at 
the rate that we subsidize it. 
   These changes are very appropriate and they save significant dollars 
over the term and move us toward--closer in the direction of solvency, 
which is very appropriate. 
   What has been the Democratic response so far? Well, I have heard, 
not the Chairman--in fact, I think the Chairman has been very 
responsible on this. But members on his side of the aisle who represent 
the ideology of the Democratic Party, or at least they assert that they 
do because they are running for president, saying that these Medicare 
proposals of the President's are cuts, they are slashes to the system, 
they are a dramatic disassemblage of the system. And of course, they 
are not anything like that. 
   They are very reasoned, very appropriate attempts to try to bring 
under control a system that is not going to be sustainable. What will 
be a slashing to the system is if we continue on the path that we are 
presently on, which will give our children a system they cannot afford 
and give the retired people a system that cannot be paid for. So 
starting now make sense. 
   A second idea that has come forward from the other side of the aisle 
and has now passed the House and which I know the Secretary is very 
familiar with because it tells the Secretary, is to give the Secretary 
the authority to negotiate drug prices relative to the Part D premiums. 
What is the practical effect of that? Well, you cannot have that 
authority unless you also have a formulary, we all know that, which is 
a list of drugs that would be acceptable because that is where the club 
comes from. 
   So what essentially it is is a rationing proposal. What the other 
side of the aisle is suggesting that our senior citizens should have 
their drugs rationed, and the decision on what they want and what they 
will not get will be decided by the Secretary of HHS, whoever that 
person may be. 
   It is put forward in the motherhood language of negotiating drug 
costs but the practical effect would be that, like veterans, who only 
have the access to about 37 percent of the drugs that are on the market 
today, American citizens would no longer have access to all of the 
drugs that are out there, which would reduce their quality of life. And 
we have seen the marketplace has had a fairly significant impact on 
pricing of drugs relative to Part D, so much so that we have saved 
almost $100 billion off the baseline in that program as a result of the 
competition. 
   So to go to a system of rationing seems to fly in the face of what 
is working, which is a market oriented system. But that is the proposal 
from the other side of the aisle. 
   So I look forward to the Secretary's outlining in further detail the 
Department's position, both relative to Medicare and its proposal, and 
relative to the rationing proposal that the Democratic party has put 
forward as the essence of their health care plan. 
   I also look forward to the Secretary giving us some thoughts on how 
we deal with Medicaid because states are being overwhelmed by the cost 
 of Medicaid. We are not doing a very good job of managing Medicaid. 
And I would be interested in his thoughts relative to using the States 
as more aggressive incubators of ideas in the area of Medicaid. Having 
been a former Governor, I know he has been very aggressive in that 
issue. 
   Thank you. 
   Chairman CONRAD. Thank you. I would just say to my colleague, I do 
not know if he was able to see the press from over the weekend but on 
the question of income relating Medicare, I said this weekend I think 
that has to be done. 
   Senator GREGG. I think I was very--I hope I gave you enough praise 
for your position, which is what I think is a correct position. And you 
have been a voice of reason on the issue. 
   Chairman CONRAD. Let me just say, I do not, for the life of me, I 
cannot understand how it is progressive in any way to have very wealthy 
retirees being subsidized by working families. It makes no sense to me 
and we cannot continue that, of course, in my judgment. 
   When I look at what is going to have to be done here, that is one 
thing that is going to have to be part of a solution. I think the 
Administration was constructive in putting it forward. 
   There are other things the Administration has proposed, we will have 
a chance to get into momentarily, that I have a less favorable view of. 
But I thank my colleague for raising the issue. 
   Thank you, Mr. Secretary, and please proceed with your testimony. 
   
                  STATEMENT OF HON. MIKE LEAVITT, SECRETARY, 

                  DEPARTMENT OF HEALTH AND HUMAN SERVICES 

   
   Secretary LEAVITT. Thank you, Mr. Chairman, Senator Gregg, and 
members of the committee. 
   Mr. Chairman, I have submitted a statement that I would like to have 
entered for the record. 
   Chairman CONRAD. Without objection. 
   Secretary LEAVITT. Thank you. 
   I would like to take a few moments and just give you a sense of 
overview of the way we went about creating this budget. As you know, a 
budget of this size takes hundreds of people and is worked on over the 
course of a year, and requires guidance from the Secretary as well as 
guidance from the President. The President very clearly wants this to 
be a deficit reduction budget. 
   And so when we are dealing with deficit reduction, we are dealing 
with priority selections that we have all had to deal with. They are 
hard. I have made decisions that some of you will disagree with. I am 
here to basically give you a good sense of the rationale for that. But 
I would like to give you a sense of the guidance that I gave my 
colleagues as they went into the tens of thousands of individual
decisions that made it. 
   First, may I comment on the issues related to the entitlements. I am 
here as Secretary, but I also wear the mantle of a trustee of the 
Medicare Trust Fund. As we began work on this deficit reduction budget, 
it was clear to me that those things had to be dealt with as well. The 
proposals that I have made today, I am prepared to defend on each of 
the specific issues. When you roll them all up, they come up with a sum 
of money. But there is a whole series of individual decisions that have 
been made that I think bear scrutiny and I am prepared to defend them. 
   I will say that as we started into it I told my colleagues, I want 
this to be about weight loss, not amputation. And each one of these 
reductions in the growth rate that we have made, that add up to a lot 
of money when they get out into the future, have been thought through 
in a way that I believe can be defended. 
   If we put them all together on that graph that you created, they 
still only make the Trust Fund sustainable from 2018, it goes out to 
2022. So there is a lot more work to be done but this is at least a 
start and the kinds of things that we are all going to collectively 
have to face. 
   With respect to the discretionary budget, may I say that I gave my 
colleagues four basic priorities to follow if they were going to add 
anything to this budget. The first is I wanted to focus on high demand 
highly efficient programs, and you will see that we have protected some 
programs like the Indian Health Service and Head Start and the way we 
treat refugees and so forth. 
   You will also see that there are some Presidential initiatives that 
I wanted to assure were completed. One of them is the community health 
centers. The President made a commitment for 1,200 of them. This budget 
completes that. The commitment we made to HIV/AIDS, this continues 
that. The commitment we have all made to fight pandemic, this continues 
that effort. 
   It recognizes there are new pressing needs that have not been 
contemplated before, like the FDA and drug safety. You will find 
initiatives in that area. 
   Then You will find a series of things that we have approached before 
that have not been funded to the degree that I believe they need to be. 
One is health IT. Right at the center of that cost problem is the need 
for electronically connected records. 
   Now turning to the savings side of this budget, I gave my colleagues 
a series of guidelines that I wanted them to follow. For example, you 
will see situations where we have not repeated one-time funds. There 
will be a lot in this group that are a fan, like I am, of CDC. We have 
undertaken a big building program there. You will see that CDC's budget 
is not what it was last year because we did not repeat those one-time 
funds. 
   You will see that I have given a bias to direct services, as opposed 
to just building infrastructure. I suspect we will talk about health 
professions. That budget has been reduced in favor of having more 
community health centers. That is an example of the tradeoff I am 
talking about. 
   You will see that I have looked for grant programs, grant activities 
that may have reached the conclusion of their activity and I have not 
automatically proposed those be renewed. A good example of that is the 
National Cancer Institute, where we have more actually competitive 
grants that will go out but the actual budget itself is slightly 
smaller. 
   I have also looked for under performing programs, I have looked for 
reductions. I have offered some reductions we have offered before, for 
example in Medicare again, the issues related to durable medical 
equipment. We had an opportunity to talk about that. I think there is a 
lot of fraud in that area and I think there are things we can do to 
reduce it. 
   But that will give you an overview of the kind of guidelines. And as 
we talk about specifics, I will do my best to put the specifics into 
that framework. 
   And I am eager now, Mr. Chairman, to entertain your questions. 
   [The prepared statement of Secretary Leavitt follows:] 

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   Chairman CONRAD. Well, thanks again, Mr. Secretary. And we do very 
much thank you for your service. I have found you to be one of the most 
responsive people I have ever worked with in an administration, and we 
appreciate very much the way you have been open in your work with 
members of the committee. 
   Let me talk about something in the budget that I am not a fan of, 
and that is the way you have treated the cuts to doctors. As you know, 
we have a scheduled cut to doctors in their reimbursement of 10 
percent. This goes back to the last time there was reform of the 
entitlement programs and a series of cuts to doctors were put in place 
that have been on a schedule. And every time one of these cuts comes 
up, Congress finds a way to put it off and to kick the can down the 
road. We have done that again and now the next scheduled cut is 10 
percent. 
   We all know that that is not going to happen. But in the 
Administration's budget, you assume that it will, at a savings of $250 
billion, as I understand it, over 10 years. 
   You know that is not going to happen, we know it is not going to 
happen. Why does the President's budget assume that we are going to cut 
doctors 10 percent? 
   Secretary LEAVITT. I presume the reason that they have done it in 
the out-years is because that is what the statute would call for absent 
a statute change. 
   Let me say I think this system has to be improved. There is no 
question about the fact that doctors have to have an economic model 
that will allow their practice to function. But I would suggest that 
one of the things that needs to change as we look for a better formula 
is that we have to begin to pay physicians not simply on the basis of 
how many procedures they perform, and begin at least in part to pay 
them on the basis of the quality of their work and also the value of 
what they provide. 
   I would like to see the entire system begin to be a system of 
competition based on value, which requires that we begin to measure 
quality and have costs that can be compared. 
   The new head of CBO called it a health sector. I think that is 
absolutely right. We do not have a health care system. What we have is 
a large sector, and we need a more systemic way of connecting all of it 
together and paying physicians properly as part of that. 
   Chairman CONRAD. Let me just say that the statute, the existence of 
a statute, requires CBO to score a budget in the way you have 
described. It does not require the Administration to write a budget 
that way. The Administration has an assumption here that I think is 
just totally unrealistic, that they are going to save $250 billion by 
cutting doctors 10 percent. 
   So let me just say that when I look at this budget, I do not think 
it is realistic with respect to how it is going to treat physicians. 
And that savings, which is needed to make the President's budget 
balance, is not real. 
   Let me go to health IT if I can, just quickly. My time is rapidly 
fleeting. 
   You have a number of major projects underway with respect to 
information technology. Can you give us a brief update on where we are 
with those major projects and when we might expect to see results in 
that area? 
   Secretary LEAVITT. Mr. Chairman, the most important project, in my 
assessment, is the development of standards for health information 
technology systems. We have formed a national collaborative group 
called the American Health Information Community. We have laid out the 
most important standards that need to be established and created a 
means now of making progress in that area. 
   I can report to you that we are making very serious progress. We 
have also created a way of certifying systems so that we know they are 
on a pathway to interoperability. 
   I met with a young physician who was just going into practice in 
Tennessee. He said, ''I like health IT. I want to buy a system. I just 
have a question, which system should I buy? I can only afford to do 
this one time.'' 
   He was asking the question that doctors all over the country have 
been asking, ''which system do I buy to know that I am able to achieve 
interoperability?'' I now have an answer to that, and it is that you 
buy a system that is CCHIT, which is the Certification Commission on 
Health Information Technology. If it has been certified by the time, 
you are on a pathway to interoperability. 
   I believe that we now have nearly 40 vendors who are receiving this 
CCHIT certification and more applying. The standards are becoming more 
robust. I think that we will begin to see interoperability pick up 
steam and we will also now begin to see more adoption of health IT 
systems. 
   Chairman CONRAD. We will have a chance for further discussion on 
that. My time has expired. 
   Senator GREGG. 
   Senator GREGG. I am glad you brought that issue because I have 
something called the Medicare Quality Enhancement Act, which does 
exactly that, and which we had hoped to get through last year and we 
hope to get it through this year. I would just highlight it. 
   Talk a little bit, if you will, about your proposal on Medicare. I 
have three issues. Let me write them down because by the time you 
finish you will have used up all my time. 
   Tell us a little bit about the Medicare proposal and why it does not 
affect the low income and middle income beneficiary, but is directed at 
basically getting a fair reimbursement to providers and also high 
income individuals. 
   Second, if you could talk a little bit about a proposal that has 
passed the House, which would authorize you to negotiate drug prices, 
which would require you, I believe, to have a formulary--although it 
says you cannot have a formulary but you cannot really negotiate 
without a formulary--and what the effect of that would be on supply and 
options for seniors, the fact that seniors would have fewer options, in 
my humble opinion, if you are going to have that authority effectively. 
   And third, I would like to get your thoughts on an idea that was put 
forward by another former secretary and Governor and now senator, 
Senator Alexander, who was Secretary of Education, of course, and 
Governor of Tennessee, and has suggested that we do a swap with the 
States where we take all of the Medicaid and they take all of the 
education, elementary and secondary school costs and we do a direct 
swap. The States are winners financially and we both specialize in an 
area where we can make sense. 
   Secretary LEAVITT. First, on the Medicare proposal. May I say again 
that the guideline here is this is weight loss, not amputation. If we 
were to impose all of these reductions in the growth rate, we would see 
Medicare continue to grow. It would grow at roughly 5.6 percent into 
the next 5 years, as it is slated now to be 6.5 percent. So this is not 
a reduction. This is not a cut. It is a reduction in the growth rate. 
   Now we frankly achieve that, in many cases, by looking at the 
projected growth rate in various services and trimming them back just a 
little. And if you trim them back just a little in the early years, by 
the time you are out 5 years or 10 years they are very large savings. I 
think that begins to make the point that you did earlier, the sooner we 
deal with this the better. 
   There is a point in the life of every problem when it is big enough 
you can see it but small enough you can still do something about it. 
And while we may be moving beyond that point in Medicare, the sooner we 
act the better. 
   You will see proposals similar to the one that we mentioned earlier, 
where we recognize that there are those who are receiving full 
subsidies for Medicare, both in the drug benefit and in Part B. It 
makes very little sense to me for a young family, 28 years old, who do 
not have health insurance, to be taxed in a way that contributes to 
their ability not to have it, so that they contribute to a person who 
is 70 years old, making $250,000 a year to have full coverage. That 
does not make sense. And this includes that kind of change. 
   On the second question you asked with respect to Medicare Part D, it 
has been a resounding success. We have 90 percent of those who are 
eligible now receiving the benefit. Every independent survey I know 
says that between 75 percent and 80 percent of the beneficiaries are 
happy. The cost started out at $37 a month, it is now this year it will 
be $22. When you ask the actuaries why, they will tell you one word. It 
is competition. When you give the people the ability to choose and 
information about the cost and the quality, they will choose those 
which will drive quality up and costs down, and that is exactly what 
happened. 
   There is only one way to negotiate drug prices and it is to 
negotiate the formulary. You say I am going to take your pill off my 
plan if you do not reduce the price. If we allow that to be a 
Government function, we will have fewer choices and less happiness with 
the plans. It will not do anything to reduce the cost. That is not my 
estimate. That is the CBO estimate. It is independent actuaries making 
the same point. 
   With respect to the third question on the swap, there have been a 
number of discussions. One would be to have the States take welfare, or 
long-term care rather, and the States--or the Federal Government take 
long-term care. I would be open to any of that kind of thinking. We 
have to do something. Medicaid is not only eating away our economic 
capacity as a country, it is also starting education in the States. It 
is also starving many of the other aspects. 
   At the root of it, however, is what the Chairman said, it is the 
high cost of health care. I would hope when I have more time that I 
could talk a little bit about some of the things that I believe need to 
be done to reduce the escalation of costs. 
   Senator GREGG. Thank you. 
   Chairman CONRAD. Senator Feingold. 
   Senator FEINGOLD. Thanks very much, Chairman Conrad and Senator 
Gregg, for holding this hearing. Thank you, Secretary Leavitt, for 
being here. I am glad we are focusing on the Health and Human Services 
Budget. 
   But some of the cuts in the budget will directly affect my home 
State of Wisconsin. There are two health care programs, very important 
in my State, SeniorCare which is the prescription assistance program 
for Wisconsin seniors, and BadgerCare, which is Wisconsin's Children's 
Health Insurance Program. The President's budget appears to cut this as 
well. 
   I hope this is not the case. There are 108,000 Wisconsin seniors 
enrolled in SeniorCare and 64,000 Wisconsinites enrolled in BadgerCare. 
   These programs, I can tell you because I go to every county every 
year and hold a town meeting, are effective, popular, and cheaper than 
private coverage and other alternatives. So I do not think it makes 
sense to pull support from these programs. 
   To follow on that, as I mentioned, 108,000 seniors in Wisconsin are 
enrolled in the State's prescription program known as SeniorCare. 
Governor Doyle of Wisconsin has a waiver application pending with HHS. 
Approval of this waiver would allow the program to continue, but the 
State still has not received a final answer and the current waiver is 
set to expire in less than 6 months. 
   Mr. Secretary, are you familiar with Wisconsin's SeniorCare program 
and this waiver? 
   Secretary LEAVITT. Yes, I am, Senator. 
   Senator FEINGOLD. Thank you. 
   Your budget request appears to assume that the SeniorCare program, 
Wisconsin Pharmacy Plus demonstration, will lose its Federal funding 
after fiscal year 2007. Is this the case? And does that signal that HHS 
will be rejecting the waiver application? 
   Secretary LEAVITT. That matter is still being deliberated on. I will 
tell you that I am very familiar with this. I have had many 
conversations, both in Wisconsin and with Governor Doyle. The 
SeniorCare waiver was approved at a time when there was no prescription 
drug benefit. And the issue before HHS will be a question of whether 
SeniorCare should be continued or not. It is whether or not Federal 
money will continue to support it. 
   We supported it before because there was no prescription drug 
benefit. The issue that will be before us now is should we continue to 
support it, given the fact that there are several hundred thousand 
members of the Wisconsin public that are on Part D. 
   Senator FEINGOLD. I want to check my facts but I believe one waiver 
was granted after the program was enacted, I believe that is the case. 
Secretary LEAVITT. I think we put a waiver into place to help 
coordinate the integration of Part D and SeniorCare, and we have been 
working very closely with Governor Doyle to make certain that the 
coordination was effective. 
   The issue of whether or not the Federal Government continues to 
support both plans is a matter that is being deliberated on right now. 
But we have been very clear with Governor Doyle that we wanted to make 
Part D work, and he has been very cooperative to make certain that it 
did. 
   Senator FEINGOLD. I appreciate the attention that is being paid to 
it. It is very important to our State. I take it from your briefings 
you are aware that SeniorCare costs the Federal Government $617 per 
participant, and the Federal Government spends $1,174 per participant 
on Medicare Part D. 
   This program cost the taxpayers less money and I think it is more 
popular than Medicare Part D. I can tell you that from my knowledge of 
Wisconsin. It is what the State of Wisconsin wants. It is budget 
neutral due to savings generated in Medicaid, and is the primary source 
of prescription coverage for over 100,000 seniors in my State. 
   I just want to make it clear that if this waiver extension is denied 
it will, in effect, cost the Federal Government more money while 
simultaneously dropping seniors from their preferred drug coverage. 
   I think that is a lose-lose situation. To use your excellent phrase, 
more like an amputation than weight loss. I think it could be easily 
remedied if you approved this waiver. So I hope you will seriously 
consider that. 
   The budget discourages coverage of childless adults under the 
State's of Children Health Insurance Program, SCHIP. I am concerned 
that this will lead to a policy of not covering any adults with program 
funds. 
   My State of Wisconsin covers parents of Medicaid and SCHIP children 
in addition to pregnant women. There is good evidence that family based 
coverage is better for children and families and there is no other 
affordable insurance for these adults. 
   Does the President support States being able to cover these adult 
populations under SCHIP? And would the Administration support States 
like Wisconsin continuing coverage of adults with SCHIP funs? 
   Secretary LEAVITT. We do support continuation of adults who are 
currently on the program. We will not be supportive of extending 
coverage to new adult populations. We believe that SCHIP should be 
focused on its original intent, which is to help lower income children 
and we are enthusiastic about its reauthorization. But we do have the 
feelings I have expressed. 
   Senator FEINGOLD. Secretary, thank you for your testimony and for 
your attention to these matters. 
   Chairman CONRAD. Senator Allard. 
   Senator ALLARD. Thank you, Mr. Chairman, and welcome, Mr. Secretary. 
   I want to followup a little bit on the physician reimbursement. If 
the Congress does not enact the changes to physician reimbursement that 
the President recommends, what is the plan? Do you have a plan in place 
to deal with that? 
   Secretary LEAVITT. The reduction is a matter of statute and in order 
to cure the circumstance, it will require a change in the statute. We 
remain eager to work on that. If we end up with seeing a 10 percent 
reduction in Medicare, it is clear to me--or reimbursements, it is 
clear to me that there will be a certain number of physicians who that 
will affect. And that becomes a big problem for the Secretary of Health 
and Human Services, given that I have 43 million beneficiaries-- 
including my parents--who depend on them. 
   Senator ALLARD. Have you talked about getting that statute changed 
to Members of Congress? 
   Secretary LEAVITT. There is an ongoing discussion that we are a 
participant in. We have made clear that we believe that some part of 
the improvement or change in the formula needs to include payment to 
physicians and hospitals on the basis of performance or their adherence 
with good quality procedures. We think that is not only important from 
a cost standpoint but it will improve the quality, as well. 
   Senator ALLARD. On the issue of reimbursement, some States seem to 
get better reimbursements--at least the physicians do not seem to 
complain as much as in other States. My State is one where physicians 
are complaining a lot that they are not getting adequate reimbursement. 
   In fact, I heard from physician whose practice is solely Medicare. 
When I heard that I could not believe that he is still in business, 
frankly. 
   I did go and visit his practice. It is a very austere practice. He 
does not have a lot of office furniture. He is not located in a high 
rent area. 
   He is near the point where he just cannot sustain his practice. He 
is ready to go out of business. It looks to me like an efficiently run 
practice, although I do not know what the quality is like. I know that 
he has more patients than he apparently is able to handle.  
   What do we do? In Colorado, our physicians are taking fewer Medicare 
patients. 
   Now some of those, they can cost shift a little bit and probably do 
to some degree. But what do you do when somebody like that who strictly 
specializes in Medicare patients, becomes a primary care physician. 
Because that is his entire clientele, he is probably very much of an 
expert in that area. 
   Secretary LEAVITT. We monitor this very closely for the reasons I 
just expressed. I will say that we have not yet seen a dramatic 
reduction in the number of physicians who are receiving Medicare 
patients. But it is a concern and it is a problem, in my judgment, we 
have to deal with on a long-term basis. 
   We continue-- 
   Senator ALLARD. But let me catch you there. The number of physicians 
that are accepting Medicare patients, what you ought to look at is the 
number of physicians that are taking on new Medicare patients. I think 
that would give you a more accurate reflection of what is going on. 
   I want to move on. There is a Government Performance and Results 
Act. Are you familiar with that? It measures performance of various 
programs. 
   Secretary LEAVITT. I know the function. I did not know it by that 
name. 
   Senator ALLARD. The President's program is called PART. There are 
some 32 programs in the Department of Health and Human Services that 
are considered non-performing. There are six of them that are 
characterized as ineffective. 
   What do you do when you get these recommendations from the Office of 
Management and Budget? 
   What do you do with these programs? Some of them, maybe one or two, 
it is kind of hard for me to tell, might have been some that you talked 
about. Some of them are popular programs. There is the domestic 
HIV/AIDS prevention program that is classified as results not 
demonstrated. I think you mentioned something about doing more on AIDS. 
I even see that some of those programs that were brought up as perhaps 
non-performing, you might even still continue to promote. 
   So my question is what are you doing with these programs? 
   Secretary LEAVITT. I mentioned earlier in my remarks that one of the 
criteria I gave those who make the tens of thousands of judgments that 
go into this budget, that we should pay particular attention to 
ineffective, under performing programs. If they are not absolutely 
vital to our mission, then they are reduced in funding or eliminated. 
You will see that reflected in this budget. 
   If they are a vital program that simply needs to be improved, then 
we have gone about the business of remediating them. 
   Senator ALLARD. Are there any of them that are classified as 
ineffective that you did completely eliminate? 
   Secretary LEAVITT. Yes, block grants under the-- 
   Senator ALLARD. I saw that somewhere here. 
   Secretary LEAVITT. That is one example. A big one. 
   Senator ALLARD. Yes, it is a big one. 
   I see my time has expired but when you testify in front of me, 
expect a question on the performance of the various programs that are 
under your jurisdiction. 
   Thank you for your testimony. 
   Chairman CONRAD. Senator Cardin. 
   Senator CARDIN. Thank you, Mr. Chairman. 
   Mr. Secretary, I think the Chairman pointed out in the beginning the 
need to focus on our health care budget. The amount of money we spend 
as a Nation and our health care performances have us all reason to 
pause. We are spending a lot of money and we are not getting the 
results we should. 
   So I want to talk about one of the cost centers that jumps out at 
me, and that is prescription drug costs. For medicines that are 
manufactured at the same location, American consumers pay a lot more 
than consumers in Mexico and Canada. Why? What is the reason for it? 
   Why do we pay so much more for drugs than other countries? 
   Secretary LEAVITT. Senator, I think at the root of that is a trade 
problem. We need to deal with it as a trade problem. 
   Our effort at HHS is to assure that the drugs we do have are safe 
and effective, and we do that through the FDA. The manufacturers of the 
drugs oftentimes will go to another country, they will be subject to 
trade negotiations that provide for them to sell it cheaper, I suppose. 
I do not know the full answer to that. 
   Senator CARDIN. I took economics in college and learned that market 
share is an important issue in negotiating price. All of these other 
countries, including Mexico and Canada, basically negotiate with the 
strength of a larger market share than we do in the United States 
because the payers have relatively a small market share of the full 
cost. 
   So all the other countries seem to want to organize their market in 
a more efficient way to negotiate a fairer price. You seem to resist 
that as a way to deal with the reducing costs in America. 
   Secretary LEAVITT. No, actually negotiation is a very important part 
of what we do. Almost all of the prescription drug benefit would be 
negotiated through PBMs and they negotiate with--people think the 
United States Government is the largest purchaser or the payer of 
prescription drugs. That is not true. The PBMs are, in many cases, 
three of them are substantially larger and they are the ones doing the 
negotiating. 
   Senator CARDIN. There is no reason why we could not have the PBMs 
have a larger share, if we could figure out a way to negotiate on a 
larger basis. 
   I heard Senator Gregg and you talk about restricting drugs to our 
seniors. And yet nearly all of our consumers other than seniors who are 
buying medicines are doing so through third-party payers that use some 
form of negotiated formularies. And I do not get a lot of complaints in 
my office about being denied access to drugs. In fact, when a doctor 
believes it is essential to use a specific drug, normally the plans 
provide a process for that. 
   So trying to scare seniors that organizing the market more 
efficiently would lead to the rationing of drugs is not helpful to this 
debate. It is wrong for consumers in America to pay the prices they are 
paying for drugs. And our health care system cannot afford to continue 
to make those payments. 
   We have to figure out a way to get a fair price for medicines. I 
appreciate your support for us having tougher trade negotiations. I 
agree with you on that. And I do think we need to talk about the trade 
policies of America. 
   But you are the Secretary of Health and I think we should have 
answers as to how we can bring drug costs down for consumers in this 
country, including Medicare beneficiaries. 
   I want to mention one other point before my time expires because I 
mentioned it last year when you were before the Ways and Means 
Committee. And that is racial and ethnic disparities in America. I was 
disappointed last year that it was not a part of your testimony. I am 
disappointed again this year that you have not specifically mentioned 
dealing with the disparities in this country. 
   According to the National Center for Health Statistics, infant 
mortality rates for African-Americans are double that for whites. If 
you are an African-American male, you have a one-third higher chance 
for heart disease than a white man. American Indian women are three 
times more likely than white women to receive late or no prenatal care.
Diabetes is much higher among Mexican-Americans. 
   And your budget nearly zeroes out health professional training 
activities, which is a vital program for training minority health care 
providers. 
   I just want to focus for a moment on trying to use our budget to 
reduce these disparities. I would hope that this is a priority of the 
Administration, and I would hope that it would be included as one of 
the pillars of programs that we should be considering to reduce 
disparities among Americans. 
   Secretary LEAVITT. Senator, just two comments. One, with respect to 
the negotiation of prescription drugs, I believe that the reason you do 
not get too many complaints about people not being able to get the drug 
they want is because they have a choice of plans. And because they have 
a choice of plans, they can find a formulary that fits their needs and 
they can do it at the lowest possible price. I think that is why we 
have had 90 percent or 80 percent of them are happy. 
   With respect to the-- 
   Senator CARDIN. But they have formularies. All these plans have 
formularies. 
   Secretary LEAVITT. They do, and they can choose one that has a 
formulary that fits their needs. if we had one play, they would not 
have that capacity. 
   Senator CARDIN. No one is suggesting one plan. What is being 
suggested is to negotiate on a larger market share the pricing with 
the pharmaceutical manufacturers. 
   Secretary LEAVITT. But that does not work in the construct of our 
economy. We have a free market economy where people--we do not have the 
drug stores owned by the Government and being able to act as 
dispensaries. 
   Senator CARDIN. I understand that and that is the same way that the 
private market negotiates prices. If you have a larger share you are 
going to get a lower price. It is economics 101. 
   Secretary LEAVITT. I took economics 101 and I agree that that is the 
way that it works. I believe we are currently seeing the benefits of 
robust negotiations that are taking place when consumers make those 
decisions as opposed to the Government, but-- 
   Senator CARDIN. My time has expired. 
   Secretary LEAVITT. May I just say, Mr. Chairman, on this, we have 
robust programs on obesity, HIV/AIDS, and prenatal care. And they need 
to be because inequities exist. The fact that I did not mention it in 
my opening statement does not mean it does not loom large in my heart. 
   Chairman CONRAD. Senator Bunning. 
   Senator BUNNING. Thank you, Mr. Chairman. 
   I took economics 101 also, but I did not take it where they had a 
controlled economy. I took it in a free economy. And the Federal 
Government did not set prices like they do in Canada. They also had a 
chance to control the quality of the drugs. And the development is 
being paid for by the American consumer for almost every other economy 
in the world, because we are the only ones developing new drugs. 
   So there is an explanation for difference in Canada, Mexico and the 
United States. 
   Discretionary spending at HHS makes up only about 10 percent of your 
budget, 84 percent of the budget goes to two programs: Medicare and 
Medicaid. Long-term what does this mean for your agency? How critical 
is it that we get a handle on the entitlement spending? 
   Secretary LEAVITT. It is critical not just for my Department. It is 
critical for the country. We are now measuring Medicare as a percentage 
of the gross domestic product. It is 3.2 percent of the gross domestic 
product. By the time my grandson becomes an adult it will be 8 percent 
of the gross domestic product. By the time he becomes my age, it will 
be 14 percent of the gross domestic product. 
   None of us believe that will happen because we will have either been 
eliminated from the economic competition in this world, or we will have 
changed the direction of it. The sooner we change the direction of it, 
the better off we will be. 
   Senator BUNNING. I will followup on that in just a minute, but one 
of the things that really hit me between the eyes is a 17 percent 
reduction in Low Income Home Energy Assistance Program that is in the 
President's budget. Mr. Secretary, you know and I know that that is not 
going to happen. 
   Last year, in the 206th Congress, we put in $1 billion more in 
emergency spending into that program. My home state of Kentucky 
received over $45 million in LIHEAP in 2006. 
   Under your budget, Kentucky would receive only $21 million. Now 
costs for heat and low income people have not diminished in Kentucky. 
So what you are proposing is a direct confrontation with me and 
everybody sitting up here on LIHEAP. 
   Now you ought to know better. You ought to know better because you 
know we are not going to allow that to happen. Even though it is one of 
the programs that consumers, particularly low income consumers, use 
this program need desperately. 
   Now we have had a fairly light winter but we are going to have, as 
we are getting right now, a heavier winter, maybe later, maybe not as 
big as last year, maybe as good as last year. But that is not a 
reasonable assumption on the budget of the President of the United 
States, to make a 17 percent reduction in LIHEAP. 
   Secretary LEAVITT. I can, at least, offer some explanation. The $1 
billion that we added last year was actually by agreement, $1 billion 
we accelerated from the 2008 budget. 
   Senator BUNNING. Yes, because we did it in an emergency supplemental 
program. 
   Secretary LEAVITT. Everyone at this table or in this room knows that 
members of the public who do not have heat need to have it and that we 
are going to meet that obligation. That was done because it was in the 
2008 budget-- 
   Senator BUNNING. Do you think somebody is cheating LIHEAP? 
   Secretary LEAVITT. No. 
   Senator BUNNING. Do you think consumers are cheating? 
   Secretary LEAVITT. No, no, no. I did not say that. 
   Senator BUNNING. The fact of the matter is that there is a huge need 
out there. 
   I want to get back, I am almost out of time, concerned about 
entitlement growth, particularly in Medicaid and Medicare. The budget 
slows the rate of growth, as you said in your opening statement, from 
6.5 to 5.6 over 5 years. In Medicaid the growth rate from 7.3 to 7.1. 
   Our-year, 75 years out, it saves $8 trillion, $8 trillion. That is 
not going to be enough to save the program but we better make the 
start. And we have to have a reasonableness about these two programs or 
we are not going to have any programs, as the chairman has said, in 
2045 or 2050, depending on who is doing the addition and subtraction. 
   So please stick to your guns on this, because we have to have this 
if we are going to have a program for my 35 grandkids and my four great 
grandkids. They are not going to have a program. 
   Secretary LEAVITT. It is our budget and we are sticking with it. 
   Senator BUNNING. It is going to take some negotiations to stick with 
it, but I hope you do. 
   Chairman CONRAD. Senator Menendez. 
   Senator MENENDEZ. Thank you, Mr. Chairman. Mr. Secretary, welcome. 
   Mr. Secretary, can you tell me, do you believe the SCHIP program has 
proven to be effective in covering children and families? 
   Secretary LEAVITT. It has. 
   Senator MENENDEZ. I am glad to hear that. In New Jersey we are 
successfully covering over half a million children under SCHIP. But I 
am concerned that the President's budget request undermines the future 
of that ability to do so. 
   So I have heard you say in other hearings that you do not believe 
that children will be dropped from the program under the President's 
budget proposal. Is that still your belief? 
   Secretary LEAVITT. That is our belief. 
   Senator MENENDEZ. Are you going to be guaranteeing the States will 
be reimbursed for children's coverage at their current rate? 
   Secretary LEAVITT. It is our position that children who are 
currently covered need, under the construct of reauthorization, to 
continue as well as adults. We do, however, believe that in the future 
we should focus SCHIP on the core mission which is children. And we do 
not support the addition of additional adults. And we believe that 
children who are in excess of 200 percent of the poverty line should be 
matched at the normal Medicaid match rate, as opposed to the enhanced 
match rate. 
   Senator MENENDEZ. So as I hear your answer, because I am concerned 
that instead of weight loss we have a gastric bypass here, that, in 
fact, all of those who are presently covered, children and adults, it 
would be the Administration's position that the rate of reimbursement 
would be the same as that which they presently are enjoying. Is that 
what I understand you to say? 
   Secretary LEAVITT. I want to confer with my colleague. 
   Senator as I have expressed, our position is on anything in excess 
of 200 percent of the Federal poverty line we would support 
continuation of coverage, but only at the normal match rate, not the 
enhanced match rate. 
   Senator MENENDEZ. So that means, in fact, if a State--for argument's 
sake--had 225 percent of coverage and you are presently covering them 
at the enhanced rate, then you would drop back down by, in that 
example, 25 percent. 
   Secretary LEAVITT. We would continue to support it at the normal 
rate but not at the enhanced match rate. 
   Now, I would add that we feel strongly that our objective ought to 
be to have a basic affordable plan available to every American and that 
SCHIP is a very important part of that and that we should be working 
with States to integrate what they are doing with SCHIP into their 
other efforts. 
   We do not see SCHIP as the vehicle to cover all Americans, but we do 
think it is important component of-- 
   Senator MENENDEZ. I appreciate that. But the bottom line is that you 
cannot quite make the statement then that those children and adults 
presently covered under State programs, like New Jersey's program, will 
continue to receive the current rate of assistance from the Federal 
Government because if that rate is beyond the 200 percent then you will 
not fund it beyond that. 
   That means that, in fact, States would either have to make a 
 decision to cover it themselves out of their own resources or drop 
those individuals who do not qualify above 200 percent. 
   Secretary LEAVITT. They would remain eligible for the program but we 
would standardize our reimbursement in the way that you have 
acknowledged. That does not mean they would be dropped from coverage. 
It does mean that in our partnership with the State they would be 
required, on those efforts that are above 200 percent, to offer more 
support or to find a different way to cover them. 
   And we think there are many. I have been working with Governor 
Corzine to look at ways that we could offer a basic affordable policy 
to every citizen of New Jersey. 
   Senator MENENDEZ. Well, I appreciate that. But the bottom line is 
that, in essence, to me, this means that there are States who are 
clearly going to receive cuts. We can dance around how we describe it. 
But the bottom line is if there is a present rate of reimbursement and 
that is no longer to be held, that means the States will receive a cut 
and they will have to make choices as to whether or not they can cover 
someone and how they do so. 
   And that is different than when I see the President get up at the 
State of the Union and talk about enhanced coverage. I just do not see 
enhanced coverage in this process. I see a diminution of coverage to 
some of the individuals who are among the most neediest in our society 
and the most vulnerable in our society. 
   So I appreciate the President's suggestion of a program of a tax 
deduction. The only problem with that is, first of all, that 
flexibility has already existed by waiver. And second, it is only good 
if you have the money in the first place to dish out to buy health 
insurance. 
   In a high cost State like New Jersey, in the family incomes that I 
am talking about, which exceed 200 percent but certainly not put them 
anywhere near the ability to do that, it is meaningless. 
   Secretary LEAVITT. Well, the President has made clear that we should 
be willing to contribute Federal resources to assure everyone has a 
basic affordable plan. We do not view SCHIP as the logical vehicle to 
extend that coverage to every resident of the State of New Jersey or 
any other State. We think it ought to focus on its core mission, which 
is children. 
   Senator MENENDEZ. I have no doubt that--I am not suggesting that this 
is a vehicle to create universal coverage. What I am suggesting is that 
the Federal Government should at least keep its obligation to that 
which has--to those which are presently enjoying the benefit of the 
coverage and for which the Federal Government made a determination to 
be supportive of the enhanced rate. Absence of that means a cut and a 
cut ultimately means decisions as to whether you keep children and 
certain parents on or whether you release them. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator. 
   Senator CORNYN. 
   Senator CORNYN. Thank you, Mr. Chairman. 
   Mr. Secretary, thank you for your service and for being here today. 
   Last year 19 senators, including eight on this committee, sent you a 
letter urging you to make diabetes screening in the Medicare population 
a priority in the budget. As you know, more than 61 percent of the 
Medicare population has either diabetes or prediabetes, and most of 
those with prediabetes are undiagnosed, almost 14 million people. 
   When you combine this number with the fact that NIH's diabetes 
prevention project proved that people age 60 and older could reduce 
their rate of diabetes and its complications by a staggering 71 
percent, it is clear that we could save money and lives by identifying 
those seniors and helping avoid diabetes and its devastating 
complications, including blindness, amputation, and kidney failure. 
   Could you tell me whether your new budget responds to the concerns 
that were raised in this letter last year about diabetes screening? 
   Secretary LEAVITT. It does in several ways, Senator. One that I 
point to that I believe is perhaps the most important is the effort to 
assure that we are beginning to measure quality in practice. One of the 
most important quality measures, for example, in a practice would be 
the testing of hemoglobin A1c among those who have diabetes and testing 
for diabetes generally among the larger population. 
   We are proposing, in our efforts, that as physicians are able to 
meet those quality measures that the costs will be improved and lives 
will be saved. Rather than just spending more money to test, we want to 
hold the testing as a standard of practice so that we discover it early 
and save the money and the lives that are accomplished by that. 
   Senator CORNYN. When I went out to the NIH last and talked about the 
challenges they face and the opportunities that they see, they 
mentioned to me that--and I believe this was confirmed also by the 
American Diabetes Association--that about $134 billion in avoidable 
costs could be saved if we did a better job of preventing diabetes 
which, as you know, is largely preventable in its most common form by 
improved diet and exercise. 
   What can we do to provide the financial incentives to the health 
care community to focus on prevention and obviously save a lot of money 
and avoid a lot of human misery? 
   Secretary LEAVITT. I mentioned earlier in our conversation today 
here in the committee that health care costs are primarily a function 
not just of efficiency in the system but also prevention. We make 
prevention, if we pursue it as tenaciously as treatment after we are 
sick, we will start to see reductions in dollars. But we will also see 
a lot of lives saved. 
   I will tell you that we are currently spending about $600-plus 
million a year on the subject of obesity, how can we begin to change 
the patterns of Americans that are producing the tens of millions of 
people who suffer from diabetes? It will be obesity and the inherent 
diseases that result have to be considered among our most significant 
health threats in this country. 
   Senator CORNYN. Is there something we can do in terms of health care 
provider payments, to provide them the financial incentive to do the 
early intervention and prevention? I appreciate your comment earlier 
about calling it the health care sector rather than a health care 
system, because we do not really have a functional system. And some 
have observed we actually have a sick care system, not a health care 
system. 
   So are there financial incentives that we can create to give 
providers the incentive to actually act to intervene before people 
become ill? 
   Secretary LEAVITT. I look forward to the day when we have electronic 
health records that will allow us to measure how many patients have 
proper preventative measures taken by physicians and by health care 
providers at various stages that will result in fewer cases of 
diabetes. And we can reward physicians for having done that. 
   Now physicians do not control everything their patients do but they 
can control what they do when they come in and whether they talk with 
them and counsel them and whether they are doing the kinds of things 
that could begin to drive those down. 
   Senator CORNYN. Thank you, Mr. Secretary. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator Cornyn. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Welcome, Secretary Leavitt. 
   Secretary LEAVITT. Thank you, Senator. 
   Senator WHITEHOUSE. I would even go so far as to say we do not just 
have health care system, we do not even have a health care sector. We 
have a health care mess and we really need to straighten it out. It is 
very, very urgent. 
   In the context of that, I just want to react to some things you 
said. We had testimony in this room not long ago that the cost of the 
Part D program to American taxers looking forward was $8 trillion. We 
have seen reports just out recently that the difference between the 
cost that the drug companies get through Part D versus what they get 
through the United States Government Veterans program is as much as 58 
percent. If you take the 100 percent cost and add the 58 percent, it is 
about one-third extra. 
   If the $8 trillion is right, that is $2 trillion over the life of 
this program. By any standard that is big money. And the idea that we 
are not going to pursue that just astounds me. 
   It is not a formulary. I just want to make it clear to anybody who 
is watching what the expectation would be here. It would be that you 
would be the power to negotiate, the one that your predecessor, 
Governor Thompson said was the biggest thing that he missed in that 
position. And that with that power to negotiate, you could bring 
together the different providers so that through their existing 
formularies the same drugs that there are in, you could negotiate 
collectively to bring the price down. 
   And ideally, I would like to see you have a competing program of 
your own which would add to the choice of seniors. So when people come 
in here and say well, it is a formulary or it takes away choice, that 
is just nonsense. That is just not true, not I think if you try to 
understand where people who are pushing for this are coming from. 
   I think you can be effective if you picked the top 10 or the top 20 
drugs and get the providers together and negotiate with the 
pharmaceutical industry to the prices that they are already paying the 
VA. I do not know what the exact number is but it is a big, big number. 
And it is extraordinarily frustrating to have us be stonewalled when we 
are having these discussions about how much money we need to save and 
we are talking about cutting things like SCHIP, to have the 
Administration unwilling to pursue what seems to me to be obvious. 
   I would love to work with you more on that but I really think that 
you are just talking past me when you say these things and you are not 
even talking realistically from where I am coming from. So maybe 
off-line we should have a further conversation, if you are interested. 
But I just do not get it. 
   The other place where I just do not get it is with health 
information technology. You said it was the most important thing that 
we are working on, that you have a very serious program. The RAND 
Corporation says that we could save either $81 billion a year with 
adequate investment in health information technology, that is their 
lowball bid or estimate, $162 billion a year was the mid-line number. 
By comparison to other industries, they said it could be $345 billion a 
year. 
   If you take the lowest number, the $81 billion a year, I calculate 
that--maybe my math is no good. I did not take economics 101. But my 
arithmetic is that that is $221 million a day in savings from adequate 
health information technology in our health care system. 
   Your entire on-CHIP budget is $118 million, less than 1 day's 
savings. Mr. Braylor is gone for months. There is no replacement. 
   I appreciate the energy of your words on this subject but I would 
like to see appointments and budget money that gets behind the need 
that we have. Because I agree with you. I think that health information 
infrastructure is the key to colossal savings in the system. 
   And we in this room are going to have a tragic choice coming up 
between cutting benefits or raising taxes if we do not get under why 
this health care mess is broken. And we need that information 
technology to make it happen. 
   And I urge you to consider real investment in this, and really 
getting behind it, not the kind of investment where you could get it 
back in 1 day of the projected savings. 
   Secretary LEAVITT. Senator, there are hundreds of millions, billions 
of dollars being invested right now in health information technology 
throughout our economy. The proper function of the Federal Government 
is to assure that they are operating on standards that will allow them 
to interconnect. We are making dramatic and rapid progress toward that. 
   Senator WHITEHOUSE. In Rhode Island, the leading edge of health 
information technology is a group of private physicians-- 
   Secretary LEAVITT. My point exactly. 
   Senator WHITEHOUSE [continuing]. Who got so frustrated with this 
that they are trying to develop an electronic health record on their 
own. 
   Secretary LEAVITT. Senator, they joined-- 
   Senator WHITEHOUSE. I have to tell you-- 
   Secretary LEAVITT. They join 200 other vendors who are offering 
health information technology. And if they do not connect, they have 
value in their practice but they do not create a system of health 
information technology. 
   With respect to the matter of the drug benefit, may I just say our 
time is up but I completely disagree with your characterization. Do not 
take my word for it. Take the word of CBO or for independent actuaries 
who make very clear that there would be zero savings if the Government 
were negotiating. And what you would have are a lot of unhappy 
beneficiaries because they would not be able to get the medications 
that they seek. 
   They are currently able to do it because they can choose a plan with 
a formulary. We are saving money, a lot of it, and people are happy. 
   And by the way, former Secretary, former Governor Thompson, 
indicated that he sees the program working and sees no reason to change 
it. 
   Senator WHITEHOUSE. I am out of time, Mr. Chairman. 
   Chairman CONRAD. We will have another round. 
   Senator NELSON. 
   Senator NELSON. Good morning, Mr. Secretary. 
   Secretary LEAVITT. Good morning, Senator. 
   Senator NELSON. Mr. Secretary you have covered a lot of different 
questions here. I want to get on one that you have not covered and it 
is a particular matter that we have a lot of unfortunate experience in 
my State of Florida, in the confiscation of senior citizens' 
prescription drugs when they order them from Canada. 
   We have been through this for several years and naturally your 
Department has an interest in seeing that the drugs are safe. And the 
Acting Administrator before you became Secretary, the Acting 
Administrator of the Food and Drug Administration, assured me that what 
the FDA was looking at was trying to get at the people who are gaming 
the system with counterfeit drugs and so forth, that the individual 
citizen that is ordering by mail or by the Internet or by telephone for 
a limited supply for personal use--and that FDA Administrator defined a 
limited time a 90-day or less supply--that it was the position of FDA 
that they were not going to try to confiscate those drugs. 
   So we rocked along and we have had an up-and-down on this. But 
finally last October, Customs Department threw up its hands and said we 
are not going to confiscate these drugs anymore. 
   I thought that was the end of it. But what has happened just in the 
last month is that at least just in my State, just in South Florida, 37 
packages of medicine shipped to South Florida for senior citizens was 
confiscated. 
   Now Senator Vitter and I thought that we had taken care of this 
problem on one of the appropriations bills last year by putting an 
amendment on that said that if the drugs were from Canada and it was 
for limited supply and it was for personal use that that was going to 
be legal. But you know the trouble that we got into with 11 of the 13 
appropriations bills. When they went to conference they never passed it 
and that is what we are dealing with where I have just come from the 
floor right now with an emergency continuing resolution to keep funding 
the Government in those 11 departments that were not funded. 
   So that amendment that we put on is not the law, and yet customs 
said it was not going to confiscate, but here we go again. Now 
confiscations are occurring. 
   So I need some direction from you. 
   Secretary LEAVITT. Senator, I am not able to respond with respect to 
the Customs. Our role at FDA is typically to test and to determine the 
efficacy and legitimacy of drugs that are presented to us by the 
Customs, Immigration and Customs. The specifics of the 37, I am not 
able to respond to. I can tell you there has been no change in policy 
during that period. And so perhaps we ought to pursue the specifics of 
those proposals off-line. 
   Senator NELSON. OK. Let me just give to you the commentary for 
additional elucidation. On a Friday in early February, a Food and Drug 
Administration spokeswoman said that the Canadian pharmacy shipments 
were detained at the Miami International Airport for routine reasons. 
   And so we have--what I am afraid is we have one hand that does not 
know what the other hand is doing. And I would appreciate it if you 
would get in. Now, of course, you and I know that this does not solve 
the problem. What solves the problem is a lot of these other issues 
that have been discussed here today with regard to the cost of 
medicine. 
   But it is, for some of our seniors who are having difficulty in 
making financial ends meet, it is a lifeline to help them be able to 
afford their drugs and also to afford groceries to eat. Because in most 
of these cases they are getting these drugs from Canada at half the 
price that they would pay in a pharmacy in the United States. 
   So if you would like to do this off-line, I would appreciate it if 
you would then respond in writing so that we can get to the bottom of 
this and solve a problem that otherwise should not be a problem. 
   Secretary LEAVITT. Can you supply me with the specifics of this 
situation? Because I do not know them and I would be happy to respond 
to that specific. 
   I know that the time is up, this has been an ongoing problem and one 
we are all trying to solve. It does not eliminate, however, the 
potential for unsafe drugs under the banner of the Canadian flag coming 
into this country in a way that is hurtful, harmful, and dangerous to 
people. Counterfeit drug making is a big industry and it is a worry to 
me. 
   Senator NELSON. Well, I understand that. And of course, that is the 
reason that Customs and FDA have given in the past. But you all have to 
worry about people really taking advantage of the system and getting in 
big quantities of these things where they can then be resold and who 
knows what is in them because they are counterfeit and so forth. 
   But the likelihood of that occurring from a Canadian pharmacy for an 
individual prescription prescribed by an individual doctor for an 
individual person for a supply of 3 months or less, that likelihood is 
de minimis compared to what you are looking at. 
   And when you balance that against the financial need of the seniors 
until we can get the overall cost of these drugs down, it is--you have 
to make choices. And this is the choice. And the Senate has made this 
choice, and so has the House. But for the appropriations bill not 
passing we would have this etched into law. 
   And I thought we had solved our problem but we have not, now that we 
are seeing these additional confiscations, Mr. Chairman. 
   Mr. Chairman, I know you want to close. I will just say this, that 
really what we ought to do is go on and passed the bill that you filed 
and I have cosponsored, which will etch this thing in law. And then I 
will not have to go around and try to amend it on appropriations bills. 
   Chairman CONRAD. I thank the Senator. 
   Secretary Leavitt, I have a couple more questions and I think 
Senator Whitehouse would like another round as well. 
   On your means testing proposal, I want to understand this better if 
I can. First of all, I have stated publicly and I have said here today, 
I support a means testing or income relating, whatever one wants to 
call it these days. I think it is going to be essential to dealing with 
the long-term imbalances that we confront. We are going to have to make 
tough choices. I am thoroughly prepared to make that as one. 
   But when I look at your proposal, the proposal that is in this 
budget, it is not indexed. And so the question comes to mind what 
happens over time as you have a means testing not indexed? 
   It seems to me unavoidable that you would have more and more people 
who would be forced out of Medicare or choose not to participate, 
especially as this goes on for an extended period of time. Have you 
done any analysis of the 10-year effect, the 15-year effect and beyond? 
How many people would choose not to participate or be forced out of 
Medicare because your plan is not indexed? 
   Secretary LEAVITT. Analysis has been made, only a small percentage 
of all eligible Part D beneficiaries would be paying higher premiums, 
2.7 percent in 2008, and just 4.7 percent would be paying in 2017. 
   We do not believe that it would ultimately force people out of 
Medicare. For the most part, people find Medicare a very helpful 
service because-- 
   Chairman CONRAD. But I am talking now further out. If you have a 
limit here, an income test, and again I support the basic notion. But 
when you do not indexed it over an extended period of time it starts 
small. But they are talking here about $8 trillion of savings from your 
various proposals--and this is one of the biggest ones. I assume 
substantial part of that $8 trillion is from this proposal. 
   Over 20 years, 25 years, the percentage has to increase 
dramatically. 
   Secretary LEAVITT. It removes any indexing so, as you say, it is not 
indexed--or indexes it rather, so that it does go up over time. 
   Chairman CONRAD. It is indexed? 
   Secretary LEAVITT. It is not indexed. 
   Chairman CONRAD. Well, that is my point. If it is not indexed, then 
it over an extended period of time many more people have to be 
affected. 
   Secretary LEAVITT. You asked if we had done analysis. We have. It 
would affect 2.7 percent in 2008 and it would affect 4.7 percent in 
2017. 
   Chairman CONRAD. Many people is that? 
   Secretary LEAVITT. Two million. 
   Chairman CONRAD. Two million by 2017. But beyond that, what are we 
talking about-- 
   Secretary LEAVITT. That is Part D I am talking about. 
   Chairman CONRAD. Part D. 
   I am talking about all of the parts because this is a proposal that 
just does not affect Part D. This affects Part D. This affects, as I 
understand it, all of the elements. 
   So how many people would we be talking about--and again I am not 
talking about just the 10-year effect. Because if it is not indexed as 
you go out to 2025 and 2035, this thing must have an effect on millions 
of people. 
   Secretary LEAVITT. The information I have just been presented 
indicates that beneficiaries paying the higher premium in 2017 under 
Part B would be 9.5 percent that would be affected. Again, the 
principle is the same. 
   Chairman CONRAD. But how many people would leave? How many people 
would choose not to participate? 
   Secretary LEAVITT. I do not have information that would reach that 
conclusion. I think you could draw conclusions recognizing that there 
will be some who will, as they get into higher incomes, will have 
greater income to pay. The principle is the same, Senator. 
   Chairman CONRAD. Hasn't the CMS Actuary given you an estimate? 
   Secretary LEAVITT. If they have, I do not have it with me today. 
   Chairman CONRAD. Let me tell you, the estimate that I have from CMS, 
which is your agency, is that by 2017 43,000 people would leave 
Medicare. That is just Part B. That is just Part B. 
   That is the near-term effect. What I am concerned about is if you do 
not index, when people up here are talking about $8 trillion in 
savings, we have to understand what that assumption means. 
   So I am going to ask you today, I would like to have CMS give us 
their estimates of how many people would be affected, how many people 
would leave Medicare or, in essence be forced out, because it is not 
indexed. 
   We have to understand before we pursue this, and let me just 
reiterate I am for the basic notion. I think it has to be part of the 
solution. But I do not want to have something that winds up excluding 
tens of millions of people because it is not indexed. And when you get 
out 40 years all of a sudden you have excluded 10 million people. 
   Secretary LEAVITT. That will be helpful information and we will be 
happy to provide it. 
   Chairman CONRAD. I think we need to know that. 
   SCHIP, our staff estimates are that it takes $15 billion to maintain 
the SCHIP program as is and that this budget only provides $5.6 
billion. So that the basic SCHIP program that is available now is 
significantly underfunded, and could not be maintained under this 
budget. 
   Do you have estimates of how many children would be excluded from 
SCHIP as a result of this budget, in comparison to the budget required 
to maintain the SCHIP program as it exists? 
   Secretary LEAVITT. Senator, I have articulated the position of the 
Administration as clearly as I can. It is our belief that the budget 
proposal we have put forward would allow that policy to be implemented. 
The actuarial figures I do not have today. Obviously, as the 
conversation goes forward we would be happy to provide whatever backup 
we can. 
   Chairman CONRAD. I have a very specific question. And that is with 
this budget, in comparison to a budget that would maintain the SCHIP 
program as it currently is, how many children would be excluded from 
coverage? 
   Because we have roughly 4 million children, as I understand it, 
covered. As we look at these numbers that are in the budget, there is 
no way to maintain the program as it is for those people. 
   A final question I would like to go to, and I thank my colleague for 
his patients, is the question of fraud. A number of years ago we had a 
series of hearings on fraud in the Medicare program and I tell you it 
was truly outrageous. 
   We found in wound kids, for example, wound kits, there was a scam 
going on around the country--in fact, I held a hearing in North Dakota 
and we had several providers stand up and say they had been presented 
with this scam operation which was to cheat Medicare by getting wound 
kits that normally, as I would recall, cost $8. And they would 
basically defraud Medicare by charging three times as much to Medicare 
than what the things really cost. 
   It was a scam that involved some operations on the East Coast and 
then they were being aided and abetted by people who delivered the 
service around the country who were invited to share in the fraudulent 
returns. And so they set up a giant network. 
   Now you mentioned at the beginning of your testimony and in our 
conversation, and I do not want you to go into things that would in any 
way jeopardize your ongoing investigation. But can you give this 
committee insight, to the extent you can, on what you are finding with 
respect to fraud? 
   Secretary LEAVITT. Senator, I indicated to you that I had recently 
participated in activities of the Office of Inspector General where we 
have actually gone out and begun to inspect the compliance of various 
durable medical equipment providers in certain communities around the 
country. 
   I will confess to you that it was one of the most disheartening 
experiences of my public service career. We walked up to a strip mall 
in a particular area. There are 21 different criteria than a provider 
has to give if they are to be given a number and be able to do 
business. Those things include you have to have a place of business, 
you have to be able to demonstrate you have a supply of medical 
equipment, you have to have your name posted prominently and a 
telephone number. 
   And so we would walk up to these strip mall places and rattle the 
door during the middle of the day and there was no one there. And you 
would look inside and there would be three chairs and a little supply 
of medical equipment. And then you would see the name--that had met the 
requirements of the number but there was clearly no business going on 
there. And when you would go back and check against it you would find 
that there were hundreds of thousands, often millions of dollars, 
billed against that number. 
   I then went to an office building of about 20,000 square feet, two 
stories. There are four rows on the marquee of businesses, probably 70 
or 80 businesses in this building. I would guess three-fourths of them 
were durable medical equipment suppliers. 
   Chairman CONRAD. In one building? 
   Secretary LEAVITT. In one building. I walked up and down the aisles 
and it was like a dormitory. On each side you would see doors. When you 
would knock on the door there would be no one there. When you would 
finally get somebody to open it, it would be a woman who would have 
children and generally they would not speak English. It was very clear 
that this was a building full of businesses that were front operations. 
   Chairman CONRAD. Front operations. 
   Secretary LEAVITT. In the particular city where I was on that day, 
the agents told me that there were four such buildings. We inspected 
several hundred different providers and found that nearly half of the 
number were fronts. And we are proceeding to cancel and we are working 
with all of our resources to convict and to ferret this out. 
   Chairman CONRAD. Do you have any estimate, Mr. Secretary, on what 
the losses might be from these kinds of operations? 
   Secretary LEAVITT. We are working, at this point, to try to 
establish that. It is very clear that in a program that you are going 
to have some losses. But it is at a rate that is untenable and 
unacceptable. 
   Our budget includes $183 million which we believe to be essential to 
be able to beef up our enforcement activities. It is clear to me, Mr. 
Chairman, that the payback return on that investment is multiple. 
Chairman CONRAD. Mr. Secretary, for the purposes of this committee, if 
you could provide us--given you have to submit a budget long ago. We 
understand that. You have new information here. 
   If you could give us some idea of what additional resources are 
necessary to pursue these scams. I think the message needs to be loud 
and clear. If you are engaged in this kind of scam, we are coming after 
you and you are going to regret that you ever entered into this kind of 
fraudulent enterprise. The Federal Government is coming after you and 
we are going to have the full resources to put you in jail and get full 
restitution. And this will be--you will regret you ever went down that 
road. 
   Secretary LEAVITT. Mr. Chairman, we will provide it and we 
appreciate your interest in it. 
   Chairman CONRAD. We thank you. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thanks, Mr. Chairman. 
   It sounds like your building in the Cayman Islands that we had 
featured in an earlier hearing. 
   As our time ran out, Mr. Secretary, you mentioned a CBO report that 
suggested that negotiating by Federal Government would not save any 
money for taxpayers or for the system. I am aware of one conclusion 
that was drawn by CBO, which is that passing the statute that withdrew 
the bar or on your negotiations would not save any money. I have talked 
to CBO about that and I just want to make sure you are aware of why 
they decided that. 
   They decided that because all that would do would be to take away a 
restriction on you doing what Director Thompson said was the most 
important power that he did not have as Director. But it would not 
guarantee that you would. 
   And because they have to kind of read the future and prognosticate, 
because there was the prospect of the Department of Health and Human 
Services would simply sit on its hands and not negotiate or do so 
halfheartedly or not be effective in the way it went about doing it, 
they could not tell where it would fall and they could not provide a 
number. 
   But you should not believe that the CBO does not think that there 
are significant opportunities for savings for American taxpayers from 
getting the Government involved in these negotiations. They just cannot 
identify them because they do not know what you are going to do about 
it yet. 
   Secretary LEAVITT. Well, then let us talk about the independent 
actuaries who drew the same conclusion, or let us begin to look at 
the-- 
   Senator WHITEHOUSE. Would you send me that because I do not have 
those. I would love to continue this debate because I think is vital. I 
mean, $8 trillion, sir, is $27,000 per American. And most Americans--a 
lot of Americans do not pay taxes. So for people who are watching this, 
and are actually tax paying Americans, they are looking at a good deal 
more than $27,000 skin in the game on this. 
   And if, as reports that we have seen from independent folks are 
saying, there is a 50 percent extra premium being paid to the 
pharmaceutical industry because we will not negotiate, that is 
trillions and trillions of dollars and we, I think, have to have a 
really honest discussion about that and understand exactly what the CBO 
said in its report. And I am happy to followup with you and look at 
these other things. 
   But please do not count the CBO as having said no, no, no, negotiate 
will not save money. All they said is that just by changing the statute 
they could not tell whether you would actually do anything under it and 
so they could not put a number on it. 
   Secretary LEAVITT. Senator, I am prepared to remain open-minded on 
that point if you would remain open on the point that there is no way 
that there are trillions of dollars that can be saved over an efficient 
marketplace. You have-- 
   Senator WHITEHOUSE. What makes you think this is an efficient 
marketplace? 
   Secretary LEAVITT. Because you have the largest payers in the 
business competing. And when they compete, they very clearly say if I 
do not have the lowest possible price, then there is no way for me to 
keep the business of 38 million people. 
   Senator WHITEHOUSE. We are going to disagree about that because I 
think the fundamental problem is that we have market failure in the 
health care system. And until we straighten it out, the marketplace 
effects are muted and dissolved and we do not really take advantage of 
it. 
   Secretary LEAVITT. We will agree on the point that we did not have a 
system of competition in health care, generally. But one of the best 
examples we have where competition has been injected and where it has 
worked has been in the Medicare Part D. It is indisputable that the 
actuarial estimates started at $37. And this year they will pay $22. 
And the actuaries very clearly indicate that that is because of 
competition. 
   And with the number of plans we have if there is anyone who has the 
capacity to deliver a drug program at a dime cheaper, they are going to 
get a lot of business. And they will. 
   Senator WHITEHOUSE. And I think if the Federal Government got 
involved, it would drive it down even further. 
   Secretary LEAVITT. I do not think there is evidence on that, but we 
will-- 
   Senator WHITEHOUSE. A separate point. On the reduction to Medicare 
doctors of 10 percent, in addition to what Chairman Conrad suggested, 
which is that is probably not going to happen in this building, I would 
suggest to you that if you tried to implement it, even if we put it 
through, it would not affect 10 percent savings across the board 
anyway. Because there is such an elaborate system out there for 
fighting back and forth over claims payment, and so many different ways 
that providers can reconfigure their claims filing methodology, that an 
enormous amount of that goes out the door. And a lot of it that does 
not go out the door gets lost in patient care to the people who this is 
designed to do. 
   So I think is a very, very effective and inefficient way to try to 
pursue savings in the system. But I have never seen a good number for 
how much you think that costs, the battle between the insurance 
industry on the one hand with all of its utilization review technology, 
and the providers on the other side. I am drilled into this reasonably 
far in Rhode Island, sir, and I want you to know that the doctors in 
Rhode Island, they are involved so heavily in trying to fight for 
payment, in many cases 50 percent of their staff is doing nothing but 
fighting for payment. We have trench warfare over payment in the health 
care system and it produces, by my lights, not a dime of health care 
value. 
   So to me the trick is how do you dissolve that trench warfare? How 
do you get clarity as to what should be paid for and what should not, 
rather than putting more pressure into the trench warfare by saying OK, 
across the board 10 percent reduction? 
   I just think it backfires. I do not think it is a good strategy. 
   Secretary LEAVITT. Listen, Senator, I think the way we reimburse 
health care is a witch's brew that no one understands. I think that it 
is saturated with inefficiency and that it clearly, over time, should 
be replaced with a system of competition based on value. Where we have 
a system of electronic health records that connects us into a system 
where consumers can have an independent assessment of the quality that 
they are receiving, where they can have care that is provided to them 
in episodes of care where the price is understandable, and where the 
incentives for everyone is to drive the costs down and the quality up. 
   We are pursuing all of those policies aggressively. And I would love 
to spend some time talking with you about the way I view this system. 
Because it sounds to me as though we could reach agreement on the fact 
that the system we currently have does not work well and that we ought 
to be migrating toward-- 
   Senator WHITEHOUSE. That is the understatement of the day. 
   Secretary LEAVITT. I want to underscore it and make it the quote of 
the day. 
   Senator WHITEHOUSE. I appreciate it and I do look forward to working 
with you. I think this is urgent. I think we are late. I think it is 
scandalous how we have allowed the system to develop to this point. 
   And the fact that we, in this building, are going to start to have 
to look at benefit cuts for people who are at the very most difficult 
part of their lives, seniors, people just making it economically, that 
we are going to have to look at giving them a hit because we have not 
done our jobs in supervising and administering and creating a system 
that cleans itself and that does these things right. 
   I mean, it is just an absolute disgrace. And I really want to work 
as hard as I can with you to solve that problem. 
   Secretary LEAVITT. Good. 
   Chairman CONRAD. I thank the Senator. Let me just say I have asked 
Senator Whitehouse, because of his very strong background in this area, 
he was put in charge of a very serious problem in the State of Rhode 
Island that required immediate action, and he did a remarkable job 
there on these issues. 
   And so he has a very significant expertise that this committee is 
drawing on. I have asked he and Senator Wyden and Senator Stabenow to 
lead a subpanel of this committee to focus on health care and the 
opportunities that we have to rein in these costs and to provide better 
health care outcomes. So I thank Senator Whitehouse for his attention 
to this. 
   And I thank you, Mr. Secretary. Thank you for coming before the 
committee. We thank you for your service. You know, we have 
disagreements, we have debates. That is what the system is about. That 
is how we get at the truth. But I think all of us know you are an 
outstanding public servant and we very much appreciate your service. 
   Secretary LEAVITT. Thank you, Senator. 
   Chairman CONRAD. Thank you. 
   [Whereupon, at 11:49 a.m., the committee was adjourned.] 

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                   THE PRESIDENT'S FISCAL YEAR 2008 BUDGET 
                        PROPOSALS ON TAX COMPLIANCE 
                                  ------
            
                        WEDNESDAY, FEBRUARY 14, 2007 

                                           UNITED STATES SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:07 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Wyden, Lautenberg, Stabenow, Whitehouse, 
Gregg, and Grassley. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority.                    


               OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. The hearing will come to order. We thank everybody 
for being here. We especially thank the Commissioner for braving the 
snows of Washington. We thank our colleagues, as well. It seems to be 
 that much of Washington is shut down but we are open and ready for 
business. 
   I also want to wish Senator Gregg a happy birthday. He is 29 years 
old today. It is amazing how gracefully he has aged. 
   Senator GREGG. Do you have a chart to that effect? 
   Chairman CONRAD. I am bringing a cake. So happy birthday to Senator 
Gregg, and best wishes for this day. 
   I do not know exactly what the Senate schedule will be like with the 
weather outside, but we are going to go forward with this hearing. 
   I especially want to thank Commissioner Everson for coming today, 
and for sharing his insights with us. It is good to have the former 
chairman of the Finance Committee with us as well, but now ranking 
member, Senator Grassley. 
   Let me begin by highlighting the serious fiscal challenges that we 
see facing the Nation. I call it the wall of debt. We started out this 
administration, after the first year, with almost $6 trillion of debt. 
By the end of this year it wail be $9 trillion, headed for $12 trillion 
by 2012 if we do not respond. 


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   It is very interesting, I would say to my colleagues on the 
Committee, in my work on this budget I find among our colleagues such a 
deep impulse to embrace every tax cut and embrace every spending 
initiative. Even though we all know we have to change, there is, among 
our colleagues, a great impulse not to change. It has been made very 
clear to me over the last several days. 
   While increased spending has contributed to this growing debt, lower 
revenue has also been a factor. If we look at the revenue since 2000, 
back in 2000 we had just over $2 trillion of revenue. 
   We did not get back to that amount in real terms until 2006. We did 
not get back to the revenue base we had in 2000, in real terms, 
inflation-adjusted terms, until 2006. 

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   And my colleagues are quick to talk about the revenue increase of 
the last several years, and they are absolutely right about that. If 
you just focus on the last several years, we have had strong revenue 
growth, which is typical of any recovery. 

   But what nobody wants to talk about is we have had 6 years of no 
revenue growth. The result is, with increased spending, is the debt has 
jumped dramatically. This is before the baby boomers retire. We are 
faced with a very inconvenient truth. And the inconvenient truth we are 
faced with is the baby boomers are going to retire and they are going 
to be eligible for Social Security and Medicare. We are going to have 
to do something about it. 
   Even with the recent revenue improvements, real revenues are still 
lagging  behind where they would be in a typical recovery. We have 
looked now at the nine recoveries since World War II, the nine major 
recoveries, and we find we are still running $127 billion short of the 
typical recovery. 

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   According to IRS's latest estimate, the tax gap in 2001 was $345 
billion. The tax gap is the difference between what is owed and what is 
paid. My own belief is since 2001 that it is likely that the tax gap 
has grown even larger. I have long believed that closing the tax gap is 
one of the first steps we should take on the revenue side. 
   Let me be clear, closing the tax gap is not about raising taxes on 
anyone. It is simply collecting taxes that are already due and owed. 

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   I want to salute the Commissioner for the strides that he has made 
in addressing the tax gap because he has moved on the enforcement side 
of the equation and moved aggressively. Frankly, I do not think we have 
given you the resources you need. I am especially troubled by the CR 
that took $100 million away from you on the enforcement side. That, to 
me, is going in the wrong direction. 

   The tax gap is simply unfair to the vast majority of American 
taxpayers who pay what they owe. And I believe the vast majority of 
taxpayers do pay what they owe. But we have, unfortunately, some number 
out there, and it appears to be a growing number, that do not. And that 
is true on the corporate side, as well. 

   To put a $345 billion tax gap in perspective, consider that it is 
almost $100 billion larger than the size of the deficit in 2006. It is 
important to remember that the added burden placed on taxpayers from 
the tax gap is real. The National Taxpayer Advocate, in her report to 
Congress, wrote compliant taxpayers pay a great deal of money each year 
to subsidize noncompliance by others. Each household is effectively 
assessed an average surtax of about $2,600 to subsidize noncompliance. 
That is not a burden we should expect our Nation's taxpayers to bear 
lightly. 


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   That is her conclusion, and I agree with it entirely. 
   To close the tax gap we need to improve reporting and withholding 
requirements. We know that taxpayer compliance improves dramatically 
with increased reporting and withholding. For example, according to the 
IRS, for income that is subject to substantial reporting and 
withholding requirements, such as wages and salaries, we see a 99 
percent compliance rate. When reporting requirements are in place we 
see a 91 percent compliance rate. Where we have neither, we see the 
compliance rate dropping to below 50 percent. 

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   So that is one part of the way forward, increased reporting. The 
other way is through better enforcement by the IRS. I am particularly 
concerned about enforcement that involves offshore tax havens. I used 
to be a tax commissioner. I have gone after these myself in my career. 
I have seen how incredibly lucrative it can be. 
   For six years I was tax commissioner in the State of North Dakota 
and four of those years I was chairman of the Multistate Tax 
Commission. I dealt with this not only in the North Dakota context but 
on behalf of about 20 other states. And I personally reviewed the 
records of many large multinationals, and I saw how much revenue is 
hemorrhaging because of the games that are being played. 
   This very modest building in the Cayman Islands is the home to 
12,000 companies, all of them claiming they are doing business out of 
this building. Amazing how many companies can do business out of there. 

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   Of course, they are not doing business out of there. They are 
engaged in, for the most part, a giant tax scam. Those are the kinds of 
things we simply cannot permit to continue. 
   So with that, I am looking forward to the testimony of the 
Commissioner, and I again want to commend him publicly for the 
leadership he has provided there. 
   Senator GREGG. 

          OPENING STATEMENT OF SENATOR JUDD GREGG 

   Senator GREGG. Thank you, Mr. Chairman. Thank you for your wishes. I 
appreciate them. 
   It is nice to have the Commissioner here. 
   Chairman CONRAD. Can you tell us what birthday it is? 
   Senator GREGG. You know, being a member of the Budget Committee, I 
do not think I can add that up. It is too big a number. 
   It is nice to have the Commissioner here. He has done a very good 
job, I believe, and I thank him for his excellent work. 
   Obviously, this has been an issue, this issue of tax gap has been a 
major issue for the Chairman for many years. And I believe he has 
managed, through his perseverance and energy, to finally get us fairly 
well focused on it. And I will be interested in the Commissioner's 
thoughts on what the real numbers are that we can recover of this 
number that we know is the tax cap and how much we have already 
recovered. 
   I think the Commissioner's testimony may be that of that 2001 
number, a significant effort has been made and there is significant 
recovery already occurring, and so that number has probably been 
reduced. 
   This is legitimate and what we need is a number that is reasonable 
so that we can figure it out and then give you the resources to 
accomplish that. 
   On the second issue, though, of what the tax cuts have done and what 
they have not done I must, whenever the Chairman puts his charts up, 
respond kindly to him that I think he is living in the past and maybe 
not looking at results that are current. You can obviously make a 
fairly effective argument that in the early 2000 period the revenues 
dropped precipitously. 
   I would argue they dropped precipitously primarily because we went 
into a recession, which was a function of two major events: the 
bursting of the Internet bubble which was the biggest bubble in the 
history of the world, bigger than the South Seas bubble, bigger than 
the-- 
   Chairman CONRAD. Tulip. 
   Senator GREGG. Tulip Bubble, that is right, which was a big bubble, 
actually. But a bubble of disproportionate effect on our economy when 
it did burst. 
   And then second, the attacks of 9/11, which threw us into disarray 
as a Nation, emotionally, psychologically, culturally, and 
economically. 
   We have come out of that, though. We have come out of it primarily 
because we have put in place an economic program which has energized 
the economy. We have created 7.4 million jobs. We have had, I think, 34 
months of continuous recovery and growth. We see revenues jumping 
dramatically in the last 3 years and 9 percent just in the last 
quarter, which is a huge jump considering that 9 percent is off a base 
that actually jumped by about 11 percent in the prior quarter, 
comparative quarter, and about 7 percent in the prior quarter to that. 
   We are now generating revenues, and this is the most significant 
point, which actually exceed the historic average of revenues to the 
Federal Government. We are up around 18.4 percent of gross national 
product coming into the Federal Government. Historically, we have been 
at 18.2 percent. And we are headed toward 18.6 percent, which are big 
numbers. Those are big numbers between 0.2 and 0.4. 
   So we are generating significant revenues at the Federal level. It 
is also important, I think, to appreciate the fact that the income tax 
has become even more progressive under the President's proposals, under 
the Republican proposals that were passed in the early 2000's under the 
leadership of Senator Grassley. We now have more progressive income tax 
law, where the top 20 percent of income tax--of earners in our society 
are paying almost 85 percent of the burden of the income tax, whereas 
under President Clinton they were paying about 81 percent of that 
burden. 
   And the lowest 40 percent of income earners, they do not pay taxes. 
They are getting more back under the Earned Income Tax Credit, almost 
by a factor of two, then they received back under President Clinton's 
period. 
   So we now have a tax law that is generating more revenues to the 
Federal Government than historically it has generated, and is more 
progressive. It taxes higher income--higher income people are paying 
more. 
   I congratulate Senator Grassley for having orchestrated that. I 
think the success story is significant and we should acknowledge that. 
   But there still remains this issue, which the Chairman and I totally 
agree on, which is that in the out-years we do not have a Government we 
can sustain because of the fact that we are facing a baby boom 
generation that is going to double the size of the retired population, 
which increases exponentially the cost of health care benefits and 
retirement benefits, and that our children will not be able to afford 
our generation when it is retired. 
   And so we should be looking for more places where we can more 
efficiently raise revenue. And I guess my questions to you will be 
along the lines of--after you have explained to us what really is the 
tax gap that we can still recover, what is that number--is there a 
better way to raise revenue independent of the tax gap? Is there a 
better way we can do this? Should we go back to an 1986 type of tax 
reform exercise where we basically consolidate, reduce the number of 
deductions? Actually reduce rates but clean out the underbrush of 
deductions? 
   I think you can be very helpful to us not only in explaining what 
the real number is that we could score and generally use, a hard number 
for covering the tax gap over the next 5 years, but if you have ideas 
as to how we can actually have a better system of taxation. 
   I thank you. 
   Chairman CONRAD. I am sure my colleague misspoke when he said 40 
percent of the people do not pay taxes. I think he meant to say income 
taxes. 
   Senator GREGG. That is correct, I was talking about income taxes. 
   Chairman CONRAD. As he so well knows, a significant majority of the 
people in the country pay more in payroll taxes than they pay in income 
taxes. 
   Senator GREGG. But I would note that my statistic is correct, that 
for the bottom 40 percent who pay income-who are subject to income 
taxes, those folks do not pay an income tax, but rather they receive 
money back under what is basically an inverted tax system, through the 
Earned Income Tax Credit. And they are now receiving more money back, 
as almost twice as much money back, today as they received under the 
Clinton years. 
   Chairman CONRAD. And of course, not all of the 40 percent received 
earned income tax credit but some of them do. 
   Where we have a difference is there is no question that tax 
reductions help fuel economic growth. There is also no question that 
tax cuts do not pay for themselves. If they did, we could just cut 
taxes more and balance the budget. 
   So all of this is a matter of balance. How do we ultimately achieve 
balance so that we are not continuing to run up this massive debt? And 
that is a place where the ranking member and I entirely agree. We have 
to have some balanced approach to deal with this demographic tsunami 
that is coming at us. 
   And one approach that we hope is fruitful is to deal with the tax 
gap. And that is why we have asked for this hearing and asked, Mr. 
Commissioner, to have you here. So please proceed with your testimony. 

               STATEMENT OF HON. MARK W. EVERSON, COMMISSIONER, 
                         INTERNAL REVENUE SERVICES, 
                         DEPARTMENT OF THE TREASURY 

   Commissioner Everson. Thank you, Mr. Chairman, ranking member Gregg, 
members of the committee. 
   I am pleased to be with you this morning to discuss the President's 
2008 budget proposals on tax compliance. I am glad that the committee 
has again expressed an interest in this subject of tax administration, 
and is holding this hearing, even in this inclement weather. 
   Actually, I am not really surprised that two individuals from North 
Dakota and New Hampshire failed to be intimidated by what sends 
Washington into something of a tailspin. 
   And we did note in our records, Senator Gregg, your birthday, and we 
wish you many happy returns. 
   Senator GREGG. That must be an inside joke. You use that a lot, 
don't you? 
   Commissioner Everson. Thank you for your interest in our activities. 
I have been on this job almost 4 years now. And during this period we 
have worked hard to restore IRS enforcement capabilities. We have made 
a great deal of progress. As we discussed last year, for a period of 
time our enforcement functions largely stood down. Over the last 
several years I would suggest we have restored respect for tax 
enforcement and the need to comply with the law. 
   But I would add that we have not done so at the expense of service 
to taxpayers. In fact, Senator Grassley recently visited the IRS and he 
made this point, and made it publicly, that we have been able to bring 
up the enforcement level without a lot of complaints about service. 
That has been very important. 
   At the IRS, our working equation remains service plus enforcement 
equals compliance. I think we have a pretty good balance right now and 
are making strides in both areas. 
   Turning to the President's budget request for the IRS for 2008, I 
want you to know that I am pleased with the submission, which provides 
almost a 5 percent increase from the expected 2007 funding levels. Most 
significantly the request not only augments our enforcement activities, 
but also devotes moneys to rebuild our systems infrastructure and 
increase our research capabilities. I feel that the request reflects 
Secretary Paulson's and Director Portman's confidence that the IRS will 
use these moneys wisely and generate a positive return for the 
Government. 
   I know that a subject of keen interest to members of the committee, 
and to many others in the Congress, is the tax gap. By the tax gap, I 
mean the difference between taxes owned the Government and those 
actually paid on a timely basis. 
   Before taking your questions, I would like to make several 
observations about the tax gap. First, while the most recent National 
Research Program study did a good job of updating our numbers, we need 
more research to better identify the sources of noncompliance. We need 
to conduct this research on a timely and continuing basis. 
   Second, I think it is well understood that we will never be able to 
audit our way out of the tax gap. While simplification of our tax laws 
will surely help the vast majority of Americans who already voluntarily 
comply with those laws, I would note that we will actually have to 
complicate the code to change the behavior of noncompliant taxpayers, 
for example, by requiring more information reporting. 
   Third, in recent years we have, as you noted Senator Gregg, made 
progress in improving compliance, as indicated by the steady growth in 
our enforcement revenues--the direct moneys we receive from collections, 
audit, and document matching activities. 
   Fourth, to reduce the tax gap dramatically would take some draconian 
steps, ones that would fundamentally change the relationship between 
taxpayers and the IRS, require an unacceptably high commitment of 
enforcement resources and risk imposing unacceptable burdens on 
compliant taxpayers. 
   Nevertheless, there are reasonable steps that can be taken to 
improve compliance. We have made 16 such proposals. In order to further 
improve tax administration, I ask the Congress to fully fund the 
President's 2008 budget request for the IRS and to enact the 16 
accompanying legislative proposals into law. 
   Thank you. 
   [The prepared statement of Commissioner Everson follows:] 


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   Chairman CONRAD. Thank you, Commissioner. I appreciate very much 
your testimony. 
   Let us get right to it. In previous testimony before the committee, 
you have indicated that you believed that we could capture $50 billion 
to $100 billion a year in additional revenue without dramatically 
affecting the relationship between the taxing authority and taxpayers? 
   Commissioner Everson. Yes. 
   Chairman CONRAD. You have now come forward with 16 proposals, many 
of them on the information side which I completely agree with. That is 
a place that you need our support. 
   Let me talk first about the budget side, because I look at what was 
done to you in the CR and I regret very much that you were reduced $100 
million on the enforcement side from what was in the President's 
proposal. Is that not correct? 
   Commissioner Everson. I believe that is about correct, yes, sir. 
   Chairman CONRAD. That is an area, it seems to me, that should be 
made up to you. That would be the first area. 
   The second area, as I look at, being a former tax commissioner, I 
look at the infrastructure, especially on the technology side, 
especially on the information technology side. And I know what a 
profound difference it made to my operation when we had a great leap 
forward. 
   I have looked at the spending there and I believe it would be 
prudent to add some money there. We do not want to waste money. We do 
not want to give you money that you could not spend efficiently. 
   So it looks to me like the combined effect of those two would be 
$200 million or $250 million for 2008 and then something on that order, 
adjusted for inflation, going forward. If we were to provide you that 
kind of additional resources, could you employ them efficiently? 
   I know you are not here asking for more money. You have made that 
very clear to me. And I understand the way it works in an 
administration. I understand how that works. You fight for a budget. 
   But I will tell you looking at this, I look at the enforcement, I 
see that Congress took action to deny you $100 million that the 
President thought you should have. It seems to me that is just a 
mistake by Congress not to give you what was requested on the 
enforcement side. 
   And then I look on the information technology side and I know, I 
used to work very closely with the IRS on these issues when I was 
chairman of the Multistate Tax Commission. If you are going to be as 
efficient as you can be and have the spin off benefit of an improved 
information system, we need to put some more money there. 
   So I would ask you, if we were to give you another $200 million to 
$250 million, could you give us a plan on how you would deploy that and 
could you deploy it efficiently? 
   Commissioner Everson. Let me respond first that I would ask the 
Congress to give us a budget. We are now 4.5 months into this fiscal 
year and I do not have a budget for the IRS. That is not the way to run 
a railroad. 
   I would ask you, first and foremost, to finish your work on the 
budget and the appropriations before fiscal year 2008 starts. We can 
plan, we can make adjustments, we can be much more rational in how we 
run an agency if we have a budget before the year starts. 
   Second point I would make is I am pleased with this budget. I am 
asking for every penny of this budget and not a penny more. As you know 
from our discussions, I have been through four budget processes so far, 
and we have never been fully funded on the infrastructure. If you look 
at the combination of the infrastructure and the enforcement side, this 
core infrastructure line has been held sort of stable. 
   Chairman CONRAD. In fact, is it not the truth of the matter you have 
been--as I look back--you have been cut every year? 
   Commissioner Everson. We have been cut about $570 million from the 
President's request in the enforcement and infrastructure categories 
over that period of time. I would note the infrastructure is 
particularly important in the 21st century and that it does not just 
help on enforcement. It helps on the services side of the organization, 
too. It is very important in terms of processing returns, being able to 
answer questions, processing notices, a whole host of things that 
happen. 
   But what I would caution the committee, again I am not asking for 
this additional money. If you have a tight budget or you cut a budget, 
an organization responds by cutting capacity. That is what we do. If 
you grow a budget too quickly, you lose control. You do not want to 
lose control at the IRS. We will head back down a road that is not 
good. We have been very careful as we have brought back up enforcement. 
So particularly on enforcement, I think there is an issue here. We have 
attrition and we have, as many agencies do, have a higher level of 
attrition that is taking place right now with the older work force. 
This is a Government-wide issue but one we have felt particularly 
acutely. 
   The combination of hiring to replace attrition and then adding new 
people for the over $200 million of enforcement initiatives we have 
means that we are about at the max of what we could take. It would be 
imprudent to throw more money at us in that regard, if you follow the 
concept. Just the ability to hire and train-- 
   Chairman CONRAD. And I understand that absolutely. That is why I am 
asking you, we do not want to give you money that you cannot 
efficiently and effectively employ. 
   Commissioner Everson. Yes. 
   Chairman CONRAD. But you have been reduced from what the President 
concluded that you needed in enforcement, $100 million in 1 year. It 
seems to me clearly we ought to make that up to you. 
   And then on the technology side, it looks to me like you could, just 
looking at the budget submission, knowing what I know about where you 
are, that you could use another $100 million or $150 million there 
effectively. 
   We know you are not asking for more. You have made that very, very 
clear. 
   Commissioner Everson. You know, I cut a deal with the 
Administration. We work hard to get to a number that everybody can be 
happy with. 
   Chairman CONRAD. I know how that works and I respect it and I 
respect that you are a good soldier. But we have an obligation here, 
too. Frankly, Congress took this $100 million out of enforcement. I am 
asking if we gave you that $100 million back, could you effectively and 
efficiently employ that? 
   Commissioner Everson. We would take a look at that issue. Again, it 
comes down to the hiring. And on the infrastructure it comes down to a 
whole series of things we would have to look at. If you ask us, we will 
look at it. 
   Chairman CONRAD. If we were to give you another $100 million or $150 
million on the information technology side, could you effectively and 
efficiently employ that? 
   Commissioner Everson. That is somewhat less sensitive to the issue 
of absorption, but not totally insensitive to that issue. So again, you 
would have to be very careful as to where you spent that money. 
   Chairman CONRAD. Let us go back to the question, and I have gone 
past my time here. 
   When you previously testified, you indicated that we could--if all 
of the things were done that you were suggesting, that we could raise 
$50 billion to $100 billion a year without having a significant impact 
on the relationship between taxpayers and the taxing authority. 
   Commissioner Everson. Sure. This comes down to what Senator Gregg 
was referring to. If we look here, this chart shows the change in 
enforcement revenues that the IRS brings in over a period of time. The 
blue tube is the collections: money that people recognize they owe, but 
they have not paid, and that we get over a period of time. 


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   The yellow strip, that is our document matching activities. That 
process is when we send you a notice saying we have seen more dividends 
reported by the brokers than you have actually shown on the return. 
   And the green strip, which has shown quite a bit of growth, is audit 
results. 
   If you take the difference between 2001 and 2006--and 2001 coincides 
with when we did the studies that came up with the $345 billion and the 
$290 billion--the delta is about, I think, plus or minus $15 billion. 
Now if we go to the next chart, the people who have studied this would 
say those moneys are just the direct impact. That is when we audit Kent 
Conrad and we know you are clean as a whistle--but it might influence 
your colleague, Senator Gregg, to be maybe a little less aggressive. 
That is the indirect effect. 

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   Chairman CONRAD. He is clean as a whistle, too. 
   Commissioner Everson. Is he? Good. 
   Senator GREGG. You can take that to the bank. 
   Commissioner Everson. But the people who study this would tell you 
that, depending on the nature of the enforcement activity, there is an 
indirect compliance effect of four or five, sometimes 10, to one. What 
we have done here is said, even if you assume a very conservative 
indirect effect of three to one, that would indicate if you have a 
direct impact of somewhere around $15 billion, you might have already 
recovered $60 billion or so. 
   So I think that probably just by bringing up the enforcement--I do 
not want to be precise here. I would caution everybody to not try and 
get too exact here. I think we are probably somewhere around the lower 
end of that bracket. 
   Now what the Administration has done is put in some more money for 
service. You could argue about whether we ought to put in a little bit 
more. We believe that will get us additional moneys in, both directly 
and indirectly. And then we have put together a basket of these 16 
proposals and that will get us some more as well. So I think we will 
get into this zone. 
   Now there has been conversation, I know my boss was here last week 
and also testified at Finance and elsewhere, with some people saying 
''jeez, you have to go further, this is a modest set of proposals.'' I 
think these proposals are quite significant in the sense that we have 
already got people screaming about the credit card reporting. That is, 
I think, the most important proposal. We are asking that for small 
businesses, which really very significantly understate their revenues, 
that we get the gross receipts once a year from the credit card issuers 
about a dry cleaning business or a restaurant or a car dealership. We 
think that will have a big impact. 
   But already we are into arguments where people are screaming about 
how much burden and how unfair some of these steps will be. What I 
 would say to the committee is I am satisfied with the basket of 
proposals we have, just like I am satisfied with the budget. I think if 
we do these two things together we will get more squarely into this 
zone, this range. 
   You asked me that question last year, Senator, and that is when I 
offered a guess, $50 billion to $100 billion. But I think we will 
approach the middle of that range if we do these things that we have 
proposed. 
   Chairman CONRAD. All right. Senator Gregg. 
   Senator GREGG. Thank you. Picking up on that point, if I read these 
charts  correctly what you are really saying here is that because you 
have ramped up enforcement significantly since 2001 and you have 
generated the $17 billion in real gain and enforcement, and then the 
$68 billion in what you think is enforcement that comes because people 
see somebody else being audited and they say well, I better get my act 
together, that really the increment that you are talking about that may 
still be available as low hanging fruit, so to say, would be between 
$68 billion and say $100 billion, somewhere in that range. So the 
increment on top of this probably is $30 billion or $20 billion, not 
$100 billion; is that correct? 
   Commissioner Everson. I think that is right. This gets harder with 
each additional step. Senator Grassley, of course, can comment on the 
struggles in Finance to get anything through to close some of these 
loopholes; it gets harder. 
   Senator GREGG. What I am trying to get to is a quantifiable number. 
Commissioner Everson. Yes. 
   Senator GREGG. It looks to me, looking at your charts here, that 
what you are essentially saying is that over a 5-year period--and 
remember I presume you would again only ramp up--that by the fifth year 
you might be able to generate another $20 billion to $30 billion? 
   Commissioner Everson. I think if we got everything here, meaning the 
budget and the proposals. I think the proposals have been scored 
conservatively by the Treasury Department economists, and will been 
looked at by the Joint Committee economists conservatively, as well. 
And there are valid reasons for that, because oftentimes you will pass 
something into law and the IRS will not fully implement it because, for 
example, we will not get the money to do the document matching that we 
are now allowed to do from the third-party reporting. 
   But if everything works together, I think we will get that kick, 
that lift. I would not want to speculate that it would get as high as 
$30 billion. But when I think of the basket and compare it to 2006 
where we say maybe haveten at the low end of that range, $20 billion 
would be a reasonable ballpark 4 years out. 
   Senator GREGG. If we were thinking about how we would score this 
budget-wise, assuming we could even get OMB to score it at all, which 
they probably would not, you would have to ramp up to that $20 billion. 
So over a 5-year period you are probably talking, because these 
regulations would go into--assuming you could even get these 
regulations passed--they would go in over a period of time. And 
certainly, for example, reporting capital gains basis would take a long 
lead-in. 
   Commissioner Everson. Yes, sir, that definitely ramps up overtime. 
   Senator GREGG. So we are probably talking a ramp up to say $25 
billion or somewhere between $20 billion and $30 billion, which would 
mean over the 5-year period you might be able to score say $35 billion 
total, something like that. 
   Commissioner Everson. I do not want to promise a particular number, 
but you are looking at it conceptually correctly. 
   Senator GREGG. Conceptually and in a range. 
   Commissioner Everson. Yes. 
   Senator GREGG. So when you talk about these proposals, you have 
given us these 16 proposals. We are not the authorizing committee, 
obviously Senator Grassley is the former chairman and ranking member of 
that committee. 
   But I asked you if you could rate these on a--if you could give me 
the top four. And just for the public record, you told me the top four 
were--the first one you have already mentioned, which is getting gross 
receipts from merchants' credit cards. 
   Commissioner Everson. Yes. 
   Senator GREGG. The second one would be a felony for failure to file. 
   Commissioner Everson. Yes, sir. 
   Senator GREGG. The third one would be basis reporting on security 
sales. 
   And the fourth one would be failure to file electronically for 
businesses. Those would be the top four that you think would be the 
most-- 
   Commissioner Everson. The last one is actually lowering the 
threshold where you make it mandatory to file electronically.  
   Senator GREGG. Which is a specific assessable penalty. No, it says 
establish specific assessable penalty for failure to file, so I may 
have misunderstood. 
   Commissioner Everson. That is actually a slightly different type 
of-- 
   Senator GREGG. You are talking about expanding electronic filing. 
   Commissioner Everson. Yes, lowering the threshold for when you are 
required to electronically file. 
   Senator GREGG. So those would be the top four and then the rest, 
obviously the other 12 you would also like on top of those. 
   Commissioner Everson. What I would like to emphasize to the 
committee is these all work together. What happens is preparers and 
others respond to the overall change in the climate, and to the fact 
that the IRS and Congress are doing more. So, I am not trying to say it 
is an all or nothing proposal. But the more you do, the bigger this 
indirect effect, I believe, becomes. 
   Senator GREGG. I think that is just human nature and unfortunately 
OMB refuses to score--or CBO refuses to score obvious human nature, 
such as if you cut capital gains rates people free up capital and sell 
and generate more capital gains, things like that that are obvious are 
not obvious to some. But your point is obvious to me. 
   Thank you. 
   Commissioner Everson. We try to be practical at the IRS. We are not 
as smart as the economists. 
   Chairman CONRAD. Let me just say that I think you are being you too 
modest. If the tax gap net is about $300 billion a year times five, 
that is $1.5 trillion. And as I have heard your answer to Senator 
Gregg, it sounds to me like you are talking about recovering $30 
billion to $50 billion of that. That would be, on the low side, 
one-500th of it, and on the high side one-300th. 
   Senator GREGG. He is saying-- 
   Chairman CONRAD. What he has done is he has put a multiplier effect 
on a number that is hard. The multiplier is soft. If you put a 
multiplier on the tax gap that was identified by the Revenue Service 
back in 2001, $290 billion, if you put that same multiplier on it as he 
has put on collections, you would have a tax gap that was $1 trillion. 
   Senator GREGG. That is apples and oranges. 
   Chairman CONRAD. No, it really is not apples and oranges because he 
is saying that compliance has a ripple effect. Certainly noncompliance 
would have a ripple effect, too. 
   Commissioner Everson. I do not think that is fair, Mr. Chairman, 
because what we did our best to do in the NRP study was to measure at a 
point in time, and to come up with a real estimate of total 
noncompliance. 
   Chairman CONRAD. But isn't it the case that that point in time is 
2001? 
   Commissioner Everson. Absolutely, that is correct. 
   Chairman CONRAD. But we do not know what happened between 2001 and 
later. 
   Commissioner Everson. That is why I am trying to be very general and 
not be precise when we get into, ''is it $60 billion or $50 billion?'' 
I am just trying to say I think we were already somewhere around the 
lower end of the bracket that you and I discussed last year. 
   Chairman CONRAD. I have a hard time believing that, I honestly do, 
because I know what happened. I have many contacts, as you know, and as 
you do, in the taxing profession and the accounting profession. They 
tell me the culture has changed dramatically and people have gone to a 
far more aggressive approach to how they approach paying their taxes. 
   Again, I would just say to you if the tax gap was $300 billion a 
year, 5 years, that is $1.5 trillion. What I hear you talking about 
here is it may be $50 billion. That is one-300th, according to my math. 
We have to do better than that. 
   Senator WHITEHOUSE. 
   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   I want to, first of all, make clear to people who are watching that 
as we are talking about the potential for increased enforcement, the 
average American taxpayer, who feels a chill down his or her spine when 
he hears that phrase, is not really the focus of what we are getting 
at. We are getting at relatively complex schemes to dodge taxes; is 
that correct? 
   Commissioner Everson. Senator, on the first point, we say that we 
want to provide services to taxpayers because it helps them understand 
their obligation and facilitate their participation in the system. We 
enforce the law because average Americans, the vast majority, pay 
honestly and accurately. And they have every right to believe that when 
they do so, neighbors and competitors are doing the same. 
   But while you are correct that there is a lot of money in the 
high-end and the complicated shelters which we have been pursuing--my 
first priority over these last 4 years is to increase our penetration 
in high-income individuals and corporations. And we have done that. The 
majority of the tax gap is in under-reported income by individuals. 
And the biggest single piece of this under-reported income is by 
individuals who are actually operating as a small business but 
unincorporated. This is the understatement of revenues, principally. 
   The difference is what I would say is-- 
   Senator WHITEHOUSE. But it is pretty hard to deploy the limited 
resources that you have effectively on a case-by-case basis to make a 
case against an individual private owner. 
   Commissioner Everson. Yes, sir. 
   Senator WHITEHOUSE. Those are the people who feel the effects of it 
and get the message and comply. But the actual enforcement would 
presumably be directed against high income, high networth, and 
corporate entities. 
   Commissioner Everson. It would be a combination of things. What you 
are getting at is one reason why we are putting in the third-party 
reporting proposals. 
   Let me give you one example. The last time there was significant 
change in this area was in 1986, when there was major tax reform, as 
you may remember. That year we added a requirement to the 1040 for the 
Social Security numbers of dependents. The next year, even though the 
IRS did no matching with Social Security--it took us a year to get that 
going--five million dependents vanished. That is a lot and that is a 
lot of money. 
   Senator WHITEHOUSE. Well, let me give you a counter-example. This is 
a story from the Wall Street Journal that does not involve Federal 
taxes, it involves State taxes. But it is pretty remarkable. 
   It talks about Wal-Mart, and I will read just a few selections. ''As 
the world's biggest retailer, Wal-Mart Stores Incorporated pays 
billions of dollars a year in rent for its stores. Luckily for 
Wal-Mart, in about 25 states it has been paying most of that rent to 
itself--and then deducting that amount from its state taxes. 
   The strategy is complex but the bottom line is simple: It has saved 
Wal-Mart from paying several hundred million dollars in taxes, 
 according to court records and a person familiar with the matter. 
   ''The arrangement takes advantage of a tax loophole that the Federal 
Government plugged decades ago, but which many States have been slower 
to catch. Here is how it works: One Wal-Mart subsidiary pays the rent 
to a real estate investment trust, or REIT, which is entitled to a tax 
break if it pays its profits out in dividends. The REIT is 99 percent 
owned by another Wal-Mart subsidiary, which receives the REIT's 
dividends tax-free. And Wal-Mart then gets to deduct the rent from 
State taxes as a business expense, even though the money has stayed 
within the company... 
   The so-called captive REIT strategy alone cut Wal-Mart State taxes 
by about 20 percent over one 4 year period...'' 
   ''The structure Wal-Mart is using''--this is the part I love-- 
''features some unusual elements. Because REITs must have at least 100 
shareholders to gain tax benefits, roughly 100 Wal-Mart executives were 
enlisted to own a combined total of around 1 percent of the REIT 
shares,'' all nonvoting. So they went and rounded up 100 executives and 
said guess what, you are a shareholder to make this thing work. 
   ''A single Wal-Mart real estate official, Tony Fuller, represented 
the company both as tenant and landlords in its leases with itself. 
Ernst and Young, the accounting firm that sold the strategy to 
Wal-Mart, also is the company's outside auditor.'' 
   Now that is a ton of effort to go through just to beat one State's 
taxes. So I have to believe that if one of the biggest corporations, a 
proud American corporation, is willing to create what looks to me an 
awful lot like a dummy corporation, set up with its own executives as 
the shareholders, just to dodge it, there is a lot of dodging going on 
out there. And the poor regular taxpayer who owns his own little 
business or just is getting a salary, nobody can compete with that kind 
of cleverness. 
   Commissioner Everson. Senator, we set out and we started in this 
enforcement build-up to work on high-income individuals with the 
shelters and the corporations. And we have brought up the enforcement 
quite significantly in both of those areas. I agree with your 
assessment. I spoke 2 years ago in January to the New York State Bar 
Association taxation section. There were 98 tables of 10, and these 
people are not representing EITC taxpayers. 
   You are entirely correct, there is a lot of energy around complying 
and then making sure that you are absolutely minimizing tax, if not 
altogether getting out of tax. 
   We work hard on this. This budget requests more moneys for going 
after the high-income individuals who are engaged in these shelters. 
Our audit rate is now over 6 percent for individuals who are earning $1 
million. That is a very high audit rate. We have $26 million more in 
here for the corporate arena and something like $70 million or $80 
million to work in the small business and high-income individual areas. 
So we agree with you that is where you go. 
   I do want you to understand, though, that the big piece of the tax 
gap is in the individuals and small business area, which is not all 
high income people, just plain under-reporting income. We do not want 
to enforce our way out of this. What do want to get some help on the 
reporting. 

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   Senator WHITEHOUSE. Thank you, Mr. Chairman. 
   Chairman CONRAD. Senator Grassley. 
   Senator GRASSLEY. Thank you very much. 
   I am going to put a statement in the record that was leading up to 
my questions, so I can go immediately to the questions. 
   [The prepared statement of Senator Grassley follows:] 

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   The second question I was going to ask has been pretty thoroughly 
handled by Senator Gregg. But I want to emphasize there, if I can, and 
ask you to shake your head without taking too much time because I want 
to get to the other four questions. 
   I think the bottom line of what you and Senator Gregg were speaking 
about it that the $50 billion to $100 billion figure of the tax gap, a 
lot of that is already in the baseline? 
   Commissioner Everson. That is right, sir. We have already achieved, 
probably, toward the lower end of that range. 
   Senator GRASSLEY. So then I want to interpret what Senator Gregg was 
saying about getting a quantifiable number. I do not know why Senator 
Gregg wanted to get a quantifiable number, but the reason I want to get 
a quantifiable number is because regardless of the fact that the Joint 
Committee on Taxation and CBO do not score revenue from changes in 
enforcement, a quantifiable number and a pretty hard number is pretty 
important. Because there is a lot of people over the next month or 
month-and-a-half, when we are having budget debates in the committee 
and on the floor, they are going to look at the tax gap as a pot of 
gold. And it is a legitimate question. 
   I have been working with Senator Baucus, he has been working with 
me. We are going to try to get all the money we can. But I want to make 
sure that we are talking about real money and not blue smoke. And there 
is a lot of people who are going to be counting blue smoke because they 
want it as offsets. 
   Commissioner Everson. I agree. 
   Senator GRASSLEY. They want it as offsets. So that is why it is very 
important for you to help us get as definitive figures as you can of 
quantifiable numbers, so we do not get a lot of this blue smoke 
involved in this offset game. 
   Commissioner Everson. Yes, sir. 
   Senator GRASSLEY. I am going to go through these other questions 
quickly because you are supposed to have some idea what I was going to 
ask. 
   How would the IRS have to change its enforcement practices to 
actually close the tax gap? How much more intrusive would the IRS be in 
the lives of taxpayers? And what kind of timeframe should Congress 
expect for the resulting revenues to come into the Treasury? 
   The fourth question, the President's budget contains proposals that 
would expand information reporting from credit card transactions, 
broker transactions, payments to corporations, and cost basis for 
security transactions. 
   Some members, and principally those on the other side of the aisle, 
have criticized these proposals as not going far enough because they 
only bring in about 1 percent of the tax gap. 
   So how could these proposals be strengthened? And what other types 
of income should be considered for expanded information reporting and 
withholding? 
   Fifth, in your view what role should tax reform and simplification 
play in this? 
   And the last question, these last two will be a little--let me go to 
the sixth one. 
   The role of the private debt collection program in going after the 
tax gap is how big of a factor? Would you answer those, which would be 
basically three, four, five and six? 
   Commissioner Everson. Let me sort of group the first two. What I 
would say is this gets back to this question of burden and balance, and 
when do you get to be too intrusive? The packet of proposals we have 
made, with the credit card reporting and others, we think, are 
significant; they already are generating a lot of squawking. 
   Other ideas that have surfaced. The taxpayer Advocate has talked 
about withholding, more withholding, on payments to independent 
contractors. I have opposed that, saying that I do not think that is 
something prudent to do now. 
   But there are any number of things that you can add to this package. 
You just get to the very difficult tradeoffs and add more burden for 
the people that Senator Whitehouse was concerned about a few minutes 
ago. That is the nub of this. That is where, if you really want to get 
big money, you have to go. But you are going to get a firestorm. 
   And I have to say again, just as the budget has not been passed, we 
had five of these proposals up here last year, as you know, and we got 
one through. So let's get these done before we talk about going any 
further. 
   Tax reform. We favor tax reform. I testified before the Tax Reform 
Panel, saying that simplification is a good thing. What I always say is 
that complexity obscures understanding. The fellow who wants to be 
compliant can throw up his hands and say, ''hey, why bother? It is just 
too tough.'' Then the others, the fellows doing business--or purporting 
to do business-out of that house or building that you have shown, they 
use complexity and technology and all of the different subsidiaries 
that are mentioned in that article to obscure our understanding and 
 make it tougher to catch them. So we want simplification. We really 
do. I support that. 
   The last point, and I am glad you raised this, on the private debt 
collection. This relates to the issue that we talked about before, 
adding enforcement personnel. As we have brought up our enforcement 
capacities that, in turn, generates more collection work because we 
provide more assessments. We do an audit and then we have to collect 
that money. So our collection activities are growing, as well. 
   Add to all of this the churning of our own people. And then we add 
people through this initiative. I can tell you that this private debt 
collection is critical to supplement what we are doing, because we 
would not be working these cases. We have already started this program 
successfully, got in some millions of dollars already. These are cases 
we would not be working in the next several years in any event, just 
because of capacity issues in terms of how quickly you can grow your 
work force. 
   So I am pleased with the program. We are monitoring it very, very 
closely to make sure we get the right quality, sir. And I think so far, 
so good. 
   Senator GRASSLEY. Thank you. 
   Chairman CONRAD. Senator Wyden. 
   Senator WYDEN. Thank you, Mr. Chairman. 
   Mr. Commissioner, in your view, would tax simplification and tax 
reform be a significant help in closing the tax gap? 
   Commissioner Everson. I believe tax simplification will help. What 
is important, and I said it in my testimony before that Tax Panel a 
couple of years ago, you cannot compare a perfect theoretical system 
with an imperfect real system. You have to make an apples to apples 
comparison, though. 
   Because people talk, as you know, you have raised reform proposals 
yourself. People talk about VAT and other systems. Whatever system you 
choose, there are compliance issues with that system. That is what I 
ask people to consider. The other thing I ask people to remember is, 
whatever you do, if you did real simplification or real change, you 
would have a transition period that would run for some years. It takes 
us a long time to unwind what has happened in a given point in the 
year. So you just need to be attentive to those two factors, sir. 
   Senator WYDEN. We will be back at you on this topic. Chairman Conrad 
has put together a group here on the committee that is going to look at 
these issues. We will have some more to discuss with you in that regard 
shortly. 
   Let me ask you about a very troubling report that involves senior 
agents in the IRS complaining. This is the people with decades of 
experience complaining in the large corporate auditing unit that 
deadlines have been set by some of the political appointees that close 
the audits early. 
   The reason I find this troubling is that some of these employees 
have been in the IRS for decades. There is a fellow in Colorado who has 
been one of your auditors for three decades and he is speaking out 
publicly. He got asked to be transferred, and the like. 
   And so you hear his comments and you square it with what you have 
told us, which I have always thought was laudable, that you wanted to 
put a bigger focus on it. What is going on here? Are these agents just 
wrong? Because apparently there are a substantial number of them that 
are very outspoken and they are also describing specifically the 
techniques by which the agency is involved in some of these strategies 
that limit our ability to close the tax gap. 
   Commissioner Everson. I am glad you raised this issue, and I get the 
opportunity set the record straight on this. Let me make a couple of 
points. 
   First, there are only two political appointees in the IRS. I am one 
and the Chief Counsel is another. Two out of 100,000. We play it 
straight down the middle. I make decisions every day that favor the 
Administration or disfavor the Administration. And they are made 
without regard to politics. 
   I believe I do my job best by calling it down the middle. That 
serves the country, and I think it serves the President as well, 
because we all know there is a bad record when you try to reach into 
the IRS from the White House or anywhere else. So the first point I 
want to make is there is no politics in here. 
   The second point comes down to cycle time. I believe that one of the 
biggest problems we have in the system is the long period of time it 
takes to resolve tax matters. You will come up with an idea, and it 
will go into law, and it is not clear what the ramifications of that 
law is for up to 20 years. That is because the IRS takes several years 
to issue guidance on what you really meant. Then it takes us five or 10 
years to get to an audit on a large corporation. We make an assessment. 
Then they go into the appeals process. And then it goes into the courts 
and it takes 5 years. It can take 10 or 20 years. 
   In today's world, that long cycle time is a detriment to compliance 
because the world is changing rapidly. Corporations need some stability 
to plan. And I would say to you, as a general principle, uncertainty is 
a bad thing for the compliant taxpayer and the length of cycle time is 
bad for us in terms of getting after problems. 
   Senator WYDEN. Let me, if I might, because I am running out of time. 
I think those are all valid points. 
   Commissioner Everson. I have some specific statistics I would like 
to show you, but I wanted to make that point. 
   Senator WYDEN. Good. 
   Commissioner Everson. Can I show those to you? 
   Senator WYDEN. Sure. 
   Commissioner Everson. Corporate audits, let us go to the audit 
numbers. The corporate audits on the biggest corporations, which were 
the subject of these discussions, reached a low point in 2003. That is 
the year I got there. 


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   The audits are now higher--these are the biggest companies that he 
was writing about--than at any time in recent years. What we have done 
is brought up the penetration in the companies with between $10 million 
and $250 million in assets, where we were doing very little. 

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   Now dollars recommended, which is what gets into, ultimately, the 
enforcement revenue. In 2003, when I got here, on these big companies 
we recommended $12 billion. That has more than doubled. Last year it 
was $30 billion and $25 billion in 2006. 
   I would be concerned if these agents were saying that they were 
being sent home to work on training or something and they were not 
doing work. But the truth is we are doing more audits. We have gone 
from 7,000 total audits to 10,000 total audits. And we have recommended 
more money. We have gone from $13 billion to $26 billion. 
   The final point I would make on this is that corporate tax receipts 
as a percentage of the GDP have gone to the highest level in 18 years. 
They have recovered to the highest level. They mirror profits. We put 
in the cycle time initiative and I would be very concerned if either 
what we were setting up was going down or not recovering. When I look 
at it in the big picture, I think it is OK. 

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   The last thing I will say is individual managers may make a mistake 
in saying to employees, ''you have to close this out and move on to 
something else.'' That is a difficult discussion. I am sure we are not 
perfect there. But I look at the big picture, Senator, and I think what 
we have done is responsible and correct. 
   Senator WYDEN. The only thing I would say, Mr. Commissioner, and I 
want to ask one other question, with the Chair's indulgence, is I have 
seen your numbers. I have heard you speak about this. And yet I read 
these reports about policies, coming from these senior people that are 
troubling. I would just like you to look into them and get back to me. 
For example, apparently these senior auditors are saying they were told 
to limit questioning only to those specific issues that the IRS and the 
companies had agreed in advance to examine. So they get into the audit, 
they see other things, and apparently these people say they are not 
allowed to go further. 
   Would you get back to me on that? 
   Commissioner Everson. I certainly will and I appreciate your raising 
the question. 
   Senator WYDEN. Great. One last question, and I appreciate the 
Chairman's indulgence on this. 
   As both Chairman Conrad and Senator Grassley know--Senator 
Whitehouse has not gone through it--we have gone through a long debate 
about the question of Internet taxation. And what I and others have 
tried to do, and it is awfully arcane kind of stuff, is to say what we 
want to do is make sure that what applies off-line applies online. In 
other words, we would have neutrality. Nobody gets any breaks. 
Everybody is treated the same. 
   You all have been thrashing through this whole question of the 
auctions and brokers and the like. And there are some parts of the 
President's budget that raise questions in my mind with respect to 
making sure that there still is this nondiscrimination approach, as it 
relates to the technology companies. 
   The President's proposal, for example, requires reporting by brokers 
to the IRS. That strikes me as a constructive idea, as it will help in 
preventing tax cheats from getting away with their cheating and in 
closing the gap. 
   However, I am concerned that even though they are a broker under 
what is now the definition of a broker, the Joint Tax definition, that 
some may be trying to change the definition of a broker that could 
impact a variety of our technology companies. 
   Can you tell us your desires in this area? And particularly, I know 
it is hard to go through all of the details in a short exchange like 
this, your commitment to try to keep technological neutrality. We 
should not be favoring the on-line world. We should not be hurting the 
off-line world. What we have been trying to do is keep it in balance. 
Your thoughts. 
   Commissioner Everson. I am happy to get back to you in more detail 
on that, but my understanding of that proposal is that it does just 
what you have said, sir, which is it is neutral. The idea here is to 
sweep in brokers who hit a certain volume of activity. We do not want 
to burden somebody who is running a business--it could be a physical 
business or otherwise--where it is not even a business, let's say. 
   But if you are doing a real business and that is how you make your 
money, we want some reporting on it after you reach a certain trip line 
of volumes. The physical versus Internet piece is not, as I understand, 
a determining factor at all. So I think we are in the same place. 
   Senator WYDEN. Mr. Chairman, thank you for the extra time. 
   Chairman CONRAD. I want to go back over. 
   Senator GRASSLEY. Mr. Chairman, would I be able to get 5 minutes 
before 11:30? 
   Chairman CONRAD. Sure. 
   Senator GRASSLEY. Thank you. 
   Chairman CONRAD. Last year you testified before this committee--and 
Senator Gregg asked you this question: Let us say we were to take this 
number, $137 million, the President has asked for and double it. Could 
we presume that our return on that would be five times, 10 times? I 
mean, how would we--what, in other words, if we were going to offset 
that with receipts that we would score in our baseline, what would the 
number be that we would be considering putting in as a result? And when 
do we get to a diminishing return event? 
   Your answer: I do not 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 
billion or $100 billion without changing the way the government 
interacts with its citizenry. 
   And you had indicated that that was $50 billion to $100 billion a 
year. 
   Now you tell us, a year later, that all of a sudden, as I heard you 
say it, the most you could get is $30 billion a year. 
   Commissioner Everson. I think that if there is a disconnect here, it 
is that we were always talking about this 2001 starting point, which is 
where the latest research was. And I probably, to be clearer, should 
have drawn out all of the stuff that we were doing. You are right, I 
did not make that point as to what we were already doing. But I was 
looking at the reference point, as I do now, of the research in we did 
2001. And then you get into that zone, as I have indicated. 
   I probably was not as clear as I could have been, Senator. Because 
that is where the number came from. The number came from 2001 and the 
work we did based on that point in time. 
   Chairman CONRAD. By 2001, we have two moving pieces here. We have 
2001. If that is your base, is it your conclusion that the tax gap did 
not grow between 2001 and 2006? 
   Commissioner Everson. I believe we have made progress on the tax gap 
but obviously the tax gap--if all else was held equal, there were no 
changes--the tax gap would grow simply because the economy grew and the 
revenues grew. Whether you do it in real or nominal dollars, that is a 
different discussion. 
   But obviously, it changes. It also changes, sir, because of the 
change in the--you have different compliance rates on different revenue 
streams, as you can appreciate, as well. 
   Chairman CONRAD. I do. 
   It still leaves me baffled. Honestly, your testimony baffles me. I 
do not know how it can be that last year we could recover $50 billion 
to $100 billion a year from the tax gap. And now, as I hear your 
testimony, somehow magically that has been reduced to one-third of 
that. 
   When I look at the record on collections between 2005 and 2006 from 
enforcement, it has gone up by $1.4 billion. It went from $47.3 billion 
to $48.7 billion, a $1.4 billion increase. And all of a sudden your 
testimony of last year that was very strong, $50 billion to $100 
billion, you said you can clearly reduce it by $50 billion or $100 
billion. 
   And now your testimony this year is, as I hear you say it, $30 
billion. How can that possibly be the case? 
   Commissioner Everson. Again, we are now talking about a higher 
number than I actually gave. Senator Gregg picked $30 billion. I did 
not pick $30 billion. 
   But again, it depends on your starting point, sir. I think that if 
you take a look at this, you talked about the revenue recovery since 
2003. We have had this discussion, revenues have increased by over $600 
billion. I think tax administration has played a part in that and 
stronger enforcement has contributed to that increase. 
   I do not want to try to be overly precise, but I do not think we are 
just starting from ground zero today. 
   Chairman CONRAD. I know but this is testimony--Mr. Everson, this is 
testimony you gave this committee last year. 
   Commissioner Everson. Yes, and I did not say starting from today. 
Perhaps I failed to be clear. I was always looking at the context of 
2001. And I am sorry if that was not clear or I did not fully get that 
out. We have not been just sitting here. We have done quite a bit, as 
you know. 
   Chairman CONRAD. That is not my point. 
   Commissioner Everson. I understand. It is a different expectation. I 
understand. 
   Chairman CONRAD. My point is last year you testified very clearly 
before this committee and you said you can clearly--your words--you can 
clearly reduce it by $50 billion or $100 billion a year. 
   And now 1 year later, after a very modest increase in enforcement, 
actual collections, now you are all of a sudden at less than one-third. 
   Commissioner Everson. I do not think that is what I am saying at 
all. I am saying we are getting well over that. And if we did the 
research, we are going to start doing our research now. 
   Chairman CONRAD. All I can say is that is the most magical 1-year 
performance in history of tax administration. 
   Commissioner Everson. I did not say what the tax gap was. I never 
said what the tax gap was, sitting here a year ago. We are talking 
about 2001, sir. 
   Chairman CONRAD. Well, what you told us was--I do not know any other 
way to interpret your testimony, sir. Last year you told us very 
clearly--in fact your words--you can clearly reduce it by $50 billion 
or $100 billion a year. 
   Commissioner Everson. And I think we will have done that. When we 
next do the measurement, we will have seen that. 
   Chairman CONRAD. Based on 1 year of increasing collections by $1 
billion? 
   Commissioner Everson. What we talked about before, all of what has 
been done since 2001. 
   Chairman CONRAD. I will tell you, it is not credible with me. I am a 
tax administrator. We have a tax gap, I believe, conservatively $300 
billion a year, I believe conservatively. Because that is based on 
2001. There is no way the tax gap has not gotten bigger given the 
aggressive nature of accounting today and given the growth of the 
economy. There is no way that it is not more than $300 billion. 
   Commissioner Everson. Let me say this, too. 
   Chairman CONRAD. And to say we can only collect $30 billion of that? 
   Commissioner Everson. Let me be clear, too. I do not want a fixed 
point so that if we are here a year from now we have a similar 
conversation. The tax gap will, again absent these mixed factors, if 
you just take the gap as a percentage of the overall revenue stream, 
that will continue to grow. 
   What we are talking about--and you have that baked into your budget 
projections anyway. That is baked into your budget projections, the 
continuing growth in the tax gap. 
   What I am talking about with the $50 billion or the $100 billion, 
was at any point bringing that down relative to where it would 
otherwise have been. So you have to consider all of those factors, the 
growth and then the onset, which is real progress as a percentage of 
the total revenue stream. 
   Chairman CONRAD. Are you saying to us that you can only recover 10 
percent of the tax gap in a year? 
   Commissioner Everson. I do not think that is what we have said, at 
all. I think that what we said-- 
   Chairman CONRAD. What percentage--let me ask you that way. What 
percentage of the tax gap over time, if Congress goes along with your 
proposals, can you close? What percentage of it? 
   Commissioner Everson. Starting from here. 
   Chairman CONRAD. Yes. 
   Commissioner Everson. Starting from here-- 
   Chairman CONRAD. And what do you think the tax gap is starting from 
here? 
   Commissioner Everson. I do not have a precise number now. What I 
have said to you is if you look, coming back from that starting point, 
the $345 billion, we have done two things. We have made improvement 
through the recoveries, which is the extra $15 billion in direct moneys 
since 2001. And that recovery also has an indirect impact. So I am 
hopeful that if you measured today, did the same work, you would see 
some improvement in there. I think it gets toward--and again, I caution 
against real precision here. That was a pretty wide range--I think it 
gets toward the lower end of that range that we talked about last year. 
   If you now look going forward and you look at three things: the 
direct impact from the enforcement and the indirect impact that you are 
talking about in the budget; the legislative proposals; and the other 
point that Senator Gregg made that I did not draw out as precisely as I 
could have, the normal growth in our enforcementactivities. 
   Let us say if you take that at just 2 percent a year, you would 
expect, running a business, to get more productivity out of the 
business even with just a steady investment stream. If you just hold us 
to 2 percent a year there, then the impact of that is growth in that 
direct enforcement number as well. 
   So all of those things together, they mix up and they get to a 
number somewhere near what Senator Gregg was talking about. 
   Chairman CONRAD. So let me ask you, what is your testimony today? 
Last year you told us $50 billion to $100 billion a year. What is your 
testimony today? 
   Commissioner Everson. I will try to be as clear as I can and not 
over-promise the committee, because if I did that last year, if I was 
not clear enough saying looking at where we were in 2001, I apologize 
for that. 
   I think that if you look at these three things that I am 
mentioning--giving us the more money on both the infrastructure and 
the enforcement side, that basket of proposals, and the normal 
growth--I think that you are going to get a pop up by 2010 that might 
be somewhere around $20 billion, something like that. That is how I 
would bracket these things. 
   The numbers you have in the detailed budget submissions, they will 
tell you that we get $700 million on the enforcement initiatives and it 
would tell you that by 2010 you get $3.5 billion on the legislative 
 proposals, if you do all of them. And I would say if you take the 
indirect effect of the productivity and the growth and the enforcement 
initiatives, that would account for the bulk that would get you 
toward--somewhere toward over $20 billion. 
   But again, these things all work together. I want to say, if we sit 
here next year or Senator Baucus is quizzing me, as Senator Grassley 
knows, ''where is that money?'' But you have not given us legislative 
proposals or you cut the budget or you say spend the money differently, 
you get to a very different answer. 
   Chairman CONRAD. Let me just tell you, my conclusion from your 
testimony is that you are talking about recovering maybe one in every 
$30 that is in the tax gap in a year. 
   Commissioner Everson. I do not read it that way, 70 out of--if you 
take-- 
   Chairman CONRAD. But the problem is you are talking about dollars 
compared to a 2001 base. That is what you did apparently last year, 
your testimony this year, which I find baffling. 
   The tax gap is growing. There is no question in my mind the tax gap 
is growing. If it was $290 billion in 2001, what is it going to be in 
2010? It would not be unreasonable to expect it to be double that 
amount. That would be $600 billion. $600 billion and you are going to 
collect $20 billion of it, that is one-thirtieth. That is 3 percent. 
That is pretty tepid. 
   Commissioner Everson. I do not think you are recognizing the 
progress we have already made. 
   Chairman CONRAD. You have made progress. What I do not buy is the 
notion that this tax gap, even with your increased efforts, is not 
growing. The economy is growing and tax avoidance is growing. And 
anybody that is in your business that does not know or does not testify 
before this committee that there is aggressive tax avoidance going on 
out there is not being straight with this committee, in my judgment. 
   Commissioner Everson. Senator, I have to take exception to that 
because that implies that I do not strongly combat aggressive tax 
avoidance. 
   Chairman CONRAD. No, sir, that is not what I said. In fact, if you 
listened carefully, I commended you for what you have done. 
   Commissioner Everson. I know you did. 
   Chairman CONRAD. But let's deal with reality. The reality is that 
the economy is growing. 
   Commissioner Everson. I agree. 
   Chairman CONRAD. The reality is global economy is growing. The 
reality is you talk to any accounting firm off the record, and you know 
it and I know it, and they will tell you that tax avoidance is growing 
and it is growing dramatically. 
   When we have 12,000 companies doing business out of a five-story 
building in the Cayman Islands and they all say they are doing business 
down there look, I know better. I have been a tax administrator. I have 
audited the books and records. And I have talked to people who I trust 
in the accounting profession. This kind of scam is doing nothing but 
growing. 
   That is not a comment on you, it is a comment on reality. 
   Commissioner Everson. Let me take one final pass at this and then I 
will retreat. 
   As Senator Grassley knows--he had a hearing last June--some of the 
issues get beyond what would be, Senator, in the tax gap itself. There 
is a lot of aggressive tax planning and what we called tax arbitrage. 
That is not captured in this tax gap. That is the use by sophisticated 
players to generate excess foreign tax credits or to take advantage of 
the difference between debt and equity, the treatment under the law 
between different countries. 
   That is not captured in the tax gap. But it can be at variance--and 
I stated my real concern about it--with the intent of what you pass in 
Congress. You can end up in a situation where a big company will end up 
paying tax neither here nor in the United Kingdom, as an example. 
   We are aggressively working on that. But it is a very tough line 
between what is legal and what is not. 
   Chairman CONRAD. Let me just say, we have had testimony before this 
committee on just that area. And people who are experts in this area 
sat at that table and testified that that area is burgeoning with the 
global economy. 
   Commissioner Everson. I agree with that. 
   Chairman CONRAD. And that is not even captured-- 
   Commissioner Everson. It is not captured. 
   Chairman CONRAD [continuing]. In the tax gap. But I will tell you, 
that is not an area that I think involves hundreds of billions of 
dollars, hundreds of billions of dollars that is--not in a single year, 
but that is being avoided and evaded. 
   I have personally audited the books and records of large 
multinationals. I mean, I have followed them offshore. I have seen 
their books and records. I have seen what they were doing to dodge what 
they legitimately owe. 
   And the notion that we can only do $20 billion a year more in 
collection leaves me cold. I will tell you that. 
   Senator GRASSLEY. 
   Senator GRASSLEY. Thank you very much. 
   I think that the Chairman has brought up, in regard to that 
international economy, a good point. I think it is something that he 
and I been working on trying to change the law, to some extent, to 
close those. We have a long ways to go. But we have done some of that 
in the case of the shell corporations, as an example, in Bermuda. We 
have even some of it for ex-patriots in our small business tax bill on 
the minimum wage bill. 
   This first question is only because of the discussion you had with 
Senator Conrad, and it is not to combat anything Senator Conrad said. 
But when you come to estimating tax gap, isn't it true that like any 
other estimate it is a guide for us as policymakers? 
   Would you say that the estimate is as precise as what Joint Tax 
Committee might have for a specific legislative proposal? It surely 
cannot be as precise. So when you are talking about a tax gap, and 
there is a lot of taxes that are not being paid, but it could be $10 
billion plus or minus, or it could be $50 billion plus or minus, could 
it not? 
   Commissioner Everson. You are entirely correct. We use the research 
for directional purposes and, when we get down to the level of 
specificity, to update our audit models. 
   The other thing though, Senator, as you know, is we try to run a 
balanced system. If you only made decisions based on just what is 
easiest or maybe most profitable, you would beat the bejesus out of the 
middle class and go after some things like more document matching. 
   Senator GRASSLEY. I think that the Chairman might be right in trying 
to pin you down on what you can get from enforcement. But the biggest 
part of what we are after in the tax gap is going to take place in 
these changes in the laws, of which you suggested and the 
Administration is suggesting is five. They suggested X number last time 
and we did not do anything about it. So it is not your fault, it is 
Congress's fault, if we are going to close the tax cap as much as we 
should. 
   Now those are things that Senator Conrad and I have to work on. 
   My third point would be just a comment on where I left off with you 
on the sixth question, where you spoke very positively about the need 
for private debt collection. Because we have this anomaly now. You are 
trying to institute something we told you to institute and you see it 
as being, at least initially, as a good thing. 
   For instance, we hear about creating good jobs in rural America. 
There is a company in my State that is doing one of these and it has 
good paying jobs. 
   They are also, it seems to me, trying to help us close the tax gap. 
It is part of it. And you have this ironic situation where people are 
complaining about not having enough good paying jobs in the private 
sector and about closing the tax gap. And then they want to shut down 
these private debt collection agencies. So I am going to keep making 
that point as people move forward to do this. 
   I do not think you have backed off any that these are very helpful 
toward closing the tax gap. 
   Commissioner Everson. We appreciate your support of that program and 
I have been clear on this--Congress asked us to do this. It is not a 
question, in my view, of whether it would be cheaper if the Government 
did it. First of all, we cannot, as I indicated, do it in the next 
several years unless we had a lot more personnel. 
   It is a question of getting money that we would not otherwise get. 
So that is correct, Senator. 
   Senator GRASSLEY. Then, following up on the reference to the culture 
of tax compliance, and Senator Conrad made a good point. I would like 
to raise a couple of points for you to comment on. 
   One, I would agree that in the late 1990's and early part of the 
decade, this decade, there was an out-of-control culture of 
noncompliance. However, due to the bipartisan anti-tax shelter 
legislation that we have done through the Finance Committee and through 
enforcement, we have changed that culture. Now there is a lot more, of 
course, we can do. We have proposals in the Senate version of the 
minimum wage bill that I have already made reference to. 
   Do you see any reason for delaying action on these compliance 
measures? 
   Commissioner Everson. Senator, I do not want to comment on the 
pending legislation. 
   Senator GRASSLEY. Could you comment just on the compliance measures, 
not on the process-- 
   Commissioner Everson. The compliance measures are always important. 
We do want the Congress to act on tax administration issues as a 
general matter. I really do not want to go further than that. 
   But can I respond to one thing you just said though, it gets back to 
Senator Conrad? I do want to say that I believe--and Senator Conrad I 
would draw out this point, because I do not think I responded to your 
observation about the change in culture that Senator Grassley is 
talking about now--I do believe that while there are these challenges, 
particularly in the area of international and globalization and tax 
arbitrage, that the companies, the bigger companies have pulled back 
considerably from the blatant noncompliance which we have drifted to. 
It is not just the IRS, it is largely Sarbanes-Oxley and a series of 
other things. 
   So I agree with you, Senator Grassley, it is a whole series of 
things, in part what the Congress has done. 
   Senator GRASSLEY. You just brought up Sarbanes-Oxley. Would you 
agree that that has somewhat changed the culture in large corporations 
and there is probably more we can do in that area, particularly in the 
economic substance area as well, because there is uncertainty and 
inconsistency in how the courts apply the substance doctrine to a 
greater extent. 
   In fact I think there was a case that was just decided in the 
District Court level that the IRS won on some economic substance 
grounds, but lost on the penalty issues. 
   Commissioner Everson. Yes, in Texas, I believe. 
   Senator GRASSLEY. We have a responsibility to clarify it. But you 
know, it is very difficult to get some of that stuff through. Maybe the 
changed climate here would do it. But Sarbanes-Oxley has probably 
helped that to some extent? 
   Commissioner Everson. I think Sarbanes-Oxley has had a positive 
impact on the corporate tax compliance. 
   Senator GRASSLEY. Mr. Chairman, that is the end of my questioning. 
   Chairman CONRAD. Thank you, Senator Grassley. 
   I want to go back at this because honestly your testimony here today 
is among the most baffling I have ever confronted. It really baffles 
me. Last year you testify to this committee--let's put that up. Let's 
put up the quote. This is what you told us. You can clearly reduce the 
tax gap by $50 billion or $100 billion without changing the way the 
Government interacts with its citizenry. 
   Now this year your testimony is you are down to $20 billion. 
   I look at your chart. I look at--we do not have 2007 data obviously, 
but we have hard numbers from you that your direct enforcement revenue 
from 2005 to 2006 went up by $1.4 billion. You say on this indirect 
compliance effect, which is a multiplier on what you are actually 
doing, I do not know what you have to back up this multiplier. I have 
never seen such a thing applied, frankly. I have always looked at 
direct dollars. 
   How much did you increase, dollars in the door, by enforcement? Your 
chart shows 2005, $13.5 billion; 2006 $14.9 billion. That is a $1.4 
billion increase. That is about a 10 percent increase year over year. 
   And yet last year you testified before the committee, as I have 
indicated, that we could recover $50 billion to $100 billion a year. 
Now it is $20 billion. How can that be? How do you reconcile that? 
   Commissioner Everson. Again, I think we talked past each other and I 
clearly was not as precise as I should have been, saying we were 
starting at that gap in 2001. And the next time you measure that-- 
   Chairman CONRAD. But that makes no sense. 
   Commissioner Everson. It may make no sense and perhaps-- 
   Chairman CONRAD. 2001 is the last time you have data for what the 
tax gap is. 
   Commissioner Everson. I am sorry? That is the last time, yes. 
   Chairman CONRAD. The only relevance of 2001 is that your agency's 
estimate of the tax gap was based on 2001 data. That is the only 
relevance of 2001. You were not testifying last year on something other 
than where we were last year. Where we were last year was what you were 
doing in compliance, what you were doing in enforcement, and what could 
be recovered if we did a better job and if we gave you more resources 
and we did the other legislative proposals that were before us. 
   So I honestly do not know how $50 billion to $100 billion turns into 
$20 billion with the only evidence of actual direct enforcement revenue 
increase is $1.4 billion. How is that possible? 
   Commissioner Everson. Again, I think we are measuring from different 
starting points. Senator, the only way this will be resolved is, as we 
get, presumably, this money and do more research, we will see whether 
the compliance rate is better. And then you measure that against all of 
what we talked about, including the size of the economy. If you assumed 
a stable rate on all those streams, did we make that improvement? 
   Chairman CONRAD. How much money do you collect a year in revenue? 
   Commissioner Everson. $2.4 trillion is what we took in last year. 
   Chairman CONRAD. $2.4 trillion? 
   Commissioner Everson. Yes. 
   Chairman CONRAD. In a future year you can do $20 billion more, that 
is what you are telling us? 
   Commissioner Everson. Just in a couple of years from now. 
   Chairman CONRAD. In a couple of years from now, when you will 
probably be collecting $2.5 trillion, you are going to collect $20 
billion more? 
   Commissioner Everson. Again, this goes back to several points. 
   Chairman CONRAD. What is that as a percentage? 
   Commissioner Everson. I guess that is right. This is maybe a better 
place to have the conversation, going forward, let us talk about that. 
I think, that is a better place to be. 
   First, there is a limit, again, on how much we can add into this 
capacity of the service. 
   Chairman CONRAD. Tell me how much is $20 billion of $2.5 trillion? 
   Commissioner Everson. It's about 1 percent, a little bit below 1 
percent. 
   Chairman CONRAD. Less than 1 percent, about 0.8 percent. 
   So you are telling me that the best that you can do is to increase 
this by 0.8 percent? 
   Commissioner Everson. Well, 0.8 percent on total revenue is a pretty 
big move. Let's assume, just for this argument, that you take my side 
for just a minute and you say all right, maybe-- 
   Chairman CONRAD. I have been on your side. That is why I find this-- 
   Commissioner Everson. I know you are. 
   What we are trying to do here is positive. We are trying to set 
expectations. And I apologize for any part I have played resulting in 
higher expectations. But if you look at that-- 
   Chairman CONRAD. I will tell you, without higher expectations we do 
not accomplish anything. 
   Commissioner Everson. Fair enough. 
   Chairman CONRAD. That is a problem with this town, nobody wants to 
go on the line to accomplish anything. It is unbelievable the way this 
town is about reducing expectations so they do not have to produce. 
   Commissioner Everson. Let me say, though, that if you looked at this 
noncompliance rate before our recoveries, and that was based on the 
2001 research of overall 16.3 percent, if you follow me. It was like 
83.7 percent is the overall, if you look at the mix. And just take 
broad numbers. 
   Let us assume $20 billion, more or less. That would be, if you add 
the $20 billion to the $50 billion. If you assume that I am 
directionally correct, you are more or less somewhere in that ballpark. 
That would be a 3 or 3.5 percent reduction of the 16 percent. That 
would be cutting that noncompliance rate by maybe 20 percent. That is a 
big move in a big complicated system. 
   And I cannot tell you sitting here, with all of the factors like you 
have talked about and-- 
   Chairman CONRAD. Let me just tell you what I do not believe. I do 
not believe the tax gap was static between 2001 and 2006. Do you? 
   Commissioner Everson. I do not believe it was static. I agree that 
there were a lot of factors in there. That is why I do not want to be 
overly precise. But I believe that we have made some progress. 
   Chairman CONRAD. Just notionally, did the tax gap grow between 2001 
and 2006? 
   Commissioner Everson. It clearly would have grown because of 
economic activity-- 
   Chairman CONRAD. Not only because of economic activity but your own 
testimony shows compliance dropped. Yes, 2003 was a low point according 
to your charts. 
   Commissioner Everson. Yes, and then it has recovered significantly, 
yes. 
   Chairman CONRAD. Right. 
   Commissioner Everson. If you compare 2001, look at the delta on 
these numbers here, the 2001 versus 2006. That is up $15 billion. That 
is not up the $1 billion you were talking about. It is up $15 billion. 
And that is what I am talking about. 
   Again, these are very fair points to debate. We believe there is an 
indirect impact. I believe that is real. I think that the problems that 
Senator Gregg was talking about before, of the economy with the 
recession and 9/11, I think those were compounded by the IRS drawing 
down its resources in that period. 
   Chairman CONRAD. When you show--the $1 billion I am talking about is 
from your chart. 
   Commissioner Everson. Yes, the difference in one--just 1 year--that 
chart is derivative of that chart there. 
   Chairman CONRAD. And that is direct enforcement revenue. 
   Commissioner Everson. That comes right off of that number there. 
   Chairman CONRAD. So I am using your numbers when I talk about direct 
enforcement revenue went up from $13.5 billion to $14.9 billion. 
   Commissioner Everson. Right. 
   Chairman CONRAD. Let me ask you a broader question because we have 
this whole area that you have acknowledged is not captured in the tax 
gap at all. It is not in the tax gap calculations. And it is the amount 
of money that is flowing through these international entities to avoid 
taxes not only in this country but to avoid them up right around the 
world. 
   And we see, I see, and when I talk to people in the accounting 
profession, they tell me this is exploding. And that is not captured in 
the tax gap at all; is that correct? 
   Commissioner Everson. There is a lot in what you just said. And 
portions of it, I would suggest, are captured and portions are not. Let 
us go to the tax gap map. 
   The first thing I would tell you is we did not update our research 
on corporations in the 2001 study. And that is a very clear soft spot. 
   What I have said when questioned on this is that it would not have 
changed my resource allocation because we already have a very high 
audit rate on those companies, as I was talking about with Senator 
Wyden. 
   But I believe undoubtedly that number there, the $30 billion on the 
C-Corps, was understated and significantly. But it would not change the 
relative parameters that the big piece of this gap is in the 
individuals. 

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT] 

   Chairman CONRAD. But I am talking now about other things because tax 
gap is not illegal activity. 
   Commissioner Everson. That is right, and let me make a couple of 
points here. 
   We have traditional areas that are very tough. Transfer 
pricing--very, very tough to deal with. That would be, if you updated 
this--and we are going to start to do some work on the 
corporations--that would fall into this tax gap, if we assess an extra 
$500 million for a big company or something. 
   The problem on updating this gets back to this long tail here. Just 
because our auditors set up $500 million, how do you say what the real 
noncompliance is? Because by the time you are done it has gone through 
an appeals process in the courts, it might be $200 million. So it takes 
a long time to be precise. 
   Chairman CONRAD. Believe me, I know how all that works. 
   Commissioner Everson. But let me give you the other piece because it 
is real. Arbitrage and all the other things that take this line as to 
whether it is in this complicated code or past it, that line is 
constantly challenged by all the intermediaries. 
   Now I do not want to give the impression that we are not trying to 
address it. I testified to Senator Grassley about what the big issues 
are, one of them being this arbitrage. We are addressing it 
aggressively. 
   We started something called the Joint International Tax Shelter 
Information Center. It is here in Washington. It is a partnership 
between the United States, the United Kingdom, Canada, and Australia. 
It is working on these kind of transactions. We have been too slow at 
working on complicated transactions. 
   I chair an OECD group of tax administrators, and we had a forum in 
Seoul, a meeting of some three dozen countries. That group is concerned 
about this. We have commissioned a study-- 
   Chairman CONRAD. Why was this group formed? 
   Commissioner Everson. The OECD group of tax commissioners? To share 
information. And then we put a finer point-- 
   Chairman CONRAD. But why to share information? What are you 
concerned about? 
   Commissioner Everson. We are concerned about just what you are 
getting after. What are the best practices? What is happening in most 
countries? 
   Chairman CONRAD. Most of this is not included in the tax gap 
calculation? 
   Commissioner Everson. I am sorry? 
   Chairman CONRAD. Most of this would not be included in the tax gap 
calculations? 
   Commissioner Everson. Again, some would, but much would not. If you 
are dealing in the tax arbitrage area, much would not be. 
   Chairman CONRAD. Let me ask you, why do you think--here is this 
building in the Cayman Islands, a nice-looking building, a five-story 
building. Why do you think 12,000 companies call that building home? Do 
they just like the weather down there? Are they down there to golf? Why 
do you think they got-- 
   Commissioner Everson. I have never been to the Cayman Islands, sir. 
   Chairman CONRAD. What do you think 12,000 companies call that 
building home? Do you think it has anything to do with taxes? 
   Commissioner Everson. I am with you on this. The tax havens are a 
real problem. We do our best on this but this is an area that is an 
extremely difficult enforcement challenge for us. 
   Chairman CONRAD. Is this captured in the tax gap? 
   Commissioner Everson. A good bit of that would not be. We do include 
it if we do some high income audits and we pick something up on an 
individual and unravel something then you might be in there. But I 
would suggest a lot of it we are missing. 
   Chairman CONRAD. I will tell you something, I was just down in the 
Bahamas a few months ago. Boy, it was very interesting to read the 
pitch that they were making to people who might invest there and live 
there, very interesting. The big pitch was on taxes. 
   Commissioner Everson. Right. 
   Chairman CONRAD. You know, one of the biggest creditors of the 
United States now are the so-called Caribbean Banking Centers. Did you 
know that? We owe the Caribbean Banking Centers, as a Nation, about 
$100 billion. They are places like the Cayman Islands, the Bahamas. 
   How do they have all this money? I think we can probably figure out 
where some of it is coming from. But a lot of it is illegal activity. 
Drug dealers are funneling funds through these operations because they 
do not have to reveal anything or they reveal very little. 
   And then you have operations like this, where you have thousands of 
companies claiming they are doing business out of this building. They 
are not doing any business out of this building. They are engaged in a 
tax dodge because the Cayman Islands has a very favorable tax 
structure. That is what is really going on. 
   We need your help in how we go after this. So what do we do to go 
after this kind of thing? 
   Commissioner Everson. I think, sir, that supporting the budget will 
help us because we will be bringing up the enforcement resources and 
the infrastructure. 
   Let me say something that we did that does not get to these 
Caymans--I do not want to confuse the issues--but it really makes a big 
change. When we mandated the electronic filing for corporations, which 
I did at the end of 2004 for the biggest outfits, this is going to make 
a sea change in our ability to do analysis. A lot of this is that there 
is too much potential information and because of complexity and 
everything else how do you sift through it? 
   Now what we are going to do with all of this stuff that is coming in 
online now, starting with the last few months, we are going to be able 
to do much more sophisticated analysis and risk assessment that will 
help the compliant taxpayer. I do want you to know I do not think there 
is lot legitimate tax planning in the international arena. Cooperation 
is very important to the growth of our economy. It is good for America. 
   Chairman CONRAD. I do not dispute that but I am talking here about 
abusive--I am talking about-- 
   Commissioner Everson. This is really tough to get at and we are 
working with other countries to try and have joint approaches. But some 
of this gets into, obviously, the conduct of tax haven countries and 
the laws they set up. And then our ability to understand what is going 
on over there is quite limited. 
   Chairman CONRAD. Let me just tell you, a case I was involved with 
when I was the tax commissioner and it involved the Cayman Islands. I 
found a major company that was reporting virtually no profits anywhere 
in the United States. But they got down to the Cayman Islands and they 
reported $20 million with one employee, $20 million in profits with one 
employee. 
   And of course, they paid no taxes to the Caymans either. So they 
structured their business to report no profits in any of their 
subsidiaries in the United States. They get to the Cayman Islands, all 
 of a sudden they make $20 million where conveniently there are no 
taxes. 
   I know what is going on and there is a lot of this going on and we 
have to go after it. 
   Commissioner Everson. Yes, I agree with you 100 percent. 
   Chairman CONRAD. The question is let us say you collect $2.4 
trillion this year. By 2010 you will be $2.5 trillion, probably more 
than that. And you are telling us you can do better by $20 billion. 
That is 0.8 percent. We have to do better than that. And you have to 
help us understand how we could do better than that. 
   What could we do to do better than that? 
   Commissioner Everson. What I would suggest to you, Senator, and I 
know Secretary Paulson feels the same way, we will work and review 
ideas that the Congress puts forward on all of these areas. What we are 
asking you to do now, meager as you might characterize these 
representations-- 
   Chairman CONRAD. I accept that. I have your message on that. Let us 
do that. But you have to tell us-- 
   Commissioner Everson. Let us do those and then let us see what wlse 
we can stomach. Because for what is more intrusive on the reporting or 
the withholding, these get to things that will be difficult. 

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   Chairman CONRAD. And I understand that. I will tell you something, 
what is outrageous is the vast majority of Americans pay what they owe. 
The vast majority of companies pay what they owe. But we have a growing 
group that does not. And we cannot permit that. Obviously there is 
always going to be some tax gap. No system is going to be 100 percent. 
We understand that. 
   But just so people who are listening to this understand, the 
difference between 0.8 percent on an improvement on collection and say 
going to 4 percent is the difference between $20 billion and $100 
billion a year. It is the difference between all the rest of us who pay 
what we owe having to pay more to cover for those who are not. 
   I will tell you this is one thing that outrages me. This kind of 
scam, this outrages me, 12,000 companies saying they are doing business 
out of this building. Excuse me? That is outrageous and unacceptable 
and they ought to know we are coming after them. 
   Commissioner Everson. It does not even look like there is a 
McDonald's or a retail business in there. 
   Chairman CONRAD. No, I do not think--you know 12,748 companies, it 
is amazing how efficient that building is. It is probably the most 
efficient building in the world. Probably the most profitable building 
in the world, because they are scamming. And that just cannot be 
allowed to continue. 
   We, again, appreciate your testimony and we will close the hearing. 
   [Whereupon, at 11:54 a.m., the committee was adjourned.] 

                        ADDITIONAL MATERIALS SUBMITTED 
                               BY SENATOR 
WHITEHOUSE
 

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                         ANSWERS TO QUESTIONS SUBMITTED 

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                      THE PRESIDENT'S DEFENSE BUDGET 
                          REQUEST FOR FISCAL YEAR 2008 
                              AND WAR COSTS 
                              -----------
                          THURSDAY, MARCH 1, 2007 

                                           UNITED STATES SENATE, 
                                           COMMITTEE ON THE BUDGET, 
                                                        Washington, DC. 

   The committee met, pursuant to notice, at 10:03 a.m., in room 
SD-608, Dirksen Senate Office Building, Hon. Kent Conrad, chairman of 
the committee, presiding. 
   Present: Senators Conrad, Lautenberg, Nelson, Menendez, Gregg, and 
Allard. 
   Staff present: Mary Naylor, Majority Staff Director, Scott Gudes, 
Staff Director for the Minority. 

             OPENING STATEMENT OF CHAIRMAN KENT CONRAD 

   Chairman CONRAD. The committee will come to order. I would like to 
welcome everyone to today's Budget Committee hearing on the President's 
defense budget and requests for additional war funding. Our witnesses 
today are Gordon England, the Deputy Secretary of Defense; Admiral John 
Giambastiani--I hope I pronounced that right. 
   Admiral GIAMBASTIANI. He did great, sir, thank you. 
   Chairman CONRAD. OK. As I have told you, my wife is Italian, as 
well. 
   Vice Chairman of the Joint Chiefs of Staff. Ms. Tina Jonas, the 
Under Secretary and Comptroller of the of the Department of Defense. 
We appreciate very much all of you being here. 
   We all know that Secretary England serves as the Chief Operating 
Officer of the Department of Defense and was previously the Secretary 
of the Navy. 
   Our witnesses today are all dedicated public servants and we very 
much appreciate not only their service to the country but their being 
here today. 
   I wanted to be clear, the Budget Committee is disappointed that 
Secretary Gates was not able to testify here. We hope that he will 
testify before this committee later this year, and the committee feels 
strongly about that issue and we want to make certain that that is 
communicated. 
   The defense budget represents the single largest area of 
discretionary spending. Secretary Gates has acknowledged the magnitude 
of the President's defense request. He recently stated ''The truth is 
they represent a staggering amount of money.'' Certainly that is the 
case. We also want to put in context, in terms of our overall budget, 
what these costs are as a share of our gross domestic product. We will 
get that momentarily. 

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   To put the defense request in some historical perspective, we can 
see that under the President's request defense spending for 2008 will 
exceed the highest levels during the cold war. We will spend more then 
at the peak of the Vietnam War or the peak of the Korean War, even 
after adjusting for inflation. And defense spending has been rising 
rapidly as a share of GDP, from 3 percent in 2001 to 4.2 percent in 
2008. 

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   Now as a share of GDP, we are not at a historic peak or anywhere 
close to it. So I think it is very important to understand both points. 
On a dollar basis, inflation adjusted, we are at a peak compared to 
those previous time periods. But as a share of GDP, we are nowhere 
close to a peak. And I think it is important for people to understand 
both of those facts. 

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   The costs of the war in Iraq are the major factor driving our 
defense expenditures higher. It is worth noting that before the Iraq 
War began, the Bush Administration suggested that this war would not be 
this costly. Here is a transcript of an interview with the previous 
Secretary of Defense on This Week With George Stephanopoulos. 
   Stephanopoulos asked ''What should the public know right now about 
what a war with Iraq would look like and what the cost would be?'' 

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   Secretary RUMSFELD. ''The Office of Management and Budget estimated 
it would be something under $50 billion.'' 
   Stephanopoulos: ''Outside estimates say up to $300 billion.'' 
   The Secretary ''BALONEY.'' well, now we know that the $300 billion 
cost estimate was not baloney, it was actually too low. CBO now 
estimates the war cost is approaching $532 billion. That is what has 
already been appropriated and what has been requested. That is, of 
course, on top of the regular defense budget. That brings the total 
cost of the Iraq War close to what we spent in Vietnam over 12 years, 
even adjusting for inflation. 


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   And that is not going to be the end of these costs. The President's 
budget includes a request for $145 billion for 2008, a partial plug as 
they call it of $50 billion for 2009, which we do not believe is 
realistic. 
   While that is more realistic than previous Bush Administration 
budgets, it is still, we believe, underestimating the likely ongoing 
costs. 

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   Let me stress, this is not just with respect to the war in Iraq. 
This also involves the war in Afghanistan and the overall war on 
terror. I have found many times in the press reports, they collapse it 
all down to just be the war in Iraq. That is not the case. I think it 
is very important for people to understand. Even if the war in Iraq 
were to end relatively soon we would still, in all likelihood, have 
ongoing costs certainly in Afghanistan, I believe, and in the ongoing 
war on terror. 
   Let me get into another issue that has been of concern to the 
committee, and that is the estimate of the costs of the surge--or 
whatever one terms it--with respect to putting the additional troops 
into Iraq. The Administration indicated that the cost would be $5.6 
billion but the Congressional Budget Office estimated that the surge 
could actually cost $9 billion to $27 billion because the 
Administration was not fully accounting for the cost of all the support 
troops. CBO says that achieving a surge of 20,000 combat troops will 
actually require 35,000 to 48,000 total additional personnel, once you 
count all the support troops that are required and support units. 

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   This committee held a hearing on the issue and we found CBO's 
analysis to be quite compelling. We would be interested in exploring 
that after the testimony of our witnesses today. 
   Let me close with one more important point, and Senator Gregg and I 
strongly agree on this. Until this year the Administration has not been 
financing the war through the regular budget process, but instead 
through a series of supplemental appropriations bills on an emergency 
basis. We strongly urged the White House to put these war costs in the 
regular budget process. And to their credit, and I think actually very 
much to the credit of Senator Gregg, they did increase quite 
dramatically what they put in the budget. But it is still done on an 
emergency basis, and that troubles us, in terms of the regular order 
here and having the disciplined oversight that we think is critically 
important to making certain dollars are not wasted. When we are 
spending over $10 billion a month, we think it is critically important 
that Congress conduct responsible oversight and look at all of our 
fiscal obligations. 
   With that, I would like to turn to the distinguished ranking member, 
Senator Gregg. 

                OPENING STATEMENT OF SENATOR JUDD GREGG 

   Senator GREGG. Thank you, Mr. Chairman, and we thank the panel for 
appearing today. Thank you, Admiral, and thank the Secretary and  
Comptroller Jonas for taking the time to go before the Budget 
Committee. 
   Yesterday or the day before yesterday we had the Chairman of the 
Joint Chiefs and the Secretary of Defense before the Appropriations 
Committee. A lot of interesting issues were raised but I think there 
are points which need to be addressed here which I would like to 
highlight and then hopefully we can get into them in more specifics. 
   The first I will pick up, not necessarily in order of priority, but 
first picking up on the last statement by the Chairman, is the 
continued financing of the war in a manner which is outside the budget 
process. Declaring the funding for the war to be an emergency is really 
no longer a defensible position, because clearly we know we have these 
costs and obligation in this war now, after 5 years. And we certainly 
understand that we are going to be engaged in it for some time to come. 
And these costs should be predictable to a large extent. To the extent 
they are not predictable, they would be at the margin and could come up 
in an emergency supplemental. But the vast majority of the costs are 
clearly predictable. 
   So these should not come forward as an emergency supplemental. I do 
not have any problem with them coming forward in what I call a 
''sidecar'', where they are essentially not folded into the base of the 
basic defense budget, the war costs, and I do not think they should be. 
Because hopefully two or three or 4 years from now, when we are 
disengaged completely, hopefully, from Iraq we do not want to have to 
sift these accounts out. But they should no longer be declared an 
emergency and, in my opinion, the emergency designation should be 
stripped from the supplemental. 
   Also the supplemental process, the emergency supplemental process, 
is being used to shield spending which is clearly not part of the war 
effort, in my opinion, and is being used as a way, because money is 
fungible, to basically bump up the base budget and put accounts into 
the emergency exercise which should be properly reviewed as part of the 
basic defense budget. 
   I would take, for example, in the supplemental we have pending 
before us, there is an Osprey proposed which is not part of this war 
effort, will not be on line in time for the war effort. There are five 
C-130Js, which again probably will not even get to the theater. There 
are eight E-18 Growlers. There is a permanent force structure increase 
which again, is not part of the war effort. It is part of reorganizing 
the core element of the Marines, clearly. And there are even two Joint 
Strike Fighters in this budget, in the supplemental. They will not even 
be completed until 2013. 
   I suppose it is human nature, when you have a vehicle moving you 
know you are going to get through, to try to load it up. Regrettably, 
some of my colleagues are throwing baggage on this train which has 
nothing to do with the war effort or emergencies, also. But it is one 
of the problems of sending this up through an emergency process. 
   Those programs that I just outlined should go through the 
authorizing process, should go through the authorizing committee and 
then come to the Appropriations Committee in the regular order. They 
should not be set outside the process. So that concerns me. 
   Those are concerns of significance, but I think the bigger concern 
is where our costs of defense are going. There is no question that the 
first responsibility of a government, especially our government, is to 
defend our Nation. We have an obligation. But we are seeing an 
explosion of cost here in the core defense budget which is very 
significant, and that is not necessarily related to the war effort. Or 
if it is related to the war effort, then it is projecting the war 
effort to go on for a lot longer than I hope it will go on, relative to 
the Iraq situation. 
   For example, the Select Acquisition Report, which basically reflects 
what the Defense Department needs to buy, in 2001 was projecting 
weapons systems that would cost us about $790 billion. The Select 
Acquisition Report for 2005 is projecting acquisition costs of $1.5 
trillion. So it has more than doubled in 4 years. That is a big jump. 
One wonders whether we can afford that sort of pace of expansion in 
those types of accounts. 
   There are other issues which concern me. In the statement from the 
Secretary today, the statement is made that Iran, North Korea, and 
China, in different ways, are currently the most worrisome concerns. In 
my opinion, al Qaeda is the most worrisome concern, and the threat of a 
terrorist attack on American soil using a weapon of mass distraction is 
our greatest threat. These other nations are obviously significant 
concerns, and certainly a nuclear Iran is a very significant concern. 
   But it does seem to me that if the mentality of the defense 
structure is that we are basically focused, as our primary concern, on 
those three nations in the traditional war fighting balance of power 
structure, that we are missing the point that we are now engaged in an 
entirely different world where boots on the ground do not necessarily 
win the fight. Intelligence and the capacity to find the people before 
they attack us wins the fight. The people who want to attack us are not 
organized in nation-states, they are just very organized as religious 
fanatics. 
   And so I am interested in knowing how the Department of Defense 
reviews the balance between those two issues of confronting 
nation-states and confronting a very orchestrated, very large, 
religiously fanatically--a group of religious fanatics who believe 
genuinely that they should destroy our Nation and our culture. 
   These are just some questions I have and I look forward to hearing 
from the Secretary on these. But let me end my statement by saying that 
I greatly admire the service that you folks give our Nation. I think we 
all do, obviously. We appreciate it. We know you are in difficult times 
and having tremendous stress on you, as individuals, and obviously on 
the people you serve with who are in harm's way. And we thank you their 
service and your service. 
   Chairman CONRAD. Thank you, Senator Gregg. 
   Secretary England, why don't you proceed with your testimony. 

               STATEMENT OF HONORABLE GORDON ENGLAND, DEPUTY 
                 SECRETARY, DEPARTMENT OF DEFENSE, ACCOMPANIED BY 
                 ADMIRAL EDMUND P. GIAMBASTIANI, JR., VICE CHAIRMAN, 
                 JOINT CHIEFS OF STAFF, DEPARTMENT OF DEFENSE, AND 
                 TINA JONAS, UNDER SECRETARY OF DEFENSE (COMPTROLLER), 
                 DEPARTMENT OF DEFENSE 

   Mr. ENGLAND. Mr. Chairman, thank you very much. Senator Gregg, thank 
you for the comments. 
   We do have a written statement which has been turned in and I am 
just going to make a few comments because I would much rather discuss 
what is on your mind. 
   Mr. Chairman, I am sorry the Secretary is not here. You sort of have 
the backup quarterback today. But hopefully I can provide some useful 
information for you that will help in your deliberations and certainly 
we will try to do so. 
   I would comment, first, lots of views about America and our defense 
of America. But I do know this. Everybody knows that we need to protect 
and defend our freedoms and our liberty. So while people may have 
different views on how to do that, I am encouraged that everybody is 
debating the core about how is the best way to do that. And we do that 
to the very best we can. And we are blessed, as you said, to have these 
magnificent men and women who serve our Nation every day. 
   My job and the job at the other people in the Department of Defense 
is to provide them the equipment and the training and everything they 
need to carry out that mission for America. 
   I am pleased to have my good friends and coworkers with me, the Vice 
Chairman, Ed Giambastiani, Admiral Giambastiani; and also the 
Comptroller, Ms. Tina Jonas. We work together every day, so hopefully 
we can be helpful together in providing you some information today. 
   The Secretary was absolutely right, it is a staggering amount of 
money. We understand that. The total request before the Congress is 
$716 billion and it is three pieces. It is the supplemental, it is the 
2008 base budget, and then it is also that 2008 what we called GWOT, 
which is the Global War on Terror amount. 
   I understand the comment about why is it a supplemental and not in 
the base budget. Of course, that is a decision, first, of OMB, not the 
Department of Defense. But this year we did turn in with the 2008 
budget, at the request of Congress, our best estimate of what the war 
costs would be in 2008. And I will tell you--the dilemma we are always 
in, and we had this discussion last year. If we do a supplemental, it 
is very near term, in terms of the estimates are much better. If we 
look out further they become less predictable. 
   So when we put the numbers together for 2008 we basically took a 
projection of 2007. So not knowing if it goes up and down, we just took 
where we were in 2007 and pretty much straight-lined that in terms of 
the number of troops and the cost of war. And so the expectation will 
be, frankly, that that number will change as we get closer and know 
more about what is happening on the ground. And it could go up or down, 
depending on what the situation in Iraq is. But it was the best we 
could estimate for the 2008 period. 
   The 2007 supplemental, of course, is more near-term to us, so 
hopefully it has a higher degree of fidelity. 
   In terms of what is in the supplemental, we provide extensive 
detail, more than I think we have ever provided, and as much as we 
provide for the budget itself. So we provide all of the supporting 
detail, how many thousand pages? I mean, 30,000-some pages in support. 
So we have provided a lot of information in support of it. And 
obviously we are pleased to discuss that whatever detail members of the 
committee would like to discuss that. 
   Mr. Gregg, we do try to limit this to war costs. Your comment about 
the airplanes, I mean here again is the issue we have with this: we 
look at what has been lost as a consequence of the war itself or what I 
will call the accelerated depreciation of assets. So if we are flying 
airplanes a lot during the war and the life is getting very short on 
those airplanes, just like any other enterprise, we try to recover that 
depreciated cost. 
   And then we buy whatever it is that we are buying. So those 
airplanes, a lot of what is being lost is no longer in production or 
those models are no longer available. So we buy whatever is in 
production. And they may not show up immediately. But if we do not 
replace them, at some point we will be short those assets. 
   So this is, frankly, recovering the cost of using the assets for the 
war, whether they are lost or just being used up, recovering that cost 
and then applying them to whatever it is that is already being bought 
at that point in time. If we do not do that, then we will be short in 
the future. The war costs will eventually just consume our assets. So 
frankly, I do not see that we have any choice in how we do that. 
   But we do religiously go through this. Our analysis people go 
through all of the war data, all of the operational rates, all of the 
burn rates, et cetera. And we only include in the supplemental those 
things that we can directly relate to the war. 
   So hopefully, that is some feedback in terms of how we got to where 
we are today. 
   With that, I will stop. Because frankly I would much rather discuss 
what is on your mind this morning. You already have our written 
statement and obviously you are quite familiar with the budget we 
submitted. 
   [The prepared statement of Mr. England follows:] 

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   Chairman CONRAD. Thank you, Mr. Secretary. 
   Let me go right to it, if I could, and first discuss the difference 
between Administration estimates of the cost of the surge and what CBO 
testified before this committee. I referenced that in my opening 
remarks. I talked with you about this before the hearing, that this 
would be a question. And I think it naturally flows from what this 
committee has been told. 
   The original estimate that we were given from the Administration was 
that the surge would cost $5.6 billion. And the CBO said well, it would 
cost a multiple of that because of additional support personnel. Can 
you give us your best estimate at this time of what the surge will 
cost? 
   Mr. ENGLAND. If we can, perhaps between all three of us here we can 
bring some clarity to that. First, one of the differences, Mr. 
Chairman, is that we have costed the search through this fiscal year. 
So there is no money past 1 October in our estimate because, as 
Secretary Gates has testified, in his view we will know sometime this 
summer the success of that program, of the surge program. So we funded 
basically what we knew in terms of those requirements. So there is a 
significant difference there. 
   Also, my understanding is the Congressional Budget Office had a 
very, very large number of support troops. And we already have a large 
number of those support troops in-theater. So while the number we have 
estimated may vary somewhat, it is not at all going to be in that many 
orders of multiples that was estimated by CBO. 
   So I think there is just a difference in terms of the troops that 
are already there in the support arena versus added troops that would 
have to be provided. 
   Ed, you may add to that, and Tina. 
   Admiral GIAMBASTIANI. I think the question or the comment, first of 
all, on the length of what we had estimated out through the end of 
fiscal year 2007, so in other words through the 30th of September, 
there is a difference. I believe CBO was out to 2009 sometime. 
   In addition, the numbers of these combat service and service support 
or what we would call enablers also, there is a sizable difference. We 
have an established and well-established logistics base inside and 
outside of the area of Iraq. And therefore, we believe that we will 
need considerably less combat service and service support than was 
estimated there. 
   I think their numbers would be good if, in fact, we were doing this 
from a cold start. 
   Chairman CONRAD. Have we got the chart that has General Schoomaker, 
is it?    General Schoomaker said, on February 16th in testimony, that 
the increase of 17,500 Army combat troops represents only the tip of 
the iceberg, and will potentially require thousands of additional 
support troops and trainers as well as equipment. 
   Do you disagree with General Schoomaker's assessment that this is 
the tip of the iceberg? 
   Admiral GIAMBASTIANI. I do not in that it will require some numbers 
of thousands of support troops. But with regard to the readiness issue, 
it is important for us to remember what he was saying. You have to get 
below the water level on the iceberg here to make sure we all 
understand on the readiness issue. 
   If we are training simply a force for counterinsurgency, then we 
lose some of the readiness that we might otherwise do for other types 
of conflicts. For example, if we have aircraft that are flying all the 
time and doing air-to-ground missions, they lose their air-to-air 
proficiency. So those are the types of things we are talking about. 
   But remember, this surge is 21,500 plus or minus some thousands here 
of support troops out of 2.4 million Americans in the active component 
and the Reserve component. 
   We have done a risk assessment and we understand that we are ready 
to meet any crisis or contingency that, frankly, we think will be posed 
to us. And the Chairman of the Joint Chiefs has signed out a risk 
assessment to the Secretary and the Congress. It is available to all of 
the defense committees in a classified form. All of us Joint Chiefs, 
myself included, have worked on that. I do not think this additional 
plus-up will change, frankly, that overall assessment that we will be 
ready to do our job to meet any crisis. 
   What will happen is there will be some added risk with regard to the 
time it takes us to be victorious or to win and potentially you will 
have some additional casualties. But let there be no mistake, we can 
get our job done if another crisis comes about. 
   Chairman CONRAD. Let me ask you this question because our obligation 
to our colleagues on this committee is to try to give them--we are not 
the policymakers with respect to how the war is conducted. That is not 
our job. Our job is to try to give our colleagues as accurate a 
reflection as possible of what things are really going to cost. That is 
the way I see our obligation. I know there are some, even on this 
committee, who want this to be the forum for debating the war posture 
and the war policy. I do not see that as that form. 
   I see our obligation as to try to give our colleagues as accurate an 
assessment is possible of the cost. 
   Can you tell me how many support troops have now been requested by 
commanders on the ground in Iraq to support the surge? 
   Admiral GIAMBASTIANI. What I would tell you is that right now we 
have approved requests for forces of about 2,400. 
   Chairman CONRAD. But that is not my question. I am asking how many 
have actually been asked for? I am told, from my own sources in the 
Pentagon, that more than 10,000 troops have been requested. Is that 
accurate? 
   Admiral GIAMBASTIANI. No, sir, it is not. What I was going to do is 
finish this off. There are 2,400 approximately that have been approved 
to date. And in addition, there are some additional requests for, I 
would gather, in the order of--for combat service and combat service 
support, detainee operations, these types of things--somewhere in the 
order of about 4,000 additional, 3,000, 4,000 that are there. But once 
again, these numbers are much lower than what you have seen before. And 
we are, inside the Joint Chiefs of Staff, reviewing these requests 
right now. 
   Chairman CONRAD. Can I say this to you, and I am going to stop here. 
My time is rapidly drawing to a close. 
   We are going to have to write a budget here in the next few weeks. 
We have not been given absolute assurance when our time will come, but 
it looks like probably the third week of March we will be on the floor 
with a budget. Which means this committee has to mark up the week 
before that. 
   Senator Gregg and I, through our staffs, are now talking about that 
kind of a schedule. It would be very helpful to this committee to have 
the most accurate assessment that we can get. 
   I find it a little troubling that the assessment, the numbers that 
have been given us before of $5.6 billion is for such a limited time, 
only until October 1st, as you describe it. It strikes me as just 
unlikely that this commitment would be that limited or that the costs 
would be that restricted. 
   Mr. ENGLAND. If I can comment, Mr. Conrad, I believe the Secretary's 
view on this is that we would know sooner rather than later the success 
of this effort in Iraq, and that we would certainly by this summer, his 
view and I believe General Petraeus' view, is by this summer we would 
have some pretty good measures in terms of where we are. As far as you 
probably know, the Secretary this afternoon is briefing on the measures 
and measures to the Congress. There is a briefing this afternoon on 
this whole subject. But by this summer we would have a much better 
indication in terms of the success of the program. And so at that time 
we would adjust however is appropriate to do so. 
   And I believe that is the whole concept here, is cost it through, 
get a level of confidence, see what happens and then we will adjust 
depending on what the outcome of this effort is. 
   The other comment I would make is I am pleased to hear of the 
schedule because the supplemental for us will be very important by like 
the middle of April. Last year it was very difficult for us because we 
had to start reprogramming. That caused great problems for as. 
   Chairman CONRAD. On that point, they are talking about doing the 
supplemental the last week of March on the floor. So that would be 
timely in terms of your deadline. 
   Mr. ENGLAND. Can I go back to the surge a minute, before you-- 
   Chairman CONRAD. Yes, absolutely. 
   Mr. ENGLAND. Because I want to make sure it is clear. There is a war 
going on. And when the commanders on the ground, I mean things are 
going to happen and people are going to request troops. And the way 
that happens is it comes into the Chairman of the Joint Chiefs and they 
work this. So I would expect over a period of time there is going to be 
variations up or down. 
   That said, my judgment is that the budget we have should be adequate 
to handle whatever those variations will be. Obviously, the $5.6 
billion is an estimate itself. All of the numbers are our best 
judgment. Some are slightly over, some slightly under. I mean, events 
change. But I do believe the budget. But if the changes, we will 
definitely get back with you quickly on this matter. 
   I would hope, however, that however these numbers may change, that 
we can accommodate them. If we cannot, we will definitely be back and 
talk to you. 
   Admiral GIAMBASTIANI. Mr. Chairman, if I could just emphasize the 
point the Deputy Secretary made about the fact that commanders come in 
all the time. We meet with the Secretary as a minimum once a week, the 
Chairman and our operations people, changing deployment and 
redeployment orders constantly with new requests in from the field, 
Afghanistan, Horn of Africa, Southern Command, all over the world, in 
addition to Iraq. 
   I would just tell you that we have new commanders in the field 
today. You have a new Multinational Corps Commander in Lieutenant 
General Odierno. You have a new General, Dave Petraeus, as you well 
know. You have confirmed him here recently. And he has only been on the 
ground since essentially the 10th of February. 
   So it will not surprise me if these commanders come up with 
different requests. So we are trying to give you the best information 
we have right now. 
   Chairman CONRAD. Put me down as a skeptic on the $5.6 billion. 
   Senator GREGG. 
   Senator GREGG. Thank you, Mr. Chairman. 
   I think it is obvious the $5.6 billion is a number that is not 
accurate. 
   Independent of that, however, this supplemental request, and I 
understand your argument, Mr. Secretary, that these various items that 
I listed will basically be replacing items that are lost or are no 
longer functional or just go beyond useful life as a result of fighting 
a war on the ground in Iraq and Afghanistan. I think that can be 
debated, but it is a legitimate viewpoint. I give you credit for that. 
But what I find difficult to accept, and this is rhetorically, you do 
not have to answer this unless you feel comfortable answering it, that 
a supplemental which is coming up to fund soldiers who are in the field 
at war appears to be coming--starting to be used by Members of Congress 
as a vehicle to load up with hometown interests. 
   We have the avocado growers in California throwing baggage on this 
train. We have the loggers in the Northwest throwing baggage on this 
train. We have the Gulf Coast states throwing baggage on this train. 
According to an AP report today, SCHIP is going to be included in this. 
It is just incredibly unseemly, when we are at war, to be using a 
vehicle that is supposed to be supporting the troops who are fighting 
that war as a vehicle for basically taking care of issues which are 
probably legitimate, may be legitimate, but clearly are not part of the 
war effort and are part of the traditional piling on effort around here 
in spending money. 
   I suspect the Pentagon has no opinion on that, since you are just 
interested in making sure you get money for the war effort. But to me 
it is fiscally irresponsible and it is blatantly unseemly to be doing 
this, and inappropriate. We are supposed to be fighting this war, and 
paying for the troops, making sure they have what they need. We are not 
supposed to be paying for avocado growers in California and loggers in 
the Northwest. 
   Independent of that, on the issue of how money is being spent, it is 
hard to get a handle on just how much money has been lost there in the 
reconstruction effort. Nobody really seems to know. I am afraid when we 
write the history books on this, it is going to turn out to be a 
multiple billion number, maybe a very large multiple billion number. 
   But you have now set up these Commander Emergency Response Funds. Do 
you think these approaches, giving the commanders on the ground the 
flexibility to have the funds and spend the money, is probably 
producing a more efficient way of doing this reconstruction than what 
we started out with, which was to have an independent construction 
effort which was pretty much independent of the commander on the 
ground? 
   In other words, are we going to see less waste, fraud, abuse, lost 
money? 
   Mr. ENGLAND. So two comments. I meet regularly with Stu Bowen, who 
is the Special IG for Iraq. He was in my office just before he went 
back the other week, we met again. I think we go over his reports and 
talked in detail, et cetera. 
   Lately, there has been this discussion about $6 billion wasted. But 
yesterday, I mean literally I had one of the folks talk to Stu in Iraq 
about what is the basis of $6 billion. Frankly, there is no basis for 
this. I am not sure where-- 
   Senator GREGG. You do not subscribe to the view that at the 
beginning of this effort there was flow into Iraq large sums of cash, 
multiple hundreds of millions, potentially billions, that is now not 
accounted for? 
   Mr. ENGLAND. I actually do not know. I do not know that. 
   I can only talk about reconstruction. And there were issues with 
reconstruction. There has been a lot of IG reports dealing with the 
reconstruction. And some of it was poor workmanship. 
   My indications, about 75 percent is just like you would find 
anywhere else in America. About 25 percent had various degrees of 
problems. 
   Senator GREGG. Well, if I can stop you there, there are specific 
instances involving health care reconstruction in Iraq that have been 
shown to be--it appears from reports--represented as non-existent but 
money was spent on them anyway. You are not aware of those issues? Or 
you see that as a State Department issue versus a Defense Department 
issue? 
   Mr. ENGLAND. Mr. Gregg, I guess some of it is Iraqi issues, because 
some of it was Iraqi money doing their thing. I am not sure I can 
differentiate. 
   Again, I can only tell you the IG's view, and having looked at the 
reports. I think certainly there is always some issues. It is a 
difficult environment. 
   Senator GREGG. Anyway, let us get to the essence of the question, 
which is the Commander's Emergency Response Funds a more effective way 
to manage the money coming into the country for reconstruction than 
what we were doing before? 
   Mr. ENGLAND. It is effective and, frankly, my judgment is and our 
judgment is it is crucial. The commanders do have good accountability 
of this money. They can put people to work. They can do things that are 
instantly beneficial to the people. 
   As you know, this whole effort is not just military, it is also 
economic. It is political in-country, and they have to work together. 
So this is part of the economic dimension that gives the commander 
flexibility that, along with the military effort, they can do things 
that are economically important to the people and do it immediately, 
real-time, which is what counts. 
   In the past, this has made a giant difference. Going forward it will 
be even a bigger difference. So this is very, very important money that 
was asked for. 
   Senator GREGG. It seems logical. 
   Mr. ENGLAND. It is logical and necessary. 
   Admiral GIAMBASTIANI. If I could, just to add to this, the CERP 
program, the Commander's Emergency Response Program, funding is--we 
consider it a different form of ammunition. It is the type of 
short-term projects that we can do. These are generally shorter term 
and smaller projects than the large reconstruction pieces. 
   Senator GREGG. You obviously did not run that phrase through a focus 
group, Admiral. 
   Admiral GIAMBASTIANI. I have not. 
   Senator GREGG. But I think it is an appropriate-- 
   Admiral GIAMBASTIANI. It is a good way, I think, to talk about it. 
But we use it for such things as short-term, 60 to 90-day garbage 
cleanup, sewage disposal, those types of things, rehabilitating 
hospitals, fixing schools up, and those types of things. And we find 
that it gives the commander a way to talk to the local sheiks, to the 
local population. And that is why we think it is real ammunition for 
them. 
   So thank you for your strong support of this. 
   Senator GREGG. I think it makes sense and I think it is an 
adjustment which I wish we had made a few years earlier. 
   My time is about up, but I would be interested. Do you think it is 
unseemly that we are going to be using a war supplemental to basically 
fund domestic activities here in the United States which basically 
could be characterized as pork? 
   Mr. ENGLAND. As you said, Senator, we are anxious that we fund the 
United States military. And what the Congress decides to fund other 
than that is, frankly, up to the Congress. But I would hope that none 
of that detracts from the needs of our men and women in uniform. 
   Senator GREGG. Thank you. 
   Chairman CONRAD. That is a very good answer. 
   There is a differing perspective on this. This is a supplemental 
appropriations bill. The vast majority of it is directed toward the war 
effort. There are urgent emergency situations that have to be addressed 

by the Congress. That is a reality. 
   Senator GREGG. Even accepting that there may be issues that are 
emergencies, it is very clear that there is a lot being thrown on this 
train that does not even have a scent of emergency. 
   Chairman CONRAD. Let me just say that I, behind the scenes I have 
joined you in that sentiment. And I have told colleagues that I do not 
believe anything should be put on here that is not a true emergency. 
Those things that are costs that were fully predictable have no 
business being in an emergency supplemental. I have the wounds to show 
the fight behind the scenes on that. 
   And I can tell you we so far have stopped some things that I think 
would have been very egregious. Now I cannot, at this moment, tell you 
we have won all of the battles. I doubt it. But there been some things 
that were proposed that had nothing to do with emergency. 
   And we still have ongoing fights on things that I do not consider 
emergency and I know you would not. 
   But be that as it may, Senator Allard. 
   Senator ALLARD. Thank you, Mr. Chairman. 
   I do want to touch briefly on the President's new strategy in Iraq. 
The question that I would like to put forward to you is has there been 
an immediate impact of security, positive or negative, in Baghdad since 
either the President's plan went public or increased American forces 
have begun to arrive? 
   Mr. ENGLAND. Senator, I would say speaking or just looking at the 
reports from the people on the ground, I think their assessment would 
be it is too early to draw any conclusions because this is still in the 
early stages. So there have been reports about less sectarian killings 
et cetera. But I think the assessments I have read is it is too early 
to draw any conclusions. 
   So your conclusion is that it is early but anecdotal evidence early 
on indicates that there is a difference in a positive way that is 
happening? That would be another way of phrasing your response that 
would be acceptable? 
   Mr. ENGLAND. I would say that is valid. Admiral, you are even closer 
to the military. I will let you comment. 
   Senator ALLARD. Do you want to comment, Admiral? 
   Admiral GIAMBASTIANI. Yes, sir. What I would say is, first of all, I 
would confirm exactly what the Deputy said. We do not like a week or 
two, if you will, just a week or two of statistics to indicate an 
overall trend because we have learned over long years of doing this-- 
   Senator ALLARD. I can understand that. 
   Admiral GIAMBASTIANI. However, we do see sectarian killings are down 
right now and that is substantial. We hope that that trend continues. 
But it is not really a trend yet. So these are the early anecdotal 
pieces, the statistics we are looking at. 
   I talked to General Petraeus yesterday on this very issue, and he 
relayed that the sectarian killings are down. 
   One other potential bright spot--potential, I might mention--is that 
the sectarian migration from Baghdad, for example, and throughout the 
country is also down. 
   Senator ALLARD. That is encouraging. 
   Admiral GIAMBASTIANI. So those two things are a little bit of a 
bright light. 
   Senator ALLARD. Which means they are more comfortable at home. 
   Admiral GIAMBASTIANI. Yes, sir, but too early to tell. 
   Senator ALLARD. Yes, I understand. 
   Another aspect of the renewed initiative is more flexibility for our 
troops when they are combating outside forces that provide advanced 
weaponry and training to our enemies in Iraq. What about those impacts? 
   Admiral GIAMBASTIANI. I did not quite understand your question. 
   Senator ALLARD. As I understand it, part of the President's new plan 
includes flexibility on outside sources of weapons coming in. Those 
soldiers have more flexibility in addressing those individuals when 
they come in contact with them. Has this had an immediate--has this had, 
again anecdotally at least, has it provided any positive or negative 
impact as far as advanced weaponry or training? 
   Admiral GIAMBASTIANI. What I would tell you is as far as what is 
coming in from outside, I think it is public that we have actually had 
some raids recently where we have picked up materials. But I do not 
think we can tell you what the overall effect is on the level of 
violence. 
   I will tell you though, separate from what may be moving across the 
borders, we have, in fact, found a couple of the significant caches of 
improvised explosive device material here over the last 2 weeks. Once 
again, General Petraeus was mentioning these to me. We are very pleased 
that these were bomb factories that were in and around the Baghdad 
area, and finding large caches of these types of things, particularly 
the more advanced ones, is very important to stopping violence and 
obviously causing casualties to not only coalition forces, United 
States forces, but also to the civilians there. 
   Senator ALLARD. DOD's Selective Acquisition Report, commonly 
referred to as SAR, is one of the tools--some say the best tool--for 
understanding the future budget consequences of present and past 
decisions. Now SAR measures the total acquisition of costs of major 
weapons systems. 
   In September of 2001, they come up with an aggregate cost. And then 
4 years later in 2005 they come up with another aggregate cost. I have 
those coming up. And the cost doubled in the 4-year period there. 
   Are we going to have some serious affordability problems when these 
developmental system such as future combat system, the Joint Strike 
Fighter and the DD-21 hit full production a few years from now? 
   Mr. ENGLAND. Senator, I would tell you we have issues today. 
Frankly, most of our equipment we buy at very, very low rates. And we 
buy them at low rates because that is the rates we can afford. But when 
you buy them at low rates, they cost you more. 
   We are in this cycle frankly, of-- 
   Senator ALLARD. They cost you more because you extend out the 
program? Is that what you're saying? 
   Mr. ENGLAND. Yes. And obviously a car a year, if you built it, is 
not like if you built a million cars a year. So whenever the rate is 
low, the cost per unit is higher for us. 
   So we are generally, across all of our equipment, we are at very low 
rates.  And when we need to adjust, what we do is we stretch the 
program. So cost goes up but that year the cost goes down. 
   Although we have managed to increase--since President Bush, we have 
gone from, I believe, $40 billion to $100 billion a year in 
procurement. This year it is $101 billion. But you know, for a long 
time, in the 1990's, we did not buy much equipment. So a lot of that 
equipment hasten very old. So if you look at a lot of our assets now, 
particularly Air Force assets but also even some of our submarine fleet 
is 18 years old now. A lot of those assets are aging. 
   Right now, for example, this year we have put out the tanker program 
RFPs, but our tankers are already well over 30 years old. And by the 
time we replace them, I mean some of them will be 50 or 60 years old. 
So yes, it will be an issue in the future and it is an issue today, 
frankly. We keep trying to increase rates but costs go up about as fast 
as our budget. 
   Senator ALLARD. And particularly the equipment that we have in the 
dry, sandy environment in Afghanistan and Iraq. That equipment wears 
out much quicker because of the hostile environment with the sand and 
everything it has to operate in. And when you put this off, it tends to 
snowball at the end. And that is some of the concern that I am trying 
to express here. 
   Mr. ENGLAND. And I appreciate it, Senator, because it is very 
important. In our budget and in these supplementals, of course, we have 
reconstitution money to replace that equipment. That was part of the 
discussion we had even on the airplanes. It is hugely important that we 
have the funds to repair and replace all of this war equipment. 
Otherwise, when this is over, we would leave literally a hollow 
military. So it is an obligation, I believe, both of the people in the 
DOD and the Congress and the American people, to make sure at the end 
of this war we did not have a hollow force. 
   So each year we put money in the budget to repair and replace the 
equipment that is being worn out, damaged or destroyed as we pursue 
this global war on terror. 
   Senator ALLARD. Ms. Jonas, do you have any comments in that regard? 
I noticed you were kind of nodding your head there. 
   Ms. JONAS. Well of course, as the Deputy said, on the reset piece we 
have about $13.9 billion in the supplemental for resetting and 
reconstituting. And in the GWOT request that we have in for 2008 we 
have another $37 billion. So that is very important to the Department. 
Senator ALLARD. Mr. Chairman, I see my time is expired. Do you want me 
to continue? No, go ahead. 
   [Laughter.] 
   Chairman CONRAD. If I could go to a separate question, we are 
considering, we have not yet reached conclusion, but I would like to 
have your thoughts on this. And I know that you are here as 
representatives of the Administration and so you have to support the 
Administration's budget request just as it is through the 5years. I am 
not asking you to contradict any of that. 
   We are considering using a CBO score on war cost. 
   Let me back up and say, first of all, we are thinking of putting in 
as a defense request the money the President has requested of the basic 
defense request. Then in terms of the war cost request, we are 
considering using a Congressional Budget Office estimate that over the 
5-years is actually $85 billion roughly over and above what the 
President has requested because, as you know, the President has no 
request past 2009. 
   But as part of that, the CBO estimate for the next year is slightly 
under, I think about $20 billion less than the President. The next year 
it is $25 billion more. The next year it is somewhere in that range, 
$25 billion more. So overall through the 5-years, it is actually $85 
billion above what the President has requested. 
   Senator ALLARD. Mr. Chairman, so the first year here in 2008, there 
is actually a reduction of $20 billion? And then you pick that 
difference up? 
   Chairman CONRAD. The next year you have $25 billion more. The next 
year you have some $25 billion more. And the next year-- 
   Senator ALLARD. But isn't the first year of the budget the most 
crucial aspect of the 5-year budget? I mean, that is the one that 
really speaks to what actual spending is going to be. And then the out 
years after that, that is just a matter of moving the figures around. 
   Chairman CONRAD. Well, you know, it is a 5-year budget. So every 
year the President has estimates of what the costs are. We have 
estimates. Over the time--and we will be scored for the whole 
expenditure. We will be scored as spending $85 billion more than the 
President. When they draw the lines, they will say we are $25 billion 
more. 
   We are in a situation where you have to have some basis for making 
these estimates. You get an estimate from the Department and the 
Administration. You get an estimate from CBO. We are trying to use some 
objective third party so that there is some merit to the number. 
   Would you have any comment on that? 
   Mr. ENGLAND. Mr. Chairman, first, I have not seen the CBO estimate. 
But again, even for fiscal year 2008, we literally took an extension of 
2007 because we did not know if 2008 is up or down. And if you do not 
know if it is up or down the safest thing to do is to just 
straight-line it. So that is what we did for 2008. 
   Chairman CONRAD. I understand how you arrived at it. That is why CBO 
has looked at your analysis and they have come up with a marginally 
different conclusion. 
   Mr. ENGLAND. But when they look out to 2009 and all that, I do not 
have any idea how they would project that because we do not know how to 
project it even a year ahead because it is a war and you do not know-- 
   Chairman CONRAD. But Mr. Secretary, to estimate that it is nothing, 
I mean that is what the President's budget is telling us, there is no 
cost. We are talking now about Iraq and Afghanistan. Saying there is no 
cost just strains credulity, frankly. 
   Mr. ENGLAND. I would expect certainly there is going to be some tail 
cost to all of this. When the war is over, we know there is a 
reconstitution cost, for example, which we have testified that even 
when the war is over there is equipment at the end that will have to be 
refurbished. So I am not sure what that rationale is. 
   I am not sure how you estimate it. It is not zero but I do not know 
what that number is, Senator. 
   Chairman CONRAD. I appreciate that. We do not know either. We are 
searching here for something that is credible and defensible and we 
have not reached conclusion on these matters. But we are trying to find 
some objective measure that has--at least appears to have some 
credibility attached to it. 
   Senator GREGG. Can I pick up on that point? 
   Chairman CONRAD. Sure. 
   Senator GREGG. If you assume that you are going to the answer to 
whether the surge worked or not by the middle of the summer, which was 
your statement, or a pretty good feel for what is going on, is it 
reasonable to assume that next year's supplemental war costs can be 
reduced by the amount of the surge costs because that number would be 
no longer needed? 
   Mr. ENGLAND. I would say, Mr. Gregg, by this summer, depending on 
what the situation is and what the projection is, at the time we would 
certainly update the estimates going forward for 2008. At this point, I 
do not know if that is up or down. But we would certainly know more. I 
think that is the general consensus, that by the middle of the summer 
we will know more. 
   Senator GREGG. What the chairman is saying is that they are reducing 
your straight-line projection by $20 billion for the year 2008. I do 
not know where they are taking that money and what they are doing with 
it. 
   But my question would be of that $20 billion, if the surge cost is 
$5.6 billion, that is your estimate--even though I not it is rather 
low--is it reasonable to assume that at least that amount could be 
reduced from the straight-line projection? 
   Mr. ENGLAND. Again, if the surge continues past 1 October, then 
there would be costs added for the surge because there is no surge cost 
past 1 October. So again, it would depend on what the circumstances are 
this summer. So it could go up or down. 
   Senator GREGG. Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you. 
   Senator NELSON. 
   Senator NELSON. Thank you, Mr. Chairman. 
   First of all, you have my commitment to support you and Senator 
Gregg as you all are trying to get your arms around this overall 
spending. If I may, since we have such esteemed leaders of our Defense 
establishment here, I would like to get into a couple of specific 
programs with your permission, Mr. Chairman. 
   Chairman CONRAD. Absolutely. 
   Senator NELSON. I feel compelled, on the basis of the commitment I 
made to the Marines in Western Iraq, to bring back and articulate on 
behalf of them their need to shift from a flat-bottomed vehicle to the 
V-bottom vehicle, what is called the MRAP vehicle. 
   Do you all have any direct knowledge that we are going to increase 
the production of these vehicles so that the Marines will be able to 
have them instead of the flat-bottomed vehicle? 
   And the Army seems to have a lack of interest in this V-bottom 
vehicle. Why? 
   Mr. ENGLAND. I do not think they have a lack of interest, probably 
not the same need. Now we have some V-bottom vehicles in Iraq today. We 
do have Buffalos, we have different vehicles. 
   The Army is typically in heavier vehicles than the Marine Corps. So 
with their Strykers and their tanks and everything else they have, I 
believe they have more protection today than the Marines. 
   So going forward, they do not have the same number. But they do have 
needs and they have articulated quantities of these vehicles, also. I 
do not have the exact number. They also have a need, but it is not as 
high as the Marine Corps just because the Marine Corps, it is a lighter 
vehicle in the past. So they have more of a need for this vehicle going 
forward, Senator. 
   Senator NELSON. Does the Army have everything other than the 
up-armored Humvee? 
   Admiral GIAMBASTIANI. Again, what the Deputy said is very important. 
If you take an Armored Cavalry Regiment, for example, if you take an 
armored unit there are very heavy on Bradley fighting vehicles, they 
are very heavy on M1 tanks. Our best armored vehicle out there is an M1 
tank. 
   We also have now a series of three going to a larger number of 
Stryker Brigade Combat teams. These are very effective, much more 
effective than up-armored Humvee vehicles. The problem with the Marine 
Corps is they only have one tank battalion for the entire Marine Corps. 
So they normally move in either one, Humvees; or two, they will move in 
amphibious assault vehicles. So their need for these types of, if you 
will, armored vehicles is greater than the Army's is. 
   The Army actually started the work on these and brought them in in 
their route clearance teams and populated their explosive ordnance 
disposal combat engineers. So there is a tremendous interest on both 
the Army and the Marine Corps part. The difference is that the Marines 
want to replace essentially most of their Humvees, which the Army does 
not transport by to the degree the Marine Corps does, percentage wise. 
   Senator NELSON. Right, but the Army does transport with up-armored 
Humvees? 
   Admiral GIAMBASTIANI. Yes, sir, they do. 
   Senator NELSON. So why wouldn't they want to move like the Marines 
do? 
   Admiral GIAMBASTIANI. They do want to and, in fact, we have a 
sizable request, as a matter of fact, in for these V-shaped hulls for 
both Army and Marine Corps in the current budget submission and 
supplementals. You will see those in there now. 
   Senator NELSON. On another subject, you all have been reading the 
daily chronicles of the Washington Post with this stuff that is going 
on out at Walter Reed. This is not the first time that I have heard of 
this, because I have heard of the lack of attention of medical care to 
our troops. 
   It was extraordinary the other day when the winner of the 
Congressional Medal of Honor, Senator Danny Inouye, told what it was 
like after World War II or during World War II, in his case when he 
lost his arm, that the military would not release them from active duty 
military until they had had all of the rehabilitation and all of the 
counseling and so forth so that they could cope with their wounds. 
   And that seems to be the opposite of what we are doing. We are 
releasing them and letting them fend for themselves, not even to speak 
of what the Washington Post is talking about in the deficiencies out at 
Walter Reed. 
   Your comments, Mr. Secretary? 
   Mr. ENGLAND. Senator, I guess it is sort of multifaceted here. 
First, there is an independent review group that the Secretary of 
Defense has put together to look at all aspects of this. And so that 
group is being stood up so we get an independent look at it. 
   Personally, I go out to Walter Reed regularly, and I think probably 
a lot of people in this room do. I meet a lot of the wounded people at 
ball games we take them to, and soccer games, and dinners almost every 
Friday night. Frankly, the people I meet, we ask every single person 
how are you doing? How about the parents? How is your spouse? How are 
the kids? And if we hear about a problem, we fix it for them. 
   Look, I do not believe this is widespread. The people that I talk to 
specifically, and they are pretty straightforward because they come to 
tell me--I ask them. And I can fix things for them, so they are pretty 
forthright about it. 
   I believe we give the best treatment in the world to our men and 
women in uniform. But frankly, it sounds like some have fallen through 
the cracks. We will know more with this independent review team. 
   I can tell you, it is the full intent and the dedication of every 
single person in the Department of Defense to provide them the very 
best care we can. I know that goes for the VA also. And we work 
extraordinarily hard to do that. 
   The Secretary of Defense has also said that he holds people 
accountable because we do have a standard of care for people who serve 
in our military. So he has a standard of accountability. And I can tell 
you, this is very serious for us because it underlines, I mean the 
people we serve knowing that we care for them is fundamental to 
everything. 
   Senator NELSON. Do we muster them out and then turn them over to the 
VA, unlike what Senator Inouye said in World War II, that they would 
not release them until they had rehabilitated them? 
   Mr. ENGLAND. I think a lot of people--just about everybody there are 
still active military. Occasionally, I will have someone that will come 
to me asking for a special--can we look into maybe keeping them a few 
more months for some reason. But a lot of these folks are with us for a 
couple of years after their injuries. 
   Of course, a lot of them we keep back in the military. They come 
back and serve because we have roles in the military they can continue 
to serve. Some of these great Americans--I was just with someone last 
Friday night back in jump school who lost his leg back in jump school. 
We have a number of people like that who lost limbs and are still 
serving. 
   So my view is the vast, vast majority of people we treat 
extraordinarily well because we work at it very hard. But it is pretty 
obvious that it has not worked 100 percent of the time. We are going to 
understand why. We have a review group to look into that. And we will 
do whatever and anything it takes to make this absolutely perfect. 
   Senator ALLARD. Senator Nelson, may I followup on your line of 
questioning if it's OK with the Chairman? 
   Chairman CONRAD. It is really on Senator Menendez. 
   Senator ALLARD. I do not plan on taking much time. 
   Are we expanding Bethesda Medical Complex out there to begin to take 
the soldiers and everything that were going to Walter Reed? 
   Mr. ENGLAND. Yes, Senator. As part of BRAC we decided rather than 
having two separate medical facilities in the Washington, 
D.C. area, we would have one literally world class facility and that 
would be Bethesda-Walter Reed. 
   Senator ALLARD. Because I saw that a lot of infrastructure at Walter 
Reed looked like they were in pretty bad shape. But we are building a 
new facility then? 
   Mr. ENGLAND. Yes, we are. We will have a whole new facility at--we 
will have the current facility plus other facilities expanded, our 
medical school. It is right there. The National Institutes of Health is 
right nearby. So the whole plan was to have a complex new, modern, with 
our very best capability at one place, rather than dividing it between 
the two locations. 
   Chairman CONRAD. Senator Menendez. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   Mr. Secretary, I want to go--I understood there was some discussion 
here before. But I want to return to the costs of the escalation of the 
war, where the Administration has asked for $5.6 billion. 
   If the Chairman were to put you under oath, would you say that that 
is the total cost of the escalation? 
   Mr. ENGLAND. Yes, I would. I would have one proviso. I would say 
that it is a war we are in. So things are going to change on the 
ground. 
   Earlier, we said the commanders have asked for some additional 
support personnel and things, and that is being evaluated by the 
Chairman's office today. So there will constantly be some variation in 
this. But that is very close. That was the best estimate at the time. 
   Senator MENENDEZ. How is it that the CBO comes here before the 
committee and says that they have a really different sense of what you 
need in support troops, based upon your own standards? And we are being 
told, I understand your earlier testimony here is that you only need a 
couple of thousand. What is the total amount of support troops that you 
are going to need for the escalation? 
   Mr. ENGLAND. The Admiral testified just earlier that if you were 
doing this from scratch, you would need more support troops. But we are 
not doing it from scratch. We have a lot of support troops already 
in-country, deployed in-country. So there is a benefit, in a sense, of 
having already deployed forces-- 
   Senator MENENDEZ. My question is how many will you need in addition 
to, for purposes of this escalation? What is the total number? 
   Mr. ENGLAND. It is going to be in the several thousands category, so 
we have some estimated. The Secretary said 10 to 15 percent added to 
the 21,000. 
   There has also been requests now-- 
   Senator MENENDEZ. So are you talking about 3,000? Are you talking 
about 5,000? What are we talking about? 
   How do you ask us to budget in the blind? How do you ask us to 
provide moneys you in the blind? You must have some sense of what the 
support troops that you will need to backup your escalation. 
   Mr. ENGLAND. So the answer, Senator, is 10 to 15 percent is what the 
Secretary of Defense has estimated of the 21,000, so that is somewhere 
around 3,000. 
   Senator MENENDEZ. That is the total amount of support troops you 
think you are going to need for this escalation? 
   Mr. ENGLAND. And in addition, General Petraeus on the ground has 
identified some additional needs, in terms of people. That, I believe, 
is on the order of 3,000 to 4,000. And that is currently being 
evaluated by the Chairman's office. 
   Senator MENENDEZ. So if that were to be accepted, then we are 
talking about anywhere between 6,000 and 7,000? 
   Mr. ENGLAND. That is correct. 
   Senator MENENDEZ. In your request to the Congress for the $5.6 
billion, do you include the 6,000 to 7,000 additional support 
personnel? 
   Mr. ENGLAND. In terms of the funding, our judgment is that that will 
fit within the funding we have requested. Our funding is not just $5.6 
billion. It is our defense budget to conduct the war. So we conduct the 
work. We do not tag people to fit $5.6 billion. We conduct the war. 
That is a delta cost of the war. 
   So within the total costs--I mean, obviously some things change. 
Some things are plus, some things are minus. Within this cost estimate, 
our best judgment is we can handle whatever those costs are for 
whatever the support costs are-- 
   Senator MENENDEZ. You mean within your overall request, beyond the 
escalation? 
   Mr. ENGLAND. Again, because this is a war cost--I mean, we do not 
differentiate the dollars. 
   Senator MENENDEZ. I know, Mr. Secretary, it is a war cost. But the 
reality is you do not have a blank check from us. I hope you do not 
expect a blank check from us. It is tough enough to look at the budget 
and try to figure out what you want to moneys for. I know money is 
fungible, but at some point you just cannot have an endless pot without 
justification. 
   Mr. ENGLAND. We provide you, Senator, 35,000 pages of backup for our 
request. 
   Senator MENENDEZ. That is why the CBO said that they had to go 
through extraordinary efforts just to determine what, in fact, you were 
asking for, what purposes. 
   Let me just say, I do not believe, for the life of me, that $5.6 
billion is going to be enough. Are you going to come back for a 
supplemental? 
   Mr. ENGLAND. A supplemental? 
   Senator MENENDEZ. Yes. Are you going to come back for a supplemental 
in 2008? In addition to your overall request, not only for the 
escalation but all your other requests. You are going to come back for 
a supplemental? 
   Mr. ENGLAND. In 2008 there is a GWOT request in now, in addition to 
the base budget. So there is $141 billion, as I recall, which is the 
GWOT costs, our best estimate of what the 2008 cost of the war will be 
based on our 2007 expenditures. 
   So there is already submitted to the Congress a $141 billion request 
for fiscal year 2008 that is not part of the base budget--this is a 
discussion we had earlier--which is a supplemental. 
   Senator MENENDEZ. Mr. Chairman, I do not know if you are having a 
second round or if I can pursue this. I see my time is--I am sorry-- 
   Mr. Chairman, I do not know if we are having a second round or if I 
can just pursue a little longer? 
   Chairman CONRAD. No, you can go. We have allowed others to go 
further. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   Mr. Secretary, let me just get one more thing on this. So now you 
have support troops in the field, but they are supporting present 
missions. Are you saying that your standards--maybe the Admiral can 
respond to this--that the same standards that the Department of Defense 
has about the X number of personnel to support active combat personnel 
is going to be diminished? That you are going to have less than your 
normal standards? 
   Admiral GIAMBASTIANI. If I could help to answer that for you, 
Senator, first of all with regard to the support personnel necessary. 
One of the comments I had made earlier, before your entry, was that we 
are operating on an established series of logistics bases, and in 
particular, around the Baghdad area where the plus-up is going. So we 
already have a substantial logistics combat service and service support 
establishment there. 
   So when we bring in additional troops we can accommodate some level 
of them with the already existing support troops, which is why when CBO 
would estimate--I did not look at their estimate. But I believe they 
did it using the standard metrics for an unestablished or a new base of 
operations, where you would need a substantial number of support 
troops. Which is why our estimates are lower. 
   The second thing is that they estimated through fiscal year 2009. We 
have only estimated the cost through the end of this fiscal year, which 
I know you know. That is that $5.6 billion. 
   Senator MENENDEZ. So then if one is to believe that the escalation 
continues beyond, your cost will be greater, obviously. 
   Admiral GIAMBASTIANI. I think one would have to say yes. 
   Senator MENENDEZ. Let me just turn to one other question and then I 
will stop. 
   Mr. Secretary, I met with the Special Inspector General for Iraq 
Reconstruction. The Administration comes before the Congress and asks 
for all this money. I have a real problem when the Special Inspector 
has told Congress that 15 percent of all of the money that the United 
States has spent on Iraq Reconstruction has been wasted, and that they 
are investigating cases of potential criminal activity. 
   I have a real concern when we spend $43 million for a residential 
camp for police training personnel that is never used, when we spend $4 
million on 20 VIP trailers and an Olympic-sized pool not authorized by 
us. I have a real problem when the Inspector General found that the 
government may have spent $36 million on weapons and equipment that 
they cannot account for. I have a real problem when we take $4 billion 
into Baghdad on giant pallets aboard military planes and cannot account 
for a good amount of it. 
   How do you expect us to continue to give you an open check with such 
incredible waste, fraud and abuse? 
   Mr. ENGLAND. Senator, I also meet with Stu Bowen regularly. 
   Senator MENENDEZ. Do you hear the same things that I hear from him? 
   Mr. ENGLAND. No, I do not. 
   Senator MENENDEZ. You do not? 
   Mr. ENGLAND. I read all the reports. I have read all of the reports, 
Senator. I have actually read all the--seen all of the pictures, talk 
to him regularly. 
   I do not think he said it was 15 percent. I think he said he did not 
know what it was. But without doing an analysis, if he just had to 
guess, he would guess it would be 10 to 15 percent. But he actually did 
not know. 
   But there is obviously some level, I mean it is a war. So there are 
some things that obviously do not work out. I mean, some of the 
buildings-- 
   Senator MENENDEZ. Mr. Secretary, I hate to interrupt you, but is 
that an excuse for everything? 
   Mr. ENGLAND. It is not an excuse at all. 
   Senator MENENDEZ. I understand war has its exigencies and unexpected 
circumstances. But that is also not an excuse. Every time we ask the 
Administration, the answer is we are in a wary. But even some things 
are clearly definable. There are control mechanisms to be had to make 
sure that we do not have waste, fraud and abuse. 
   Saying that we are simply in a war is not acceptable. 
   Mr. ENGLAND. He is part of the control mechanism, so that is part of 
what the IG does is uncover issues so we can go fix them. We work at 
those. And so whenever we find a problem, we do work those problems. It 
is not an excuse. It is a just a fact of the environment where they 
are. 
  Where there is waste or fraud, we obviously work that. There are 
people who do egregious things, just like they do in the civilian 
world. There are people who take advantage of circumstances. And 
fortunately a number of them have been caught and convicted, and I 
applaud that. That is exactly what should happen. 
   So we do not have perfect people, like no other organization does. 
But we do have systems in place like the IG. That is the purpose is to 
uncover those problems so they can be fixed. So we work closely with 
the IG. 
   Senator MENENDEZ. My final comment, and then I will cease. It is not 
whether we have perfect people, Mr. Secretary. We know we do not have 
perfect people in the world. It is not whether--the IG should not be 
the vehicle by which we--that is the after fact. 
   It is the Department of Defense that needs to have control 
mechanisms to ensure that the taxpayers' money that we give to you is 
ultimately spent in the most efficient way, both for our people who 
serve us in protecting them and meeting their mission, and also in 
terms of these other elements that the administration has asked for. 
   To say that the Inspector General is part of that control mechanism, 
that is the after fact. He finds out what went wrong. The question is 
what mechanisms does the Department have. And I think the Department 
does not seem to feel that they need to have mechanisms. 
   Mr. ENGLAND. Last year we conducted 35,000 audits, Senator. So we 
have a lot of controls in place. But again, not everything is perfect 
and we appreciate the efforts of the IG. 
   Senator MENENDEZ. Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator. I feel the need to set the 
record straight on a couple of things. 
   In terms of the CBO estimates, the CBO estimates were based on 
experience in Iraq, not just in other places but in Iraq, and 
specifically on the surge in 2005. And when we look at total troops, 
ground forces in-theater, and the number of combat brigades and the 
number of troops per combat brigade, the lowest number of troops per 
combat brigade was back on December 31st of 2004. That was the lowest 
since 2003, and it was 8,300. 
   That would equate to a total of over 40,000 troops for the surge. 
This is the basis for CBO's estimate. It is based on previous 
experience in Iraq. 
   Let me go to the Washington Post story and Walter Reed, because I 
watched the Secretary. I thought his response was exactly right. I 
thought he was personally angered and offended by what was occurring 
there. And he is right to be. 
   I think we have to differentiate. What is happening in combat is the 
best medical care in the history of warfare. That is the record. It is 
remarkable what an exceptional job the American military is doing of 
providing medical care in combat. So that needs to be laid out there 
and stated, because it is a fact. 
   Second, when they come home and they are going through medical 
treatment directly at Walter Reed and Bethesda, that is excellent care. 
Many Members of Congress get their care from those same caregivers. And 
I think all of us would acknowledge their excellence and their 
incredible dedication. 
   We also know as a fact that there are serious problems with those 
who are outpatients especially, and those who have need for specialty 
care and delays in getting appointments. 
   The Washington Post story, let me just refer to it. You have all 
read it. Ever member of this panel has read it. They talk about how the 
wounded can wait for weeks with no help from staff to arrange 
treatment. 
   Now these are typically people who are either outpatient or who are 
in these auxiliary facilities. 
   Recuperating soldiers are asked to manage and guard other soldiers.   
Caseworkers are untrained and there are not enough of them. Lost 
paperwork and bureaucratic delays are common. 
   Look, I have had a fair number of soldiers wounded from my home 
State. We have found a lot of bureaucratic delays, a lot of things that 
should not happen. And that has to be addressed. 
   Can you tell us, Mr. Secretary, what is being done to address that? 
   Mr. ENGLAND. Senator, first of all, there are a lot of things being 
done immediately on-scene. But I believe the most important thing is 
this independent review team that the Secretary has put together to 
report back to him, to look broadly at this whole issue, to make sure 
that we are doing it right. We actually want people from the outside, 
but with some familiarity, to come in and critique the system. So we 
have asked people to do that. I believe that is the most valuable 
thing, so that we can fix whatever the systemic problems are. 
   Frankly, it is not difficult to go fix a room or whatever that is 
not right. All those things are being done. I think more attention 
immediately is being taken at Walter Reed. 
   But the question is do we have a systemic issue? And so this 
independent review team will examine that. 
   I will tell you the Secretary, as you rightly observed, is pretty 
much outraged, as we all are. So we take this extraordinarily serious. 
I mean, these soldiers are part of the family. These are people who we 
dearly love who serve in our military. They are family members for us 
and many of us know them as family members. So we are going to take 
whatever action we need to do. And that is anything we need to do. This 
is the most important job we have. 
   So whatever those issues are, they will be addressed systemically 
and fixed. 
   Chairman CONRAD. This is a story from this morning ''Hospital 
Officials Knew of Neglect: Complaints About Walter Reed Were Voiced For 
Years.'' 
   This is one of the most disturbing stories that I have read 
actually, out of this whole sad episode. I would hope that people who 
knew that there were very serious problems and did not act or did not 
sound a warning, that those people be held accountable. 
   Mr. ENGLAND. They absolutely will. The Secretary said that. This is 
a failure of leadership. And appropriate people will be held 
accountable. So that will definitely happen, Senator. 
   Chairman CONRAD. I appreciate that. It is important that it be done. 
   Senator LAUTENBERG. 
   Senator GREGG. Mr. Chairman, can I just ask, just as a technical 
point, the Chairman has now had 2 second rounds and I have not had a 
second round yet. And we have gone back to your side three times, prior 
to coming back to our side. 
   Chairman CONRAD. We would be happy to go to the Senator. 
   Senator GREGG. I know it is the minority being difficult again. 
   Chairman CONRAD. No, no. 
   Senator GREGG. 
   Senator GREGG. I am sorry. 
   Chairman CONRAD. I was trying to give people who have not had any 
rounds a round. 
   Senator GREGG. You are correct, and I appreciate that. 
   Senator LAUTENBERG. I want to defer. 
   Senator GREGG. No, I just wanted to make my point and then I will 
defer to the good Senator from New Jersey because he has not been here, 
and let him make his points. 
   Chairman CONRAD. You know, the way it works, and I know it worked 
this way when the ranking member was Chairman, when additional members 
come that have not had a round, we give them their round. 
   Senator LAUTENBERG. 
   Senator GREGG. I agree. We should have stopped your round. He was 
complaining as soon as he came. 
   [Laughter.] 
   Chairman CONRAD. Senator Lautenberg. 
   Senator LAUTENBERG. If it is urgent-- 
   Senator GREGG. No, please proceed. 
   Senator LAUTENBERG. I think mine are, not to make light of the 
subject here today at all. 
   There is so much heavy weight over the country and over the citizens 
in the country and we see it not just in the polls, but if you get out 
in the field and you talk to people. I do not care where you meet them 
or what their profession or what their economic standing is, they are 
worried about this war. They really are. 
   The last couple of nights we have seen the Woodruff experience--I do 
not know what the title of it is. But it demonstrates, more than one 
can imagine, the pain of war. 
   I served in World War II during the active war in Europe and I take 
pride in my service as a veteran. It was not heroic but it was steady, 
in terms of my work. 
   And so when I look, Admiral Giambastiani--[continuing in Italian.] 
   I wanted to ask about recruiting. What is the situation? What has it 
been like for the last couple of years, Admiral? 
   Admiral GIAMBASTIANI. With regard to recruiting across all of the 
services, frankly about 3 years ago we wound up having a problem inside 
the United States Army. This is just as we were increasing the overall 
levels within the Army, increasing through the supplemental by 30,000. 
So we had an in-strength for the Army of 482,400. We increased that, 
Congress allowed us to go up to an additional 30,000 at the request of 
the Administration. 
   During that time, over 3 years ago, when we first started moving up, 
we had difficulty meeting our new goals in the Army. However, I can 
tell you that for about the last year and a half all services have 
continued to meet their goals. 
   This month, for example, and the Army has continuously met their 
goals--I will take a look at it in just a second but I think it is 
about 15 or 16 months in a row. They were over 100 percent. The Navy is 
over 100 percent on the active component. The Air Force is over 100 
percent and the Marine Corps is. So all of the services are meeting 
their goals. 
   Now that does not mean it is not a tough recruiting environment, but 
we project that we will meet our goals throughout the rest of this 
fiscal year also, even though we have additional in-strength and 
additional recruiting coming on. We have authorized the Department, and 
the Secretary has authorized and requested an additional 5,000 Marines 
and an additional 7,000 soldiers for the Army per year. 
   Senator LAUTENBERG. Is the same true of the Reserve Corps? 
   Admiral GIAMBASTIANI. Now, on the Reserve component side, we had 
some difficulty also meeting our National Guard in-strengths however, 
and I am going to pull out my figures here while we are talking, we did 
make Army National Guard goals. Let me just get these numbers here and 
I will tell you exactly. 
   Army National Guard recruiting was 113 percent. Army Reserve, 
however, was just under, at 94 percent. United States Navy Reserve, but 
by request of the CNO, was a little under 90 percent. And then the 
other services made the Reserve components. 
   Senator LAUTENBERG. Thanks very much, Admiral. What did we have to 
do to meet those goals? Did we change our standards? 
   Admiral GIAMBASTIANI. I would tell you no, sir, we did not 
fundamentally change our standards. What we did is the first thing we 
did is put many more recruiters in the field, particularly in the Army 
and the Marine Corps. The Army had to put a lot more. 
   Have we changed and allowed some additional folks to come in? The 
answer is yes, but not in large numbers. Not in large numbers. 
   Senator LAUTENBERG. The time is short, so unfortunately I have to 
leave that subject. I am concerned about that. 
   Madam Secretary, is there any thought to increasing pay for 
hazardous or combat duty for our troops serving in Iraq and 
Afghanistan? I particularly look to those who are called up from the 
Reserve units, be it the Guard or the regular Reserves, where families 
left behind do not have the advantage of a base facility for medical or 
health care, and their tours of duty are much longer than ever, ever 
anticipated. 
   So is there any thought to making life a little bit easier for those 
who are serving in the combat theater, to pay extra bonuses for their 
service? 
   Ms. JONAS. Mr. Lautenberg, we appreciate the question. 
   The budget that we have before the Congress right now includes a 
substantial amount on both topics for recruiting and retention, about 
$4.3 billion. There is a specific consideration for providing--I 
believe it is $1,000--for Reservists who are extended beyond the time 
that they are supposed to serve. So that is a piece of it. 
   We are constantly working with the personnel and readiness community 
to make sure that we have appropriate bonuses and support for the 
families. 
   Senator LAUTENBERG. Mr. Chairman, can I have another-- 
   Chairman CONRAD. Yes, sir. 
   Senator LAUTENBERG. I really appreciate it. 
   The question that comes to my mind as we look to escalate and expand 
the number of people there, it is a shocking thing to look at. I was 
the first legislator to go to the Gulf War I theater and we had 540,000 
troops there. And now to be doing the job that our people are being 
asked to do--and they are doing it heroically and bravely and often at 
a disadvantage because of equipment delays. 
   I just wonder, if we do succeed despite greatly opposing opinion 
here and in the world outside of here, do we guarantee that the people 
that we are going to send there will have the latest in the equipment, 
everything that they need? Will the vehicles be armored sufficiently? 
Will the flak vests or body armor be the latest that is available? Will 
it be there at the moment of their arrival? 
   Admiral GIAMBASTIANI. Senator, I can assure you that anyone we send 
into combat to do any of this work will have the appropriate equipment, 
both body armor, armored vehicles, ammunition, food supplies, whatever 
it is. 
   Senator LAUTENBERG. That has not been our experience, Admiral, in 
all due respect. 
   Admiral GIAMBASTIANI. No, sir. I just want to come back to you for a 
second here. We will never have enough of everything as we change 
something new. Let me give you an example. 
   We have changed our body armor many times. But anybody who goes 
outside of what we call the wire, moves outside of our bases, and goes 
on operations, we give the front-line armor to, the frontline armored 
vehicles. 
   Now inside forward operating bases, for example, in Afghanistan and 
Iraq, we have unarmored vehicles, we have slightly armored vehicles, 
and they will operate on those. I have just been to Baghdad a couple of 
weeks ago. I was driving around in a Suburban. I did not wear my armor 
most of the time, and neither did any of the troops with me. But as 
soon as we went outside of the base, when we were flying in helicopters 
and the rest--and this is the same standard we apply to our troops 
across the board in the theater. As a member of the Joint Chiefs, I can 
assure you we do not let our folks go out and operate without the 
front-line equipment, period. 
   When I say there is not enough, there is not enough to equip every 
single individual with every single piece of whatever it is. And I 
suspect there never will be. 
   Mr. ENGLAND. If I can comment, Senator, I mean part of what we do is 
to keep upgrading. We keep adjusting to the threats. So, for example, 
we started this war we had 700 armored vehicles. We have built 43,000. 
But now we have another new model which is better. 
   So if you go to Iraq today there are handfuls of the latest vehicle. 
Everybody does not have those because obviously it takes some lead time 
to build them up. And finally we will build all those up. But I expect 
they will be replaced at some point. 
   So we have this constant turnover of the ''latest'' equipment. So at 
any given point in time, ''nobody'' has all the latest equipment 
because it is in manufacture because we are always going to the next, 
better model. 
   Admiral GIAMBASTIANI. And these budget submissions that we have made 
include many of these pieces of equipment and vehicles to upgrade so 
that we can continue to upgrade and supply our troops. 
   Senator LAUTENBERG. The Iraqi government sits on billions of dollars 
that it owns, however it got there. Why should we give any more money 
to their reconstruction when we have lots of requirements here that are 
some of them urgent, bridges obsolete and perhaps can collapse. 
   Why should we be giving those in Iraq more money for reconstruction 
when the Iraqi government is sitting on a fairly significant reserve? 
   Mr. ENGLAND. Senator, my understanding is they have somewhere 
between $12 billion and $15 billion in terms of their own reserves. But 
they are spending those reserves. They are spending them first to train 
their own forces and also to equip them and also to develop their oil 
and electricity and all of that. So there is just a lot of large needs 
in Iraq. And the dollars we spend there are very important. 
   Part of this whole effort, as you know, is not just military. It is 
economic and also political. But there is an economic side of this that 
is equally very important that we accomplish in conjunction with the 
military operation. 
   So we do augment Iraqi funds in this regard. So we do augment those 
funds, but they also spend their own funds for these-- 
   Senator LAUTENBERG. Has there been any diminution of their--I will 
call it that treasury or that reserve fund? Those reserve funds that 
they have? 
   Mr. ENGLAND. Their budget has been going up each year. I do know 
that. I am not sure of all of their income, et cetera. But they have, 
indeed, been spending more. I do not know if their reserves have 
changed or not, Senator. I will have to get back with you on that. 
   Senator LAUTENBERG. Admiral, and I will close with this, Mr. 
Chairman. 
   I am upset by the lack of knowledge. I mean here we have had this 
expose in newspapers across the country and television about the 
disregard for information that the leadership had. And to see these 
people being put in these humiliating, degrading facilities I think 
adds insult to injury. Admiral, for a long time now, it has been 
against the rules to permit photographs of caskets returned, flag 
covered in every instance, to be widely distributed, disseminated. 
   Now in front of my office, I am proud to say, that we have easels 
with lots of the pictures of those who have perished. It is up to date 
as quickly as we can get the pictures. And it has those who have fallen 
from every State in the country. And we have a journal that people 
write comments. They are touching. I read them all of the time. 
   That picture there brings pride to everybody who sees it. And I 
cannot, for the life of me, understand why when a coffin is there and 
it is another one of our bravest, why we cannot permit the photography 
of that occasion and that flag that says your country loved you and we 
regret so much that you have paid the price but we honor your 
sacrifice. 
   We all have seen it. When Nancy Reagan got the flag from President 
Ronald Reagan's coffin, she held it like a newborn child. I have seen 
that with mothers at the burials, wherever they took place, whether it 
is here or at home. 
   Can you explain that policy? 
   Admiral GIAMBASTIANI. I do not know the exact policy but let me just 
say to you, I do not think there is any issue with ever taking 
photography at funeral services, presentations of flags. 
   Senator LAUTENBERG. They cannot stop those, Admiral. 
   Admiral GIAMBASTIANI. I have seen many of those and I just see 
nothing. 
   I think the only restriction that I know of is a restriction when a 
military aircraft flies in a large number of coffins together, because 
we bring lots of troops back, dignitaries, other folks, and we put all 
kinds of cargo on them. Those are the only ones I know of when those 
coffins are being taken off. 
   But I will be happy to look into it. 
   Senator LAUTENBERG. I would appreciate it. 
   Admiral GIAMBASTIANI. I will just tell you that I grew up, like you, 
at the Naval Academy during Vietnam looking at pictures of every single 
one of the fallen and looking at their biographies, which classes they 
were in. I see this constantly in the military. I look at those tolls 
personally every single day. And we mourn every single loss of those 
folks and every single one of the wounded. 
   But I will look into it. I do not know, Gordon, if you had anything 
you wanted to add to that. 
   Mr. ENGLAND. I do not. 
   Senator LAUTENBERG. Thank you, very much. 
   Thank you, Mr. Chairman. 
   Chairman CONRAD. Thank you, Senator. 
   Senator GREGG. 
   Senator GREGG. I just wanted to pursue this one issue which I am not 
sure you are in a position to answer. But this question of how you rank 
the threat and what we should be developing in the military to address 
as a threat. In your statement, as I mentioned in my opening statement, 
you pointed to North Korea, Iran and China potentially in different 
ways as being the priority that we need to worry about. 
   My reaction was where is al Qaeda and where is the threat of a 
terrorist attack, a weapon of mass destruction, whether it was a 
nuclear or a biological weapon. 
   Physical military response to a terrorist event is maybe not the 
priority to stopping that event. The priority is to have intelligence 
on the event's potential occurrence and then being able to interdict 
the event before it occurs. 
   And how is the Defense Department approaching that? And are we 
thinking in those terms? Or are we truly thinking in the terms of 
nation-state opposition? 
   Mr. ENGLAND. Senator, if I could just try, first of all, we do try 
obviously to deter future adversaries, whoever they may be. So we do 
maintain a core capability, United States military and our Air Force 
and our Navy and in all of our forces, because it is obviously a lot 
cheaper to deter in terms of both lives and suffering and the Nation's 
wealth than it is to fight the war. 
   So we do invest in deterring, and that is a significant part of our 
procurement every year, and also of our training. 
   When it comes to al Qaeda and terrorists, obviously we have a 
significant cost of literally fighting them every day as part of this 
global war on terror. 
   But then here in the United States we do have Northern Command, 
which we stood up as a new combatant commander, Northern Command, who 
works hand-in-glove with the Department of Homeland Security. So that 
is the direct military support combatant commander here in the United 
States for combating terrorism. So we have an entire combatant 
commander dedicated to this function here in the United States of 
America. 
   And as you know, we obviously invest in our intel assets and our 
human--that is all a growing part, our Special Forces are all a growing 
part of our force as part of our global war on terrorism. A lot of that 
is in our base budget. 
   The QDR last year, we spent an entire year on this whole subject of 
making sure we had the right assets, the right sort of training, the 
right mix of forces. And we made significant changes across the entire 
United States military and Department of Defense. 
   So the QDR really outlines the analysis and the strategic approach 
going forward, including with our coalition partners and friends. 
Because there is a recognition in this war on terror that no single 
nation can prevail. This is about friends and allies because a lot of 
this is taking place obviously in other people's territory. So it does 
require this constant attention of the world community and that is a 
large part of the trust we had in our QDR. 
   So I believe that we have taken a balanced approach and a thoughtful 
approach in terms of how do we do this in the Department of Defense. 
   Admiral GIAMBASTIANI. If I could add to what the Deputy has said, 
your question is a very appropriate one. As Gordon said, we tried to 
address this in the Quadrennial Defense Review and we have written 
quite a bit about it. 
   Operating against nation-states and operating against these 
terrorist entities is a very different ball game. As you well know, 
they do not operate by United Nations conventions, Security Council 
resolutions, the Geneva Convention, or those types of things that 
nation-states recognize. 
   For example, just a simple thing, I carry an identification card 
that says it is a Geneva Convention ID card. None of these folks do. I 
wear a uniform, and the 2.4 million Americans who are members of the 
armed forces wear uniforms. These folks do not. 
   We have designated this as irregular warfare which is why, as the 
Deputy mentioned, we are increasing, for example, the size of our 
Special Operations forces. Just in the budgets we have submitted to you 
there is about 6,000 Special Forces and Special Operations forces that 
are included in this. 
   Also, between nation-states there is varying degrees of 
transparency. We put out public budgets. Other people do not. Al Qaeda 
does not, for example, and many of these other outfits. So this is a 
very different world we are moving into, operating with these very 
shadowy groups that operate across borders, that do not recognize those 
types of conventions. 
   Senator GREGG. I appreciate that answer and it is really a topic for 
a much broader discussion. But I guess my concern is the emphasis and 
whether we are effectively--I see this threat as being the most present 
and immediate threat, the use of a weapon to mass destruction on 
American soil by a terrorist group, which is probably Islamic 
fundamentalist driven. 
   Mr. ENGLAND. Senator, we do prioritize in the Department, what we 
call war plans. Obviously, I cannot go into detail. But I will tell you 
the No. 1 priority in the Department of Defense is combating terrorism, 
al Qaeda and other groups like al Qaeda. So that is the No. 1 priority. 
And we fund those efforts. Those funding requests have priority within 
the Department of Defense. 
   We do not deny funding or anything for areas where its focused on 
the global war in terror. That is our No. 1 funding priority in the 
Department of Defense. 
   Senator GREGG. I appreciate all of the time you have given us this 
morning. 
   Thank you again for your service. 
   Chairman CONRAD. Would you like another round? 
   Senator GREGG. I think I am owed three or four. Put them on account. 
   [Laughter.] 
   Chairman CONRAD. First of all, thank you very much for being here. 
We appreciate it. We appreciate all of your service for the country. 
   You know, one of the great things about a democracy is we can 
disagree without, I hope, having to be disagreeable. On a question of 
disagreement, I hope you will take back this committee is not buying 
the estimate on the surge. We thought the CBO testimony was very 
credible. No estimate is going to be exactly right. We understand that. 
It is especially difficult in a war. We understand that. 
   Our obligation, I hope you understand, is to try to give the best 
possible estimate to our colleagues. It is extremely difficult over an 
extended period. And we are just trying to do a credible job. 
   I can tell you, whether we are on the defense budget, we are going 
to provide in the resolution that I present to our colleagues, we are 
going to provide every dime that is in the President's defense budget. 
We are going to provide, on the question of funding of the war, we are 
going to provide actually more funding because we think the President's 
budget has understated the war cost over the 5-year period. 
   And we await tomorrow's re-estimate from the Congressional Budget 
Office before we finalize our budget. That is the last step before we 
make final determinations. 
   So with that, again, we thank you for coming and we appreciate your 
service. 
   Mr. ENGLAND. Mr. Chairman, thank you for your professionalism. Thank 
you especially for recognizing this need for the supplemental. Moving 
that along is hugely important to our men and women in uniform and I 
appreciate your personal efforts there. 
   Chairman CONRAD. We will get that job done. 
   Thank you. 
   [Whereupon, at 11:54 a.m., the committee was adjourned.] 


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